Got the ticket today...

The examination ticket is available on the CIE website. I got it downloaded today and matched the details with my passport. The ticket is different than it was in the previous year. It reminds me of the days last year when I was preparing for Level I. As compared to that I can certainly experience great deal of addition to my knowledge and so does the exam pressure. This is the moment for me not to bother about result as luck does matter in Level II. Can I fight with that? Well certainly no but will it give me a fair play? I believe yes and I need to give tough time to it. Almost done with first reading except 3,4 LOS. Aiming to revise the whole syllabus at least once. FinQuiz curriculum notes are quite helpful in that regard... 370 pages summing up the whole curriculum and missing nothing. Will be appearing in the mocks after 20th May and share the results. Fingers crossed for Level II exam but the fear is failure is no more. Those who cannot face failure have no right to win! I need to put in my best efforts because they are in my control. What if I fail? Will appear in the Level II exam again and will keep on appearing every year unless I pass. Will failure be another opportunity to learn? Certainly that would be. Am I thinking about the exam result? Nah... will start thinking over it after 3rd June.. At present the full focus is on revising the stuff and making myself better in it.

Good Luck for the Exam.

Converting from LIFO to FIFO

I saw this question posted by someone on a forum.

Due to declining prices, Steffen Inc. has a LIFO reserve of –$20. Its income tax rate is 35%. If an analyst is converting Steffen’s financial statements to a FIFO basis, which of the following adjustments is most likely required?

A)

Increase assets by $20.

B)

Increase shareholders’ equity by $13.

C)

Decrease liabilities by $7.

The interesting thing to note in this question was the negative LIFO Reserve. So far I have been dealing with questions which have positive LIFO Reserves through the ending was less in many instances but the Net value to be negative... I hadn't seen it before. 

When Financial Statements are converted from LIFO basis to FIFO basis there is an imbalance which occurs in the Balance Sheet Equation. As FIFO Inventory = LIFO Inventory + LIFO Reserves, changing the cost flow basis increases the inventory but in this case the LIFO Reserve is negative, the inventory would decrease so A is incorrect.

Since FIFO COGS are less (Under inflationary environment) Reducing them results in higher net profit margins after tax adjustments and so does Retained Earnings. Therefore they increase by the amount = LIFO Reserves x (1-tax rate). In this it is clearly written that the environment is deflationary so converting to FIFO basis the Retained Earnings will increase by -20 x (1-35%) = -13$, effectively decreasing, so B is Incorrect.

Apparently the answer should be C as both A & B have been concluded as wrong. To balance the accounting equation, Liabilities must decrease by amount 20 x tax rate = 7$ as Assets are decreasing by $20, Equity is decreasing by $13 therefore Liabilities must decrease by $7 so C is Correct.

Okay but which liability is gonna decrease? Now this is interesting. I think that deferred tax liabilities accounts for the differences between tax payable and the tax actually paid. If tax payable is higher under some transaction taking place today but not paid then a liability is recorded which will be settled in the future. We know that under LIFO companies report less taxes as LIFO COGS are higher. Changing the cost flow basis to FIFO results in higher tax payable amount and if it is not paid in cash then a liability, deferred tax, is created. However in this case as the LIFO Reserves have become negative, the Deferred tax liability will decrease. The option that any other asset will increase is not provided and apparently the liability which should reduce seems to be Deferred Tax. 

Revision Plan

Initially I had thought of not making a detailed coordinated plan and just start of with areas and decide about the next one after completing the previous one. Intention behind choosing this path was not to put in a lot of energy in planning rather focusing more on actually revising the course. And it went disastrous! Anyhow I have now divided the subjects into two categories. 1. Those which require hard work i.e. immense effort and 2. Those which have either already been practised by my several times like Equity, Fixed Income and Derivatives, or are not more in weight-age like Quantitative Methods. I am simultaneously taking both these categories so that I may not sound less productive by going through two areas simultaneously which are easy or do not freak out by taking two areas which are hard for me. For light areas I am giving 5 days per area and for hard ones I am covering them in 8 days each. Effectively I will be able to go through all the areas by 20th May once and after that in 10 days I will try my best to practice by giving 3 mocks and chapter end questions and revising my weak points. A similar kind of strategy worked for me in Level I and my fingers are crossed this time. Do share if you are working with any strategy of revising and covering the whole stuff.

Good Luck for your exam!

Poll Result - No. of Mocks for Level II

Hi. Below is the graphical representation of the poll result which I posted over my bog. 34 candidates have taken part in this poll. Although most of the participants have said that at least 3 mocks are necessary. Based on these results I have decided to appear in 3 mocks.

Investment Classification - USGAAP vs IFRS

Knowledge Application - SPE

I just completed reading 22 (Revision) SPE are discussed in last section of this topic. I found this related news item to it.

Read the news item: http://www.independent.ie/business/irish/government-fights-to-keep-nama-debt-off-its-books-3078860.html

Reading 20,21 FRA Impact on several Ratios

Impacts on profitability, liquidity, activity and solvency ratios of finance lease, operating lease, inventory write downs, choice of inventory valuation etc. can be tested highly. While doing the chapter end questions of Reading 20 and 21 (Study Session 5) I encountered several questions framed on ratios. I was having a trouble in solving them but when I sketched in my mind the impact of any accounting choice to the numerator and denominator of the ratios and then tried to figure out the effects, my answers started getting correct. Another important aspect in that regard was the effect of adding the same amount to the numerator and to the denominator. Suppose a company has off balance sheet lease arrangements (operating lease) if it had classified it as finance lease the liabilities to total assets ratio would be higher or lower? This was interesting as the same amount will be added to the asset base and a liability equal to the PV of lease obligation would be created. The numerator and the denominator of the liabilities to total assets ratio will increase with the same amount. This will result in decreasing the ratio not increasing it. The answer therefore is lower. Such concepts, which are present in the chapter end questions, can be tested in the exam. I have made myself comfortable with them today and I hope when I'll be encountered with any question like this, I would be able to connect it with what I experienced today.

Revision - FRA

FRA is a major area in Level II. I have started to review it from yesterday and I have planned to cover 2 readings a day. This is the time for me to go through the chapter end questions. I am not reading from the CFAI text rather using my Curriculum Notes (FinQuiz) to go through the stuff. Revision has become pretty easy as only a few pages to read with all important points written in bullets and chapter end questions to test myself up. I will be giving the whole week to FRA and will create a test on Sunday and solve it to check my standings. Study Session 6 is tough and I am going to start it from tomorrow. Planning to give 1 day to each reading and complete it in 3 days. A lot of stuff to retain in this study session but this is the time to do it. In May I would be revising it for the mock but will be extensively practising it now to make myself comfortable with it. After this study area I would be comfortable with Equity and FRA. Three more study areas to go namely Ethics, Economics and Corporate Finance. I believe scoring above 70 in these will have significant impact on the final result. Fixed Income and Derivatives can also aid in passing the exam after these. I will be revising both of them in first week of May. Do share your plans for these months.

Good Luck

Real Options in Projects (Corporate Finance)

My family is in the business of production. They have installed computerized embroidery machines. The business model is such that buyers, who are whole sellers of female embroidery suits, contact the factory and place order. They purchase the dyed base cloth from the market and along with the design send those to the factory. My family charge them according to no. of stitches and once the embroidery is done the lot is returned back and the buyer is charged off with the amount of work (embroidery) done on the cloth sent.

My Uncle also deals in selling the machines. One typical machine costs around 2.5 million PKR. The origin is China and he has developed significant credentials in this field. I was observing him while dealing with a potential customer. He was informing him that a 42 head stitch sequin machine is worth 2.9 million because it gives the option of being operated only on thread (without sequin - a start like element placed on clothes) through sequin and also act as a 21 head machine. Since the market trends keep on changing, the sequin is not in fashion through out the year but in some months, installing this machine provides the option of managing both the seasons and with high volumes of production and less. While listening to what he was saying, my mind immediately went to the topic of Real Options in Corporate Finance. I was wondering about the flexibility option of the machine which apparently worth 4 hundred thousand. While calculating the NPV of the project incorporating the effect and value of this real option will generate a more realistic result and can aid in analysis. The beauty is the connection which developed immediately in my mind regarding the topic and I was able to recall and connect what I had learnt with something happening in front of my eyes. Believe me my uncle and the buyer would have no idea of the analytical aspects connected with this option. For them it would have been something which must happen like this but at that time, my mind had started processing about calculating the NPV of that project and incorporating the value and cost of this option. I was wondering that is how this course develops skills and knowledge. Its not necessary that we need to be at the right place to apply this knowledge but in business transactions happening in front of use, this knowledge is pretty helpful!

Direct Quote & Indirect Quote - Economics

An easy way to remember direct quote and indirect quote is remembering this notation

FC:DC = xxDC

This one is a direct quote for a domestic investor in foreign currency

For example
DC = AUD
FC = USD
USD:AUD = 1.003 AUD

This is a direct quote for an AUD investor in USD

DC:FC = xxFC

This one is an indirect quote for a domestic investor in foreign currency.

DC = AUD
FC = USD
AUD:USD = 0.997 USD

This one is an indirect quote for an Australian Investor in USD

Note: Direct & Indirect quotes are reciprocal of each other.
Direct = 1.003
Indirect = 1/1.003 = 0.997

Cross Over Rates - Using Algebraic Expressions to make the calculation easier.

I figured out that using algebraic expression to calculate cross over rate makes it easier.

For instance you want to calculate AUD:PKR and you have US:AUD and US:PKR the expression would be

AUD:PKR = AUD:US x US:PK

It can also be written as

AUD/PKR = AUD/US x US/PKR

We have been given with US:AUD and we require AUD:US so inverse that and then multiply it with US:PKR to get AUD:PKR

It becomes quite simple and easy to remember using the algebraic expressions. Easy to remember and easy to apply!

Bloomberg News Item - Top Junk Pummels Treasuries for Safest Profits: Riskless Return

A lot of key terms related to Fixed Income of Level II, credit ratings, junk bonds, option adjusted spread etc. are required to be understood before reading this news pick. The curriculum has enabled me to read and understand these news items just because of the relevance and matching of the concepts with what that has been written there in the text with what that is happening 24/7 in the amazing world of finance.

Read the news: http://www.bloomberg.com/news/2012-03-21/top-junk-pummels-treasuries-for-safest-profits-riskless-return.html

Credit Enhancement - A distinctive feature of Asset Backed Securities (External Enhancements)

Credit enhancement occurs when a security’s credit quality is raised above that of the sponsor’s unsecured debt or that of the underlying asset pool. Credit enhancement levels are determined relative to a specific rating desired by the issuer for a security by each rating agency. There are two general types of credit enhancement
structures:

1. External Credit Enhancements:

a) Third-Party or Parental Guarantees (Bond issuance): A third party e.g. an insurer, or the parent company
of the seller/servicer promises to cover losses that may arise on non-performance of the collateral up to a stated maximum dollar amount. Unlike municipal bond insurance which guarantees the entire principal amount, the guarantee in a securitization is only for a percentage of the par value at origination. For example, a $100 million securitization may have only $5 million guaranteed by the monoline insurer.

b) Letter of Credit (LOC): In this case a financial institution, typically a bank, is paid a fee to reimburse the trust for any losses actually incurred, up to the required credit-enhancement amount.

c) Corporate guarantees: Usually provided by the issuer of the ABS or its parent company.

Letter of credit from a bank and a guarantee by the seller of the assets are two less common forms of credit
enhancement because of the “weak link approach” employed by rating agencies. According to this approach, if an issuer seeks a triple A rating for one of the bond classes in the structure, it would be unlikely to be awarded such a rating if the external credit enhancer has a rating that is less than triple A. External credit enhancement exposes the investor to “third-party risk,” where the ABS rating will be dependent on the creditworthiness of the institution.

News Pick - Low listings prompt property market stall warning

There are several LOS in CFA Level II Curriculum which relate to the content of this news pick. Primarily the news item is related to home loans which have been discussed in level II fixed income. Going through these news picks and articles enable me to interlink the theoretical concepts with real life examples thus enabling me retain the topics through these news items. It is not only about the understanding of the topics but also the 'finance vocabulary' which builds through the CFAI Text books, helps a lot in reading these articles. It is encouraging when things start to make sense!

Read the news: http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10796416

(News Pick) The Economic Times - Financial reporting system undergoing a change in US

Financial Reporting & Analysis is one of the major section of Level II. I was looking over this news item of Economic Times.

Read the news: http://economictimes.indiatimes.com/features/investors-guide/financial-reporting-system-undergoing-a-change-in-us/articleshow/12492739.cms