Turns out, fairly pedestrian stuff. There's a reading on leverage (operating, and financial), a chapter on WACC, a chapter on NPV and other methods of valuing projects. The biggest issue here is going to be definitions, and making sure those are well-understood. There's also a section on corporate governance, which is completely qualitative, and appears to be mostly common sense mixed with a little experience.

Most of the three quantitative chapters are "Optional," and while this is stuff we had covered in class, the CFA seems to think that, for Level I, at least, the material isn't necessary to pass the exam.

The Portfolio section is expectedly disappointing. There's a basic section on asset allocation, and then two most chapters based on Markowitz and CAPM. Both of these theories rely on the clearly untrue notion that price movements are normal, and that price levels and log-normal. The whole exercise has the air of medieval medicine, or maybe modern social sciences, where you have to score points by repeating back orthodoxies.

Still, the good news is that I should be able to work through the corporate problems today, the portfolio problems tomorrow, and I will have knocked off a whole book (#4) in two days.

Companies are given two choices for this statement: the direct method and the indirect method. Both methods break cash down into three groupings: operations, financing, and investment. It's in the Operations section that things differ.

The direct method works like your checkbook, beginning with the starting balance and ending with, well, the ending balance. The indirect method starts with Net Income and then backs out cash flow from operations. First of all, it reverses all the signs, so things that cost cash are positive and things that produce cash are negative. Secondly, it means that you may be reconciling with non-existent lines on the income statement. (Many income statements have an net income from operations, but not a cash flow from operations.) Finally, it's working backwards.

So what's with the title of the post? Well, it turns out that there's a certain amount of - latitude - in cash flow categorization. The book notes that a number of companies engage in receivable secrutization, in effect selling their receivables as a security. They have a record of collections, so other companies are willing to pay them now for the hamburger they'll get on Tuesday.

The problem is that the rules are unclear whether the income from that security belongs under the Financing section (because it's basically issuing debt secured by the receivables) or the Operations section (because the income eventually comes from receivables). Because of this, many companies net it our vs. increases in receivables and put it under the Operating Cash Flows. This almost certainly over-values the company, since OCF/NI and OCF/Sales, FCF/Market Cap are commonly used metrics.

The first two readings are about trade,. the value of free trade, \Why Tariffs Are Baaaad, balance of payments, that sort of thing.

The second two are about exchange rates, and really could have been condensed into one. It's the return of actual math, with real equations and problems and everything. But if you've made it this far, the only equations that won't be obvious are interest rate (or inflation rate) parity and the bid-ask spread.

Even though the formula isn't obvious, the idea behind interest rate parity is. Basically, if I can get 5% on my dollars and 0% on my yen, by the end of the year, the yen will be worth 5% more vs. the dollar. Figuring out what goes on with exchange rates is about 75% guesswork and witchcraft, But within that other 25%, interest rate parity is about as close to ontological certainty as we can get.

The bid-ask spread is one of those practical things, but they make it much more difficult than it needs to be. Bssically, the rule of thumb is that you use whatever number is most advantageous for the bank, and least advantageous to you. Surprised? I thought not.

Suppose this is the bid-ask table for the dollar vs. the Hungarian Forint. The Forint isn't the most liquid currency in the world, so even though the bank shares office space with the local consulate, the spread's pretty big:

The book would say that the rate that's used is the direct Ask and the indirect Bid. I would say that the bank's going to give you as few Forints for as many Dollars as it can. And vice-versa. For the bank, there's always an arbitrage opportunity. That way, when you get to the test and have to work out which is which, you can reason it out.

The Phillips Curve example is more ink-blot dynamics than market dynamics. Take a look at his chart:

I've colored in the dots for his groupings in time, and I've been exceedingly generous, coloring them in for his groupings. And they still don't work! The lines he's got remind me of the imagination that produced the northern constellations. (Yeah, that looks like a lion...sort of...a little....Oh, wait! You say the head's at the other end?) If I really wanted to be mean, I'd say let's lump the yellow, red, and green dots together for an unbroken 20-year run of positive correlation.\

And what's this with lumping 81 and 75 together, ignoring both 1980 and the 1982-83 peregrination? The 70s seem to hang together well enough, until you see that 1975 gets a Curve of Its Own. I suppose the author could claim that the green 1990s dots are the transition from one curve to another, but if so, they're the only one. Every other jump from curve to curve is in one year.

The one curve that really does work is curve A, the 1960s. Which is when the theory was formed, probably why it was formed then. The curve really should just ignore monetary inflation and focus on business-cycle price changes. It would then operate more like a four-stroke engine, as well as actually making sense. There clearly is a short-term negative correlation between price changes and unemployment. But the sort of broad, sweeping general application produced through narrowly-squinted eyes and heavy drinking has long ceased to inform the Fed.

Illiteracy about macroeconomics leads people to assume that price rises mean inflation. Inflation is a monetary phenomenon. Illiteracy about microeconomics leads people to ignore how poorly gate space is allocated at DIA. Gates are not offered by competitive bid, leading to all sorts of market distortions. Historically, I would guess that micro-illiteracy is dangerous all the time, while macro-illiteracy is mostly dangerous on four- and two-year cycles.

But when politicians talk about 'windfall' taxes on oil companies, then complain about lack of slack in refinery capacity, or when they shut down drilling on the Roan Plateau, then complain about natural gas prices, it's dangerous micro-illiteracy. Or demagoguery taking advantage of it, which amounts to the same thing.

In discussing the depredations of price caps, they look at the housing market after the San Francisco earthquake. After the quake, there were no rent controls, and there was - voila! - no housing shortage. Owners could charge what they liked, which encourage people to build housing. True, they point out, the government could have imposed rent control, and then passed laws against charging afew hundred dollars for drapes, but the cost of enforcement wouldn't have justified it. Not understanding this sort of thing let Bill Mauldin to wonder why housing wasn't available in postwar NY for the returning soldiers.

Just because they're reasonable doesn't mean they're right. They discuss whether monopolies may actually be more innovative than competitive environments. While they seem to accept the idea that monopolies are less innovative, they also claim that economies of scale make larger companies better at adopting and propagating innovation. There may be some truth to that in certain cases, but only in cases where they're kept sharp by competition. And even then, remember that very Fortune 500 companies from 1980 are still there today.

Right.

The fact is, companies may not be able to pass taxes along to customers. Customers may not be willing to pay them. We've gotten used to the idea that certain costs can just be passed along to clientele. A fertilizer company I covered briefly used to talk about transportation costs as a pass-through, meaning they just tacked on a transportation charge to the farmers. A specialty alloy company I covered used to talk about the cost of copper as a pass-through; they routinely mentioned the fact that they were able to pass 90% of the cost on to customers.

The can (or could) do this because the demand for their product didn't depend much on price. The technical term for this was that the demand was, "inelastic." Conservatives, when they talk about individuals paying taxes, are often treating demand as though it were inelastic. Meaning that companies will just pass the cost along. This may be true for a few products, but not many, and people are very good at finding substitutes. (Liberals like Chuck Schumer are just clueless; they think corporate taxes are cost-free. Others are a little smarter, and they assume the corporate demand for labor is inelastic. They're both very wrong.)

In fact, both individuals and corporations pay taxes. If demand is normal, companies will be able to pass along some, but not all, of the tax. People pay to the extent they're willing to, and companies to the extent they're willing to. Without the tax, consumers could buy more of the product, and companies could sell more of it.

I've fallen victim to the sort of conservative reasoning above myself, when it comes to Social Security and Medicare/Medicaid taxes. I had always more or less modeled my thought on my own experience paying the emploeyer's portion - as tghe "self-employment tax." I figured that if a company didn't have to pay its portion of the payroll tax, then I'd see all or most of that in my salary. And I, being in a high-demand industry like programming, probably would have. From my own experience as an independent contractor, my demand for my own labor was fairly inelastic - I wanted as much work as I could get.

In fact, for most workers, the amount of that payroll tax they would see would probably fluctuate, depending on the market conditions for their labor.

You're all ready to start studying. You've got your nice shiny new books lined up on the shelf. You've looked through the smartly-organized course of studies. You're dragging out notes from b-school and trying to remember which order derivative bond curvature is. And the first thing you're confronted with is the law.

OK, not really the law, usually. But same thing: ethics. It's interesting in a Talmudic sort of way. Still, it lacks context. I know why they place it up front, to show how important it is. And of course, ethics are important. The whole point of having a CFA in the first place is to denote trustworthiness. But frankly, it makes much more sense at the end. After having reviewed the material, I'll have more context for these rules, and it'll be easier to remember them. Each rule, each type of rule, will have a place in the structure that I can attach it to.

It's also the only part of the course that's actually new material. (Except for the Economics, if you went to DU's graduate program.) It'll be easier to remember at the end than at the beginning.

Which is why I'm saving it for last.

The fact is, the calcuator will do most of this for us, anyway. What it won't do is tell us which test is appropriate for which type of data. And that's really what the exam ought to be testing, anyway.

OK, not really, but the first few readings focus on this simple equation: compound interest, and how to make it flow in both directions.

Basically, it lets you take money flows for any period into the future and compare them. One of the obvious uses is to compare projects using something called Net Present Value. The initial investment (and any subsequent investments) are negative cash flows, while the returns are positive cash flows. Discount them back to today, and see what the total are. Then, pick the project that has the highest value.

The CFA also teaches something called the Internal Rate of Return, or the effective interest rate that a project's investment would appreciate at over the life of the project. It's a more complex calculation, and interestingly, because it's much more sensitive to assumptions. It's completely unclear what value this calculation is, since we're told to ignore it when it disagrees with Net Present Value.

One of the major problems is that the study classes are all on Saturday, so I'm going to look for one that sacrifices a weeknight rather than weekends.