CFA Level 1 - 101 Must Knows Questions With Complete
Solutions
Industry Analysis & Porter's 5 Forces
Pricing power depends on degree of competitive pressure in
industry
A firm is likely to have more pricing power if...
CBUS (Charlie's Unique Butt Songs)
- Concentration
- Undercapacity
- Barriers to entry
- Stable market shares
Porter's Five Forces
RTTPP (Run Through The Purple Pasture)
- Rivalry Among Existing Competitors
- Threat of Entry
- Threat of Substitutes
- Power of Buyers
- Power of Suppliers
Peer Groups
BDCA (Baby Don't Act Crazy)
Firms with similar:
,- Business activities
- Demand drivers
- Availability of capital
- Cost drivers
Equity Valuation using Price Multiples
Price multiple is a ratio of share price to measure of firm's value
or performance
P/E = Share price / EPS
Other Price Multiples
Price / Sales
Price / CF
Price / BV
Justified (leading) P/E Ratio
Based on constant-growth dividend model
P(0) = D(1) / (k - g)
Divide both sides by next period's earnings
(P(0) / E(1)) = (D(1) / E(1)) / (k - g)
where D(1) / E(1) = div payout ratio
Justified P/E = Dividend Payout Ratio / (k - g)
Dividend Discount Model (Concept)
,Principle that asset's intrinsic value is PV of future cash flows
DDM (Preferred)
Treat as perpetuity:
P(0) = Dividend / k
DDM (Constant Growth) or Gordon Growth Model
P(0)
= (D(0)*(1+g)) / (1+k)
+ (D(0)*(1+g))^2 / (1+k)^2
+ (D(0)*(1+g))^n / (1+k)^n
This converges to:
P(0) = D(1) / (k-g)
DDM (Rapid Growth) or Two Stage
REMEMBER: Constant growth DDM estimates value one
period before dividend you use (see photo)
The first dividend we can use for constant-growth is one that
grows at constant rate
Approximate Modified Duration
Linear estimate of the sensitivity of a bond's price to change in
YTM
, (Price after (up) YTM - Price after (down) YTM) / (2 Original
Price Change in YTM as a decimal)
Convexity
Estimate of the curvature of the price-yield relationship
Greater for bonds with longer maturity dates and lower coupons
Percent Change in Bond Price
- Duration Change in YTM + (0.5) Convexity * (Change in
YTM)^2
Spot & Forward Rates
Regardless of when you borrow (whether spot or forward), rates
should be equal
(1 + S1)^3 = (1 + S1) * (1 + 1y2y)^2
(1 + S1)^3 = (1 + S1) (1 + 1y1y) (1 + 2y1y)
(1 + S1)^3 = (1 + S2)^2 * (1 + 2y1y)
Yield Spreads
G-Spread: Bond YTM minus YTM of maturity matched gov't
bond yield
I-Spread: "Interpolated" spread, relative to maturity-matched
swap rate
Solutions
Industry Analysis & Porter's 5 Forces
Pricing power depends on degree of competitive pressure in
industry
A firm is likely to have more pricing power if...
CBUS (Charlie's Unique Butt Songs)
- Concentration
- Undercapacity
- Barriers to entry
- Stable market shares
Porter's Five Forces
RTTPP (Run Through The Purple Pasture)
- Rivalry Among Existing Competitors
- Threat of Entry
- Threat of Substitutes
- Power of Buyers
- Power of Suppliers
Peer Groups
BDCA (Baby Don't Act Crazy)
Firms with similar:
,- Business activities
- Demand drivers
- Availability of capital
- Cost drivers
Equity Valuation using Price Multiples
Price multiple is a ratio of share price to measure of firm's value
or performance
P/E = Share price / EPS
Other Price Multiples
Price / Sales
Price / CF
Price / BV
Justified (leading) P/E Ratio
Based on constant-growth dividend model
P(0) = D(1) / (k - g)
Divide both sides by next period's earnings
(P(0) / E(1)) = (D(1) / E(1)) / (k - g)
where D(1) / E(1) = div payout ratio
Justified P/E = Dividend Payout Ratio / (k - g)
Dividend Discount Model (Concept)
,Principle that asset's intrinsic value is PV of future cash flows
DDM (Preferred)
Treat as perpetuity:
P(0) = Dividend / k
DDM (Constant Growth) or Gordon Growth Model
P(0)
= (D(0)*(1+g)) / (1+k)
+ (D(0)*(1+g))^2 / (1+k)^2
+ (D(0)*(1+g))^n / (1+k)^n
This converges to:
P(0) = D(1) / (k-g)
DDM (Rapid Growth) or Two Stage
REMEMBER: Constant growth DDM estimates value one
period before dividend you use (see photo)
The first dividend we can use for constant-growth is one that
grows at constant rate
Approximate Modified Duration
Linear estimate of the sensitivity of a bond's price to change in
YTM
, (Price after (up) YTM - Price after (down) YTM) / (2 Original
Price Change in YTM as a decimal)
Convexity
Estimate of the curvature of the price-yield relationship
Greater for bonds with longer maturity dates and lower coupons
Percent Change in Bond Price
- Duration Change in YTM + (0.5) Convexity * (Change in
YTM)^2
Spot & Forward Rates
Regardless of when you borrow (whether spot or forward), rates
should be equal
(1 + S1)^3 = (1 + S1) * (1 + 1y2y)^2
(1 + S1)^3 = (1 + S1) (1 + 1y1y) (1 + 2y1y)
(1 + S1)^3 = (1 + S2)^2 * (1 + 2y1y)
Yield Spreads
G-Spread: Bond YTM minus YTM of maturity matched gov't
bond yield
I-Spread: "Interpolated" spread, relative to maturity-matched
swap rate
