New Information in 2006 LOS - Bullets
LOS 3-1-C-b
Interpret the p-values for regression coefficients;
Many software programs also report p-values for the regression coefficients. For each regression coefficient, the p-values would be the smallest level of significance at which we can reject a null hypothesis that the population value of the coefficient is 0, in a two-sided test. The lower the p-value, the stronger the evidence against that null hypothesis. A p-value quickly allows us to determine if an independent variable is significant at a conventional significance level such as 0.05, or any other standard we believe is appropriate.
LOS 4-3-A-b
distinguish between spot and forward transactions and calculate the annualized forward premium/discount for a given currency and infer whether the currency is 'strong' or 'weak';
International Investments Page 15
Given an exachange rate of x/y, the annualized forward premium on y =
((Forward Rate - Spot Rate)/Spot Rate)* (12 / No. Months Forward) * 100%
of course, the annualized forward premium on x can be found by taking the spot rate minus the forward rate on this equation.
For all currencies except the euro and British pound, a positive premium indicates that currency on the line is "strong" relative to the dollar because the rates quoted are the currency price of one dollar, e.g. SFr/$. Because the euro and the pound are quoted as the dollar value of one euro or one pound, a premium for these two lines indicates that the currency is "weak" relative to the dollar, while a discount (a negative premium) indicates that currency is "strong".
LOS 5-1-D-a
estimate the effects of changing interest rates on the market value of debt and on financial statements and ratios;
covered in book 3, page 66 of the note. Need further explanation
LOS 5-1-D-b
analyze the impact of debt covenants on a company's financial statements and ratios;
covered in book 3, page 66 of the note. Need further explanation
LOS 8-1-B-b
explain the effect on shareholders of the adoption of investment opportunities with 1) zero net present values and 2) positive net present values;
1. no change 2. higher? seems nothing special here.
LOS 9-2-g
explain the relationship between a firm's optimal capital structure and the firm''s 1) weighted average cost of capital and 2) stock price;
The optimal capital structure is the one that maximizes the price of the firm's stock (and minimize the WACC), and this generally calls for a debt ratio which is lower than the one that maximizes expected EPS.
Even though raise the debt ratio raises EPS, the higher EPS is more than offset by the corresponding increase in risk.
LOS 10-2-B-g
discuss franchise value and the growth process and calculate and interpret a company's tangible P/E value, franchise factor, growth factor, and franchise P/E value;
the intrinsic P/E can be calculated directly by (1-b)/(r-g). It can also be broken down into the non-growth factor and growth factor.
Tangible P/E = 1/r
Franchise P/E = FF * G franchise factor and growth factor
FF = (ROE-r)/(ROE*r) or 1/r - 1/ROE
G = g/(r-g) where g = b*ROE
LOS 14-1-A-d
evaluate the capacity of an issuer of a corporate bond to pay interest and repay principal, given such data as key financial ratios for the issuer and the industry;
1. Profitability Ratios
return on stockholder's equity
return on total assets
profit margin
asset turnovers
2. Debt and Coverage Analysis
A. Short-term solvency ratios
- Current Ratio
- Acide Ratio (i.e. quick ratio)
B. Capitalization Ratio
- Long-term debt to capitalization (debt + equity)
- total debt to capitalization
C. Coverage ratios
- EBIT interest coverage ratio
- EBITDA interest coverage ratio
- funds from operations/total debt ratio
- free operating cash flow/total debt ratio
LOS 14-1-B-d
explain the swap rate curve (LIBOR curve) and discuss the reasons that market participants have increasingly used the swap rate curve as a benchmark rather than a government bond yield curve.
Fixed Income Analysis Page 265-267
LOS 14-1-C-a
state the importance of using an arbitrage-free value when valuing a bond, and describe the methodology to ensure that an arbitrage-free value is being used;
Fixed Income Analysis Page 294, 312
LOS 14-1-C-b
explain the importance of the benchmark interest rates in interpreting spread measures;
Fixed Income Analysis Page 297
LOS 14-1-C-c
explain the purpose of relative value analysis and determine, given an appropriate benchmark, whether a security is undervalued of overvalued;
Fixed Income Analysis Page 297
LOS 15-1-B-b
explain prepayment tranching and credit tranching;
Fixed Income Analysis Page 407
LOS 15-1-B-e
describe the cash flow and prepayment characterstics for securities backed by home equity loans, manufactured housing loans, automobile loans, student loans, SBA loans and credit card receivables; (auto and credit card were covered in 2005)
Fixed Income Analysis Page 414-418, 420-425
LOS 15-1-B-f
compare and contrast the residential MBS issued in the UK and in Australia
Fixed Income Analysis Page 418-420
LOS 15-1-B-g
describe a collaterized debt obligation (CDO) and the different types (cash and synthetic);
Fixed Income Analysis Page 426
LOS 15-1-C-a
discuss the computation, use and the limitations of ... nominal spread and zero volatitity spread for a mortgage backed security and an asset backed security;
Fixed Income Analysis Page 449-450
LOS 15-1-C-d
discuss path dependency in passthrough securities and the implications for valution models;
The concept is very vague here. Fixed Income Analysis Page 457-462
LOS 17-2-a
characterize the change in the value of an interest rate swap for each counterparty when interest rate change;
LOS 17-2-b
compare the position of 1) the counterparties in an interest rate swap to be counterparties in an interest rate futures, and 2) the counterparties in an interest rate swap to the counterparties in a floating rate bond purchased by borrowing on a fixed-rate basis;
LOS 17-2-c
demonstrate how both a cap and a floor are packages of 1) options on interest rates, and 2) options on fixed income instruments;
LOS 18-2-f
discuss the reason ethical conduct is a requirement for managing investment portfolios;
Candidate reading, book 2, page 363
Interpret the p-values for regression coefficients;
Many software programs also report p-values for the regression coefficients. For each regression coefficient, the p-values would be the smallest level of significance at which we can reject a null hypothesis that the population value of the coefficient is 0, in a two-sided test. The lower the p-value, the stronger the evidence against that null hypothesis. A p-value quickly allows us to determine if an independent variable is significant at a conventional significance level such as 0.05, or any other standard we believe is appropriate.
LOS 4-3-A-b
distinguish between spot and forward transactions and calculate the annualized forward premium/discount for a given currency and infer whether the currency is 'strong' or 'weak';
International Investments Page 15
Given an exachange rate of x/y, the annualized forward premium on y =
((Forward Rate - Spot Rate)/Spot Rate)* (12 / No. Months Forward) * 100%
of course, the annualized forward premium on x can be found by taking the spot rate minus the forward rate on this equation.
For all currencies except the euro and British pound, a positive premium indicates that currency on the line is "strong" relative to the dollar because the rates quoted are the currency price of one dollar, e.g. SFr/$. Because the euro and the pound are quoted as the dollar value of one euro or one pound, a premium for these two lines indicates that the currency is "weak" relative to the dollar, while a discount (a negative premium) indicates that currency is "strong".
LOS 5-1-D-a
estimate the effects of changing interest rates on the market value of debt and on financial statements and ratios;
covered in book 3, page 66 of the note. Need further explanation
LOS 5-1-D-b
analyze the impact of debt covenants on a company's financial statements and ratios;
covered in book 3, page 66 of the note. Need further explanation
LOS 8-1-B-b
explain the effect on shareholders of the adoption of investment opportunities with 1) zero net present values and 2) positive net present values;
1. no change 2. higher? seems nothing special here.
LOS 9-2-g
explain the relationship between a firm's optimal capital structure and the firm''s 1) weighted average cost of capital and 2) stock price;
The optimal capital structure is the one that maximizes the price of the firm's stock (and minimize the WACC), and this generally calls for a debt ratio which is lower than the one that maximizes expected EPS.
Even though raise the debt ratio raises EPS, the higher EPS is more than offset by the corresponding increase in risk.
LOS 10-2-B-g
discuss franchise value and the growth process and calculate and interpret a company's tangible P/E value, franchise factor, growth factor, and franchise P/E value;
the intrinsic P/E can be calculated directly by (1-b)/(r-g). It can also be broken down into the non-growth factor and growth factor.
Tangible P/E = 1/r
Franchise P/E = FF * G franchise factor and growth factor
FF = (ROE-r)/(ROE*r) or 1/r - 1/ROE
G = g/(r-g) where g = b*ROE
LOS 14-1-A-d
evaluate the capacity of an issuer of a corporate bond to pay interest and repay principal, given such data as key financial ratios for the issuer and the industry;
1. Profitability Ratios
return on stockholder's equity
return on total assets
profit margin
asset turnovers
2. Debt and Coverage Analysis
A. Short-term solvency ratios
- Current Ratio
- Acide Ratio (i.e. quick ratio)
B. Capitalization Ratio
- Long-term debt to capitalization (debt + equity)
- total debt to capitalization
C. Coverage ratios
- EBIT interest coverage ratio
- EBITDA interest coverage ratio
- funds from operations/total debt ratio
- free operating cash flow/total debt ratio
LOS 14-1-B-d
explain the swap rate curve (LIBOR curve) and discuss the reasons that market participants have increasingly used the swap rate curve as a benchmark rather than a government bond yield curve.
Fixed Income Analysis Page 265-267
LOS 14-1-C-a
state the importance of using an arbitrage-free value when valuing a bond, and describe the methodology to ensure that an arbitrage-free value is being used;
Fixed Income Analysis Page 294, 312
LOS 14-1-C-b
explain the importance of the benchmark interest rates in interpreting spread measures;
Fixed Income Analysis Page 297
LOS 14-1-C-c
explain the purpose of relative value analysis and determine, given an appropriate benchmark, whether a security is undervalued of overvalued;
Fixed Income Analysis Page 297
LOS 15-1-B-b
explain prepayment tranching and credit tranching;
Fixed Income Analysis Page 407
LOS 15-1-B-e
describe the cash flow and prepayment characterstics for securities backed by home equity loans, manufactured housing loans, automobile loans, student loans, SBA loans and credit card receivables; (auto and credit card were covered in 2005)
Fixed Income Analysis Page 414-418, 420-425
LOS 15-1-B-f
compare and contrast the residential MBS issued in the UK and in Australia
Fixed Income Analysis Page 418-420
LOS 15-1-B-g
describe a collaterized debt obligation (CDO) and the different types (cash and synthetic);
Fixed Income Analysis Page 426
LOS 15-1-C-a
discuss the computation, use and the limitations of ... nominal spread and zero volatitity spread for a mortgage backed security and an asset backed security;
Fixed Income Analysis Page 449-450
LOS 15-1-C-d
discuss path dependency in passthrough securities and the implications for valution models;
The concept is very vague here. Fixed Income Analysis Page 457-462
LOS 17-2-a
characterize the change in the value of an interest rate swap for each counterparty when interest rate change;
LOS 17-2-b
compare the position of 1) the counterparties in an interest rate swap to be counterparties in an interest rate futures, and 2) the counterparties in an interest rate swap to the counterparties in a floating rate bond purchased by borrowing on a fixed-rate basis;
LOS 17-2-c
demonstrate how both a cap and a floor are packages of 1) options on interest rates, and 2) options on fixed income instruments;
LOS 18-2-f
discuss the reason ethical conduct is a requirement for managing investment portfolios;
Candidate reading, book 2, page 363
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