Monday, December 30, 2013

Innovation is king, copycats be damned

Alright the title is a bit harsh, but it's true. Regulators and payers have had it up to here with incremental advances. I fully understand that what seems like "me too" drugs aren't as devious and underhanded as they seem. Innovation really pays big for companies like Biogen Idec (NASDAQ: BIIB). Here's a snip:
The financial risks associated with getting a drug out of the lab and into the market are astronomical. It's easy to understand the tendency for the Drug Majors to play it safe and funnel their limited resources toward programs likely to win approval. Sadly, with the string of big expiring patents over the past few years, this has been happening far too often.
Consider sodium glucose co-transporter 2 (SGLT2) inhibitors for treatment of type 2 diabetes. There are at least half-a-dozen late stage programs all trying to fit in this space. During the latest annual meeting of the American Diabetes Association,Boehringer Ingelheim clinical development director, Dr. Maximilian von Eynatten, said "I think probably from a clinical perspective, there is no big difference between the SGLT2 compounds so far, at least from everything we have seen." His employer is partnered with Eli Lilly to develop these compounds, and even he admits the program isn't accomplishing anything significant.
Government and private payers are getting fed up with the lack of innovation coming out of Big Pharma. During Q3 2013, Express Scripts Holding Company implemented a far more aggressive design of its National Preferred Formulary. Government payers in the Eurozone have long been austere, but are increasingly flexing their muscles. Demanding heavy discounts for non-breakthrough therapies in return for reimbursement approvals is on the rise.

Read the whole piece only at The Motley Fool.

Saturday, December 28, 2013

A Heartwarming Tale of a Medtech Company Turning Itself Around

Here's a Boston Scientific article recently published at the Motley Fool. Read it here.
The past couple of years have been tough on medtech companies. Few of the industry leaders that derive their revenue solely from medtech sales have had a rougher time than Boston Scientific Corporation (NYSE: BSX) . While industry stalwart Medtronic, Inc. (NYSE: MDT) has posted steady gains, Boston Scientific has been losing ground over the past 5 years.
Losing heart
The cardiovascular segment remains the company's largest, but sales during the third quarter of 2013 were a paltry $667 million; that would be $2.67 billion on an annualized basis. In 2007, that figure was $6.56 billion. That is a slight improvement over 2012's dismal performance, however, when the company's share price nearly fell through the $5 dollar range.
The intensely competitive fields, cardiac rhythm management (CRM) and interventional cardiology, still represent the majority of the company's sales. The bleeding has stopped from the CRM segment, but growth is currently flat. Bringing those numbers up will be a difficult task going forward. Over the past several years, Medtronic also had difficulty achieving growth in its CRM segment. Its sales in the most recent quarter were up 4% year over year at $1.27 billion, however. Odds are that Boston Scientific will continue to operate in its shadow.
Pounce on the weak
Although Boston Scientific might not be stealing Medtronic's piece of the CRM market, St. Jude Medical Inc.'s (NYSE: STJ) grip has been slipping.
Read the full article only at the Motley Fool.

Tuesday, December 24, 2013

A Spiteful New Twist In The Questcor Drama

Here's a perfect example of how the greed of a few, can cast dark clouds over an entire industry. The Questcor (QCOR) drama so far has been well covered except for a fun, unexpected twist at the end.

Illegal? Not necessarily. Morally reprehensible? Definitely.
I'll spare you a rehash of every sordid detail, but here's the tale in a nutshell. Questcor found a way to increase the price of Highly Purified Acthar Gel from $50 to $28,000, and get us all to pay for it.

The best part isn't the aggressive marketing, but the charity. Questcor has been donating heavily to the Chronic Disease Fund (CDF), a charity that helps patients meet the co-pay amount. In effect, Questcor has found a way to buy dollars with nickels. If you're wondering how many nickels, here's a quote from the company's latest 10-Q: "For the three and nine months ended September 30, 2013, we contributed approximately $3.1 million and $9.0 million, respectively, to the Chronic Disease Fund in support of its co-pay assistance programs."

A deeper discussion of the Questcor/CDF shenanigans can be found here, and more recently here.

The Drug
Adrenocorticotropic hormone (ACTH) is typically secreted by the anterior pituitary gland in response to biological stress. It is involved in a number of processes, but mainly its job is to signal the adrenal gland to release corticosteroids.

One reason for Acthar Gel's success is the wide variety of physiological processes that involve corticosteroids. Currently, Questcor's H.P. Acthar Gel is approved by the FDA for the treatment of 19 indications. I won't list them all, but the most popular include infantile spasms, multiple sclerosis, and rheumatology related conditions.

If you can't beat 'em, buy 'em.
Despite an admitted lack of contract manufacturing experience, Questcor acquired Biovectra, a contract manufacturer in January 2013. The CMO is Questcor's manufacturing partner for the API in H. P. Acthar Gel. Although this acquisition was arguably a smart vertical integration move, its next was a bit shady.

Tetracosactide (Synacthen) is a synthetic analogue of ACTH marketed in Europe by Novartis (NVS). Prices and overall volume requirements vary, but in the EU Novartis generally charges less than 1% the cost of H.P. Acthar Gel in the US.

In June 2013, Questcor acquired a license to develop, market, manufacture, distribute, sell and commercialize Synacthen and Synacthen Depot for all uses in humans in the US. Questcor paid Novartis $60 million upfront, and three years of annual cash payments of $25 million. The annual payments will continue until Questcor wins FDA approval for the drug, or the total reaches $300.

I smell something. Do you smell something?
Questcor wasn't the only bidder for Synacthen. New York troublemaker Retrophin (RTRX), a biotech currently traded over-the-counter, offered Novartis $40 million and a 20% royalty on US sales. Less than a year ago, leading up to the Retrophin bid, Questcor management was fairly dismissive of Synacthen, citing the negative effects of benzyl alcohol present in the formula. Now, it's spending hundreds of millions developing it for sale in the US.

Retrophin's new ticker symbol (NASDAQ: SPITE)?
Retrophin isn't finished with its assault on Questcor. It has been making some noise lately about filing an initial public offering to raise around $40 million. Apparently, it intends to use that capital to continue annoying Questcor. On Monday, December 16, Retrophin withdrew an offer for Transcept Pharmaceuticals (TSPT). The following day it announced its intentions for the development of RE-034, another synthetic ACTH analog similar to Synacthen. The only difference, as far as I can tell, is that RE-034 lacks benzyl alcohol.

Wait. It might get even better.
Retrophin was founded and run by former biotechnology hedge fund manager Martin Shkreli. The former parent MSMB Capital Management LLC, spun Retrophin off in 2009.
There has been rumor, I repeat rumor, that MSMB Capital admits to shorting Questcor in its newsletter. Trouble is I can’t find any newsletter. MSMB has allowed its website domain to expire and I can’t find any insider activity relating MSMB to Questcor. Speculator @HedgeyeAC claims it was in "a private letter to clients."

Sunday, December 22, 2013

Baxter International Is An Undervalued Dividend Growth Machine

Best of all it appears severely undervalued for a firm this size. It seems the short term minded market isn't at all concerned with long term growth. Here's a snip, read the entire report only at Seeking Alpha here.
For a company expecting long-term earnings to grow at 8% to 10%, Baxter International (BAX) is looking mighty cheap today. Using the low end of the company's topline growth projections with recent operating margins improving at 25 basis points annually gives the company a fair value north of $85, using a DCF model. Even after the recent pop from winning both an FDA approval and a CE mark on Dec. 19 and 20 respectively, Baxter appears undervalued by more than 20%.
Diverse, not sprawling
Baxter's operations are split nearly evenly between its BioScience and Medical Product segments. As a medtech firm, Baxter doesn't command a share of the market anywhere near that of Johnson & Johnson (JNJ) or Medtronic (MDT), but it has carved out a nice sized corner.
Its $3.9 billion acquisition of Swedish dialysis competitor Gambro should quickly be giving the company a large share of the European dialysis market. Analyst consensus provided by the Evaluate Group puts growth of the company's medtech segment at around 9% just below management estimates of 10%.
 See the complete report here.

Friday, December 20, 2013

What's Going To Drive Growth At Medtronic Going Forward

This piece on Medtronic is intended to be the first of a two part series. Here are the first two paragraphs. Read the complete post here.
Medtronic (MDT) is a global leader in medical device technology from concept to sale. Although it is dwarfed by Johnson & Johnson (JNJ), General Electric (GE), and Siemens AG (SI), it is the world's largest medical device focused company. It has produced steady top line growth for over a decade.
Overall the medtech industry should experience a CAGR of about 4.5% over the next five years. Although in-vitro diagnostics is likely to be the fastest growing segment in the coming years, this is a thriving industry expected to grow across the board.
In this post, I would like to outline the factors likely to allow Medtronic to grow at a modest, but steady rate over the next five years and beyond. In the near future, once the market produces more data on recent product launches, I'll cover the negatives. More specifically, the US excise tax on medical devices, pricing issues in Asia, CoreValve litigation, diabetes, and transcatheter valve competition.
Continuing, but tapering growth
Over the past decade Medtronic has managed to grow its top line by a CAGR of 8.76%. Per share earnings have also steadily increased at a slightly higher rate. I've included a chart below with quarterly periods to illustrate the company's rock steady earnings.
Again, you can only read the complete post at Seeking Alpha. Here's the link.

Alexion Pharmaceuticals, cPMP and the FDA's Breakthrough Designation

This post is really more about the new accelerated pathway that drugs like Sofosbuvir and Abbvie's HCV combination therapy are or were developed through. Here are the first two paragraphs. Read the complete post only at Seeking Alpha here.
What it takes to be a winner
Along with Alexion Pharmaceuticals' (ALXN) ALXN1101, more than 30 "Breakthrough Therapy" designations have been granted since the new accelerated approval pathway's inception. As of December 6, 2013, just three (PDF) have resulted in an accelerated approval. They are Genentech's Obinutuzumab, Pharmacyclics' (PCYC) Ibrutinib, and Gilead Science's (GILD) Sofosbuvir. As a potential Alexion investor, I'd like to take a closer look at the winners and the designation's criteria in order to assess the likelihood of ALXN1101's accelerated approval.
Reasons for another expedited pathway
Expedited pathways for life-threatening illnesses lacking available, effective treatments are hardly a recent development at the FDA. However, for patients clearly willing to trade certainty for speed, clinical development requirements were still viewed as far beyond what should be necessary. When a targeted therapy achieves its intended effect on its intended human subjects during early stage clinical trials, traditional late phase trials that last several years seems criminally excessive. The trouble was that prior to the passage of the FDA Safety and Innovation Act of 2012 ((FDASIA)), the requirements for expediting development of clearly effective drugs wasn't as clearly defined as it needed to be.
Again, you can read the complete post here.

The Thin Ice Enanta Was Standing On Has Cracked

Just two days after I posted this Gilead released some positive data. The thin ice Enanta was standing on cracked as I expected and the stock has lost 25%. You'll notice some very negative comments, you'll also notice things got very quiet very fast! I'll paste a snip from the conclusion. See the complete post here.
The risk-to-reward profile of its current partnerships, make Enanta just the sort of well managed biotechnology company I would recommend owning for the long haul, but I wouldn't start a position now at $37 per share. Given the lack of late stage candidates beyond ABT-450, the recent price is too dependent on a blended percentage of royalties from a not-yet-approved therapy for an increasingly competitive indication.
Enanta is certainly worth a spot in a watch list. It doesn't need Abbvie's combination to succeed, or even win approval, to remain buoyant. The risk is entirely on Abbvie. Enanta has no debts and is producing positive net income on a trailing twelve month basis. With four of the six Phase 3 trials associated with the Abbvie NDA to be completed by March 2014, an entry opportunity may present itself fairly soon. In the mean time I recommend keeping a close eye on this promising upstart.
Again the complete post is only available at Seeking Alpha here.

Friday, December 13, 2013

MacroGenics A Biotech Stock For Investors That Like A Floor Well Above Zero

Looking for a chance to reap huge rewards with a promising biotechnology company, but would like some sort of safety net high enough off the ground that you won't get bruised on the slightest hint of bad news. The Monoclonal Antibody (MAB) discovery machine that is MacroGenics $MGNX has enough steady milestone payments to keep afloat even if the worst happens to its wholly owned programs. Here's a snip from a report I published recently at Seeking Alpha (Full analysis here).
Big Pharma's hunger for access to monoclonal antibody development and production technology hasn't grown much over the past few years, but it isn't slowing either. Five of last year's top 20 drugs by sales contained antibodies. Although there has been a disconcerting amount Big Pharma dollars funding university based discovery, innovative biotechs are still getting plenty of attention.
Rookie deal maker of the decade
Fresh off its October IPO, MacroGenics (MGNX) has been getting a great deal of attention from deep pocketed deal seekers both in the US and abroad. The 13-year-old Rockville, Maryland company discovers and develops monoclonal antibody-based therapeutics for the treatment of cancer, autoimmune, and infectious diseases. Its candidates are generated via a suite of proprietary platforms that the drug industry values quite highly. The Company has entered into deals with titans like Gilead Sciences (GILD), Pfizer (PFE), France's Servier, and Germany's Boehringer Ingelheim.
Failure of a lead program during Phase 3 trials is the sort of news you would expect to cripple a budding biotech. MacroGenics suffered just this calamity, and promptly entered something of a golden age. The company quickly peeled itself off the lab floor after teplizumab, the diabetes treatment in-licensed by Eli Lilly (LLY), failed in October 2010. Less than a week after the disappointing announcement, the company announced deals with Pfizer and Boehringer Ingelheim potentially worth billions.
Read the complete analysis here.

Monday, November 11, 2013

Weighted Average Cost Of Capital for an uncharacteristic project

Honestly here is the sort of calculation that you want to circle, then come back to if you have enough time.

Refried Bean Company (RBC) is considering a project in the high-end hotdog business. Its debt currently has a yield of 10%. Degen has a leverage ratio of 2.5 and a marginal tax rate of 40%. Luxury Hotdogs Inc. (LHI), a publicly traded firm that operates only in the high-end hotdog business, has a marginal tax rate of 30%, a debt-to-equity ratio of 2.5, and an equity beta of 1.2. The risk-free rate is 4% and the expected return on the market portfolio is 10%. Calculate the appropriate WACC to use in evaluating the Refried Bean Company's boutique schnitzel project.

This is just a WACC problem with a twist. Instead of calculating the WACC with the cost of equity, we need to calculate a "project cost of equity" and add it to RBC's cost of debt. We get the project cost of equity from the risk free rate, plus the Project Beta times the difference between the return on the market portfolio, and the risk free rate: The Project Beta is derived from LHI's Asset Beta, which we can find using figures given.

Step one, find LHI's asset beta: Basset = company beta[1 / (1 + (1 - LHI's tax rate)( LHI's debt to equity ratio))]  = 1.2[1 / (1 + (1 - 0.30)(2.5))] = 0.28

Step two, find RBC's equity beta for this project: Bequity = Basset[1 + (1 - RBC's tax rate)(LHI's equity beta)] = 0.28[1 + (1 - 0.4)(1.2)] = 0.48

Step three, find the project cost of equity: 4% + 0.48(10% - 4%) = 6.9%

Step four, find RBC's cost of debt: 10%(1 - 0.4) = 6%

Step five, find the weight of RBC's debt and equity: Wdebt = 0.6 and Wequity = 0.4

Step six, solve for the project's WACC: 0.6(6%) + 0.4(6.9%) = 3.6 + 2.76 = 6.36%

Like most problems, the hardest part is getting started. I always get mixed up with step one and two, but with some practice it isn't as impossible as it seems.

Now a word of caution, yesterday I didn't really know how to do this. There is a good chance I've made mistakes, if you see one, please comment.

Sunday, November 10, 2013

Variance and standard deviation of perfectly correlated two-stock protfolios

Here's another quick tip, if you're faced with a question regarding a two stock portfolio, if the stocks are perfectly positively correlated. If this is the case, you can save yourself a heap of time by avoiding the long calculation: σ portfolio = [W12σ12 + W22σ22 + 2W1W2σ1σ2r1,2]1/2
If the two stocks, or whatever type of assets, have a correlation of 1.0, then you can simply find a weighted average.

Here's an example: If 30% of an investor's portfolio consists of an asset with a standard deviation of 0.4 and 70% consists of an asset with a standard deviation of 0.2, you can solve for the overall standard deviation of the portfolio like this:
(0.3)(0.4) + (0.7)(0.2) = 0.12 + 0.14 = 0.26
Now isn't that a lot faster than dragging out the long calculation with all those 0's and chances to miss a button. Lets hope there's a question like this on December 7th!

Friday, November 8, 2013

How to use your calculator's NPV functions to complete a two-stage dividend discount model

I got my but kicked on the CFA Institute mock exam yesterday, mainly because I ran out of time. I've been going through the calculations and trying to find ways to speed them up a bit. Here's one that anyone with a TI BA 2 plus calculator, or just about any calculator with net present value (NPV) functions.

Valuing a company with a period of accelerated dividend increases to be followed by a a slower more stable rate requires you to find the DDM value at the point in time where the accelerated dividend growth stops, then add that to previous dividends

Borrowing from Mock Exam - morning session, question 82 (available free to registered candidates):
The accelerated dividend distributions are: D1=$2.00, D2=$2.50, and D3=$3.13
The first slow/stable distribution is: D4=$3.28
Here's the crux of using the two stage model: use the DDM to find a value for the company's shares at time 3 using the given investor required rate of return, $3.28/(0.12-0.05)=$46.86

Add that to the last accelerated distribution for the cash flow at time 3: $46.86+$3.13=$49.99 ~ $50.00

Now, here's how to use your calculator's NPV functions to find a current value per share:
CF0=0, CF1=2, CF2=2.5, CF3=50, I=12

This gives you a NPV=39.37, which is a penny off from the answer.

Sorry about the lack of subscripts, but I think you can get the picture from here. Go ahead and hit me up with any questions.

Thursday, October 31, 2013

Monetary Policy, the Neutral Interest Rate, and Seething Hatred

I straight up hate Economics.

As I cycle through all the topics on the CFA level one exam, I nearly decided to skip over the entire Economics chapter.

If, like me, you never took an Economics class in your life, there are more terms and concepts per potential exam question question than any other topic on the test. At just 10% of the exam there are 100 learning outcome statements. Each LOS contains an average of 97 new terms, that are used in twelve new concepts and associations (personal estimate) that are never expanded upon in further readings.

The most frustrating thing about the Economics readings is that I scored above 50% on the practice questions without exposing myself to the material. In fact I found the readings so tedious that that's how I've approached the entire topic, practice questions first. If I can't understand the answer, then back to the readings. I'm now averaging over 70% on Economics practice tests. I've been back to the readings exactly zero times.

So with that said here are 0.0023% of the required terms and concepts (another personal estimate) in the CFA Level 1 Economics readings:

Monetary Policy and the Neutral Interest Rate

The neutral interest rate is the trend rate of real economic growth plus the target inflation rate, or:

Neutral interest rate = trend rate of economic growth + target inflation rate

Monetary policy is considered:

Expansionary if the neutral interest rate > the policy rate

Contractionary if the neutral interest rate < the policy rate

I'm going to go buy a bottle of high quality whiskey, then beat myself over the head with it until the seething, soul consuming hatred I'm feeling for Economics subsides.

Happy Halloween!

Wednesday, October 30, 2013

CFA Level 1 Exam: Quantitative Methods: Error Types And Feeling Rejected

It's been about 14 years since I took Statistics, and I have to admit that a month ago I couldn't remember how to calculate a standard deviation. I also couldn't remember the difference between a Type I and a Type II error, and the other terms that correspond with them. Just last week in The Economist, there was a great article (are any of them bad?) about some serious issues facing Science. Well within was a one paragraph explanation that summarized error types better than the any other source I can remember:
A type I error is the mistake of thinking something is true when it is not (also known as a “false positive”). A type II error is thinking something is not true when in fact it is (a “false negative”). When testing a specific hypothesis, scientists run statistical checks to work out how likely it would be for data which seem to support the idea to have come about simply by chance. If the likelihood of such a false-positive conclusion is less than 5%, they deem the evidence that the hypothesis is true “statistically significant”. They are thus accepting that one result in 20 will be falsely positive—but one in 20 seems a satisfactorily low rate.
Here's the rest of the Unreliable Research Briefing.

Here is another breakdown that I put together and taped to the wall until it was committed to memory. Again. And again.

Type I error: Rejecting the null hypothesis when it is actually true (False Positive).
Significance Level of a test: The probability of a Type I error.
The "p-value" is smallest level of significance at which the null hypothesis can be rejected.

Type II error: Failing to reject the null hypothesis when is actually true (False Negative).
The Power of a test is one minus the probability of a Type II error.

Remember is that you never accept a hypothesis. You only reject the null hypothesis, or fail to reject the null hypothesis. The best way to remember this concept is by remembering that your geeky sciency friends are so annoying because they never accept anything!

So... Go out tonight and reject a scientist. Give them a dose of their own medicine.

Tuesday, October 29, 2013

Misrepresentation: Plagiarism

The Misrepresentation standard as it involves plagiarism is fairly straightforward, but there are a few sticking points that I was getting hung up on. Usually, I would just err on the side of caution, but knowing exactly where the lines are drawn is what makes the Ethical and Professional standards section so difficult. Here are two bits that was having a bit of trouble with.

Quoting a LIBOR or the latest consumer price index figures released whatever government department-bureau-place publishes them is perfectly acceptable. Directly quoting a person that works for that department, like Janet Yellen, or any FED Chairperson without citing them as the source is not allowed.

Within a firm: When using charts and graphs developed at the firm, they must be must be cited as property of the firm. Although it would be nice of you to mention the colleague responsible for developing the fancypants graphs in your report, it isn't necessary.

Obviously, there is a lot more to the standard than what I've included here, but these are the sorts of details that I stumbled over a few times. If I made a mistake, or you just want to say "Cheers!" please leave a comment.

My CFA Level 1 Exam Study Sheet

This is a fairly random list of all the little odds and ends that cause me to miss points when taking CFA level 1 practice tests (I’ll be sitting for the exam in December). I’ve tried to arrange them by the session they fall into as best I can, but they’re pretty scattered. I’m not really posting these for anyone’s benefit but my own. I just intend to push the post to Instapaper, because it is just the best way to read on my phone before passing out at night.

My Level One Stickies – Tuesday, Oct 29

Session 1 – Ethical and Professional Standards

Proxies should be completed by members. Proxies for pension plans should be voted by the member, in the best interests of the beneficiaries, not the plan sponsor.
Concerning conflicts of interest, personal relationships with company management trumps a relative’s low level employment.
Plagiarism: Fed Reserve Chairman Quotes need to be cited. Materials like charts, graphs, and algorithms developed at a member’s firm need to be cited for the firm, but not for the individual that actually developed them.
Under Standard IV(A) Loyalty: making preparations to leave are not a violation as long as they do not interfere with you acting in the best interests of your current employer.
Under Standard IV(A) Loyalty: Contacting old clients after employment has officially ended is not a violation, if you did not misappropriate their contact information from the former employer.
The nine sections of GIPS standards are Fundamentals of Compliance, input data, calculation Methodology, Composite Construction, Disclosure, Presentation and Reporting, Real Estate, Private Equity, and Wrap Fee/Separately Managed Account Portfolios.
GIPS does not require managers to include non-fee-paying accounts in composites.
Belief of a friend’s ownership of less than $1000 worth of a company’s stock would not be considered a potential conflict of interest.
Standard V Record Retention: Recreating reports from memory after leaving an employer is acceptable if the member can recreate ALL supporting information through sources available to him after leaving.

Session 2 – Quantitative Methods: Basic Concepts

The multiplication rule is used to determine the probability of two (or more?) events both occurring.
The addition rule is used to determine the probability of at least one (or more?) event out of two (or more?) events occurring.
Total probability is used to determine the unconditional probability of an event occurring.
The coefficient of variation is the standard deviation divided by the mean.
To calculate the present value of an annuity due, you can reduce N by one, but DON’T FORGET to add one payment to your calculated present value.
Geometric Return of the following data set: 20, 15, 0, -5, -5 would be calculated as [(1 + 0.20) × (1 + 0.15) × (1 + 0.0) (1 − 0.05) (1 − 0.05)]^(1/5) – 1
Probability Types: For a stock, based on prior patterns of up and down days, the probability of the stock having a down day tomorrow is an example of an Empirical Probability.
EAY = (1 + HPY)^365/t - 1; HPY = (1 + EAY)^t/365 - 1

Session 3 – Quantitative Methods: Application

T-bill yields contain an inflation premium. The yield is considered a nominal risk-free rate because they contain a premium for expected inflation.
Type 1 error: Rejecting the null Hypotheses when it is true (false positive).
Type 2 error: Failing to reject a null hypothesis that is false (false negative)
The probability of a type 1 error is the significance level of the test.
The power of a test is one minus the probability of a type 2 error.
P-value is the SMALLEST level of significance at which the null hypothesis can be rejected.
The F-distributed test statistic is used to compare the variances of two normally distributed populations. F = s12 / s22
Standard error of the sample mean equals the standard deviation of the population divided by the square root of the sample size
Sampling error is the difference between a sample statistic and its corresponding population parameter.
The table of areas under the normal curve shows the percent of observations that lie to the left of the mean plus x amount of standard deviations from the mean.
With smaller samples, use the t-table. To construct a confidence interval be careful: mean +- Number of Sdevs from t-table (Sdev/(number of samples)^0.5)
Degrees of freedom is equal to number of samples minus one.
test statistic = (sample mean – hypothesized mean) / (population standard deviation / (sample size)1/2)
The safety first ratio is identical to the Sharpe ratio, but it replaces the risk free rate with a predetermined determined threshold rate.
Depending upon the author there can be as many as seven steps in hypothesis testing which are:
1.    Stating the hypotheses.
2.    Identifying the test statistic and its probability distribution.
3.    Specifying the significance level.
4.    Stating the decision rule.
5.    Collecting the data and performing the calculations.
6.    Making the statistical decision.
7.    Making the economic or investment decision.

Session 4 – Economics: Microeconomic Analysis

Supply curves for products are typically more elastic over a long time period than over a shorter period.
The long run supply curve for constant cost industries is horizontal.
The long run supply curve for decreasing cost industries slopes downward to the right.
Marginal product is at a maximum when marginal cost is at a minimum.
Producer Surplus is best described as the excess price over the opportunity cost of production.
Utility theory explains consumers’ behavior based on their preferences for various combinations of goods, in terms of the level of satisfaction each combination provides. In other words utility measures the satisfaction consumers receive from consuming a specific combination of goods.
Price Discrimination: The practice of charging different consumers different prices for the same product or service. Think Agoda and users of PCs or Mac. Counterintuitive: you would think it is discriminatory pricing, but apparently it isn’t.
A monopolist will expand production until MR=MC The price of the product will be determined by the demand curve.

Session 5 – Economics: Macroeconomic Analysis

Interest rates only affect the demand for money.
Only monetary authorities determine the supply of money.
Long-run Aggregate Supply (LAS) can be thought of as the potential real output of the economy.
LAS is positively related to the quantity of labor, quantity of capital, and technology.
The level of real output (real GDP) on the LAS curve is the economy’s level of production at full employment.
Full employment does NOT equal zero unemployment.
The components of GDP are consumption, investment, government spending, and net exports (exports-imports).
Core Inflation vs. Headline Inflation: Core inflation does not include food and energy prices, which makes it a better measure of the underlying trend in prices.
The neutral interest rate = trend rate of real economic growth + the target inflation rate.
Monetary policy is expansionary if the policy rate < the neutral interest rate; Monetary policy is contractionary if the policy rate > the neutral interest rate
The one-year forward exchange rate = spot rate(1 + one-year forward rate)
The GDP deflator = nominal / real x 100; rate of decrease = (deflator / 100)^(1/t) – 1
Automatic stabilizers are built-in fiscal devices that ensure deficits in a recession and surpluses during booms. They limit the problem of proper timing.
Velocity of money is the GDP of a country divided by its money supply.
Potential Real GDP < Actual Real GDP, the economy is probably in an inflationary phase.
Potential Real GDP = Actual Real GDP, the economy is at full employment.
Potential Real GDP > Actual Real GDP, the economy is in a recessionary phase.
The labor force population rate = people working or actively seeking employment / working age population

Session 6 – Economics in a Global Context

With formal dollarization or a monetary union, a country does not have its own currency.
GNP includes goods and services produced outside the country (by labor and capital)
Marshall-Lerner condition: A country’s ability to narrow a trade deficit by devaluing its currency depends on the elasticity of demand for imports and exports.
Aggregate output is also known as Gross Domestic Product.
Aggregate income and aggregate output must be equal for an economy as a whole.
The nominal exchange rate is simply the price of one currency relative to another.
In the currency markets, traders quote the nominal exchange rate.
Economic Unions and common markets remove all barriers to the movement of labor and capital among their members. Customs unions do not.
Imports > Exports: There is a current account deficit. To make up the difference the country becomes a net borrower, creating a capital account surplus in the process.
The Ricardian model of trade only considers labor as a factor of production. Comparative advantage results from differences in labor productivity.
The Hecksher-Ohlin model of trade considers both capital and labor productivity.
A country’s comparative advantage arises from its ability to produce a specific good with lower opportunity cost than other countries.

Session 7 – Financial Reporting and Analysis: An Introduction

The FASB framework lists revenues, expenses, gains, losses, and comprehensive income as elements related to performance.
 The IASB framework lists elements related to performance as income and expenses, only.
Cash collections include sales revenue and changes in unearned revenue
Cash expenses include wages expense, changes in wages payable, insurance expense, changes in prepaid insurance, interest expense, and changes in interest payable.
Convergence is defined as moving towards a single set of accounting standards.
A proxy statement before an annual shareholder meeting, or other shareholder vote, is filed with the SEC on form DEF-14A
Options and diluted EPS: (# of contracts) – [($ExPrice)(# of contracts) / ($AvgSharePrice)]
Return on equity (ROE) = net profit margin × asset turnover × leverage
sustainable growth = (1 – dividend rate)(ROE)
quick assets = current assets - inventory
Session 8 – Financial Reporting and Analysis: Income Statements, Balance Sheets, and Cash Flow Statements

Depreciation is a non-cash expense.
IFRS uses component depreciation. GAAP does not.
Although Notes are always audited, MD&A isn’t.

Session 9 – Financial Reporting and Analysis: Inventories, Long Lived Assets, Income Taxes, and Non-current Liabilities
A Tax Loss Carryforward is a net taxable loss that can be used to reduce taxable income in the future.
Adjusting asset values from historical cost to reflect current values is simply a valuation adjustment, NOT accumulated depreciation. Changes to owners equity is often reflected in changes to “other comprehensive income.”
By definition differences that result in deferred taxes are expected to reverse in the future.
Under IFRS, investment property is defined as an asset owned for the purpose of earning income from rentals and/or capital appreciation. Be careful: although the purchase/sale of a factory or warehouse is classified as an investing cash flow, the property is not considered an investment property.
If a firm redeems a bond before maturity for a price that is different from the carrying value of the bond liability, the firm will recognize the difference as a gain or loss. At maturity the carrying value of the bond liability is equal to the face value of the bond, so there is no gain or loss recorded.
Securities with market value < carrying value: If classified as held to maturity, reported at amortized cost. If classified as available-for-sale, reported at fair value.
kps = Dps / P0
kce = (D1 / P0) + g

Session 10 – Financial Reporting and Analysis: Evaluating Financial Reporting Quality and Other Applications

FIFO ending inventory = LIFO ending inventory + LIFO reserve
FIFO after-tax profit = LIFO after-tax profit + (change in LIFO reserve)(1 − t)
Session 11 – Corporate Finance
Financial Leverage: reduces taxes, has no effect on operating income (although interest paid is a CFO), but it does affect Net Income and, in turn, EPS.
The marginal cost of capital (MCC) and the weighted average cost of capital (WACC) are the same thing.
Project Sequencing refers to the opportunity to decide  to invest in a related project in the future due to the performance of a previously started project.
For independent projects: NPV and IRR will lead to the same decision.
For mutually exclusive projects: Higher NPV projects should be accepted for projects with similar IRRs.
IRR assumes that periodic cash flows are reinvested at the IRR rate, not the cost of capital. NPV assumes that cash flows are reinvested at the cost of capital. This is why NPV is preferred to IRR.
An investor may find multiple IRRs if there are negative cash flows after the initial investment.
Payback periods ignore the time value of money.
Counterintuitive: A firm’s target capital structure is NOT based on existing book values of debt, equity and preferred stock. It’s based on market values.
Business Risk can be defined as the uncertainty inherent in a firm’s return on assets.
The cash conversion cycle measures the length of time required to convert a firm’s investment in inventory back into cash.
The cash conversion cycle = average days of receivables + average days of inventory – average days of payables
Primary sources of liquidity: ready cash balances, short-term funds like trade credit and bank lines of credit, and cash flow management
Secondary sources of liquidity: negotiating debt contracts, liquidating assets, bankruptcy, and reorganization.
“Borne by” Apparently financial risk is “borne by” common shareholders, NOT creditors (which is bullshit), and certainly not managers.
Flotation cost is a cash outflow that occurs at the initiation of a project. The correct way to account for it when issuing new equity to finance a project is to adjust cash flows in the computation of the projects NPV. You do not account for flotation cost by adjusting the cost of equity.
Corporate Governance defines the appropriate rights, roles and responsibilities of a corporation’s management, board of directors, AND SHAREHOLDERS.
Just 2-3 years for a board member is plenty long.
CAPM = RE = RF + B(RM − RF); WACC = (Equity ÷ Vtotalassets)(RE) + (Debt ÷ Vtotalassets)(RD)(1 − t)
DTL = (Sales − Variable Costs) / (Sales − Variable Costs − Fixed Costs − Interest Expense)
Degree of operating leverage (DOL) = (Sales – Variable Costs) / (Sales – Variable Costs – Fixed Costs)
Degree of financial leverage (DFL) = EBIT / (EBIT – I) = 875,000 / 807,500 = 1.08

Session 12 - Portfolio Management

An “Asset Class” should be defined by type of security, like stock, bond, etc… So consumer cyclical is not a valid asset class, but consumer cyclical equities is a valid asset class.

The formula for the covariance for historical data is:
cov1,2 = {Σ[(Rstock A − Mean RA)(Rstock B − Mean RB)]} / (n − 1)
Mean RA = (10 + 6 + 8) / 3 = 8, Mean RB = (15 + 9 + 12) / 3 = 12
Here, cov1,2 = [(10 − 8)(15 − 12) + (6 − 8)(9 − 12) + (8 − 8)(12 − 12)] / 2 = 6

A defined benefit pension plan typically has a long investment time horizon, low liquidity needs, and high risk tolerance.
Insurance companies and banks typically have low risk tolerance and high liquidity needs.
Banks and property and casualty insurers typically have short investment horizons.
An investment policy for a firm’s short-term cash management fund is highly unlikely to include a list of permissible securities, because it would be too limited and restrictive. However, a list of permissible security TYPES is appropriate.
In the context of the CML, the market portfolio contains all the stocks, bonds, and risky assets in existence.
The Markowitz efficient frontier lists portfolios with the highest return (Y-axis) for given levels of risk (X-axis).
The optimal portfolio in the Markowitz framework occurs when the investor achieves the diversified portfolio with the highest utility.
Portfolios on the right (“up”) of the market portfolio on the capital market line are only created by borrowing more funds to own more than 100% of the market portfolio.
The optimal portfolio for an investor is the highest indifference curve that is tangent to the efficient frontier. It is not simply the highest point up the line because of the associated increase in risk, and individuals’ appetite for risk.
Covariance-ab = (correlation coefficient)(Sa)(Sb)
If two assets have a perfect negative correlation it is possible to reduce the overall portfolio variance to zero.
The Capital Market Line (CML) is a straight line drawn from the risk free rate of return through the market portfolio. Risk is the x-axis and rate of return is the y-axis. The market portfolio is determined as the point where the straight line is exactly tangent to the efficient frontier.

Session 13 – Equity: Market Organization, Market Indices, and Market Efficiency

The target market of an index is the securities market or portion of a securities market that the index will be designed to represent.
The securities from the target market that are included in the index are called its constituent securities.
Initial Margin is defined as the minimum amount of funds that must be supplied with purchasing a security on margin.
Margin Call Tipping Point = (initial share price) x (1-initial margin requirement) / (1-maintenance margin requirement)
Market-cap weighted index with two stocks value = [(Current ShareA Price)(Number Of ShareA shares outstanding) + (Current ShareB Price)(Number of ShareB shares outstanding)] / [(Previous ShareA Price)(Number of shares of ShareA outstanding) + (Previous ShareB price)(Number of ShareB shares outstanding)](100)
Private equity firms might not offer the transparency of those that are publicly traded, but the reduced short term minded pressures of public shareholder should result in better long term performance.
Continuous markets are markets where trades occur at any time the market is open, not necessarily 24 hours/day.
Call markets are markets in which the stock is only traded at specific times.
Setting one negotiated price to clear the market is a method used to set opening prices, NOT closing prices, in major continuous markets.
Market efficiency does not assume that individual market participants correctly estimate asset prices, but does assume that some agents will over-estimate and some will under-estimate, but they will be correct, on average.

Session 14 - Equity Analysis and Valuation

The simple DDM: Stock Value = Dividend Per Share / (Discount Rate “k”) – (Dividend Growth Rate “g”)
Use the CAPM to find the Discount Rate. CAREFUL, use next year’s Expected dividend, not last year’s
The Earnings Multiplier Model: P0/E1 = (D1/E1)/(ke − g)
The relationship between "k" and "g" is critical - small changes in the difference between these two variables results in large value fluctuations.
ke is the required rate of return for the stock
g = (earnings retention rate)(ROE)
A low capacity level is associated with higher pricing power. With a low capacity levels there is a higher chance that supply in the short run will be less than demand at current prices. Think: “new iPhones”
Firms operating in industries with low barriers to entry and low industry concentration typically experience very limited pricing power.
When book values are stable calculating ROE based on beginning book values is acceptable. If book values are not stable, divide beginning and ending book values by two to calculate ROE.
The free cash flow to equity model is a type of present value model, or discounted cash flow model. It estimates a stock’s value as the present value of cash available to common shareholders.
The enterprise model is an example of a multiplier.

Session 15 – Fixed Income: Basic Concepts

In times of higher than normal demand for bonds, yield spreads tend to narrow.
Higher supply and higher liquidity premiums tend to widen yield spreads.
The duration of a zero coupon bond is approximately equal to its time to maturity.
Duration = (PV after yield decrease)(PV after yield increase) / (2)(FV)(Change in Yield)
Revenue bonds, issued by municipalities, are serviced by the income generated from specific projects.
Cap risk occurs with floating rate bonds that have a cap placed on how high the coupon rate can go.
The London Interbank Offered Rate is the interest rate paid on negotiable CDs by banks with operations in London, not necessarily “British” banks. It is determined every day by the British Bankers Association.
The relationship of duration to maturity is direct. Shorter time to maturity => shorter duration.
The relationship of coupon size is indirect. Bonds with larger coupons => shorter duration.
Call risk is composed of three components: the unpredictability of the cash flows, the compression of the bond’s price, and the high probability that when the bond is called the investor will be faced with less attractive investment opportunities, AKA reinvestment risk.
Bond covenants are classified as positive and negative. A performance promise, like a minimum current ratio, is considered a positive covenant. A prohibitive agreement, like no more borrowing, is considered a negative covenant.
Effective convexity accounts for embedded options.
The four C’s of credit analysis are capacity, collateral, covenants, and character.

Session 16 – Fixed Income: Analysis and Valuation

The option adjusted spread for a putable bond is the Z-spread plus the put option cost in percent.
Modified Duration: assumes that all the cash flows on a bond will not change
Effective Duration: considers changes in cash flow that may occur due to embedded options.
Although rare, negative convexity occurs with callable bonds.
Annual Yield to Maturity (YTM) is easy. Just plug and chug for I/Y. To find the Bond Equivalent Yield (BEY): BEY = 2 x [(1 + YTM)^(0.5) – 1]
When estimating the potential return on a callable bond, it is better to use the Yield to Call rate than the standard Yield to Maturity rate.
Eurodollar Time Deposits: U.S. dollar (USD) denominated deposits at large banks in London, Tokyo, and elsewhere outside the US, are Eurodollar accounts. By convention the rates are quoted as an add-on yield.
Following the convention of quoting Eurodollar account rates as add on yields, euro-denominated deposits held outside of the EU would be called “Euroeuro” deposits.

Session 17 - Derivatives

Angel Investment: Planning and establishment of a firm.
Seed Stage Investment: market research, product development, and marketing.
Early Stage Investment: Large scale production, and sale of product.
Although payoffs on futures options are related to the spot price of the underlying commodity, spot price doesn’t factor into the payoff amount equation. When the option holder exercises the futures option they receive an underlying futures position. The cash payoff = exercise price – futures contract price.
Although a protective put and covered call are both ways to insure against impending downside, the payoff diagram of a protective put is nearly identical to a long call, shifted upward by the exercise price of the put.
European put options suck. Remember that all things equal American options are always worth more up to the point of expiration, because they can be exercised anytime before their expiration. European options cannot.
“American” options are not necessarily traded in the US. The term refers to the option to exercise the contract before its expiration.
I’m having issues with calculating margin balances.
In US futures markets the clearing house acts as counterparty to every contract and guarantees performance of contract obligations. The exchange decides which assets will have futures contracts and the contract specifications.
Forwards dealers are not end users of forward contracts. Governmental agencies and non-profit organizations both are end users.
Forwards carry counterparty risk. Futures do not.
Both forwards, and futures may be either cash-settlement or deliverable contracts.
Call Value = Stock Price + Corresponding Put Value – Strike / [(1+Rate)^(t/360)]
At the Chicago Board of Trade foreign currency contract sizes are fixed in foreign currency units, and priced in dollars per foreign currency unit.

Session 18 – Alternative Investments

An issuer of floating rate debt can create an interest rate collar by buying an interest rate cap and selling an interest rate floor.
The money added to a margin account to bring the account to the required level is called the variation margin.
The minimum allowed in the account is called maintenance margin.
The daily settlement process requires marking-to-market each day.
Maintaining privacy is a valid reason for a swap contract.
A positive roll yield results from a backwardated market, whereas a negative yield is produced in a contango market. In backwardated (contango) markets, futures prices are lower (higher) than spot prices. Futures markets that are dominated by long (short) hedgers tend to be in contango (backwardation).
The futures price curve of backwardated markets slopes down. Contango markets slope upward.
Futures price ≈ Spot price (1 + risk-free rate) + storage costs − convenience yield. If convenience yield is low and storage costs are high, it is likely that the futures price is greater than the spot price, or in contango.
Use of derivatives introduces operational, financial, counterparty, and liquidity risk.
The income approach to valuing real estate properties estimates values by calculating the present value of expected future cash flows from property ownership, OR by dividing the net operating income for a property by a capitalization rate.
The cost approach to valuing real estate properties is based on the estimated cost to replace an existing property.
The comparable sales approach to valuing real estate properties estimates property values based on recent sales of similar properties.