Guide CFA Level I Exam Review Notes: Debt & Derivatives

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Derivatives While there is no credit risk at contract initiation, the potential credit risk of an interest rate swap is greatest at the middle of its life; it does not increase throughout the life of the swap. Economics external factors in porters framework are government , social changes, technology, demographics and foreign influences.

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Economics graham and dodd want to buy cycling businesses at bargain prices and growth stocks at or under intrinsic value. FSA equity income is only from those you control consolidation or JVs not equity or small investments. FSA all current method all assets convert at current rate year end , all income statement converts at the average rate. Alternatively, it is the change in the pension obligation less the change in plan assets adjusted for cash contributions and benefit payments. Sale of receivables with recourse can be thought of as collateralized borrowing and needs to be part of the adjustment to the debt level.

So total assets decrease by The adjustment would also require an increase the bad debt expense of which reduces net income by FSA Quality of earnings refers to the degree of conservatism in reported earnings. Accelerated depreciation methods are an indication of high earnings quality; both sale of receivables with partial recourse and guarantees of unconsolidated subsidiary debt represent off-balance sheet financing techniques, which lower the quality of earnings. Your email address will not be published.

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I hope they are of use to someone out there… Alternative Investments Altinv bonds The purpose of credit tranching is for the subordinate tranche to absorb credit losses. FRA is yet another derivative product. The underlying in an FRA is an interest rate on a deposit or on a loan i. It is the beginning and ending of these periods that form the notation of an FRA.

For example, 2 x 5 FRA means that the derivative contract expires in 2 months and the underlying deposit or loan is initiated at the end of 2 months from now and ends at the end of 5 months from now i. The payment made at the expiration of the FRA is the difference between the Value of the FRA and the agreed upon price of the FRA, adjusted by the notional principal and the number of days.

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Pricing Futures is similar to Forwards, future price for an asset with no storage costs is given by:. The market price of a Forward contract is the amount a party to the transaction is willing to pay to terminate the contract. However, because futures are traded on an exchange and are settled and marked-to-market daily , the Futures contract have zero value at the end of the day and have non-zero value during the day.

Because of the daily settlement feature of futures, cash is exchanged daily between the long and the short and this cash can be invested to earn a return.

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  • And because of this futures prices are sometimes higher than forwards for an identical contract. If holding an underlying asset results in monetary costs and benefits net cost , futures price is:. If holding an underlying asset results in non-monetary benefits convenience yield , futures price is:. All other formulas dividend paying asset, coupon paying asset, etc for pricing futures are similar to forwards. The above stuff is easy on its own but gets tricky when combined with International Asset Pricing reading from study session 18 on Portfolio Management.

    Note here that the price levels are already adjusted for inflation, hence if real exchange rates are constant then any change in nominal exchange rate is explained by the difference in inflation.


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    According to the Schweser, most people find the Derivatives topic to be the most difficult in Level 2 … I find it fun and relatively easy perhaps because I want to work in the dazzling world of derivatives … Because you need to understand forwards to understands futures and swaps, this will be a long post. The key to derivatives is to understand how the price of the underlying asset and interest rates influence the value of the derivative…read on and it will be clear.

    At expiration, a forward contract can be terminated by having the short make delivery of asset to the long or having the long and short exchange the equivalent cash value. If the asset is worth more less than the forward price, the short long pays the long short the cash difference between the market price or rate and the price or rate agreed on in the contract. A party can terminate a forward contract prior to expiration by entering into an opposite transaction with the same or a different counterparty.

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    It is possible to leave both the original and new transactions in place, thereby leaving both transactions subject to credit risk [counterparty risk], or to have the two transactions cancel each other. In the latter case, the party owing the greater amount pays the market value to the other party, resulting in the elimination of the remaining credit risk. This elimination can be achieved, however, only if the counterparty to the second transaction is the same counterparty as in the first.

    The forward price is the price that a long will pay the short at expiration and expect the short to deliver the asset. There is no cash exchange at the beginning of the contract and hence the value of the contract at initiation is zero. The value of a forward contract after initiation and during the term of the contract as the price of the underlying asset S changes.

    The value or payoff of a short position is the opposite of the long i. Valuation of a forward contract is important because 1 it makes good business sense to know the values of future commitments, 2 accounting rules require that forward contracts be accounted for in income statements and balance sheets, 3 the value gives a good measure of the credit exposure, and 4 the value can be used to determine the amount of money one party would have to pay another party to terminate a position.

    Calculating the forward price of a security with cash flow includes one additional which is either the present or future value of the cash flow discounted at the risk free rate.

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    In words of CFA Institute:. The [forward]price, which is actually an exchange rate, of a forward contract on a currency is the spot rate discounted at the foreign interest rate over the life of the contract and then compounded at the domestic interest rate to the expiration date of the contract.

    This reading introduces some of the basic concepts of analyzing equity investments. Global financial analysis involves comparing company ratios with global industry averages.

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    In this context, DuPont analysis uses various combinations of the tax retention, debt burden, operating margin, asset turnover, and leverage ratios. Inflation affects historical inventory and borrowing costs on reported earnings, as well as the inflation tax reflected in capital gains taxes i. This index is used to measure competition in an industry. The US Department of Justice uses this index to measure industry concentration.