IFoA CB1 flashcards

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

Primary market

Market where new securities are issued and sold by companies or governments to raise capital, with proceeds going to the issuer.

Bid-ask spread

Difference between the price a dealer pays to buy and the price charged to sell; compensates for inventory risk, adverse selection and processing costs.

Repo

Sale of securities with a simultaneous agreement to repurchase them later at a higher price, the difference being repo interest.

Lender of last resort

Central bank function of providing liquidity to solvent but illiquid banks during stress to prevent contagion and systemic collapse.

Present value

Value today of a future cash flow, computed by discounting at the appropriate rate: PV = CF/(1+r)^t for discrete compounding.

Modified duration

Approximate percentage change in a bond's price for a one percentage point change in yield, equal to Macaulay duration divided by one plus yield.

Put-call parity

For European options on a non-dividend stock, C - P = S - K·e^(-rT); deviations permit arbitrage through replication.

Gordon growth model

Equity valuation P0 = D1/(r - g), where D1 is next year's dividend, r the required return and g the sustainable growth rate.

Time value of option

Portion of an option premium above intrinsic value; greatest at-the-money and decays to zero as expiry approaches.

Forward price with income

F = S·e^((r-q)T) where q is the continuous income yield; the yield reduces the forward relative to the spot.

Weighted average cost of capital

WACC = (E/V)·Re + (D/V)·Rd·(1-t), using market values and target weights; used to discount average-risk projects.

CAPM

Re = Rf + β·(Rm - Rf); required return depends only on systematic risk because unsystematic risk is diversifiable.

Modigliani-Miller with tax

Levered firm value equals unlevered value plus tax rate times debt, implying debt adds value through tax shield.

Pecking order theory

Firms prefer internal funds, then debt, then equity, because of asymmetric information and issuance costs.

Theoretical ex-rights price

Weighted average of pre-issue market value and rights subscription proceeds, divided by total shares after the rights issue.

DuPont analysis

Return on equity decomposed into profit margin, asset turnover and financial leverage, revealing which driver creates returns.

Interest cover

EBIT divided by interest expense; a low value indicates earnings barely cover debt service and refinancing risk is high.

Free cash flow

Operating cash flow minus capital expenditure; cash available for debt service, dividends and buybacks, unaffected by accounting accruals.

Economic value added

(ROIC - WACC) × invested capital; positive when returns exceed the cost of capital and value is created.

Cash conversion cycle

Inventory days plus receivable days minus payable days; measures how long cash is tied up in working capital.

Three lines of defence

Risk governance model: business units own risk, risk and compliance oversee, internal audit assures the board independently.

Insider trading

Trading on material non-public information in breach of fiduciary duty; regulated through disclosure rules, restricted lists and surveillance.

Board independence

Proportion of non-executive directors free of material relationships with the company; supports objective oversight of management.

Value at risk

Loss threshold not expected to be exceeded with a stated probability over a stated horizon; ignores the size of tail losses.

Expected shortfall

Average loss conditional on losses exceeding the VaR threshold; a coherent risk measure capturing tail severity.

Expected loss

PD × LGD × EAD: probability of default times loss given default times exposure at default for a credit portfolio.

Basis risk

Risk that a hedge's value and the hedged exposure do not move perfectly together because the underlying instruments differ.

Prospect theory

Decisions evaluated as gains or losses relative to a reference point, with loss aversion and diminishing sensitivity.

Loss aversion

Tendency for losses to feel roughly twice as painful as equivalent gains are pleasurable, producing reluctance to realise losses.

Herding

Individuals imitate the crowd rather than their own information, amplifying market moves and enabling information cascades.

Porter's five forces

Framework assessing supplier power, buyer power, new entrants, substitutes and rivalry to judge industry profitability.

Balanced scorecard

Performance system tracking financial, customer, internal process and learning perspectives to balance short-term and long-term goals.