Changes in CFA level 2 curriculum 2012 So sánh CFA curriculum level 2 năm 2012 vớinăm 2011 thì các thay đổi chủ yếu là loạibỏ bớt các phần lúc trước viết trùng lặp hoặc lan man, rườm rà. Sự loạibỏ này làm cho số lượng readings của level 2 giảmtừ 70 readings năm 2011 xuống còn 64 readings năm 2012. Còn kiến thức thêm vào nhiều nhất là ở reading 47 (Investing in Hedge Funds: a survey) của môn Alternative Investments. Môn Alternative Investments : Reading 50 cũ‐ Commodity (họcvề Contango, Backwardation, roll yield…) bị loạibỏ, có lẽ là do nội dung này sẽ được covered đầy đủ hơn ở level 3. Reading mớisố 47 (Investing in Hedge Funds: a survey) thay thế reading 51 cũ (Evaluating performance of Hedge Funds) và reading 52 cũ (Buyer Beware: evaluating and managing the many facets of risks of hedge funds). Môn Equity :Bỏ hẳn 2 readings là reading 36 và 38 cũ. Reading 36 cũ‐ Equity, Markets and Instruments‐ là một reading khá dài và nhiều chữ bàn luậnvề các loại thị trường, các công cụ và vấn đề về thuế khi đầutư ra nước ngoài, ADR‐ American Depository Receipts, ETFs, country funds…. Reading 38 cũ‐ Equity concepts and Techniques‐ gồm nhiềunội dung bị lặp trong các readings khác, như country analysis, industry analysis. Tuy nhiên trong reading 38 đã bị bỏ có hai mô hình khá thú vị là 1. Franchise model (tính intrinsic P/E theo tangible P/E (1/r) và Franchise P/E (= franchise factor x growth factor)) và 2. công thức tính P/E vớisự góp mặtcủa inflation flow through rate. Các readings còn lại có thay đổi nhỏ một hai LOS không đáng kể. Môn Economics : Reading 17 cũ‐ Exchange rates and Balance of Payment‐ bị loạibỏ.Nội dung này được đưa xuống level 1 (tham khảo level 1 reading 20‐ International Trade and Capital Flows và reading 21‐ Currency Exchange Rates). Môn Fixed Income : Reading 54 cũ‐ Liquidity conundrum (có đề cậptới Minsky hypothesis và giải thích lý do khủng hoảng nhà đấtcủaMỹ vài năm trước…) bị loạibỏ, có lẽ là do các thông tin này giờđã out‐of‐date. Môn Corporate Finance :Bỏ một LOS nho nhỏ về lịch sử các antitrust legislations ở Mỹ (trong reading 32‐ M&A). Năm môn còn lại‐ Ethics, Quantitative analysis, Derivatives, Portfolio management, FRA giữ nguyên. Ngườitổng hợp : Lê Trọng Tuấn Anh & Nguyễn Hoài Phương, AFTC. CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 1
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Changes in CFA level 2 curriculum 2012
So sánh CFA curriculum level 2 năm 2012 với năm 2011 thì các thay đổi chủ yếu là loại bỏ bớt các phần lúc trước viết
trùng lặp hoặc lan man, rườm rà. Sự loại bỏ này làm cho số lượng readings của level 2 giảm từ 70 readings năm 2011
xuống còn 64 readings năm 2012. Còn kiến thức thêm vào nhiều nhất là ở reading 47 (Investing in Hedge Funds: a
survey) của môn Alternative Investments.
Môn Alternative Investments: Reading 50 cũ‐ Commodity (học về Contango, Backwardation, roll yield…) bị loại bỏ,
có lẽ là do nội dung này sẽ được covered đầy đủ hơn ở level 3. Reading mới số 47 (Investing in Hedge Funds: a
survey) thay thế reading 51 cũ (Evaluating performance of Hedge Funds) và reading 52 cũ (Buyer Beware: evaluating
and managing the many facets of risks of hedge funds).
Môn Equity: Bỏ hẳn 2 readings là reading 36 và 38 cũ. Reading 36 cũ‐ Equity, Markets and Instruments‐ là một
reading khá dài và nhiều chữ bàn luận về các loại thị trường, các công cụ và vấn đề về thuế khi đầu tư ra nước ngoài,
ADR‐ American Depository Receipts, ETFs, country funds…. Reading 38 cũ‐ Equity concepts and Techniques‐ gồm
nhiều nội dung bị lặp trong các readings khác, như country analysis, industry analysis. Tuy nhiên trong reading 38 đã
bị bỏ có hai mô hình khá thú vị là 1. Franchise model (tính intrinsic P/E theo tangible P/E (1/r) và Franchise P/E (=
franchise factor x growth factor)) và 2. công thức tính P/E với sự góp mặt của inflation flow through rate. Các
readings còn lại có thay đổi nhỏ một hai LOS không đáng kể.
Môn Economics: Reading 17 cũ‐ Exchange rates and Balance of Payment‐ bị loại bỏ. Nội dung này được đưa xuống
level 1 (tham khảo level 1 reading 20‐ International Trade and Capital Flows và reading 21‐ Currency Exchange Rates).
Môn Fixed Income: Reading 54 cũ‐ Liquidity conundrum (có đề cập tới Minsky hypothesis và giải thích lý do khủng
hoảng nhà đất của Mỹ vài năm trước…) bị loại bỏ, có lẽ là do các thông tin này giờ đã out‐of‐date.
Môn Corporate Finance: Bỏ một LOS nho nhỏ về lịch sử các antitrust legislations ở Mỹ (trong reading 32‐ M&A).
Năm môn còn lại‐ Ethics, Quantitative analysis, Derivatives, Portfolio management, FRA giữ nguyên.
Người tổng hợp: Lê Trọng Tuấn Anh & Nguyễn Hoài Phương, AFTC.
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 1
CFA LEVEL 2
ETHICAL & PROFESSIONAL
STANDARDS
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 2
1. Code OfEthics AndStandards
OfProfessional
Conduct
a1.
All CFA Institute members and candidates arerequired to comply with the Code and Standards
Structure of the CFAInstitute ProfessionalConduct Program
Basic structurefor enforcingthe Code andStandards
The CFAInstituteBylaws
Rules ofProcedure
Based ontwoprimaryprinciples
Fair process tomember andcandidateConfidentialityof proceedings
ProfessionalConductprogram(PCP)
The CFAInstituteBoard ofGovernors
Maintains oversightand responsibility
Through the DisciplinaryReview Committee (DRC)
Is responsible for theenforcement of theCode and Standards
The CFADesignatedOfficer
Directs ProfessionalConduct Staff
Conducts professionalconduct inquiries
An inquiry can be promptedby several circumstances
Process for theenforcement ofthe Code andStandards
When aninquiry isinitiated
The ProfessionalConduct staffconducts aninvestigation thatmay include
Requesting a writtenexplanation from themember or candidate
InterviewingThe member or candidateComplaining partiesThird parties
Collecting documentsand records in supportof its investigation
Upon reviewing thematerial obtained duringthe investigation, theDesignated Officer may
Conclude the inquiry withno disciplinary sanctionIssue a cautionary letter
If finding that aviolation of theCode andStandardsoccurred, theDesignated Officerproposes adisciplinarysanction
Accepted bymember
Rejected bymember
The matter isreferred to ahearing by apanel of CFAInstitutemembers
a2.
Six components ofthe Code of Ethics
Seven Standards ofProfessional Conduct
b. Ethicalresponsibilities
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 3
2.1 Standard IPROFESSIONALISM
A.Knowledgeof the law
Guidance
Recommended procedures for compliance (RPC)
Application
B. Independenceand objectivity
Guidance
Maintain independence and objectivity in professional activities
How to copewith externaland internalpressures
Externalpressures
By benefits
GiftsInvitations to lavish functionsTicketsFavorsJob referralsAllocation of shares in oversubscribedIPOs to investment managers....
From publiccompanies
To issue favorable reports
From Buy-side clients May try to pressure sell-side analysts
Internalpressures
From theirown firms
e.g. to issue favorable researchreports/recommendations for certain companies
Investment-bankingrelationships
to issue favorable research on current orprospective investment-banking clientsConflicts of interest
-->
-->Modest gifts and entertainment areacceptable but special care must be taken
-->must disclose to employers
-->Best practice: reject any offer of gift,..threatening independence and objectivity
-->Recommendations mustconvey true opinionsfree of bias from pressuresbe stated in clear and unambiguous language
-->Portfolio managers must respect and foster honesty of sell-side research
Issuer-paidresearch
Is fraught with conflicts
-->Analysts
Must engage in thorough, independent, and unbiased analysisMust fully disclose potential conflicts, including the nature of compensationMust strictly limit the type of compensation they accept for conducting research
Best practiceAccept only flat fee for their work prior to writing the reportW/O regard to conclusions or reccomendations
RPC
Protect integrity of opinionsCreate a restricted listRestrict special cost arrangementsLimit gifts
Must not misrepresent anyaspect of practice, including
qualifications or credentials, servicesperformance recordcharacteristics of an investmentany misrepresentation relating to member's professional activities
Must not guarantee clients specific returnon investments that are inherently volatile
Standard I(C) prohibits plagiarism inpreparation of material for distribution to
employersassociatesclientsprospectsgeneral public
RPC
Written list of available services, description of firm's qualificationDesignate employees to speak on behalf of firmPrepare summary of qualifications and experience, list of services capable of performing
To avoid plagiarismMaintain copiesAttribute quotationsAttribute summaries
D.Misconduct
Guidance
Address conduct related to professional life
Violations
Any act involving lying, cheating, stealing, other dishonest conduct that reflects adversely onmember's professional activities would be violationConduct damaging trustworthiness or competenceAbuse of the CFA Institute Professional Conduct Program
RPCDevelop and/or adopt a code of ethicsDisseminate to all employee a list of potential violationsCheck references of potential employees
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 4
2.2 Standard IIINTEGRITY OF
CAPITALMARKET
A. Materialnonpublicinformation(MNI)
Guidance
Definition of "Materialnonpublic information"Must be particularly aware of infoselectively disclosed by corporations
Mosaic Theory
Analysis of Public info +nonmaterial nonpublic info -->Investment conclusionAnalysts are free to act onthis collection of info w/orisking violationAnalysts should save anddocument all their research
RPC
Make reasonable efforts to achievepublic dissemination of material info
If public disseminationis not possible,
Must communicate the info only to thedesignated supervisory andcompliance personnel within the firmMust not take investmentaction on the basis of the info
Must not knowingly engage in conductinducing insiders to privately disclose MNI
Prohibition of all proprietary trading while firmis in possession of MNI may be inappropriate
B. Marketmanipulation
Definition
can berelated to
transactions that deceivemarket participants
Transactions that artificiallydistort prices or volumeSecuring a controlling,dominant position in a financialinstrument to exploit andmanipulate price of a relatedderivative/or underlying asset
dissemination of false ormisleading info
including spreading false rumorsto induce trading by others
Standard II(B)not meant to prohibit legitimate trading strategies
prohibit transactions done for tax purposes
The intent of action is critical to determiningwhether it is a violation of this Standard
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 5
2.3Standard
IIIDUTIES
TOCLIENTS
A. Loyalty,prudence,and care
GuidanceResponsibilityto a clientincludes
duty toexercisereasonablecare
Prudencerequire cautionsand discretion
act with care, skill, and diligencefollow the investment parameters set forthby clients & balancing risk & return
duty ofloyalty
Understand & adhereto fiduciary duties
Determine identity of "client"Must be aware of whether they have"custody" or effective control of client assets
Manage pool of assets in accordancewith terms of governing documentsPut their obligation to client first in all dealingsAvoid all real or potential conflicts of interestForgo using opportunities for their own benefit at the expense of clientFollow any guidelines set out by client for the management of assetsJudge investment decisions in context of total portfolioVote proxies in an informed & responsible manner
"Soft dollars"
RPC
Submit to clients at least quarterly itemized statementsSeparate assetsReview investments periodicallyEstablish policies & procedures with respect to proxy voting and the use of client brokerageEncourage firms to address some topics
B. Fairdealing
Guidance
Do not discriminate against any clients"Fairly" vs "equally
Investmentrecommendations
Standard III(B) addresses the manner of disseminating investmentrecommendations or changes in prior recommendations to clientsEnsure fair opportunity to act onEncourage firms to design equitable system to preventselective, discriminatory disclosure
Material changes should becommunicated to all current clients
particularly clients may have acted onor been affected by earlier advise
Clients who don't know changesand therefore place orders contraryto a current recommendation
should be advised of thechanged recommendationbefore the order is accepted
Investmentactions
Treat all clients fairly in light of theirinvestment objectives & circumstancesDisclose to clients &prospects writtenallocation procedures
duty of fairness and loyalty to clients can never be overridenby client consent to patently unfair allocation procedures
Should not take advantage of their position in the industry to the detriment of clientsRPC
C. Suitability
GuidanceIn investmentadvisoryrelationships
Be sure to gather client info in the form of an IPS and make suitabilityanalysis prior to making recommendation/taking investment actionInquiry should be repeated at least annually/prior to material changesIf clients withhold infoRisk analysisFund managers
In case of unsolicited trade requests unsuitable for clientRPC
D. Performancepresentation
Guidance
Standard III(D) prohibits misrepresentaions of past performanceor reasonably expected performance--> Provide credible performance info-->Should not state or imply that clients will obtain orbenefit from rate of return generated in the past
Research analysts promoting the successof accuracy of their recommendations
--> ensure that their claims arefair, accurate, and complete
If the presentation is brief, must make available toclients and prospects the detailed info upon request
RPC GIPS
E. Preservation ofconfidentiality
Guidance
Standard III(E) is applicable when members receive infoComply with applicable laws
When in dout -->consult with compliance department/outside counsel before disclosing
Standard III(E) does not prevent cooperating with an investigation by CFAI PCPRPC
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 6
2.4 Standard IVDUTIES TO
EMPLOYERS
A. Loyalty
Employer-employeerelationship
In matters related to their employment, membersand candidates must not engage in conduct thatharms the interests of the employer
-->Comply with policies and procedures established byemployers that govern employer-employee relationship
Standard IV(A) does not require to place employerinterests ahead of personal interests in all matters
The relationship imposes duties andresponsibilities on both parties
Independentpractice
Abstain from independent competitive activitythat could conflict with employer's interests
Provide notification to employer, obtainconsent from employer in advance
Leaving anemployer
Must
Planning to leave, must continueto act in employer's best interestFirm records or work performed on behalfof firm stored on a home computer shouldbe erased or returned to employer
Must not
engage in activities conflicting withduty until resignation effective
contact existing clients/potentialclients prior to leaving for soliciting
take records of files to a newemployer without written permission
Free to make arrangements/preparationsprovided that not breaching duty of loyalty
Applicable non-compete agreement
Whistleblowing
Nature of employment
B. Additionalcompensationarrangements
Guidance Obtain written consent from employer before acceptingcompensation or other benefits from third parties...
RPC Should make an immediatewritten report to their employers
C. Responsibilities ofsupervisors
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 7
2.5 Standard V
INVESTMENTANALYSIS,
RECOMMENDATIONS& ACTIONS
A. Diligence andreasonable basis
Guidance
The application of StandardV(A) depends on
investment philosophy followedrole of member in theinvestment decision-makingprocesssupport and resourcesprovided by employer
Must make reasonable efforts to cover all pertinentissues when arriving at recommendation
Provide or offer to provide supporting info to clients whenmaking recommendations/changing recommendations
Using secondary orthird-party research
-->must make reasonable &diligent efforts todetermine whether 2nd/3rd party research is sound
Group researchand decisionmaking
If member does not agreewith the independent andobjective view of the group
-->Not necessarily have todecline to be identified ifbelieving consensus opinion hasreasonable & adequate basis-->Should document member'sdifference of opinion with group
RPC
B. Communicationwith clients andprospective clients
Guidance
Standard V(B) addresses conduct with respect to communicating with clients
Communication is not confined to writtenform but via any means of communication
Developing and maintaining clear, frequent, andthorough communication practices is critical
Must
distinguish clearly between facts & opinionspresent basic characteristics of the analyzedsecurity in preparing research reportadequately illustrate to clients & prospective clients the mannerof conducting investment decision-making processkeep them informed with respect to changesto the chosen investment process
Briefcommunications
-->must be supported by backgroundreport or data on request
Capsule formrecommendations
-->should notify clients that additional info andanalyses are available from the producer of the report
Investment advicebased on quantitativeresearch and analysis
-->must be supported by readilyavailable reference material-->in a manner consistent with previously appliedmethodology or with changes highlighted
Should outline known limitations, considerprincipal risks in investment analysis, report
RPC
C. Record retention
Guidance
In hard copy or electric form
Fulfilling regulatory requirements maysatisfy the requirements of this Standard
Must explicitly determinewhether it does
Absence of regulatory guidance,CFAI recommendsmaintaining records for atleast 7 yrs
RPC
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 8
2.6 Standard VICONFLICTS
OF INTEREST
A. Disclosureof conflicts
Guidance
Managingconflicts
is a critical part of working in investment industry
can takemany forms
Best practice is to avoid conflictsof interest when possibleIf not, disclosure is necessary
Disclosuresmust be
prominentmade in plain languagein a manner to effectively communicate the info to clients
Disclosureto clients
All mattersmay impairobjectivity
Relationships
between member ortheir firm and issuerinvestment bankingunderwriting and financialrelationships
Broker/dealer market-making activitiesMaterial beneficial ownership of stockInvestment personnel also serves as a director
-->Sell-sidemembers
should disclose material beneficial ownershipinterest in securities/investment recommended
Disclosure ofconflicts toemployers
What?Same circumstances with clientsAny potential conflict situation
How? Enough info
Other requirements
B. Priority oftransactions
Guidance
Clients & employers' transactions have priority
Co-investment-->personal investment positionsor transactions should neveradversely affect client investments
Conflicts ofinterests
may occur
-->make sure
client is not disadvantaged by the tradeinvestment professional does not benefitpersonally from trades undertaken for clientsinvestment professional complies withapplicable regulatory requirements
Having knowledge of pending transactions, assess to info duringnormal preparation of research recommendations
-->Must notconvey such info
May undertake personal transactions after clients & employershave had adequate opportunity to act on recommendation
Family accounts (thatare client accounts)
should be treated like other accounts
if member hasbeneficial ownership
-->may still be subject topre-clearance or reportingrequirements
C. Referral feesInform
whomemployerclientprospective client
what
compensationconsiderationbenefitreceived from, or paid to, others
howbefore entry into any formal agreementnature of the consideration or benefit
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 9
2.7 Standard VII RESPONSIBILITIESAS CFA MEMBER /
CANDIDATE
A. Conduct asmembers andcandidates inthe CFAprogram
Prohibiting any conduct thatundermines the integrity ofthe CFA charter
Cheating on CFA exam or any exam
Not following rules andpolicies of the CFA program
Giving confidential info on the CFAProgram to candidates or the public
.....
Not precluded from expressing opinionregarding the CFA Program or CFAI
B. Reference toCFA Institute, theCFA Designationand the CFAprogram
Preventing promotional efforts thatmake promises or guarantees tiedto the CFA designation
Over-promise thecompetence of anindividual
Over-promise futureinvestment results
Applies to any form ofcommunication
To maintain CFAImembership
Remit annually to CFAI a completedProfessional Conduct Statement
Pay applicable CFAI membershipdues on an annual basis
Using the CFA designation(see Curriculum)
Referencing candidacy in the CFAprogram (see Curriculum)
Proper using of the CFA marks(see Curriculum)
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 10
3.1 CFA InstituteSoft DollarStandards
Soft DollarStandards (SDS)
are voluntary standards for Members
focus on 6key areas
DefinitionsTo enable all parties dealing with SD practices to have acommon understanding of all of the different aspects of SD
ResearchTo give a clear guidance to investment managers on what products andservices are appropriate for a manager to purchase with client brokerage
Mixed-used productsTo clarifiy the manager's duty to clearly justify the use ofclient brokerage to pay a portion of mixed-use product
DisclosureTo obligateinvestmentmanagers to
clearly disclose their SD practicesgive detailed info to each client when requested
Record keeping To ensure that client canreceive assurances that what investment managers aredoing with client brokerage can be supported in an "audit"receive important info on request
Client-directedbrokerage
To clarify the manager's role and fiduciary responsibilities to clients
a1. Define "Soft Dollar"Arrangements
Investment Manager directs transactions to a Broker, in exchange for whichBroker provides brokerage and research services to the Investment Manager
includeProprietary ResearchArrangementsThird-party Research Arrangements
Not include Client-directed Brokerage Arrangements
a2. Some definitions
Agency trade A transaction involving the pmt of a commission
Principal trade A transaction involving a "discount" or a "spread"
Soft dollarpractices involve the use of client brokerage by an investment manager to obtain products
and services to aid the manager in investment decision making process
Brokerage The amount on any trade retained by a brokerto be used directly or indirectly as pmt for
ResearchServies and/or products provided by a broker, the primary use of which mustdirectly assist the investment manager in its investment decision making process
TypesProprietary researchThird-party research
Mixed-Use
Services and/or products,provided to an investmentmanager by a broker througha Bokerage Arrangementused for both
Investment decision making processManagement of theinvestment firm
Client-directedbrokeragearrangement An arrangement whereby a client directs that trades
for its account be executed through a specific brokerin exchange for which the client receives abenefit in addition to execution services
a3. General principles ofSoft Dollar Standards
2 key principlesof SDS
1. Brokerage is theproperty of client
2. Investment managershave a duty to
obtain best executionminimize transaction costsuse client brokerage to benefit clients
CFAI SDS areintended to ensure
Full and fair disclosure of the investmentmanager's use of a client's brokerageConsistent presentation of info->all partiesclearly understand brokerage practicesUniform disclosure and record keepingHigh standards of ethical practiceswithin the investment industry
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 11
3.2 CFA InstituteSoft Dollar
Standards (cont.)
b. Critique company SDpractices and policies
I. General
II. Relationships with clients
III. Selection of brokers
IV. Evaluation of research
V. Client-directed brokerage
VI. Disclosure
VII. Record keeping
c. Permissibleresearch guidance
Level 1- Define the Product/ServiceLevel 2- Determine UsageLevel 3- Mixed Use Analysis
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 12
4. CFA InstituteResearch
ObjectivityStandards
CFAI-ROS areintended to be
specific, measurable standardsfor managing and disclosing conflicts of interest that may impede a research analyst's ability to conduct independent research and make objective recommendations
a. Objectives of Research Objectivity Standards (ROS) (p.104)
1. Research objective policy2. Public appearances3. Reasonable and adequate basis4. Investment banking5. Research analyst compensation6. Relationships with subject companies7. Personal investments and trading8. Timeliness of research reports and recommendations9. Compliance and enforcement10. Disclosure11. Rating system
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 13
5.6.7 Case Studies
5. The Glenarm Company
Case outline
Case results
6. Preston Partners
Case outline
Case results
7. Super Selection
Case outline
Case results
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 14
8. Trade Allocation:Fair Dealing And
Disclosure
a. Trade allocationpractice critique
b. Appropriate responseto inadequate tradeallocation practices
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 15
9. ChangingInvestmentObjectives
a. Critique disclosure ofinvestment objectivesand basic policies
b. Appropriateresponse toinadequatedisclosureprocedures
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 16
10. Prudence InPerspective
Warm-up: The OldPrudent Man Rule
a. Basicprinciplesof the NewPrudentInvestorRule
1. Diversification is fundamental to risk minimization
2. Trustees must base an investment's appropriateness on risk/return profile
3. Trustees have a duty to avoid fees, transaction costs,and other expenses that are not justified
4. The fiduciary's duty of impartiality requires aconscious balancing of current income and growth
5. Trustees may have a duty, as well as theauthority, to delegate as prudent investors would
b. GeneralFiduciaryStandards
A trustee mustexercise
Care
Skill
Caution
Loyalty
Impartiality
c. Differentiate
The Old PMR
The New PIR
Use of total returnRisk managementEvaluation in a portfolio contextSecurity restrictionsDelegation of duty
d. Keyfactorsshould beconsideredwheninvestingandmanagingtrust assets
1. Economic conditions
2. Effect of inflation and deflation
3. Impact of investment decisions on the beneficiary's tax liability
4. How each investment contributes to risk/return of the overall trust portfolio
5. Expected total return from income and capital appreciation
6. Other resources of beneficiaries
7. Needs forliquidityregularity of incomepreservation or appreciation of capital
8. Whether any assets have a special relationship tothe requirements of the beneficiary or the trust
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 17
CFA LEVEL 2
QUANTITAVE ANALYSIS
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 18
EXAMPLE READING 11: (Excel output) Observation X Y1 12 50
. Adjust standard errors: Hansen-White std. errors(correct both heteroskedasticity & autocorrelation) Serial correlation consistent→recalculate t-stats. Improve specification (include seasonal terms)
. Omit 1 or more variables (not easy, must use stepwise regression)
NOTES: . Regression analysis tests (t-tests, F-tests):H0: bad model (Reject H0 →good model)
. Assumption tests:H0: no violation (Fail to reject H0 → good model)
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 23
12.2. MultipleRegression &
Issues InRegression
Analysis
Warm-up: Why multipleregression isn't easy as it looks
Assumptionviolations
i1. Heteroskedasticity
What is it?UnconditionalConditional
Effects on regression analysis
Detecting heteroskedasticity
Correcting heteroskedasticity
i2. Serial correlation(autocorrelation)
What is it?PositiveNegative
Effects on regression analysis
Detecting
Correcting
j. Multicollinearity
is
Effects on regression analysis
Detecting
Correcting
Warm-up: Model specification
k. Modelmisspecification
Subcategory 1: Misspecifiedfunctional form
Misspecification 1: Omitting a variable
Misspecification 2: Variables should be transformed
Misspecification 3: Incorrectly pooling data
Subcategory 2: explanatoryvariables correlated with error term
Misspecification 4: use lagged Y as X
Misspecification 5: Forecasting the past
Misspecification 6: Measuringindependent variables with error
Subcategory 3: misspecifications resulting in nonstationarity
l. Models with qualitativedependent variables
Probit and logit models
Discriminant models
m. Interpreting regression results
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 24
13.1. Time-Series
Analysis
Trendmodels
a. 2 models Linear trend modelLog-linear trend models
b1. Which model is best?
b2. Limitations oftrend models Autocorrelation
Autoregressive(AR) models
d. Structure of an ARmodel of order p
Forecasting with anautoregressive model
e. Autocorrelation & Model fit
l. Seasonality
Definition
Detecting
Correcting
Forecasting with an ARmodel with a seasonal lag
g. In-sample andout-of-sampleforecasting
In-sample forecasts
Out-of-sample forecasts
Root mean squarederror criterion (RMSE)
h. Regression coefficient instability
c. Covariancestationarity
3 conditionsConstant and finite expected valueConstant and finite varianceConstant and finite covariancewith leading or lagged values
Significance of a seriesnot being stationary
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 25
13.2. Time-Series
Analysis
f.
Mean reversion
Calculate amean-reverting level
i. Random walks
Random walk
Random walk with a drift
Covariance stationarity
j. Unit roots
First differencing
k,n. Nonstationarityand cointegration
Unit root test fornonstationary
Cointegration
m. Autoregressive conditionalheteroskedasticity (ARCH)
o. Choosing the correct model
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 26
CFA LEVEL 2
ECONOMICS
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 27
14. EconomicGrowth
Warmup: Economicgrowth (EG)
Estimating EGRule of 70
a1. Sources of EG
Land
Capital goods
Labor
Entrepreneurial ability
a2. Preconditions forE.G. Incentive system
Markets
Property rights
Monetary exchange
Theproductivitycurve (PC)
Labor productivity =Real GDP per labor hour
Definitionof PC
2 properties of PC 1. Growth in capital per labor hour > movement along PC
2. Technological growth > shift PC upwards
Law ofdiminishingreturns
b. The ONETHIRD Rule
c. Fastereconomicgrowth
Three waysIncreasing the growth of physical capital
Technological advance
Investment in human capital
>Suggestions
Stimulate saving
Stimulate R&D
Target hightechnology industriesEncourage international trade
Improve the quality of education
d. Growththeories(GT)
Classical GT
Growth in GDP: not permanent
When real GDP per person above subsistence level > population explosion >real GDP per person back to subsistence level
Figure
Neoclassical GT
Technological change > increased saving & investment >capital per labor hour increase > long term growth in GDP
Different from classicalGT: population growth
Independent of econ. growth (or real wage rate or real GDP)
But influenced by opportunity cost to women for entering workplace
Technological growthNot influenced by economic growth
Occur through trial & error (R&D)
New GT
Based on 2 properties of market economiesDiscoveries are the result of choicesDiscoveries lead to profit & competition eliminates profit
Technologicalchange
driven by profit
there is ongoing search to discover technologies
2 other keyassumptions
Discoveries are public capital goods
Law of diminishing returns doesnot apply to knowledge capital
> no mechanism to stop economic growth
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 28
15. Regulation AndAntitrust Policy In AGlobalized Economy
Warmup: Natural monopolies
a.
Rationale for
Economic regulation ofnatural monopolies
Social regulation ofnonmonopolistic industries
b. Socialregulation
Potentialbenefits
Possiblenegativeside effects
Creativeresponse
Conform to the letter (the words),but not to the intent
Feedbackeffect
is a typical example ofcreative responseNew regulation changes consumers'behavior > undermine the original intent
c.Regulators'behavior
Capturehypothesis
regulators are selected from industry experts > have relationships> sometimes decisions influenced/controlled by the industryat regulatory hearing: consumers less prepared andless persuasive than industry members
Sharethegains,sharethepaintheory Regulators try to
satisfy all 3 parties
LegislatorsCustomersRegulated firms
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 29
16. Trading WithThe World
a.
Comparativeadvantage
ConceptLaw of comparativeadvantage
Specialize in lowopportunitycost goods > exportImport highopportunitycost goods
License to import a limitedamount > reduce supply >
higher pricelower equilibrium domestic quantity
less foreign competition >benefit domestic producers
deadweight loss firms with import licenses get the gains
Voluntaryexportrestraints(VERs)
are agreements by exporting countries to voluntarily limit the quantity of goods
firms with export permits get the gains (different from quotas)Government officials who choose firms may receive some gain.
c. Critquetheargumentsfor traderestrictions
Arguments withsome support
Infantindustryargument
Argument:infant industries should be protected while they getup to world standards of productivity and quality
Critiques:Benefits not the whole economy but to firms &workers in those industriesTariff or quota is market distorting > Government subsidy is better
Dumpingargument
> Antidumping law:
Exporters should be prohibited from sellinggoods abroad at less than production cost
Critiques:
Difficult to estimateproduction costs
price lower than in foreign firms'market is not evidence of dumping
drive domestic firmsout of business >
still have competition fromother countriesthose domestic firms could reenterwhen foreign firms raise prices
Nationalsecurityargument
ArgumentIndustries associated with national defense should beprotected so they will exist domestically in case of war
Critiques:
almost all industries contribute or potentiallycontribute to national defense
government should choose strategic industries tosubsidize rather than impose trade restrictions
Arguments withvery little support
Trade barriers protect jobs
Trade restrictions create jobs
Trade with lowwage countries depresseswages in highwage countries
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 30
Stock appreciation rightsCondition: share price increase over a threshold
Payment: cash or equity or both
Phantom stocks: stock appreciation rights for privately held/ highlyilliquid firms --> based on performance of hypothetical stock
Stockoptions
In the past: intrinsic value method (recognize an expense if market price> exercise price on grant date). Problem: usually no intrinsic value
Current: Fair value method (using Black Scholes Merton or binomialmodels to calculate value of option --> amortize over service period=grantdate to vesting date). Problem: very subjective
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 38
24.Multinational
Operation
a. Distinguish
Local currency
Functional currency
Presentation (reporting) currency
b. Impact of changes in exchange rates on the translatedsales of the subsidiary and parent company
c.
If foreign currencyappreciates
All-current methodNet assets exposure -->
Net liabilities exposure -->
Temporal methodNet monetary assets exposure -->
Net monetary liabilities exposure -->
d. Compare 2 methods
Income before translation G/L
Translation G/L
Net income
Total assets
e. Affecting theparent company'sfinancial ratios
Temporal vs. All current(parent currencydepreciated -->) ROA__; ROE__; TATO___; Invt TO___; A/R TO___
All current vs. OriginalPure BS or Pure IS ratios
Mixed BS/IS ratios(using end-of-period BS)
f. Subsidiariesoperating inhyperinflationaryeconomies
USGAAP: Functional = Presentation & use temporal method
IFRS
Non-monetaryAsset & Liab
adjust using price index betweenacquisition date & balance sheet date
Shareholders'equity
adjust using price index from date of contribution orfrom year of beginning, whichever is later
Monetary Asset & Liab. no adjustment
Net purchasing power Gain /Loss --> Income statement
Analyzing foreign currency disclosure : Difficulty: little requirement for disclosure. 1 parent may have manysubsi using diferrent methods --> solution: add delta CTA to Net income (clean surplus accounting)
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 39
25. TheLessonsWe Learn
Lesson 1: Understandwhat you are looking at
a. Distinguishamong variousdefinition ofearnings
EBTDA, Operating income, EBT,Income from continuing operations,Income before extraordinary items,Income before effect of changes inaccounting principles, net income
Lesson 2: Read the fine print
Lesson 3: If it's too good to be true, it may be
Lesson 4: Follow the money
b. Trends in CFO more reliable than trends in earnings
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 51
CFA LEVEL 2
CORPORATE FINANCE
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 52
28.1. CapitalBudgeting
Warmup: Basics
Projectcategories
Replacement to maintain biz > no detailed analysisReplacement for cost reduction > fairly detailed analysisExpansion > very detailedNew product/ market > detailedMandatory (required by Govt. or insurance such as safety or environmental projects)Other (pet projects or high risk like R&D)
Principles
Incremental CF, not accounting incomeTiming of CF > TVMAfter tax
Notes
ExcludeSunk costFinancing costs
IncludeExternalitiesOpportunity costs
MACRS= Modified Accelerated CostRecovery System (for tax purpose) Halfyear convention
No salvage
a. Capital budgetingproject evaluation
Expansionprojectanalysis
Initial investment outlay=
Aftertax O.CF=
T.NO.CF=
Replacementprojectanalysis
Initial investment outlay=
Aftertax O.CF=
T.NO.CF=
b. Inflation effects (ifactual inflation higherthan expected)
Principle Nominal CF > use nominal discount rateReal CF > use real discount rate
__________ project profitability
__________ tax savings from depreciation
__________ value of payments to bondholders
Affects Revenues and Costs differently > CF may be worse or better
c1. Projectswith differentlives
Least common multipleof lives approach(replacement chain)
Equivalent annual annuity(EAA) approach
c2. Capital rationing= insufficientcapital > violate market efficiency
Hard rationing: allocated funds cannot be increased
Soft rationing: allocated funds can be increased
d. Projectriskanalysis
Sensitivity analysis: Base case, then change ONLY 1 variable up/down
Scenario analysis: Base case, then change MANY variables > Worst case, Best case > Risk analysis
Simulation analysis (Monte Carlo): Probability distribution of NPV
e. Determine discount rateCAPM > WACC
When risk of project # overall risk > CANNOT use WACC
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 53
28.2. CapitalBudgeting (cont.)
f. Evaluatingprojects withreal options
Typesof realoptions
Timing options: option to delay investment
Abandonment options: abandon if NPVexit > NPVcontinue (=put option)
Expansion options: option to have additional investment (=call option)
Fundamental options: project itself = option (e.g.: copper mine)
Evaluatingapproaches
If NPV without option >0 > Project will be more valuable with option
NPV = NPV without option + option value option cost
Decision tree
Option pricing models
g. Commoncapitalbudgetingpitfalls
Failing to incorporate economic responses: e.g..: profitable but low entry barriers > competitors
Misusing standardized templates, which are not an exact match
Pet projects of senior management: less analysis
Basing investment decisions on EPS or ROE > avoid projects with high NPV but low EPS orROE in the short run (especially when management compensation is tied to EPS or ROE)
Using IRR for project decision: for mutually exclusive projects, should use NPV instead
Poor CF estimation: double count or omit a CF. E.g..: inflation
Misestimation of overhead costs (e.g..: management time, IT support): difficult to quantify
Using the incorrect discount rate: WACC or should adjust?
Politics involved with spending the entire capital budget: e.g.. :management tries to spendall budget to ask for more next year
Failure to generate alternative investment ideas: most important step ("good" is the enemy of "better")
Improper handling of sunk and opportunity costs
h. Measuresof incomeand valuationmodels
ECONOMICINCOME
= CASHFLOW minus ECONOMIC DEPRECIATIONEconomic Depreciation year t = Beginning market value minus Ending market value for year t
Market value year t = sum of PV of all CF left
ACCOUNTINGINCOME
From Income statement
# economic incomeDepreciation based on original cost, not market valueDeduct interest expense
i. Othervaluationmodels
ECONOMICPROFIT (EP)
= NOPAT WACC in dollarsTo bond and equity holdersSum of EP discounted at WACC = MVA (Market Value Added) = NPV
RESIDUALINCOME
= ACCOUNTING NET INCOME minus EQUITY CHARGETo equity holdersSum of RI discounted at cost of equity = NPV
Claimsvaluation Free cash flows to company (debt and equity holders) > discount at WACC
Free cash flows to equity (shareholders) > discount at cost of equity
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 54
29. CapitalStructure &Leverage
a1. Capitalstructuretheory
Capital structure objectiveMaximize Firm Value MM Proposition I
Minimize WACC MM Proposition II
No taxesMM Proposition I
MM Proposition II
With taxesMM Proposition I
MM Proposition II
a2. Costs and theirpotential effect onthe capital structure
Costs of asymmetric information:(managers vs. creditors and owners) > increase required rate of return
a3. Implications formanagerialdecision making
MM's propositions with no taxes: Capital structure is irrelevant
MM's proposition with taxes: optimal capital structure is 100% debt (highest tax shield, max value, min WACC)
Pecking order theory: order of raising funds: Internally generated equity > Debt > External Equity
Static tradeoff theoryFirm value:
Optimal capital structure achieved when:Marginal Tax Benefit = Marginal Cost of Financial Distress
b. Target capitalstructure (optimal)
2 reasons for actual capitalstructure to fluctuate aroundtarget capital structure
Opportunities in afinancing source
E.g.: temporary increase in stock price
Market valuefluctuations
D, E = market value
c. Role of debt ratingsMoody's; S&P's
d. Capital structurepolicy and valuation
Factors toconsider
Changes in capital structure overtimeCompetitors with similar business riskAgency costs (corporate governance)
e. Internationaldifferences inleverage
Internationaldifferences
Total debt: Japan, France: more debt than UK, USDebt maturity: US longer than JPEmerging market differences: emerging market less and shorter debt
Factors
Institutionaland legalfactors
Strength of legal system: strong > reduce agency cost> less and longer debtInformation asymmetry: increase debt (auditors, analystshelp reduce info asymmetry > decrease debt)Taxes: high > increase debt. Tax on dividend: high > decrease debt
Financialmarkets andbankingsystem factors
Liquidity of capital markets (debt market): high > longer debtReliance on banking system > increase debtInstitutional investor (shareholders) presence >decrease information asymmetry > decrease debt
Dividend initiationsambiguous: sharing wealth or lack ofprofitable reinvestment opportunities
Dividend increases Strong future
Unexpected Dividenddecreases / omissions
Business in trouble or moreinvestment opportunities
Country differences: US # Asia in perception
e. Taxationof dividends
Taxondividendsystems
Double taxation
Split rate
Imputation
c. Clienteleeffect
Tax considerations
Requirements of institutional investors
Individual investor preference
c2. Agencyissues
Restrictionson dividendpayments
"Impairment of capital" ruleDebt covenantsCash flowIndustry life cycle
Flotation costs on new issues vs. cost of retained earningsShareholder preference for current income vs. capital gains
f. Dividend policyapproaches
Residual dividend model
Longerterm residual dividend e.g.:forecast capital budget for 5 years,Leftover = total net income 5 years minus capital budget for 5 years.Dividend each year = Leftover/5
Dividend stability: steady dividend payout (taking into account inflation)> dividend growth rate g = company's long term growth rate
Target payout ratio Payout ratio = constant
Payout ratio moves toward the target
g. Sharerepurchase
Compare with cash dividend
EPSeffect
If Cost of Debt < Earning yield > EPS_____If Cost of Debt > Earning yield > EPS_____
MethodsBuy in the open marketBuy a fixed number of shares at a fixed price: tender offer: P > PmarketRepurchase by direct negotiation: to avoid price decrease (e.g.: greenmail premium)
Rationales
Capital structurePrevent EPS dilution from employee stock optionsSupplement to cash dividend > residual dividend policyManagement is viewing stocks as strongGood future outlook signal
h. Global trends
i. Dividend coverageratios based on
Net incomeFCF
j. Symptoms of not being ableto sustain cash dividend
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 56
31. CorporateGovernance
Warmup: conflicts ofinterest in a corporation
Multiple owners vs managersDirectorsCreditors, Employees, Customers
a. Corporategovernance(SarbanesOxley)
Definition: system ofPrinciples & PoliciesProceduresResponsibilities & Accountabilities
Objectives Eliminate or reduce CONFLICTS of interest (esp. mgmt vs. shareholders)Use ASSETS in best interests of investors and other stakeholders
Attributes ofeffective CG
RIGHTS of shareholders & stakeholdersOversight RESPONSIBILITIES of managers and directorsFair and equitable TREATMENTTransparent & accurate DISCLOSURES about operations, performance, risk and financial position
b. Business forms
Sole proprietorship no owner vs. manager conflict. Just creditors, suppliers, customers...
Partnerships no owner vs. manager conflict. Just creditors, suppliers, customers...
Corporations (US: 20% in number but account for 90% revenue)
c. Conflictsin agencyrelationships
Manager >< ShareholderExpand firm to increase power, security, compensation
Excessive compensation and perquisites (e.g.. lavish jet)Invest in risky ventures (succeed > benefit from stock options, fail > not share the loss)Not taking enough risk
Director >< Shareholder
Lack of independencePersonal relationship btw board managementBoard: consulting/ other biz with firm
Interlinked boards 2 companies
Directors are overcompensated
d,e. Boardof Directors
Responsibilities(check and balance)
Institute corporate values & CG > proficient, ethical, fair biz conductionEnsure compliance: with all legal & regulatory requirementsCreate longterm strategic objectivesDetermine management's responsibilities (need to be able to measure performance)Hire, compensate, evaluate CEORequire complete and accurate information from managementMeet regularlyEnsure board members are adequately trained
Points toassess Board
Composition and independence recommend at least 3/4
Board election methodall or staggered? Staggered: keep board continuitybut limit shareholders' power & slow down changes
Board selfassessment practices annually
Frequency of separate sessions for independent directors annually, quarterly
Audit committee and audit oversight only independent directors, with expertise
Nominating committee all independent
Compensation committee
Use of independent or expert legal counsel internal counsel > weak CG
Statement ofgovernancepolicies
f. Statementof CGpolicies
Codes of ethicsDirectors' oversight, monitoring and review responsibilitiesManagement's responsibilities to the boardReports of directors' oversight and review of managementBoard self assessmentsManagement performance assessmentsDirector training
Disclosure and transparencyInsider or relatedparty transactionsResponsiveness to shareholder proxy votes
g. Valuationimplications ofCorporateGovernance
Strong/effective CG system > higher measures of profitability & returns for shareholders
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 64
38. ValuationIn Emerging
Markets
Warmup: Real andnominal valuation
CFestimation
a. Effectsof inflation
Income taxesNWCCapital expenditures
b. Calculate nominaland realterm financialprojections 5step
approach
1. Operating results real
2. Operating results nominal
3. NOPLAT real
4. Free CF real & nominal
5. Firm value real & nominal
c. Account foremergingmarket risks
Adjust CFs, b/c
Country risks arediversifiable
Companies respondifferently to country risk
Country risk is onesided risk
Identifying CF effects aidsin risk management
Rather than adjusting r
d. Estimatingcost of capital
KeRfBetaMarket risk premium
Kd (1t) Kdt
Capital structure weights
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 65
39. DiscountedDividendValuation
a. Measures of CF
Dividends
FCF
Residual income
DDM
Appropriateness
b.OneperiodTwoperiod
Multiperiod
Warmup: General DDM
i,l. Multistagegrowth models
Assumptions
Selection of
Twostage DDM
Hmodel
Threestage DDM
Spreadsheet modeling
j. Businessphases
Initial growthTransition
Maturity
k. Terminal value
GGM
c. Assumptions
d. Implied growth rate
f. Justified P/E Justified leading P/E
Justified trailing P/E
h. Strengths
Limitations
e. PVGO
g. Value ofpreferred stock
m. Calculateexpectedreturn with
GGM
Hmodel
Twostage DDM
n. Sustainable growth rate
o. Use of spreedsheet modelingTo forecast dividends
To value common shares
p. Over/Fairly/Undervalued
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 66
40. FreeCash FlowValuation
a. Interpret &compare
FCFF
FCFE
b,f. Ownership perspective& recognition of value
FCFE, FCFF
DDM
c,d. Calculate
FCFF
FCFE
e. ForecastingFCFF and FCFE
Historical free cash flow
Components of free cash flow
g. FCFF & FCFEaffected by
Dividends
Share repurchases
Share issues
Changes in leverage
h. Critique the use of NI andEBITDA as proxies for CF
i. Models
Single stage
MultistageHow many variations are there?
Model assumptions &Firm characteristics
j. Calculate the value ofa company
k. Sensitivity analysis
l. Terminal value
FCFF is preferred toFCFE when
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 67
41.1.Marketbased
Valuation
Types of valuationindicators
Price multiplesEnterprise value multiplesMomentum indicators
a. Twomethods
Method of comparablesMethod based onforecasted fundamentals
b. Justified price multiple
c,d,g. Pricemultiples
P/E Trailing P/ELeading P/E
P/B
P/S
P/CF
c,d,g. Dividendyield (D/P)
Trailing D/P
Leading D/P
e. Underlying earnings(persistent, continuing,core); Normalized EPS
Exclude nonrecurring components(G/L from asset sales, writedowns...)Method of historicalaverage EPSMethod ofaverage ROE
f. Earnings yield (E/P)
h. Calculate
Justified P/E
Justified P/B
Justified P/S
Justified P/CF
Justified EV/EBITDA
Justified D/P
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 68
EQUITY LEVEL 2, READING 4144. c,d,h,n
Multiples(LOS c,d)
Advantages Disadvantages Notes Justified (LOS h)
P/E + Popular+ Earnings power (EPS) is the primary determinant of inv. Value+ Proved by empirical evidence
- EPS might be <0 --> P/E is meaningless- Earnings have 1 portion that is volatile & transitory -> difficult to interpret- Earnings can be distorted by mgmt --> lower comparability
* Trailing P/E: not useful for forecastin & valuation* Leading P/E: not relevant if earnings are too volatile
P/B + Usually BV>0, more stable+ Firms that primarily hold liquid assets --> BV~VE
+ Useful in valuing companies expected to go out of biz.+ Proved by empirical evidence
- Not reflect intangible assets (human capital)- Misleading due to differences in asset size (eg.: outsource vs. not outsource)- Different accounting standards --> affect comparability (eg.: R&D is expensed in US)- BV # MV b/c of inflation or technological change
Adjustments to BV:. Exclude intangible assets (GW, patent). Adjust for OBS. Adjust to reflect fair value. Adjust for # accounting policies (eg.: LIFO vs. FIFO)
P/S + S is always >0, even when E,B<0 --> P/S meaningful for distressed firms+ Not as easy to manipulate/ distort+ Not as volatile --> estimate is more reliable+ Appropriate for start-up companies, mature&cyclical industries, investment mgmt companies+ Proved by empirical evidence
- High sales growth --> not mean high operating profit --> not as meaningful as P/E & P/CF- Not capture cost differences- Can still be distorted (eg.: bill-and-hold)
P/CF + CF is harder to manipulate+ P/CF is more stable than P/E+ Avoid "quality of earning" problem of P/E+ Proved by empirical evidence
- If CF=NI+NCC --> ignore NCRev. & WC- FCFE is preferred to CFO but more volatile
D/P + D/P (with capital gain) contributes to R investment+ Div less risky than capital gain
- Ignores capital appreciation --> incomplete focus- "Div displacement of earnings" concept: trade-off btw div & future earnings (current & future CF)
. Used to value index
. Distinguish: Trailing D/P=
Leading D/P=
EV/EBITDA(LOS n)
+ Useful when comparing firms with different leverage and capital intensive (high DA)+ EBITDA usually > 0
- When WC increases, EBITDA overstates CFO- Ignore how revenue recognition affects CFO- CAPEX # Depr -> EBITDA not capture CAPEX --> # FCFF --> not linked with valuation theory
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 69
41.2Marketbased
Valuation(cont.)
i. PredictedP/E ratio
j. Evaluate stock bymethod of comparables
k. PEG ratio
l. Use of price multiples in determiningterminal value in a multistage DCF model
m. Alternative definitions of CFused in price multiples
n. EV/EBITDA
o. Sources of differences incrossborder valuation comparisons
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 70
42. ResidualIncome
Valuation
a. Calculate
RI =
EVA =
MVA =
b. Use of RI models
c. FV of RI
d. Fundamentaldeterminants of RI
e. Relationbetween
RI valuation
Justified P/B ratio
f. Singlestage &multistage RI model
g. Calculate impliedgrowth rate (g)
h.ContinuingRI
is.....
Persistentfactor
Assumptions
RI persists atcurrent level forever
RI dropsimmediately to zero
RI declines overtime to zero
RI declines to LR levelin mature industry
i. Compare
RI
DDM
FCFE
j. RI models
Strengths
Weaknesses
k. Justify theselection of RI model
l. Accountingissues
Violations of the cleansurplus relationship
Variations from fair value
Intangible assets effects on BV
Nonrecurring items and otheraggressive accounting practices
International accounting differences
m. Over/Fairly/Undervalued
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 71
43.1 PrivateCompanyValuation
a. Privatecompanyvaluationvs. public
Companyspecific factors
Stage of lifecycleSizeQuality & depth of mgmtMgmt/SHD overlapST investorsQuality of financial & other info.Taxes
Stockspecific factorsLiquidityRestrictions on marketabilityConcentration of control
b. Uses of privatebusiness valuation
Transaction relatedvaluations
Venture capital financingIPOSale in an acquisitionBankruptcy proceedingsPerformancebasedmanagerial compensations
Compliance relatedvaluations Financial reporting
Tax purposes
Liquidation relatedvaluations
c. Definitionsof value
Fair market value
Fair value for financial reporting
Fair value for litigation
Market value
Investment value
Intrinsic value
d. Valuationapproaches
f. Incomeapproach
Free CF method
Capitalzed CF method
Excess earnings method
Marketapproach
Assetbasedapproach
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 72
43.2 PrivateCompanyValuation
(cont.)
e. Estimate
Normalized earnings
CF
g. Elements ofdiscount rate
Size premiums
Availability and cost of debt
Acquirer vs. target
Projection risk
Lifecycle stage
h. Estimate ke
CAPM
Expanded CAPM
Buildup method
i. Marketapproaches
GPCM (Guideline publiccompany method)
GTM (Guidelinetransactions method)
PTM (Prior transaction method)
j. Asset basedapproach
k. Use of discounts& premiums
Discount forlack of control
Discount for lackof marketability
l. Role ofvaluationstandards
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 73
CFA LEVEL 2
ALTERNATIVE INVESTMENTS
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 74
44.Investment
Analysis
a. RE Investmentcharacteristics
Valuing realestateinvestments
c. Calculate
CFAT = NOI - debt service - taxes payable
EART = selling price - selling costs - mortgage balance - taxes on sale
b. Evaluate a real estateinvestment using NPV, IRR
d. Potentialproblemswith IRR
Multiple IRRs
Ranking conflicts
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 75
45. IncomePropertyAnalysis
AndAppraisal
a. Capitalization ratevs. discount rate
b. Determinecap rate by
Marketextractionmethod
band ofinvestmentmethod
builtupmethod
c.
Directcapitalizationapproach
Gross incomemultiplier technique
d. Contrast
Limitations of the directcapitalization approach Selecting the appropriate cap rate
Application to incomeproducing property
Limitations of thegross incomemultiplier approach
Discontinuous pricing
Lack of information
Gross rent vs. NOI
Distorted selling prices
Unique or nonincomeproducing properties
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 76
46.1. PrivateEquity
Valuation
Background: Private equity (PE)
a. Sources of valuecreation in PE
1. Reengineering
2. Favorable debt financing
3. Superior alignment ofinterests (also see los b)
b. Aligningmanagerial andownership interestsin PE firms
Incentives Compensation
Tagalong, dragalong clauses
Effectivestructuring ofinvestmentterms
Board representationNoncompete clausesPriority in claimsRequired approvalsEarnouts
c. Characteristics ofVenture Capital
Buyout Investments
d. Valuationissues
e. Exit routes in PE
IPO
Secondary market sale
MBO
Liquidation
g. Investingin PE firms
Risks Specific risksGeneral risks
Costs
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 77
46.2.PrivateEquity
Valuation(cont)
f. PEFund
Structures
Company limited by shares
Limited partnership (Most)LPsGP
Most are closedend
2 businessesraising fundmanaging PE investments
Terms
Shouldfocus onaligningtheinterestsof GP &LPs
Economicterms
Management fees
Transaction fees
Carried interest
Ratchet
Hurdle rate
Target fund size
Vintage
Terms of the fund
Corporategovernanceterms
Key man clause
Performance disclosure &confidentiality
Clawback
Distribution waterfall
Tagalong, dragalong clauses
Removal for cause
Nofault divorce
Investment restrictions
CoinvestmentOnly vailable for "qualified" investorsFund prospectus
Valuation NAV
Ways todetermineNAV
1. At cost, adjusting for subsequent financing and devaluation2. The minimum of cost or market value3. By revaluing a portfolio company anytime there is new financing4. At cost with no adjustment until exit5. By discounting for restricted securities6. Less frequently, marked to market by reference to a peer group ofpublic companies, applying illiquidity discounts to public comparables
Issues incalculatingNAV
Stale NAVNo definitive methodUndrawn LP capitalComparison between PE fundsGP usuallyvalues
>Now, more and more independent parties value
Due diligence of PEfund investments
PE funds tend to exbihit a strong persistence of returns over timeThe performance range between funds is extremely largeLiquidity in PE is typically very limited and thus LPs are locked for the long term
a
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 78
46.3. PrivateEquity
Valuation(cont.)
h.Evaluationof PEfundperformance
Quantitativemeasures
IRRGross IRR
Net IRR
Multiples
PIC
DPI
RVPI
TVPI
i. Calculatingperformancemeasures
management feescarried interestNAV
Multiples
PIC
DPI
RVPI
TVPI
Other analyses
Benchmarks
Components ofperformancefrom an LBO
Earning growths
Increase in price multiples
Debt reduction
Exit value = investment cost + earnings growth +increase in price multiple + reduction in debt
j. VC method
1.1. Valuation for a singlefinancing round
1.2. Valuation for multiplefinancing rounds (11 steps)
Funds from operations / Total debtFunds from operations / capital spending requirements(Free operating CF + Interest) / InterestDebt service coverage = (Free OCF + interest) /(Interest + annual principal repayment)
Leverage ratio = Debt payback period = Total debt / Discretionary CF
Limits of the Basic SecurityFlow of funds structureRate, or UserCharge,CovenantsPriorityofRevenue ClaimsAdditionalBonds test
i. Analysis ofSovereign Bonds
Keyconsiderations
Economic risk(ability)
Economic and Income structureProspects for economic growthDegree of fiscal flexibilityPublic debt burdenMonetary policy and Price stabilityBOP flexibilityExternal debt and liquidity
Political risk(willingness)
2 ratings Local currency debt ratingForeign currency debt rating
j. Contrast creditanalysis
Corporate bonds vs. ABSCorporate bonds vs. Municipal securitiesCorporate bonds vs. Sovereign debt
CFA MINDMAPS 2012- LEVEL 2- AFTC copyright Page 83
b. Factors that favorinternational marketintegration
Many private and institutional investors who are internationally activeEssentially all major corporations have multinational operationsCorporations and Governments borrow and lend on an international scale
StandardCAPM
2 basic results Separation theorem
Riskpricing relationship
c. Assumptionsof domesticCAPM
Riskaverse investorsHomogeneous expectationsInvestors concerned with nominal returns in home currencyRisk free security available for lending and borrowingNo taxes, no transaction costs
d. ExtendedCAPM
Elements Riskfree rate = Investor's domestic risk free rateMarket portfolio = All risky assets in the world
Additional assumptions(unreasonable) Investors have identical consumption baskets
PPP holds exactly
ICAPM
Warmup: domestic and foreign currency returns
e. Real e/r and domesticcurrency returns
f. CalculateExpected exchange rateDomesticcurrency HPRon a foreign bond
g. CalculateEndofperiod real e/rDomestic currency expostreturn on a foreign bond
h. Calculate foreigncurrency risk premium
i. ICAPM FormulaInvestor's domestic risk free rateWorld market risk premiumSensitivity of asset to changesin all foreign currencies