MAFF common mistakes
MAFF · Understand the traps and how to avoid them.
Computing present value and future value using nominal rates while the cash flow series is expressed in real terms, or mixing annual rates with monthly periods without adjusting both n and i together.
Candidates learn the TVM formulas as isolated algebraic drills and then apply them mechanically. Under exam time pressure they grab the rate given in the question without checking whether the periods and the rate share the same compounding basis, and they default to annual periods even when the question describes quarterly or monthly cash flows.
What to do instead
Before touching a calculator, write two labels above the formula: the rate basis (annual, quarterly, monthly) and the cash flow basis (nominal vs real). Convert both to the same basis first: divide the nominal annual rate by the compounding frequency, multiply n by the frequency, and convert real to nominal with (1+real)(1+inflation)=1+nominal. Build a one-line habit of stating the adjusted i and n explicitly before computing, and practice with a mixed set of quarterly and monthly problems until the adjustment is automatic.
Reading a ratio off the financial statements without reconciling the numerator and denominator to the same point in time or the same accounting basis, for example dividing a flow measure like net income by a point-in-time equity figure without noting the mismatch, or computing return on assets using year-end assets only.
Ratio formulas are memorized as two-item fractions. Candidates under time pressure use whichever balance-sheet number is printed most prominently, usually the closing balance, and never pause to ask whether an average balance is required. The result is a defensible-looking number that is arithmetically correct but analytically wrong and often not among the answer choices.
What to do instead
For every ratio, classify the numerator and denominator as flow (income statement, statement of cash flows) or stock (balance sheet). If one is a flow and the other a stock, use the average of opening and closing stock unless the question explicitly says otherwise, and say so in your working. When a computed ratio is not among the options, recompute with average balances before assuming a calculation error.
Treating a reported earnings figure as cash flow, or accepting operating cash flow at face value without adjusting for non-cash charges, working capital swings, and non-recurring items, then using that unadjusted figure in a valuation or coverage ratio.
Candidates conflate profitability with liquidity because both are reported on the same statements and both are called 'earnings' in casual usage. They also skip the reconciliation because it is time-consuming, so they use net income directly in free cash flow and in interest coverage, which understates or overstates the true figure depending on the direction of accruals.
What to do instead
Always rebuild cash flow from the top: net income, add back depreciation and amortization and other non-cash charges, subtract the change in working capital, and separate capital expenditure from operating items. Flag any line described as one-off, restructuring, or impairment and decide explicitly whether to include it. Practice by taking a set of income statement and balance sheet changes and producing the cash flow statement from scratch until the reconciliation becomes a reflex.
Selecting a project or investment by comparing internal rates of return across mutually exclusive options, or by ranking on IRR alone when the projects differ in scale, timing, or duration.
IRR is introduced first and feels intuitive because it is a single percentage. Candidates carry that preference into capital budgeting questions where projects are mutually exclusive or cash flows are non-conventional, and they do not notice that IRR can rank projects differently from net present value or can produce multiple solutions when sign changes occur.
What to do instead
For mutually exclusive projects, rank on NPV at the firm's cost of capital, not IRR; use IRR only as a supplementary screen. When cash flows change sign more than once, state that multiple IRRs may exist and rely on NPV. When scale differs, compute the profitability index or the equivalent annual annuity to compare projects of unequal lives. In every capital budgeting question, write the decision rule ('accept if NPV > 0 at the given cost of capital') before computing.
Estimating the cost of equity by plugging a stale or arbitrary risk-free rate and equity risk premium into the CAPM without checking that the inputs are consistent in currency, maturity, and time period, and without adjusting beta for leverage when comparing firms with different capital structures.
The CAPM formula is simple enough to apply without thought, so candidates lift the first numbers they remember rather than the ones implied by the question. They also forget that an observed equity beta reflects the firm's current leverage, so using it to value a differently financed project or to compare peer companies systematically distorts the discount rate.
What to do instead
For each valuation, state the currency of the cash flows and match the risk-free rate to that currency and to the horizon of the cash flows. Use a consistent equity risk premium and document its source assumption. When comparing firms or evaluating a project with different leverage, unlever the observed beta to an asset beta and relever at the target capital structure. Sanity-check the resulting cost of equity against the cost of debt and the overall WACC.
Valuing a bond by discounting all cash flows at the yield to maturity of a comparable bond, or by assuming the yield curve is flat, and ignoring the difference between yield to maturity, spot rates, and forward rates when pricing or assessing reinvestment risk.
Yield to maturity is taught as 'the' discount rate and is easy to apply, so candidates use a single rate for every maturity. They also confuse the yield with the actual return earned, which depends on reinvestment of coupons, and therefore misjudge the effect of a change in the curve on bond prices.
What to do instead
Separate the three concepts explicitly: spot rates discount each cash flow at its own maturity, forward rates are implied by the spot curve, and yield to maturity is the single internal rate that equates price to cash flows. Price bonds with the spot curve when the question supplies one. When asked about realized return, decompose it into coupon income, reinvestment income, and price change. Practice bootstrapping a spot curve from bond prices so the distinction becomes concrete rather than verbal.
Reporting a portfolio's risk as the weighted average of individual asset standard deviations, or adding a newly purchased asset's volatility to the portfolio without accounting for its correlation with existing holdings.
Candidates treat risk as additive because returns are additive, and weighted averages are the familiar calculation. The diversification benefit is stated in textbooks but not internalized, so under exam conditions the simpler arithmetic wins and the answer comes out too high, often matching a distractor option.
What to do instead
For any portfolio of two or more assets, compute variance as the sum of weighted variances plus the weighted covariance terms, and use the correlation coefficient explicitly. Before calculating, ask whether the question is testing the diversification effect, and if so check whether the answer choices include the naive weighted average as a trap. Work several two-asset problems by hand until the covariance term is the first thing you write down.
Interpreting a beta or duration figure as a complete measure of risk and ignoring the exposures it does not capture, such as credit risk and liquidity risk in a bond portfolio or idiosyncratic and factor exposures in an equity portfolio.
Beta and duration are the headline numbers in the curriculum and are easy to compute, so they become the default answer to any risk question. Candidates do not stop to ask what the measure assumes, and therefore miss questions that hinge on the limitations of the metric rather than its value.
What to do instead
For every risk measure you use, keep a short mental list of what it omits. Beta measures sensitivity to the market portfolio and assumes diversified investors, so it says nothing about idiosyncratic risk or non-market factors. Duration measures sensitivity to a parallel shift in yields and ignores convexity, credit spread changes, and liquidity. When a question describes a scenario involving default, spread widening, or a non-parallel shift in the curve, reach for the measure that captures it rather than the headline number.
Resolving an ethics question by asking which course of action produces the best outcome for the client or the firm, rather than by identifying the specific standard and duty that governs the situation.
Candidates bring everyday consequentialist reasoning into a code-based exam. Because most ethics vignettes describe sympathetic clients and plausible commercial pressures, the outcome-maximizing answer often reads as reasonable, and candidates choose it without checking it against the letter of the applicable standard.
What to do instead
Approach each ethics item in a fixed sequence: identify the duty owed and to whom, name the specific standard implicated, determine whether disclosure, consent, or avoidance is required, and only then evaluate the options. Eliminate any option that requires violating a standard even if the outcome looks better. Practice by writing the standard's name next to each vignette before reading the answer choices, and review the cases where the correct answer is the less commercially attractive option.
Answering questions about conflicts of interest and disclosure by assuming that disclosing a conflict resolves it, or by treating verbal assurance from a supervisor as sufficient authorization for an action that the standards require to be in writing or to be refused outright.
Candidates collapse the standards into a single rule of 'be transparent'. Disclosure is the most familiar ethical tool, so it is applied to every situation, including those where the standards require the conflict to be avoided, managed, or escalated rather than merely revealed, and where written consent from the client or employer is the actual requirement.
What to do instead
Distinguish three responses to a conflict: avoid it, disclose and manage it with consent, or decline the engagement. Learn which situations require each. Treat written consent and written disclosure as distinct requirements and check whether the question specifies them. When a supervisor instructs an action that conflicts with a standard, the correct response is to escalate through the firm's compliance process, not to rely on the instruction as authorization.