60 Series 16 Part 2 Exam Concepts You Need to Know Before Test Day

Your first review job is provenance. Every figure in a research report must carry a label telling the reader where it came from: company-reported, analyst-estimated, or third-party supplied. Company filings and the subject company itself are fair game, but vendor data is different. Subscription services typically license data for internal use only, and many prohibit redistribution or require attribution. If an analyst drops a consensus estimate or a pricing feed into a published report without the firm having redistribution rights, the report fails review even if every number is accurate. The Supervisory Analyst checks the sourcing footnotes, confirms the labels match the data, and verifies the firm actually holds permission before approving anything for publication.

Memory hook:No label, no license, no report — accuracy alone never clears third-party data.

Every number an analyst presents must trace back somewhere. Revenue, EPS, margins, and share counts in the report's text and tables should tie to the company's financial statements or to clearly labeled adjusted figures. Your review is a reconciliation exercise: pull the latest filing, recompute the ratios yourself, and confirm the report's summary table matches the narrative. Watch for stale data, transposed digits, and mixed periods — fiscal year figures quoted beside calendar year comparisons. Where the analyst uses an adjusted number, the adjustment must be disclosed and the underlying GAAP figure identifiable. A stated EPS that does not match the income statement is a defect you are expected to catch before publication, not after.

Memory hook:Every number traces to the statements or carries a visible adjusted label.

Market data errors are the most visible errors in a research report, so you verify them independently. Price, trading volume, 52-week high and low, dividend, yield, and market capitalization should be checked against a credible source as of a stated date. Two recomputations catch most problems: market cap equals price multiplied by shares outstanding, and yield equals annual dividend divided by price. A market cap built on a stale price or an outdated share count is a classic defect, especially after a secondary offering or buyback. Also confirm the 52-week range is genuinely the trailing 52 weeks and that the data date is disclosed, since readers must know when the snapshot was taken.

Memory hook:Price times shares equals cap; dividend over price equals yield — recompute both.

A rating and a price target are two expressions of one conclusion, so they must agree. Compute the implied upside: target minus current price, divided by current price. If the target sits below the current price, a Buy rating is incoherent; if the target implies enormous appreciation, a Hold looks arbitrary. Then verify the target's construction. A multiple-based target should apply a multiple to the report's own published estimate, not to a different figure buried elsewhere. A discounted cash flow target should use the growth and discount assumptions the report actually states. When the inputs and the conclusion point in different directions, the report fails review regardless of how polished the writing is.

Memory hook:Target minus price, over price — the implied upside must match the rating.

Projections are opinions, but they must be defensible ones. Review growth assumptions against the company's history, industry trends, capacity constraints, and any company guidance. A revenue forecast growing far faster than anything the firm has achieved needs support in the report itself. Estimate changes get separate scrutiny: when an analyst revises an earnings estimate, the report must explain what changed and why — a new contract, a margin reset, a regulatory hit. A revision with no stated rationale fails review because the reader cannot evaluate the analyst's reasoning. Your job is not to second-guess the number itself but to confirm the assumptions are articulated, plausible, and consistent with the rest of the report's analysis.

Memory hook:Every changed estimate needs a stated reason the reader can follow.

The valuation method must actually produce the recommendation. If a discounted cash flow or multiple-based valuation implies a value below the current price, a Buy rating has no support, no matter how enthusiastic the prose. Review the method chosen, confirm the inputs are the ones the report discloses, and check the conclusion follows from them. Then read the report against itself: the summary, body, tables, risk discussion, and rating must all point the same way. A report that highlights deteriorating margins in the text while raising estimates in the table is internally inconsistent and fails review. The recommendation is the last thing you approve, because everything before it either supports it or does not.

Memory hook:Thesis, tables, and rating must all point the same direction.

The income statement is built on accrual logic: revenue is recognized when earned and realizable, not when cash arrives, and expenses are matched to the period that benefits from them. The structure runs in tiers. Revenue minus cost of goods sold gives gross profit. Subtract operating expenses and you reach operating income, the core profitability measure. Below the line sit interest expense, other income, and taxes, arriving at net income. Nonrecurring items — asset sale gains, restructuring charges — belong below operating income so the operating tier reflects the ongoing business. When reviewing a report, check that the analyst has not buried a one-time gain inside operating results, inflating the number the market actually watches.

Memory hook:Revenue when earned, expenses when matched — everything else is line placement.

The statements interlock, and the linkage is where errors surface. Net income closes into retained earnings, so ending retained earnings equals beginning retained earnings plus net income minus dividends declared. That single equation ties the income statement to the balance sheet: if the report's net income does not explain the change in retained earnings, something is missing, usually a dividend. The balance sheet also balances by construction — assets equal liabilities plus equity — because every transaction touches at least two accounts. For a Supervisory Analyst, articulation is a verification tool. When a report quotes equity, retained earnings, and net income, you can check whether those figures could plausibly come from the same set of books.

Memory hook:Beginning retained earnings plus income minus dividends equals the ending balance.

The indirect method starts where the income statement ends: net income. From there you undo accrual accounting. Add back non-cash charges such as depreciation and amortization. Remove non-cash gains and add back losses. Then adjust for working capital: increases in receivables or inventory consume cash and get subtracted; increases in payables supply cash and get added. The result is operating cash flow. Investing activities cover capital spending and asset purchases; financing covers debt, stock issuance, and dividends. The three sections sum to the net change in cash, which must equal the change in the cash balance on the balance sheet. A company reporting profits while operating cash bleeds out is the classic earnings-quality warning.

Memory hook:Start at net income, undo the accruals, land on cash.

Four opinion types, ranked by severity. An unmodified opinion is clean: statements fairly present the financial position. A qualified opinion flags a material but contained problem — either a GAAP departure or a scope limitation confined to specific accounts. An adverse opinion says departures are material and pervasive; the statements cannot be relied on. A disclaimer means the auditor could not gather enough evidence to opine at all. Going concern is different: it is an explanatory paragraph added when substantial doubt exists about the entity surviving a year, and it does not by itself change the opinion type. An emphasis-of-matter paragraph similarly highlights something without altering the opinion. Read the opinion before trusting any figure in the filing.

Memory hook:Unmodified is clean, qualified excepts, adverse disagrees, disclaimer cannot say.

The financial statements tell you what; the footnotes tell you how and what is hidden. Accounting policies — inventory method, revenue recognition, depreciation lives — live there. So do the items that never appear as balance sheet line items: operating lease commitments, guarantees, purchase obligations, contingent liabilities from litigation, and related-party transactions. Debt terms, covenant details, and segment results are disclosed there too. The auditor covers the footnotes, which gives them reliability the MD&A lacks. For a Supervisory Analyst, the footnotes are where you check whether an analyst's adjusted numbers are legitimate — the footnote on that restructuring charge or lease obligation is the evidence that supports or undermines the adjustment.

Memory hook:The statements show the tip; the footnotes show the iceberg.

The MD&A is management's own narrative explaining the period's results, liquidity, capital resources, and known trends and uncertainties. It is unaudited, but it is reviewed by the SEC and it is where management must explain why margins moved, where cash came from, and what risks it sees ahead. That makes it a review tool in two directions. First, it tells you what management itself blames for a revenue decline or margin compression, which you can compare against an analyst's explanation. Second, its forward-looking statements about trends and uncertainties are exactly the raw material a research report's projections should be tested against. If an analyst forecasts a rebound the MD&A gives no basis for, question it.

Memory hook:MD&A is management explaining the numbers — unaudited, but revealing.

Raw reported figures are often not comparable across periods or peers, so analysts adjust — and your job is to police the adjustments. For operating income, strip out nonrecurring items: gains on asset sales, restructuring charges, litigation settlements, impairments. The goal is an operating figure that reflects the ongoing business. For sustainable cash flow, normalize by removing one-time cash effects and non-cash charges, and consider whether working capital swings are temporary or structural. The discipline is threefold: the adjustment must be genuinely nonrecurring, it must be labeled, and it must be applied consistently across all periods shown. An analyst who adjusts the current quarter but not the prior one is manufacturing a growth trend that does not exist.

Memory hook:Strip the one-timers, label what is left, apply it to every period.

How a parent accounts for another entity determines what shows up in its statements. Consolidated subsidiaries are folded in line by line, with noncontrolling interests carved out so equity reflects only the parent's share. Equity-method investments — typically where the holder has significant influence but not control — appear as a single investment line plus a share of income, not the underlying revenue and assets. Foreign operations add a translation step: subsidiary results are converted to the parent's currency before consolidation, so reported growth blends real performance with currency movement. When comparing companies, check whether the analyst has matched the accounting — comparing a consolidator's revenue against an equity-method holder's is meaningless.

Memory hook:Consolidate control, equity the influence, translate the foreign.

Per-share figures are only comparable if the share count is consistent, so splits and stock dividends require retroactive restatement of all historical per-share data. After a 2-for-1 split, prior-year EPS is divided by two; otherwise the chart shows a fake earnings collapse. Stock dividends work the same way because they increase the share count without changing the company. Cash dividends are different: they do not change shares outstanding, so no per-share restatement is needed. They reduce retained earnings and cash, and they feed the yield calculation, but the EPS history stands as reported. When reviewing a report, check that any split during the comparison period was applied backward through every per-share figure shown.

Memory hook:Split the shares, rewrite the history; pay cash, leave the count alone.

Non-GAAP measures — adjusted EPS, EBITDA, core earnings — are permitted in research, but Regulation G fences them in. Any non-GAAP figure must be reconciled to the most directly comparable GAAP measure, showing clearly how the company got from GAAP to the adjusted number. The GAAP measure cannot be presented with less prominence than the non-GAAP one, and the non-GAAP measure must be labeled as such. Reconciling items also cannot be presented in a way that misleads, and adjustments for normal, recurring cash operating expenses raise particular concern. For the Supervisory Analyst, the checklist is: is there a reconciliation, is the GAAP figure at least equally prominent, and are the exclusions genuinely nonrecurring?

Memory hook:Non-GAAP rides only with a reconciliation ticket, and never in the front seat.

Basic EPS equals income available to common shareholders divided by weighted-average shares outstanding, weighted by the time each share was outstanding during the period. Diluted EPS asks what happens if potential shares become real. The treasury stock method handles options and warrants: assume exercise, use the proceeds to buy back shares at the average price, and add the net new shares. The if-converted method handles convertibles: add the shares and add back the interest expense to the numerator. Diluted EPS is always less than or equal to basic. In a report, the share count must be consistent everywhere — the EPS table, the market cap, and the per-share book value should all draw on the same share figure.

Memory hook:Weight shares by time; options get treasury stock, convertibles get if-converted.

Both ratios measure short-term liquidity, but they draw the line in different places. The current ratio is all current assets over current liabilities — everything expected to convert to cash within a year counts, including inventory and prepaid expenses. The quick ratio, or acid test, strips out what cannot be quickly converted at near book value: quick assets equal cash, marketable securities, and receivables, divided by current liabilities. The gap between the two ratios is diagnostic. A company with a comfortable current ratio but a weak quick ratio is leaning on inventory — fine for a grocer, alarming for a manufacturer of slow-moving goods. When reviewing a report, check which ratio the analyst used and whether the choice suits the industry.

Memory hook:Quick subtracts what you cannot quickly sell — inventory first, prepaids too.

The cash collection cycle measures how long a dollar is tied up between paying suppliers and collecting from customers. Build it from three turnover ratios. Receivables turnover equals sales divided by average receivables; days sales outstanding equals 365 divided by that turnover. Inventory turnover equals cost of goods sold divided by average inventory; days inventory outstanding equals 365 over that. Payables turnover uses cost of goods sold over average payables, giving days payables outstanding. The cycle equals DSO plus DIO minus DPO — collection days plus inventory days, less the time suppliers finance you. A lengthening cycle means cash is draining into working capital, which is a warning even when reported profits look fine.

Memory hook:Sales drive receivables; COGS drives inventory and payables; cycle = DSO + DIO − DPO.

Both ratios measure efficiency: how much revenue each dollar of funding generates. Asset turnover equals sales divided by total assets; equity turnover equals sales divided by shareholders' equity. A high asset turnover says the business squeezes substantial revenue from a lean asset base — typical of retailers and distributors. A low turnover suggests heavy assets relative to sales, common for utilities and manufacturers, which is fine only if margins compensate. The two ratios connect through leverage: since assets exceed equity in a levered firm, equity turnover always runs higher than asset turnover. This is also the middle gear of the DuPont framework — return on equity equals net margin times asset turnover times the equity multiplier.

Memory hook:Sales over assets, sales over equity — efficiency per dollar, the DuPont middle gear.

The margin ladder walks down the income statement, and each rung is a specific line item divided by revenue. Gross margin = (Revenue - COGS) / Revenue, isolating production and pricing power. Operating margin = EBIT / Revenue, adding SG&A and depreciation. Pre-tax margin = EBT / Revenue, adding interest expense. Net margin = net income / Revenue, adding taxes. The value is in the gaps: a stable gross margin with a shrinking operating margin tells you overhead is the problem, not pricing or input costs. A widening gap between pre-tax and net signals a tax anomaly worth checking. Always compare the same rung across companies.

Memory hook:Gross covers production, operating adds overhead, pre-tax adds interest, net adds taxes — each rung over revenue.

EBIT margin = EBIT / revenue; EBITDA margin = EBITDA / revenue, where EBITDA = EBIT plus depreciation and amortization. Because EBITDA strips out non-cash D&A, it is handy for comparing operating efficiency across firms with different asset ages or capital intensity, and for capital-intensive businesses where depreciation swamps operating results. The manipulation risk is real: EBITDA ignores the very real cost of replacing worn-out assets, so it flatters heavy-capex companies, and management adjustments can quietly add back recurring items. Never treat EBITDA as cash flow or earnings. If a report quotes only EBITDA, ask what the D&A figure is hiding.

Memory hook:EBITDA adds back depreciation — the cost that never actually goes away.

Interest coverage = EBIT / interest expense, and it answers one question: how many times could operating earnings pay the interest bill? Coverage of 5x means a 20 percent drop in EBIT still covers interest; coverage near 1x leaves no cushion. Higher is safer, and the trend matters more than the snapshot — coverage sliding from 6x to 2x is a warning even if 2x still looks passable. Some analysts use EBITDA in the numerator, which produces a higher, more forgiving number for capital-intensive issuers. As a reviewer, check which numerator the report uses and confirm the figure reconciles to the income statement before relying on the solvency conclusion.

Memory hook:Coverage asks one question: how many times can EBIT pay the interest bill?

Debt-to-capital = total debt / (total debt + equity); debt-to-equity = total debt / equity. Both measure leverage, but debt-to-capital is bounded between 0 and 1 while debt-to-equity has no ceiling, so a debt-to-capital of 0.5 equals a debt-to-equity of 1.0. The long-term variants exclude short-term borrowings and current maturities, which makes them look lower and focuses on permanent capital structure. Total variants capture everything, including commercial paper and the current portion of long-term debt. When checking a report, first confirm which variant is used, then confirm consistency: if the report switches between total and long-term figures across pages, the comparison is not apples to apples.

Memory hook:Debt-to-capital tops out at 100 percent; debt-to-equity has no ceiling.

ROA = net income / total assets; ROE = net income / shareholders' equity. The DuPont decomposition splits ROE into three drivers: ROE = (net income / sales) x (sales / assets) x (assets / equity) — net margin, asset turnover, and the equity multiplier. That third term is pure leverage. Two companies can post identical 15 percent ROEs while one earns it through fat margins and the other through heavy borrowing, and the second carries far more risk. DuPont tells you where the return actually comes from. When reviewing a report that touts a strong ROE, decompose it into the three parts before accepting the conclusion.

Memory hook:ROE = margin times turnover times leverage — three levers, one return.

ROIC = NOPAT / invested capital, where NOPAT = EBIT x (1 - tax rate) and invested capital is typically debt plus equity minus cash. The ratio only means something against the cost of capital: if ROIC exceeds the weighted average cost of capital, each dollar invested adds value; if it falls short, growth actually destroys value, so a fast-growing company can still be a poor investment. That is the decision rule analysts apply when judging whether expansion is worth funding. The common error is comparing ROE or ROA to the cost of capital — both are contaminated by leverage and cash balances. Use after-tax operating profit over operating capital, then compare to the hurdle.

Memory hook:ROIC must clear the WACC hurdle, or growth destroys value.

Leverage is measured in degrees. Degree of operating leverage: DOL = percentage change in EBIT / percentage change in sales — fixed costs magnify sales swings into bigger EBIT swings. Degree of financial leverage: DFL = percentage change in EPS / percentage change in EBIT — interest magnifies EBIT swings into bigger EPS swings. Degree of total leverage: DTL = DOL x DFL = percentage change in EPS / percentage change in sales. A firm with high fixed costs and heavy debt can see EPS move several times as fast as revenue. The chain matters: operating leverage runs from sales to EBIT, financial leverage runs from EBIT to EPS, and total leverage is the product of the two.

Memory hook:Sales to EBIT is operating; EBIT to EPS is financial; total is the product.

Inventory method determines which costs flow to COGS. In rising prices, LIFO sends the newest, most expensive units to COGS, so reported earnings and ending inventory are lower — and taxable income is lower, which is why many US firms adopted it. FIFO sends the oldest, cheapest units to COGS, producing higher earnings and a higher, more current inventory balance. Falling prices reverse every effect. Note the boundary: US GAAP permits LIFO, IFRS does not, so cross-border comparisons require adjustment. When reviewing a report that compares a LIFO reporter to a FIFO reporter, the analyst must restate one to the other's basis or the margin comparison is meaningless.

Memory hook:LIFO pushes the newest, priciest costs into COGS first — rising prices mean cheaper profits.

Depreciation is a timing choice, not a total-cost choice: every method expenses the same amount over the asset's life. Straight-line spreads it evenly, so early-year earnings and book value run higher. Accelerated methods such as double-declining balance front-load expense, depressing early earnings and book value but deferring taxes — cash the company keeps in the meantime. The earnings effect reverses in later years when accelerated expense falls. For comparability, an analyst reviewing two firms must check whether the same method and useful lives are used; a switch to longer lives or straight-line mid-stream is a classic earnings-quality flag because it boosts reported profit without changing the underlying assets.

Memory hook:Accelerated depreciation front-loads expense — same total, different timing.

Effective tax rate = income tax expense / pre-tax book income — not the statutory rate. The gap comes from two sources. Permanent differences, like certain credits or non-deductible expenses, never reverse and simply move the effective rate. Temporary differences reverse over time and create deferred taxes: accelerated tax depreciation creates a deferred tax liability because book income exceeds taxable income now, while net operating losses create deferred tax assets usable as future deductions. Watch for rate changes too — a statutory change remeasures deferred balances through income. When a report forecasts earnings, check that the assumed tax rate matches the company's actual effective rate and that any difference is explained.

Memory hook:Effective rate: tax expense over pre-tax income; temporary differences defer, permanent differences stay.

Finite-life intangibles are amortized over their useful lives, but indefinite-lived intangibles and goodwill are not amortized — they sit on the balance sheet and are tested for impairment annually or when a triggering event occurs. Goodwill arises only in acquisitions: it is the excess of purchase price over the fair value of identifiable net assets. Impairment testing compares carrying value to fair value; a shortfall forces a write-down that hits earnings, often as a large non-operating charge. For earnings quality, recurring impairments are a red flag — they suggest management overpaid and that reported returns on past deals were overstated. Check the footnotes for the impairment assumptions.

Memory hook:Goodwill never amortizes — it waits for the impairment test.

Consolidation applies when the parent controls the subsidiary — generally more than 50 percent of voting shares. The statements then include 100 percent of the subsidiary's revenue, expenses, assets, and liabilities, even though the parent owns less than that. The portion owned by outsiders is noncontrolling interest: a separate equity line on the balance sheet, and on the income statement net income attributable to noncontrolling interest is deducted so the bottom line reflects only the parent's shareholders. The reviewing rule is simple: per-share figures, EPS, and ROE must be built from income attributable to the parent, not consolidated net income. Reports that skip this step overstate per-share results.

Memory hook:Consolidate everything, then peel off the minority slice.

In an acquisition, the acquirer records the target's assets and liabilities at fair value, not book value. Goodwill is the residual: purchase price minus fair value of identifiable net assets. Two consequences follow. First, stepped-up asset values generate higher depreciation and amortization afterward, which drags combined earnings — so pro forma comparisons must reflect purchase accounting, not just the target's historical numbers. Second, a large goodwill balance is a standing impairment risk if the deal underdelivers. Transaction costs are expensed as incurred. When a report projects post-merger earnings, verify that the D&A step-ups and any planned impairments are in the model rather than ignored.

Memory hook:Pay above fair value and the excess sits as goodwill, waiting to be tested.

Pension expense is built from pieces: service cost (benefits earned this year, a compensation expense), plus interest cost on the projected benefit obligation, minus the expected return on plan assets, plus or minus amortization items. The soft spot is the expected return: companies choose that assumption, and a higher expected return lowers pension expense even when actual returns disappoint. The difference between actual and expected return does not hit current earnings — it accumulates in other comprehensive income, smoothing reported results. When reviewing a company that changed its expected return or discount rate assumptions, ask why, because assumption tweaks can manufacture earnings improvements without any operational change whatsoever.

Memory hook:Service plus interest minus expected return — the assumption that flatters the expense.

Under GAAP, stock options are compensation expense, measured at fair value on the grant date and recognized over the vesting period — so reported earnings already bear the cost. For diluted EPS, the treasury stock method assumes option proceeds are used to repurchase shares at the average market price: incremental shares = shares from options minus shares repurchased with the proceeds. Only the leftover shares are added to the share count, and only if the result is dilutive; anti-dilutive options are excluded entirely. The common error is adding all option shares without the buyback offset, which overstates dilution and understates diluted EPS. Check that the diluted share count reconciles with the reported EPS.

Memory hook:Treasury stock method: take the proceeds, buy back shares, add the leftovers.

Price elasticity of demand = percentage change in quantity demanded / percentage change in price. The threshold is 1: if the magnitude exceeds 1, demand is elastic and a price increase cuts total revenue (price up, revenue down); below 1, demand is inelastic and a price increase raises total revenue. Unit elastic means revenue stays flat. Elasticity runs higher when substitutes are plentiful, the good is discretionary, the budget share is large, or the time horizon is longer. This is classic exam logic: a report says a firm raised prices and revenue fell sharply — that single fact tells you demand is elastic, no calculation needed.

Memory hook:Price up, revenue down means elastic; price up, revenue up means inelastic.

Structure turns on the number of sellers and the ease of entry. Pure competition: many sellers of identical products, firms are price takers, and free entry erodes economic profit toward zero in the long run. Monopoly: one seller, high barriers, the firm is a price maker and can sustain above-market margins until the barriers fall. Oligopoly: a few large, interdependent sellers, where one firm's pricing move forces rivals to respond — hence kinked demand curves, price wars, and the temptation to collude. For an analyst, the practical question is always the same: what protects margins, and for how long? Barriers to entry are the answer.

Memory hook:Many sellers take the price; one sets it; few watch each other.

Fiscal policy is government spending and taxation. Expansionary policy — more spending, lower taxes — shifts aggregate demand to the right, raising output and employment in the short run, with inflation pressure if the economy is near capacity. Contractionary policy shifts demand left and cools activity. Supply-side effects work through aggregate supply: tax changes that alter incentives to work or invest can shift AS. Two second-order effects matter: the multiplier magnifies the initial spending change, and crowding out can offset it — government borrowing pushes up interest rates and squeezes private investment. When a report claims fiscal stimulus will lift a sector, check whether it accounts for crowding out and the economy's remaining slack.

Memory hook:Spend more, tax less, and demand shifts right.

The chain runs deficits to rates to inflation. A larger budget deficit means more government borrowing, which bids up demand for loanable funds and pushes interest rates higher — crowding out private borrowers. If the deficit is accommodated by monetary expansion instead, the added money raises inflation risk. Inflation then feeds back into nominal rates through the Fisher relationship: nominal rate = real rate + expected inflation, so anticipated inflation gets priced into yields. The reviewing skill is separating real from nominal: a 6 percent yield with 4 percent expected inflation is only a 2 percent real return. Reports that quote nominal yields without inflation context overstate the return investors actually earn.

Memory hook:Deficits bid for funds; inflation gets priced into nominal yields.

The cycle runs expansion, peak, contraction, trough, then recovery. Sector sensitivity is the analyst's tool: cyclicals — autos, housing, industrials, technology, luxury goods — see earnings surge in expansion and collapse in contraction because demand tracks income and confidence. Defensives — utilities, consumer staples, healthcare — hold up through the downturn because their demand is steady regardless of the economy. Indicators help place the cycle: leading indicators like building permits turn first, coincident indicators track current activity, and lagging indicators like unemployment confirm after the fact. The practical rule: match recommendations to the cycle stage, and be wary of a report pushing cyclicals late in an expansion.

Memory hook:Cyclicals ride the expansion; staples and utilities hold the trough.

Monetary policy transmits to the real economy through a chain you should be able to trace step by step. When the Fed tightens, it raises short-term rates and drains reserves, pushing borrowing costs up across the economy. Higher rates discourage business investment and consumer purchases of homes, cars, and durables, so aggregate demand falls. Firms respond by cutting output and, with a lag, employment. Easier policy reverses the chain: lower rates stimulate borrowing, spending, output, and hiring. Know the secondary channels too: higher rates tend to strengthen the currency and dampen net exports, while expectations about future policy shape long-term rates immediately. The lag between the policy move and the employment effect is long and variable.

Memory hook:Tighten: rates up, then output down, then jobs down—slowly, in that order.

Velocity measures how fast money turns over: V = nominal GDP / money supply. The quantity theory ties everything together with MV = PY, where M is money, V is velocity, P the price level, and Y real output. If velocity is stable and the economy is near full capacity, growth in M translates directly into higher prices—inflation. If velocity rises, the same money stock supports more spending, which is why velocity can surge when accumulated savings finally get spent. For the exam, treat velocity as the multiplier that converts money growth into nominal spending growth, and remember the identity works in both directions: solve for whichever variable the question withholds.

Memory hook:MV = PY: money times velocity equals prices times output.

The balance of payments records every transaction between a country and the rest of the world, and by accounting construction it always balances. The current account tracks goods, services, investment income, and transfers; the capital and financial account tracks asset purchases and sales. A current account deficit must be offset by a capital inflow. Interest rate differentials drive those flows: when domestic rates rise relative to foreign rates, foreign investors buy domestic assets, bidding up the currency. The reverse holds when rates fall. Expect the exam to link a rate hike to currency appreciation through capital inflows, and to test that a trade deficit is financed, not left hanging, by the capital account.

Memory hook:Higher rates pull foreign money in; money in lifts the currency.

The Federal Reserve System has a Board of Governors in Washington plus twelve regional banks. The FOMC, the policy-making body, combines the governors with regional bank presidents; the New York Fed holds a permanent voting seat while other regional presidents rotate. On money definitions, start narrow and build outward. M1 is currency in circulation plus checkable demand deposits—the most liquid, immediately spendable money. M2 adds small savings deposits, small time deposits, and retail money market funds—money that is near-liquid but not instantly spendable. Broader aggregates add less liquid instruments. Expect questions that hand you a list of instruments and ask which aggregate each belongs to, so memorize the boundaries between the definitions.

Memory hook:M1 moves money now; M2 adds money parked nearby.

These features allocate interest rate risk between issuer and investor. Call protection is a lockout period during which the issuer cannot redeem the bond, shielding the investor from early redemption when rates fall; once it expires, the issuer calls opportunistically. A sinking fund forces the issuer to retire bonds on a schedule, which adds call-like risk but improves credit safety. A put is the investor's option to return the bond at par, usually on set dates—valuable when rates rise, so put bonds yield less. Extendables let the holder stretch maturity at a known rate. Rule of thumb: any issuer option, like a call or sinking fund, costs the investor yield; any investor option, like a put, costs the issuer.

Memory hook:Issuer options take yield; investor options give protection—options cost whoever lacks them.

A zero-coupon bond pays no interest; the investor buys at a deep discount and receives par at maturity, with the discount representing the total return. The IRS taxes the yearly accretion as imputed interest even though no cash arrives, which is why zeros are popular inside tax-deferred accounts. On the price side, zeros are the most volatile bonds: with no coupons to reinvest, all cash flow sits at maturity, so their duration equals their maturity. A given rate move therefore produces a bigger price swing than on a comparable coupon bond. Expect a comparison setup: same maturity, one coupon bond and one zero—the zero's price reacts more violently to any rate change.

Memory hook:No coupons, no cash—yet taxes accrue and prices swing hardest.

Mortgage- and asset-backed securities repay principal over time, so stated maturity tells you little. Average life is the weighted average time until principal is returned, weighting each payment by its size. Half-life is simpler: the time until half the face amount has come back. Prepayments are the wildcard. When rates fall, homeowners refinance and principal returns fast, shortening average life—bad, because cash comes back at the worst time to reinvest. When rates rise, prepayments slow and average life extends—also bad, because your money stays locked at the old low rate. The exam likes to flip the rate move and ask which way average life goes; the answer usually runs opposite to investor intuition.

Memory hook:Rates down, prepay up, life shortens; rates up, life stretches.

Yield measures answer different questions. Current yield = annual coupon / price. Yield to maturity is the discount rate equating price to all cash flows, assuming reinvestment at that same rate. Yield to call applies when a call is likely. Duration measures price sensitivity: approximate percentage price change = duration × change in yield, with the sign flipped. Longer maturity, lower coupon, and lower yield each mean higher duration. Convexity corrects duration's error for large rate moves; actual prices rise more when rates fall and drop less when rates rise than duration alone predicts, and positive convexity always benefits the bondholder. Calculations here are plug-and-play, so practice the duration approximation formula until it is automatic.

Memory hook:Duration times the yield move gives the price move; convexity rounds the corner.

The yield curve plots yields against maturity. Normal curves slope upward—longer terms earn more. Flat curves signal transition. Inverted curves, where short yields exceed long, have historically preceded recessions because the market expects rates to fall. Three main theories explain the shape: expectations, where long rates reflect expected future short rates; liquidity preference, where investors demand extra yield for tying up money; and market segmentation, where supply and demand operate within each maturity bucket. Spreads measure relative value: the nominal spread compares a bond's yield to the Treasury of matching maturity, while the option-adjusted spread strips out embedded option cost. A wide spread signals cheap or risky; the analyst's job is deciding which.

Memory hook:Inverted curve: short pays more than long—recession's warning sign.

Rating agencies grade default risk on letter scales, with investment-grade and speculative-grade divided around the BBB/Baa tier; below that sits high-yield, or junk. Ratings are opinions, not guarantees, and the exam treats them as one input, not a verdict. Earning power tests ask whether operations can service debt: interest coverage = EBIT / interest expense, and cash-flow-based coverage measures are even harder to pass. Asset tests ask what backs the claim: net tangible assets versus total debt, and the quality of those assets—receivables and inventory count for more than intangibles. A company can pass one test and fail the other, so expect questions that force you to weigh earning power against asset protection.

Memory hook:Earning power pays the interest; assets stand behind the principal.

Bond swaps trade one bond for another to capture an advantage. The classic types: a substitution swap trades into a nearly identical bond with a higher yield; an intermarket spread swap bets the spread between two sectors will narrow; a rate anticipation swap adjusts duration ahead of an expected rate move; a pure yield pickup swap simply trades up in yield, accepting added risk; a tax swap sells a loser and buys something similar to realize the loss without abandoning the position. Credit default swaps are different animals: the buyer pays a periodic premium, and the seller pays upon a defined credit event such as default or restructuring. Wider CDS spreads signal deteriorating credit before ratings move.

Memory hook:Bond swaps chase yield, spreads, or taxes; CDS is insurance with a spread price.

Preferred stock blends bond and equity traits: a fixed dividend rate, priority over common, and typically no maturity date. Cumulative preferred accrues missed dividends before common gets anything; convertible preferred can switch into common; participating preferred shares in extra profits. Value straight preferred like a perpetuity: price = dividend / required yield. ADRs are dollar-denominated receipts for foreign shares, trading in the U.S. and sparing investors foreign-currency settlement, though currency risk remains. Rights let existing shareholders subscribe to new shares below market; theoretical value is roughly (market price − subscription price) / (number of rights needed + 1). Warrants are long-dated purchase options, usually attached to bonds, and dilute existing holders when exercised.

Memory hook:Preferred = perpetuity; rights are short, warrants are long.

DCF says a business is worth the sum of its future cash flows, each discounted to present value: value = sum of CFt / (1 + r)^t, plus a terminal value capturing everything beyond the forecast window. Terminal value is usually a perpetuity: TV = CFn+1 / (r − g), then discounted back to today. The mechanics make sensitivity obvious: a higher discount rate shrinks every term, and a higher growth rate inflates the terminal value, which often dominates the total. The constraint that r must exceed g is not cosmetic—if growth meets or beats the discount rate, the formula explodes and the model is broken. Reviewers should confirm the analyst's r and g are defensible and used consistently.

Memory hook:Terminal value = cash flow over r minus g—growth must stay below the discount rate.

Multiples value a stock relative to a fundamental. P/E = price per share / EPS, or equivalently market cap / net income; EV/EBITDA compares enterprise value to operating earnings before non-cash charges, sidestepping capital structure differences. Absolute models—DCF, dividend discount—produce an intrinsic value standing on its own. Relative models—comparables, sector multiples—say whether a stock is cheap against peers but say nothing about whether the whole sector is overpriced. That is the critical limitation: in a frothy market, every comparable looks fairly priced while all are expensive. The exam asks which approach answers which question, so anchor the distinction: absolute models yield a target price, relative models yield a ranking.

Memory hook:Absolute answers what is it worth; relative answers cheap compared to whom.

Dividend discount models value stock as the present value of expected dividends. The constant-growth version is V = D1 / (r − g), where D1 is next year's dividend, r the required return, and g the growth rate. Growth comes from retention: g = ROE × retention ratio, and retention = 1 − payout ratio. Payout ratio = dividends / EPS; a high payout leaves little to fund growth, while a low payout funds growth but tests dividend patience. Dividend security asks whether the dividend is safe: covered comfortably by earnings and, more strictly, by free cash flow. A payout near or above 100 percent of earnings or cash flow warns the dividend is at risk.

Memory hook:DDM: next dividend over r minus g; growth equals ROE times what is kept.

Industry appraisal starts with supply and demand: is capacity tight or glutted? Shortage conditions let producers raise prices; excess capacity forces discounting and squeezes everyone's margins. Pricing power depends on differentiation—commodity products compete purely on price, while differentiated products hold margins through brand, technology, or switching costs. Cost structure determines how profits respond: high fixed costs create operating leverage, so a small revenue gain produces a large profit gain, but a small revenue loss is equally amplified. Variable-cost-heavy industries flex with volume and stay steadier. The exam pairs these: identify whether the industry sells commodities or differentiated goods, then judge whether its cost base amplifies or cushions demand swings. Both answers drive the margin forecast.

Memory hook:Commodity sells on price; fixed costs amplify whatever demand does.

Beta measures sensitivity to the market: a beta of 1.2 means the stock tends to move 12 percent for a 10 percent market move. Beta prices systematic risk through CAPM: required return = risk-free rate + beta × (market return − risk-free rate). Alpha is what remains after the market's pull is removed—excess return relative to the risk taken. Positive alpha suggests skill or mispricing. Quantitative factors are the numbers—beta, volatility, correlation, standard deviation; qualitative factors are the judgments—management quality, competitive position, regulatory exposure, governance. A sound research report weighs both, and the supervisory analyst checks that a quantitative screen is not masquerading as a complete analysis, or vice versa.

Memory hook:Beta follows the market; alpha beats it after adjusting for risk.

Breadth gauges how broad a market move really is. The advance/decline index cumulatively tracks advancing issues minus declining issues; a rising index with a rising market confirms the rally, while a falling index against a rising market—negative divergence—warns the rally is thin. Momentum measures the speed of price change; fading momentum near highs often precedes turns. Available funds looks at fuel: margin debt growth and cash balances at institutions signal buying power, since markets rarely rally far without fresh money. Sentiment indicators—short interest, put/call ratios—reveal crowd positioning. The exam's favorite setup is divergence: the headline index hits a new high while breadth deteriorates, and the correct read is caution, not celebration.

Memory hook:Breadth confirms the trend; divergence between index and breadth warns it is thin.

Charts reduce price history to levels and trends. Resistance is a ceiling where selling repeatedly halts advances; support is a floor where buying repeatedly halts declines. A breakout—a decisive move through resistance on strong volume—signals demand has overwhelmed supply and often starts a new leg up; breakouts on thin volume are suspect. Once broken, old resistance tends to become new support, and vice versa. Moving averages smooth out daily noise: a shorter average like the 50-day turns faster than a 200-day, and the price crossing above an average, or the short average crossing above the long one, is read as a trend shift. Volume is the confirmation tool throughout—price says what, volume says how seriously.

Memory hook:Breakouts need volume; broken levels flip—old ceilings become new floors.

Overbought means prices have risen so far so fast that a pause or pullback is likely; oversold is the mirror image after a sharp decline. The catch: strong trends can stay overbought for a long time, so overbought is a caution flag, not a sell signal by itself. Consolidation is sideways movement after a move—the market digesting gains or losses, often forming a base before continuing. Stabilization is the early stage after a decline when selling pressure fades and prices stop making new lows, suggesting the worst may be over. The exam tests whether you treat these as signals versus warnings: overbought cautions, consolidation waits for direction, stabilization hints the bottom is forming.

Memory hook:Overbought warns, does not sell; consolidation waits; stabilization hints the bottom is in.