 beta estimate difference  sources of error
 tax drag
 synthetic CDO
 effective collar
 option adjusted spread
 pure expectation & liquidity preference theory
IACPM = R_{F} + world market risk premium * sensitivity + foreign currency risk premium(expected appreciation  R_{F}Δ) sensitivity
Quantitative Methods
 mean reversion = b_{0} / (1  b_{1})
 Sharpe ratio = E(R_{m})  R_{F} / σ_{m}
ANOVA(Analysis of Variance)
 SST(total variation) = RSS(explained variation; regression value  mean) + SSE(unexplained variation; observed value  regression value)
 MSR(regression mean square) = RSS / k(# independent factors)
 MSE(mean squared error) = SSE / (n  k  1)
 SEE(standard error of estimate) = √MSE
 R²(% of total variation explained by independent variable) = RSS/SST
 R_{adj}²(adjusts for cost of adding more independent variables) = 1  [ (n1)/(nk1) * (1R²) ]
 Fstatistic = MSR / MSE
Multiple Regression violations
 Heteroskedasticity residual variance // independent variable; results Type I errors; detected by BreuschPagan χ² test; corrected by Whitecorrected standard ε
 AutoCorrelation correlated residuals, error term tends in same direction as previous term(+); results Type I errors; detection with DurbinWatson test; corrected by Hansen method
 Multicollinearity correlated independent variables; results Type II errors; conflicting t and F statistics; corrected by dropping correlated variable
Financial Statement Analysis
Intercorporate Investment
 Purchase method: consolidation at market value
 Pooling of interest method: recorded at book value, no goodwill
 Trading  Available for sale  Held to maturity

Balance Sheet  fair value  fair value w/ unrealized G/L in equity  amortized cost

Income Statement  dividend + unrealized G/L  dividend  interest + realized G/L only

 Equity method: lower leverage, higher profit margin
 Proportionate Consolidation: required under IFRS
 Bootstrap earnings effect  acquirer's P/E > acquiree's P/E, and doesn't decline postmerger
Pension program equations
 ΔPBO(projected benefit obligation) = service cost + interest cost + amortization(previous service cost + aRoA  eRoA  benefits paid
 PBO ⇑ when life expectancy⇑, salary growth⇑, discount rate⇓
 ΔFVPA(fair value of plan assets) = aRoA + employer contribution  benefits paid
 Funded status = net asset  liability (U.S. GAAP)
 Net pension asset = funded status  unrecognized losses (IFRS)
 Net pension expense = service cost + interest cost  eRoA + amortization
 CTA_{f} = Asset  Liabilities  common equity  RE_{f}
 RE_{f}(final retained earning) = RE_{i} + N/I  dividend
 Economic pension expense = (PBO_{f}  PBO_{i}  actual RoA?) = ΔFS  employer contributions = service cost + interest cost  actuarial gain  actual RoPA
Overseas Subsidiary
 translation(current method) results equity account adjustment
 remeasurement(temporal method) results gain/loss in income statement
 revenue & operating exp. translated at average rate under allcurrent method
 Temporal method  Allcurrent method

Assets/Liabilities  monetary A/L  current rate nonmonetary A/L  historical rate  all current rate

Common stock  historical

Equity  mixed rate balanced by R/E  ΔR/E reflected at current rate, balanced by CTA account

Revenues/SG&A  average rate  average rate

COGS & Depreciation  historical rate

FX Gain/Loss  I/S at historical rate  current rate in equity CTA account

Earnings Quality
B/S adjustment  applicable situation  effect

Operating asset capitalization  operating leases, unconsolidated SPEs, receivable sales, corporate guarantees, longterm investments  Asset ↑ Liability ↑

Asset revaluation  marketable securities, inventory valuation change(LIFO>FIFO), depreciation method, foreign currency effect, R&D expense, PP&E&intangible asset impairment, goodwill writeoff  ΔA > ΔE

Reclassification  eliminated deferred tax A/L, deferred revenue, convertible debt to equity, longterm debt amortization  ΔL > ΔE

Accrual ratio = (NI  CFO  CFI)/NOA
 lower accrual ratio > higher earnings quality
Corporate Finance
 Static tradeoff theory seeks an optimal capital structure with an optimal proportion of debt, to balance the costs of financial distress with the tax shield benefits from using debt
Divestitures
 Carveouts: new subsidiary shares issued to existing common shareholders
 Spinoffs: shares not sold in public, only distributed to existing shareholders
 Contango: future value > spot price
 Backwardation: future value < spot price
Equity Investments
Discounted Dividend Model minority owner perspective
 equity risk premium = dividend rate on market index + longterm earnings growth  longterm govt. bond yield
 V_{0} = D_{0}(1+g_{L} + H(g_{s}g_{L})) / (rg_{L})
 2stage model
 grow dividends at high growth period, then calculate future value using perpetual growth model, and discount back by required return
Free Cash Flow control perspective
 FCFF = CFO + Int(1t)  FC_{Inv} = NI + NCC  WC_{Inv} + Int(1t)  FC_{Inv}
 FCFE = FCFF + net borrowing  Int(1t) = NI + NCC  WC_{Inv}  FC_{Inv} + net borrowing
 NCC(noncash charges) = depreciation&amortization  gain/(loss) on asset sale + restructuring expense _ nonreversible deferred tax liability + bond discounts/(premiums) amortization
 FCF // liability(accounts payable, accrued taxes & expenses)
Price Multiples
(note that ROEg ~ dividend / book value)
 EV(enterprise value) = MV_{common stock} + MV_{debt} + MV_{preferred}  cash&investment
 intrinsic P/E = tangible P/E + franchise P/E = 1/r + (1/r  1/ROE) * (g / rg)
 buildup method
 required return on equity = riskfree rate + equity risk premium + size premium + specific company premium
Residual Income net income  opportunity cost of equity (amt. equity capital * cost of equity)
 EVA(economic value added) = NOPAT  (%_{WACC} x total capitalization)
 NOPAT = EBIT(1t)
 single stage model: V_{0} = B_{0}[1 + (ROE  r)/(rg)]
Alternative Investments
Real Estate
 Taxes = (NOI  depreciation  interest) x tax rate
 CFAT(cash flows after tax) = NOI  principal debt service  taxex
 ERAT(equity reversion after taxes) = selling price  selling costs  mortgage balance  taxes on sale
Income property analysis
 capitalization rate = r  g
 MV = NOI / (rg)
Private Equity
 exit value = investment cost + earnings growth + multiple expansion + debt reduction
 carried interest estimation = (NAV_{before}  committed capital) * %carried interest
Fixed Income
 interest rates
 Zspread  OAS = option cost
 embedded options
 finance Greek variables
 delta: // spot price
 gamma: // Δdelta
 vega: // volatility
 theta: // time to expiration
 rho: // riskfree rate
 Conditional Payment Rate = 6% * t/30 * PSA
 Single Monthly Mortality = 1  (1  CPR)^{0.083}
Derivatives
 Futures FP = S_{0}(1+r)^{T}  FVD
