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CFA Level II Updated
How is a fence collar constructed for zero-cost hedging?
A fence collar is a hedging structure combining a long OTM put with a short OTM call while holding the underlying. Strikes are chosen so the call premium equals the put cost.
What is return on capital employed and how does it differ from ROIC?
Return on capital employed (ROCE) and return on invested capital (ROIC) are closely related but not identical.
What is the Damodaran country risk methodology and how do I apply it?
Damodaran's framework: CRP = Default spread × Relative equity/bond volatility. Example for Ayurvedant Labs in India: 215bps × 1.18 = 2.54% CRP, plus 5.5% US ERP = 8.04% India ERP. Uses lambda for firm-specific exposure...
What is a macroeconomic factor model?
Macro factor models use observable economic surprises (GDP, inflation, spreads) as factors, aiding interpretation and scenario analysis.
Which sectors hold up best during a recession and why?
Recession winners are Staples, Healthcare, Utilities, and Telecom. Financials, Industrials, Materials, and Real Estate lag the most.
How do I compute the dollar-value LIFO index and new layers?
DVL converts ending inventory to base-year dollars using a price index, identifies real quantity growth, then layers in the increase at current cost. Cascade's 22.58% index implies a $100K real layer worth $122.58K at current prices.
What is reverse causality in finance research?
Reverse causality flips the direction of causation. Pemberton's 'ESG causes returns' may actually be 'profitability funds ESG.' Instrumental variables and natural experiments help.
What is the sustainable growth rate and how does it differ from a firm's actual growth?
SGR = ROE × retention ratio — the growth ceiling without external financing. Actual growth above SGR signals leverage, dilution, or operational improvement.
How should I manage Days Sales Outstanding to strengthen cash flow?
Days Sales Outstanding measures average collection time. Rising DSO consumes cash and signals deteriorating customer quality or collection discipline.
How do you measure rivalry intensity among competitors?
Measure rivalry via share volatility, HHI, price dispersion, A/S ratio, capacity utilization, exit barriers, and fixed-cost intensity.
How does graded vesting affect the pattern of share-based compensation expense recognition?
Graded vesting can be treated as separate awards (required under IFRS, optional under US GAAP) producing front-loaded expense, or as a single award with straight-line recognition (US GAAP only). The separate awards method accelerates expense recognition significantly.
How does an interest rate collar work for a floating-rate borrower?
Collar = long cap + short floor. Caps borrowing cost at high end, gives up savings below floor. Often structured as zero-cost.
What is a ladder spread and how does its multi-strike structure work?
A ladder spread uses three strikes instead of two, creating a tiered payoff. A bull call ladder is long one ITM call, short one ATM call, and short one OTM call.
How does a risk-reversal option strategy work and when is it used?
A risk-reversal combines a long out-of-the-money call with a short out-of-the-money put (bullish version) on the same underlying and expiry. The short put finances the long call.
How do Gaussian mixture models differ from K-means clustering?
GMM models data as a weighted sum of Gaussians and produces soft cluster probabilities via the EM algorithm, handling elliptical clusters K-means cannot.
When is financial leverage efficient versus risky?
Leverage is efficient when the after-tax cost of debt is below the return on invested capital and when the cash flow cushion can absorb downturns.
What is an inverse floor and when would an investor use it?
An inverse floor pays the holder when the reference rate is above the strike, with the payoff capped. It's effectively a capped cap structure...
How do I identify the late-cycle phase and position sector weights?
Late-cycle signals include inflation above 3%, curve inversion, and PMI falling. Overweight Energy, Materials, and Healthcare. Underweight Discretionary, Financials, and Real Estate.
When is the gross profit method acceptable for inventory estimation?
Estimated COGS = Sales x (1 - GP%); Ending Inventory = Goods Available - Est COGS. Keystone's $616K estimate supports the insurance claim. Acceptable for interim and casualty loss scenarios but not annual audited statements.
What is look-ahead bias in backtesting?
Look-ahead uses data unavailable at trade time. Fenwick Strategies' 18% return drops to 11% after applying 75-day earnings lag and point-in-time data.
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