CFA Level I flashcards

32 cards. Read the term and the definition here. The deck at the top of this page is optional.

Mosaic Theory

An analyst may act on public information combined with individually nonmaterial nonpublic information, even if the assembled conclusion is material, provided no single piece is material and nonpublic.

Fair Dealing Standard

Standard III(B) requires members to treat all clients fairly when issuing recommendations or taking investment action. It permits differing service levels but forbids favouring some clients with advance information.

Priority of Transactions

Standard VI(B) ranks client and employer transactions above personal transactions. Investment personnel must avoid trading ahead of clients and typically face pre-clearance and blackout requirements.

Effective Annual Rate

EAR = (1 + periodic rate)^m − 1, where m is the number of compounding periods per year. It exceeds the stated annual rate whenever compounding occurs more than once annually.

Coefficient of Variation

Standard deviation divided by expected return. It measures risk per unit of return and allows risk comparisons across assets whose expected returns differ substantially in magnitude.

Money-Weighted Return

The internal rate of return of a portfolio's cash flows, including external deposits and withdrawals. It is sensitive to the size and timing of those flows, unlike the time-weighted return.

GDP Expenditure Approach

Gross domestic product equals consumption plus gross private investment plus government spending plus net exports, where net exports are exports minus imports for the period.

Covered Interest Rate Parity

The forward rate divided by the spot rate equals one plus the price-currency interest rate divided by one plus the base-currency rate. Persistent deviations create covered arbitrage opportunities.

Money Multiplier

One divided by the reserve requirement. It gives the maximum potential expansion of the money supply resulting from an increase in bank reserves, assuming no currency drain.

Accounting Equation

Assets equal liabilities plus owners' equity. Every recorded transaction affects at least two accounts and leaves this identity in balance at all times.

LIFO Liquidation

Occurs when a LIFO firm sells more units than it purchases, so older lower-cost inventory layers enter cost of goods sold, temporarily raising gross profit relative to current replacement cost.

DuPont Decomposition

Return on equity expressed as net profit margin times total asset turnover times financial leverage. It separates profitability, operating efficiency and leverage as drivers of shareholder returns.

Weighted Average Cost of Capital

The market-value-weighted average of after-tax debt cost, preferred cost and equity cost. It is the minimum return a firm must earn on investments of average risk.

NPV Decision Rule

Accept a project if its net present value is positive. When projects are mutually exclusive, select the one with the highest positive NPV, since it adds the most shareholder value.

Free Cash Flow to Firm

Net income plus noncash charges plus after-tax interest minus fixed capital investment minus working capital investment. It is the cash available to all debt and equity providers.

Gordon Growth Model

Value equals next year's dividend divided by the required return minus the growth rate. It requires constant growth below the required return and suits mature dividend-paying firms.

Justified Leading P/E

The payout ratio divided by the required return minus the growth rate, derived from the Gordon model. The multiple rises with payout and growth and falls with the required return.

Semi-Strong Market Efficiency

Prices reflect all publicly available information, so trading on financial statements, news or analyst reports cannot consistently earn abnormal returns. Fundamental analysis is therefore ineffective.

Modified Duration

Macaulay duration divided by one plus the yield per period. It estimates the percentage price change for a small parallel shift in yield, before applying the convexity adjustment.

Accrued Interest

Interest earned since the last coupon payment date. The full or dirty price equals the clean price plus accrued interest; the clean price is the quoted price.

Spot and Forward Rates

Spot rates discount single future cash flows. Forward rates are implied by the spot curve and lie above spot rates when the curve slopes upward, reflecting expected rate increases.

Put-Call Parity

For European options on a non-dividend-paying stock, call plus present value of exercise price equals put plus stock price. Violations allow arbitrage using synthetic positions.

Cost of Carry

The forward price equals the spot price compounded at the risk-free rate, plus storage costs, minus convenience yield and any income earned over the contract period.

Option Delta

The change in an option's price for a one-unit change in the underlying asset price. Calls have deltas between zero and one; puts have deltas between minus one and zero.

Two and Twenty Fees

A hedge fund fee arrangement charging a 1–2% management fee on assets plus roughly 20% of profits as an incentive fee, often subject to a hurdle rate and high-water mark.

High-Water Mark

The peak net asset value used to compute incentive fees. After a loss, the manager earns performance fees only on profits above that previous peak value.

Convenience Yield

The non-monetary benefit from holding physical inventory rather than a futures contract. A high convenience yield lowers the futures price relative to full cost of carry.

Hedge Fund Redemption Gates

Contractual limits on the percentage of fund assets that may be withdrawn at a redemption date. Gates protect remaining investors when many holders exit simultaneously.

Sharpe Ratio

Excess portfolio return divided by the standard deviation of portfolio returns. It measures return per unit of total risk and suits portfolios that are not fully diversified.

Security Market Line

A graph of expected return against beta under the CAPM. Assets plotting above the line offer more return than required for their systematic risk and are undervalued.

Jensen's Alpha

Actual portfolio return minus the return predicted by the CAPM given the portfolio's beta. A positive alpha indicates outperformance after adjusting for systematic risk.

Information Ratio

Active return divided by active risk, where active return is portfolio minus benchmark return and active risk is the standard deviation of that difference.