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Category: Level I
Earnings per Share (EPS)
Calculating earnings per share (EPS) is relatively straightforward: calculate earnings (available to common shareholders), then divide it by the weighted-average number of shares of common stock outstanding (WACSO). However, there are possibly two EPS calculations that you need to show on an income statement: basic EPS and fully diluted EPS: Basic EPS uses the existing…
Weighted Average Common Shares Outstanding (WACSO)
One key to computing earnings per share (EPS) is computing the number of shares of common stock to use in the denominator; we call this number the weighted average common shares outstanding (WACSO). There are two ways to calculate WACSO; I’ll cover both. There are several transactions than can change the number of shares of…
Put-Call Parity
Put-call parity is nothing more than an equation that shows how the price of a (European) put option (on, say, a stock) relates to the price of a (European) call option (on the same stock). The equation arises from a simple finance fact: If, given any set of circumstances, portfolio A and portfolio B have…
Credits and Debits
It is certainly possible to learn everything you need to know about financial reporting and analysis (for both Level I and Level II) without understanding fully credits and debits, but it is unquestionably more difficult than if you do understand them. The good news is that they’re not difficult to understand. Income statements gave rise…
Margin Call Price
The price at which you will receive a margin call on a long position in a stock is given by: \[margin\ call\ price\ =\ P_0\left(\frac{1\ –\ initial\ margin}{1\ –\ maintenance\ margin}\right)\] where: \(P_0\): initial price of the stock The price at which you will receive a margin call on a short position in a stock…
Degree of Total Leverage (DTL)
The degree of total leverage (DTL) is defined as: \[DTL\ =\ \frac{\%\ change\ in\ Net\ Income}{\%\ change\ in\ Sales}\ =\ \frac{\dfrac{\Delta Net\ Income}{Net\ Income}}{\dfrac{\Delta Sales}{Sales}}\] Suppose that a company has only variable expenses – 70% of sales – and no interest expense; taxes are 40% of EBT. If Sales are $100,000 and ΔSales is $1,000, then,…
Degree of Financial Leverage (DFL)
The degree of financial leverage (DFL) is defined as: \[DFL\ =\ \frac{\%\ change\ in\ Net\ Income}{\%\ change\ in\ EBIT}\ =\ \frac{\dfrac{\Delta Net\ Income}{Net\ Income}}{\dfrac{\Delta EBIT}{EBIT}}\] Suppose that a company has no interest expense, and that taxes are 40% of EBIT. If EBIT is $20,000 and ΔEBIT is $300, then, taxes will be $8,000 (= $20,000…
Degree of Operating Leverage (DOL)
The degree of operating leverage (DOL) is defined as: \[DOL = \frac{\%\ change\ in\ EBIT}{\%\ change\ in\ Sales}\ =\ \frac{\dfrac{\Delta EBIT}{EBIT}}{\dfrac{\Delta Sales}{Sales}}\] Suppose that a company has only variable expenses, and those are 70% of sales. If Sales are $100,000 and ΔSales is $1,000, then, expenses will be $70,000 (= $100,000 × 70%) Δexpenses will…
Herfindahl-Hirschman Index (HHI)
The Herfindahl-Hirschman Index (HHI) is a measure of the degree of concentration in an industry; it is defined as: \[HHI\ =\ \sum_{i=1}^n MS_i^2\] where: \(n\): number of firms in the industry \(MS_i\): market share of firm i (Technically, if there are more than 50 firms in the industry, the HHI sums over only the largest…
Macaulay Duration, Modified Duration, and Effective Duration
In this article I’ll cover three quantities that go by the name of “duration”: Macaulay duration Modified duration Effective duration I’ll explain how each type of duration is calculated, the characteristics of each type of duration, the similarities and differences amongst the types of duration, and how they are used in practice. Types of Duration…