LEVEL 1 CFA
EDUCATION QUICKSHEET
QUANTITATIVE MARKETS
TIME VALUE OF MONEY Trimmed mean (x%): Exclude highest and
Future Value (FV): amount to which lowest x/2 percent of observations.
investment grows after one or more Winsorized mean (x%): Substitute values
compounding per periods. for highest and lowest x/2 percent of
Future Value: FV= PV(1+I/Y)^{N} observations.
Present Value (PV): current value of VARIANCE AND STANDARD DEVIATION
some future cash flow Variance: average of squared deviations
PV- FV/(1+I/Y)^{N} from mean.
Annuities: series of equal cash flows Sample variance=
that occur at evenly spaced intervals
over time. Standard deviation: square root of
Ordinary annuity: cash flow at end-of- variance.
time period. TARGETED DOWNSIDE DEVIATION
Perpetuities: annuities with infinite
lives.
PV_{perpetuity}= PMT/(discount rate).
REQUIRED RATE OF RETURN HOLDING PERIOD RETURN (HPR)
Components:
1. Real risk-free rate (RFR).
COEFFICIENT OF VARIATION
2. Expected inflation rate premium (IP).
Coefficient o f variation (CV): expresses
3. Risk Premium.
Rreal how much dispersion exists relative to
E(R)= (1+RF )(1+1P)(1+RP)-1
mean of a distribution; allows for direct
Approximation formula for nominal required
comparison of dispersion across different
rate:
data sets. CV is
E(R) RFR+IP+RP
calculated by dividing standard deviation
Means
of a distribution by the mean or expected
Arithmetic mean: sum of all observation
value of the distribution:
values in sample/population, divided by # of
observations.
Geometric mean: used when calculating ROY’S SAFETY-FIRST RATION
investment returns over multiple periods or
to measure compound growth rates.
EXPECTED RETURN/STANDARD DEVIATION
Geometric mean return:
Expected Return-
Harmonic mean=
CENTRAL LIMIT THEOREM
EXPECTED STANDARD DEVIATION
Central limit theorem: when selecting
Probabilistic variation-
simple random samples of size n from
population with mean μ and finite variance
Standard deviation: take square root of σ², the sampling distribuition of sample mean
variance. approaches normal probability distribuition
CORRELATION AND COVARIANCE with mean μ and variance equal to σ²/n as
Correlation: Covariance divided by product of the sample size becomes large.
the two standard deviations.
STANDARD ERROR
Standard error of the sample mean is the
Expected return, variance of 2-stock portfolio: standard deviation of distribuition of the
sample means.
known population variance:
NORMAL DISTRIBUTIONS
Normal distribuition is completely described unknown population variance:
by its mean and variance. CONFIDENCE INTERVALS
68% of observations fall within ± Iσ . Confidence interval: gives range of values
90% fall within ± 1.65σ. the mean value will be between, with a given
95% fall within ± 1.96σ. probability (say 90% or 95%). With known
99% fall within ± 2.58σ. variance, formula for a confidence interval
COMPUTING Z- SCORES is:
Z-score: “standardizes” observation from
normal distribution; represents # of standard = 1.645 for 90% confidence intervals
deviations a given observation is from (significance level 10%, 5% in each tail)
population mean. = 1.960 for 95% confidence intervals
(significance level 5%, 2.5% in each tail)
= 2.575 for 99% confidence intervals
BINOMIAL MODELS
(significance level 1%, 0.5% in each tail)
Binomial distribution: assumes a variable can
take one of two values (success/failure) or, in NULL AND ALTERNATIVE HYPOTHESIS
the case of a stock, movements (up/down). A Null Hypothesis(H ): hypothesis that
binomial model can describe changes in the contains the equal sign (=,≥, ≤).
value of an asset or portfolio; it can be used to Alternative Hypothesis(H ): concluded if
compute its expected value over several there is sufficient evidence to reject the null
periods. hypothesis.
SAMPLING DISTRIBUITION DIFFERENCE BETWEEN ONE- AND TWO-
Sampling distribution: probability distribution TAILED TESTS
of all possible sample statistics computed One-tailed test: tests whether value is
from a set of equal-size samples randomly greater than or less than a given number.
drawn from the same population. The Two-tailed test: ctests whether value is
sampling distribution of the mean is the equal to a given number.
distribution of estimates of the
mean.
TYPE I AND TYPE II ERRORS
Type I error: rejection of null hypothesis when
it is actually true.
Type II error: failure to reject null hypothesis
when it is actually false.
HYPOTHESIS TEST:
c2
c2
ECONOMICS
ELASTICITY MARKET STRUCTURES
Own price elasticity= Monopoly: Single firm with significant pricing
power; high barriers to entry; advertising
If absolute value> 1, demand is elastic. used to compete with substitute products. In
If absolute value< 1, demand is inelastic. all market structures, profit is maximized at
On a straight line, demand curve, total the
revenue is maximised where price elasticity= - output quantity for which marginal revenue =
1. marginal
cost.
Income elasticity= GROSS DOMESTIC PRODUCT
Real GDP = consumption spending +
If positive, the good is a normal good, investment + government spending + net
If negative, the good is an inferior good. exports.
SAVINGS, INVESTMENT, FISCAL BALANCE,
Cross price elasticity=
AND TRADE BALANCE
If positive, related good is substitute, Fiscal budget deficit (G - T) = excess of saving
If negative, related good is a complement. over domestic investment (S - |) - trade
balance (X - M)
BREAKEVEN AND SHUTDOWN
EQUATION OF EXCHANGE
Breakeven: total revenue= total cost.
MV = PY,
Operate in short run if total revenue is greater
where M = real money supply,
that total variable cost but less than total
V = velocity of money in transactions,
cost. Shut down in short run if total revenue is
P = price level, and Y = real GDP
less than variable cost.
BUSINESS CYCLE PHASES
MARKET STRUCTURES
Perfect Competition: Many firms with no Expansion; peak; contraction; trough.
pricing power; very low or no barriers to entry; ECONOMIC INDICATORS
homogenous product. Leading:Turning points occur ahead of peaks
Monopolistic Competition: Many firms; some and troughs (stock prices, initial
pricing power; low barriers to entry; unemployment claims, manufacturing new
diffrentiated products;large advertising orders)
expense. Coincident: Turning points coincide with
Oligopoly: Few firms that may have significant peaks and troughs (nonfarm payrolls,
pricing power; high barriers to entry; products personal income, manufacturing sales)
may be homogeneous or differentiated. Lagging: Turning points follow peaks and
troughs (average duration of unemployment,
inventory/ sales ratio, prime rate)
