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CFA Level I Updated
What are the main theories on dividend policy and do dividends actually matter?
The main dividend theories are: M&M irrelevance (dividends don't matter in perfect markets), bird-in-hand (investors prefer certain dividends), tax preference (capital gains are tax-advantaged), signaling (dividend changes convey information), and agency theory (dividends reduce free cash flow waste).
How does a protective put work as portfolio insurance?
A protective put involves owning a stock and buying a put option on it, creating a floor on losses. Your maximum loss is capped at (purchase price minus strike) plus the premium, while upside remains unlimited.
What are the key components of an Investment Policy Statement (IPS)?
An IPS has two main sections: objectives (return and risk) and constraints (time horizon, taxes, liquidity, legal/regulatory, and unique circumstances — remember TTLLU). It serves as the blueprint governing portfolio management decisions.
What are the key characteristics of infrastructure as an asset class, and how do brownfield and greenfield investments differ?
Infrastructure assets provide essential services with long lives, stable cash flows, and inflation linkage. Brownfield investments are existing operational assets with lower risk and return, while greenfield investments involve new construction with higher risk and return potential.
When should I use P/E vs. P/B vs. P/S ratios for equity valuation, and what are the pitfalls of each?
Each price multiple suits different company types: P/E for profitable firms, P/B for banks and asset-heavy companies, P/S for unprofitable growth firms, and P/CF for capital-intensive businesses. The key is matching the multiple to the company's characteristics.
What does 'fair dealing' actually mean when disseminating investment recommendations?
Standard III(B) requires dealing fairly with all clients when providing recommendations or taking investment action. Fair does not mean equal — it requires a systematic process that does not systematically advantage any group.
Can someone explain comparative advantage vs. absolute advantage with a clear example?
Comparative advantage means producing a good at a lower opportunity cost, not necessarily with fewer resources. Even a country worse at producing everything benefits from trade by specializing in what it gives up least to produce.
What are the key assumptions of multiple regression and how do I detect violations?
The five key assumptions of multiple regression are linearity, homoscedasticity, no serial correlation, no multicollinearity, and normality of errors. The CFA exam commonly tests your ability to detect violations from regression output.
What are the different money market yield conventions and how do I convert between them?
Money market instruments use different yield conventions than bonds. The three main types — discount yield, add-on yield, and bond equivalent yield — differ in their denominator (face value vs. price) and year basis (360 vs. 365 days).
How do floating rate notes work, and why do they have almost no interest rate risk?
Floating rate notes have coupons that adjust periodically based on a reference rate plus a fixed spread. This reset mechanism keeps the price near par and gives FRNs extremely low duration — approximately equal to the time until the next coupon reset.
How do you classify cash flows into operating, investing, and financing activities, and what are the IFRS vs GAAP differences?
Cash flows are classified into operating, investing, and financing activities. The key exam topic is the IFRS vs. US GAAP difference in classifying interest paid, interest received, dividends paid, and dividends received. Under IFRS, companies have flexibility; under US GAAP, the classification is fixed.
Under what conditions can an investment professional port their performance track record to a new firm under GIPS?
GIPS portability requires that substantially all decision-makers transfer, the investment process remains intact, and supporting documentation exists. Ported performance must initially be shown as supplemental information before being linked to the new firm's composite.
How does the if-converted method work for convertible preferred stock in diluted EPS calculations?
The if-converted method for convertible preferred stock assumes conversion at the beginning of the period, adding back preferred dividends to the numerator and adding conversion shares to the denominator. Include the security only if the result reduces diluted EPS below basic EPS.
What are appropriated retained earnings, and why would a company restrict a portion of retained earnings?
Appropriated retained earnings are a portion designated by the board for a specific purpose, signaling those earnings are not available for dividends. It is purely an equity reclassification with no cash impact — total retained earnings and total equity remain unchanged.
How do cumulative preferred dividends in arrears affect the financial statements and basic EPS?
Cumulative preferred dividends in arrears are not a liability until declared — they are disclosed in the notes. For basic EPS, the annual preferred dividend is subtracted from net income each year regardless of declaration, preventing double-counting when arrears are eventually paid.
What is participating preferred stock, and how are dividends allocated between preferred and common shareholders?
Participating preferred stock receives both a stated dividend and a share of remaining dividends alongside common stockholders. Fully participating preferred shares in all excess dividends proportionally, while partially participating preferred is capped at a specified additional rate.
How is convertible preferred stock accounted for, and how does it affect diluted EPS?
Convertible preferred stock is recorded entirely as equity at issuance. Conversion uses the book value method with no gain or loss recognized. For diluted EPS, the if-converted method adds back preferred dividends to the numerator and adds potential common shares to the denominator.
How does a calendar spread exploit time decay, and what market view does it express?
A calendar spread sells a near-term option and buys a longer-term option at the same strike, profiting from the fact that near-term options decay faster. The strategy profits when the stock stays near the strike price and when implied volatility increases.
What framework does the CFA curriculum use for sovereign credit analysis?
Sovereign credit analysis evaluates five pillars: institutional strength, economic structure, external position, fiscal performance, and monetary flexibility. Local currency ratings typically exceed foreign currency ratings because governments can print domestic currency.
How do I run an accretion/dilution test for a share buyback, and when does a buyback actually increase EPS?
A share buyback is accretive to EPS when the earnings yield of the stock exceeds the after-tax cost of financing the repurchase. The key test compares E/P to the after-tax return on cash (if cash-funded) or after-tax cost of debt (if debt-funded).
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