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Being long the FRA means you gain when ____ rises.

LIBOR or whatever the floating rate rises.

When the forward contract is established, the forward price is negotiated such that the market value of the forward contract is?

Zero on the initiation date.

This is a result of the principal of no-arbitrage.

Bonds with the same credit rating have ____ probability of default but ____ severity of loss given default.

Bonds with the same credit rating have approximately the same probability of default but not necessarily the same severity of loss given default.

Remember credit ratings are ordinal rankings and do not adjust quickly to changes in business cycle. This extra stability lowers the correlation with default probabilities.

EV vs EVA vs MVA

EV = Enterprise Value

EV = Market Value of Common Equity, Preferred Shares & Debt – Cash & Cash Equivalents & Short Term Investments like marketable securities

EVA = Economic Value Added

EVA = EBIT(1-tax) – $WACC

$WACC = WACC * Invested Capital

MVA = Market Value Added

MVA = Market Value of total Capital – Book Value of Capital

Capital = Debt plus Equity basically L + SE

How to calculate Working Capital Invested?

[(Current Assets – Cash and Equivalents)@t – (Current Liabilities – Notes Payable and Current Portion of Long Term Debt)@t] – [(Current Assets – Cash and Equivalents)@t-1 – (Current Liabilities – Notes Payable and Current Portion of Long Term Debt)@t-1]

A ____ significance level implies a ____ confidence interval implies a ____ absolute value at risk.

A lower significance level ⇒ greater confidence interval ⇒ higher absolute VAR

For VAR we only care about the lower tail of the distribution.

5% VAR ⇒ 90% Confidence Interval ⇒ 1.65 standard deviations below expected return

2.5% VAR ⇒ 95% Confidence Interval ⇒ 1.96 standard deviations below expected return

.5% VAR ⇒ 99% Confidence Interval ⇒ 2.58 standard deviations below expected return


With regards to multicollinearity if the t-statistic is significant most likely…

…multicollinearity is not a problem.

Also not whether R^2 is high and whether the F-statistic is significant.

If everything is high/significant you’re good, there is likely no multicollinearity.

The Molodovsky Effect

The observation that P/E ratios tend to be high on depressed EPS at the bottom of a business cycle and tend to be low on unusually high EPS at the top of a business cycle.

Therefor of particular relevance to cyclical stock evaluation.

If a subsidiary operates in a highly inflationary environment…

…the parent’s currency is the functional currency.

Thus the Temporal Method is used.


Productivity Curves (diagram)