Community Q&A
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CFA Updated
What does Standard I (Professionalism) actually require? How does Knowledge of the Law work in practice?
Standard I covers professionalism requirements. The critical rule for Knowledge of the Law: always follow the stricter requirement when there's a conflict between local law, firm policy, and CFA Standards.
Can someone explain pension accounting -- PBO, plan assets, and funded status?
Pension accounting involves tracking the PBO (present value of earned benefits), plan assets (investments to pay benefits), and funded status (plan assets minus PBO). Pension expense components are split between the income statement and OCI depending on the reporting standard.
How do deferred tax assets and liabilities arise, and what is a valuation allowance?
Deferred taxes arise because financial reporting and tax rules use different timing for income and expenses. A DTL forms when book carrying value exceeds tax base for an asset, while a DTA forms when future deductible amounts exist. A valuation allowance reduces a DTA if future profitability is uncertain.
What is active share and how does it help detect closet indexing?
Active share measures the percentage of holdings that differ from the benchmark, calculated as half the sum of absolute weight differences. Values below 40% suggest closet indexing; above 60% indicates truly active management. It complements tracking error in evaluating manager style.
How is Natural Language Processing (NLP) applied in finance?
NLP in finance involves analyzing unstructured text (earnings calls, news, filings) using techniques like sentiment analysis, topic modeling, and named entity recognition to generate investment signals. Key preprocessing steps include tokenization, stop word removal, and TF-IDF feature extraction.
How do you conduct a DCF sensitivity analysis and which inputs matter most?
DCF sensitivity analysis tests how valuation changes when key inputs vary. WACC and terminal growth rate are typically the most impactful — a 1% change in WACC can shift value by 15-25%. Two-way tables and scenario analysis provide ranges rather than point estimates.
When must a company consolidate a Special Purpose Entity (SPE) or Variable Interest Entity (VIE)?
Companies must consolidate SPEs/VIEs when they are the primary beneficiary — having power to direct the entity's significant activities AND obligation to absorb losses or right to receive benefits. This applies even without majority ownership.
What is a hedge fund lock-up period and why do they have gate provisions?
Lock-up periods prevent investors from withdrawing capital for a set time (usually 1-3 years), allowing the fund to pursue illiquid strategies. Gate provisions limit redemptions per period (typically 10-25% of NAV) to prevent fire sales that would harm remaining investors.
What are the main theories on dividend policy and do dividends actually matter?
The main dividend theories are: M&M irrelevance (dividends don't matter in perfect markets), bird-in-hand (investors prefer certain dividends), tax preference (capital gains are tax-advantaged), signaling (dividend changes convey information), and agency theory (dividends reduce free cash flow waste).
How does a protective put work as portfolio insurance?
A protective put involves owning a stock and buying a put option on it, creating a floor on losses. Your maximum loss is capped at (purchase price minus strike) plus the premium, while upside remains unlimited.
What are the key components of an Investment Policy Statement (IPS)?
An IPS has two main sections: objectives (return and risk) and constraints (time horizon, taxes, liquidity, legal/regulatory, and unique circumstances — remember TTLLU). It serves as the blueprint governing portfolio management decisions.
What strategies are available for managing concentrated stock positions?
Concentrated stock position strategies include outright sale, exchange funds, equity collars, prepaid variable forwards, and charitable giving. Each has different tax, liquidity, and upside retention trade-offs that must be matched to the client's specific situation.
What makes farmland an attractive alternative investment, and how do returns compare to traditional assets?
Farmland returns come from operating income and land appreciation, driven by crop prices, population growth, and arable land scarcity. It offers strong inflation hedging and low correlation with traditional assets, but carries weather, water, and illiquidity risks.
How does ESG integration affect corporate valuation and the cost of capital?
ESG affects valuation through two channels: the cost of capital (risk premiums) and cash flows (revenues, costs, risk events). Analysts can incorporate ESG by adjusting the discount rate, modifying cash flow projections, or using scenario analysis.
What are the key characteristics of infrastructure as an asset class, and how do brownfield and greenfield investments differ?
Infrastructure assets provide essential services with long lives, stable cash flows, and inflation linkage. Brownfield investments are existing operational assets with lower risk and return, while greenfield investments involve new construction with higher risk and return potential.
When should I use P/E vs. P/B vs. P/S ratios for equity valuation, and what are the pitfalls of each?
Each price multiple suits different company types: P/E for profitable firms, P/B for banks and asset-heavy companies, P/S for unprofitable growth firms, and P/CF for capital-intensive businesses. The key is matching the multiple to the company's characteristics.
How does the Mundell-Fleming model predict the effect of monetary and fiscal policy on exchange rates?
The Mundell-Fleming model shows that under floating exchange rates with high capital mobility, monetary policy is effective while fiscal policy is crowded out through currency appreciation. Under fixed rates, the opposite holds.
What does the Carhart 4-factor model add beyond Fama-French, and how does momentum factor work?
The Carhart 4-factor model adds WML (Winners Minus Losers) to capture momentum — the tendency of recent winners to keep winning. It was designed to strip out momentum-driven returns when evaluating fund manager skill.
How does vega work and why does implied volatility matter more than historical volatility for options pricing?
Vega measures an option's sensitivity to changes in implied volatility, not historical volatility. It is highest for at-the-money, longer-dated options and is always positive for long positions. Portfolio vega determines P&L impact from volatility changes.
What does 'fair dealing' actually mean when disseminating investment recommendations?
Standard III(B) requires dealing fairly with all clients when providing recommendations or taking investment action. Fair does not mean equal — it requires a systematic process that does not systematically advantage any group.
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