CFA Level II key terms

An approach permitting an analyst to combine public information with nonmaterial nonpublic or nonproprietary information to reach an investment conclusion, provided that no material nonpublic information is used.

Information unavailable to the public that, if disclosed, would likely move a security's price or that a reasonable investor would consider important; trading on it, or causing others to trade on it, breaches Standard II(A).

The duty under Standard I(B) to keep research and recommendations free from influence by gifts, compensation, internal pressure, or outside relationships, and to disclose or refuse arrangements that could reasonably compromise professional judgment.

A grouping of one or more portfolios managed according to a similar investment mandate, objective, or strategy; firms must include all actual, fee-paying, discretionary portfolios that fit the composite definition.

Condition in which the variance of regression residuals is not constant across observations; coefficient estimates stay unbiased, but standard errors become unreliable, so hypothesis tests about the coefficients may be wrong.

Condition in which regression residuals are correlated with one another across observations, common in time-series data; it distorts standard errors, and positive serial correlation usually makes t-statistics too large.

Condition in which two or more independent variables in a regression are highly correlated, inflating coefficient standard errors and making individual coefficients unstable or insignificant even when the model fits well overall.

Property of a time series whose autoregressive coefficient equals one, making it nonstationary with a variance that grows over time; regressions using such series can give spurious results unless the data are differenced.

Situation in which two or more nonstationary time series share a long-run relationship, so a linear combination of them is stationary; this permits a meaningful regression using the levels of the series.

Autoregressive conditional heteroskedasticity: a model in which the variance of a time series' error term depends on the size of recent past squared errors, capturing volatility clustering in financial returns.

Condition stating that the forward premium or discount between two currencies equals the interest rate differential, so borrowing in one currency, converting, and lending in another with a forward hedge earns no arbitrage profit.

Theory holding that the expected change in the spot exchange rate equals the interest rate differential between two currencies, so higher-yielding currencies are expected to depreciate enough to equalize unhedged returns.

Rule stating that a currency depreciation improves a country's trade balance only if the sum of the absolute values of export and import demand elasticities exceeds one.

The portion of economic output not explained by increases in labor and capital inputs, reflecting technology, efficiency, and institutional quality; a key driver of long-run growth beyond capital deepening.

Translation approach in which all assets and liabilities are translated at the closing rate, income statement items at the average rate, and the resulting adjustment is reported within equity as a cumulative translation account.

Translation approach using historical rates for items carried at historical cost, the closing rate for monetary items, and the average rate for income statement items, with translation gains or losses reported in net income.

Accounting for investments giving significant influence, typically 20 to 50 percent ownership, where the investor records its share of the investee's profit in income and adjusts the investment's carrying value accordingly.

Actuarial present value of all pension benefits employees have earned to date under the plan, using assumed future salary increases; compared with plan assets, it determines the plan's funded status.

Capital structure theory in which firms balance the tax savings from debt against the rising costs of financial distress, producing an optimal leverage ratio where marginal benefits equal marginal costs.

Theory that firms prefer internal funds first, then debt, and issue equity only as a last resort, so profitability and information asymmetry, rather than an optimal leverage target, drive capital structure choices.

Dividend policy that pays out only what remains of earnings after funding all positive net present value projects at the target capital structure, letting dividends fluctuate with investment opportunities and earnings.

Cash available to common shareholders after operating expenses, taxes, interest, and reinvestment, but before debt repayments; it is used to value equity directly by discounting at the cost of equity.

Valuation approach that sets equity value at book value plus the present value of expected earnings in excess of the required return on equity, useful when free cash flows are negative or hard to forecast.

Dividend discount model that assumes growth starts high and declines linearly to a stable long-run rate over a specified period, capturing the value of extraordinary growth in a single formula.

The price-to-earnings multiple supported by fundamentals, computed as the payout ratio divided by the difference between the required return and expected growth; used to compare market price with fundamental value.

The constant spread over the benchmark yield curve that equates a bond's modeled cash flows, adjusted for embedded options, to its market price; it isolates credit and liquidity compensation from option risk.

A measure of a bond's price sensitivity to a small parallel shift in the benchmark yield curve, computed with a pricing model that revalues the bond under up and down rate scenarios, including embedded options.

Sensitivity of a bond's price to a change in yield at one specific maturity along the curve while other maturities hold constant; used to measure and manage exposure to curve reshaping.

A lattice of possible future benchmark rates, calibrated so that discounted model values match observed bond prices, used to value bonds with embedded options and to compute option-adjusted spreads.

Relationship for European options on the same asset and strike: a fiduciary call (call plus riskless bond) and a protective put (put plus underlying asset) must have equal value, so departures signal arbitrage.

The change in an option's price for a one-unit change in the underlying asset's price; also read as the number of underlying shares equivalent to one option and used to build delta-neutral hedges.

The volatility input that makes an option pricing model reproduce the option's observed market price; it reflects the market's expectation of future volatility and is the standard quotation convention for options.

Pattern in which private equity or hedge fund returns are negative early in the fund's life as fees and initial investments weigh on performance, then rise as portfolio companies mature and exits occur.

A provision preventing a fund from collecting incentive fees on gains that merely recover earlier losses; fees are paid only on profits above the highest prior net asset value.

A minimum return, often tied to a benchmark or a fixed percentage, that a fund must earn before the manager receives an incentive fee; it may be applied before or after the base management fee.

A return model expressing asset returns as sensitivity coefficients, or factor betas, multiplied by several common risk factors plus an asset-specific component; used for risk analysis and return forecasting.

The standard deviation of the differences between portfolio returns and benchmark returns, measuring how closely a portfolio follows its benchmark and serving as the denominator of the information ratio.

Active return divided by active risk, or tracking error, showing how much excess return a manager generates per unit of deviation from the benchmark; higher values indicate more efficient use of active risk.