## Wednesday 29 February 2012

### News Pick - Goldman Mirrors JPMorgan Mirrors Goldman on Swap Exposure to European Debt

Derivatives are complex financial instruments. Level I contains a brief overview but Level II contains a lot more on this interesting but complex topic. The following article written in Bloomberg today uses several of the key concepts related to this particular area which have been explained well in the curriculum. Level I and Level II candidates would find an application of their knowledge through reading this article.

### Solving FCFE Questions - A technical point to ponder

FCFE from NI is calculated as follows

FCFE = NI + NCC + Net Borrowings - WCInv - FCInv

As you can see in the above formula there is no link of tax as Interest rate net of tax is added back to the FCFF but while calculating FCFE it is not included as FCFE are free cash flows available to equity investors. I encountered a question in which it was stated that the tax rate of investor is 35% and for me it was strange, I immediately thought that FCFE has nothing to do with tax so the question contains a trick. I solved it and to my surprise the answer was wrong. Later on reviewing the question I came to know that if the question states to use a different tax rate then in spite of starting from NI we should use Profit before tax (EBT) and then tax it to arrive at NI in order to calculate the FCFE. Later I thought it made sense but while I was solving the question I ignored this point and concluded incorrectly.

Moreover the WCInv and FCInv are two numbers which mostly require lengthy calculation as compared to the other values in calculating FCFE or FCFF. After solving a lot of questions I have concluded that when the question asks about calculating FCFE or FCFF then the first calculation should be done of WCInv and FCInv as other numbers are pretty straight forward and can be plugged into the calculator but these two, since require some calculations, if gathered early then arriving at FCFE and FCFF becomes easy.

I hope these will help you out. Equity is not only an area with high weight-age but it is also a high scoring area. I think ample practice can help in getting above 70 in this area and impacting the overall result positively.

## Tuesday 28 February 2012

### News Pick - Roche extends hostile offer for Illumina

When I was reading Mergers & Acquisition in Corporate Finance, I came to know about Roche attempting to acquire Illumina. Initially I was not able to understand the whole picture as I was unaware of the concepts related to M&A. Once I was done with the reading and then I dipped myself into this, I was able to see what exactly was going on. The following article is a development in which Roche has extended its tender offer.

### Impairments - Level II FRA (Financial Assets)

A financial asset (debt or equity) is impaired when:
Carrying Amount of the asset is permanently > Recoverable Amount

Under IFRS:
· At each reporting period, Held-to-maturity and Available-for-Sale financial assets are assessed for impairment.
· Held-for-Trading securities and investments classified at fair value through profit or loss are not assessed for impairment because they are reported at fair value and any impairment loss is already recognized in Income Statement immediately.

Reversal of Impairment Loss:
· Impairment losses on Available for Sale Equity Securities cannot be reversed.
· Impairment losses on Available for Sale Debt Securities can be reversed.
· When impairment loss is reversed, the amount of reversal is recognized in Income Statement.

Under U.S. GAAP:
Available for sale and held-to-maturity securities are considered impaired only when the decline in their value is other than temporary.

· When a decline in value is other than temporary, the carrying value of security is written down to its fair value and it becomes a new cost basis.
· The amount of the write-down is treated as Realized loss and reported on the Income Statement.

Reversal of Impairment Loss:
· Impairment losses on Available for Sale Equity and/or Debt Securities cannot be reversed.
· Subsequent increases in fair value (and decreases if other than temporary) can be treated as unrealized gains or losses and included in Other Comprehensive Income.

## Monday 27 February 2012

 Year Capital Lease (in million dollars) Operating Lease (in million dollars) 2012 322 180 2013 228 130 2014 109 113 2015 17 102 2016 11 95 Thereafter 130 325 Total 817 945

### News Pick - Sovereign, Corporate Bond Risk Rises, Credit-Default Swaps Show

How Credit Default Swaps operate and the nature of such instruments a long with their relation with the Corporate Bond Risk have been explained in the CFA Level II Curriculum, Fixed Income. If you've covered that area and you are aware of the relationship between Corporate Bond Risk and Credit Default Swap then this  story of Bloomberg will make sense to you.

## Sunday 26 February 2012

### Footnotes in the Curriculum

All the candidates who have appeared in the Level II exam I have come across, so far, say one thing in common. There is nothing which you can take risk of leaving assuming it wont be tested! Does the same go for footnotes provided in the CFA Curriculum? I don't exactly know its answer but normally when I am in a flow and reading any topic from the curriculum, unfortunately I skip the footnotes. May be their font size is so small or the subscript appears 'unimportant' while reading or may be it act as an obstacle in the flow which makes me feel uncomfortable with going through the footnotes while reading from the curriculum. Moments earlier I was going through Reading 40 from my Finquiz curriculum notes. When I reached the heading 5, I saw the formula of Excess Cash = Total Cash Available - (total assets of firm x (median level of industry cash / median level of industry total assets)). The curriculum was also open in front of me and my eyes rolled to heading 5 and the formula wasn't written there. To my surprise I started reading from the curriculum and was rather worried to figure out that the formula was explained in the footnote! It took me away as I have covered more than 50% of the syllabus and consistently I had been ignoring the footnotes whenever I referred to the curriculum. Thanks to my notes which contain all the important information available in the footnotes so that one may not skip it. The relevance and importance of information provided in the footnote with exams perspective is unknown to me but considering how crucial is the exam, I just can't take the risk of missing anything...

## Saturday 25 February 2012

### Remembering the Formulae.

In Level I, I used to re-read the material in order to remember the formulas. Used mnemonics in case of Ethics and other areas so that I could remember important key terms and other relations. This thing is not working that well in Level II probably due to immensely excessive material as compared to Level I. I heard some one saying that he used to remember the formulas by taking a snapshot of them in his mind and then recalling that picture again and again to not forget. I have tried this and it has helped me a bit but the thing which I did only once was reading, remembering and re-writing the formulae again and again to make myself comfortable with them, which proved productive. For Free Cash Flow valuations and arriving at FCFF or FCFE starting from NI, EBIDTA, EBIT, or CFO, plenty of formulae are involved which need to be remembered. I am going to try remembering them all through re-writing them. I hope it will be productive. You should also try this....

### Reclassification of Available for Sale (Debt) Securities - U.S. GAAP & IFRS

Under IFRS
Debt securities initially recognized as Available-for-Sale can be reclassified to Held-to-maturity if a change in intention or ability has occurred. When a security is reclassified:
· The fair value carrying amount of the security at the time of reclassification becomes its new amortized cost.
· Any previous gain/loss that was recognized in Other Comprehensive Income is amortized to profit and loss over the remaining life of the security using the effective interest rate method.
· Any difference between the new amortized cost of the security and its maturity value is amortized over the remaining life of the security using the effective interest rate method.
Any Financial asset can be reclassified to historical cost (when no reliable fair value measure is available).If a reliable measure of fair value becomes available, the financial assets must be reclassified to the available for sale category.
· Changes in fair value are recognized in Other Comprehensive Income (if reclassified to the available for sale category).

Under US.GAAP
i. When a security which is initially recognized as Available-for-Sale is reclassified to the held for trading category:
· The cumulative amount of gains/losses previously recognized in Other Comprehensive Income is recognized in the Income Statement on the date of transfer.
ii. When a debt security is transferred from availablefor-sale to Held-to-maturity category:
· The cumulative amount of gains/losses previously recognized in Other Comprehensive Income is amortized over the remaining life of the security.

## Friday 24 February 2012

### Problem Solving vs Auditing - An important aspect which can add value.

There is considerable difference between solving the problems and auditing them. Usually when I am looking at the examples of curriculum, after reading the statement I immediately look at the solution to check the answer and pamper myself that how simple and logical is the answer, obviously this is the way it should be done. Does that really serve my cause? The answer is clearly NO. I don't know what exactly you guys would be doing but for sure if you are doing Equity, FSA, Corporate Finance, Derivatives or any other areas which require calculations and trickiness, I believe the 'justified' behaviour would be to solve those examples and chapter end questions without referring to the answers immediately. Unless the 'brain machinery' utilizes its self on the problem and figuring out its correct answer, the purpose of learning does not serve! I did this for Derivatives especially in swaps and I am doing this on Reading 39 and 40 (at present) of Equity to make myself comfortable with the concepts. I hope it will help you out.

### News Pick - Apollo Said to Be Near Deal to Buy El Paso Oil Exploration Unit

Leveraged Buyout, Spin Off, Split Off, Takeover etc. are not only key terms but critical concepts. They have been discussed in several LOS of the CFA Level II Curriculum. A basic introduction of Leveraged Buyout (LBO) is part of the Level I curriculum but spin off, split off, takeover, friendly and hostile etc. are explained in the Level II curriculum. How these terms can be connected with the real world happenings can be experienced through this Bloomberg Story written by Cristina Alesci

## Thursday 23 February 2012

### Samsung Electronics - Equity (Extract from Financial Statements)

 Equity Jun-11 Dec-10 % Change (in thousands of U.S. dollars) Equity attributable to owners of the parent Preferred stock 110,813 110,813 0.00% Common stock 721,684 721,684 0.00% Share premium 4,084,865 4,084,865 0.00% Retained earnings 83,878,986 78,855,904 6.37% Other component of equity -4,732,798 -4,384,008 7.96% Non-controlling interests 3,691,031 3,487,183 5.85% Total Equity 87,754,581 82,876,441 5.89%

### News Pick (Bloomberg) - JPMorgan Places \$72B Bet on Homeowners

Another interesting article related to Mortgage Loans comprising plenty of terms related to Fixed Income. Candidates of Level II particularly who have covered Mortgage Backed Securities will find reading this article as a bridge of what they have been studying a long with the real world.

## Wednesday 22 February 2012

### Market Watch - Why calm in Europe will boost Apple, Home Depot

Those who are done with Level I or Level II Equity would enjoy reading this article. Since I am going through this topic, the 'pleasing factor' for me is a bit more. A lot of terminologies which we read in the curriculum are used here. This particular exercise which relates the 'real world happenings' to what that I read helps me get familiar with a lot of stuff which after some time sounds normal to me and the jargon become my routine words. I hope you'll be experiencing the same.

### Equity - Some important Learnings

Like the progress thermometer states now a days I am preparing Equity. It is a major area of Level II and multiple item sets are expected in the exam. Reading 39,40,41 are related to calculations. Topics which involve formulas and calculations, it is my shortcoming that I focus more on them and oversee the minute details which could be tested. For instance in Reading 39 the benchmarks which have been explained regarding when to use DDM, GGM, Free Cash flow models and Residual income models are very important with exams perspective. While doing practice questions today I experienced questions framed on which valuation model to use was asked. Thanks to my curriculum notes where such important points are highlighted in the form of bullet points so that I can easily remember and apply them.. What I wanted to share was that do consider the points that when an analyst should use Dividend Discount Model, when to use Gordon Growth Model, Free Cash Flow models and when to use Residual Income models etc. While reading the vignette try thinking critically on points which could help in shaping up the story. For instance if the purpose is to have minority interest in any company and valuation is required them DDM is preferred etc. This is an important thing which I learned today and I hope it will help you out.

## Tuesday 21 February 2012

### Walter J. Schloss (August 28, 1916 – February 19, 2012)

Regarded as a value investor, Walter J. Schloss and a disciple of Benjamin Graham School died of leukemia at the age of 95 this week. He was a runner in Wall Street in 1934 and did not attend college. Schloss also worked with Graham-Newman Partnership. Later he started off his own investment company and managed to earn 15.3% compound return over the course of five decades beating S&P 500's 10%. Warren Buffet called Schloss as a 'superinvestor' in 1984 during a speech at Columbia Business School. In his letter to Berkshire Hathaway shareholders in 2006 he praised Walter Schloss as one of the good guys of Wall Street. For Buffet, Schloss's streak of investment returns rejected the efficient market hypothesis.

On 10th March 1994 Walter & Edwin Schloss Associates wrote a letter titled "Factors needed to make money in the stock market". Original letter is available on scribd and can be accessed by clicking here. In his memory I am mentioning the 16 factors which Schloss highlighted.

Factors Needed to make money in the stock market
• Price is the most important factor to use in relation to value
• Try to establish the value of the company. Remember that a share of stock represents a part of a business and is not just a piece of paper.
• Use book value as a starting point to try and establish the value of the enterprise. Be sure that debt does not equal 100% of the equity. (Capital and surplus for the common stock).
• Have patience. Stocks don’t go up immediately.
• Don’t buy on tips or for a quick move. Let the professionals do that, if they can. Don’t sell on bad news.
• Don’t be afraid to be a loner but be sure that you are correct in your judgement. You can’t be 100% certain but try to look for the weaknesses in your thinking. Buy on a scale down and sell on a scale up.
• Have the courage of your convictions once you have made a decision.
• Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.
• Don’t be in too much of a hurry to sell. If the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit. Before selling try to re evaluate the company again and see where the stock sells in relation to its book value. Be aware of the level of the stock market. Are yields low and P-E ratios high. If the stock market historically high. Are people very optimistic etc?
• When buying a stock, I find it helpful to buy near the low of the past few years. A stock may go as high as 125 and then decline to 60 and you think it attractive. 3 years before the stock sold at 20 which shows that there is some vulnerability in it.
• Try to buy assets at a discount than to buy earnings. Earning can change dramatically in a short time. Usually assets change slowly. One has to know much more about a company if one buys earnings.
• Listen to suggestions from people you respect. This doesn’t mean you have to accept them. Remember it’s your money and generally it is harder to keep money than to make it. Once you lose a lot of money, it is hard to make it back.
• Try not to let your emotions affect your judgement. Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks.
• Remember the work compounding. For example, if you can make 12% a year and reinvest the money back, you will double your money in 6 years, taxes excluded. Remember the rule of 72. Your rate of return into 72 will tell you the number of years to double your money.
• Prefer stock over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.
• Be careful of leverage. It can go against you."

### Wall Street Journal - Italian Bond Yields At Lowest Since September After Greek Deal

The bonds are yielding at their lowest which means that the prices rose. Low yield implies the risks associated with bonds have reduced. The article in Wall Street Journal unfolds the story. The relationship between bond price and yields, risks associated with bonds have been discussed in Level I. Regarding default risk, the case with Greece, has been discussed in detail in Level II Fixed Income.