Formula Sheet

• This formula sheet does not necessarily contain all the formulas covered or required in this class,
but I will keep updating it to try to achieve that goal (let me know if some formulas are missing).
• A few of the formulas below are not needed for the exam (denoted with a ? below).
• Some of the formulas will be provided in the formula exam sheet (denoted with a † below). The
exam formula sheet will be provided well before the exam on Blackboard so that you exactly know
which formulas you will be given. The remainder formulas (except those with a ?) you should know
for the exam.

T
X C Par Value
Bond Price = t
+
t=1
(1 + r) (1 + r)T
T  
X 1 1 1
Annuity factor (r, T) = = 1 −
t=1
(1 + r)t r (1 + r)T
1
PV factor (r,T) =
(1 + r)T
Annual coupon Days since last coupon
Accrued Interest = ×
no. of coupon payments Days separating coupon payments
Annual Coupon Payment
Current yield =
Bond price
Yield to Maturity = the interest rate which equates bond price with cash flows
Yield to Call = the interest rate which equates bond price with cash flows
if called at earliest date
Coupon income + (Sale Price - Purchase Price)
HPR =
Purchase Price
  T1
VT
Realized compound return r = −1
V0
(1 + yn )n
Forward rate fn = −1
(1 + yn−1 )n−1
Par Value - Purchase Price 365
Bond equivalent yield = ·
Purchase Price Days to Maturity



length of365i in days
Effective annual yield = 1 + i −1
T
X CFt /(1 + y)t
Duration D = t · wt where wt =
t=1
Bond price
1+y
Duration of Perpetuity D =
y

1
 D
Modified Duration D̃ =
(1 + y)
∆P/P
Effective duration for callable bonds? = −
∆r
∆P
≈ −D̃ · ∆y
P
∆P
= −D̃ · ∆y + 1/2 · Convexity · (∆y)2
P
T  
† 1 X CFt 2
Convexity = (t + t)
P · (1 + y)2 t=1 (1 + y)t
APR = n × rT
 n
Quoted Rate
EAR = 1 + −1
n
EAR, continuous compounding EAR = eQuoted Rate − 1
X
E(X) = p(x)x
all x
X
V(X) = p(x) · (x − E(X))2
all x
XX


Cov(X,Y) = p(x, y) · x − E(X) · y − E(Y)
all x all y

σxy
Correlation Coefficient ρx,y =
σx · σx
E(aX+bY) = aE(X) + bE(Y)
V(aX+bY) = a2 V(X) + b2 V(Y) + 2abCov(X,Y)
Cov(aW+bX, cY+dZ) = Cov(aW, cY) + Cov(aW, dZ) + Cov(bX, cY) + Cov(bX, dZ)
= acCov(W,Y) + adCov(W,Z) + bcCov(X,Y) + bdCov(X,Z)
N
1 X (ri − r̄)3
Skewness? =
N i=1 σ̂ 3
N
1 X (ri − r̄)4
Kurtosis? = −3
N i=1 σ̂ 4
E(rP ) − rf
Sharpe Ratio =
σ
v P
u
u 1 X N


LPSD = t 1ri <rf · (ri − rf )2
N − 1 i=1
E(rP ) − rf
Sortino Ratio =
LPSD
U = E(r) − 1/2 Aσ̂ 2

2
Capital Allocation Line:


E(rC ) = yE(rP ) + (1 − y)rf = rf + y E(rP ) − rf

Portfolio return/risk for 2 assets:

E(rP ) = w1 E(r1 ) + w2 E(r2 )

σP2 = w12 σ12 + w22 σ22 + 2w1 w2 Cov(r1 , r2 )
X X
σP2 = wi wj Cov(ri , rj )
i∈{1,N j∈{1,N }

Weights for the Markowitz Minimum Variance Portfolio consisting of 2 risky assets† :

σ22 − Cov(r1 , r2 )
w1min =
σ12 + σ22 − 2Cov(r1 , r2 )
w2min = 1 − w1min

Weights for the Markowitz optimal risky portfolio if there are only 2 risky assets and no risk-free asset† :

E(r1 ) − E(r2 ) + A(σ22 − σ1 σ2 ρ12 )

w1∗ =
A(σ12 + σ22 − 2σ1 σ2 ρ12 )
w2∗ = 1 − w1∗

Weights for the Markowitz optimal risky portfolio consisting of 2 risky assets and 1 risk-free asset† :

E(R1 )σ22 − E(R2 )Cov(R1 , R2 )

w1∗ =  
E(R1 )σ22 + E(R2 )σ12 − E(R1 ) + E(R2 ) Cov(R1 , R2 )
w2∗ = 1 − w1∗
where R represents the excess return.

Optimal fraction for risky portfolio:

E(rP ) − rf
ỹ =
AσP2

3
Single Index Model:
ri = E(ri ) + βi m + ei
σi2 = βi2 σm
2
+ σ 2 (ei )
2
Cov(ri , rj ) = βi βj σm
Corr(ri , rj ) = Corr(ri , rM )Corr(rj , rM )
E(Ri ) = αi + βi E(RM )
| {z }
(the Security Characteristics Line)
 2 n  2
αA X αi
SP2 = 2
SM + = 2
SM +
σ(eA ) i=1
σ(ei )
| {z }
the Information Ratio

†
Treynor-Black Procedure: Optimal risky portfolio construction for the Single Index Model

Step 1: wi0 = αi /σ 2 (ei )

Pn
Step 2: wi = wi0 / i=1 wi0
Pn
Step 3: αA = i=1 wi αi
Pn
Step 4: σ 2 (eA ) = i=1 wi2 σ 2 (ei )
Pn
Step 5: βA = i=1 wi βi
0 αA /σ 2 (eA )

Step 6: wA = E(R M )/σ
2
M
0
∗ wA
Step 7: wA = 0
1+(1−βA )wA
∗ ∗
Step 8a: wM = 1 − wA
Step 8b: wi∗ ∗
= wA wi
∗ ∗ ∗


Step 9: E(RP ) = wM + wA βA E(RM ) + wA αA
∗ ∗

2 2  ∗
2
Step 10: σP2 = wM + wA β A σM + wA σ(eA )
E(rP )−rf
Step 11: ỹ = AσP 2

Multi-Index Model: E(ri ) = αi + β1i F1 + β2i F2 + ... + βki Fk + i

Capital Asset Pricing model:

E(ri ) = rf + βi E(rM ) − rf
Cov(ri , rM )
βi =
Var(rM )
E(rP ) = rf + ĀσP2
(Fama-French) 4-factor model:
E(ri ) = rf + βiCAPM (E(rM ) − rf ) + βiSMB SMB + βiHML HMLt + βiUMD UMD

4
Abnormal return / risk-adjusted return / alpha:

αi = ri − E(ri )

Cumulative abnormal return methods? :

T
X

CAR = rt − E(rt )
t=1
BHAR = ΠTt=1 (1 + rt ) − ΠTt=1 (1 + E(rt ))

Tracking error and Benchmark risk? :

Tracking error TE = RP − RM
∗ ∗ ∗


= wA αA + [1 − wA (1 − βA )]RM + wA eA − RM
∗ ∗ ∗
= wA αA − wA (1 − βA )RM + wA eA
q
∗ 2 + [σ(e )]2
Benchmark risk σ(TE ; wA = 1) = (1 − βA )2 σM A

Tracking error-adjusted weights in active portfolio? :

σ0 (TE )
wA (TE ) = ∗ = 1)
σ(TE ; wA
wM = 1 − wA (TE )

Black-Litterman model: incorporating manager’s private views? :

P RT = Q + ε