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FinancialReportingisusedtoprovide
shareholders,potentialinvestors,lenders
andcreditorsthenecessaryresourcesto
maketheirdecisions.
IncomeStatement
Statementofoperations
ProfitLossStatement
Itisadynamicstatementitspansaperiod
oftime.
Itisdividedinto3segments:revenues,
expenses,andotherincome(gainsand
losses).
StatementofComprehensiveIncome:
Reportsallchangesinequityexceptfor
shareholderstransactions(dividends
distribution,buybacks...)
BalanceSheet
Atapointintime
CashflowStatement
Adynamicstatementthattrackschangesin
cash.
Thereare3categories:
OperatingCashflow(CFO):
Cashgeneratedfromcoreactivities.
InvestmentCashflow(CFI):
Buyingassetsforgeneratingrevenue
(plants,equipment,etc.)
FinancingCashflow(CFF):
Issuingdebt,dividends,etc.
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StatementsofChangesinOwnersEquity:
Stockholders'equityfromlastyearis
reconciledfromthisyear.
Buybackofshares,issuanceofshares,
dividends,Netincomefromtheincome
statement,andothercomprehensive
income(unrealizedgainsandlosses)
Whataretheimportanceoffootnotes?
Basisofpresentations
Accountingmethodsandassumptions
Furtherinformationonamountinprimary
statements(moredetailslikepension
liability)
Businessacquisitionsanddisposals
Contingency(liabilityoffutureevents)
Legalproceeds
Stockoptionsandbenefitplans
Significantcustomers
Segmentdata(breaksdownkey
informationlikesales,assets,operating
profitsondivisionallevel)
Quarterlydata(IfitisaEuropean
companytheyreportsemiannually)
RelatedPartyTransactions(any
transactionsbetweenemployees)
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ManagementDiscussionandAnalysis:
NotAudited:(Thereforenotcompletely
dependable)
Adescriptionofhowthefirmhasdonein
thepastandhowitwillpreforminthe
future.
Itbreaksdownitsoperationsandexplains
howtheyaredoingit.
Itisbasicallyanoverviewofthebusiness.
Cashflowtrends
Discussiononcriticalaccountingchoices
(alsodiscussedhereaswellasat
disclosure.)
Uncertaintyandriskisdiscussedhere.
TheAuditReportObjective:
TheAuditisanindependentreviewofthe
companiesfinancailstatements
Appointedbytheshareholders
Itstrivestoreduceagencycost(making
surethemanagementisn'thidinganything
fromtheshareholders.
ReasonableAssurance:
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Reasonableassurancethatthefinancial
statementsarefreefrommaterialerror.
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AuditOpinions
Unqualified:Clean
Qualified:Exceptionstoaccounting
principles.Theauditorsdisagreewith
certainpartsofthetreatmentofthe
financialstatements.
AdverseOpinion:Wedonotbelievethe
accountsaretrue.Thisstatesthatthe
financialstatementscannotbetrusted.
DisclaimerofOpinion:Thereis
insufficientdatatomakeanopinion.
WhatdoestheUSGAAPrequirefrom
auditors?
Aopiniononthecompaniesinternal
controls.
AuditReport
1)Responsibilityofmanagementto
prepareaccounts
Independenceofauditors.
2)Properlypreparedinaccordancewith
relevantGAAP:
IFRS(IS)orUSGAAP.
3)Accountingprinciplesandestimates
chosenarereasonable.
SupplementarySourcesofInformation:
Quarterly,semiannualreports.
ProxyStatements
Corporatereports,pressreleases
Economic,Industrydata.
Quarterly,semiannualreports.
Updatesofmajoraccountingstatements
(Balancesheet,cashflow,income
statementandfootnotes.
ProxyStatements:
Containinformationonwhatshareholders
arevotingon.
Economic,andindustrydata.
Wallstreetjournalisanexample.
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FinancialStatementAnalysisFramework
1)Purposeandcontextofanalysis
2)CollectData
3)ProcessData
4)Analyze/InterpretData
5)Conclusionandrecommendations
6)Updateanalysisonperiodicbasis.
Regardingthereportofofindependent
auditorsunderU.S.GAAP,theaudit
report:
Mustprovideopiniononcompanies
internalcontrols.
OwnersEquityFormula:
ContributedCapital+RetainedEarnings
CapitalatParValue
Sharesatparvalue
AdditionalPaidinCapital
Anyincreasesinsharevalue
ContributedCapital
ContributedCapital=CapitalatparValue
+AdditionalPaidinCapital
RetainedEarnings
RE=
LastyearsRE
+/Earnings(Loss)
Dividends.
AccrualandValuationAdjustments
Accruedexpenses(Liability)
Bad/DoubtfulAccounts(Asset)
Prepaidexpenses(Asset)
AccruedRevenue(Asset)
Impairment/Writedown(Asset)
UnearnedRevenue(Liability)
FASB:
FinancialAccountingStandardsBoard:
IASB:
InternationalAccountingStandardBoard
SEC:
ThelistingservicesofUS.
IOSCO:
InternationalOrganizationofSecurity
Commission
1)Protectinvestors
2)Insuringmarketsarefair,transparent,
andefficient.
3)Reducesystematicrisk.
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ConvergenceofIFRSandIASB.
1)IncreaseComparability.
2)Decreasetheproblemsandexpensesin
raisingcapitalinforeigncapitalmarkets.
3)Decreaseproblemsincreating
consolidatedfinancialstatementsfor
foreignsubsidiaries.
BarriersinConvergence:
1)Differenceinviews
2)Pressurefromindustrygroups
3)Manydifferentcountriesinvolved.
IFRSFramework:
1)Relevance
Theinformationcaninfluenceusers
opinion.
Materiality
2)Characteristics:
Comparability
Verifiability
Timeliness
Understandability
IFRSFrameworkTradeoffs:
Relevancevs.verifiability(moretime
givenwillgiveabetterideaofcertain
accounts.)
Benefitsvs.Costs
Excludenonquantifiableinformation.
IFRSAssets:
Resourcescontrolledbytheentity
resultingfrompasttransactions.
Probablefutureeconomicbenefitsflowto
enterprise
IFRSLiability:
Obligationsresultsfrompastevents
Settlementresultsinprobableresource
outflow
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IFRS(Equity)
Shareholders'residualinterest
AssetsLiabilities
IFRS(Income):
Resultinanincreaseinequity
IFRS(Expenses):
resultinadecreaseinequity.
IASBRequiredStatements:
BalanceSheet
IncomeStatement
StatementofComprehensiveIncome
ChangesinEquity
CashFlowStatements
AccountingPolicies,notes
IASBFundamentalPrinciples:
FairPresentation
GoingConcern
AccrualBasis
Consistency
Materiality
IASBPresentationRequirements
Aggregationwhereappropriate
NoOffsetting(separateaddingup
expensesandrevenuesintoonetotal)
Classifiedbalancesheet
Minimuminformationonface
Minimumdisclosure
Comparativeinfo.
Reportingfrequencyneedstobeatleast
annual.
IFRS/U.S.GAAPDifferences
FASBdefinesincomeandexpensesas
elementsrelatedtoperformancewhile
IASBalsoincludesgains,losses,and
comprehensiveincome.
FASBdefinesanassetasafuture
economicbenefitwhereIASBdefinesitas
aresourcesfromwhicheconomicbenefits
comesfrom.
FASBDoesnotallowupwardvaluation
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BarrierstoSingleFramework:
Valuation:
HistoricvalueReliable
FairValueRelevant
StandardSetting
Princplebasedveryewspecificrules
abouttransactions
RulesbasesRespectivebutnotflexible
ObjectbasesCombinesprinciplesand
ruleswhatIFRSandUSGAAPuse.
Measurement:
IFRSandUSGAAPmostlyfocusonthe
balancesheetandtheincomestatement
comesasresidualofthat.
IASBRequirementsforRevenue
Recognition:
1)Riskandrewardtransferredtonew
owner.
2)Nocontinuingcontroloverthegood
sold
3)Reliablerevenuemeasurement
4)Probableflowofeconomicbenefit
5)Measurable.
SECAdditionalGuidanceforRevenue
Recognition:
1)Evidenceofanarrangmentbetween
buyerandseller.
2)Completionoftheearningprocess,firm
hasdeliveredproductorservice.
3)Priceisdetermined.
4)Assuranceofpayment,abletoestimate
probabilityofpayment.
SalesBasisMethod:
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Usedforwhenagoodorserviceis
providedattimeofsale.
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PercentageofCompletion:
Aconstructionrevenuerecognition
criteria.
Musthavereliableestimatesoftotalcosts,
revenues,andcompletiontime.
SameforIFRSandGAAP.
Revenue=(TotalCosttoDate/Total
ProjectCost)xSalesPrice
Profit=RevenueCostincurredthatyear
Rememberforsubsequentyearstodeduct
therevenuethatyouhavealready
recorded.
CompletedContractMethod:
Ifyoudon'thavereliableestimatesoftotal
costs,revenues,andcompletiontime.
Keepseverythingoutoftheincome
statementuntilthecontractisactually
fulfilled.
Sojusttotalthecostsandsaleintheend!
NotallowedunderIFRS!USGAAPonly!
UnderIFRSyoumatchexpenseswith
sales,sonoprofit,untilcompletion.
So1styearexpense=1styearrevenueand
soonuntilcompletion.
Atcompletionyouthenrecordaprofit.
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Installment:
Allowsacustomertopayininstallments.
Usedwhenacompanycannotdetermine
thelikelihoodofcollectionbutdoesknow
relativelytheexpensesitwilloccur.
Thereby,theexpensesandsalesare
matched.
Theamountofrevenuerecognizedduring
aperiodiswhatevertheinstallment
amountis.However,theexpenseisa
percentageofhowmuchtheinstallementis
payingoff.
Forexample:ifthetotalsalevalueis
30,000,totalexpenseis10,000,andthe
installmentamountinthefirstyearis
8,000then:
revenue:8,000(installementamount)
expense:2,666.67(8,000/30,000x10,000)
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CostRecoveryMethod:
Therearetwosourcesofuncertainty:
1)Whetherthecustomerwillpayyou.
2)Youdon'tknowthetotalcostofthe
serviceorgoodsprovided.
Matchcostsagainstrevenueandnot
recognizerevenuetilltheend.
Soforinstanceifthetotalsalevalueis
30,000butyoudon'tknowtheexpenses
quiteYETsoyouwritedowntherevenue
andexpensesuntilthefinalyearwhenyou
knowthetotalexpenses.
Firstyearsayyoureceived14,000.
Revenue:14,000
Expenses:14,000(yousimplymatch)
Secondyeartheprojectiscompletedand
yourfigureoutthatthetotalexpenses
incurredwere$18,000andyoureceivea
secondpaymentof16,000fromyour
client.
Revenue:16,000
Expenses:4,000(whateverisleftfromthe
totalexpenses).
Whateverleftisprofit,inthiscaseitis
12,000.
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WhataretheeffectsofPOCvs.CC
methodinregardstotheincome
statement?
Incomevolatility?
Cashflow?
POCwillresultahigherincomestatement.
CCwillresultinasignificantlyhigher
incomevolatilitysincetherewillbeno
revenuerecognizeduntilthefinalyear
whereuponamassiverevenuerecognition
occurs.
Remember:volatilityisrisk!
Cashflowmethodsarenoteffected!The
reasonforthisisbecausenoactualcashis
seenreceivedtheend.
InstallmentpaymentsunderIFRS:
YourecordthePVvalueofthe
installmentsandrecordwhatever
differenceyouactuallyreceivefromthe
installmentsasinterestearnedovertime.
Iftheoutcomeoftheprojectcannotbe
estimatedreliably,revenuerecognition
underIFRSissimilartocostrecovery
method.
Barter:
Anexchangeofgoodsandservicesinstead
ofcash.
Recordsthesaleatthepriceofthefair
marketvalue.
Thevalueshouldbeatarmslength(not
insiders.)
IFRS:
USGAAP:Fairvalueonlyifthegoods
weresoldforcashinthepast,orotherwise
youusethecarryingvalue(asset
accumulateddepreciation.)
Netreporting:
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Sellproductsbutneverholditintheirown
inventory.
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USGAAPshouldreportgrossif:
1)Istheprimaryobligator
2)Bearsinventoryrisk
3)Bearscreditrisk
4)Canchoosesupplier
5)Haslatitudetosetprice
Giveexampleof"aggressiverevenue
recognition"
Percentageofcompletion(becauseyou
recognizerevenuesooner.)
Conservative:
Costrecovery.
Expense:Accrualbasis
Matchexpensestorevenuesotheydon't
pileup.
COGSCalculation:
BGNInventory
+Purchases
Endinginventory
=COGS
Amortizationforgoodwill:
Itisn'tamortized.Insteaditischeckedfor
impairment.
AccountingChanges:Principle
Principle:forexample:LIFOtoFIFO
Youhavetoshowthepastfinancial
statementsrestatedunderthenew
accountingchanges.
AccountingChanges:Estimates
Youdonothavetorestateprior
statements.
PriorPeriodAdjustments:
Typicallyrequiresarestatementof
financialstatements
Mustdisclosethenatureoftheerror.
NonOperatingItems:
Interest
Dividends
GainandLossondisposal.
SimpleCapitalStructure:
Nopotentiallydilutedsecurity.
Adilutedsecurityisanysecuritythatis
convertible(convertiblebonds,warrants,
etc.)
ComplexCapitalStructure:
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Youhavedilutedshares.
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Potentiallydilutedsecurities:
Stockoptions(employee)
Warrants
ConvertibleBonds
Convertiblepreferredshares
DilutivesecuritiesdecreaseEPS
AntidilutivesecuritiesincreaseEPS
BasicEPS
BasicEPS=
(NetIncomePreferredDividends)/
(Weightedaverage#ofcommonstock)
HowisstockDividendaccountedforina
weightedaverage#ofsharesquestion:
Itisappliedtotheamountofshares
outstandingforthepreviousmonths.
IncomeTaxExpense=
TaxesPayable+ChangesinDeferredTax
TaxLossCarryforward:
Whenyouhaveanetlossyougeta
deferredtaxfornextyear.
TaxBase:
Netamountsofassetsorliabilitiesusedfor
taxreportingpurposes
IncomeTaxExpense:
Taxpayable+ChangeinDTLDTA
(DeferredTaxAsset)
DTL:
DeferredTaxLiability:
Bypayinglesstaxesnow,youwillhaveto
paymoreinthefuture.
DTA:
DeferredTaxAsset:
Payingmoretaxesnowwillresultinless
taxesinthefuture.
YieldRatio:
Exactlythesameasrelativespreadexcept
no1
CreditSpread:
Differencebetweenyieldsofbondsthat
onlydifferincreditrating.
Oftenknownasaspreadtotreasuries.
Creditspreadsnarrowduringgrowthand
widenduringrecession.
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Calloption
Callawayfromthebondholder.
Thereforeitincreasesyieldinorderto
keepthebondattractive.
LessLiquid=
Moreyield&greatyieldspread
AfterTaxYield=
TaxableYield(1Tax)
Y=7%
Tax=30%
=0.07(10.3)
TaxableEquivalentYield=
Takesthetaxfreeyieldbackwardsin
regardstotheaftertaxyieldformula:
TaxfreeYield/(1tax)
LIBOR:
LondonInterbankOfferRate:
Mostimportantreferencerateforfloating
ratesecurities.
FundedInvestor:
BorrowingshorttermatLIBORtofinance
aninvestment.
ArbitrageFreeBondPricing:
Theyieldcurverepresentsachangein
yieldthroughouttime.Byusingaspotrate
itispossibletodiscountSINGLEfuture
couponpaymentsusingaspotrate.
Soforawholebondsincethereisabunch
ofcouponpaymentsyoudiscounteach
couponpaymentsatdifferentspotrates.
Thereisarbitrageinthissincethespotrate
canbehigherthantheyield.
PV=
FV/[(YTM/2)+1]
Howtoprofitofarbitrageinregardsto
bonds?
Ifthearbitratefreevalueishigherthenbut
thebond,stripandsellthecoupons.
Ifthearbitragefreevalueislessthanthe
bondvaluethenbuythestrippedcoupons
andmakeabond.
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YTMisalsoknownas...
BEY:BondEquivalentYield
REMEMBERONTHEEXAMTHEY
WILLTRICKYOU,ALWAYSMAKEIT
SEMIANNUALYIELDBECAUSEITS
ABOND!!!
soifit'sannualonyourcalc,transferit
backtosemiannual!!!
CurrentYield=
AnnualCouponPayment/CurrentPrice
SovereignDebt:
Bondsissuedbycentralgovernment.
TheUSTreasurysecuritiesareconsidered
freeofdefaultrisk.
Consideredriskfree.
RegularCycleAuctionSingleprice:
Thehighestpriceatwhichtheentireissue
canbesold.
RegularCycleAuctionMultipleBid:
Winnerbiddersreceivethebondsat
whateverpricetheybid.
AdHocSystem:
Governmentauctionsnewsecuritieswhen
themarketconditionsareadvantageous.
TapSystem:
Bondsareidenticaltopreviouslyissued
bonds.
Theyreleasethemwhenevertheyneed
them.
TBills:
TreasuryBills.Purediscountsecurities,0
couponbonds.
Simplybuythemforacertainprice,then
matureatanother.
NotesandBonds:
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Offersemiannualcouponpayments.
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TIPS:
TreasuryInflationProtectedSecurity:
Couponrateisfixed
Realrateofreturn
Parvalueisadjustedforinflation.
1/2couponratexinflatedadjustedpar
value=Semiannualpayments.
LikeafloatingcouponrateexceptthePV
isadjusted.
OntheRunIssues:
Themostrecentlyissuedsecurity.
Havethemostaccuratepricingandarethe
mostliquid.
OffTheRunIssues:
Olderissuedsecurity.
StrippedTreasurySecurity:
0couponbondcreatedfromtreasurynotes
andbondsthepiecesareseparated.
CouponstripsaredenotedCI
PrinciplestripesaredenotedPI
Stripsaretaxedonexplicitinterest.
SecuritiesIssuedbyFederalAgencies:
Federalrelatedinstitutions:
GNMA,TVA...
GovernmentSponsoredEnterprises:
SalieMae,FreddieMac,MannieMae
AgencySecurities:
Verylittlerisk.
Debentures:
Securitiesnotbackedbycollateral
unsecuredbonds.
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MPS:
MortgagePassthroughSecurityisa
securitymadefromapoolofmortgages.
Theownerofasuchasecuritygetsa
certainpercentageoftheinterest,principle,
andprepaidprincipleinreturnfor
purchasingthesecurity.
Theriskwiththesesecuritiesisthatwhen
interestratesgoup,prepaymentof
principlegoesdownsincenoonewantsto
refinanceamortgagewheninterestrates
aregoingup.
CMO:
CollateralizedMortgageObligations:
CreatedfromMPSwiththemaingoal
beingtolevelouttheriskfromthepre
paymentdropsduetointerestraterises.
TherearethreeTranchesshort,medium,
andlongperiodandgetfilledupinthat
order.
Basicallywhenpaymentsstartcomingin
fromprepaymentsduetolowinterestrate
risktheyareredirectedtowardsthese
tranchesthatthenpayoutacoupon
paymenttomaketheMPSattractiveagain.
PrepaymentRisk:
Wheninterestratesfallprepaymentsstart
cominginandthiscausesthelenderto
reinvestthatmoneyatalowinterestrate.
MunicipalSecurities:
Exemptfromincometaxinthestateof
issue.
TaxbackedBonds:
GeneralObligationBond,dependonthe
taxingauthorityforpayments.
RevenueBonds:
Dependsontherevenuegeneratedfroma
specificgovernmentproject,likeatoll
road.
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InsuredBonds:
Backedbyinsurancepoliciesintheevent
ofdefaults.
SecuredDebt:
Likeamortgagebonditisassetbacked.
DebentureBond:
Unsecuredbond.
RevenueBonds:
Dependsontherevenuegeneratedfroma
specificgovernmentproject,likeatoll
road.
InsuredBonds:
Backedbyinsurancepoliciesintheevent
ofdefaults.
Prerefundedbond.:
Bondsthathavetheirprinciplecash
amountalreadyheldasidebytheoriginal
issuerofthedebt.Asubsetofthe
municipalandcorporatebondclasses,the
fundsrequiredtopayoffrefundedbonds
areheldinescrowuntilthematuritydate,
usuallybypurchasingTreasuryoragency
paper.
Refundedbondswilltypicallybe'AAA'
ratedduetothecashbackingand,assuch,
willofferlittlepremiumtoequivalentterm
Treasuries.Thedateofrefundingwill
usuallybethefirstcallabledateofthe
bonds.
SecuredDebt:
Likeamortgagebonditisassetbacked.
DebentureBond:
Unsecuredbond.
SeniorDebenture:
Bondshaveapriorityofrepayment,
seniorshavethehighestone.
CommercialPaper
2270days,notliquid,basicallycorporate
IOU.
MediumTermNote:
Continuouslyofferedbyanagent.
Theycanbecreatedanytimeandarevery
customizable.
StructuredSecurity:
MediumTermNotecombinedwithsome
debenture.
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NegotiableCB
DaystoYears,
Secondarymarket.
BankersAcceptance:
Createdtoguaranteepaymentforshipped
goods.
Shortterm,
Purediscount,
Liquidityrisk.
ABS:
AssetBackedSecurity:
Backedbyfinancialassetlikereceivables.
SoldbycreatingaSPV:SpecialPurpose
VehiclewhichasecurityformedfromAR.
ExternalCreditEnhancement:
CertainABShaveahighdefaultrateand
thereforeareunattractivetoinvestors.To
maketheABSmoreattractive,aexternal
creditenhancementisapplied.Itbasically
isaguaranteeofpaymentviainsurance.
CDO:
CollateralizedDebtObligation:
Asecuritythatcanbecreatedbasicallyout
ofanything.
PrimaryMarket:
Newlycreatedsecurities:
Firmcommitment:thebankerpurchases
awholeissueandresellsit.
Besteffortbasis:Bankerattemptstosell
asmuchashecan.
PrivatePlacement:Theissuesaresold
privately.
InterestRatePolicyTools:
OpenMarketOperations,
DiscountRate,
BankReserveRequirements.
OpenMarketOperations:
Buyingandsellingtreasurysecuritiesin
theopenmarket.
DiscountRate:
theratethatthebankborrowfromthefed
inordertokeepuptheirreserves.
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BankReserveRequirements:
Theamountofmoneyabankhastokeep
inreserve.
Iftheychangeitthishasaneffecton
lendingratessincealowerbankreserve
willfreeupmoneyforthebanks.
Bybuyingbondsintheopenmarketthey
putoutnewcashintothesystembecause
beforethatmoneywassittinginthe
treasuryinaccessibletonongovernmental
people.
TermStructureTheory:
1)Pureexpectationtheory
2)LiquiditypreferenceTheory
3)MarketSegmentationTheory
Pureexpectationtheory:
ThistheorysignifiesthataYieldgraphis
anindicationofthemarketsexpectations.
Forinstance,anincreaseinyieldinregards
tomaturitysignifiesanexpectationof
interestraterise.
Aflatexpectsinterestratetostayflat.
Adeclineexpectsinterestratefalls.
LiquiditypreferenceTheory:
Similartopurseexpectationtheory.
Sincelongermaturity=morerisk.
MarketSegmentationTheory:
Therearesegmentationtotheyieldcurve
inregardstoshort,medium,andlongterm
durations.Somecompaniesworkinthe
shorttermwhileothersinthelongterm.
Thereisasupplyanddemandineach
segmentandacurvecanbeanyshape.
TreasurySpotRates:
theappropriatediscountrateatapointin
thefuture.
AbsoluteSpread:
AbsoluteSpread=Highyieldlowyield
RelativeSpread:
Yieldonsubjectbond/yieldon
benchmarkbond
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GDP:
GrossDomesticProduct.
Itisthetotalmarketvalueoftheproducts
producedinacountryoreconomyduringa
period.
Thiscountsforfinalproductsonly.
Separatecomponentsdonotcount.
GDPalsoincludesrentalvalueforowner
occupiedhousing.
Governmentservices(atcost).
GDP:IncomeApproach.
+Earningofallhouseholds
+business
+government
=GDP
GDP:ExpenditureApproach
C=Consumptionspending
+I=businessinvestment(capital
equipment+changeininventories)
+G=Governmentpurchases
+X=Exports
I=Imports
Sumofmarketvaluesofallfinalgoods
andservicesproducedintheeconomy.
or
Sumalltheincreasesinvalueateachstage
oftheproductionprocess(Valueadded).
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FinalValueAdded:
Giveexampleandexplain:
Material>Fabricator
Fabricator>Assembly
Assembly>Consumer
Eachofthesestagesaddedvalue.
Thisvaluecanbelookedatintwoways:
asatotalofthevalueaddedandasafinal
pricegiventoconsumers.
Thefinalpricegiventoconsumershould
beequaltothevalueadded.
NominalGDP:
(QtxPt)
P=Price
Q=Quantity
RealGDP:
Withbaseyear=t5:(QtxPt5)
Usesbaseyearpricesbecauseifitdidnot
PcouldrisewhileQisdecreasingthereby
givingtheillusionthattheGDPisnot
changing.Thereforeabasepriceisgiven
inordertogivetherealGDP.
GDPDeflator:
NominalGDP/RealGDP
Thisisreallyameasureofinflation.
GDP
=NationalIncome
+CapitalConsumptionAllowance
+statisticaldiscrepancy(notinCFA)
CapitalConsumptionAllowance:
Theoutputthatgoestoreplacethestock
thatiswearingout.
Basicallylikeallocatingmoneytowards
depreciationofmoneymakingobjects.
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NationalIncome=
=EmployeewagesandBenefits
+
+corporateandgovernmentprofitspretax
+Interestincome
+unincorporatedbusinessowners'income
+rent
+indirectbusinesstaxessubsidies.
(taxesandsubsidiesincludedinfinal
prices)
PersonalIncome:
=NationalIncome
+Transferpaymentstohouseholds
Indirectbusinesstaxes
Corporateincometaxes
Undistributedcorporateprofits
PersonalDisposableIncome:
=Personalincomepersonaltaxes
=Aftertaxincome.
Thismoneycaneitherbesavedorspent.
FundamentalRelationship:
S=I+(GT)+(XM)
Savings=
Investment
+GovernmentExpenditures
TaxCollections
+Exports
Imports
Savingsareeitherinvested,usedtofinance
governmentdeficit,prusedtofundatrade
surplus,whenbothexist.
Whatismonetarysupply?
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Themanagementofmoney&credit
supply.
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Howdoesmonetarypolicywork?
Throughexpansionaryandcontractionary
actions.
Expansionaryrefererstotheincreasein
moneysupplywhichcanbeviewedasan
increaseininventoryforbankswhich
therebyreducesborrowingcosts(lower
interestrate).Contractionaryisjustthe
opposite.
WhatarethetoolsofFiscalPolicy?
Fiscalpolicyimplementsspendingandtax
revenue.
Expansionaryincreasesspendingand
decreasestaxes.
Contractionarydecreasesspendingand
increasestaxes.
Whatisthepolicycalledwhenabankhave
tokeepacertainamountofmoneythatit
lendsoutinthereserves?
FractionalReserve.
DescriptiveStatistics:
Describethepropertiesofalargedataset.
InferentialStatistics:
Useasamplefromapopulationtomake
probabilisticstatementsaboutthe
characteristicsofapopulation.
Population:
Acompletesetofoutcomes.
Samples:
Asubsetofoutcomesdrawnfroma
population.
NOIR:
Nominal,Ordinal,Interval,Ratio.
Nominal:
Onlynames(bird:robin,parrot,seagull)
Ordinal:
Ordered(large,mid,small).
Interval:
Gobyintervals(040,4180,81120).
Ratio:
Ratiosmakesense,absolutezero.
Parameter:
Describeacharacteristicsofapopulation.
Samplestatistic:
Describesacharacteristicofasample.
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FrequencyDistribution:
atablethatsummarizesalargedatasetby
assigningtheobservationstointervals
(Histogram).
Relativefrequencydistributions:
Atableorderedbypercentage
CumulativeFrequencyDistribution:
Showsthepercentageofobservationsless
thantheupperboundofeachinterval.
PopulationMean:
Mew
SamplesMean:
Xbar
GeometricMean(Descriptionand
formula):
Usedtocalculatecompoundgrowthrates.
Ifthereturnsareconstantovertime,
geometricmeanequalsarithmeticmean.
Thegreaterthevariabilityofreturnsover
time,themorethearithmeticmeanwill
exceedthegeometricmean.
AlsoknownasAverageAnnual
CompoundRateofReturn
PeriodicR=[(1+R1)(1+R2)...
(1+Rn)^(1/n)]1
sqroot^nof(x1x2x3*xn)
example:
2,3,4
Gmean=sqroot^3(2x3x4)
=2.88
WeightedMean:
Placesapercentageweightonsectionsofa
problem.Ameaninwhichdifferent
observationshavedifferentproportional
influenceonthemean.
X=sumofWixRi=W1R1+W2R2+....
WherebyWistheweight(%)
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HarmonicMean:
Usedtofindouttheaveragecostper
sharesovertime.
Xharmonic=N/sum(1/Xi)
T1=3,000@$20/share
T2=3,000@$25/share
Xharmonic=6,000/270shares=
$22.2/share
Arithmeticmean:
=(x1+x2+x3+...+xn)/n
Example:
=(2+3+4+5+6+7)/6
Median:
Itismidpointofapopulationofnumbers.
Ifthereisanevennumberthenyouadd2
middlenumbersanddivideby2.
Advantages:resistanttooutliers.
Mode:
Themostcommonobservation.
Example:
1,2,3,3,4,4,4,4,4,5,5,6,7,8,8,9.
Modeis4becauseitappearedthemost.
Therecanbemorethanonemode
(bimodal).
Quantiles:
Likefromstandardizedtests.
Example:
"Youareinthe75thpercentile."
"60%ofthedatapointsarelessthanthe
6thpercentile."
Range:
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Rangeofthedata.
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MeanabsoluteDeviation:
Averageoftheabsolutevaluesof
deviationsfromthemean.
[I(X1mean)I+I(X2mean)I+...+I(Xn
mean)I]/n
StandardDeviationandVariance:
Howspreadoutthedatais.Thebiggerthe
standarddeviation,thebiggerthedeviation
fromthemean.
Variance=sum[(Ximean)^2]/n
StdDiv=sqroot(Variance)
Example:
Mean=2
X1=2,X2=3X4=5
=[(22)^2+(32)^2+(42)^2]/3
=1.33
StdDiv=sqroot(1.33)
SampleVariance:
Sameequationasthemeanexceptyouadd
1tothen.
Variance=sumof[(Ximean)^2]/(n1)
Chebyshev'sInequality:
Specifiestheminimumpercentageof
observationsthatliewithinkstandard
deviationofthemeanappliestoany
distributionwithk>1.
Min%=1(1/k^2).
Example:
Theminimumpercentageofobeservations
ofanydistribtuionsof2standard
deviationsofthemean?
=1(1/2^2)=75%
Remember,thisisforANYdistribution.
CoefficientofVariance.
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Riskperunitofmeasure.Therefore,the
lowerthebetter.
CV=StdDiv/Mean
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SharpeRatio:
Excessreturnperunitofrisk.Morethe
better.
(RpRf)/StdDivP
Rf=Averageriskfreerate
Rp=MeanPortfolioRisk
StdDivP=PortfolioStandarddeviation
RandomVariable
UncertainNumber
Outcome
RealizationofrandomVariable
Event
Setofoneormoreoutcomes
Mutuallyexclusive
Cannotbothhappen.
Exhaustive
Setofeventsincludesallpossible
outcomes.
Empirical:
Basedonanalysisofdata.
Usingpastinformationtomakea
predictionaboutafutureoutcome.
Subjective:
Personalopinion.
APriori:
Basedonreasoning,notexperience.
Oddsfor:
Example:20%ofthetimeahorsewill
win.
Oddsagainst:
Example:80%ofthetimeahorsewill
lose.
Unconditional:
Probabilityofaneventthatisindependent
ofotherevents.
P(A).
Conditional:
Aprobabilitythatisdependentonother
events.
P(A|B):ProbabilityofAgivenB.
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Whataretheprobabilityrules?
Additionrule:
P(AorB)=P(A)+P(B)P(AB).
Multiplication(JointProbability):
P(AB)=P(A|B)xP(B)
Multiplication(IndependentPr.):
P(AB)=P(A)xP(B)
TotalProbabilityRule:
P(A)=P(A|B)xP(B)+P(A|Bc)xP(Bc)
P(A)=P(AIS1)xP(S1)+P(AIS2)xP(S2)
+...
Giveexampleofajointprobability:
P(Interestrateincreased)=
P(I)=0.4
P(Recessiongivenatarateincrease)=
P(R|I)
Theprobabilityofarecessionandan
increaseinrates=
P(R|I)xP(I)=0.7x0.4=28%
Giveequationforjointprobabilityevents
andexplainit.
Howisthisdifferentfrommutually
exclusive?
P(AorB)=P(A)+P(B)P(A|B).
DependentEvents:
Knowingtheoutcomeofonetellsyou
somethingabouttheprobabilityofthe
otherevent.
IndependentEvents:
Occurrenceofoneeventdoesnotinfluence
theoccurrenceoftheother.
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YoumustsubtractP(A|B)becauseifyou
lookataVenndiagramyouwillnoticethat
youhavecountedtheoverlappingsection
oftwocirclesmorethanonce.
Mutuallyexclusiveeventsdonotrequire
thefinalsubtraction.
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Covariance:
Ameasureofhowtwovariablesmove
together.
Thevaluerangefrom+infinity,to
infinity.
[(xmean)/(Sx)]
Correlation:
p(Ri,Rj)=(Cov(Ri,Rj)/(Ri)(Rj)
Smallprepresentscorrelation.
ExpectedValue:
P*x
Example:
75%chancethatyouwillreceive
$125,000.
Theexpectedvalueis93,750.
PortfolioExpectedValue:
WeightedAveragebasically.
PortfolioVarianceandStandardDeviation.
Var(Rp)=w+w+
2wwp
note:piscorrelation.Derivedfrom
correlationformula.
Factorial:
Example:
3!=3x2x1
6!=6x5x4x3x2x1
WhenshouldyouusenCrandwhen
shouldusenPr?
nCrwhenorderdoesnotmatter.
nPrwhenorderdoesmatter.
Signforsamplemean?
Samplemean=xbar
Signforpopulationmean?
Populationmean=
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Explainthegeometricmeanformula:
SimplymultiplyallthenumbersgivenX1
xX2xXn...thentaketheroottothe
powerofhowevermanyobservationsthere
are(n).
Sinceyoucannottaketherootofa
negativenumberyoumustinsteadadd
eachreturnby1thenmultiply
(X1+1)x(X2+1)x(Xn+1)...
thentaketherootofthattothepowerofn.
WhatisMADandhowisitdifferentfrom
variance?
MADusesanabsoluteandisnotsquared.
MAD=
[|X1mean|+|X2mean|+|Xnmean|]/n
Variance=
[(X1mean)^2+(X2mean)^2+(Xn
mean)^2]/n
So,basicallyinsteadofabsolutesyouhave
squares.
Standarddeviation=
Squarerootofthevariance.
What'sthedifferencebetweenthesample
varianceformulaandthevariance
formula?
the1atthedivisor.
CoefficientofVariation?
StDiv/Mean.
Notbloodyhard.
SharpeRatio?
Thesharperatioissimplythemeanreturn
fromaninvestmentminusariskfreerate
(likeatbill)alldividedbythestandard
deviationofthatinvestment.
Theinvestmentcanbeaportfolio.
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Kurtosis?
Leptokurtic?
Platykurtic?
Mesokurtic?
Kurtosisisameasureofthepeeklikeqin
afrequencyfilter.
SampleSkewness?
Howskewedthesampleis.
(1/n)[(X)^3/(^3)]
SampleKurtosis?
Sameassampleskewnessbutreplacethe
3swith4s.
HowtodetermineiftheIRRisacceptable
foraproject?
Itishigherthanthegivendiscountrate.
HoldingPeriodYield:
Theactualreturnaninvestorwillreceiveif
themoneymarketinstrumentishelduntil
maturity.
Leptokurtic=morepeek.
Platykurtic=lesspeek.
Mesokurtic=normalpeek.
HPY=Profit/Purchaseprice
Example:
100,000TBillboughtfor98,000.
2,000/98,000=2.041%
rMM
anannualizedHPYonthebasisof360
daysanddoesNOTincorporatetheeffects
ofcompounding.
Rmm=HPY/(#ofdaysheld/360)
EAY
anannualizedHPYonthebasisof360
daysanddoesNOTincorporatetheeffects
ofcompounding.
EAY=(1+HPY)^(365/150)1
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BondEquivalentyield
2timesthesemiannualdiscountrate.This
conventionstemsfromthefactthatyields
onU.S.bondsarequotedastwicethe
semiannualrate,becausethecoupon
interestispaidintwosemiannual
payments.
[(1+HPY)^2]1
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