CFA I Equity/Debt

  1. Margin leverage factor and levered return
    • Leverage factor - 1/margin%
    • Levered return - HPR x Leverage factor
  2. Relationships between k and g in dividend discount model
    difference between k and g widens, value of stock falls
  3. P/E = ?
    P/E = Payout ratio/(k-g)
  4. Leading vs trailing P/E
    • Leading P/E = price/forecast EPS next 12 months
    • Trailing P/E = price/EPS for past 12 months
  5. Bullet bonds, Serial bonds, Sinking fund provisions, Call provisions, Refunding provisions
    • Bullet bonds - lump sum at maturity pays entire principal
    • Serial bonds - pay off principal through series of payments over time
    • Sinking fund provision - provide for bond retirement through predefined principal payments over life of the issue
    • Call provision - issuer has right to retire all or part of an issuance at a set schedule and price
    • Refunding provision - nonrefundable bonds prohibit premature retirement of an issue from proceeds of a lower coupon bond. Freely callable, but nonrefundable
  6. Effective Duration
    Average % movement (up or down)/value change in yield

    takes embedded options into account, unlike modified duration

    • Ex: P = 50
    • if yield goes down .5%, P = 54
    • if yield goes up .5%, P = 48
    • Average movement = (54-50 + 50-48)/2 = 3
    • Average % movement = 3/50 = 6%
    • Duration = 6%/.5% = 12
  7. Change in price using duration and convexity
    %change in price = -Duration*(change in yield in decimal form) + convexity*(change in yield in decimal form)^2

    duration of a floater is the time to the next reset date

  8. Term structure theories (expectations, liquidity preference, market segmentation)
    • Expectations hypothesis: yield curve shape reflects investor expectations about future behavior of short-term rates
    • Liquidity preference theory: investors prefer greater liquidity, so longer term bonds will include a liquidity risk premium
    • Market segmentation: Market for debt securities is segmented on basis of investor maturity preferences. Each segment's interest rate is determined by supply and demand.
  9. Interest rate risk approaches
    full valuation > duration/convexity > duration

    full valuation: start with market yield and price, estimate hypothetical changes in yields, recompute bond price using new yields, compare resulting price changes

    duration/convexity and duration are summary measures that sacrifice accuracy for simplicity
  10. debenture bond
    unsecured, backed by the
  11. coupon rate, current yield, ytm relation
    current yield will always be between coupon rate and ytm

    if selling at a premium, coupon rate > current yield > ytm

    if selling at a discount, ytm > current yield > coupon rate
  12. z-spread
    interest rate that is added to each zero-coupon bond spot rate that will cause the present value of the risky bond's cash flows to equal its market value

    not used for bonds with options

    z-spread = option adjusted spread + cost of the call option in percent
  13. $ Price change using duration

    Price Value of a Basis Point
    Dollar price change = yield change in decimal form*duration*(price+accrued interest)

    Price Value of a Basis Point: how much the price will change given a 1 bp change in yield

    PVBP = .0001*duration*(price+accrued interest)
  14. Interest expense on a bond
    total amount paid by issuer - amount received by issuer

    • Ex. 10% coupon, 8% ytm, semiannual, 5 years, 1000, pv 923
    • Interest expense = 10*40 + 1000 - 923
  15. municipal bonds
    not all are tax exempt

    investors may be taxed on capital gains

    moral obligation bong = no legal obligation to pay
  16. technical bond default
    issuer breaks bond covenants, like maintaining a certain debt-to-equity ratio
  17. yield curve
    time on x, yield on y
  18. cum coupon, ex coupon
    cum coupon - buyer has the right to the next coupon, and pays the seller accrued interest. This is the way bonds are traded in the U.S. and many other countries

    ex coupon - buyer forfeits the right to the next coupon, which should be taken into account when calculating price
  19. bond trading flat
    issuer is in default and the bond is trading without accrued interest
  20. floating rate bonds, how do the following affect volatility: fixed component (LIBOR + 2%)
    reset dates
    a fixed component will increase volatility

    a cap will increase volatility

    reset dates that are farther apart will increase volatility
  21. external enhancements
    a third party guarantees bond performance

    government, another firm, or insurance

    rating can only be as high as the guarantor
  22. regular redemption price, special redemption price
    • regular redemption price: bonds are redeemed based on call provisions in the indenture
    • special redemption price: bonds are redeemed to comply with sinking fund provisions
  23. curtailment
    a prepayment for a portion of the principal
  24. price compression
    the result of a call option on a bond, it hurts price appreciation
  25. accrual bond
    accrue interest over the life of the bond, then pay it out with the final principal or according to some schedule of future principal/interest payments
  26. Bank Discount-Basis Yield, Money Market Yield, Bond Equivalent Yield
    Bank Discount-Basis Yield: Image Upload 1

    Money Market Yield: Image Upload 2

    Bond Equivalent Yield: Image Upload 3
Card Set
CFA I Equity/Debt
CFA Equity