AFA cheat sheet

Code of Ethics states six principles: integrity, competence, diligence, respect, and ethical behavior toward markets, clients, employers, and profession.

Standards I-VII cover professionalism, integrity of capital markets, duties to clients, duties to employers, investment analysis, conflicts of interest, and responsibilities as a member.

Priority order when duties conflict: integrity of capital markets first, then clients, then employers; never subordinate client interest to personal gain.

Independence and objectivity (I-B) prohibits accepting gifts or benefits that could reasonably compromise judgment; disclosure of employer-consented gifts is required.

Misrepresentation (I-C) covers plagiarism, omission of material facts, and guaranteeing returns; cite sources and attribute forecasts to their author.

Fair dealing (III-B) applies to all clients, not just those with similar mandates; priority trade allocation must follow disclosed written policy, not client size.

Performance presentation (III-D) must be fair, accurate, and complete; simulated or back-tested results must be labeled and not linked to actual results.

GIPS requires composites of all actual, fee-paying, discretionary portfolios; composites are asset-weighted and include a minimum of five years of performance.

Accounting equation: Assets = Liabilities + Equity; every transaction preserves this balance in at least two accounts.

Revenue recognition requires a valid contract, performance obligation, and transfer of control; recognize over time if criteria met, otherwise at a point in time.

Capitalizing versus expensing: capitalizing an expenditure increases assets and future earnings (via depreciation) but lowers current expenses and raises current net income.

LIFO versus FIFO during inflation: LIFO yields higher cost of goods sold, lower ending inventory, lower net income, and lower taxes; FIFO inflates gross profit.

Inventory write-downs under lower of cost or market reduce inventory, increase cost of goods sold, and lower the current ratio and gross margin.

Depreciation methods: straight-line = (cost - salvage)/useful life; double-declining = 2/useful life × beginning book value; units-of-production ties expense to usage.

Indirect method cash flow from operations: net income + non-cash charges - increases in working capital (add decreases in receivables, subtract increases in payables).

Free cash flow to firm = CFO - capital expenditures + net borrowing adjustments; FCFE = CFO - capex + net borrowing; use FCFF for enterprise valuation.

Net present value = sum of discounted cash flows minus initial outlay; accept positive-NPV projects; NPV is the primary decision rule.

Internal rate of return is the discount rate making NPV zero; IRR can mislead with non-conventional cash flows or mutually exclusive projects of different scale.

Weighted average cost of capital = (E/V)×Re + (D/V)×Rd×(1-tax rate); use market values and target capital structure weights.

Cost of equity via CAPM: Re = risk-free rate + beta × equity risk premium; beta measures systematic risk relative to the market.

Cost of debt is the yield to maturity on existing debt adjusted for the marginal tax shield; flotation costs are usually ignored in WACC.

Leverage raises equity beta: unlevered beta = levered beta / [1 + (1 - tax) × (D/E)]; relever for the target capital structure.

Dividend policy: in perfect markets dividend policy is irrelevant (Miller-Modigliani); taxes, signaling, and agency costs create real-world effects.

Working capital management: cash conversion cycle = days inventory outstanding + days sales outstanding - days payables outstanding; shorter is generally better.

Gordon growth model: P0 = D1 / (r - g); valid only when g < r and growth is stable and sustainable.

Two-stage DDM discounts high-growth dividends individually, then applies a terminal value using the Gordon growth formula at the transition point.

Justified P/E = payout ratio / (r - g); higher payout, higher growth, and lower required return raise the justified multiple.

Free cash flow to equity model: value = sum of FCFE / (1 + r)^t; FCFE = net income - capex + depreciation - change in working capital + net borrowing.

Residual income model: value = book value + present value of expected residual income, where residual income = earnings - (r × beginning book value).

Porter's five forces: threat of new entrants, bargaining power of buyers, bargaining power of suppliers, threat of substitutes, and rivalry among existing firms.

Enterprise value = market value of equity + market value of debt - cash and investments; EV/EBITDA is capital-structure neutral.

Sustainable growth rate = retention ratio × return on equity; growth above this requires external financing or improving ROE.

Bond price and yield are inversely related; price = sum of coupon/(1+y)^t plus par/(1+y)^n, where y is the yield per period.

Macaulay duration is the weighted average time to cash flows; modified duration = Macaulay duration / (1 + yield per period).

Price change approximation: percentage price change ≈ -modified duration × yield change + 0.5 × convexity × (yield change)^2.

Convexity is positive for option-free bonds; greater convexity means larger price gains for yield falls and smaller losses for yield rises.

Spot rates discount each cash flow separately; forward rates are implied by spot curve: (1+s2)^2 = (1+s1)(1+1f1).

Credit spreads widen in risk-off environments; spread duration measures price sensitivity to changes in spread, not to benchmark yields.

Callable bonds have negative convexity and lower duration than otherwise identical option-free bonds; putable bonds have higher duration.

Yield curve shapes: upward sloping (normal), inverted (recession signal), and flat; expectations, liquidity, and segmentation theories explain them.

Forward contract payoff at maturity: long = spot - forward price; short = forward price - spot; forwards have zero initial value.

Call option payoff at expiration: max(0, S - K); put payoff: max(0, K - S); option value = intrinsic value + time value.

Put-call parity (European, no dividends): C + K/(1+r)^T = P + S0; violations imply arbitrage opportunities.

Binomial option pricing values options by replicating payoffs with a riskless hedge; risk-neutral probabilities discount expected payoffs at the risk-free rate.

Futures versus forwards: futures are exchange-traded, marked to market daily, and standardized; forwards are OTC and customizable.

Hedge fund strategies: long/short equity, event-driven, relative value, global macro, and managed futures; lockups and gates limit redemptions.

Private equity returns are reported as IRR and multiples (TVPI, DPI); IRR can be inflated by early distributions and is not comparable to time-weighted returns.

Real estate and commodities provide diversification and inflation sensitivity; direct real estate is illiquid and appraised rather than continuously priced.

Portfolio expected return = weighted average of asset returns; portfolio variance depends on weights, individual variances, and covariances.

Diversification benefit increases as correlation falls; with correlation of +1 no risk reduction is possible, and with -1 risk can be eliminated.

Capital market line uses total risk (standard deviation) for efficient portfolios; security market line uses beta for any security.

Sharpe ratio = (portfolio return - risk-free rate) / standard deviation; higher is better for evaluating total-risk-adjusted performance.

Treynor ratio = (portfolio return - risk-free rate) / beta; appropriate when the portfolio is one holding within a diversified fund.

Investor risk tolerance combines ability (financial capacity, horizon, liquidity needs) and willingness (psychological attitude); the lower of the two governs.

Asset allocation policy drives most return variability; strategic allocation sets long-term weights, tactical allocation makes short-term deviations.

Rebalancing to target weights enforces buy-low/sell-high discipline; calendar and threshold rebalancing are common approaches.

Time value: PV = FV / (1 + r)^n; for annuities use PV = PMT × [1 - (1+r)^-n] / r.

Effective annual rate = (1 + stated rate/m)^m - 1; continuous compounding EAR = e^r - 1.

Coefficient of variation = standard deviation / expected return; it measures risk per unit of return for comparing investments.

Regression: slope = covariance(x,y)/variance(x); R-squared is the fraction of variation in y explained by the model.

Hypothesis testing: reject the null when the test statistic exceeds the critical value; a p-value below significance level rejects the null.

Price elasticity of demand = percentage change in quantity / percentage change in price; elastic demand means |elasticity| > 1.

GDP expenditure approach: GDP = C + I + G + (X - M); real GDP removes price-level effects using a base year.

Monetary policy transmission: central bank changes policy rate, affecting short-term rates, credit, asset prices, exchange rates, and aggregate demand.