LEVEL 2 CFA

EDUCATION QUICKSHEET
 quantitative methods
READING 1 : INTRODUCTION TO LINEAR
REGRESSION

where:
Y = dependent variable
X = independent variable
b_0 = intercept
b_1 = slope coefficient
= error term
n = number of observations

LINEAR LEAST SQUARES

TEST STATIC FOR SLOPE COEFFICIENT

TEST STATIC FOR CORRELATION

Note : Correlation coefficient is labelled as COEFFICIENT
Multiple R in regression output.

TEST STATIC FOR THE INTERCEPT

 If sample is very large,
PREDICTION INTERVAL FOR

where r = sample correlation between

regression residuals from one period and
those from the previous period
LOG-LIN MODEL LOGISTIC REGRESSION (LOGIT MODEL)

LIN-LOG MODEL

LIN-LOG MODEL

READING 2 ; MULTIPLE REGRESSION

READING 3: TIME-SERIES ANALYSIS

where : LINEAR TREND MODELS
Y = dependent variable
x = independent variable
b_0 = intercept
t = time (independent variable)
b_1, b_2, ...., b_k = slope efficients
LOG-LINEAR TREND MODELS
= error term
n = number of observations
k = number of independent variables
b_0, b_1, b_2,...., b_k = regression coefficients

BREUSCH-PAGAN TEST

R^2 = R-squared between squared residuals on

independent variables
DURBIN WATSON TEST
READING 4 : BIG DATA PROJECTS
Normalization of variable X

Standardization of variable X
 economics
READING 5 : CURRENCY EXCHANGE RATES : RELATIVE PP
UNDERSTANDING EQUILIBRIUM VALUE

EX ANTE PP

COVERED INTEREST RATE PARITY

INTERNATIONAL FISHER EFFECT

= Expected inflation rate

= Actual inflation rate
READING 6 : ECONOMIC GROWTH AND THE
INVESTMENT DECISION
MARKET-TO-MARKET VALUE OF A FORWARD
CONTRACT
Return on aggregate equity market
Original position : Long base currency d
forward at forward rate
P = aggregate value of equities
E = aggregate earnings
COBB-DOUGLAS PRODUCTION FUNCTION

UNCOVERED INTEREST RATE PARITY

Y = Output
α = Share of output allocated to capital (K)
1 - α = share of output allocated to labor (L)
T = total factor productivity (TFP), represents
technological progress of the economy

ABSOLUTE PP
Growth Accounting equation:

Growth rate in potential GDP = Long term

growth rate of labor force + Long term growth
rate in labour productivity

Sustainable growth rate of output per capita

Sustainable growth rate of output

Equilibrium output to capital ratio

ENDOGENEOUS GROWTH MODEL

Production function :

Growth rate of output per capita :

y_e = output per worker

k_e = capita
c = marginal product of capital in the aggregate
economy (constant)
financial reporting and analysis
READING 7 : INTERCORPORATE Full Goodwill = fair value of entity - fair value
INVESTMENTS of net identifiable assets
FINANCIAL ASSETS Non controlling interest = %NCI x fair value
Amortized Cost of entity
Ending debt investment = beginning debt IFRS
investment + interest income - interest Impairment loss = carrying value of cash
received generating unit - recoverable amount of cash
Realized gain = sales proceeds - carrying generating unit
US GAAP
value of financial asset
implied goodwill = fair value of reporting unit
FVOCI or FVPL
- fair value of reporting unit‘s identifiable net
Unrealized gain or loss = change in fair value
assets.
fo financial asset
impairment loss = carrying value of goodwill
INVESTMENTS IN ASSOCIATES
- implied goodwill.
Ending investment in associates = beginning READING 8 : EMPLOYEE COMPENSATION -
investment in associates + share of net POST-EMPLOYEMENT AND SHARE-BASED
income - share of dividend received - funded status - fair value of plan assets - PV
amortization of excess purchase price. of defined benefit obligation.
Impact on investor’s income statement = net Pension Asset = Min(Positive Funded
share of net income - amortization of excess State, Asset Ceiling).
purchase price - share of unrealized profit periodic pension cost = employer
from downstream or upstream sale. contributions - ( ending funded status -
ACQUISITION METHOD beginning funded status )
Excess purchase price = Acquisition price - = current service costs + interest expense +
%ownership x book value of net identifiable past service costs - actual return on plan
assets assets + actuarial loss (gain).
Partial Goodwill = Acquisition price - ending benefit obligation = beginning benefit
(%ownership x fair value of net identifiable obligation + service cost. +interest cost -
assets) benefits paid + actuarial loss/(gain).
= acquisition price - %ownership x book value ending fair value of plan assets = beginning
of identifiable net assets - %ownership x fair value of plan assets + actual return on
plan assets + employer‘s contribution -
excess purchase price attributable to net
benefits paid.
identifiable assets.
Non controlling interest = %NCI x fair value of
identifiable net assets
IFRS
periodic pension cost in income statement =
current service costs + past service costs + net
interest expense/(income)
net interest expense/(income) = discount rate x
(beginning PBO - beginning plan assets)
READING 10 : EVALUATING QUALITY OF
US GAAP
FINANCIAL REPORTS
periodic pension cost in income statement =
current service costs + amortized past service
costs + interest expense - expected return on
plan assets + amortized actuarial loss/(gain)
interest expense = discount rate x beginning
PBO
expected return on plan assets = expected rate
of return x beginning plan assets
READING 9 : ANALYSIS OF FINANCIAL
INSTITUTIONS

READING 11 : INTEGRATION OF FINANCIAL

STATEMENT ANALYSIS TECHNIQUES

Bank can withstand a stress level volume of

cash outflows for (LCR x 30) days.

PROPERTY AND CASUALTY COMPANIES

 CORPORATE FINANCE
READING 12: CAPITAL STRUCTURE SHARE REPURCHASE

Weighted average cost of capital, rWACC

Value of levered firm,

ANALYSIS OF DIVIDEND SAFETY
Cost of Equity, re

READING 14 : MERGERS AND AQUISITIONS

If acquirer pays using shares:

STATIC TRADE OF THEORY:

COMPARABLE COMPANY ANALYSIS

rd = Cost of debt(pre-tax)
r0 = Cost of an all- equity firm

READING 13: DIVIDENDS AND SHARE

REPURCHASES ANALYSIS BID EVALUATION

TARGET PAYOUT ADJUSTMENT MODEL

(LINTNER MODEL)

CONSTANT DIVIDEND PAYOUT RATIO

POLICY
READING 15 : CAPITAL BUDGETING

Initial Outlay =

Annual after-tax operating cash flows, ATOCF

Terminal year after-tax non-operating cash flow,

TNOCF

FCI_nv = fixed capital investment

WCI _nv = working capital investment
Sal_0 = sales proceeds of old equipment
B_0 = net book value of old equipment
T = marginal tax rate

EQUIVALENT ANNUAL ANNUITY (EAA)

[PV] = -Project NPV
[I/Y] = Project’s discount rate
[N] = Project life
[FV] = 0
[CPT] [PMT] EAA
 EQUITY VALUATION
READING 16 : EQUITY VALUATION FAMA-FRENCH MODEL
APPLICATIONS AND PROCESS Required return on stock

PASTOR-STAMBAUGH MODEL
where: VE = Estimated intrinsic value Required return on stock
P = Market Price
V = Intrinsic Value
R_F= 1-month T-bill rate (for Fama-French and Pastor-
Stambaugh models only)
Conglomerate Discount = Sum-of-the-parts R_mkt-R_f= return on value-weighted market index minus
value - Market Value risk-free rate
R_small-R_big= Small-cap return premium (R_small Cap-
R_large Cap)
READING 17 : RETURN CONCEPTS R_HBM - R_LBM= value return premium (R_value-R_growth)
R_LowLiq- R_HighLiq= Liquidity premium (R_LowLiquidity
stocks - R_High liquidity stocks)

V0 = true intrinsic value BUILD UP METHOD:

Equity risk premium, ERP =

BOND-YIELD-PLUS-RISK-PREMIUM METHOD:

GORDON GROWTH MODEL:

BLUME’S ADJUSTMENT FOR REGRESSION BETA

IBBOTSON - CHEN MODEL:

CAPM:

COUNTRY SPREAD MODEL

 H - half-life in years of the high-growth period
READING 18 : INDUSTRY AND COMPANY
ANALYSIS Sustainable growth rate,

Return on invested capital (ROIC) = PRAT MODEL

NOPLAT = Net operating profit less adjusted taxes

Return on capital employed (ROCE) = READING 20 : FREE CASH FLOW VALUATION

READING 19 : DISCOUNTED DIVIDEND FREE CASH FLOW TO THE FIRM (FCFF)

VALUATION VALUATION APPROACH

DISCOUNTED DIVIDEND VALUATION

FCFE VALUATION APPROACH

GORDON GROWTH MODEL SINGLE-STAGE (CONSTANT GROWTH) FCFF AND

FCFE MODEL

FCFF VALUATION APPROACH

FIXED-RATE PERPETUAL PREFERRED STOCK

Value of stock= Value of a company with zero- FCFE VALUATION APPROACH

growth + Present value of growth opportunities
(PVGO)

FREE CASH FLOW TO THE FIRM, FCFF

If dividend and earnings growth rate is constant,

Where:
NI=Net Income available to common
TWO-STAGE DIVIDEND DISCOUNT MODEL shareholders
NCC= Net Noncash Charges (e.g. depreciation)
Int= Interest expense
FCInv = Investment in fixed capital
THE H-MODEL = Maintenance Capex + Growth Capex
=
WCInv= Investment in working Capital
 Method 2 : Average ROE Approach
FREE CASH FLOW TO THE EQUITY, FCFE
FCFE = FCFF-Int(1-Tax Rate)+ Net borrowing
= CFO- FCInv+ Net borrowing
Where:
Net Borrowing=Debt issues-Debt repaid
If (FCInv- Dep) and WCInv funded using Debt Earnings Surprise = Reported EPS - Experted EPS
(based on debt ratio)
FCFE= NI+ Dep-FCInv+Net borrowing Scaled earnings surprise =

Where: Standardised unexpected earnings (SUE) =

Net borrowing = DR(FCInv-Dep) + DR(WCInv)

Portfolio P/E
If company issues preferred shares:

TWO-STAGE FREE CASH FLOW MODELS

READING 22 : RESIDUAL INCOME VALUATION

ECONOMIC VALUE ADDED (EVA)

MARKET VALUE ADDED (MVA)

Value of the Firm = Value of operating assets +
Value of non-operating assets RESIDUAL INCOME, RI
READING 21 : MARKET-BASED VALUATION PRICE
AND ENTERPRISE VALUE MULTIPLES RESIDUAL INCOME MODEL
Enterprise Value, EV= Market value of common
stock+ Market value of preferred equity+ market
value of debt + minority interest- cash and
investments Single-stage residual income valuation model

Tobin‘s Q =

Continuing Residual Income

If RI declines to Long-run level In mature find

industry, with premium over book value

Underlying Earnings= EPS- Non recurring gains+

non recurring loss
NORMALISED EARNINGS
Method 1 : Average EPS Approach
Clean surplus relationship:

READING 23 : PRIVATE COMPANY VALUATION

CAPITALISED CASH FLOW METHOD (CCM)

EXCESS EARNINGS METHOD (EEM)

Excess Earnings= Normalised Earnings - Earnings
required to provide the required rate of return on
working capital and fixed assets

DISCOUNT FOR LACK OF CONTROL AND

MARKETABILITY
 FIXED INCOME
READING 24 : THE TERM STRUCTURE AND FOR PARALLEL SHIFTS IN YIELD CURVE:
INTEREST RATE DYNAMICS

FORWARD PRICING MODEL

NON-PARALLEL SHIFTS (i.e. CHANGE IN
SLOPE OR CURVATURE):

READING 25 : THE ARBITRAGE-FREE

VALUATION FRAMEWORK

Arbitrage-free value of bond:

FORWARD RATE MODEL

BACKWARD INDUCTION VALUATION

METHODOLOGY

CALCULATING SPOT RATE FROM ONE-

PERIOD FORWARD RATES

FIXED SWAP RATE

SWAP SPREAD =
COX-INGERSOLL-ROSS (CIR) MODEL
TED SPREAD =

VASICEK MODEL
LIBOR-OIS SPREAD =
 Expected Loss = Probability of Default x Loss Given
a = Speed of reversion (>0) Default
b = Long-run interest rate
𝜎 = Interest rate volatility

HO-LEE MODEL

KALOTAY-WILLIAMS-FABOZZI (KWF) MODEL

READING 26 : VALUATION AND ANALYSIS -

BONDS WITH EMBEDDED OPTIONS

Value of callable bond = Value of straight bond -

Value of issuer call option

Value of putable bond = Value of straight bond +

Value of investor put option STRUCTURAL MODEL

CONVERTIBLE BONDS
Present Value of Expected Loss (PVOEL) = PV of
risk-free bond - PV of risky bond
READING 28 : CREDIT DEFAULT SWAPS
CDS payout amount = Payout ratio x Notional
= (1-Recovery rate) x Notional

Upfront payment = PV of protection leg - PV of

premium leg

READING 27 : CREDIT ANALYSIS MODELS

 Derivatives
READING 29 : Pricing and Valuation of Valuation for Fixed Income forward
Forward Commitments contracts:
Forward Pricing:

Valuation for fixed income futures

contracts:

Note: CC and CB are continuously Interest Rate Swaps (IRS):

compounded rates Pricing:
Forward Valuation (Long Position):

Valuation:
Pay-fixed, receive-floating IRS
Forward Rate Agreement (FRA):
Payoff at expiration:
Long FRA payoff at expiration of FRA
Receive-fixed, pay-floating IRS
=

Pricing : Currency Swap:

Pricing for fixed leg of currency in currency 𝑎
Valuation (prior to FRA Experience):

Value of a fixed-for-fixed currency swap

Fixed Income Forwards and Futures :

Pricing:
Equity Swap: Black-Scholes Option Pricing Model
Value of equity swap (receive fixed-rate,
pay equity return)

Cash flow for equity leg= National x Put-call Parity:

Periodic equity return

READING 30: Valuation of Contingent Claims

BSM model with Carry benefits:

No-Arbitrage Approach:

Put-call Parity:
Black Option Valuation Model: European
Expectations Approach:
Options on Futures

One-period binomial model:

Put-call parity:

Note: For interest rate options, π= 0.5 and

Interest Rate Options:
discount expected option payoff using the
1-period forward rates.
Two -period binomial Model:

For 2-period American-styled call option

with dividend in t = 1:
Payer Swaption

Receiver Swaption

Optimal Number of Hedging Units

 Alternative Investments
READING 31 : Real Estate Investments Appraisal with Terminal Value (or
Net lease= Gross lease- operating expense Resale/Reversion Value):
Appraisal-based Index:

Highest and Best Use: N= Investor‘s Holding period

Implied land value= Value after Going in Cap Rate=
construction- Cost to construct building
Private Market Real Estate Debt
Direct Capitalisation Method LTV Ratio=
Value of property (at the time of
purchase)= Debt Service coverage ratio, DSCR=
Equity dividend rate=
Value of property (at the time of
purchase)=

Cap Rate of comparable= Note: Equity dividend rate also called

“cash-on-cash“ return.
IRR= Cap rate+ Growth rate of NOI
Net Asset Value Approach:
If property under renovation. NAV Per Share=
Value of property= Value if renovated -
Loss in value due to renovation
Where:
Gross income multiplier= Value of operating estate=

Discounted Cash Flow Method Funds from Operation:

Constant Growth Rate: FFO=

Adjusted Funds from Operations:

AFFO=
 READING 32 : Private Equity Investments
Venture Capital Method:

Post money valuation=

VC Fractional Ownership=

VC Fractional Ownership=

Price paid per share=

For two stages of financing (Stage A and

Stage B)

Return Multiples for Private Equity Funds

Paid in Capital, PIC=

Distributed to paid in, DPI=

Residual value to be paid in, RVPI=

Total value to be paid in, TVPI= DPI+ RVPI

READING 33: Introduction to Commodities

ands Commodity Derivatives
 Portfolio Management
READING 34: Exchange-Traded Funds: WML = winners minus losers, a momentum
Mechanics and Applications factor; return on a portfolio of past year’s
End-of-day ETF Premium or discount (%)= winners minus return on a portfolio of past
year’s losers.

Intraday ETF premium or discount(%)= Macroeconomic Factor Model:

Holding period cost (%)=

Round trip trade cost (%)= Fundamental Factor Model:

READING 35 : Using Multifactor Models Return Attribution

Arbitrage Pricing Theory(APT):

Tracking Error, TE=

Information ratio, IR=

Active risk squared=

Carhart Four-Factor Model
Active factor risk + Active Specific risk
READING 36 : Measuring and Managing
Models
RMRF= Return on a value-weighted equity
Parametric VaR (Using Normal
index minus one-month T-bill rate
Distribuition)

SMB = small minus big; average return on

three small-cap portfolios minus the
average return on three large-cap
portfolios
Two- Asset Portfolio:

HML = high minus low; average return on

two high book-to-market portfolios minus
average return on two low book-to-
market portfolios
Scanning from Daily returns to annual returns: =policy rate at time t
=level of real short-term interest rates that balance long
term savings and borrowing in the economy
=rate of inflation
=target rate of inflation
Percentage change in bond price: = logarithmic level of actual GDP
= logarithmic level of potential real GDP
= output gap
Corporate Bond:

READING 37 : Economics and Investment

Markets
Equity:
One-Period real-risk free rate:

Internal-temporal rate of
substitution

Commercial Real Estate:

Where:
= Risk neutral present value

= Covariance between
investor’s inter-temporal rate of READING 38 : Analysis of Active Portfolio
substitution and the random future price Management
the investment at t + 1, based on the
information available to investor today.

s= time to maturity of investment

Default-free nominal coupon-paying bond

For Optimal Sharpe ratio:

Short-dated nominal zero-coupon

government bonds(T-Bills) For Optimal Sharpe ratio:

Taylor Rule:
Transfer Coefficient, TC= For Sell orders:

Information Coefficient, IC=

Note: Midquote prices calculated based on bid
and ask prices at the time order was entered.

Effective spread= 2 X Effective spread

Mean-variance optimal weights transaction cost estimate.

VWAP Transaction cost estimate:

Full Fundamental Law: For Buy orders:

For Sell orders:

Performance Measurement:

= Proportion of variation in realised

performance attributed to realised
information coefficient.

= realised information coefficient

Ex-ante measurement of skill:

Independence of Investment Decision:

READING 39 : Trading Costs and Electronic

Markets
Optimal Mid-quote price=

Effective Spread transaction cost estimate:

For Buy orders: