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LOS Detail June 2010 (Old) LOS Detail June 2011 SS LOS LOS Description Sub Sub LOS Description SS LOS LOS Description LOS 1 1 Code of Ethics a. state the six components of the Code 1 1 Code of Ethics and Standards of of Ethics and the seven Standards of and Standards of Professional Professional Conduct; Professional Conduct Conduct b. explain the ethical responsibilities required by the Code and Standards. 2 "Guidance" for a. demonstrate a thorough knowledge 2 Guidance for Standards I-VII of the Code of Ethics and Standards Standards I-VII of Professional Conduct by applying the Code and Standards to specific situations; b. recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct. 3 CFA Institute Soft a. define soft-dollar arrangements and 3 CFA Institute Soft Dollar Standards state the general principles of the Dollar Standards Soft Dollar Standards; b. critique company soft-dollar practices and policies; c. determine whether a product or service qualifies as “permissible research” that can be purchased with client brokerage. 4 CFA Institute a. explain the objectives of the 4 CFA Institute Research Research Objectivity Standards; Research Objectivity b. critique company policies and Objectivity Standards practices related to research Standards objectivity and distinguish between changes required and changes recommended for compliance with the Research Objectivity Standards. 2 5 The Glenarm a. critique the practices and policies 2 5 The Glenarm Company presented; Company b. explain the appropriate action to take in response to conduct that violates the CFA Institute Code of Ethics and Standards of Professional Conduct. 6 Preston Partners a. critique the practices and policies 6 Preston Partners presented; b. explain the appropriate action to take in response to conduct that violates the CFA Institute Code of Ethics and Standards of Professional Conduct. 7 Super Selection a. critique the practices and policies 7 Super Selection presented; b. explain the appropriate action to take in response to conduct that violates the CFA Institute Code of Ethics and Standards of Professional Conduct. 8 Trade Allocation: a. critique trade allocation practices and 8 Trade Allocation: Fair Dealing and determine whether there is Fair Dealing and Disclosure compliance with the CFA Institute Disclosure Standards of Professional Conduct addressing fair dealing and client loyalty; Fair Dealing and determine whether there is Fair Dealing and Disclosure compliance with the CFA Institute Disclosure Standards of Professional Conduct addressing fair dealing and client loyalty; b. discuss appropriate actions to take in response to trade allocation practices that do not adequately respect client interests. 9 Changing a. critique the disclosure of investment 9 Changing Investment objectives and basic policies and Investment Objectives determine whether they comply with Objectives the CFA Institute Standards of Professional Conduct; b. discuss appropriate actions needed to ensure adequate disclosure of the investment process. 10 Prudence in a. explain the basic principles of the 10 Prudence in perspective new Prudent Investor Rule; Perspective b. explain the general fiduciary standards to which a trustee must adhere; c. differentiate between the old Prudent Man Rule and the new Prudent Investor Rule; d. explain the key factors that a trustee should consider when investing and managing trust assets. 3 11 Correlation and a. calculate and interpret a sample 3 11 Correlation and Regression covariance and a sample correlation Regression coefficient and interpret a scatter plot; b. explain the limitations to correlation analysis, including outliers and spurious correlation; c. formulate a test of the hypothesis that the population correlation coefficient equals zero and determine whether the hypothesis is rejected at a given level of significance; d. differentiate between the dependent and independent variables in a linear regression; e. explain the assumptions underlying linear regression and interpret the regression coefficients; f. calculate and interpret the standard error of estimate, the coefficient of determination, and a confidence interval for a regression coefficient; g. formulate a null and alternative hypothesis about a population value of a regression coefficient, select the appropriate test statistic, and determine whether the null hypothesis is rejected at a given level of significance; h. calculate a predicted value for the dependent variable, given an estimated regression model and a value for the independent variable and calculate and interpret a confidence interval for the predicted value of a dependent variable; i. describe the use of analysis of variance (ANOVA) in regression analysis, interpret ANOVA results, and calculate and interpret an F- statistic; j. discuss the limitations of regression analysis. 12 Multiple a. formulate a multiple regression 12 Multiple Regression and equation to describe the relation Regression and Issues in between a dependent variable and Issues in Regression several independent variables, Regression Analysis determine the statistical significance Analysis of each independent variable, and interpret the estimated coefficients and their p-values b. formulate a null and an alternative hypothesis about the population value of a regression coefficient, calculate the value of the test statistic, determine whether to reject the null hypothesis at a given level of significance by using a one-tailed or two-tailed test, and interpret the results of the test; c. calculate and interpret 1) a confidence interval for the population value of a regression coefficient and 2) a predicted value for the dependent variable, given an estimated regression model and assumed values for the independent variables; d. explain the assumptions of a multiple regression model; e. calculate and interpret the F-statistic and discuss how it is used in regression analysis; define, distinguish between, and interpret the R2 and adjusted R2 in multiple regression; and infer how well a regression model explains the dependent variable by analyzing the output of the regression equation and an ANOVA table. - - - - f. formulate a multiple regression equation by using dummy variables to represent qualitative factors and interpret the coefficients and regression results; g. discuss the types of heteroskedasticity and the effects of heteroskedasticity and serial correlation on statistical inference; h. describe multicollinearity and discuss its causes and effects in regression analysis; i. discuss the effects of model misspecification on the results of a regression analysis and explain how to avoid the common forms of misspecification; j. discuss models with qualitative dependent variables; k. interpret the economic meaning of the results of multiple regression analysis and critique a regression model and its results. 13 Time-Series a. calculate and evaluate the predicted 13 Time-Series Analysis trend value for a time series, Analysis modeled as either a linear trend or a log-linear trend, given the estimated trend coefficients; b. discuss the factors that determine whether a linear or a log-linear trend should be used with a particular time series and evaluate the limitations of trend models; c. explain the requirement for a time series to be covariance stationary and discuss the significance of a series not being stationary; d. discuss the structure of an autoregressive (AR) model of order p, calculate oneand two-period-ahead forecasts given the estimated coefficients, and explain how autocorrelations of the residuals can be used to test whether the autoregressive model fits the time series - - e. explain mean reversion and calculate a mean-reverting level; f. contrast in-sample and out-of-sample forecasts and compare the forecasting accuracy of different time-series models based on the root mean squared error criterion; g. discuss the instability of coefficients of time-series models; h. describe the characteristics of random walk processes and contrast them to covariance stationary processes; i. discuss the implications of unit roots for time-series analysis, explain when unit i. roots are likely to occur and how to test for them, and demonstrate how a time series with a unit root can be transformed so it can be analyzed with an AR model; j. discuss the steps of the unit root test for nonstationarity and explain the relation of the test to autoregressive time- series models; k. discuss how to test and correct for seasonality in a time-series model and calculate and interpret a forecasted value using an AR model with a seasonal lag; l. explain autoregressive conditional heteroskedasticity (ARCH) and discuss how ARCH models can be applied to predict the variance of a time series; m. explain how time-series variables should be analyzed for nonstationarity and/or cointegration before use in a linear regression; n. select and justify the choice of a particular time-series model from a group of models. 4 14 Economic Growth a. define the sources of economic 4 14 Economic Growth growth and discuss the preconditions for economic growth; b. discuss how the one-third rule can be used to explain the contributions of labor and technological change to growth in labor productivity; c. discuss how faster economic growth can be achieved by increasing the growth of physical capital, technological advances, and investment in human capital; d. compare and contrast classical growth theory, new classical growth theory, and new growth theory. 15 Regulation and a. explain the rationale for government 15 Regulation and Antitrust Policy in regulation in the form of 1) economic Antitrust Policy in a Globalized a Globalized Economy regulation of natural monopolies and Economy 2) social regulation of nonmonopolistic industries; b. discuss the potential benefits and possible negative side effects of social regulation; c. differentiate between the capture hypothesis and the share-the-gains, share-thepains theory of regulator behavior. 16 Trading with the a. explain comparative advantage and 16 Trading with the world how countries can gain from World international trade; b. compare and contrast tariffs, nontariff barriers, quotas, and voluntary export restraints; c. critique the arguments for trade restrictions. 17 The Exchange a. define an exchange rate and 17 The Exchange Rate and the differentiate between the nominal Rate and the Balance of exchange rate Balance of Payments and the real exchange rate; Payments b. explain the factors that influence supply and demand in the foreign exchange market; c. discuss how the supply and demand for a currency changes the exchange rate; d. differentiate between interest rate parity and purchasing power parity; e. describe the balance of payments accounts; f. describe the following exchange rate policies: flexible exchange rates, fixed exchange rates, and crawling pegs. 18 Currency a. define direct and indirect methods of 18 Currency Exchange Rates foreign exchange quotations and Exchange Rate convert direct (indirect) foreign exchange quotations into indirect (direct) foreign exchange quotations; b. calculate and interpret the spread on a foreign currency quotation and explain how spreads on foreign currency quotations can differ as a result of market conditions, bank/dealer positions, and trading volume; c. calculate and interpret currency cross rates, given two spot exchange quotations involving three currencies; d. calculate the profit on a triangular arbitrage opportunity, given the bid–ask quotations for the currencies of three countries involved in the arbitrage; e. distinguish between the spot and forward markets for foreign exchange; f. calculate and interpret the spread on a forward foreign currency quotation and explain how spreads on forward foreign currency quotations can differ as a result of market conditions, bank/dealer positions, trading volume, and maturity/length of contract; g. calculate and interpret a forward discount or premium and express it as an annualized rate; h. explain interest rate parity and illustrate covered interest arbitrage; i. distinguish between spot and forward transactions, calculate the annualized forward premium/discount for a given currency, and infer whether the currency is “strong” or “weak.” 19 Foreign a. explain how exchange rates are 19 Foreign Exchange Parity determined in a flexible (or floating) Exchange Parity Relations exchange Relations rate system; b. explain the role of each component of the balance of payments accounts; Relations Relations c. explain how current account deficits or surpluses and financial account deficits or surpluses affect an economy; d. describe the factors that cause a nation’s currency to appreciate or depreciate; e. explain how monetary and fiscal policies affect the exchange rate and balance of payments components; f. describe a fixed exchange rate and a pegged exchange rate system; g. define and discuss absolute purchasing power parity and relative purchasing power parity; h. calculate the end-of-period exchange rate implied by purchasing power parity, given the beginning-of-period exchange rate and the inflation rates; i. define and discuss the international Fisher relation; j. calculate the real interest rate, given interest rates and inflation rates and the assumption that the international Fisher relation holds; k. calculate the international Fisher relation, and its linear approximation, between interest rates and expected inflation rates; l. define and discuss the theory of uncovered interest rate parity and explain the theory’s relation to other exchange rate parity theories; m. calculate the expected change in the exchange rate, given interest rates and the assumption that uncovered interest rate parity holds; n. discuss the foreign exchange expectation relation between the forward exchange rate and the expected exchange rate. 20 Measuring a. distinguish between the different 20 Measuring Economic Activity measures of economic activity and Economic Activity their components; b. differentiate between GDP at market prices and GDP at factor cost and explain the adjustments made; c. differentiate between current and constant prices and describe the GDP deflator. 5 21 Inventories: Implications for Financial Statements and Ratios 22 Long-lived Assets: Implications for Financial Statements and Ratios 5 21 Intercorporate a. describe the classification, 6 23 Intercorporate Investments measurement, and disclosure under Investments the International Financial Reporting Standards (IFRS) for 1) investments in financial assets, 2) investments in associates, 3) joint ventures, 4) business combinations, and 5) special purpose b. distinguish between IFRS and U.S. GAAP in the classification, measurement, and disclosure of investments in financial assets, investments in associates, joint ventures, business combinations, and special purpose and variable interest entities; c. analyze the effects on financial ratios of the different methods used to account for intercorporate investments. 6 22 Employee a. discuss the types of post- 24 Employee Compensation: employment benefit plans and the Compensation: Post-Employment implications for Post-Employment and Share-Based and financial reports; Share-Based b. explain the measures of a defined benefit pension plan’s liability (i.e., defined benefit obligation and projected benefit obligation); c. describe the components of a company’s defined benefit pension expense; d. explain the impact of a defined benefit plan’s assumptions on the defined benefit obligation and periodic expense; e. explain the impact on financial statements of International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (U.S. GAAP) for pension and other post- employment benefits that permit items to be reported in the footnotes f. evaluate pension plan footnote disclosures including cash flow related information; g. evaluate the underlying economic liability (or asset) of a company’s pension and other post-employment benefits; h. calculate the underlying economic pension expense (income) and other postemployment expense (income) based on disclosures; i. discuss the issues involved in accounting for share-based compensation; j. explain the impact on financial statements of accounting for stock grants and stock options, and the importance of companies’ assumptions in valuing these grants and options. 23 Multinational a. distinguish among presentation 25 Multinational Operations currency, functional currency, and Operations local currency; b. analyze the impact of changes in exchange rates on the translated sales of the subsidiary and parent company; c. compare and contrast the current rate method and the temporal method, analyze and evaluate the effects of each on the parent company’s balance sheet and income statement, and determine which method is appropriate in various scenarios; d. Calculate the translation effects, evaluate the translation of a subsidiary�s balance sheet and income statement into the parent company�s currency, and analyze the differential effect of the current rate method and the temporal method on the subsidiary�s financial ratios; e. analyze how using the temporal method versus the current rate method will affect the parent company’s financial ratios; f. illustrate and analyze alternative accounting methods for subsidiaries operating in hyperinflationary economies. 7 24 The Lessons We a. distinguish among the various 7 26 The Lessons We Learn definitions of earnings (e.g., EBITDA, Learn operating earnings, net income, etc.); b. illustrate how trends in cash flow from operations can be more reliable than trends in earnings; c. provide a simplified description of the accounting treatment for derivatives being used to hedge: exposure to changes in the value of assets and liabilities, exposure to variable cash flow, and a foreign currency exposure of an instrument in a foreign corporation 25 Evaluating a. contrast cash-basis and accrual- 27 Evaluating Financial basis accounting and explain why Financial Reporting Quality accounting Reporting Quality discretion exists in an accrual accounting system; b. describe the relation between the level of accruals and the persistence of earnings and the relative multiples that the cash and accrual components of earnings should rationally receive in valuation; c. discuss the opportunities and motivations for management to intervene in the external financial reporting process and the mechanisms that discipline such intervention; d. discuss earnings quality and the measures of earnings quality, and compare and contrast the earnings quality of peer companies; e. explain mean reversion in earnings and how the accruals component of earnings affects the speed of mean reversion; f. discuss problems with the quality of financial reporting, including revenue recognition, expense recognition, balance sheet issues, and cash flow statement issues, and interpret warning signs of these potential problems. 26 *Integration of a. demonstrate the use of a framework 28 Integration of Financial for the analysis of financial Financial Statement statements, Statement Analysis given a particular problem, question, Analysis *Techniques or purpose (e.g., valuing equity based Techniques on comparables, critiquing a credit rating, obtaining a comprehensive picture of financial leverage, evaluating the perspectives given in management's discussion of financial results); b. identify financial reporting choices and biases that affect the quality and comparability of companies’ financial statements and illustrate how such biases affect financial decisions; c. adjustments to improve quality and comparability with similar companies, including adjustments for differences in accounting rules, methods, and assumptions; d. predict the impact on financial statements and ratios, given a change in accounting rules, methods, or assumptions; e. analyze and interpret the effects of balance sheet modifications, earnings normalization, and cash-flow- statement-related modifications on a company’s financial statements, financial ratios, and overall financial condition. 8 27 Capital Budgeting a. compute the yearly cash flows of an 8 29 Capital Budgeting expansion capital project and a replacement capital project and evaluate how the choice of depreciation method affects those cash flows; b. discuss the effects of inflation on capital budgeting analysis; c. evaluate and select the optimal capital project in situations of 1) mutually exclusive projects with unequal lives, using either the least common multiple of lives approach or the equivalent annual annuity approach, and 2) capital rationing; d. explain how sensitivity analysis, scenario analysis, and Monte Carlo simulation d. can be used to assess the stand- alone risk of a capital project; e. discuss the procedure for determining the discount rate to be used in valuing a capital project and calculate a project’s required rate of return using the capital asset pricing model (CAPM); f. discuss the types of real options and evaluate a capital project using real options; g. discuss common capital budgeting pitfalls; h. calculate and interpret accounting income and economic income in the context of capital budgeting; i. differentiate among and evaluate a capital project using the following valuation models: economic profit, residual income, and claims valuation. 28 Capital Structure a. define and explain leverage, business 30 Capital Structure and Leverage risk, sales risk, operating risk, and financial risk and classify a risk, given a description; b. calculate and interpret the degree of operating leverage, the degree of financial leverage, and the degree of total leverage; c. calculate the breakeven quantity of sales and determine the company’s net income at various sales levels; d. describe the effect of financial leverage on a company’s net income and return on equity; e. compare and contrast the risks of creditors and owners; f. discuss the Modigliani–Miller propositions concerning capital structure, including the impact of leverage, taxes, financial distress, agency costs, and asymmetric information on a company’s cost of equity, cost of capital, and optimal capital structure; g. explain the target capital structure and why actual capital structure may fluctuate around the target; h. review the role of debt ratings in capital structure policy; i. explain the factors an analyst should consider in evaluating the impact of capital structure policy on valuation; j. discuss international differences in financial leverage and the implications for investment analysis. 29 Dividends and a. discuss cash dividends, stock 31 Dividends and Dividend Policy dividends, stocks splits, and reverse Share stock splits and Repurchases: evaluate their impact on a Analysis shareholder’s wealth; b. compare the impact on shareholder wealth of a share repurchase with a cash dividend of equal amount; c. calculate the earnings per share effect of a share repurchase when the repurchase is made with borrowed funds and the company’s after-tax cost of debt is greater (less) than its earnings yield; d. calculate the book value effect of a share repurchase when the market value of a share is greater (less) than book value per share; e. compare and contrast share repurchase methods; f. review dividend payment chronology including declaration, holder-of- record, exdividend, and payment dates and indicate when a dividend is reflected in the share price; g. summarize the factors affecting dividend payout policy; h. calculate the effective tax rate on a dollar of corporate earnings distributed as a dividend using the double-taxation, split rate, and tax imputation systems; i. discuss the types of information that dividend initiations, increases, decreases, and omissions may convey and cross- country differences in the signaling content of dividends; j. compare and contrast the following dividend policies: residual dividend, longerterm residual dividend, dividend stability, and target payout ratio; k. calculate a company’s expected dividend using the variables in the target payout approach; l. discuss the rationales for share repurchases and explain the signals that share repurchases may generate; m. differentiate among the schools of thought on dividends (dividend irrelevance, dividend preference, and tax aversion) and discuss their implications for shareholder value and the price-to- earnings ratio; n. demonstrate how the initiation of a regular dividend payout might affect the price-to-earnings multiple. 9 30 Corporate a. explain corporate governance, 9 32 Corporate Governance discuss the objectives and the core Governance attributes of an effective corporate governance system, and evaluate whether a company’s corporate governance has those attributes; b. compare and contrast the major business forms and describe the conflicts of interest associated with each; c. discuss the conflicts that arise in agency relationships, including manager–shareholder conflicts and director–shareholder conflicts; d. describe the responsibilities of the board of directors and explain the qualifications and core competencies that an investment analyst should look for in the board of directors; e. illustrate effective corporate governance practice as it relates to the board of directors and evaluate the strengths and weaknesses of a company’s corporate governance practice; f. describe the elements of a company’s statement of corporate governance policies that investment analysts should assess; g. discuss the valuation implications of corporate governance. 31 Mergers and a. categorize merger and acquisition 33 Mergers and Acquisitions (M&A) activities based on forms of Acquisitions integration and types of mergers; b. explain the common motivations behind M&A activity; c. illustrate how earnings per share (EPS) bootstrapping works and calculate a company’s postmerger EPS; d. discuss the relation between merger motivations and types of mergers based on industry life cycles; e. contrast merger transaction characteristics by form of acquisition, method of payment, and attitude of target management; f. distinguish and describe pre-offer and post-offer takeover defense mechanisms; g. summarize U.S. antitrust legislation; h. calculate the Herfindahl–Hirschman Index and evaluate the likelihood of an antitrust challenge for a given business combination; i. compare and contrast the three major methods for valuing a target company, including the advantages and disadvantages of each; j. calculate free cash flows for a target company and estimate the company’s intrinsic value based on discounted cash flow analysis; k. estimate the intrinsic value of a company using comparable company analysis and comparable transaction analysis; l. evaluate a merger bid, calculate the estimated post-merger value of an acquirer, and calculate the gains accrued to the target shareholders versus the acquirer shareholders; m. explain the effects of price and payment method on the distribution of risks and benefits in a merger transaction; n. describe the empirical evidence related to the distribution of benefits in a merger; o. compare and contrast divestitures, equity carve-outs, spin-offs, split-offs, and liquidation; p. discuss the major reasons for divestitures. 10 32 A Note on Asset - valuation by Graham and Dodd and 10 34 A Note on Asset Valuation John Burr Williams are reflected in Valuation modern techniques of equity valuation. (page 13) 33 Equity Valuation: a. define valuation and intrinsic value, 35 Equity Valuation: Applications and and explain possible sources of Applications and Processes perceived Processes mispricing; 33 Equity Valuation: 35 Equity Valuation: Applications and Applications and Processes Processes b. explain the going-concern assumption, contrast a going concern value to a liquidation value, and identify the definition of value most relevant to public company valuation; c. discuss the uses of equity valuation; d. explain the elements of industry and competitive analysis and the importance of evaluating the quality of financial statement information; e. contrast absolute and relative valuation models, and describe examples of each type of model; f. illustrate the broad criteria for choosing an appropriate approach for valuing a given company. 34 Equity: Markets a. explain the origins of different 36 Equity: Markets and Instruments national market organizations; and Instruments b. differentiate between an order-driven market and a price-driven market and explain the risks and advantages of each; c. calculate the impact of different national taxes on the return of an international investment; d. discuss the various components of execution costs (i.e., commissions and fees, market impact, and opportunity cost) and approaches to reducing these costs; e. describe an American Depositary Receipt (ADR) and differentiate among the various forms of ADRs in terms of trading and information supplied by the listed company; f. explain why companies choose to be listed abroad and calculate the cost tradeoff between buying shares listed abroad and buying ADRs; g. state the determinants of the value of a closed-end country fund; h. discuss the advantages of exchange- traded funds (ETFs) and explain the pricing of international ETFs in relation to their net asset value (NAV); i. discuss the advantages and disadvantages of the various alternatives to direct international investing. 35 Return Concepts a. distinguish among the following 37 Return Concepts return concepts: holding period return, realized return and expected return, required return, discount rate, the return from convergence of price to intrinsic value (given that price does not equal value), and internal rate b. explain the equity risk premium and its use in required return determination, and demonstrate the use of historical and forward-looking estimation approaches; c. discuss the strengths and weaknesses of methods used to estimate the equity risk premium; d. Demonstrate the use of the capital asset pricing model (CAPM), the Fama�French model (FFM), the Pastor�Stambaugh model (PSM), macroeconomic multifactor models, and the build-up method (including bond yield plus risk premium method) for estimating the required return on an equity investment; e. discuss beta estimation for public companies, thinly traded public companies, e. and nonpublic companies; f. analyze the strengths and weaknesses of methods used to estimate the required return on an equity investment; g. discuss international considerations in required return estimation; h. explain and calculate the weighted average cost of capital for a company; i. evaluate the appropriateness of using a particular rate of return as a discount rate, given a description of the cash flow to be discounted and other relevant facts. 11 36 Equity: Concepts a. discuss common issues that arise 11 38 Equity: Concepts and Techniques when investing internationally (e.g., and Techniques differences in accounting standards); b. distinguish between country analysis and industry analysis and compare and evaluate key concepts of industry analysis, such as demand analysis, industry life cycle analysis, and competition structure analysis, as well as risk elements inherent in industry c. evaluate the common approaches of equity analysis (ratio analysis and discounted cash flow models, including the franchise value model) and identify mispriced stocks using either method; d. analyze the effects of inflation on asset valuation; e. discuss multifactor models in a global context. 37 The Five a. distinguish among the five 39 The Five Competitive competitive forces that drive industry Competitive Forces that profitability in Forces That Shape Strategy the medium and long run; Shape Strategy b. illustrate how the competitive forces drive industry profitability; c. describe why industry growth rate, technology and innovation, government, and c. complementary products and services are fleeting factors rather than forces shaping industry structure; d. indicate why eliminating rivals is a risky strategy; e. show how positioning a company, exploiting industry change, and the ability to shape industry structure are creative strategies for achieving a competitive advantage. 38 Industry Analysis a. discuss the key components that 40 Industry Analysis should be included in an industry analysis model; b. illustrate the life cycle of a typical industry; c. analyze the effects of business cycles on industry classification (i.e., growth, defensive, cyclical); d. analyze the impact of external factors (e.g., technology, government, foreign influences, demography, and social changes) on industries; e. illustrate the inputs and methods used in preparing industry demand and supply analyses; f. explain factors that affect industry pricing practices. 39 Valuation in a. describe how inflation affects the 41 Valuation in Emerging estimation of cash flows for a Emerging Markets company Markets domiciled in an emerging market; b. calculate nominal and real-term financial projections to prepare a discounted cash flow valuation of an emerging market company; c. discuss the arguments for adjusting cash flows, rather than adjusting the discount rate, to account for emerging market risks (e.g., inflation, macroeconomic volatility, capital control, and political risk) in a scenario analysis; d. estimate the cost of capital for emerging market companies and calculate and interpret a country risk premium. 40 Discounted a. compare and contrast dividends, free 42 Discounted Dividend cash flow, and residual income as Dividend Valuation Valuation measures of cash flow in discounted cash flow valuation, and identify the investment situations for which each measure is suitable; b. determine whether a dividend discount model (DDM) is appropriate for valuing a stock; c. calculate the value of a common stock using the DDM for one-, two-, and multiple-period holding periods; d. calculate the value of a common stock using the Gordon growth model and explain the model’s underlying assumptions; e. calculate the implied growth rate of dividends using the Gordon growth model and current stock price; f. calculate and interpret the present value of growth opportunities (PVGO) and the component of the leading price-to- earnings ratio (P/E) related to PVGO, given no-growth earnings per share, earnings per share, the required rate of return, and the market pr g. calculate the justified leading and trailing P/Es based on fundamentals using the Gordon growth model; h. calculate the value of noncallable fixed-rate perpetual preferred stock given the stock’s annual dividend and the discount rate; i. explain the strengths and limitations of the Gordon growth model and justify the i. selection of the Gordon growth model to value a company’s common shares, given the characteristics of the company being valued; j. explain the assumptions and justify the selection of the two-stage DDM, the Hmodel, the three-stage DDM, or spreadsheet modeling to value a company’s common shares, given the characteristics of the company being valued; k. explain the growth phase, transitional phase, and maturity phase of a business; l. explain terminal value and discuss alternative approaches to determining the terminal value in a discounted dividend model; m. calculate the value of common shares using the two-stage DDM, the H-model, and the three-stage DDM; n. explain how to estimate a required return based on any DDM, and calculate that return using the Gordon growth model and the H-model; o. define, calculate, and interpret the sustainable growth rate of a company, explain the calculation’s underlying assumptions, and demonstrate the use of the DuPont analysis of return on equity in conjunction with the sustainable growth rate expression; p. illustrate the use of spreadsheet modeling to forecast dividends and value common shares. - - 12 41 Free Cash Flow a. interpret free cash flow to the firm 12 43 Free Cash Flow Valuation (FCFF) and free cash flow to equity Valuation (FCFE); 12 41 Free Cash Flow a. interpret free cash flow to the firm 12 43 Free Cash Flow Valuation (FCFF) and free cash flow to equity Valuation (FCFE); b. compare and contrast the FCFF and FCFE approaches to valuation; c. contrast the ownership perspective implicit in the FCFE approach to the ownership perspective implicit in the dividend discount approach; d. discuss the appropriate adjustments to net income, earnings before interest and taxes (EBIT), earnings before interest, taxes, depreciation, and amortization (EBITDA), and cash flow from operations (CFO) to calculate FCFF and FCFE; e. calculate FCFF and FCFE when given a company’s financial statements prepared according to International Financial Reporting Standards (IFRS) or U.S. generally accepted accounting principles (GAAP); f. discuss approaches for forecasting FCFF and FCFE; g. contrast the recognition of value in the FCFE model to the recognition of value in dividend discount models; h. explain how dividends, share repurchases, share issues, and changes in leverage may affect FCFF and FCFE; i. critique the use of net income and EBITDA as proxies for cash flow in valuation; j. discuss the single-stage (stable- growth), two-stage, and three-stage FCFF and FCFE models (including assumptions) and explain the company characteristics that justify the use of each model; k. calculate the value of a company using the stable-growth, two-stage, and threestage FCFF and FCFE models; l. explain how sensitivity analysis can be used in FCFF and FCFE valuations; m. discuss approaches for calculating the terminal value in a multistage valuation model; n. describe the characteristics of companies for which the FCFF model is preferred to the FCFE model. 42 Market-Based a. distinguish among types of valuation 44 Market-Based Valuation: Price indicators; Valuation: Price and *Enterprise and Enterprise Value Multiples Value Multiples b. distinguish between the method of comparables and the method based on forecasted fundamentals as approaches to using price multiples in valuation, and discuss the economic rationales for each; c. describe a justified price multiple and discuss rationales for each price multiple and dividend yield in valuation; d. discuss the drawbacks to the use of each price multiple and dividend yield; e. calculate and interpret each price multiple and dividend yield; f. describe, calculate, and interpret underlying earnings, given earnings per share (EPS) and nonrecurring items in the income statement; g. discuss normalized EPS and the methods of normalizing EPS and calculate normalized EPS by each method; h. explain and justify the use of earnings yield (i.e., EPS divided by share price); i. discuss the fundamental factors that influence each price multiple and dividend yield; j. calculate and interpret the justified price-to-earnings ratio (P/E), price-to- book ratio, and price-to-sales ratio for a common stock, based on forecasted fundamentals; k. calculate and interpret a predicted P/E, given a cross-sectional regression on fundamentals, and explain limitations to the cross-sectional regression methodology; l. explain the benchmark value of a multiple; m. evaluate a stock using the method of comparables; n. discuss the importance of fundamentals in the method of comparables; o. calculate and interpret the P/E-to- growth (PEG) ratio and explain its use in relative valuation; p. calculate and explain the use of price multiples to determine terminal value in a multistage discounted cash flow model; q. discuss alternative definitions of cash flow used in price and enterprise value multiples (including enterprise value to earnings before interest, taxes, depreciation, and amortization EV/EBITDA), and explain the limitations of each; r. calculate and interpret enterprise value multiples and discuss the rationales for, and drawbacks to, the use of EV/EBITDA; s. discuss the sources of differences in cross-border valuation comparisons; t. describe the main types of momentum indicators and their use in valuation; u. discuss the use of the arithmetic mean, the harmonic mean, the weighted harmonic mean, and the median to describe the central tendency of a group of multiples; v. explain the use of stock screens in investment management. 43 Residual Income a. calculate and interpret residual 45 Residual Income Valuation income and related measures (e.g., Valuation economic value added and market value added); b. discuss the use of residual income models; c. calculate future values of residual income given current book value, earnings growth estimates, and an assumed dividend payout ratio; d. discuss the fundamental determinants of residual income; e. explain the relation between residual income valuation and the justified price-tobook ratio based on forecasted fundamentals; f. calculate and interpret the intrinsic value of a common stock using a single-stage (constant-growth) residual income model; g. calculate an implied growth rate in residual income, given the market price-tobook ratio and an estimate of the required rate of return on equity;\ h. explain continuing residual income and the common assumptions regarding continuing residual income; i. justify an estimate of continuing residual income at the forecast horizon, given i. company and industry prospects; j. calculate and interpret the intrinsic value of a common stock using a multistage residual income model, given the required rate of return, forecasted earnings per share over a finite horizon, and forecasted continuing residual earnings; k. compare the residual income model to the dividend discount and free cash flow to equity models; l. contrast the recognition of value in the residual income model to value recognition in other present value models; m. discuss the strengths and weaknesses of the residual income model; n. justify the selection of the residual income model for equity valuation, given the characteristics of the company being valued; o. discuss accounting issues in applying residual income models (e.g., clean surplus violations, variations from fair value, intangible asset effects on book value, and nonrecurring items) and the appropriate analyst response to each issue. 44 Private Company a. compare and contrast public and 46 Private Company Valuation private company valuation; Valuation b. explain the reasons for valuing the total capital and/or equity capital of private companies; c. explain the role of definitions (standards) of value, explain the different definitions of value, and illustrate how different definitions can lead to different estimates of value; d. discuss the three major approaches to private company valuation; d. discuss the three major approaches to private company valuation; e. demonstrate the adjustments required to estimate the normalized earnings and/or cash flow for a private company, from the perspective of either a strategic or nonstrategic (financial) buyer, and explain cash flow estimation issues; f. demonstrate the methods under the income approach to private company valuation, including the free cash flow method, capitalized cash flow method, and excess earnings method; g. explain the specific elements of discount rate estimation that are relevant in valuing the total capital or equity capital of a private company; h. compare and contrast models used to estimate the required rate of return to private company equity (e.g., the CAPM, the expanded CAPM, and the build-up method), and discuss the issues related to using each; i. demonstrate the market approaches to private company valuation (i.e., the guideline public company method, the guideline transactions method, and the prior transaction method), and discuss the advantages and disadvantages of each; j. demonstrate the asset-based approach to private company valuation; k. demonstrate the use of discounts and premiums in private company valuation; l. explain the role of valuation standards in the valuation of private companies. 13 45 Investment a. illustrate, for each type of real 13 47 Investment Analysis property investment, the main value Analysis determinants, 13 45 Investment a. 13 47 Investment Analysis Analysis investment characteristics, principal risks, and most likely investors; b. evaluate a real estate investment using net present value (NPV) and internal rate of return (IRR) from the perspective of an equity investor; c. calculate the after-tax cash flow and the after-tax equity reversion from real estate properties; d. explain the potential problems associated with using IRR as a measurement tool in real estate investments. 46 Income Property a. explain the relation between a real 48 Income Property Analysis and estate capitalization rate and a Analysis and Appraisal discount rate; Appraisal b. determine the capitalization rate by the market-extraction method, band- ofinvestment method, and built-up method, and justify each method’s use in capitalization rate determination; c. estimate the market value of a real estate investment using the direct income capitalization approach and the gross income multiplier technique; d. contrast the limitations of the direct capitalization approach to those of the gross income multiplier technique. 47 Private Equity a. explain the sources of value creation 49 Private Equity Valuation in private equity; Valuation b. explain how private equity firms align their interests with those of the managers of portfolio companies; c. distinguish between the characteristics of buyout and venture capital investments; d. discuss the valuation issues in buyout and venture capital transactions; e. explain alternative exit routes in private equity and their impact on value; f. explain private equity fund structures, terms, valuation, and due diligence in the f. context of an analysis of private equity fund returns; g. explain the risks and costs of investing in private equity; h. interpret and compare financial performance of private equity funds from the perspective of an investor; i. calculate management fees, carried interest, net asset value, distributed to paid in (DPI), residual value to paid in (RVPI), and total value to paid in (TVPI) of a private equity fund; A Note on the Valuation of Venture Capital Deals: (Reading Appendix 47A) j. calculate pre-money valuation, post- money valuation, ownership fraction, and price per share applying the venture capital method 1) with single and multiple financing rounds and 2) in terms of IRR; k. demonstrate alternative methods to account for risk in venture capital; Technical Notes on LBO Valuation—(A) and (B): (Reading Appendix 47B) l. calculate and interpret free cash flow forecasts in a leveraged buyout (LBO) transaction; m. explain the role of cash sweep in an LBO transaction; n. explain how private equity firms manage their exit routes in LBO companies; o. explain and calculate the value of the equity investment in an LBO company under the target IRR and equity cash flow methods of valuation. 48 Investing in a. explain why some commodity futures 50 Investing in Commodities such as gold have limited Commodities “contango,” whereas others such as oil often have natural “backwardation,” and indicate why these conditions might be less prevalent in the future; b. discuss how “roll yield” in a commodity futures position can be positive (negative); c. discuss the argument that commodity futures are not an asset class; d. demonstrate how the geometric return of an actively managed commodity basket can be positive, whereas the underlying average commodity has a geometric return near zero; e. discuss why investing in commodities offers diversification opportunities during periods of economic fluctuation in the short run and inflation in the long run. 49 Evaluating the a. discuss how the characteristics of 51 Evaluating the Performance of hedge funds affect traditional Performance of Your Hedge methods of Your Hedge Funds performance measurements; Funds b. compare and contrast the use of market indices, hedge fund indices, and positive risk-free rates to evaluate hedge fund performance. 50 Buyers Beware: a. discuss common types of investment 52 Buyers Beware: Evaluating and risks for hedge funds; Evaluating and Managing the Managing the Many Facets of Many Facets the Risks of of the Risks of Hedge Funds Hedge Funds b. evaluate maximum drawdown and value-at-risk for measuring risks of hedge funds. 14 51 General a. distinguish among default risk, credit 14 53 General Principles of spread risk, and downgrade risk; Principles of Credit Analysis Credit Analysis b. explain and analyze the key components of credit analysis; c. calculate and interpret the key financial ratios used by credit analysts; d. evaluate the credit quality of an issuer of a corporate bond, given such data as key financial ratios for the issuer and the industry; e. analyze why and how cash flow from operations is used to assess the ability of an issuer to service its debt obligations and to assess the financial flexibility of a company; f. explain and interpret the typical elements of the corporate structure and debt structure of a high-yield issuer and the effect of these elements on the risk position of the lender; g. discuss the factors considered by rating agencies in rating asset- backed securities; h. explain how the credit worthiness of municipal bonds is assessed and contrast the analysis of tax-backed debt with the analysis of revenue obligations; i. discuss the key considerations used by Standard & Poor’s in assigning sovereign ratings and describe why two ratings are assigned to each national government; j. contrast the credit analysis required for corporate bonds to that required for 1) asset-backed securities, 2) municipal securities, and 3) sovereign debt. 52 The Liquidity a. contrast the concept of liquidity as 54 The Liquidity Conundrum “appetite for risk” with the more Conundrum traditional view that liquidity is created by the central bank; b. describe how Minsky’s “financial instability hypothesis” predicts a mortgage market crisis as debt creation journeys from conservative hedging activities to more speculative activities, and finally to a Ponzi scheme phase; c. explain how subprime mortgage borrowers are granted a free at-the- money call option on the value of their property. 53 Term Structure a. illustrate and explain parallel and 55 Term Structure and Volatility of nonparallel shifts in the yield curve, a and Volatility of Interest Rates yield Interest Rates curve twist, and a change in the curvature of the yield curve (i.e., a butterfly shift); b. describe the factors that drive U.S. Treasury security returns and evaluate the importance of each factor; c. explain the various universes of Treasury securities that are used to construct the theoretical spot rate curve and evaluate their advantages and disadvantages; d. explain the swap rate curve (LIBOR curve) and discuss why market participants have used the swap rate curve rather than a government bond yield curve as a benchmark; e. illustrate the theories of the term structure of interest rates (i.e., pure expectations, liquidity, and preferred habitat) and the implications of each for the shape of the yield curve; f. compute and interpret the yield curve risk of a security or a portfolio by using key rate duration; g. compute and interpret yield volatility, distinguish between historical yield volatility and implied yield volatility, and explain how yield volatility is forecasted. 54 Valuing Bonds a. evaluate, using relative value 56 Valuing Bonds with Embedded analysis, whether a security is with Embedded Options undervalued or Options overvalued; b. evaluate the importance of benchmark interest rates in interpreting spread measures; c. illustrate the backward induction valuation methodology within the binomial interest rate tree framework; d. compute the value of a callable bond from an interest rate tree; e. illustrate the relations among the values of a callable (putable) bond, the corresponding option-free bond, and the embedded option; f. explain the effect of volatility on the arbitrage-free value of an option; g. interpret an option-adjusted spread with respect to a nominal spread and to benchmark interest rates; h. illustrate how effective duration and effective convexity are calculated using the binomial model; i. calculate the value of a putable bond by using an interest rate tree; j. describe and evaluate a convertible bond and its various component values; k. compare and contrast the risk-return characteristics of a convertible bond with the risk-return characteristics of ownership of the underlying common stock. 15 55 Mortgage-Backed a. describe a mortgage loan and 15 57 Mortgage-Backed Sector of the illustrate the cash flow characteristics Sector of the Bond Market of a fixedrate, Bond Market level payment, and fully amortized mortgage loan; b. illustrate the investment characteristics, payment characteristics, and risks of mortgage passthrough securities; c. calculate the prepayment amount for a month, given the single monthly mortality rate; d. compare and contrast the conditional prepayment rate (CPR) with the Public Securities Association (PSA) prepayment benchmark; e. explain why the average life of a mortgage-backed security is more relevant than the security’s maturity; f. explain the factors that affect prepayments and the types of prepayment risks; g. illustrate how a collateralized mortgage obligation (CMO) is created and how it provides a better matching of assets and liabilities for institutional investors; h. distinguish among the sequential pay tranche, the accrual tranche, the planned amortization class tranche, and the support tranche in a CMO; i. evaluate the risk characteristics and the relative performance of each type of CMO tranche, given changes in the interest rate environment; j. explain the investment characteristics of stripped mortgage-backed securities; k. compare and contrast agency and nonagency mortgage-backed securities; l. distinguish credit risk analysis of commercial mortgage-backed securities (CMBS) from credit risk analysis of residential nonagency mortgage-backed securities; m. describe the basic structure of a CMBS, and illustrate the ways in which a CMBS investor may realize call protection at the loan level and by means of the CMBS structure. 56 Asset-Backed a. illustrate the basic structural features 58 Asset-Backed Sector of the of and parties to a securitization Sector of the Bond Market Bond Market transaction; b. explain and contrast prepayment tranching and credit tranching; c. distinguish between the payment structure and collateral structure of a securitization backed by amortizing assets and non-amortizing assets; d. distinguish among the various types of external and internal credit enhancements; e. describe the cash flow and prepayment characteristics for securities backed by home equity loans, manufactured housing loans, automobile loans, student loans, SBA loans, and credit card receivables; f. describe collateralized debt obligations (CDOs), including cash and synthetic CDOs; g. distinguish among the primary motivations for creating a collateralized debt obligation (arbitrage and balance sheet transactions). 57 Valuing Mortgage- a. illustrate the computation, use, and 59 Valuing Mortgage- Backed and limitations of the cash flow yield, Backed and Asset-Backed nominal Asset-Backed Securities spread, and zero-volatility spread for Securities a mortgage-backed security and an assetbacked security; b. describe the Monte Carlo simulation model for valuing a mortgage- backed security; c. describe path dependency in passthrough securities and the implications for valuation models; d. illustrate how the option-adjusted spread is computed using the Monte Carlo simulation model and how this spread measure is interpreted; e. evaluate a mortgage-backed security using option-adjusted spread analysis; f. discuss why effective durations reported by various dealers and vendors may differ; g. analyze the interest rate risk of a security given the security’s effective duration and effective convexity; h. explain other measures of duration used by practitioners in the mortgage- backed market (e.g., cash flow duration, coupon curve duration, and empirical duration), and describe the limitations of these duration measures; i. determine whether the nominal spread, zero-volatility spread, or option-adjusted spread should be used to evaluate a specific fixed income security. 16 58 Forward Markets a. explain how the value of a forward 16 60 Forward Markets and Contracts contract is determined at initiation, and Contracts during the life of the contract, and at expiration; b. calculate and interpret the price and the value of an equity forward contract, assuming dividends are paid either discretely or continuously; c. calculate and interpret the price and the value of 1) a forward contract on a fixed-income security, 2) a forward rate agreement (FRA), and 3) a forward contract on a currency; d. evaluate credit risk in a forward contract and explain how market value is a measure of the credit risk to a party in a forward contract. 59 Futures Markets a. explain why the futures price must 61 Futures Markets and Contracts converge to the spot price at and Contracts expiration; b. determine the value of a futures contract; c. explain how forward and futures prices differ; d. describe the monetary and nonmonetary benefits and costs associated with holding the underlying asset, and explain how they affect the futures price; e. describe backwardation and contango; f. discuss whether futures prices equal expected spot prices; g. describe the difficulties in pricing Eurodollar futures and creating a pure arbitrage opportunity; h. calculate and interpret the price of Treasury bond futures, stock index futures, and currency futures. 17 60 Option Markets a. calculate and interpret the prices of a 17 62 Option Markets and Contracts synthetic call option, synthetic put and Contracts option, synthetic bond, and synthetic underlying stock, and infer why an investor would want to create such instruments; b. calculate and interpret prices of interest rate options and options on assets using one- and two-period binomial models; c. explain the assumptions underlying the Black–Scholes–Merton model and their limitations; d. explain how an option price, as represented by the Black–Scholes–Merton model, is affected by each of the input values (the option Greeks); e. explain the delta of an option and demonstrate how it is used in dynamic hedging; f. explain the gamma effect on an option’s price and delta and how gamma can affect a delta hedge; g. discuss the effect of the underlying asset’s cash flows on the price of an option; h. demonstrate the methods for estimating the future volatility of the underlying asset (i.e., the historical volatility and the implied volatility methods); i. illustrate how put-call parity for options on forwards (or futures) is established; j. compare and contrast American options on forwards and futures with European options on forwards and futures, and identify the appropriate pricing model for European options. 61 Swap Markets a. distinguish between the pricing and 63 Swap Markets and Contracts valuation of swaps; and Contracts b. explain the equivalence of the following swaps to combinations of other 61 Swap Markets 63 Swap Markets and Contracts and Contracts b. instruments: interest rate swaps to a series of off-market forward rate agreements (FRAs) and a plain vanilla swap to a combination of an interest rate call and interest rate put; c. calculate and interpret the fixed rate on a plain vanilla interest rate swap and the market value of the swap during its life; d. calculate and interpret the fixed rate, if applicable, and the foreign notional principal for a given domestic notional principal on a currency swap, and determine the market values of each of the different types of currency swaps during their lives; e. calculate and interpret the fixed rate, if applicable, on an equity swap and the market values of the different types of equity swaps during their lives; f. explain and interpret the characteristics and uses of swaptions, including the difference between payer and receiver swaptions; g. identify and calculate the possible payoffs and cash flows of an interest rate swaption; h. calculate and interpret the value of an interest rate swaption on the expiration day; i. evaluate swap credit risk for each party and during the life of the swap, distinguish between current credit risk and potential credit risk, and illustrate how swap credit risk is reduced by both netting and marking to market; j. define swap spread and relate it to credit risk. 62 Interest Rate a. demonstrate how both a cap and a 64 Interest Rate Derivative floor are packages of options on Derivative Instruments interest Instruments rates and options on fixed-income instruments; b. compute the payoff for a cap and a floor and explain how a collar is created. 63 Using Credit a. describe the characteristics of a 65 Using Credit Derivatives to credit default swap, and compare and Derivatives to Enhance Return contrast a Enhance Return and Manage Risk and Manage credit default swap with a corporate Risk bond; b. explain the advantages of using credit derivatives over other credit instruments; c. explain the use of credit derivatives by the various market participants; d. discuss credit derivatives trading strategies and how they are used by hedge funds and other managers. 18 64 Portfolio a. discuss mean–variance analysis and 18 66 Portfolio Concepts its assumptions, and calculate the Concepts expected return and the standard deviation of return for a portfolio of two or three assets; b. explain the minimum-variance and efficient frontiers, and discuss the steps to solve for the minimum-variance frontier; c. discuss diversification benefits, and explain how the correlation in a two- asset portfolio and the number of assets in a multi-asset portfolio affect the diversification benefits; d. calculate the variance of an equally weighted portfolio of n stocks, explain the capital allocation and the capital market lines (CAL and CML) and the relation between them, and calculate the values of one of the variables given the values of the remaining variables e. explain the capital asset pricing model (CAPM), including its underlying e. assumptions and the resulting conclusions; f. discuss the security market line (SML), the beta coefficient, the market risk premium, and the Sharpe ratio, and calculate the value of one of these variables given the values of the remaining variables; g. explain the market model, and state and interpret the market model’s predictions with respect to asset returns, variances, and covariances; h. calculate an adjusted beta, and discuss the use of adjusted and historical betas as predictors of future betas; i. discuss reasons for and problems related to instability in the minimum- variance frontier; j. discuss and compare macroeconomic factor models, fundamental factor models, and statistical factor models; k. calculate the expected return on a portfolio of two stocks, given the estimated macroeconomic factor model for each stock; l. discuss the arbitrage pricing theory (APT), including its underlying assumptions and its relation to the multifactor models, calculate the expected return on an asset given an asset’s factor sensitivities and the factor risk premiums, and determine whether an arbitrage opportunity exists, including how to exploit the opportunity; m. explain the sources of active risk, define and interpret tracking error, tracking risk, and the information ratio, and explain factor portfolio and tracking portfolio; n. compare and contrast the conclusions and the underlying assumptions of the CAPM and the APT models, and explain why an investor can possibly earn a substantial premium for exposure to dimensions of risk unrelated to market movements. 65 A Note on Harry a. discuss the efficiency of the market 67 A Note on Harry M. Markowitz’s portfolio in the CAPM and the M. Markowitz’s “Market relation “Market Efficiency: A Efficiency: A Theoretical between the expected return and Theoretical Distinction and So beta of an asset when restrictions on Distinction and So What?” What?” borrowing at the risk-free rate and on short selling exist; b. discuss the practical consequences that follow when restrictions on borrowing at the risk-free rate and on short selling exist. 66 International a. explain international market 68 International Asset Pricing integration and segmentation and the Asset Pricing impediments to international capital mobility; b. discuss the factors that favor international market integration; c. state the assumptions of the domestic capital asset pricing model (CAPM); d. justify the extension of the domestic CAPM to an international context (the extended CAPM) and describe the assumptions needed to make the extension; e. determine whether the real exchange rate has changed in a period, given the beginning-of-period (nominal) exchange rate, the inflation rates in the period, and the end-of-period (nominal) exchange rate; f. calculate the expected 1) exchange rate and 2) domestic-currency holding period return on a foreign bond (security), given expected, predictable inflation rates, the beginning-of-period nominal exchange rate, and the constant real exchange rate; g. calculate the end-of-period real exchange rate and the domestic- currency ex-post return on a foreign bond (security), given the end-of-period exchange rate, the beginning-of-period real exchange rate, and the inflation rates during the period; h. calculate a foreign currency risk premium and explain a foreign currency risk premium in terms of interest rate differentials and forward rates; i. state the risk pricing relation and the formula for the international capital asset pricing model (ICAPM); j. calculate the expected return on a stock, given its world market beta and currency exposure as well as the appropriate risk-free rates and risk premiums; k. explain the effect of market segmentation on the ICAPM; l. define currency exposure and explain exposures in terms of correlations; m. discuss the likely exchange rate exposure of a company based on a description of the company’s activities, and explain the impact of both real and nominal exchange rate changes on the valuation of the company; n. discuss the currency exposures of national economies, equity markets, and bond markets; o. contrast the traditional trade approach ( j-curve) and the money demand approach to modeling the relation between real exchange rate changes and domestic economic activity. 67 The Theory of a. justify active portfolio management 69 The Theory of Active Portfolio when security markets are nearly Active Portfolio Management efficient; Management b. discuss the steps and the approach of the Treynor–Black model for security selection; c. describe how an analyst’s accuracy in forecasting alphas can be measured and how estimates of forecasting can be incorporated into the Treynor–Black approach. 68 The Portfolio a. explain the importance of the portfolio 70 The Portfolio Management perspective; Management Process and the Process and the Investment Policy Investment Statement b. describe the steps of the portfolio Policy Statement management process and the components of those steps; c. define investment objectives and constraints and explain and distinguish among the types of investment objectives and constraints; d. discuss the role of the investment policy statement in the portfolio management process and explain the elements of an investment policy statement; e. explain how capital market expectations and the investment policy statement help influence the strategic asset allocation decision, and discuss how investors’ investment time horizon may influence their strategic asset allocation; f. contrast the types of investment time horizons, determine the time horizon for a particular investor, and evaluate the effects of this time horizon on portfolio choice; g. justify ethical conduct as a requirement for managing investment portfolios. LOS Detail June 2011 (New) Legend Sub Sub LOS Description Significance LOS None – Change is insignificant and you c a state the six components of the Code of Ethics and the seven Standards of Professional Conduct; New – New LOS in 2011 curriculum b explain the ethical responsibilities required by the Code and Standards. Low – Change is of low significance a demonstrate a thorough knowledge of the Code of Ethics and Standards of High – LOS has changed substantially an Professional Conduct by applying the Code and Standards to specific situations; b recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct. a define soft-dollar arrangements and state the general principles of the Soft Dollar Standards; b critique company soft-dollar practices and policies; c determine whether a product or service qualifies as “permissible research” that can be purchased with client brokerage. a explain the objectives of the Research Objectivity Standards; b critique company policies and practices related to research objectivity, and distinguish between changes required and changes recommended for compliance with the Research Objectivity Standards. a critique the practices and policies presented; b explain the appropriate action to take in response to conduct that violates the CFA Institute Code of Ethics and Standards of Professional Conduct. a critique the practices and policies presented; b explain the appropriate action to take in response to conduct that violates the CFA Institute Code of Ethics and Standards of Professional Conduct. a critique the practices and policies presented; b explain the appropriate action to take in response to conduct that violates the CFA Institute Code of Ethics and Standards of Professional Conduct. a critique trade allocation practices, None and determine whether compliance exists with the CFA Institute Standards of Professional Conduct addressing fair dealing and client loyalty; b discuss appropriate actions to take in response to trade allocation practices that do not adequately respect client interests. a critique the disclosure of investment objectives and basic policies and determine whether they comply with the CFA Institute Standards of Professional Conduct; b discuss appropriate actions needed to ensure adequate disclosure of the investment process. a explain the basic principles of the new Prudent Investor Rule; b explain the general fiduciary standards to which a trustee must adhere; c differentiate between the old Prudent Man Rule and the new Prudent Investor Rule; d explain the key factors that a trustee should consider when investing and managing trust assets. a calculate and interpret a sample covariance and a sample correlation coefficient, and interpret a scatter plot; b explain the limitations to correlation analysis, including outliers and spurious correlation; c formulate a test of the hypothesis that the population correlation coefficient equals zero, and determine whether the hypothesis is rejected at a given level of significance; d distinguish between the dependent None and independent variables in a linear regression; e explain the assumptions underlying linear regression, and interpret the regression coefficients; f calculate and interpret the standard error of estimate, the coefficient of determination, and a confidence interval for a regression coefficient; g formulate a null and alternative hypothesis about a population value of a regression coefficient, select the appropriate test statistic, and determine whether the null hypothesis is rejected at a given level of significance; h calculate a predicted value for the dependent variable, given an estimated regression model and a value for the independent variable, and calculate and interpret a confidence interval for the predicted value of a dependent variable i describe the use of analysis of variance (ANOVA) in regression analysis, interpret ANOVA results, and calculate and interpret an F-statistic; j discuss the limitations of regression analysis. a formulate a multiple regression equation to describe the relation between a dependent variable and several independent variables, determine the statistical significance of each independent variable, and interpret the estimated coefficients and their p-values; b formulate a null and an alternative hypothesis about the population value of a regression coefficient, calculate the value of the test statistic, determine whether to reject the null hypothesis at a given level of significance by using a one- tailed or two-tailed test, and interpret the results of the test; c calculate and interpret 1) a confidence interval for the population value of a regression coefficient and 2) a predicted value for the dependent variable, given an estimated regression model and assumed values for the independent variables; d explain the assumptions of a multiple regression model; e calculate and interpret the F-statistic, None and discuss how it is used in regression analysis; f distinguish between and interpret the None R2 and adjusted R2 in multiple regression; g infer how well a regression model None explains the dependent variable by analyzing the output of the regression equation and an ANOVA table; h formulate a multiple regression equation by using dummy variables to represent qualitative factors, and interpret the coefficients and regression results; i discuss the types of heteroskedasticity and the effects of heteroskedasticity and serial correlation on statistical inference; j describe multicollinearity, and discuss its causes and effects in regression analysis; k discuss the effects of model misspecification on the results of a regression analysis, and explain how to avoid the common forms of misspecification; l discuss models with qualitative dependent variables; m interpret the economic meaning of the results of multiple regression analysis and critique a regression model and its results. a calculate and evaluate the predicted trend value for a time series, modeled as either a linear trend or a log-linear trend, given the estimated trend coefficients; b discuss the factors that determine whether a linear or a log-linear trend should be used with a particular time series, and evaluate the limitations of trend models; c explain the requirement for a time None series to be covariance stationary, and discuss the significance of a series that is not stationary; d discuss the structure of an None autoregressive (AR) model of order p, and calculate one- and two-period-ahead forecasts given the estimated coefficients; e explain how autocorrelations of the None residuals can be used to test whether the autoregressive model fits the time series; f explain mean reversion, and calculate a mean-reverting level; g contrast in-sample and out-of-sample forecasts, and compare the forecasting accuracy of different time-series models based on the root mean squared error criterion; h discuss the instability of coefficients of time-series models; i describe the characteristics of random walk processes, and contrast them to covariance stationary processes; j discuss the implications of unit roots for time-series analysis, explain when unit j roots are likely to occur and how to test for them, and demonstrate how a time series with a unit root can be transformed so it can be analyzed with an AR model; k discuss the steps of the unit root test for nonstationarity, and explain the relation of the test to autoregressive time- series models; l discuss how to test and correct for seasonality in a time-series model, and calculate and interpret a forecasted value using an AR model with a seasonal lag; m explain autoregressive conditional heteroskedasticity (ARCH), and discuss how ARCH models can be applied to predict the variance of a time series; n explain how time-series variables should be analyzed for nonstationarity and/or cointegration before use in a linear regression; o select and justify the choice of a particular time-series model from a group of models. a define the sources of economic growth, and discuss the preconditions for economic growth; b discuss how the one-third rule can be used to explain the contributions of labor and technological change to growth in labor productivity; c discuss how faster economic growth can be achieved by increasing the growth of physical capital, technological advances, and investment in human capital; d compare and contrast classical None growth theory, neoclassical growth theory, and new growth theory. a explain the rationale for government regulation in the form of 1) economic regulation of natural monopolies and 2) social regulation of nonmonopolistic industries; b discuss the potential benefits and possible negative side effects of social regulation; c differentiate between the capture hypothesis and the share-the-gains, share-thepains theory of regulator behavior. a explain comparative advantage and how countries can gain from international trade; b compare and contrast tariffs, nontariff barriers, quotas, and voluntary export restraints; c critique the arguments for trade restrictions. a define an exchange rate, and differentiate between the nominal exchange rate and the real exchange rate; b explain the factors that influence supply and demand in the foreign exchange market; c discuss how the supply and demand for a currency changes the exchange rate; d differentiate between interest rate parity and purchasing power parity; e describe the balance of payments accounts; f describe the following exchange rate policies: flexible exchange rates, fixed exchange rates, and crawling pegs. a define direct and indirect methods of foreign exchange quotations, and convert direct (indirect) foreign exchange quotations into indirect (direct) foreign exchange quotations; b calculate and interpret the spread on a foreign currency quotation, and explain how spreads on foreign currency quotations can differ as a result of market conditions, bank/dealer positions, and trading volume; c calculate and interpret currency cross rates, given two spot exchange quotations involving three currencies; d calculate the profit on a triangular arbitrage opportunity, given the bid–ask quotations for the currencies of three countries involved in the arbitrage; e distinguish between the spot and forward markets for foreign exchange; f calculate and interpret the spread on a forward foreign currency quotation, and explain how spreads on forward foreign currency quotations can differ as a result of market conditions, bank/dealer positions, trading volume, and maturity/length of contract; g calculate and interpret a forward discount or premium and express it as an annualized rate; h explain interest rate parity, and illustrate covered interest arbitrage; i distinguish between spot and forward transactions, calculate the annualized forward premium/discount for a given currency, and infer whether the currency is “strong” or “weak.” a explain how exchange rates are determined in a flexible (or floating) exchange rate system; b explain the role of each component of the balance of payments accounts; c explain how current account deficits or surpluses and financial account deficits or surpluses affect an economy; d describe the factors that cause a nation’s currency to appreciate or depreciate; e explain how monetary and fiscal policies affect the exchange rate and balance of payments components; f describe a fixed exchange rate and a pegged exchange rate system; g discuss absolute purchasing power None parity and relative purchasing power parity; h calculate the end-of-period exchange rate implied by purchasing power parity, given the beginning-of-period exchange rate and the inflation rates; i discuss the international Fisher None relation; j calculate the real interest rate, given Low nominal interest rates and expected inflation rates, using the international Fisher relation and its linear approximation; k discuss the theory of uncovered None interest rate parity, and explain the theory’s relation to other exchange rate parity theories; - - l calculate the expected change in the exchange rate, given interest rates and the assumption that uncovered interest rate parity holds; m discuss the foreign exchange expectation relation between the forward exchange rate and the expected exchange rate. a distinguish between the measures of Low economic activity (i.e., gross domestic product, gross national income, and net national income), including their components; b differentiate between GDP at market None prices and GDP at factor cost; c differentiate between current and constant prices, and describe the GDP deflator. a explain and calculate the effect of New inflation and deflation of inventory costs on the financial statements and ratios of companies that use different inventory valuation methods (cost formulas or cost flow assumptions); b discuss LIFO reserve and LIFO New liquidation and their effects on financial statements and ratios; c demonstrate how to adjust a New company’s reported financial statements from LIFO to FIFO for purposes of comparison; d discuss the implications of valuing New inventory at net realisable value for financial statements and ratios; e analyze and compare the financial New statements and ratios of companies, including those that use different inventory valuation methods; f discuss issues that analysts should New consider when examining a company’s inventory disclosures and other sources of information. a discuss the implications for financial New statements and ratios of capitalising versus expensing costs in the period in which they are incurred; b discuss the implications for financial New statements and ratios of the different depreciation methods for property, plant, and equipment; c discuss the implications for financial New statements and ratios of impairment and revaluation of property, plant, and equipment, and intangible assets; d analyze and interpret the financial New statement disclosures regarding long- lived assets; e discuss the implications for financial New statements and ratios of leasing assets instead of purchasing assets; f discuss the implications for financial New statements and ratios of finance leases and operating leases from the perspective of both the lessor and the lessee. 2011 Level a describe the classification, None measurement, and disclosure under the International Financial Reporting Standards (IFRS) for 1) investments in financial assets, 2) investments in associates, 3) joint ventures, 4) business combinations, and 5) special purpose and variable interest entities (SPEs, VIEs); b distinguish between IFRS and U.S. GAAP in the classification, measurement, and disclosure of investments in financial assets, investments in associates, joint ventures, business combinations, and special purpose and variable interest entities; c analyze the effects on financial ratios of the different methods used to account for intercorporate investments. a discuss the types of post- employment benefit plans and the implications for financial reports; b explain the measures of a defined benefit pension plan’s liability (i.e., defined benefit obligation and projected benefit obligation); c describe the components of a company’s defined benefit pension expense; d explain the impact of a defined benefit plan’s assumptions on the defined benefit obligation and periodic expense; e explain the impact on financial None statements of International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (U.S. GAAP) for pension and other post- employment benefits that permit items to be reported in the footnotes rather than in the financial statements; f evaluate pension plan footnote disclosures including cash flow related information; g evaluate the underlying economic liability (or asset) of a company’s pension and other post-employment benefits; h calculate the underlying economic pension expense (income) and other postemployment expense (income) based on disclosures; i discuss the issues involved in accounting for share-based compensation; j explain the impact on financial statements of accounting for stock grants and stock options, and the importance of companies’ assumptions in valuing these grants and options. a distinguish among presentation currency, functional currency, and local currency; b analyze the impact of changes in exchange rates on the translated sales of the subsidiary and parent company; c compare and contrast the current rate method and the temporal method, analyze and evaluate the effects of each on the parent company’s balance sheet and income statement, and determine which method is appropriate in various scenarios; d calculate the translation effects, None evaluate the translation of a subsidiary’s balance sheet and income statement into the parent company’s currency, and analyze the different effects of the current rate method and the temporal method on the subsidiary’s financial ratios; e analyze how using the temporal method versus the current rate method will affect the parent company’s financial ratios; f illustrate and analyze alternative accounting methods for subsidiaries operating in hyperinflationary economies. a distinguish among the various definitions of earnings (e.g., EBITDA, operating earnings, net income, etc.); b illustrate how trends in cash flow from operations can be more reliable than trends in earnings; c provide a simplified description of the accounting treatment for derivatives being used to hedge exposure to changes in the value of assets and liabilities, exposure to variable cash flow, and a foreign currency exposure of an instrument in a foreign corporation. a contrast cash-basis and accrual- basis accounting and explain why accounting discretion exists in an accrual accounting system; b describe the relation between the level of accruals and the persistence of earnings and the relative multiples that the cash and accrual components of earnings should rationally receive in valuation; c discuss the opportunities and motivations for management to intervene in the external financial reporting process and the mechanisms that discipline such intervention; d discuss earnings quality and the measures of earnings quality, and compare and contrast the earnings quality of peer companies; e explain mean reversion in earnings and how the accruals component of earnings affects the speed of mean reversion; f discuss problems with the quality of financial reporting, including revenue recognition, expense recognition, balance sheet issues, and cash flow statement issues, and interpret warning signs of these potential problems. a demonstrate the use of a framework for the analysis of financial statements, given a particular problem, question, or purpose (e.g., valuing equity based on comparables, critiquing a credit rating, obtaining a comprehensive picture of financial leverage, evaluating the perspectives given in management’s discussion of financial results); b identify financial reporting choices and biases that affect the quality and comparability of companies’ financial statements and illustrate how such biases affect financial decisions; c evaluate the quality of a company’s None financial data and recommend appropriate adjustments to improve quality and comparability with similar companies, including adjustments for differences in accounting rules, methods, and assumptions; d predict the impact on financial statements and ratios, given a change in accounting rules, methods, or assumptions; e analyze and interpret the effects of balance sheet modifications, earnings normalization, and cash-flow- statement-related modifications on a company’s financial statements, financial ratios, and overall financial condition. a compute the yearly cash flows of an expansion capital project and a replacement capital project and evaluate how the choice of depreciation method affects those cash flows; b discuss the effects of inflation on capital budgeting analysis; c evaluate and select the optimal capital project in situations of 1) mutually exclusive projects with unequal lives, using either the least common multiple of lives approach or the equivalent annual annuity approach, and 2) capital rationing; d explain how sensitivity analysis, scenario analysis, and Monte Carlo simulation d can be used to assess the stand- alone risk of a capital project; e discuss the procedure for determining the discount rate to be used in valuing a capital project and calculate a project’s required rate of return using the capital asset pricing model (CAPM); f discuss the types of real options and evaluate a capital project using real options g discuss common capital budgeting pitfalls; h calculate and interpret accounting income and economic income in the context of capital budgeting; i differentiate among and evaluate a capital project using the following valuation models: economic profit, residual income, and claims valuation. - - High - - - - - - - - a discuss the Modigliani–Miller propositions concerning capital structure, including the impact of leverage, taxes, financial distress, agency costs, and asymmetric information on a company’s cost of equity, cost of capital, and optimal capital structure; b explain the target capital structure and why actual capital structure may fluctuate around the target; c review the role of debt ratings in capital structure policy; d explain the factors an analyst should consider in evaluating the impact of capital structure policy on valuation; e discuss international differences in financial leverage and the implications for investment analysis. a compare and contrast theories of High dividend policy, and explain the implications of each for share value given a description of a corporate dividend action; b discuss the types of information High (signals) that dividend initiations, increases, decreases, and omissions may convey; c illustrate how clientele effects and High agency issues may affect a company’s payout policy; d discuss the factors that affect High dividend policy; e calculate and interpret the effective High tax rate on a given currency unit of corporate earnings under double-taxation, split rate, and tax imputation dividend tax regimes; f compare and contrast stable High dividend, target payout, and residual dividend payout policies, and calculate the dividend under each policy; g discuss the choice between paying High cash dividends and repurchasing shares; h discuss global trends in corporate High dividend policies; i calculate and interpret dividend High coverage ratios based on 1) net income and 2) free cash flow; j discuss the symptoms of companies High that may not be able to sustain their cash dividend. - - - - - - - - a explain corporate governance, discuss the objectives and the core attributes of an effective corporate governance system, and evaluate whether a company’s corporate governance has those attributes; b compare and contrast the major business forms and describe the conflicts of interest associated with each; c discuss the conflicts that arise in agency relationships, including manager–shareholder conflicts and director–shareholder conflicts; d describe the responsibilities of the board of directors and explain the qualifications and core competencies that an investment analyst should look for in the board of directors; e illustrate effective corporate governance practice as it relates to the board of directors and evaluate the strengths and weaknesses of a company’s corporate governance practice; f describe the elements of a company’s statement of corporate governance policies that investment analysts should assess; g discuss the valuation implications of corporate governance. a categorize merger and acquisition (M&A) activities based on forms of integration and types of mergers; b explain the common motivations behind M&A activity; c illustrate how earnings per share (EPS) bootstrapping works and calculate a company’s postmerger EPS; d discuss the relation between merger motivations and types of mergers based on industry life cycles; e contrast merger transaction characteristics by form of acquisition, method of payment, and attitude of target management; f distinguish and describe pre-offer and post-offer takeover defense mechanisms; g summarize U.S. antitrust legislation; h calculate the Herfindahl–Hirschman Index and evaluate the likelihood of an antitrust challenge for a given business combination; i compare and contrast the three major methods for valuing a target company, including the advantages and disadvantages of each; j calculate free cash flows for a target company and estimate the company’s intrinsic value based on discounted cash flow analysis; k estimate the intrinsic value of a company using comparable company analysis and comparable transaction analysis; l evaluate a merger bid, calculate the estimated post-merger value of an acquirer, and calculate the gains accrued to the target shareholders versus the acquirer shareholders; m explain the effects of price and payment method on the distribution of risks and benefits in a merger transaction; n describe the empirical evidence related to the distribution of benefits in a merger; o compare and contrast divestitures, equity carve-outs, spin-offs, split-offs, and liquidation; p discuss the major reasons for divestitures. - valuation by Graham and Dodd and John Burr Williams are reflected in modern techniques of equity valuation. a define valuation and intrinsic value, and explain possible sources of perceived mispricing; b explain the going concern assumption, contrast a going concern value to a liquidation value, and identify the definition of value most relevant to public company valuation; c discuss the uses of equity valuation; d explain the elements of industry and competitive analysis and the importance of evaluating the quality of financial statement information; e contrast absolute and relative valuation models, and describe examples of each type of model; f illustrate the broad criteria for choosing an appropriate approach for valuing a given company. a explain the historical differences in Low market organization; b differentiate between an order-driven market and a price-driven market, and explain the risks and advantages of each; c calculate the impact of different national taxes on the return of an international investment; d discuss components of execution None costs (including commissions and fees, market impact, and opportunity cost) and approaches to reducing these costs; e describe an American Depositary Receipt (ADR), and differentiate among the various forms of ADRs in terms of trading and information supplied by the listed company; f explain why companies choose to be None listed abroad, and calculate the cost difference between buying shares listed abroad and buying ADRs; g state the determinants of the value of a closed-end country fund; h describe exchange-traded funds None (ETFs), and explain the pricing of international ETFs in relation to their net asset value (NAV); i discuss the advantages and Low disadvantages of alternatives to direct international investing. a distinguish among expected holding Low period return, realized holding period return, required return, return from convergence of price to intrinsic value, discount rate, and internal rate of return; b calculate and interpret an equity risk Low premium using historical and forwardlooking estimation approaches; - - c demonstrate the use of the capital None asset pricing model (CAPM), the Fama–French model (FFM), the Pastor–Stambaugh model (PSM), macroeconomic multifactor models, and the build-up method (for example, bond yield plus risk premium) for estimating the required return on an equity investment; d discuss beta estimation for public companies, thinly traded public companies, d and nonpublic companies; e analyze the strengths and weaknesses of methods used to estimate the required return on an equity investment; f discuss international considerations in required return estimation; g explain and calculate the weighted average cost of capital for a company; h evaluate the appropriateness of using a particular rate of return as a discount rate, given a description of the cash flow to be discounted and other relevant facts. - - a distinguish between country analysis None and industry analysis, and evaluate an industry’s demand, life cycle, competition structure, and risk elements; b discuss approaches to equity None analysis (ratio analysis and discounted cash flow models, including the franchise value model); c analyze the effects of inflation on asset valuation; d discuss multifactor models in a global context. a distinguish among the five competitive forces that drive industry profitability in the medium and long run; b illustrate how the competitive forces drive industry profitability; c describe why industry growth rate, technology and innovation, government, and c complementary products and services are fleeting factors rather than forces shaping industry structure; d indicate why eliminating rivals is a risky strategy; e show how positioning a company, exploiting industry change, and the ability to shape industry structure are creative strategies for achieving a competitive advantage. a discuss the key components that should be included in an industry analysis model; b illustrate the life cycle of a typical industry; c analyze the effects of business cycles on industry classification (i.e., growth, defensive, cyclical); d analyze the impact of external factors (e.g., technology, government, foreign influences, demography, and social changes) on industries; e illustrate the inputs and methods used in preparing industry demand and supply analyses; f explain factors that affect industry pricing practices. a describe how inflation affects the estimation of cash flows for a company domiciled in an emerging market; b evaluate an emerging market Low company using a discounted cash flow model based on nominal and real financial projections; c discuss the arguments for adjusting cash flows, rather than adjusting the discount rate, to account for emerging market risks (e.g., inflation, macroeconomic volatility, capital control, and political risk) in a scenario analysis; d estimate the cost of capital for emerging market companies, and calculate and interpret a country risk premium. a compare and contrast dividends, free None cash flow, and residual income as alternative measures in discounted cash flow models, and identify the investment situations for which each measure is suitable; b calculate and interpret the value of a None common stock using the dividend discount model (DDM) for one-, two-, and multiple-period holding periods - - c calculate the value of a common stock using the Gordon growth model, and explain the model’s underlying assumptions; d calculate the implied growth rate of dividends using the Gordon growth model and current stock price; e calculate and interpret the present None value of growth opportunities (PVGO) and the component of the leading price-to- earnings ratio (P/E) related to PVGO; f calculate the justified leading and None trailing P/Es using the Gordon growth model; g calculate the value of noncallable None fixed-rate perpetual preferred stock; h explain the strengths and limitations None of the Gordon growth model, and justify its h selection to value a company’s common shares; i explain the assumptions and justify None the selection of the two-stage DDM, the H-model, the three-stage DDM, or spreadsheet modeling to value a company’s common shares; j explain the growth phase, transitional phase, and maturity phase of a business; k explain terminal value, and discuss alternative approaches to determining the terminal value in a DDM; l calculate and interpret the value of None common shares using the two-stage DDM, the H-model, and the three-stage DDM; m estimate a required return based on None any DDM, the Gordon growth model, and the H-model; n calculate and interpret the Low sustainable growth rate of a company, and demonstrate the use of DuPont analysis to estimate a company’s sustainable growth rate; o illustrate the use of spreadsheet modeling to forecast dividends and value common shares; p evaluate whether a stock is New overvalued, fairly valued, or undervalued by the market based on a DDM estimate of value. a compare and contrast the free cash None flow to the firm (FCFF) and free cash flow to a equity (FCFE) approaches to valuation; - - b contrast the ownership perspective implicit in the FCFE approach to the ownership perspective implicit in the dividend discount approach; c discuss the appropriate adjustments to net income, earnings before interest and taxes (EBIT), earnings before interest, taxes, depreciation, and amortization (EBITDA), and cash flow from operations (CFO) to calculate FCFF and FCFE; d calculate FCFF and FCFE; None e discuss approaches for forecasting FCFF and FCFE; f contrast the recognition of value in None the FCFE model with the recognition of value in dividend discount models; g explain how dividends, share None repurchases, share issues, and changes in leverage may affect future FCFF and FCFE; h critique the use of net income and EBITDA as proxies for cash flow in valuation; i discuss the single-stage (stable- None growth), two-stage, and three-stage FCFF and FCFE models, and select and justify the appropriate model given a company’s characteristics; j estimate a company’s value using the None appropriate model(s); k explain the use of sensitivity analysis None in FCFF and FCFE valuations; l discuss approaches for calculating the terminal value in a multistage valuation model. - - a differentiate between the method of None comparables and the method based on forecasted fundamentals as approaches to using price multiples in valuation, and discuss the economic rationales for each approach; b define and interpret a justified price None multiple; c discuss rationales for and possible None drawbacks to using price multiples (including P/E, P/B, P/S, P/CF) and dividend yield in valuation; d calculate and interpret alternative None price multiples and dividend yield; e calculate and interpret underlying None earnings; f discuss methods of normalizing EPS, None and calculate normalized EPS; g explain and justify the use of earnings None yield (E/P); - - h discuss the fundamental factors that None influence alternative price multiples and dividend yield; i calculate and interpret the justified None price-to-earnings ratio (P/E), price-to- book ratio (P/B), and price-to-sales ratio (P/S) for a stock, based on forecasted fundamentals; j calculate and interpret a predicted P/E, given a cross-sectional regression on fundamentals, and explain limitations to the cross-sectional regression methodology; k evaluate a stock by the method of None comparables, and explain the importance of fundamentals in using the method of comparables; - - - - l calculate and interpret the P/E-to- growth ratio (PEG), and explain its use in relative valuation; m calculate and explain the use of price None multiples in determining terminal value in a multistage discounted cash flow (DCF) model; n discuss alternative definitions of cash None flow used in price and enterprise value multiples, and explain the limitations of each definition; o calculate and interpret enterprise None value multiples, and critique the use of EV/EBITDA; p discuss the sources of differences in cross-border valuation comparisons; q describe momentum indicators and None their use in valuation; r evaluate whether a stock is overvalued, fairly valued, or undervalued based on comparisons of multiples; s discuss the use of the arithmetic mean, the harmonic mean, the weighted harmonic mean, and the median to describe the central tendency of a group of multiples; t explain the use of stock screens in investment management. a calculate and interpret residual None income, economic value added, and market value added; b discuss the uses of residual income None models; c calculate the intrinsic value of a High common stock using the residual income model, and contrast the recognition of value in the residual income model to value recognition in other present value models; d discuss the fundamental determinants of residual income; e explain the relation between residual income valuation and the justified price-tobook ratio based on forecasted fundamentals; f calculate and interpret the intrinsic None value of a common stock using single- stage (constant-growth) and multistage residual income models; g calculate an implied growth rate in residual income given the market price-tobook ratio and an estimate of the required rate of return on equity; h explain continuing residual income None and justify an estimate of continuing residual income at the forecast horizon given company and industry prospects; i compare and contrast the residual None income model to the dividend discount and i free cash flow to equity models; j discuss the strengths and None weaknesses of the residual income model; k justify the selection of the residual None income model to value a company’s common stock; l discuss accounting issues in applying residual income models; m evaluate whether a stock is None overvalued, fairly valued, or undervalued by the market based on a residual income model. - - - - a compare and contrast public and private company valuation; b discuss the uses of private business High valuation, and explain applications of greatest concern to financial analysts; c explain alternative definitions of None value, and demonstrate how different definitions can lead to different estimates of value; d discuss the income, market, and Low asset-based approaches to private company d valuation and the factors relevant to the selection of each approach; e discuss cash flow estimation issues Low related to private companies and the adjustments required to estimate normalized earnings; f demonstrate the free cash flow, None capitalized cash flow, and excess earnings methods of private company valuation; g discuss factors that require None adjustment when estimating the discount rate for private companies; h compare and contrast models used None to estimate the required rate of return to private company equity (for example, the CAPM, the expanded CAPM, and the build-up approach); i demonstrate the market approaches to private company valuation (for example, guideline public company method, guideline transaction method, and prior transaction method), and discuss the advantages and disadvantages of each; j demonstrate the asset-based approach to private company valuation; k discuss the use of discounts and None premiums in private company valuation; l describe the role of valuation None standards in valuing private companies. a illustrate, for each type of real property investment, the main value determinants, a investment characteristics, principal risks, and most likely investors; b evaluate a real estate investment using net present value (NPV) and internal rate of return (IRR) from the perspective of an equity investor; c calculate the after-tax cash flow and the after-tax equity reversion from real estate properties; d explain the potential problems associated with using IRR as a measurement tool in real estate investments. a explain the relation between a real estate capitalization rate and a discount rate b determine the capitalization rate by the market-extraction method, band- ofinvestment method, and built-up method, and justify each method’s use in capitalization rate determination; c estimate the market value of a real estate investment using the direct income capitalization approach and the gross income multiplier technique; d contrast the limitations of the direct capitalization approach to those of the gross income multiplier technique. a explain the sources of value creation in private equity; b explain how private equity firms align their interests with those of the managers of portfolio companies; c distinguish between the characteristics of buyout and venture capital investments; d discuss the valuation issues in buyout and venture capital transactions; e explain alternative exit routes in private equity and their impact on value; f explain private equity fund structures, terms, valuation, and due diligence in the f context of an analysis of private equity fund returns; g explain the risks and costs of investing in private equity; h interpret and compare financial performance of private equity funds from the perspective of an investor; i calculate management fees, carried interest, net asset value, distributed to paid in (DPI), residual value to paid in (RVPI), and total value to paid in (TVPI) of a private equity fund; - - j calculate pre-money valuation, post- money valuation, ownership fraction, and price per share applying the venture capital method 1) with single and multiple financing rounds and 2) in terms of IRR; k demonstrate alternative methods to account for risk in venture capital. - - - - - - - - - - a explain why commodity futures such as gold have limited “contango,” whereas others such as oil often have natural “backwardation,” and indicate why these conditions might be less prevalent in the future; b discuss how “roll yield” in a commodity futures position can be positive (negative); c discuss the argument that commodity futures are not an asset class; d demonstrate how the geometric return of an actively managed commodity basket can be positive, whereas the underlying average commodity has a geometric return near zero; e discuss why investing in commodities offers diversification opportunities during periods of economic fluctuation in the short run and inflation in the long run. a discuss how the characteristics of hedge funds affect traditional methods of performance measurements; b compare and contrast the use of market indices, hedge fund indices, and positive risk-free rates to evaluate hedge fund performance. a discuss common types of investment risks for hedge funds; b evaluate maximum drawdown and value-at-risk for measuring risks of hedge funds. a distinguish among default risk, credit spread risk, and downgrade risk; b explain and analyze the key components of credit analysis; c calculate and interpret the key financial ratios used by credit analysts; d evaluate the credit quality of an issuer of a corporate bond, given such data as key financial ratios for the issuer and the industry; e analyze why and how cash flow from operations is used to assess the ability of an issuer to service its debt obligations and to assess the financial flexibility of a company; f explain and interpret the typical elements of the corporate structure and debt structure of a high-yield issuer and the effect of these elements on the risk position of the lender; g discuss the factors considered by rating agencies in rating asset- backed securities; h explain how the credit worthiness of municipal bonds is assessed, and contrast the analysis of tax-backed debt with the analysis of revenue obligations; i discuss the key considerations used by Standard & Poor’s in assigning sovereign ratings, and describe why two ratings are assigned to each national government; j contrast the credit analysis required for corporate bonds to that required for 1) asset-backed securities, 2) municipal securities, and 3) sovereign debt. a contrast the concept of liquidity as “appetite for risk” with the more traditional view that liquidity is created by the central bank; b describe how Minsky’s “financial instability hypothesis” predicts a mortgage market crisis as debt creation journeys from conservative hedging activities to more speculative activities, and finally to a Ponzi scheme phase; c explain how subprime mortgage borrowers are granted a free at-the- money call option on the value of their property. a illustrate and explain parallel and nonparallel shifts in the yield curve, a yield curve twist, and a change in the curvature of the yield curve (i.e., a butterfly shift); b describe the factors that drive U.S. Treasury security returns, and evaluate the importance of each factor; c explain the various universes of Treasury securities that are used to construct the theoretical spot rate curve, and evaluate their advantages and disadvantages; d explain the swap rate curve (LIBOR curve), and discuss why market participants have used the swap rate curve rather than a government bond yield curve as a benchmark; e illustrate the theories of the term None structure of interest rates (i.e., pure expectations, liquidity, and preferred habitat), and discuss the implications of each for the shape of the yield curve; f compute and interpret the yield curve risk of a security or a portfolio by using key rate duration; g compute and interpret yield volatility, distinguish between historical yield volatility and implied yield volatility, and explain how yield volatility is forecasted. a evaluate, using relative value analysis, whether a security is undervalued or overvalued; b evaluate the importance of benchmark interest rates in interpreting spread measures; c illustrate the backward induction valuation methodology within the binomial interest rate tree framework; d compute the value of a callable bond from an interest rate tree; e illustrate the relations among the values of a callable (putable) bond, the corresponding option-free bond, and the embedded option; f explain the effect of volatility on the arbitrage-free value of an option; g interpret an option-adjusted spread with respect to a nominal spread and to benchmark interest rates; h illustrate how effective duration and effective convexity are calculated using the binomial model; i calculate the value of a putable bond, using an interest rate tree; j describe and evaluate a convertible bond and its various component values; k compare and contrast the risk-return characteristics of a convertible bond with the risk-return characteristics of ownership of the underlying common stock. a describe a mortgage loan, and illustrate the cash flow characteristics of a fixedrate, level payment, and fully amortized mortgage loan; b illustrate the investment characteristics, payment characteristics, and risks of mortgage passthrough securities; c calculate the prepayment amount for a month, given the single monthly mortality rate; d compare and contrast the conditional prepayment rate (CPR) with the Public Securities Association (PSA) prepayment benchmark; e explain why the average life of a mortgage-backed security is more relevant than the security’s maturity; f explain the factors that affect prepayments and the types of prepayment risks; g illustrate how a collateralized mortgage obligation (CMO) is created and how it provides a better matching of assets and liabilities for institutional investors; h distinguish among the sequential pay tranche, the accrual tranche, the planned amortization class tranche, and the support tranche in a CMO; i evaluate the risk characteristics and the relative performance of each type of CMO tranche, given changes in the interest rate environment; j explain the investment characteristics of stripped mortgage-backed securities; k compare and contrast agency and nonagency mortgage-backed securities; l distinguish credit risk analysis of commercial mortgage-backed securities (CMBS) from credit risk analysis of residential nonagency mortgage-backed securities; m describe the basic structure of a CMBS, and illustrate the ways in which a CMBS investor may realize call protection at the loan level and by means of the CMBS structure. a illustrate the basic structural features of and parties to a securitization transaction; b explain and contrast prepayment tranching and credit tranching; c distinguish between the payment structure and collateral structure of a securitization backed by amortizing assets and non-amortizing assets; d distinguish among the various types of external and internal credit enhancements; e describe the cash flow and prepayment characteristics for securities backed by home equity loans, manufactured housing loans, automobile loans, student loans, SBA loans, and credit card receivables; f describe collateralized debt obligations (CDOs), including cash and synthetic CDOs; g distinguish among the primary motivations for creating a collateralized debt obligation (arbitrage and balance sheet transactions). a illustrate the computation, use, and limitations of the cash flow yield, nominal spread, and zero-volatility spread for a mortgage-backed security and an assetbacked security; b describe the Monte Carlo simulation model for valuing a mortgage- backed security; c describe path dependency in passthrough securities and the implications for valuation models; d illustrate how the option-adjusted spread is computed using the Monte Carlo simulation model and how this spread measure is interpreted; e evaluate a mortgage-backed security using option-adjusted spread analysis; f discuss why effective durations reported by various dealers and vendors may differ; g analyze the interest rate risk of a security given the security’s effective duration and effective convexity; h explain other measures of duration used by practitioners in the mortgage- backed market (e.g., cash flow duration, coupon curve duration, and empirical duration), and describe the limitations of these duration measures; i determine whether the nominal spread, zero-volatility spread, or option-adjusted spread should be used to evaluate a specific fixed income security. a explain how the value of a forward contract is determined at initiation, during the life of the contract, and at expiration; b calculate and interpret the price and the value of an equity forward contract, assuming dividends are paid either discretely or continuously; c calculate and interpret the price and the value of 1) a forward contract on a fixed-income security, 2) a forward rate agreement (FRA), and 3) a forward contract on a currency; d evaluate credit risk in a forward contract, and explain how market value is a measure of the credit risk to a party in a forward contract. a explain why the futures price must converge to the spot price at expiration; b determine the value of a futures contract; c explain how forward and futures prices differ; d describe the monetary and nonmonetary benefits and costs associated with holding the underlying asset, and explain how they affect the futures price; e describe backwardation and contango; f discuss whether futures prices equal expected spot prices; g describe the difficulties in pricing Eurodollar futures and creating a pure arbitrage opportunity; h calculate and interpret the price of Treasury bond futures, stock index futures, and currency futures. a calculate and interpret the prices of a synthetic call option, synthetic put option, synthetic bond, and synthetic underlying stock, and infer why an investor would want to create such instruments; b calculate and interpret prices of interest rate options and options on assets using one- and two-period binomial models; c explain the assumptions underlying the Black–Scholes–Merton model and their limitations; d explain how an option price, as represented by the Black–Scholes–Merton model, is affected by each of the input values (the option Greeks); e explain the delta of an option, and demonstrate how it is used in dynamic hedging; f explain the gamma effect on an option’s price and delta and how gamma can affect a delta hedge; g discuss the effect of the underlying asset’s cash flows on the price of an option; h demonstrate the methods for estimating the future volatility of the underlying asset (i.e., the historical volatility and the implied volatility methods); i illustrate how put-call parity for options on forwards (or futures) is established; j compare and contrast American options on forwards and futures with European options on forwards and futures, and identify the appropriate pricing model for European options. a distinguish between the pricing and valuation of swaps; b explain the equivalence of 1) interest None rate swaps to a series of off-market forward b rate agreements (FRAs) and 2) a plain vanilla swap to a combination of an interest rate call and an interest rate put; c calculate and interpret the fixed rate on a plain vanilla interest rate swap and the market value of the swap during its life; d calculate and interpret the fixed rate, if applicable, and the foreign notional principal for a given domestic notional principal on a currency swap, and determine the market values of each of the different types of currency swaps during their lives; e calculate and interpret the fixed rate, if applicable, on an equity swap and the market values of the different types of equity swaps during their lives; f explain and interpret the characteristics and uses of swaptions, including the difference between payer and receiver swaptions; g identify and calculate the possible payoffs and cash flows of an interest rate swaption; h calculate and interpret the value of an interest rate swaption on the expiration day; i evaluate swap credit risk for each party and during the life of the swap, distinguish between current credit risk and potential credit risk, and illustrate how swap credit risk is reduced by both netting and marking to market; j define swap spread and relate it to credit risk. a demonstrate how both a cap and a floor are packages of options on interest rates and options on fixed-income instruments; b compute the payoff for a cap and a floor, and explain how a collar is created. a describe the characteristics of a credit default swap, and compare and contrast a credit default swap with a corporate bond; b explain the advantages of using credit derivatives over other credit instruments; c explain the use of credit derivatives by the various market participants; d discuss credit derivatives trading strategies and how they are used by hedge funds and other managers. a discuss mean–variance analysis and its assumptions, and calculate the expected return and the standard deviation of return for a portfolio of two or three assets; b explain the minimum-variance and efficient frontiers, and discuss the steps to solve for the minimum-variance frontier; c discuss diversification benefits, and explain how the correlation in a two- asset portfolio and the number of assets in a multi-asset portfolio affect the diversification benefits; d calculate the variance of an equally weighted portfolio of n stocks, explain the capital allocation and the capital market lines (CAL and CML) and the relation between them, and calculate the values of one of the variables given the values of the remaining variables; e explain the capital asset pricing model (CAPM), including its underlying e assumptions and the resulting conclusions; f discuss the security market line (SML), the beta coefficient, the market risk premium, and the Sharpe ratio, and calculate the value of one of these variables given the values of the remaining variables; g explain the market model, and state and interpret the market model’s predictions with respect to asset returns, variances, and covariances; h calculate an adjusted beta, and discuss the use of adjusted and historical betas as predictors of future betas; i discuss reasons for and problems related to instability in the minimum- variance frontier; j discuss and compare macroeconomic factor models, fundamental factor models, and statistical factor models; k calculate the expected return on a portfolio of two stocks, given the estimated macroeconomic factor model for each stock; l discuss the arbitrage pricing theory (APT), including its underlying assumptions and its relation to the multifactor models, calculate the expected return on an asset given an asset’s factor sensitivities and the factor risk premiums, and determine whether an arbitrage opportunity exists, including how to exploit the opportunity; m explain the sources of active risk, define and interpret tracking error, tracking risk, and the information ratio, and explain factor portfolio and tracking portfolio; n compare and contrast the conclusions and the underlying assumptions of the CAPM and the APT models, and explain why an investor can possibly earn a substantial premium for exposure to dimensions of risk unrelated to market movements. a discuss the efficiency of the market portfolio in the CAPM and the relation between the expected return and beta of an asset when restrictions on borrowing at the risk-free rate and on short selling exist; b discuss the practical consequences that follow when restrictions on borrowing at the risk-free rate and on short selling exist. a explain international market integration and segmentation and the impediments to international capital mobility; b discuss the factors that favor international market integration; c discuss the assumptions of the domestic capital asset pricing model (CAPM); d justify the extension of the domestic None CAPM to an international context (the extended CAPM), and discuss the assumptions needed to make the extension; e determine whether the real exchange None rate has changed in a period; f calculate the expected 1) exchange None rate and 2) domestic-currency holding period return on a foreign bond (security); g calculate the end-of-period real None exchange rate and the domestic- currency ex-post return on a foreign bond (security); h calculate a foreign currency risk premium, and explain a foreign currency risk premium in terms of interest rate differentials and forward rates; i state the risk pricing relation and the None formula for the international capital asset pricing model (ICAPM), and calculate the expected return on a stock using the model; - - j explain the effect of market segmentation on the ICAPM; k define currency exposure, and explain exposures in terms of correlations; l discuss the likely exchange rate exposure of a company based on a description of the company’s activities, and explain the impact of both real and nominal exchange rate changes on the valuation of the company; m discuss the currency exposures of national economies, equity markets, and bond markets; n contrast the traditional trade approach ( j-curve) and the money demand approach to modeling the relation between real exchange rate changes and domestic economic activity. a justify active portfolio management when security markets are nearly efficient; b discuss the steps and the approach of the Treynor-Black model for security selection; c describe how an analyst’s accuracy in forecasting alphas can be measured and how estimates of forecasting can be incorporated into the Treynor-Black approach. a explain the importance of the portfolio perspective; b describe the steps of the portfolio management process and the components of those steps; c define investment objectives and constraints, and explain and distinguish among the types of investment objectives and constraints; d discuss the role of the investment policy statement in the portfolio management process, and explain the elements of an investment policy statement; e explain how capital market None expectations and the investment policy statement help influence the strategic asset allocation decision, and discuss how an investor’s investment time horizon may influence the investor’s strategic asset allocation; f contrast the types of investment time horizons, determine the time horizon for a particular investor, and evaluate the effects of this time horizon on portfolio choice; g justify ethical conduct as a requirement for managing investment portfolios. ange is insignificant and you can refer to the 2010 version. w LOS in 2011 curriculum nge is of low significance has changed substantially and you need to refer to the new book. None – Change is insignificant and you can refer to the 2010 version. New – New LOS in 2011 curriculum Low – Change is of low significance High – LOS has changed substantially and you need to refer to the new book.

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