PART II
SECTION
3
PAPER
NO. 7 REGULATION OF FINANCIAL MARKETS
GENERAL
OBJECTIVES
This paper is intended to equip the candidate with
knowledge, skills and attitudes that will enable him/her to comply with the
regulatory framework governing financial markets
7.0
LEARNING OUTCOMES
A candidate who passes
this paper should be able to
·
Comply with
the legal provisions relating to financial markets, including the laws of
contract and agency
·
Comply with
the licensing regulations of the securities exchange
·
Comply with the guidelines and rules of
the central depository system
·
Identify the offences and penalties
relating to trading in securities
·
Demonstrate an understanding of the
processes and law of anti money laundering
·
Maintain securities registers, accounts
and records
CONTENT
7.1
Introduction to law
-
Nature, purpose and classification of
law
-
Sources of law
-
The court system; structure, composition
and Jurisdiction; types of courts
7.2
law of contract
-
Definition and nature of a contract
-
Classification of a contract
-
Formation of a contract
-
Terms of a contract
-
Vitiating factors
-
Illegal contracts
-
Discharge of contract
-
Remedies for breach of a contract
-
Limitation of actions
7.3
law of agency
-
Nature of agency
-
Formation of agency
-
Special classes of agents: factors,
banks, brokers
-
Authority of the agent
-
Duties and rights of the principal and
agent
-
Personal liability of the agent
-
Termination of agency
7.4
Regulation of Financial markets
-
Historical development of the law and
regulation governing financial markets
-
Need for regulation
-
Regulatory strategies in financial
services
-
Financial regulators
-
Central Bank of Kenya
-
Deposit Protection fund
-
Insurance regulation authority
-
Retirement Benefit Authorities
-
Sacco Societies Regulatory Authority
-
Professional bodies in financial
services
-
Regulations in the international
financial markets
-
The International Organisation of
Securities Commissions Principles for Selfregulation
7.5
Regulation of capital markets
-
Capital Markets Authority
-
Investor’s Compensation Fund
-
The capital Markets Tribunal
-
The capital Markets Fraud Investigation
Unit
-
The International Organisation of
Securities Commissions Principles relating to regulator
7.6
Raising capital in securities market
-
Private offers
-
Public offers
-
Introduction
-
Tender
-
Prospectus and information memorandum
-
The International Organisation of
Securities Commissions Principles for issuers
7.7
Central depository system
-
The Central Depository Settlement
Corporation
-
Establishment of the central depository
-
Duties of the central depository
-
Central depository agents
-
Rules and Regulation of the Central
depository
-
Duty to maintain secrecy
-
Security measures
-
Disclosure of information by central
depository agents
-
Central Depository Guarantee Fund
7.8
Immobilization of securities
-
Meaning
-
Prescription of securities for
immobilization
-
Transfer to a central depository or
nominee company
-
Operation of securities account
-
Restriction of trade in eligible
securities
7.9
Regulations governing intermediaries in financial markets
-
Stockbrokers
-
Stock dealers
-
Investment banks
-
Investment advisers
-
Fund managers
-
Credit rating agencies
-
Collective investment schemes
-
Custodians
-
Venture capital funds
-
Saving and Credit Co-operative Societies
-
Micro finance institutions
-
The International Organisation of
Securities Commissions Principles for credit rating agencies, collective
investment schemes and market intermediaries
7.10
Securities Exchange
-
Establishment
-
Membership
-
Rules
-
Listing and post requirements
-
Self listings of exchange
-
Insider trading
-
Cross border listing
7.11
Securities transactions
-
Book entry o transactions and
prohibitions
-
Records of depositors
-
Suspended securities
-
Suspension and delisting of securities
-
Charging of mortgaging of securities
-
Bonus and rights issue
-
Prohibition of dealings in book entry
Securities
-
The International Organisation of
Securities Commissions Principles for enforcement of securities regulation
7.12 Securities registers, accounts and
records
-
Definition of interests in securities
-
Restrictions in securities transaction
-
Register of interest in securities
-
Types of securities accounts
-
Maintenance of records
-
Accounts statements
-
Records of depositors
-
Audit of accounts, records and registers
7.13
Corporate governance
-
Meaning of
corporate governance
-
Application of
corporate governance principle in financial markets
-
The International Organisation of
Securities Commissions Principles for corporate regulation
7.14 Prevention of money laundering
-
Meaning
of money laundering
-
Processes
of money laundering
-
Anti
money laundering legislation
-
Anti
money laundering advisory board
-
The
assets recovery agency
-
Criminal
Asset Recovery Fund
-
Prevention
of terrorism regulations
-
Counter
Financing of terrorism inter-Ministerial Committee: Objectives, Functions and
powers
-
The
financial reporting centre: objectives, functions and powers
-
Due
diligence requirements
-
Wire
transfers
7.15
Emerging issues and trends in financial markets
PAPER
NO. 8 CORPORATE FINANCE
GENERAL
OBJECTIVES
This paper is intended to equip the candidate with
the knowledge, skills and attitudes that will enable him/her to make corporate
finance decisions
8.0
LEARNING OUTCOMES
On successful completion of this paper, the
candidate should be able to:
·
Make
capital budgeting decisions
·
Compute
the cost of capital of a firm
·
Select
the optimal capital structure of a firm
·
Manage
the working capital of a firm
·
Undertake
corporate restructuring
·
Evaluate
mergers and acquisitions
·
Make
decisions in the context of Islamic finance
CONTENT
8.1
Overview of corporate finance
-
Nature and scope of corporate finance
-
Financial decision making process
-
Role of finance manager
-
Finance functions
-
Goals of a firm
-
Agency theory concept, conflict and
resolutions
-
Measuring managerial performance,
compensation and incentives
8.2
Cost of capital
-
The concept and significance of cost of
capital
-
Components of cost of capital
-
Weighted average cost of capital (WACC)
of a company
-
Marginal cost of capital (MCC) of a
company
-
Use of marginal cost of capital and the
investment opportunity schedule in determination of the optimal capital budget
-
Cost of debt capital using the
yield-to-maturity approach and the debt-rating approach
-
Computation of the cost of non-callable
and nonconvertible preferred stock
-
Computation of the cost of the cost of capital
using the capital asset pricing model approach, the dividend discount model
approach, and the bond-yield-premium approach
-
Computation of the beta and cost of
capital for a project
-
Uses of country risk premiums in
estimating the cost of equity
-
Treatment of floatation costs
8.3
Capital structure
-
Sources of capital
-
Factors to consider when selecting
sources of funds
-
Capital structure of a firm
-
Factors influencing capital structure
-
Capital structure theories: Net Income
(NI) approach; Net operating Income (NOI) approach; Franco Modingiliani and
Merton Miller (MM) propositions-MM without taxes, MM with corporate taxes, MM with corporate taxes and personal taxes, and
MM with taxes and financial distress costs
-
Target capital structure; reasons why a
company’s actual capital structure may fluctuate around its target
-
Measure of leverage: Overview of
leverage; importance of business risk, sales risk, operating risk, and
financial risk in leverage; classification of a risk; degree of operating
leverage, the degree of financial leverage on a company’s net income and return
on equity; breakeven quantity of sales levels; computational of the operating
breakeven quantity of sales
-
Role of debt ratings in capital
structure policy
-
Evaluating the effect of capital structure
policy on valuation: factors to consider
-
International differences in the use of
financial leverage, factors that explain these differences, and implications of
these differencesfor investment analysis
8.4
capital investment decisions under certainty
-
Nature of capital investment decisions
-
Classification of capital budgeting
decisions
-
Categories of capital projects
-
Basic principles of capital budgeting;
evaluation and selection of capital projects: mutually exclusive projects,
project sequencing, and capital rationing
-
Capital budgeting techniques
-
Estimating project cash flows
8.5
Capital investment decisions under uncertainty
-
Nature and measurement of risk and
uncertainty
-
Investment decision under capital
rationing: Multiperiod; investment decision under inflation, investment
decision under uncertainty
-
Techniques of handling risk: sensitivity
analysis; scenario analysis; simulation analysis; decision theory models;
certainty equivalent; risk adjusted discount rates; utility curves
-
Special cases in investment decision:
projects with unequal lives; replacement analysis; abandonment decision
-
Real options in investment decisions:
Types of real options; evaluation of a capital project using real options
-
Common capital budgeting pitfalls
-
Computation of accounting income and
economic income in the context of capital budgeting
-
Evaluation of a capital project using
economic profit, residual income, and claims valuation models for capital
budgeting
8.6
Management of working capital
-
Primary and secondary sources of
liquidity; factors that influencing a company’s liquidity position
-
Company’s liquidity measure in
comparison to those of peer companies
-
Evaluation of working capital effectiveness
of a company based on its operating and cash conversion cycles; comparison of
the company’s effectiveness with that of peer companies
-
Effect of different types of cash flows
on a company’s net daily cash position
-
Computation of comparable yields on various
securities; comparison of portfolio returns against a standard benchmark;
evaluation of a company’s short-term investment policy guidelines
-
Company’s management of accounts
receivable, inventory, and accounts payable over time and compared to peer companies
-
Evaluation of the choice of short-term
funding available to a company
8.7
Mergers and acquisitions
-
Classification of mergers and
acquisition (M &A) activities based on forms of integration and relatedness
of business activities
-
Common motivations behind M & A
activity
-
Bootstrapping of earnings per share
(EPS); computation of a company’s post-merger EPS
-
The relation between merger motivation
and types of mergers, based on industry life cycles
-
Contrast merger transaction
characteristics by form of acquisition,
method of payment, and attitude of target management
-
Pre-offer defence mechanisms and
post-offer takeover defence mechanism
-
Computation of Herfindahl- Hirschman
index, and the likelihood of an antitrust challenge for a given business
combination
-
Discounted cash flow analysis,
comparable company analyses, and comparable transaction analyses for valuing a
target company, including the advantages and disadvantages of each
-
Computation of free cash flows a for a
target company, and estimation of the company’s Intrinsic value based on
discounted cash flow analysis
-
Estimation of the value of a target company
using comparable company and comparable transaction analyses
-
Evaluation of a takeover bid;
computation of the estimated post-acquisition value of an acquirer and the
gains accrued to the target shareholders
versus the acquirer shareholders
-
Effect of price and payment method to
the distribution of risks and benefits in M&A transactions
-
Characteristics of M&A transactions
that create value
-
Equity carve-outs, spin-offs,
split-offs, and liquidation
8.8
Analysis of Corporate growth and restructuring
-
Measurements of growth: methods of
determining growth rates, sustainable versus non sustainable growth analysis of
potential growth, franchise value and the growth process
-
Return on assets (ROA) and return on
capital (ROC)
-
Common reasons for restructuring
-
Relative company return analysis
-
Valuation and analysis of corporate
restructuring; leveraged buyouts (LBO); divestitures; strategic alliances;
liquidation; recapitalization
-
Financial distress, predicting
organizational failure; solutions to financial distress
8.9
Islamic Finance
-
Justification for Islamic finance:
history of Islamic finance; capitalism; halal; haram; riba; gharar; usury
-
Principles underlying Islamic finance:
principles of not paying or charging interest, principles of not investing in
forbidden items e.g. alcohol, pork, gambling or pornography; ethical investing;
moral purchases
-
The concept of interest (riba) and how
returns are made by Islamic financial securities
-
Sources of finance in Islamic financing:
muhabaha, sukuk, musharaka, mudaraba
-
Types of Islamic financial products:
-sharia-compliant products: Islamic investment funds; tafakul the Islamic
version of insurance Islamic mortgage, murabahah, ; leasing-ijara;
safekeeping-wadiah; sukuk-islamic bonds and securitization; ; sovereign sukuk;
Islamic investment funds; join venture-musharaka, Islamic banking, Islamic
contracts, Islamic treasury products and hedging products, Islamic equity funds;
Islamic derivatives
-
International standardization
/regulations of Islamic finance: case for Islamic financial services board
8.10 Emerging
issues and trends
PAPER
NO. 9 FINANCIAL STATEMENT ANALYSIS
GENERAL
OBJECTIVES
This paper is intended to equip candidate with knowledge, skills and attitude that will enable him/her to analyse and interpret the financial statements of a firm
9.0 LEARNING OUTCOMES
On successful completion of this paper, the
candidate should be able to:
·
Evaluate the various alternative sources
of financial information
·
Apply the various financial statement
analytical tools and techniques in analyzing financial statements
·
Demonstrate an understanding of
accounting measurements and recognition
·
Compare the financial reporting and accounting
treatments of assets and liabilities
·
Comply with the requirements of IASs,
IFRSs and IPSASs
·
Evaluate the financial performance of a
firm
CONTENT
9.1
Overview of financial statement analysis
-
Definition of financial statement
analysis
-
Different reporting environment
frameworks
-
Steps in analyzing financial statements
-
Importance and challenges of financial
statement analysis
-
Sources of information for analysis
(Financial Statements, Auditors report, Management commentary, Filing with
regulatory authorities and press reports)
-
Approaches to analyzing financial
statements (Macro, industry and Firm-Either to down or bottom up)
9.2
Financial reporting on assets and liabilities
-
Investment properties; presentation and
disclosure
-
Accounting policies, changes in
accounting estimates and errors (prior period errors)
-
Events after the reporting period
-
Non-current items and non operating
items; discounted operations (Exclude disposal of subsidiaries), extraordinary
items, unusual or infrequent items, changes in recognition and disclosures and
impairment)
-
Non-current assets held for sale
-
Intangible assets
-
Leases (finance and operating,
presentation disclosure, recognition), off balance sheet leverage from
operating leases.
-
Income taxes: accounting profit and
taxable income, deferred tax assets and liabilities tax base of assets and
liabilities, temporary and permanent differences, recognition and measurement
of current and deferred tax, presentation and disclosure
-
Employee benefits (Post-employment
benefits): types of post employment benefits; impact of the assumption used
such as discount rates, return on plan assets and salary growth on the defined
benefit obligation and periodic expense; pension plan footnote disclosure,
effect on underlying economic liability (assets) of a company’s pension and
other post employment benefits; share based compensation
-
Multinational operations: foreign
currency transactions; translation of foreign currency in the financial
statements, effects of changing prices and inflation
9.3
Quality of earnings and earnings management
-
Categories of earnings: earnings before
interest, tax depreciation and armotization (EBITDA), operating earnings, net
income among others
-
Measures of the accrual components of
earnings and earnings quality
-
Earnings Per Share (EPS); Basic EPS,
diluted EPS, using EPS to value firms, criticism of EPS
-
Segment reporting; disclosure
requirements, geographical segments, segment ratios
9.4
Other Inter-corporate Investments
-
Subsidiaries
-
Associate companies
-
Jointly controlled entities
-
Evaluating the effect of the
inter-corporate investments on financial statements given the different
accounting treatment
9.5
Analysing the financial statements
-
Income statement: components and format
of the income statement, revenue recognition and expenses recognition; analysis
of the income statement; common size analysis, ratio analysis
-
Statement of financial position;
components and format of statement of
financial position (assets, liabilities and equity), off balance sheet items;
analysis of the statement of financial position; common size analysis, cross
sectional analysis, ratio analysis
-
Statement of changes in equity;
components of equity, equity valuation ratios
-
Cash flow statements; components and
format of the cash flow statement, categories of cash flow items, direct and
indirect methods for preparing cash flow statements; cash flow statement
analysis; evaluation and uses of cash, common size analysis, free cash flow to
the firm and free cash flow to equity, cash flow ratios, quality of earnings.
9.6
Financial statement analytical tools
-
Financial analysis techniques; financial
analysis framework/process; computation and analysis
-
Profitability analysis: desegregation
and interpreting return on assets (ROA), return on capital employed (ROCE),
relating ROA to ROCE, DuPont analysis.
-
Analysis of growth and sustainable
earning: growth analysis, analysis of changes in profitability and
sustainable earnings, analysis of growth
in shareholder’s equity growth, sustainable earnings and the evaluation of
price to book-P/B ratios and price earnings-P/E ratios.
-
Analytical tools and techniques; ratio
analysis, common size analysis, graphs, regression analysis.
-
Model building and forecasting;
sensitivity analysis, scenario analysis, simulation,.
-
Application of ratio analysis-cross
sectional analysis, trend analysis, forecast financial statements, credit
analysis and rating
9.7
Qualitative and other current issues in analysis of financial statements
-
Qualities of useful financial statements
-
Red flag and accounting warning signs
that may indicate financial statements are of poor quality
-
Accounting scandals
-
Accounting shenanigans on the cash flow
statement; Creative accounting and manipulating financial statements
-
Mispresentation in the financial
statements
-
Adjustments that may be required to make
financial statements comparable
9.8
Emerging issues and trends
SECTION
4
PAPER NO. 10
EQUITY INVESTMENTS ANALYSIS
GENERAL
OBJECTIVE
This paper is intended
to equip the candidate with the knowledge, skills and attitude that will enable
him/her to value and analyze equity investments
10.0 LEARNING OUTCOMES
A candidate who passes this paper should be able to:
· Undertake
industry and company analysis
· Determine
the value of equity securities
· Apply
various models in valuing equity
investments
· Calculate
and interpret equity valuation multiples
· Undertake
valuation of private companies
-
Structure
of the equity market: Financial system and intermediaries types of orders
-
Primary
and secondary markets for securities
-
Trading
equity securities
-
Types
of equity securities; ordinary shares and preference shares, private versus
public
-
Investing
in foreign equity securities
-
Risk
and return characteristics of different types of equity securities
-
Market
value and book value of equity securities
-
Comparison
of a company’s cost of equity, accounting rate of return and investors’
required rate of return
-
Equity
security and company value
-
Overview
of industry analysis
-
Uses
of industry analysis and its relationship to company analysis
-
Approaches
to identifying similar companies: product / services supplied, business- cycle
sensitivities, statistical similarities
-
Industry
classification systems (commercial and government industry classification
system), constructing a peer group
-
Factors
that affect the sensitivity of a company to the business cycle
-
Describing
and analyzing an industry: principles of strategic analysis( Michael Porters’ competitive
forces)
-
Effects
of barrier to entry, industry concentration, industry capacity, and market
share stability on pricing power and return on capital
-
Product and industry life cycle
models; Classification of industry as to life cycle phases (embryonic, growth,
shakeout, maturity and decline); limitations of life-cycle concept in
forecasting industry performance.
-
Demographic .governmental, social
and technological influences on industry growth, profitability ,and risk -
Company analysis: Elements that should be covered in a company analysis
10.3
Fundamental and technical analysis in equity valuation
-
Fundamental analysis: definition,
assumptions, advantages and disadvantages
-
Top-down, bottom-up, and hybrid
approaches for developing inputs to equity valuation models
-
Forecasting the following cost:
cost of goods sold, selling and administrative costs, financing costs, and
income taxes
-
Approaches to balance sheet
modeling
-
Growth companies and growth
stocks; defensive company and stocks; cyclical companies and stocks speculative
companies and stocks
-
Comparing estimated values and
market prices; information efficiency and efficient market hypothesis
-
Technical analysis: definition,
assumptions, advantages and challenges; Technical trading rules and indicators:
contrary opinion rules follow the smart rule, momentum indicators, pure price
and volume techniques; relationships between market efficiency and technical
analysis; application of behavioural finance in technical analysis
-
Forecasting methodology:
conditional forecasting, economic forecasting.
-
Technical versus fundamental analysis
10.4 The
equity valuation processes
-
The scope of equity valuation:
definitions of value, valuation and intrinsic value, sources of perceived
mispricing
-
Valuation and portfolio
management
-
Valuation concepts and models:
Valuation of speculative stocks; capital asset pricing model, asset valuation,
market capitalization, shareholder value
-
Performing valuations: the
financial analyst’s role and responsibilities
-
Alternative to traditional
analysis techniques: Economic value added (EVA); market value added (MVA); cash
flow return on investment (CFROI)
-
Effects of inflation on the valuation process
10.5 Discounted dividend valuation
-
Valuation model of common stock:
dividend discount model (DDM)
-
Gordon growth model; underlying
assumptions; implied growth rate of dividends using growth model and current share
price; calculation and interpretation of present value of growth opportunities
strengths and weakness of Gordon model
-
Valuation of non callable fixed
rate perpetual preferred shares
-
Zero-growth model
-
Constant growth model
-
Multiple growth model
-
Multistage dividend discount
models: valuing a non-dividend-paying company, first- stage dividend, H-model,
three-stage dividend discount models
-
Finding rates of return for any
dividend valuation model
-
Terminal value in a dividend
valuation model
-
Determination of whether a stock
is overvalued, fairly valued, or undervalued by the market based on a DDM
estimate of value
-
The financial determinants of
growth rates: sustainable growth rate, dividend growth rate, retention rate,
and return on equity (ROE) analysis
-
Financial models and dividends
-
Investment management and DDM
10.6 Free cash flow valuation
-
Free cash flow to firm (FCFF) and
free cash flow equity (FCFE) valuation approaches: defining free cash flow,
present value of free cash flow, single-stage FCFF and FCFE growth models
-
Appropriate adjustments to net
income, earnings before interest and taxes(EBIT),earnings before interest,
taxes, depreciation, and amortization (EBITDA) ,and cash flow from
operations(CFO) to calculate FCFF and FCFE
-
Forecasting free cash flow:
computing FCFF from net income(NI), computing FCFF from the statement of cash
flows, noncash charges
-
Computing FCFE from FCFF, finding
FCFF and FCFE from EBIT or EBITDA: Single -stage ,two-stage, and three stage
FCFF models; calculating terminal value in a multistage valuation model
10.7 Market- based valuation: Price multiples
-
Method of comparables and the
method based on forecasted fundamentals as approaches to using price multiples
in valuation; economic rationale for each approach
-
Alternative price multiples and
dividend yield in valuation; fundamental factors that influence alternative
price multiples and dividend yield
-
Normalised earnings per
share(EPS) and its calculation
-
Measures of relative value:
Price-to-earnings (P/E) ratio, Price-to-book (P/B) ratio, Price-to-cash flow
ratio and Price-to-sales (P/S) ratio
-
Rationale for using price
multiples to value equity
10.8
Residual income valuation
-
Residual income; economic value
added(EVA) and market value added(MVA)
-
The Residual Income Valuation
Model: uses of residual income models; fundamental determinants of residual
income ;calculation of intrinsic value of common stock using the residual
income model
-
The General Residual Income
Model: residual income valuation in relation to other approaches(single-stage
residual income valuation, multistage residual income valuation)
-
Comparison of residual income
model to divided discount and free cash flow models
-
Determination of whether a stock
is overvalued, fairly valued, or undervalued by the market based on a residual
income model
10.9 Private company valuation
-
Public and private company
valuation comparison
-
Private business valuation:
definition of value and how different definitions of value could lead to
different estimates of value; income, market, and asset -based approaches to
private companies valuation and factors relevant to the selection of each
approach
-
Cash flow related to private
company valuation; valuation of a private company using free cash flow,
capitalized cash flow and/or excess earnings methods
-
Factors that require adjustment
when estimating the discount rate for private companies
-
Valuation of private company
using capital asset pricing model (CAPM) , market approach methods and
asset-based approach
-
Role of valuation standards in
valuing private companies
10.10
Emerging Issues and Trends
PAPER
NO. 11 PORTFOLIO MANAGEMENT
GENERAL OBJECTIVE:
This paper is intended
to equip the candidate with the knowledge, skills and attitude that will enable
him/her to apply investment tools in portfolio management
11.0 LEARNING
OUTCOMES
On successful completion of this paper, the
candidate should be able to:
· Apply
various investment strategies to manage a portfolio
· Construct
and manage portfolios of both individual and institutional investors
· Assess
the risk levels of portfolios
· Prepare
investment policy statements
· Apply
behavioural finance concepts in portfolio management
CONTENT
11.1 Overview of portfolio management
-
Definition
of portfolio management and strategies
-
Portfolio
perspective and its importance
-
Steps
of the portfolio management process and the components of those steps
-
Types
of investors, their distinctive characteristics and specific needs
-
Pooled
investment products (mutual funds, exchange traded funds, separately managed
accounts, hedge funds, buyout funds/ private equity funds and venture capital
funds)
-
Definition
of portfolio planning
-
The
investment policy statement (IPS): Major components and its importance
-
Capital
market expectations
-
Investment
objectives: risk and return objectives for a client
-
Investors
financial risk tolerance: investors ability (capacity) to bear risk and willingness
to take risk
-
Investment
constraints: liquidity, time horizon, tax issues, legal and regulatory factors,
unique circumstances, and their effect to the choice of a portfolio
-
Ethical
responsibilities of a portfolio manager
-
Introduction to
asset allocation
-
Measures
of return, their calculation, interpretation, and uses: holding period
return(HPR), average returns (arithmetic average return, geometric average),
time-weighted return, money weighted return, gross return, pre-tax nominal
return, after tax nominal return, real return, leveraged return.
-
Characteristics
of major asset classes used to construct portfolios
-
Portfolio
selection; concept of risk aversion; utility theory
-
The
effect of the number of assets in a multi asset portfolio on the
diversification benefits
11.4 Capital market theory
-
Introduction to modern portfolio
theory
-
Implications of combining a
risk-free asset with a portfolio of risky assets
-
Capital allocation line (CAL) and
capital market line (CML)
-
Systematic and non-systematic
risk
-
Return generating models and
their uses
-
Capital asset pricing model
(CAPM): assumptions; applications; practical limitations; implications
-
Security market line (SML) and
its application, the beta coefficient, market risk premium
-
Market model: predictions with
respect to market returns, variances, and co- variances
-
Adjusted beta and historical
beta: their use as predictors of future betas
-
Minimum variance frontier:
importance and problems related to its instability.
-
Arbitrage pricing theory (APT):
underlying assumptions and its relation to multifactor models, estimation of
expected return on an asset given its factor sensitivities and factor risk
premiums, determination of existence of an arbitrage opportunity and how to
utilise it
-
Understanding and interpretation
of active risk, tracking error, tracking risk, information ratio, factor
portfolio and tracking portfolio
11.5 Active portfolio management: Residual risk
and return
-
Definition of active portfolio
management
-
Alpha and information ratio (IR):
their definition in both post ante and ex ante
-
Relationship between information
ratio and alphas T-statistic
-
The concept of the value added
(VA) and the objective of active portfolio management in terms of value added
-
The optimal level of residual
risk to be assumed with respect to manager ability and investor risk aversion
-
Relationship between the choice
of a particular active strategy and investor risk aversion
11.6 Fundamental law of active management
-
Information coefficient (IC) and
breadth (BR) as used in determining information ratio
-
The 'Fundamental law of active
management’: Definition; assumptions; relationship between the optimal level of
residual risk, information coefficient, and breadth; relationship between the
value added, information coefficient, and breadth
-
Market timing versus security selection
in relation to breadth and investment skill
-
Effect of augmenting original
investment strategy with other investment strategies or information changes
11.7 Behavioural finance
-
Introduction to behavioural
finance: Definition; traditional finance versus behavioural finance
-
Expected utility versus prospect
theories of investment decision
-
Effect of cognitive limitations
and bounded rationality on investment decision making
-
Behavioural biases of
individuals: cognitive errors versus emotional biases; commonly recognised
behavioural biases for financial decision making and their implications;
Individual investor’s behavioural biases; The effects of behavioural biases on
investment policy and asset allocation decisions, and how these effects could
be mitigated
-
Behavioural finance and
investment process: Uses and effects of classifying investors in personality
types; effects of behavioural factors on advisor client interactions; The
influence of behavioural factors on portfolio construction; Application behavioural
finance on portfolio construction process; Effects of behavioural factors on an
investment analyst forecasts and investment committee decision making:
mitigation of these effects
11.8 Managing individual portfolios and
institutional investors:
-
Individual investors: overview
-
Investor characteristics:
situational profiling (source of wealth, measure of wealth, stage of life);
psychological profiling (traditional finance, behavioural finance, personality
typing);
-
Investment policy statement for
an individual investor;
-
Strategic asset allocation for an
individual investor: Monte Carlo simulation in personal retirement planning
Institutional investors: overview
-
Pension funds: defined-benefit
and defined-contribution plans; pension fund risk tolerance; defined benefit
and defined contribution investment policy statement; risk management
considerations; hybrid pension plans; employee share ownership plans;
-
Other institutional investors
.Foundations, endowments, Insurance industry (life and non-life insurance
companies), banks, investment intermediaries and other institutional investors;
their background and investment setting
11.9 Risk management
-
Introduction to risk management
-
The risk management process
-
Types of risks affecting a
portfolio: market risk; credit risk; liquidity risk; operational risk; model
risk; settlement (Herstatt) risk; regulatory risk; legal/ contract risk; tax
risk; accounting risk; sovereign risk and political risk; other risks
-
Measuring risk: market risk;
credit risk; liquidity risk; nonfinancial risks;
-
Value at risk(VaR) as a measure
of risk: advantages and limitations: extensions and supplements
-
Managing risk in portfolio
management context: managing market risk; managing credit risk
11.10 Emerging issues and trends
PAPER NO. 12 QUANTITATIVE ANALYSIS
GENERAL OBJECTIVES
This
papers is intended to equip candidates with knowledge, skills and attitudes
that will enable him/her to use quantitative analysis tools in business
operations and decision making
12.0 LEARNING OBJECTIVES
A
candidate who passes this paper should be able to:
·
Use mathematical techniques in solving
business problems
·
Apply set theory in business decision
making
·
Apply operational research techniques in
decision making
·
Apply simulation techniques in analyzing
situations
CONTENT
12.1 Basic mathematical
techniques
21.1.1
Functions
-
Functions, equations and graphs: linear,
quadratic, cubic, exponential and logarithmic
-
Application of mathematical functions in
solving business problems
12.1.2
Matrix algebra
-
Types and operations (addition,
subtraction, multiplication, transposition, and inversion)
-
Application of matrices; statistical
modeling, Markov analysis, input-output analysis and general applications
12.1.3 Calculus
-
Differentiation
·
Rules of differentiation (general rule,
chain, product, quotient)
·
Differentiation of exponential and
logarithmic functions
·
Higher order derivatives: turning points
(maxima and minima)
·
Ordinary derivatives and their
applications
·
Partial derivatives and their
applications
-
Integration
·
Rules of integration
·
Application of integration to business
problems
12.2 Probability
12.2.1
Set theory
-
Types of sets
-
Set description: Enumeration and
descriptive properties of sets
-
Operations of sets: Union, intersection,
complement and difference
-
Venn diagram
12.2.2 Probability
theory and distribution
Probability theory
-
Definition: Event, outcome, experiment,
sample space
-
Types of events: Elementary, compound,
dependent, independent, mutually exclusive, exhaustive, mutually inclusive
-
Law of probability: Additive and
Multiplicative rules
-
Baye’s Theorem
-
Probability trees
-
Expected value, variance, standard
deviation and coefficient of variation using frequency and probability
Probability distribution
-
Discrete and continuous and continuous
probability distributions (Uniform, normal, binomial, Poisson and exponential)
-
Application of probability to business
problems
12.3 Hypothesis testing and
estimation
-
Hypothesis tests on the mean (when
population standard deviation is unknown)
-
Hypothesis tests on proportions
-
Hypothesis tests on the difference
between means(independent sample)
-
Hypothesis tests on the difference
between means (matched pairs)
-
Hypothesis tests on the difference
between two proportions
12.4 correlation and regression
analysis
Correlation analysis
·
Scatter diagrams
·
Measures of correlation-product moment
and rank correlation coefficients (pearson and spearman)
Regression analysis
·
Sample and multiple linear regression
analysis
·
Assumption of linear regression analysis
·
Coefficient of determination, standard
error of the estimate, standard error of the slope , t and F statistics
·
Computer output of linear regression
·
T-ratios and confidence interval of the
coefficients
·
Analysis of variance (ANOVA)
12.5 Time series
-
Definition of time series
-
Components of time series (circular,
seasonal, cyclical, irregular/random, trend)
-
Application of time series
-
Methods of fitting trend: free hand,
semi-averages, moving averages, least squares method
-
Models-additive and multiplicative
models
-
Measurement of seasonal variation using
additive and multiplicative models
-
Forecasting time series value using moving averages,
ordinary lest squares method and exponential smoothing
-
Comparison and application of forecasts
for different techniques
12.6 linear programming
-
Definition of decision variables,
objective function and constraints
-
Assumptions of linear programming
-
Solving linear programming using
graphical method
-
Solving linear programming using simplex
method
-
Sensitivity analysis and economic
meaning of shadow prices in business situations
-
Interpretation of computer assisted
solutions
-
Transportation and assignment problems
12.7 Decision theory
-
Decision process
-
Decision making
environment-deterministic situations (certainty), analytical hierarchical
approach (AHA), risk and uncertainty, stochastic situations (risks), situations
of uncertainty
-
Decision making under uncertainity
-maxmin, maxmax, minimax regret, Hurwicz decision rule, Laplace rule
-
Decision making under risk-expected
monetary value, expected opportunity loss, minimizing risk using coefficient of
variation, expected value of perfect information
-
Decision trees- sequential decision,
expected value of sample information
-
Limitations of expected monetary value
criteria
12.8 Game theory
-
Assumptions of game theory
-
Zero sum games
-
Pure strategy games (saddle point)
-
Mixed strategy games (joint probability
approach)
-
Dominance, graphical reduction of a game
-
Value of the game
-
Non zero sum games
-
Limitations of game theory
12.9 Network planning and
analysis
-
Basic concepts- network, activity, event
-
Activity sequencing and network diagram
-
Critical path analysis (CPA)
-
Float and its importance
-
Crashing of activity/project completion
time
-
Project evaluation and review technique
(PERT)
-
Resource scheduling (leveling) and Gantt
charts
-
Limitations and advantages of CPA and
pert
12.10 Queuing theory
-
Components/elements of a queue: arrival
rate, service rate, departure, customer behavior, service discipline, finite
and infinite queues, traffic intensity
-
Elementary single server queuing systems
-
Multiple server queues
12.11 Simulation
-
Types of simulation
-
Variables in a simulation model
-
Construction of a simulation model
-
Monte Carlo simulation
-
Random numbers selection
-
Simple
queuing simulation: single server, single channel “ first come first served”
(FCFS) model
-
Application of simulation models
12.12 current developments
-
Role of advancement in information
technology in solving quantitative analysis problems
12.13 Emerging issues and trends
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