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What happens when a long-term contract is expected to result in an overall loss?
When a long-term contract is expected to result in an overall loss, the entire estimated loss must be recognized immediately in the period the loss becomes apparent, regardless of the completion percentage. This applies under both percentage of completion and completed contract methods.
How is Jensen's alpha calculated, and what does it actually tell you about manager skill?
Jensen's alpha is the intercept from a CAPM regression, measuring average risk-adjusted outperformance. A positive alpha does not necessarily indicate skill — you must check the t-statistic for significance and consider that single-factor models may attribute factor exposures to alpha.
What is the Treynor ratio, and when should you use it instead of the Sharpe ratio?
The Treynor ratio measures excess return per unit of systematic risk (beta), making it more appropriate than the Sharpe ratio when evaluating funds that will be held as part of a diversified portfolio where unsystematic risk is diversified away.
How do I construct a bear spread using puts, and how does it compare to a bear call spread?
A bear put spread buys a higher-strike put and sells a lower-strike put for a net debit. Max gain equals the strike difference minus net premium when the stock falls to or below the lower strike. A bear call spread achieves the same payoff profile using calls and receiving a net credit.
What does the TED spread measure, and why is it considered a barometer of financial stress?
The TED spread measures the difference between 3-month LIBOR (interbank lending rate) and the 3-month T-bill yield, capturing the credit premium banks charge each other. Wider spreads signal banking system stress and predict broader credit market deterioration.
What does the option-adjusted spread (OAS) actually tell me, and how is it different from the Z-spread?
The OAS removes the value of embedded options from the Z-spread, leaving only credit and liquidity compensation. For callable bonds, OAS = Z-spread minus option cost. Always use OAS when comparing bonds with different option features.
Can someone explain the Ohlson model and the persistence factor in residual income valuation?
The Ohlson model extends residual income valuation by adding a persistence factor (omega) that captures how quickly abnormal earnings fade toward zero. Higher omega means a stronger competitive moat and significantly higher intrinsic value.
How does equity crowdfunding differ from a traditional IPO, and what are the risks for investors?
Equity crowdfunding lets startups raise capital from non-accredited investors through online funding portals under Regulation CF, but with significantly less disclosure and liquidity compared to traditional IPOs. Key risks include illiquidity, dilution, and high failure rates.
What is the difference between the discrete and integral approaches to interim financial reporting, and which does IAS 34 follow?
The discrete approach treats each interim period as a standalone reporting period, while the integral approach treats it as part of the annual period with costs allocated across quarters. IAS 34 follows a mixed approach — most items use discrete recognition, but income tax uses the integral approach with the estimated annual effective tax rate.
How do I distinguish between adjusting and non-adjusting events after the reporting period under IAS 10?
The distinction under IAS 10 depends on whether the condition existed at the balance sheet date. Adjusting events provide evidence of conditions already present at year-end (financial statements are adjusted), while non-adjusting events reflect conditions that arose afterward (disclosed but no adjustment to the financials).
What is economic profit and how does it differ from accounting profit for measuring value creation?
Economic profit subtracts the full cost of capital (including equity) from operating profit, while accounting profit only deducts interest on debt. A company can show positive accounting profit while destroying value if its returns are below its cost of capital.
Can a portfolio manager take their performance track record when they switch firms under GIPS?
Under GIPS, performance records can be ported to a new firm only if substantially all decision-makers transfer, the investment process remains intact, and proper documentation exists. The ported record must be labeled as prior-firm performance.
What is the difference between contango and normal backwardation in futures markets?
Contango and backwardation describe observable futures curve shapes relative to spot. Normal backwardation and normal contango are theoretical concepts about futures prices relative to the unobservable expected future spot price.
Why do we use the harmonic mean for averaging P/E ratios instead of the regular mean?
The harmonic mean is preferred for averaging ratios like P/E because arithmetic averaging of ratios creates an upward bias. One stock with an extreme P/E can dominate the arithmetic average and distort the picture.
How is the option-adjusted spread (OAS) calculated for callable bonds and what does it represent?
OAS is the spread added to every rate in a binomial tree that equates the model price of a callable bond to its market price, after accounting for the embedded call option. It isolates credit and liquidity compensation and enables fair comparison across bonds.
How does backward induction work for pricing bonds on a binomial tree?
Backward induction starts at maturity and works backward. At each node, take the probability-weighted average of the next period's values plus coupon, then discount at the current node's rate. Always discount by the rate at the node you're computing.
Why do callable bonds exhibit negative convexity and what does that mean for investors?
Callable bonds exhibit negative convexity at low yields because the issuer's call option caps the bond's price upside. As yields fall, the callable bond's price gets compressed near the call price while a non-callable bond continues to rise.
What is the pull-to-par effect and how does it work for premium and discount bonds?
The pull-to-par effect describes how a bond's price converges toward par value as maturity approaches. Premium bonds decline toward par while discount bonds rise toward par, because fewer remaining coupon payments reduce the premium or discount.
How do large working capital swings affect FCFF and what adjustments should I make?
Large working capital swings can make FCFF volatile even when the underlying business is stable. Normalize by averaging WCInv over multiple years, using WC-to-revenue ratios, or separating one-time items from structural changes.
How do you handle a multi-stage DDM when one phase has negative earnings growth?
A negative growth phase means dividends decline during that period. Use the same DDM framework with negative growth rates. The key is ensuring dividends remain positive and carefully computing the terminal value once growth stabilizes.
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