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How do recovery rates vary by seniority in the capital structure, and why does this matter for bond investors?
Recovery rates vary dramatically by seniority: senior secured bank loans recover 70-80% on average, senior unsecured bonds recover 40-50%, and subordinated bonds recover only 20-25%. These differences drive significant credit spread differentiation within the same issuer's capital structure.
What is a make-whole call provision, and why is it more bondholder-friendly than a traditional call?
A make-whole call compensates bondholders by paying the present value of all remaining cash flows discounted at the Treasury rate plus a small spread. This produces a very high call price, making it rarely economical for issuers to exercise.
What are the unique valuation challenges in cross-border M&A that don't exist in domestic deals?
Cross-border M&A introduces currency alignment challenges, country risk premiums, tax regime differences, multiple regulatory approvals, and cultural integration risks that don't exist in domestic deals.
What is the difference between ESG negative screening and ESG integration, and does either approach hurt returns?
Negative screening simply excludes certain sectors from the investable universe, while ESG integration systematically incorporates environmental, social, and governance factors into valuation models without necessarily excluding any sector.
What are gate provisions in hedge funds, and how do they protect remaining investors?
Gate provisions limit the percentage of a hedge fund's assets that can be redeemed each period, typically 10-25% per quarter. They protect remaining investors from fire-sale losses when redemption requests exceed the fund's ability to liquidate positions at fair value.
What are the Research Objectivity Standards and how do they protect analyst independence?
The Research Objectivity Standards protect analyst independence by requiring separation from investment banking, prohibiting compensation linked to banking deals, mandating disclosure of conflicts, and restricting personal trading in covered stocks.
What is rho and when does interest rate sensitivity actually matter for options?
Rho measures an option's sensitivity to a 1 percentage point change in the risk-free rate. Calls have positive rho and puts have negative rho. While often the least significant Greek, rho matters for long-dated options and deep in-the-money positions.
How is Monte Carlo simulation used in retirement planning, and why is it better than a single projection?
Monte Carlo simulation captures the full range of possible retirement outcomes, including the risk of ruin that a single-point projection completely ignores. It runs thousands of random trials to show the probability distribution of ending wealth.
How is past service cost handled differently under IFRS versus US GAAP?
Under IFRS, past service cost from a pension plan amendment is recognized entirely in profit or loss immediately. Under US GAAP, it is initially recognized in OCI and then amortized to pension expense over the average remaining service period of affected employees. The total impact is the same, but timing differs significantly, affecting earnings comparability.
How do you calculate double-declining balance depreciation and when do you switch to straight-line?
Double-declining balance uses a rate of 2 divided by useful life applied to the beginning book value each year. You switch to straight-line when the SL depreciation on the remaining book value exceeds the DDB amount, ensuring the asset reaches salvage value by the end of its life.
How do you price a European call option using a two-period binomial model?
The two-period binomial model prices a European call by building a stock price tree, calculating terminal payoffs, then using risk-neutral probabilities to work backward through each period, discounting at the risk-free rate.
What are flattening and steepening yield curve trades, and when would I use each?
Yield curve trades involve taking positions at different points on the maturity spectrum to profit from changes in the yield curve's shape. A flattener goes long the long end and short the short end; a steepener does the opposite.
What are the limitations of the PEG ratio for equity valuation?
The PEG ratio has major limitations: it assumes a linear relationship between P/E and growth (contradicting the DDM), ignores risk and cost of equity, is undefined for zero or negative growth, varies with which growth rate is used, and ignores the payout ratio.
What are the three forms of market efficiency and how is each tested?
The three forms of market efficiency differ by what information is reflected in prices. Weak form covers past price data (tested with serial correlation and runs tests), semi-strong form covers all public information (tested with event studies), and strong form covers all information including private (tested with insider trading studies).
In a step acquisition, what happens to the pre-existing equity interest when you gain control?
In a step acquisition, the previously held equity interest is remeasured to fair value at the date control is achieved. The difference between fair value and carrying amount is recognized as a gain or loss in the income statement.
How does an inventory write-down for obsolescence work, and can a company reverse it under IFRS vs. GAAP?
Both IFRS and US GAAP require inventory to be carried at the lower of cost and net realizable value. When NRV drops below cost, the company records a write-down. The key difference is that IFRS allows reversal of write-downs up to original cost, while US GAAP treats the write-down as permanent.
What's the difference between a bond's maturity and its duration? Why does duration matter more for risk?
Excellent question — the distinction between maturity and duration is fundamental to fixed income analysis and is heavily tested on the CFA Level I exam. Maturity is simply when principal is repaid. Duration, however, measures either the weighted average time to receive cash flows (Macaulay) or the bond's price sensitivity to yield changes (Modified).
How does the PSA prepayment model work for mortgage-backed securities, and what does '200 PSA' actually mean?
The PSA prepayment model ramps the conditional prepayment rate (CPR) from 0.2% in month 1 to 6.0% by month 30, then holds flat. '200 PSA' doubles all these rates (CPR peaks at 12%). Faster prepayments create contraction risk (principal returned early at low rates) while slower prepayments create extension risk.
Can someone walk through a two-stage DDM with actual numbers? I keep getting the terminal value calculation wrong.
The two-stage DDM projects high-growth dividends individually, then calculates a terminal value using the Gordon model at the transition point. The key is computing the terminal value using the NEXT dividend after the transition and discounting it back to today. Common mistakes include using the wrong dividend and forgetting to discount.
How does distressed investing work? What's the strategy behind buying bonds of companies in or near bankruptcy?
Distressed investing involves buying deeply discounted debt of troubled companies, profiting through restructuring, recovery trading, or asset liquidation. The key strategies include loan-to-own, fulcrum security identification, and trading around restructuring events.
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