IFoA CB1 cheat sheet

Primary markets issue new securities (IPO, rights issue, bond issue); secondary markets transfer existing securities and provide liquidity and price discovery.

Money markets trade instruments with maturity under one year (T-bills, commercial paper, certificates of deposit, repos); capital markets trade longer-dated bonds and equities.

A repo is a sale of securities with a simultaneous agreement to repurchase at a higher price; the price difference is the repo interest, and the securities act as collateral.

Market makers quote bid and offer prices; the bid-ask spread compensates for inventory risk, adverse selection and order-processing costs, and widens with illiquidity.

Central banks act as lender of last resort and set policy rates; open market operations alter bank reserves and hence short-term interest rates.

Banks transform maturity and liquidity: short-term deposits fund long-term loans, creating exposure to runs and requiring capital and liquidity buffers.

Insurance companies and pension funds are long-term institutional investors with liability-driven objectives; mutual funds and hedge funds pool capital with differing liquidity terms.

Order-driven markets match buy and sell orders in a central limit order book; quote-driven markets rely on dealers quoting firm two-way prices.

A stock index futures or ETF allows cheap synthetic exposure to a whole market; arbitrage links the futures price to the spot price via cost of carry.

Present value of a cash flow at time t is CF/(1+r)^t; with continuous compounding PV = CF·e^(-rt).

Bond price equals the sum of discounted coupons plus discounted redemption value; price and yield are inversely related, with longer duration amplifying the sensitivity.

Duration measures weighted average time to cash flows; modified duration approximates percentage price change per unit yield change: ΔP/P ≈ -D_mod·Δy.

Convexity corrects duration for large yield moves: ΔP/P ≈ -D_mod·Δy + 0.5·C·(Δy)^2; positive convexity benefits the holder.

Gordon growth model: P0 = D1/(r - g), valid only when r > g; the growth rate must be sustainable relative to retention and return on equity.

Forward price with no income: F = S·e^(rT); with income yield q: F = S·e^((r-q)T); with known income: F = (S - I)·e^(rT).

Put-call parity for European options on non-dividend stock: C - P = S - K·e^(-rT); violations create arbitrage via replication.

An option's value = intrinsic value + time value; time value is greatest at-the-money and decays to zero at expiry, faster as expiry approaches.

Swaps are portfolios of forward contracts; an interest rate swap can be valued as the difference between two fixed/floating bond values or as a strip of forward rate agreements.

NPV = sum of discounted incremental cash flows; accept projects with NPV > 0. IRR is the discount rate giving NPV = 0 and can mislead with non-conventional cash flows or scale differences.

WACC = (E/V)·Re + (D/V)·Rd·(1 - tax rate); use market values and the target capital structure, and match the discount rate to project risk.

CAPM: Re = Rf + β·(Rm - Rf); β measures systematic risk only, since unsystematic risk is diversifiable.

Modigliani-Miller without tax: firm value is independent of leverage. With corporate tax: value rises by tax rate × debt, but financial distress and agency costs offset this.

Trade-off theory sets the optimal capital structure where the tax shield on debt equals marginal expected distress costs; pecking order theory predicts internal funds first, then debt, then equity.

Dividend irrelevance holds in perfect markets; in practice dividends signal information and interact with taxes, clienteles and free cash flow discipline.

A rights issue prices new shares below market; the theoretical ex-rights price is the weighted average of old and new prices, and the value of the right is TERP minus subscription price.

Agency problems arise between shareholders and managers (empire building, perk consumption) and between shareholders and debtholders (asset substitution, underinvestment); governance and covenants mitigate them.

Return on equity decomposes as profit margin × asset turnover × financial leverage (DuPont), isolating profitability, efficiency and gearing drivers.

Liquidity ratios: current ratio = current assets/current liabilities; quick ratio excludes inventory. Low ratios signal liquidity stress, high ratios signal idle assets.

Gearing measures: debt/equity, debt/(debt+equity), and interest cover = EBIT/interest; interest cover below about 2-3 signals refinancing risk.

Free cash flow = operating cash flow - capital expenditure; it funds debt service, dividends and buybacks, unlike accounting profit which includes accruals.

Earnings quality checks: cash conversion (operating cash flow/net income), accruals relative to assets, and revenue recognition timing.

Economic value added = (ROIC - WACC) × invested capital; positive EVA means returns exceed the cost of capital.

Valuation multiples (P/E, EV/EBITDA, P/B) require comparable peers and consistent definitions; EV = market cap + net debt + minority interests + preferred stock.

Working capital cycle = inventory days + receivable days - payable days; shortening it releases cash without extra funding.

Agency theory justifies separation of board chair and CEO, independent non-executive directors, and board committees for audit, remuneration and nomination.

Shareholder vs stakeholder models differ on whose interests the board serves; codes typically require directors to act in the company's long-term interest.

Regulatory tools include capital requirements, conduct rules, disclosure obligations and licensing; regulation addresses market failure, systemic risk and information asymmetry.

Three lines of defence: business units own risk, risk and compliance functions oversee, internal audit provides independent assurance to the board.

Insider trading prohibitions rest on information asymmetry and fiduciary duty; material non-public information must be controlled by restricted lists and disclosure rules.

Ethical decision frameworks weigh consequences (utilitarian), duties (deontological) and virtues; conflicts of interest must be disclosed, managed or avoided.

Whistleblowing channels must be independent, confidential and protected by law to be effective.

Remuneration design aligns managers with long-term value via deferral, clawback and performance shares rather than short-term profit bonuses.

Market risk types: interest rate, equity, FX and commodity risk; measured by sensitivity (duration, beta, delta) and by VaR or expected shortfall.

VaR at confidence c states the loss not exceeded with probability c over a horizon; it ignores losses beyond the threshold, so expected shortfall (mean of tail losses) supplements it.

VaR scales with the square root of time under i.i.d. returns: 1-day VaR × √10 approximates 10-day VaR.

Parametric VaR = z × σ × exposure; historical simulation uses empirical return distributions; Monte Carlo simulates scenarios from assumed processes.

Credit risk components: probability of default, loss given default, exposure at default; expected loss = PD × LGD × EAD.

Liquidity risk splits into funding liquidity (inability to roll over liabilities) and market liquidity (inability to trade without price impact).

Operational risk covers failed processes, people, systems and external events; managed via controls, key risk indicators and loss-event databases.

Hedging with derivatives reduces risk but introduces basis risk, counterparty risk and margin/liquidity demands.

Stress testing and scenario analysis complement statistical models because historical correlations break down in crises.

Prospect theory: outcomes are evaluated as gains or losses relative to a reference point; losses loom roughly twice as large as equivalent gains (loss aversion).

The value function is concave for gains and convex for losses, and steepest near the reference point, producing risk aversion in gains and risk seeking in losses.

Overconfidence leads to excessive trading, under-diversification and underestimated risk; calibration tests show people's confidence intervals are too narrow.

Anchoring, availability and representativeness heuristics cause systematic forecasting errors; base-rate neglect is a common consequence.

Herding and information cascades amplify market moves; limits to arbitrage allow mispricing to persist.

Mental accounting and framing change choices even when the underlying payoffs are identical.

Debiasing tools: pre-mortems, checklists, independent review, decision diaries and explicit base rates.

Market anomalies such as momentum and post-earnings drift are cited as evidence against semi-strong form efficiency.

Porter's five forces: supplier power, buyer power, threat of new entrants, threat of substitutes and rivalry; use to assess industry profitability.

SWOT combines internal strengths and weaknesses with external opportunities and threats; it is descriptive, so pair it with explicit strategic options.

PESTLE scans political, economic, social, technological, legal and environmental factors affecting strategy.

Porter's generic strategies: cost leadership, differentiation and focus; being stuck in the middle without a clear advantage erodes returns.

The BCG matrix classifies products by market growth and relative share into stars, cash cows, question marks and dogs, guiding investment allocation.

Budgeting translates strategy into quantified targets; variance analysis decomposes deviations into price, volume and mix effects.

Balanced scorecard tracks financial, customer, internal process and learning perspectives to avoid short-termism.

Sensitivity and scenario analysis test plans against alternative assumptions; contingency planning prepares responses to adverse outcomes.

Prospect theory: outcomes are evaluated as gains or losses relative to a reference point; losses loom roughly twice as large as equivalent gains (loss aversion).

The value function is concave for gains and convex for losses, and steepest near the reference point, producing risk aversion in gains and risk seeking in losses.

Overconfidence leads to excessive trading, under-diversification and underestimated risk; calibration tests show people's confidence intervals are too narrow.

Anchoring, availability and representativeness heuristics cause systematic forecasting errors; base-rate neglect is a common consequence.

Herding and information cascades amplify market moves; limits to arbitrage allow mispricing to persist.

Mental accounting and framing change choices even when the underlying payoffs are identical.

Debiasing tools: pre-mortems, checklists, independent review, decision diaries and explicit base rates.

Market anomalies such as momentum and post-earnings drift are cited as evidence against semi-strong form efficiency.