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CFA Level II Updated
How should analysts quantify the valuation discount for dual-class share structures?
Dual-class share valuation discounts can be estimated through the voting premium approach (comparing prices of different share classes), comparable company multiples (10-15% average discount), or governance-adjusted discount rates (50-200 bps higher cost of equity).
How are credit options priced, and what is the difference between a credit spread option and a credit default option?
Credit spread options pay off when credit spreads widen beyond a strike level, while credit default options pay a fixed amount upon a credit event. Spread options protect against mark-to-market losses; default options protect against actual default.
How does a change in the tax rate affect existing deferred tax assets and liabilities?
When the tax rate changes, all existing DTAs and DTLs are remeasured at the new rate, with the adjustment recognized in income tax expense in the current period. A rate decrease reduces DTLs (benefit) but also reduces DTAs (expense). The net impact depends on whether the company has a net DTA or net DTL position.
How is the fixed swap rate determined in a plain vanilla interest rate swap?
The swap rate is the fixed rate that equates the present value of fixed payments to the present value of expected floating payments at inception. It can be calculated using the shortcut formula: SFR = (1 - DFn) / Sum of all discount factors.
What's the difference between OAS, Z-spread, and nominal spread, and when should I use each?
The three spread measures each serve a specific purpose. Nominal spread is a quick YTM comparison, Z-spread uses spot rates for option-free bonds, and OAS removes the embedded option effect for fair comparison of bonds with calls or puts.
What is the difference between a control premium and a minority discount, and how are they applied?
A control premium is the excess paid above minority price for a controlling stake, while a minority discount is applied to reduce control-level values to minority-level. They are related by the formula: Minority Discount = 1 - 1/(1 + Control Premium). A 30% control premium implies a 23.1% minority discount.
How do you handle multi-period intercompany inventory profit elimination for downstream sales?
Multi-period downstream inventory eliminations require removing unrealized profit from ending inventory in the year of sale, then reversing the adjustment through retained earnings when the inventory is sold externally. NCI is not affected because the parent is the seller.
How do DLOC and DLOM work in private company valuation, and can you apply both discounts simultaneously?
DLOC (Discount for Lack of Control) applies to minority interests that lack decision-making power, while DLOM (Discount for Lack of Marketability) applies because private shares cannot be easily sold. They can be stacked multiplicatively, but the starting basis of your valuation determines which discounts are needed.
How do you calculate goodwill in a business combination under full and partial goodwill methods?
Full goodwill measures NCI at fair value and attributes goodwill to both parent and minority shareholders. Partial goodwill measures NCI at its proportionate share of net assets, so only the parent's premium is recognized as goodwill. The difference between the two equals the NCI's implied share of goodwill.
What are the red flags for earnings management and how do analysts detect manipulation?
Earnings management detection involves comparing revenue/expense trends with cash flow patterns, analyzing accruals quality, reviewing footnote disclosures, and applying quantitative models like the Beneish M-Score. Key red flags include diverging receivables and revenue, declining provisions, and CFO trending below net income.
When do you recognize a deferred tax asset and what's a valuation allowance?
Deferred tax assets are recognized when temporary differences or loss carryforwards will reduce future taxes. Under US GAAP, a valuation allowance reduces the DTA when realization is not 'more likely than not.' Under IFRS, the DTA is simply not recognized to the extent realization is not probable.
What is the catering theory of dividends and how does it differ from signaling?
Catering theory (Baker-Wurgler 2004): firms adjust dividend policy to cater to time-varying investor sentiment, measured by the dividend premium. Differs from signaling (private info), clientele (heterogeneous preferences), and MM irrelevance...
What are stewardship codes and what do they expect from institutional investors?
Stewardship codes set expectations for institutional investors to engage, escalate, vote, and report on ownership responsibilities; the UK Code is the prominent benchmark.
How are CLO manager fees structured?
CLO manager fees are split into senior, subordinated, and incentive components, totaling roughly 40-55 bp per year plus performance-based upside.
What is the GP catch-up provision and how does it affect the carry split?
The catch-up provision is an intermediate tier in the distribution waterfall designed to make the GP 'catch up' to its full 20% share of total profit after LPs receive preferred.
Why is the PE hurdle usually expressed as an IRR rather than a simple return?
Private equity hurdle rates are expressed as IRRs because capital flows into and out of PE funds on irregular schedules over 5-10 years.
How do I evaluate management quality in credit analysis?
Management quality framework covers track record, strategy execution, financial policy, capital allocation, risk management, governance, transparency, and talent bench. For Crestone Hospitality CEO Renner: 8-year tenure, consistent policy, solid M&A discipline → strong M&G assessment, typically +/-1 notch rating adjustment...
What is autocorrelation and why does it matter for time-series analysis?
Autocorrelation in residuals biases OLS standard errors and is a classic smoothing fingerprint in illiquid fund returns — remedies include Newey-West and AR(1) models.
How does multiple correlation (R) relate to R-squared in regression?
Multiple R is the correlation between actual and fitted Y; R² is its square, measuring variance explained — but always cross-check with Adjusted R² for model comparison.
What do stock repurchases signal to the market?
Buybacks signal undervaluation, excess cash flow, and future confidence; tender offers signal more strongly than open-market. Positive 3-5% average announcement returns; long-run abnormal returns in value firms.
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