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How do you evaluate an international capital budgeting project when you have to deal with foreign currency cash flows?
International capital budgeting has two equivalent approaches: convert foreign cash flows to home currency using forward rates then discount at home WACC, or discount foreign cash flows at the foreign WACC then convert at spot. Both should yield the same NPV.
How are private equity funds structured, and what is the typical relationship between GPs and LPs?
PE funds use a limited partnership structure where the GP manages investments and LPs provide capital. The J-curve effect shows negative early returns due to fees and unrealized investments, with returns accelerating as exits occur in later years.
How do you value preferred stock using the perpetuity model, and what drives preferred stock yields?
Preferred stock is valued as a perpetuity: V = D/r. It trades at a discount when the coupon rate is below the required return and at a premium when above. Callable preferred has limited upside, while adjustable-rate preferred trades near par.
What is the difference between absolute and relative purchasing power parity, and does PPP actually hold in practice?
Absolute PPP states the exchange rate equals the ratio of price levels, while relative PPP states exchange rate changes equal inflation differentials. Relative PPP holds roughly over the long run but fails short-term due to capital flows, sticky prices, and non-traded goods.
What are the key extensions of the CAPM and how do they address its limitations?
The standard CAPM has several limitations addressed by extensions. Black's Zero-Beta CAPM replaces the risk-free rate with the return on a zero-beta portfolio, the International CAPM adds currency risk factors, and the Conditional CAPM allows time-varying betas.
How do you use put-call parity to create synthetic positions and spot arbitrage opportunities?
Put-call parity (C + PV(K) = P + S) can be rearranged to create synthetic positions and identify arbitrage opportunities. When the relationship is violated, you can construct a risk-free profit by selling the overpriced side and buying the underpriced side.
What exactly counts as misrepresentation under the CFA Institute Standards of Professional Conduct?
Misrepresentation under Standard I(C) covers any untrue statement or omission of fact, including direct falsehoods, plagiarism, omission of material facts, and misleading presentations like cherry-picked performance data.
What are the key differences between monetary and fiscal policy, and how do they affect financial markets?
Monetary policy (central bank) uses interest rates and asset purchases, while fiscal policy (government) uses spending and taxation. They transmit differently to markets: monetary policy primarily affects yields and discount rates, while fiscal policy drives growth and deficit dynamics.
Can someone walk through the binomial option pricing model with a two-period example?
The binomial model prices options by building a stock price tree, calculating terminal payoffs, and using backward induction with risk-neutral probabilities. Here's a complete two-period example pricing a European call.
What is key rate duration and why is it better than effective duration for managing bond portfolios?
Key rate duration decomposes a bond's interest rate sensitivity across specific maturities on the yield curve, unlike effective duration which only measures sensitivity to parallel shifts. This distinction matters when yield curves shift non-parallel.
How do I interpret z-scores in hypothesis testing — and when should I use a z-test vs. a t-test?
A z-score measures how many standard deviations an observation falls from the population mean. Use a z-test when the population variance is known or when the sample size is large (n ≥ 30). Here's a decision framework and a worked example.
What's the difference between equilibrium and arbitrage-free term structure models?
Equilibrium models (Vasicek, CIR) derive the term structure from economic assumptions and may not match today's yield curve. Arbitrage-free models (Ho-Lee, BDT) are calibrated to exactly fit the current curve and are preferred for pricing securities with embedded options.
When should you use market-based vs. asset-based valuation, and what are the key differences?
The choice between market-based and asset-based valuation depends on the type of company and data availability. Market-based valuation uses multiples from comparables, while asset-based valuation sums individual assets minus liabilities at fair market value.
What's the relationship between spot rates and forward rates, and how do you derive one from the other?
Spot rates and forward rates are two sides of the same coin — they're just different ways of expressing the term structure of interest rates. The no-arbitrage relationship links them: investing for n years at the n-year spot rate must equal rolling over shorter investments at implied forward rates.
How do you calculate a bond's full price from its yield to maturity, and what's the difference between full price and clean price?
Bond pricing from YTM is the foundation of fixed income analysis at CFA Level I. The core idea is that a bond's price equals the present value of all future cash flows, discounted at the yield to maturity. Here's a step-by-step walkthrough with the distinction between full price and clean price.
FCFE vs. FCFF: what's the difference and when should I use each for valuation?
FCFF represents cash available to all capital providers and is discounted at WACC, while FCFE represents cash available to equity holders only and is discounted at the cost of equity. Use FCFF when capital structure is changing; use FCFE for direct equity valuation when leverage is stable.
How does the H-model work for valuation, and how is it different from a two-stage DDM?
The H-model is a simplified DDM that assumes growth declines linearly from a high rate to a stable rate, rather than dropping abruptly. The formula splits value into a stable-growth component and an extra premium for above-normal growth during the transition period.
What's the real difference between accrual and cash basis accounting, and how does accrual enable earnings manipulation?
Accrual accounting recognizes revenue when earned and expenses when incurred, regardless of cash timing. While this matches economic activity to the correct period, the inherent judgment in revenue timing, expense capitalization, and reserve estimates creates opportunities for earnings manipulation.
How do you calculate the cash conversion cycle and why does it matter for liquidity analysis?
The cash conversion cycle measures how many days a company's cash is tied up in operations before it comes back as cash from sales. CCC = DOH + DSO - DPO, where DOH measures inventory holding time, DSO measures collection time, and DPO reflects how long the company takes to pay suppliers.
When do you use the equity method vs. the acquisition method for intercorporate investments?
The classification depends on the degree of influence or control the investor has over the investee. Below 20% ownership is treated as a financial asset at fair value, 20-50% uses the equity method (significant influence), and above 50% requires full consolidation via the acquisition method.
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