CFA Level I Glossary

A

Alpha: Alpha is the excess return of an investment relative to the return predicted by a benchmark or a risk-adjustment model such as CAPM, representing the value added or subtracted by the portfolio manager's decisions.

B

Beta: Beta is a measure of the systematic risk of an asset relative to the overall market, calculated as the covariance of the asset's returns with market returns divided by the variance of market returns. $\beta_i = \frac{\text{Cov}(R_i, R_m)}{\text{Var}(R_m)}$
Black-Scholes-Merton Model: Black-Scholes-Merton model is an options pricing model that calculates the theoretical fair value of European call and put options based on the underlying asset price, strike price, time to expiration, risk-free rate, and volatility of the underlying asset.

C

Capital Asset Pricing Model: Capital Asset Pricing Model (CAPM) is an equilibrium model that describes the relationship between systematic risk and expected return for assets, stating that expected return equals the risk-free rate plus a risk premium proportional to the asset's beta. $E(R_i) = R_f + \beta_i [E(R_m) - R_f]$
Coefficient of Variation: Coefficient of variation is a standardized measure of dispersion calculated as the ratio of the standard deviation to the mean, used to compare the relative risk of investments with different expected returns. $CV = \frac{\sigma}{\mu}$
Convexity: Convexity is a measure of the curvature in the relationship between bond prices and yields, used as a second-order adjustment to duration to improve the accuracy of estimated price changes for large yield movements.
Current Ratio: Current ratio is a liquidity ratio that measures a company's ability to pay short-term obligations, calculated by dividing current assets by current liabilities. $\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$

D

Debt-to-Equity Ratio: Debt-to-equity ratio is a leverage ratio that measures the proportion of a company's total debt relative to shareholders' equity, indicating the degree to which a company is financing its operations through debt versus wholly owned funds. $\text{D/E} = \frac{\text{Total Debt}}{\text{Total Equity}}$
Discounted Cash Flow: Discounted cash flow (DCF) is a valuation method that estimates the value of an investment based on the present value of its expected future cash flows, discounted at an appropriate rate reflecting the investment's risk.
Duration: Duration is a measure of a bond's sensitivity to changes in interest rates, expressed as the approximate percentage change in price for a one-percentage-point change in yield.

E

Earnings Per Share: Earnings per share (EPS) is a profitability metric calculated by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding during the period. $\text{EPS} = \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Weighted Avg. Shares Outstanding}}$
Efficient Market Hypothesis: Efficient Market Hypothesis is the theory that asset prices fully reflect all available information, implying that consistently achieving risk-adjusted excess returns through analysis is not possible. The three forms are weak, semi-strong, and strong.

F

Fiduciary Duty: Fiduciary duty is the legal and ethical obligation to act in the best interest of another party, requiring loyalty, prudence, and care in managing the assets or affairs entrusted to one's charge.
Free Cash Flow to Equity: Free cash flow to equity (FCFE) is the cash flow available to common shareholders after all operating expenses, interest, principal repayments, and necessary capital expenditures have been paid. $\text{FCFE} = \text{NI} + \text{Dep} - \Delta\text{WC} - \text{FCInv} + \text{Net Borrowing}$
Free Cash Flow to the Firm: Free cash flow to the firm (FCFF) is the cash flow available to all providers of capital (debt and equity holders) after accounting for operating expenses, taxes, and necessary investments in working capital and fixed assets. $\text{FCFF} = \text{NI} + \text{Dep} + \text{Int}(1-t) - \Delta\text{WC} - \text{FCInv}$

G

GIPS: Global Investment Performance Standards (GIPS) are a set of voluntary, ethical standards created by CFA Institute for calculating and presenting investment performance results, designed to ensure fair representation and full disclosure.
Gordon Growth Model: Gordon Growth Model is a dividend discount model that values a stock as the present value of future dividends growing at a constant rate in perpetuity. $V_0 = \frac{D_1}{r - g}$

I

Information Ratio: Information ratio is a risk-adjusted performance measure calculated as the ratio of a portfolio's active return (excess return over the benchmark) to the tracking error (standard deviation of active returns). $\text{IR} = \frac{R_p - R_b}{\sigma_{(R_p - R_b)}}$
Internal Rate of Return: Internal rate of return (IRR) is the discount rate at which the net present value of all cash flows from an investment equals zero, representing the annualized rate of return expected from the investment.

M

Money-Weighted Rate of Return: Money-weighted rate of return is the internal rate of return on a portfolio, accounting for the size and timing of all external cash flows, making it sensitive to the timing of investor contributions and withdrawals.

N

Net Present Value: Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time, used to evaluate the profitability of an investment or project.

P

Price-to-Earnings Ratio: Price-to-earnings ratio (P/E) is a valuation metric that compares a company's current share price to its earnings per share, indicating how much investors are willing to pay per unit of earnings. $\text{P/E} = \frac{\text{Price per Share}}{\text{EPS}}$
Put-Call Parity: Put-call parity is a fundamental relationship in options pricing that defines the equivalence between a portfolio of a European call and a risk-free bond to a portfolio of a European put and the underlying asset. $c + \frac{X}{(1+r)^T} = p + S_0$

Q

Quick Ratio: Quick ratio (acid-test ratio) is a liquidity ratio that measures a company's ability to meet short-term obligations using its most liquid assets, excluding inventory from current assets. $\text{Quick Ratio} = \frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}}$

R

Return on Assets: Return on assets (ROA) is a profitability ratio that measures how efficiently a company uses its total assets to generate net income. $\text{ROA} = \frac{\text{Net Income}}{\text{Average Total Assets}}$
Return on Equity: Return on equity (ROE) is a profitability ratio that measures the return generated on shareholders' equity, indicating how effectively management uses equity capital to generate profits. $\text{ROE} = \frac{\text{Net Income}}{\text{Average Shareholders' Equity}}$

S

Sharpe Ratio: Sharpe ratio is a risk-adjusted performance measure calculated as the excess return of a portfolio over the risk-free rate divided by the portfolio's standard deviation of returns. $S = \frac{R_p - R_f}{\sigma_p}$
Standard Deviation: Standard deviation is a statistical measure of the dispersion of returns around the mean, used in finance as the primary measure of total investment risk.
Systematic Risk: Systematic risk (market risk) is the inherent risk affecting all securities in the market that cannot be eliminated through diversification, arising from macroeconomic factors such as interest rate changes, inflation, and political instability.

T

Time-Weighted Rate of Return: Time-weighted rate of return is a method of calculating portfolio performance that eliminates the effect of external cash flows by geometrically linking sub-period returns, making it the preferred measure for evaluating portfolio manager skill.
Treynor Ratio: Treynor ratio is a risk-adjusted performance measure calculated as the excess return of a portfolio over the risk-free rate divided by the portfolio's beta, measuring return earned per unit of systematic risk. $T = \frac{R_p - R_f}{\beta_p}$

U

Unsystematic Risk: Unsystematic risk (idiosyncratic risk) is the risk specific to an individual security or company that can be reduced or eliminated through diversification, arising from factors such as management decisions, product recalls, or competitive pressures.

W

Weighted Average Cost of Capital: Weighted average cost of capital (WACC) is the average rate of return a company must earn on its existing assets to satisfy all providers of capital, weighted by the proportion of each type of capital in the firm's capital structure. $\text{WACC} = w_d\,r_d(1-t) + w_e\,r_e$

Y

Yield Curve: Yield curve is a graphical representation of the relationship between yields and maturities of similar-quality bonds at a given point in time, with common shapes being normal (upward sloping), inverted, and flat.

A

B

C

D

E

F

G

I

M

N

P

Q

R

S

T

U

W

Y

About FreeFellow