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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.
How do you price a currency forward using covered interest rate parity?
Currency forwards are priced using covered interest rate parity: F = S₀ × (1 + r_domestic) / (1 + r_foreign). The currency with the higher interest rate trades at a forward discount. Always check whether the quote is DC/FC or FC/DC before calculating.
How do securitization structures work — can someone walk through the waterfall with an example?
Securitization involves pooling assets in a bankruptcy-remote SPE, then issuing tranches with different priorities. Cash flows follow a strict waterfall: senior tranches receive payments first, while the equity tranche absorbs initial losses.
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.
How do CMO tranches redistribute prepayment risk, and what are PAC vs. support tranches?
CMOs redistribute pass-through prepayment risk among tranches. Sequential-pay structures direct principal to tranches in order. PAC tranches maintain a predictable schedule within a PSA band, while support tranches absorb all prepayment variability, bearing the highest risk.
What discounts apply when valuing a private company, and how do you estimate DLOC and DLOM?
Private company valuations require two key discounts: DLOC (Discount for Lack of Control) and DLOM (Discount for Lack of Marketability). DLOC adjusts for minority stakes lacking control rights, while DLOM adjusts for the inability to quickly sell at fair value. They are applied multiplicatively.
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 industry life cycle stages affect equity valuation approach and assumptions?
Industry life cycle stages — embryonic, growth, shakeout, mature, and decline — each imply different growth rates, margins, and cash flow profiles. This determines the appropriate valuation approach: early-stage companies require revenue multiples or option-based models, while mature firms suit stable DDM and peer multiples.
What are the main methods for estimating the equity risk premium and which should I use?
The equity risk premium can be estimated using historical averages (5.5-8.0%), forward-looking GGM approaches (3.5-5.0%), surveys (3.0-6.0%), or macroeconomic models (3.5-5.5%). Each method has trade-offs, and even small differences in ERP dramatically change equity valuations.
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.
When and how do you impair an equity method investment?
Equity method investments can be impaired when objective evidence of decline exists (IFRS) or when the decline is deemed other-than-temporary (US GAAP). The carrying amount is written down to recoverable amount or fair value, with a key difference being that IFRS allows reversals while US GAAP does not.
What is Bridgewater's All-Weather portfolio philosophy?
All-Weather balances stocks, bonds, gold, commodities across 4 growth/inflation regimes. Levered version institutional. 2022 exposed stagflation vulnerability.
How do TIPS (Treasury Inflation-Protected Securities) mechanically work?
TIPS adjust principal daily using CPI-U. Indexed Principal = Original × (Current CPI / Base CPI). Coupons are paid on indexed principal, so both coupons and maturity repayment rise with inflation. Deflation floor at maturity guarantees return of original face value...
What is the core-satellite approach and how do I determine the allocation split?
The core-satellite approach combines a low-cost passive core providing market beta with concentrated active satellites targeting alpha in less efficient markets. The allocation split depends on efficiency beliefs, risk budget, fee sensitivity, and alpha conviction.
How does taxation affect investment portfolio construction?
Taxation affects nearly every portfolio decision for taxable investors — asset allocation, security selection, trading cadence, and location of holdings...
How are fixed income indices constructed?
Bond indices define universe, inclusion criteria, market-value weighting, monthly rebalancing, and evaluated pricing. Market-value weighting creates the 'bums problem' favoring largest debtors; sampling replaces full replication.
How do I quantify drag from taxes and fees on a portfolio?
Tax and fee drag compound dramatically over time. 3% total annual drag can reduce terminal wealth by 57% over 30 years. Mitigation includes low fees, tax loss harvesting, asset location...
How do splines work in regression and what's the difference between natural vs cubic splines?
Spline regression joins polynomial pieces at knots to create smooth flexible curves. Natural cubic splines add linearity constraints at boundaries for stable extrapolation...
What do investor utility functions look like for different risk aversion levels?
Risk aversion A in mean-variance utility shapes indifference curves. Low A gives shallow parabolas; high A gives steep ones. Typical A values range 1-2 for aggressive to 6-10 for conservative investors...
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