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What is credit migration risk and how does a downgrade affect bond prices even without default?
Credit migration risk is the risk that an issuer's credit rating deteriorates, causing the bond's market value to fall even though the issuer continues making all promised payments.
Can someone explain the Security Market Line and how to tell if a stock is overvalued or undervalued using CAPM?
The Security Market Line (SML) is the graphical representation of CAPM, plotting expected return against beta. Securities above the SML are undervalued (positive alpha), below it are overvalued (negative alpha), and on it are fairly priced.
What are normalized earnings and when do I need them for equity valuation?
Normalized earnings estimate mid-cycle earning power for cyclical companies using either historical average EPS or average ROE applied to current book value. Method 1 is simpler but ignores growth; Method 2 captures the expanded asset base but requires reliable book values.
What is the difference between a stock dividend and a stock split, and how does each affect share price?
Stock splits divide existing shares into more shares with a proportional price reduction and require only a memo entry. Stock dividends distribute additional shares as a percentage of holdings and require a journal entry reducing retained earnings.
How is in-process R&D treated in a business combination under US GAAP and IFRS?
Under current US GAAP and IFRS, in-process R&D acquired in a business combination is capitalized at fair value as an indefinite-lived intangible asset. It is not amortized while in progress but tested annually for impairment.
When does a consignor recognize revenue for goods shipped on consignment?
In a consignment arrangement, the consignor ships goods to the consignee but retains ownership until the consignee sells to an end customer. Revenue is recognized only when the final sale occurs because that is when control transfers.
How does the Brinson performance attribution model decompose portfolio returns into allocation, selection, and interaction effects?
The Brinson-Hood-Beebower model decomposes active return into allocation effect (sector weighting decisions), selection effect (security picking within sectors), and interaction effect (the combined impact of overweighting sectors where stock picks also outperformed).
How does the Degree of Total Leverage (DTL) combine operating and financial leverage, and how do I calculate it?
The Degree of Total Leverage (DTL) equals DOL times DFL and captures the total sensitivity of EPS to revenue changes. A DTL of 3.3 means a 1% revenue change produces a 3.3% change in EPS, amplifying both gains and losses.
How do I calculate and interpret price elasticity of demand? When is demand elastic vs inelastic?
Price elasticity of demand (PED) is one of those concepts that seems simple but has nuances the CFA exam loves to test. PED measures the sensitivity of quantity demanded to a change in price. When the absolute value exceeds 1, demand is elastic and a price increase will reduce total revenue.
What can and can't I do when leaving my employer under Standard IV — Duties to Employers?
Standard IV(A) Loyalty requires that while employed, you must not solicit your employer's clients, take proprietary materials, or compete with your employer. However, you may prepare to leave by searching for jobs, forming a business entity, and making other non-competing preparations.
When do I use a chi-square test in CFA Level I, and how do I set up the hypothesis for variance testing?
For CFA Level I, the chi-square test is primarily used for hypothesis tests about a single population variance or standard deviation. The test statistic is χ² = (n-1)s²/σ₀², and the distribution is right-skewed and non-negative, requiring different critical value treatment than symmetric tests.
How do you bootstrap spot rates from the par yield curve step by step?
Bootstrapping extracts spot rates from the par yield curve one maturity at a time. Start with the 1-year spot rate (equals par yield), then use it to solve for the 2-year spot rate, and so on. Each step sets the par bond price to 100 and solves for the unknown longest spot rate.
When is P/B valuation most appropriate and how do you interpret a P/B below 1.0?
Price-to-book valuation works best for financial institutions and asset-heavy industries where balance sheet values are meaningful. The justified P/B ratio equals (ROE - g)/(r - g), so a P/B below 1.0 can signal either genuine undervaluation or value destruction when ROE is below the cost of equity.
What are the different levels of external review for green bonds, and how do they affect investor confidence?
Green bond external review ranges from second-party opinions (moderate assurance, most common) to CBI certification (highest assurance, most rigorous). Each type differs in scope, depth, ongoing monitoring, and cost, with certification providing the strongest defense against greenwashing.
What are spectral risk measures, and how do they generalize expected shortfall through risk aversion weighting?
Spectral risk measures generalize expected shortfall by applying a risk-aversion-weighted function across quantiles of the loss distribution. While ES weights all tail losses equally, spectral measures assign increasing weight to more extreme losses, making them consistent with expected utility for risk-averse agents.
What is the difference between portfolio margining and product margining, and how does portfolio margining improve capital efficiency?
Product margining calculates requirements per product with no offsets, while portfolio margining recognizes risk-reducing correlations across products. Portfolio margining typically reduces total margin by 30-70% but relies on correlation assumptions that may break down under stress.
Why does the collateral rate specified in a CSA determine the discount curve, and how does this affect derivative valuations?
The collateral rate determines the derivative discount curve because collateral earns interest, and this interest rate defines the economic cost of carrying the position. Different CSA terms (cash vs. bonds vs. uncollateralized) lead to different discount curves and therefore different valuations.
How does a digital (binary) option pay a fixed amount, and why does the discontinuous payoff create hedging challenges?
Digital options pay a fixed amount if the underlying finishes beyond the strike, and zero otherwise. The discontinuous payoff creates extreme delta and gamma near the strike at expiration, forcing dealers to use spread replication and position limits for risk management.
What is DORA, and how does it change ICT risk management requirements for financial institutions?
DORA establishes five pillars of ICT risk management for EU financial institutions: risk framework, incident reporting, resilience testing, third-party risk oversight, and information sharing. The most disruptive change is direct regulatory oversight of critical ICT providers and mandatory threat-led penetration testing.
How are liquidity horizons assigned to risk factors under FRTB, and why do they matter for capital calculations?
Under FRTB, risk factors are assigned liquidity horizons from 10 to 120 days based on how quickly they can be closed during stress. The composite ES aggregates incremental risk at each horizon, significantly increasing capital for positions in illiquid risk factors.
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