Common Mistakes

It was posted by someone else on L2… but I thought it is a good list for us too… - Computing a zero-coupon bond withouth semi-annual compounding - Forgetting to double the yield after calculating a semi-annual coupon bond when they clearly ask for annual yield - Getting number of discounting periods wrong! e.g. using 5 years instead of 4 because of question regarding beginning/end of period payments - Answering the question based on variance and not standard deviation!! - Being careless about questions that already give you the market premium… so you do not need to subtract the risk free rate. - Automatically assuming a distribution is normally distributed when the questions doesn’t say that at all!! - Forgetting about certain synonymous terms. e.g. coupon rate = nominal rate. Market maker = specialist. - Not being careful about whether the question provides a sample of data or a full population of data. - Getting overvalued/undervalued confused. Over/under term refers to position of SML relative to expected return. - Thinking that if one covariance is greater than another… that this automatically means there is a stronger relationship… when in fact you need to find the correlation to compare on standardized terms. - Forgetting that you must pay tax on implicit interest on a zero-coupon bond. (bit more specific, but important). - FAILING TO RECOGNIZE THAT SOME QUESTIONS THAT APPEAR TO REQUIRE COMPLEX MATH CAN BE SOLVED LOGICALLY IN 2 SECONDS. e.g… remember than the realized rate of return must fall between the YTM and the Reinvestment Rate. - Forgetting that in an FRA, the long position wants interest rates to rise! - Forgetting that swap payments are paid in arrears… i.e. you use the rate from the beginning of the period, not the end. - Equity margin = borrowing. Future margin = posting cash. - CFA considers anything related to real-estate to be real estate investing… e.g. MBS/CMOs - Market value of real estate does not equal investment value of real estate. Investment value with factor in user specific details such as plans for use and individual tax rates. - The cost of failure of a venture capital project is not 0. You still have all those costs to date to deal with! - Economic depreciation and accounting depreciation are VERY different. Economic deprecation is about value. Accounting depreciation is about allocation. - Duties to employers go out the window if you are protecting clients/capital markets. - Non-renewable resources have elastic supply (this still feels counter intuitive). - Land is not depreciated. - Do not confused the effects of capitalizing costs with capitalized leases! - Working capital is higher under an operating lease. In a capital lease, current liability will increase by the current portion of the lease obligation without an increase in current assets. - Market risk = systematic risk = non-diversifiable risk = risk you are compensated for. - Sinking fund provision is an OBLIGATION not a right to pay-down debt. - If OAS < z-volatility spread, then the option has a value to the issuer and it is a call. - The tax expense less DTL = Tax payable less DTA - Under GIPs: definition of firm asset should include all fee paying and non fee paying, discretionary and non-discretionary accounts. - Under GIPs: composite must include all fee-paying discretionary accounts. non-fee paying can be added if disclosed. non-discretionary cannot be added. - Fed primarily uses open market operations as their primary tool to obtain price stability as their primary goal. - Efficient frontier plots return v stddev. CML plots against total risk. CML plots against systematic risk measured by beta. - Beta is covariance of asset with market divided by market variance. This is NOT THE CORRELATION OF AS ASSET WITH THE MARKET. - Components of risk are CLEF-B. Country, liquidity, exchange rate, financial, and business. - TIPs have PRINCIPAL AND NOT COUPON that change with inflation. - Don’t screw up Dividend Payout Ratio and Retention Ratio. - Prices are quoted clean and settled dirty. - Performance results do not need to be audited or verified. - McCullum = Monetarist (new). Taylor = Keynesian (new) - Volatility always increases the value of an option. Whether or not it increase the value of a bond depends on whether the option benefits the issuer or the holder. - Dollar duration is calculated off current market price, not PAR. - When in doubt, use market prices and not book prices! - Frictional and structural unemployment are part of life. It’s cyclical unemployment that causes moves with the business cycle. - Wealth effect is not the same as income effect. Wealth effect argues that inflation will cause increased savings so people regain their original level of true buying power. Income effect argues people work less the more $$ they have. - In long run, increasing money supply will just increase prices all else equal. - Unanticipated inflation causes inefficient/poor decisions regarding wage rate and borrowing/lending decisions. Anticipated inflation also leads to mkt inefficiency as people waste time focusing on how to circumvent inflation, make fewer investments, etc. - Anticipated inflation simply looks like a movement up the LAS curve… real gdp stays in line with potential gdp. Unanticipated inflation mirrors the patters of demand pull inflation. - Book value of debt reported based on market rate at time of issuance… which can be very different over the life of the debt. - Receivables sales when a portion of risk is retained by seller is effectively a collateralized loan. - An arbitrage opportunity with abnormal return may still not be a positive return. - GIPS Standards: F.lawed I.nputs C.ause D.oomed P.erformance Fundamentals of Compliance Input Data Calculation Composites Disclosure Performance (… and then Real Estate and Private Equity) - Industry Cycle: A.void M.y S.tupid D.eficiency Pioneering Growth Acceleration Mature Growth Stabalization Deceleration

Good one.

Thanks kurm , very good tips to remember and reiterate again and again

Why was it posted by someone in L2? Is there a L3 list?

Isn’t most of this related to the L2 exam and has nothing to do with L3??