CMA Final Paper 14 (SFM) cheat sheet

Financial policy sets the firm's target capital structure, dividend policy, and investment hurdle rate; strategy sets product-market scope. Policy must fund strategy without breaching debt covenants.

WACC = (E/V)·Ke + (D/V)·Kd·(1−t). Use marginal (target-weight) costs, not book values, for investment appraisal.

Value creation test: ROIC > WACC creates economic profit; growth adds value only when the spread is positive. Economic Profit = Invested Capital × (ROIC − WACC).

Pecking order: internal funds first, then debt, then equity, reflecting asymmetric information and issue costs.

Dividend irrelevance (Modigliani–Miller) holds only in perfect markets; with taxes and flotation costs, payout policy affects value through clientele and signalling effects.

Sustainable growth rate g = ROE × retention ratio b, where b = 1 − dividend payout. Growth above g requires external equity or higher leverage.

Agency costs of free cash flow: high payout or debt discipline reduces managerial slack; Jensen's control hypothesis favours debt for mature cash-generative firms.

Strategy frameworks: Porter's five forces for industry attractiveness, value chain for cost/ differentiation positioning, BCG matrix for portfolio resource allocation.

Risk types: market (price, FX, interest rate), credit (default, migration), liquidity (funding vs. asset), operational, and strategic. Each requires a distinct measurement approach.

VaR at confidence c: the loss L such that P(loss > L) = 1 − c. Parametric VaR = z·σ·√h for a single position; portfolio VaR needs the covariance matrix.

Expected Shortfall (CVaR) = average loss beyond VaR; it is sub-additive and coherent, unlike VaR, which can violate sub-additivity.

Duration-based interest rate exposure: ΔP ≈ −D·P·Δy/(1+y) plus convexity term ½·C·P·(Δy)².

Credit risk: Expected Loss = PD × LGD × EAD. Unexpected loss drives economic capital; RWA under Basel uses IRB or standardised approaches.

Operational risk capital under Basel: Basic Indicator (15% of gross income), Standardised (business-line betas), or Advanced Measurement Approach.

Hedging decision rule: hedge when reduction in expected financial distress and agency costs exceeds hedging cost and lost upside; natural hedges (matching currency/ duration) precede derivatives.

Stress testing complements VaR by specifying scenario shocks (rate +200bp, FX −20%) and recomputing P&L, capturing tail and liquidity effects VaR misses.

Dividend discount model: P0 = D1/(Ke − g); Gordon growth requires g < Ke and stable payout. Two-stage or H-model handles transition growth.

Free cash flow to firm: FCFF = EBIT(1−t) + D&A − Capex − ΔNWC. Enterprise value = Σ FCFF/(1+WACC)^t + terminal value.

Free cash flow to equity: FCFE = FCFF − interest(1−t) + net borrowing. Discount at Ke to get equity value directly.

Terminal value (Gordon) = FCFF_{n+1}/(WACC − g); the terminal growth rate must not exceed long-run nominal GDP growth.

Relative valuation: P/E, EV/EBITDA, P/B, P/S. Choose multiples matching the value driver (earnings growth, margin, ROE); adjust for leverage when comparing EV multiples.

CAPM: Ke = Rf + β(Rm − Rf). Unlever β with Hamada: βL = βU[1 + (1−t)D/E] before relevering to target structure.

Bond valuation: price = Σ coupon/(1+y)^t + face/(1+y)^n. YTM solves price = PV; duration and convexity measure price sensitivity.

Residual income model: V0 = B0 + Σ (ROE − Ke)·B_{t−1}/(1+Ke)^t. Useful when FCF is negative or unstable.

Portfolio expected return = Σ w_i·E(R_i). Portfolio variance = wᵀΣw; diversification reduces variance but not systematic risk.

Two-asset variance: σp² = w1²σ1² + w2²σ2² + 2w1w2ρσ1σ2. Minimum-variance weights depend on ρ and individual σ.

Efficient frontier: locus of maximum return for each risk level. The tangency portfolio with the risk-free asset is the optimal risky portfolio (Sharpe-maximising).

Sharpe ratio = (Rp − Rf)/σp. Treynor = (Rp − Rf)/βp. Jensen's alpha = Rp − [Rf + β(Rm − Rf)].

CAPM equilibrium: all investors hold the market portfolio; expected excess return is proportional to beta. Fama-French adds size (SMB) and value (HML) factors.

Performance attribution decomposes active return into asset allocation, security selection, and interaction effects.

Bond portfolio duration = weighted average of individual durations; immunisation matches duration and convexity of assets and liabilities.

Rebalancing rule: calendar (periodic) vs. threshold (band) rebalancing. Threshold rebalancing controls tracking error and transaction costs better in trending markets.

Securitisation: pool assets (mortgages, receivables) into an SPV, issue tranched securities. True sale and bankruptcy remoteness isolate pool from originator credit.

Credit tranching: senior, mezzanine, equity. Losses absorb bottom-up; subordination and overcollateralisation provide credit enhancement.

Prepayment risk: PSA model scales CPR; extension risk when rates rise, contraction risk when rates fall. Pass-through securities carry both.

Forward price: F = S0·e^{(r−q)T} for a dividend yield q; for FX, F = S0·e^{(r_d − r_f)T}.

Black-Scholes: C = S·N(d1) − K·e^{−rT}·N(d2), d1 = [ln(S/K) + (r + σ²/2)T]/(σ√T), d2 = d1 − σ√T.

Put-call parity (European): C − P = S − K·e^{−rT}. Violation permits arbitrage via synthetic positions.

Greeks: delta (hedge ratio), gamma (delta curvature), vega (volatility sensitivity), theta (time decay), rho (rate sensitivity). Delta-neutral hedges need gamma monitoring.

Interest rate swap: exchange fixed for floating; value = PV of fixed leg − PV of floating leg. Swap fixed rate sets both legs to par at inception.

Transaction exposure: known foreign-currency cash flows. Translation exposure: accounting restatement of foreign subsidiary balance sheets. Economic exposure: long-run effect of rate changes on competitive position.

PPP: absolute S = P_d/P_f; relative version predicts exchange rate change ≈ inflation differential. Fisher effect links nominal rates to expected inflation.

International Fisher effect: interest rate differential equals expected spot change; combined with PPP gives forward premium ≈ interest differential.

Covered interest parity: F/S = (1 + r_d)/(1 + r_f). Deviation creates covered arbitrage; transaction costs and capital controls explain persistent small deviations.

Hedging tools: forward contract (locks rate, no premium), money market hedge (borrow/invest + spot), currency futures (standardised, margined), options (premium, upside retained), currency swap.

Option hedge decision: compare forward rate to expected future spot; hedge with options when the currency exposure is contingent (e.g., bidding for a foreign contract).

Translation methods: current rate (all assets/liabilities at closing rate), temporal (monetary at current, non-monetary at historical). Choice affects reported gains/losses.

Leading and lagging: accelerate receivables/ delay payables in weakening currency; netting and matching reduce gross exposure across subsidiaries.

International capital budgeting: discount foreign-currency cash flows at the foreign WACC, then translate at the spot rate; or translate at forward rates and discount at home WACC. Results match under parity.

Adjusted present value for foreign projects: APV = base-case NPV + PV of financing side effects (subsidised loans, tax shields, concessionary debt).

Political risk mitigation: investment insurance (MIGA), joint ventures with local partners, local debt financing, structured exit options, and bilateral investment treaties.

Cost of capital internationally: add country risk premium to Ke; relever beta to local market. Segmented vs. integrated market affects whether global or local beta applies.

Foreign tax credit and transfer pricing: double taxation relief through credit or exemption; arm's-length pricing avoids transfer-pricing penalties.

International cash management: multilateral netting, centralised pooling, leading/lagging, and target cash balances per currency to minimise transaction and opportunity costs.

Cross-border leasing and project finance: non-recourse SPV, debt-service coverage ratio (DSCR) covenants, and political risk guarantees from export credit agencies.

Eurocurrency markets: deposits/loans outside the currency's home country; LIBOR/SOFR transition moved benchmarks to risk-free overnight rates.

Synergy value = V_AB − (V_A + V_B). Acquisition premium = offer price − target pre-announcement price. Acquirer gain = synergy − premium.

Payment method: cash transfers all synergy to target (fixed price); stock sharing dilutes acquirer EPS and shares risk; mixed consideration balances control and risk.

EPS impact: accretion if target P/E < acquirer P/E in an all-stock deal (before synergies); dilution if target P/E is higher.

Exchange ratio in stock deal = offer price per target share / acquirer share price. Post-merger EPS = combined earnings / combined shares.

Defence tactics: poison pills, staggered boards, golden parachutes, white knights, pac-man defence, greenmail. Hostile bids often succeed when premium exceeds defence cost.

Valuation approaches: DCF, comparable companies, comparable transactions, LBO analysis, and sum-of-the-parts for conglomerates.

Divestitures and spin-offs: carve-out (IPO of subsidiary stake), spin-off (pro-rata distribution, tax-free if conditions met), split-off (shareholder choice), tracking stock.

Leveraged buyout: high debt, management equity, exit via IPO or sale. Returns driven by deleveraging, EBITDA growth, and multiple expansion.

Venture capital method: exit value × ownership = terminal value; discount at target IRR (30–60% for early stage) to get post-money; pre-money = post-money − investment.

Pre-money and post-money: post-money = pre-money + investment. Founder dilution = investment / post-money.

Ownership target = investment / post-money valuation. Convertible notes convert at discount or valuation cap; SAFEs have no interest or maturity.

VC term sheet terms: liquidation preference (1x non-participating vs. participating), anti-dilution (full ratchet vs. broad-based weighted average), board seats, pro-rata rights, vesting.

Private equity fund structure: LP/GP, 2/20 fee model (management fee 1.5–2%, carried interest 20%), hurdle rate 8%, catch-up clause, 10-year fund life with extensions.

J-curve: early negative returns from fees and unrealised investments, then gains as exits occur. IRR overstates early-stage returns; use TVPI, DPI, and PME.

Stage financing: seed, Series A/B/C, growth, mezzanine, buyout. Each round prices risk and dilutes founders; milestone-based tranching reduces agency risk.

Exit routes: IPO, trade sale, secondary sale, buyback, write-off. Expected exit value and exit multiple drive VC valuation sensitivity.

Three approaches: income (DCF, capitalised earnings), market (multiples, transaction comps), and asset-based (book, replacement, liquidation). Use triangulation.

DCF steps: forecast FCFF, compute WACC, discount, add terminal value, subtract net debt, divide by shares. Terminal value typically 50–75% of total value.

WACC with target weights: WACC = (E/V)·Ke + (D/V)·Kd·(1−t). Use market values and target capital structure.

Multiples selection: EV/EBITDA for capital-intensive, P/E for financial firms, P/B for banks, EV/Sales for high-growth/low-margin. Apply to forward, not trailing, metrics where possible.

Control premium and marketability discount: controlling interests command premiums (20–40%); minority stakes in private firms face DLOM (20–30%).

Normalised earnings: adjust for owner compensation, non-recurring items, related-party transactions, and one-time gains.

Asset-based valuation: adjusted book value restates assets to fair value; liquidation value assumes forced sale; replacement cost estimates new-build cost.

Valuation date and premise: going concern vs. liquidation; fair value vs. investment value vs. market value. Document assumptions and sensitivity ranges.

Financial policy sets the firm's target capital structure, dividend policy, and investment hurdle rate; strategy sets product-market scope. Policy must fund strategy without breaching debt covenants.

WACC = (E/V)·Ke + (D/V)·Kd·(1−t). Use marginal (target-weight) costs, not book values, for investment appraisal.

Value creation test: ROIC > WACC creates economic profit; growth adds value only when the spread is positive. Economic Profit = Invested Capital × (ROIC − WACC).

Pecking order: internal funds first, then debt, then equity, reflecting asymmetric information and issue costs.

Dividend irrelevance (Modigliani–Miller) holds only in perfect markets; with taxes and flotation costs, payout policy affects value through clientele and signalling effects.

Sustainable growth rate g = ROE × retention ratio b, where b = 1 − dividend payout. Growth above g requires external equity or higher leverage.

Agency costs of free cash flow: high payout or debt discipline reduces managerial slack; Jensen's control hypothesis favours debt for mature cash-generative firms.

Strategy frameworks: Porter's five forces for industry attractiveness, value chain for cost/differentiation positioning, BCG matrix for portfolio resource allocation.

Risk types: market (price, FX, interest rate), credit (default, migration), liquidity (funding vs. asset), operational, and strategic. Each requires a distinct measurement approach.

VaR at confidence c: the loss L such that P(loss > L) = 1 − c. Parametric VaR = z·σ·√h for a single position; portfolio VaR needs the covariance matrix.

Expected Shortfall (CVaR) = average loss beyond VaR; it is sub-additive and coherent, unlike VaR, which can violate sub-additivity.

Duration-based interest rate exposure: ΔP ≈ −D·P·Δy/(1+y) plus convexity term ½·C·P·(Δy)².

Credit risk: Expected Loss = PD × LGD × EAD. Unexpected loss drives economic capital; RWA under Basel uses IRB or standardised approaches.

Operational risk capital under Basel: Basic Indicator (15% of gross income), Standardised (business-line betas), or Advanced Measurement Approach.

Hedging decision rule: hedge when reduction in expected financial distress and agency costs exceeds hedging cost and lost upside; natural hedges (matching currency/duration) precede derivatives.

Stress testing complements VaR by specifying scenario shocks (rate +200bp, FX −20%) and recomputing P&L, capturing tail and liquidity effects VaR misses.

Dividend discount model: P0 = D1/(Ke − g); Gordon growth requires g < Ke and stable payout. Two-stage or H-model handles transition growth.

Free cash flow to firm: FCFF = EBIT(1−t) + D&A − Capex − ΔNWC. Enterprise value = Σ FCFF/(1+WACC)^t + terminal value.

Free cash flow to equity: FCFE = FCFF − interest(1−t) + net borrowing. Discount at Ke to get equity value directly.

Terminal value (Gordon) = FCFF_{n+1}/(WACC − g); the terminal growth rate must not exceed long-run nominal GDP growth.

Relative valuation: P/E, EV/EBITDA, P/B, P/S. Choose multiples matching the value driver (earnings growth, margin, ROE); adjust for leverage when comparing EV multiples.

CAPM: Ke = Rf + β(Rm − Rf). Unlever β with Hamada: βL = βU[1 + (1−t)D/E] before relevering to target structure.

Bond valuation: price = Σ coupon/(1+y)^t + face/(1+y)^n. YTM solves price = PV; duration and convexity measure price sensitivity.

Residual income model: V0 = B0 + Σ (ROE − Ke)·B_{t−1}/(1+Ke)^t. Useful when FCF is negative or unstable.

Portfolio expected return = Σ w_i·E(R_i). Portfolio variance = wᵀΣw; diversification reduces variance but not systematic risk.

Two-asset variance: σp² = w1²σ1² + w2²σ2² + 2w1w2ρσ1σ2. Minimum-variance weights depend on ρ and individual σ.

Efficient frontier: locus of maximum return for each risk level. The tangency portfolio with the risk-free asset is the optimal risky portfolio (Sharpe-maximising).

Sharpe ratio = (Rp − Rf)/σp. Treynor = (Rp − Rf)/βp. Jensen's alpha = Rp − [Rf + β(Rm − Rf)].

CAPM equilibrium: all investors hold the market portfolio; expected excess return is proportional to beta. Fama-French adds size (SMB) and value (HML) factors.

Performance attribution decomposes active return into asset allocation, security selection, and interaction effects.

Bond portfolio duration = weighted average of individual durations; immunisation matches duration and convexity of assets and liabilities.

Rebalancing rule: calendar (periodic) vs. threshold (band) rebalancing. Threshold rebalancing controls tracking error and transaction costs better in trending markets.

Securitisation: pool assets (mortgages, receivables) into an SPV, issue tranched securities. True sale and bankruptcy remoteness isolate pool from originator credit.

Credit tranching: senior, mezzanine, equity. Losses absorb bottom-up; subordination and overcollateralisation provide credit enhancement.

Prepayment risk: PSA model scales CPR; extension risk when rates rise, contraction risk when rates fall. Pass-through securities carry both.

Forward price: F = S0·e^{(r−q)T} for a dividend yield q; for FX, F = S0·e^{(r_d − r_f)T}.

Black-Scholes: C = S·N(d1) − K·e^{−rT}·N(d2), d1 = [ln(S/K) + (r + σ²/2)T]/(σ√T), d2 = d1 − σ√T.

Put-call parity (European): C − P = S − K·e^{−rT}. Violation permits arbitrage via synthetic positions.

Greeks: delta (hedge ratio), gamma (delta curvature), vega (volatility sensitivity), theta (time decay), rho (rate sensitivity). Delta-neutral hedges need gamma monitoring.

Interest rate swap: exchange fixed for floating; value = PV of fixed leg − PV of floating leg. Swap fixed rate sets both legs to par at inception.

Transaction exposure: known foreign-currency cash flows. Translation exposure: accounting restatement of foreign subsidiary balance sheets. Economic exposure: long-run effect of rate changes on competitive position.

PPP: absolute S = P_d/P_f; relative version predicts exchange rate change ≈ inflation differential. Fisher effect links nominal rates to expected inflation.

International Fisher effect: interest rate differential equals expected spot change; combined with PPP gives forward premium ≈ interest differential.

Covered interest parity: F/S = (1 + r_d)/(1 + r_f). Deviation creates covered arbitrage; transaction costs and capital controls explain persistent small deviations.

Hedging tools: forward contract (locks rate, no premium), money market hedge (borrow/invest + spot), currency futures (standardised, margined), options (premium, upside retained), currency swap.

Option hedge decision: compare forward rate to expected future spot; hedge with options when the currency exposure is contingent (e.g., bidding for a foreign contract).

Translation methods: current rate (all assets/liabilities at closing rate), temporal (monetary at current, non-monetary at historical). Choice affects reported gains/losses.

Leading and lagging: accelerate receivables/delay payables in weakening currency; netting and matching reduce gross exposure across subsidiaries.

International capital budgeting: discount foreign-currency cash flows at the foreign WACC, then translate at the spot rate; or translate at forward rates and discount at home WACC. Results match under parity.

Adjusted present value for foreign projects: APV = base-case NPV + PV of financing side effects (subsidised loans, tax shields, concessionary debt).

Political risk mitigation: investment insurance (MIGA), joint ventures with local partners, local debt financing, structured exit options, and bilateral investment treaties.

Cost of capital internationally: add country risk premium to Ke; relever beta to local market. Segmented vs. integrated market affects whether global or local beta applies.

Foreign tax credit and transfer pricing: double taxation relief through credit or exemption; arm's-length pricing avoids transfer-pricing penalties.

International cash management: multilateral netting, centralised pooling, leading/lagging, and target cash balances per currency to minimise transaction and opportunity costs.

Cross-border leasing and project finance: non-recourse SPV, debt-service coverage ratio (DSCR) covenants, and political risk guarantees from export credit agencies.

Eurocurrency markets: deposits/loans outside the currency's home country; LIBOR/SOFR transition moved benchmarks to risk-free overnight rates.

Synergy value = V_AB − (V_A + V_B). Acquisition premium = offer price − target pre-announcement price. Acquirer gain = synergy − premium.

Payment method: cash transfers all synergy to target (fixed price); stock sharing dilutes acquirer EPS and shares risk; mixed consideration balances control and risk.

EPS impact: accretion if target P/E < acquirer P/E in an all-stock deal (before synergies); dilution if target P/E is higher.

Exchange ratio in stock deal = offer price per target share / acquirer share price. Post-merger EPS = combined earnings / combined shares.

Defence tactics: poison pills, staggered boards, golden parachutes, white knights, pac-man defence, greenmail. Hostile bids often succeed when premium exceeds defence cost.

Valuation approaches: DCF, comparable companies, comparable transactions, LBO analysis, and sum-of-the-parts for conglomerates.

Divestitures and spin-offs: carve-out (IPO of subsidiary stake), spin-off (pro-rata distribution, tax-free if conditions met), split-off (shareholder choice), tracking stock.

Leveraged buyout: high debt, management equity, exit via IPO or sale. Returns driven by deleveraging, EBITDA growth, and multiple expansion.

Venture capital method: exit value × ownership = terminal value; discount at target IRR (30–60% for early stage) to get post-money; pre-money = post-money − investment.

Pre-money and post-money: post-money = pre-money + investment. Founder dilution = investment / post-money.

Ownership target = investment / post-money valuation. Convertible notes convert at discount or valuation cap; SAFEs have no interest or maturity.

VC term sheet terms: liquidation preference (1x non-participating vs. participating), anti-dilution (full ratchet vs. broad-based weighted average), board seats, pro-rata rights, vesting.

Private equity fund structure: LP/GP, 2/20 fee model (management fee 1.5–2%, carried interest 20%), hurdle rate 8%, catch-up clause, 10-year fund life with extensions.

J-curve: early negative returns from fees and unrealised investments, then gains as exits occur. IRR overstates early-stage returns; use TVPI, DPI, and PME.

Stage financing: seed, Series A/B/C, growth, mezzanine, buyout. Each round prices risk and dilutes founders; milestone-based tranching reduces agency risk.

Exit routes: IPO, trade sale, secondary sale, buyback, write-off. Expected exit value and exit multiple drive VC valuation sensitivity.

Three approaches: income (DCF, capitalised earnings), market (multiples, transaction comps), and asset-based (book, replacement, liquidation). Use triangulation.

DCF steps: forecast FCFF, compute WACC, discount, add terminal value, subtract net debt, divide by shares. Terminal value typically 50–75% of total value.

WACC with target weights: WACC = (E/V)·Ke + (D/V)·Kd·(1−t). Use market values and target capital structure.

Multiples selection: EV/EBITDA for capital-intensive, P/E for financial firms, P/B for banks, EV/Sales for high-growth/low-margin. Apply to forward, not trailing, metrics where possible.

Control premium and marketability discount: controlling interests command premiums (20–40%); minority stakes in private firms face DLOM (20–30%).

Normalised earnings: adjust for owner compensation, non-recurring items, related-party transactions, and one-time gains.

Asset-based valuation: adjusted book value restates assets to fair value; liquidation value assumes forced sale; replacement cost estimates new-build cost.

Valuation date and premise: going concern vs. liquidation; fair value vs. investment value vs. market value. Document assumptions and sensitivity ranges.