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How is the Kalman filter used in finance through state-space models?
A state-space model has two equations. The measurement equation y_t = Z_t alpha_t + epsilon_t links observables to the unobserved state alpha_t...
How do I immunize a portfolio against multiple future liabilities with different dates?
Match PV, duration, AND convexity/dispersion with cash flows bracketing each liability. Refine with key rate duration for non-parallel shifts.
How are interest-only (IO) strips priced and why do they behave inversely to most bonds when rates fall?
IO strips receive only interest payments whose value depends on outstanding principal. When rates fall, prepayments accelerate, shrinking the principal base and reducing future interest — causing IO values to drop. This creates negative duration, meaning IOs move in the same direction as rates.
What are the specific criteria for deep value investing and how does it differ from regular value investing?
Deep value investing targets companies trading at extreme discounts using screens like P/E below 8x, P/B below 0.7x, and price below net current asset value. It differs from regular value investing through uglier business profiles, higher value trap frequency, and the need for portfolio diversification.
How should analysts adjust financial ratios for off-balance-sheet items?
Analysts should adjust for off-balance-sheet items by capitalizing operating leases, consolidating unconsolidated entities, and adding back factored receivables to get accurate leverage, return, and efficiency ratios. The most common adjustment is adding the present value of future lease payments to both assets and liabilities, which typically increases leverage ratios and decreases return metrics.
How do stock dividends and stock splits affect the EPS calculation?
Stock dividends and stock splits are treated retroactively in EPS calculations, as if they occurred at the beginning of the earliest period presented. All prior-period EPS figures must be restated. This is because these events do not raise cash or change economic ownership. When combined with share issuances for cash, apply the split factor retroactively but weight the issuance from its actual date.
How does the cumulative translation adjustment (CTA) work under the current rate method, and what happens when you sell the subsidiary?
Under the current rate method, the CTA accumulates in equity as a component of AOCI. When the subsidiary is sold or disposed of, the accumulated CTA is reclassified from equity to the income statement as part of the gain or loss on disposal.
How does bond premium amortization work under the effective interest method, and why does interest expense decrease over time?
Under the effective interest method, interest expense equals the carrying value times the market yield. For a premium bond, the carrying value decreases each period as the premium is amortized, causing interest expense to decline while the fixed coupon stays the same.
What causes the volatility smile and skew in options markets?
The volatility smile and skew refer to the pattern of implied volatility varying across strike prices for options with the same expiration. In equity markets, the skew shows higher implied vol for low strikes due to crashophobia, leverage effects, fat tails, and jump risk.
What is Pillar 2 supervisory review and how does it complement Pillar 1 minimums?
Pillar 2 is the supervisory review process addressing risks not fully captured in Pillar 1.
What does Pillar 1 of the Basel framework require for minimum regulatory capital?
Pillar 1 establishes minimum capital requirements as ratios of eligible capital to risk-weighted assets.
How does roll yield work and when is it positive versus negative?
Roll yield is the return component a futures investor earns (or loses) from closing an expiring contract and reopening the position in the next contract along the curve...
What actuarial risks dominate a life insurance portfolio?
Life insurance actuarial risk decomposes into mortality, longevity, lapse, and expense drivers, each with distinct stress sensitivities.
How does a swap's mark-to-market evolve over its lifecycle and what drives MTM swings?
Swap MTM evolves with curve moves. Silverbrook's 5Y pay-fixed gains $1.58M when 4.75Y rate rises 50bp. MTM = notional × rate change × annuity factor...
How do regime-dependent correlation models work?
Regime-dependent correlation models recognize that correlation parameters shift across market states, captured via DCC-GARCH, Markov-switching, or copula regime models...
How do I interpret and compute an expected exposure profile?
EE(t) is E[max(0, MTM(t))] averaged over Monte Carlo paths. For a 5y IRS with Kestrelbay, EE peaks mid-life. Interpret peak timing, compare to PFE for tail behavior, and recognize netting benefits typically cut EE 40-60%.
How do I describe the distribution of counterparty credit exposure over time?
Exposure distribution evolves as max(0, MTM) from surviving party's view. For a 10y IRS with Ironwood Capital, EE peaks around year 3-4 and declines. We summarize with EE (mean), PFE (high percentile), and EPE (time-average of EE).
What does a p-value actually mean? I keep getting the interpretation wrong on practice exams.
The p-value is the probability of obtaining results at least as extreme as observed, assuming the null hypothesis is true. It is NOT the probability that the null is true — this is the most common misinterpretation on the CFA exam.
How do you compare municipal bond yields to taxable bonds? I keep getting tax-equivalent yield wrong.
Municipal bonds are typically exempt from federal income tax, so direct yield comparisons are misleading. Use the tax-equivalent yield formula: TEY = Muni Yield / (1 - Marginal Tax Rate) to compare fairly.
What are the most important IFRS vs US GAAP differences tested at CFA Level II?
The most important IFRS vs US GAAP differences at Level II span inventory (LIFO/reversals), long-lived assets (revaluation/impairment reversals), leases (single vs dual lessee model), pensions (net interest vs expected return), R&D (capitalization vs expensing), and consolidation (goodwill options).
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