NFSI common mistakes
NFSI · Understand the traps and how to avoid them.
Classifying a cash flow by its source account rather than by the activity that generated it, e.g. treating interest paid or dividends received as operating when the exam convention being tested requires financing or investing treatment.
Candidates memorize 'interest = operating' from one framework (e.g. US GAAP) and apply it mechanically without checking which convention the question specifies, especially under IFRS where classification elections exist.
What to do instead
Before answering, write down which framework (US GAAP vs IFRS) and which classification election the stem states, then map each cash flow to that rule. Practice a side-by-side table of interest paid, interest received, dividends paid, and dividends received under both frameworks until recall is automatic.
Computing ratios from average balances when the question supplies only ending balances (or vice versa), or mixing period-end and average figures within the same ratio set.
Textbook formulas often show average balances, so candidates substitute averages reflexively even when the data supports only one convention, producing internally inconsistent answers.
What to do instead
Read the data given first and default to whatever the stem supports; if both beginning and ending balances exist and the stem is silent, state the assumption explicitly. Build a checklist that flags every ratio requiring an average before calculating.
Using the accounting (book) cost of debt in the WACC calculation instead of the market value of debt, and weighting capital structure by book rather than market values.
Book values are prominently displayed on the balance sheet and are easier to find, so candidates grab them without recalling that WACC weights should reflect market values.
What to do instead
When computing WACC, always reconstruct the market value of debt (e.g. from bond price x face value or from yield-based valuation) and use market capitalization for equity. Do a sanity check that weights sum to 100% on a market-value basis, and note explicitly in the answer that book weights are a common trap.
Applying the dividend discount model or a single-stage growth assumption to a firm whose growth rate exceeds the required return, or using a sustainable growth rate that ignores the retention ratio.
Candidates plug numbers into g = ROE x b or a constant-growth formula without checking the model's validity conditions (g < r) or verifying that the inputs are internally consistent.
What to do instead
Before using any constant-growth model, test that g < r; if not, switch to a multistage model. Recompute g from fundamentals (retention ratio x ROE) and reconcile it against any growth rate given in the stem, flagging discrepancies.
Confusing yield to maturity with current yield or yield to call, and quoting a bond's price change using modified duration alone when convexity materially affects the estimate.
Candidates memorize 'duration measures price sensitivity' and stop there, forgetting that duration is a first-order (linear) approximation and that YTM assumes reinvestment at the same rate to maturity.
What to do instead
For every price-sensitivity question, compute the duration-based estimate and then adjust for convexity (positive adjustment for both up and down moves), and state which yield measure the question asks for. Practice distinguishing YTM, YTC, and current yield on the same bond.
Treating a forward or futures payoff as the same as the underlying asset's price change, or ignoring the cost-of-carry and convenience yield when pricing forwards on commodities.
Candidates conflate the derivative's value with the spot price movement and forget that forward price = spot compounded at the risk-free rate minus income/carry benefits.
What to do instead
Always write the cost-of-carry relationship (F = S x (1+r)^T minus PV of income or plus storage costs) before substituting numbers, and separately compute the derivative's value at initiation (typically zero) versus its value later. Confirm whether the question asks for the forward price, the contract value, or the payoff.
Building a portfolio recommendation that ignores the client's stated risk tolerance, time horizon, or liquidity needs because the candidate optimizes purely for expected return.
Candidates treat portfolio management as a math problem and skip the IPS constraints, so the technically 'optimal' answer violates the client's mandate.
What to do instead
Before computing anything, extract the return objective, risk tolerance, time horizon, liquidity, tax, legal, and unique constraints from the stem into a short list, then screen every candidate portfolio against that list and eliminate violators before ranking by risk-adjusted return.
Selecting the answer that is legally permissible or personally convenient rather than the one required by the Code and Standards, particularly when a supervisor, employer policy, or client instruction conflicts with the standards.
Candidates default to 'follow your employer' or 'do what the client asks' without recalling that the Code and Standards override employer policy and that client instructions cannot justify unethical conduct.
What to do instead
Apply a fixed decision hierarchy: law > Code and Standards > employer policy > client instruction. For every ethics item, identify the specific standard implicated (e.g. Independence and Objectivity, Diligence, Loyalty) and test the proposed action against it before choosing.
Failing to adjust reported financials for non-recurring items, off-balance-sheet obligations, or differences in accounting policy before comparing firms or computing ratios.
Candidates take reported net income and balance sheet totals at face value and compare companies directly without normalizing for one-time gains/losses, leases, or inventory method differences.
What to do instead
Before any cross-company comparison, build a normalization checklist: strip non-recurring items, capitalize operating leases where required, convert LIFO to FIFO if comparing across methods, and adjust for off-balance-sheet liabilities. Document each adjustment so the comparison is on a like-for-like basis.
Rushing the final answer selection by pattern-matching a familiar number in the answer choices instead of completing the full calculation and checking units, signs, and whether the result is plausible.
Time pressure leads candidates to stop at the first answer that resembles an intermediate result, and distractor options are deliberately built from common partial calculations.
What to do instead
Estimate the answer roughly before computing, complete the calculation to the end, then compare against the estimate and check units (percent vs decimal, annual vs periodic). If two choices are close, re-derive rather than guess, and flag any answer that required an unstated assumption.