CFA Level 1 Fixed Income and an Important Message



Before we begin our review of the Fixed Income topic area for the December exam, there is an important message you need to consider. As if the need to pass the exam in December were not pressing enough, it may be even more so because of curriculum changes.

The idea occurred to me while looking through the Fixed Income material for this week’s review. The December exam is still based on the 2014 curriculum. If you do not pass the exam in December, you will need to change to the 2015 curriculum. While it is not completely different, there are three new readings and six dropped readings. Along with some changes to topic weightings, this makes for a lot of additional or wasted studying if you have to retake the exam. Check out all the changes to the 2015 CFA Level 1 Curriculum in our prior post.

Now, on to the review of Fixed Income with Study Session 15. This is the first of two study sessions and includes five readings. The topic area is worth 12% of your total exam score but this basic material will be very important to your ability to understand details in the next two exams. Most candidates, myself included when I was one, have not been exposed to concepts in Fixed Income as much as we have to Equity. Some of the specifics and pricing can be pretty difficult so make sure you get these basics down now.

Fixed Income Securities: Defining Elements

Almost entirely conceptual and should be easy to pick up if you make a few flash cards for the vocabulary and broad concepts.

Sovereign bonds: Government issued and relatively lower risk. They can be issued in local or foreign currencies. Understand the basic differences of the U.S. debt like T-notes, T-bonds, Strips and TIPS.

Quasi-government: These are issued by a non-government agency but often carry an implicit guarantee as being connected to the government. The focus is on agency mortgage debt and the types of CMO and MBS, think Fannie Mae and Freddie Mac a few years ago.

Municipal or province: Like sovereign bonds but issued by smaller authorities like towns and cities. Understand the difference between tax-backed and revenue bonds and the effect on risk. The interest is often tax-advantaged for taxes owed to the issuing municipality or state.

Corporate Bonds: Understand the four factors used by credit rating agencies (character, capacity, collateral, and covenants). This section has a few formulas and is probably one of the more testable in the reading.

Mortgage backed securities: Understanding structure and prepayment risk is the important material here and will be used for more detail in the Level 2 exam.

Asset backed securities: Understand the types of internal and external credit enhancements as well as the role of special purpose vehicles.

Collateralized debt obligations: These are basically the same as asset-backed debt but the backing for the bond is a diversified pool of different debts, i.e. domestic/foreign bonds, bank loans, distressed debt, ABS, and MBS

Understand the difference between current yield (coupon interest / bond price) and yield to maturity. The YTM is the annualized rate which makes the present value of cash flows equal to current market price, effectively the yield an investor will earn if held to maturity. The YTM will not change once the bond is bought. The current yield is just a matter of where the bond trades now but can change.

Understand the basic types of affirmative and negative covenants like paying interest & taxes, meeting financial ratios, limitations on additional debt, and restrictions on asset sales. Affirmative covenants are things an issuer MUST do while negative covenants are things they must NOT do to avoid a default.

Definitions and just knowing the lingo is always important. Know what a coupon is and understand what happens to the price if the coupon rate is higher or lower than current market rates. Think about it intuitively. If a bond offers a higher coupon rate than you can find in the market, you are going to be willing to pay a premium on the price, and the opposite is true for a coupon rate below the current market yield.

Understand the basic idea behind call and put provisions, sinking funds, repurchase agreements and prepayment. Remember, the full or dirty price is the agreed price plus all accrued interest.

I always thought credit enhancements were an interesting part of the material. Internal enhancements are collateral or other features promised by the issuing company to further back the bonds. External enhancements are guarantees promised by a third-party to back the bonds. They are a way of boosting credit worthiness of the bonds and lowering the interest rate, and some are pretty creative structures.

Fixed Income Securities: Issuance, Trading and Funding

There seems to be a lot of overlap in this reading with the first. Again, almost entirely conceptual and you really just need to get the vocabulary. As always pay attention anytime the curriculum compares two options, gives advantages or limitations and provides any list detail.

The material on sovereign bonds is relatively important. Understand the difference between local currency bonds and foreign currency bonds, especially their advantages and limitations. Local currency bonds may have less demand but the government has more control of its currency to repay debt. Foreign-denominated bonds may offer lower rates (higher demand) but can present problems if the local currency depreciates against the foreign currency.

Understand the different types of corporate debt, i.e. bank & syndicated loans, commercial paper, and corporate notes. Pay attention to the different structures, term issued, and provisions in each.

Introduction to Fixed Income Valuation

This is likely the most important reading of the study session, especially when it comes to being ready for the next study session and the next two exams.

You really need to understand the concepts behind bond valuation and calculating yields. I am including a few examples of how to use your BA II Plus calculator for this work to help you do problems quickly on the test but do not completely rely on your calculator. Learn the concepts.

(Remember to always press – 2nd and then CLR TVM – to clear out prior work. It’s an easy habit to get into before each calculation and it might save you a couple of errors on the exam.)

Find the price of a 10-year fixed rate bond with a $1,000 face value and a semi-annual coupon if the yield is 6%

N = 20 (don’t forget that it is semi-annual)
I/Y = 3 (6% yield divided by twice a year)
PMT = 20 (4% coupon times face value divided by twice a year)
FV = 1000 (you receive the face value at expiration)
CPT PV = $851.23

You can use the TVM keys to find any of these (years to maturity, coupon rate, yield) as well.

Understand the idea behind discount, par and premium and how it relates to the coupon rate and market rates. If the coupon rate is above market rates then the bond will be attractive, price will be higher than par and will trade at a premium.

You absolutely must understand the basic idea behind convexity. The percentage change in a bond’s price will be different at different changes in the discount rate. This material will become even more important on the other two exams.

Pay special attention to the material on yield spreads as well. The spread is just the difference between the bond’s yield and a benchmark (usually a government issued security of the same term). Option-adjusted spread is the spread with an embedded option and represents the risk remaining after rate and volatility risk have been removed. You will see all these terms in much greater detail on the Level 2 exam.

Study Session 16 concludes the Fixed Income material with two readings on valuation of risk. One reading is mostly conceptual while the other is likely the most important and testable of the topic. We’ll cover it in detail next week. Until then, let me know if you have any questions.

‘til next time, happy studyin’
Joseph Hogue, CFA

A Secret about the CFA Curriculum that You Won’t Believe



There is a secret that many charterholders do not tell candidates. A secret so terrifying that most candidates probably wouldn’t believe it even if we told you.

After struggling through upwards of 9,000 pages of the curriculum over the course of three years, the truth is nearly impossible to fathom.

But even after more than 900 hours of study and countless study problems…
Many charterholders still read their curriculum.

Keep Your Curriculum Books!

Over the three years I studied for the CFA exams, I couldn’t stand the sight of my growing stack of curriculum books. The journey begins innocently enough with your Level 1 books. You may even be excited when that big box arrives in the mail.

But it doesn’t take long for that excitement to turn to despair and loathing as you toil through thousands of pages while your friends and family go out on the weekends.

Ok, so maybe I’m being a bit melodramatic but the fact is that most candidates avoid the CFA curriculum like the plague while studying for the exams. They rely on condensed study guides to get all their information for the exams. Sometimes it works, other times the candidate is left repeating exams because the study guides didn’t include all the detail needed to pass.

After the final Level 3 exam, the candidate breathes a huge sigh of relief and burns his curriculum books in effigy.

And then something odd happens. It happened to me and I can almost guarantee it will happen to you as well. I found myself referring back to the official curriculum in my professional career as an analyst. It starts like this, you will be looking at a company or sector and thinking how a fundamental difference in the group affects its valuation. Maybe the industry typically carries an especially high amount of goodwill on the books or maybe an accounting convention within the industry is different from other industries. It depends on where you work and the exact duties in your role but maybe you do not regularly account for that kind of detail in your analysis.

Then you remember, there was a whole section in the CFA curriculum about just such a practice! You scramble to the nearest library (because you burned your books, remember) to thumb through the curriculum. You read through the section and add it to your analysis.

This isn’t a wild story or something that will only happen to you on rare occasions. Your time spent studying for the CFA will commit to memory the basic idea of the readings even if you do not exactly remember the details. While your job as an analyst will involve going beyond the curriculum’s detail in some sections, there are some sections that you may not use or will only use broader estimates.

For example, while the curriculum goes into great depth and detail to adjust the financial statements in a number of different accounts (i.e. pensions, long-lived assets, inventories and intercorporate investments) you will likely not go into so much detail in your valuation models. That is not to say that your models will not be robust but maybe the level of detail just isn’t always needed. Until that day when you see a particular deal announced or a news release and think, “maybe this changes things and I need to look further into the details.” When you do look into the details, and it produces some real value for your firm, you will be generously rewarded.

The curriculum is your friend, you just don’t know it yet

I know it is tough to imagine how reading 3,000 pages of curriculum is a better option that relying on a 1,500 page study guide. You’ll just have to trust that all the time spent reading through the detail will pay off down the road.

This industry is full of highly intelligent and committed people. Every one of them has a cash flow model and has spent hours (more like years) studying how to analyze companies in their industry. You will only be able to compete if you can find the details that others miss. Reading the whole CFA curriculum when many candidates avoid it may just be your chance to uncover those details.

…and keep the books. It will save you a trip to the library later.

‘til next time, happy studyin’
Joseph Hogue, CFA

CFA Level 1 Review: Equity Markets



Study session 13 in the CFA Level 1 curriculum begins the material on equity investments with three readings (46-48). The material is almost completely conceptual and likely not worth a ton of points but still worth your time. Since it is all basic-level and conceptual, it is pretty easy to understand and you only need the basic idea to get any points on the exam. Make sure you understand the vocabulary and concepts, including any lists and advantages/limitations on comparisons given.

Market Organization and Structure

This is almost entirely a vocabulary lesson on the market and participants. It is important that you know the information for general knowledge but it is not as testable as some of the other readings. The key terms are good for flashcards with a quick rundown until you’ve got them.

Understand the difference between assets; i.e. fixed-income, equities and pooled investment vehicles. You likely won’t need much other than the brief definitional material for futures, options, swaps and commodities. Most of these assets are covered in much more detail in other parts of the curriculum.

Understand how to calculate returns on leveraged positions, maintenance margin requirement and the margin call price. If a buyer will receive a margin call when the value of equity drops below 25% of the maintenance margin requirement, with an initial stock price of $20 leveraged with 60% margin: the margin call price is ($8 +Price – $20) / Price = $16.

While the likelihood of seeing much of this one the exam is pretty low, make sure you have a basic grasp of the material. Understanding how the markets are organized and the primary players is an absolutely basic requirement to understanding how the markets operate. It should be repeat information for Finance students but will get you up to speed if you are from a different educational background.

Security Market Indices

The differences and calculations for the indices (price-weighted, equal-weighted, market cap, and fundamentally-weighted) are important information and have shown up on the exam. It’s really not difficult information, just understand how they are constructed and how to calculate returns.

Price-weighted indices are based on the price of each stock. This means that higher-priced stocks will have more influence on the index. It is simply calculated but biased to the higher-priced stocks and may involve a downward bias. Stock splits, spinoffs and constituent changes will all affect the divisor.

Equally-weighted indices are based on an equal-dollar amount in each stock. The advantage is that it is also easily calculated but it may bias towards small-cap firms because there are more of these in the market. It also requires frequent rebalancing (higher transaction costs) and contains potentially illiquid stocks.

Market-cap weighted indices are based on the value of each stock company in the index. Advantages include a better representation of each company’s value in the market though the index will be biased to larger firms. The index may overweight stocks that have seen their value increase (overvalued) against those that have decreased in value.

Understand the uses of indices; i.e. measuring market sentiment, as a proxy for asset classes, as benchmarks for managed portfolios and as the bases for new products.

They construction and limitations of alternative asset indices shows up several times in the curriculum, so spend some time on this section. Pay special attention to the possible biases within each index.

Market Efficiency

The efficient markets theory is a huge concept in the industry and for the exams. You do not necessarily need to know all the data and details that support it, but you should know the implications of each level of efficiency. Understand what it means for technical analysis and transaction costs in trading.

Know the difference between market value (the current price in the market) and intrinsic value (value based on investment characteristics). Depending on the efficiency of the market, these two values may differ widely.

The Institute does not ask you to take a position on the efficient market hypothesis but regardless of how you believe the markets behave, when you are taking the exam the curriculum is the ultimate truth. Know that there is considerable evidence supporting the semi-strong form of efficiency and some evidence to support the strong form. Understand the implication this has on active portfolio management, i.e. that gross performance will likely mirror the market but will underperform after fees.

Remember the factors contributing to or impeding efficiency in market prices:

  • Greater number of participants should contribute to market efficiency through consensus
  • Information availability and financial disclosure should promote fairness and efficiency
  • Limits to trading like restrictions on short-selling and operational inefficiencies (high transaction costs, difficulties in execution) impede market efficiency

The list of market anomalies is testable vocabulary and can be fun to read through. Again, mostly a flashcard exercise until you can recognize the terms and their basic idea. Understand that most of these anomalies are limited due to market knowledge that they exist and front-running.

Understand the basic idea behind the eight behavioral biases, which will be even more important in your Level 3 exam.

  • Loss aversion is bias that investors dislike losses much more than the want gains and will hold on to losers to avoid losses much longer than they should.
  • Overconfidence is the tendency to overestimate your own ability to predict/forecast prices and other market indicators. Often leads to undiversified portfolios.
  • Representativeness is the bias that investors give greater weight of probability to the current situation, i.e. investors overweight current information and trends and tend to neglect new information or trends.
  • Gambler’s fallacy is the bias to project long-term reversion to the mean, i.e. that falling stocks will reverse direction based on no fundamental change
  • Mental accounting is the bias to mentally track gains and losses for different investments within separate ‘buckets’ rather than as a whole portfolio view
  • Conservatism is the bias to under-react to new information and tendency to stick to prior views
  • Disposition effect is the tendency to avoid regret by selling winners too early and holding on to losers too long
  • Narrow framing is the tendency to analyze a situation in isolation, ignoring the larger context and forces

Again, most of this stuff is perfect for flash cards and a quick understanding of basic ideas. Just make sure you have the concepts and move on to spend more time on more important study sessions.

‘til next time, happy studyin’
Joseph Hogue, CFA

I Can’t Believe I Read the Entire CFA Curriculum



I wrote last week about the importance of reading the entire CFA curriculum and that too many candidates miss out of valuable points due to only relying on study guides. If my inbox is any indication, many candidates are still skeptical that they can get through the curriculum in their limited time available and much less with their sanity intact.

Aziz from Turkey writes, “I understand the importance of the curriculum and know deep down that I should read it but just cannot find the time. What if I read a study guide two or three times in the same time it takes for the curriculum? Is that not better?”

Vikas in India points to another problem many candidates have when he writes, “The curriculum is SO BORING! Some of the information is interesting but too much academic writing makes it impossible to get past.”

I completely understand both of these points. I worked a full-time job throughout my CFA studies and was married while studying for the final test. Throw in a social life and who has the time to get through thousands of pages of material?

If you want to pass the CFA exams, then you have to make time. I’ve written a few posts about finding time for the exams. It can be difficult to sacrifice a little more time for studying but we are all investors here and I guarantee you the return you realize for that extra time will be well worth it. As I wrote in last week’s post, you must commit to the official curriculum if you want the max points possible. Studying only the study guides is a sure way to miss important information that is left out. Studying these guides three or four times isn’t going to help if the material is not in there.

I did get some positive feedback from a few candidates on last week’s post. Mark from St. Louis writes, “I tried for two years to pass the Level I CFA Exam with only study guides. I tried two different providers but failed the exam each year. On the third attempt, I committed to reading the entire curriculum and finally made it through. Can’t say that it was only because of the curriculum but I can say that there was information in the books that I don’t remember seeing in the study guides.”

Making it through the curriculum is one thing, making it through the curriculum without falling asleep every couple of hours is another thing. I agree that the curriculum can be a little boring at times. Think of it as exercise for all those company reports you will need to read as an analyst. If you thought 2,500 pages of the CFA curriculum is tough to get through in six months then you have a rude awakening coming as an analyst.

Reading through the curriculum translates to about 400 pages a month. As an analyst, I read through that just about every week! You will constantly be looking through annual and quarterly reports, trade journals and other analyst’s commentary in your daily work routine. Not all of it is going to be compelling material and you just have to learn to push through it. Taking quick notes in the margin of the page helps to stay focused and there’s nothing wrong with a little help from Mr. Coffee.

No one said it would be easy working through the entire CFA curriculum but it is definitely worth your time. It takes determination and sacrifice but those traits will serve you well that first Saturday of June and for the rest of your life. Good luck.

‘til next time, happy studyin’
Joseph Hogue, CFA

CFA Level 1 Review: Equity Investments



Study session 14 in the CFA Level 1 curriculum concludes the material on equity investments with three readings (49-51). I wanted to hit on this study session before the beginning material in SS13 because it is a little more important and will be the base of what you need for the second exam. Most of the material is conceptual and will be repeat for students of finance. If you are new to the industry, spend a little time to get the vocabulary and concepts.

The topic area is only worth about 10% of your first exam but is extremely important in the other two tests and through your career as an analyst. Much like the introductory material on Financial Statements, this material will act as base knowledge you absolutely must know.

Overview of Equity Securities

The reading is all conceptual so make sure you get the general ideas and the vocabulary. Understand the characteristics of equity and what function they serve. As always, pay special attention anytime the curriculum compares one idea with another and discusses advantages/weaknesses. This kind of list and definitional material is easily testable in a multiple choice format.

Whereas debt securities represent a liability of the issuing company, equity represents a residual ownership on the company’s assets. This implies higher risk but also potentially higher return. There are three types of equity securities; common shares, preferred stock and other. There is some material on preferred stock, i.e. adjusting some of the metrics and its higher status for payments, but you will spend the vast majority of your time learning about common shares.

The material on private equity investments, i.e. venture capital and buyouts is fairly interesting. Understand the objectives of these investors and the summary idea behind the investments. Private equity generally has a lock-up period of 3-5 years, meaning the money is committed for a long-time and illiquid. Understand the difference in exit plans for these groups, i.e. venture capital generally looking to take the company public or sell to another fund; buyouts will recapitalize the company (take on debt) and manage a turnaround to issue shares again or sell to another fund.

The Institute has scaled-back the material on foreign stocks and emerging markets over the last few years but there is still some information you should remember. Understand the reasons a foreign company would issue Depository Receipts and the three levels of sponsored ADRs.

The last section, Equity Securities and Company Value, is probably the most important since it gets you ready for valuation. Understand the different valuation ideas, i.e. book value and market value. Return on equity and the cost of equity are two very important concepts throughout the CFA so make sure fully understand them here.

Return on equity (ROE) is a key measure of profitability and can be calculated as the net income over the book value of equity. How much income is the company able to generate on investor’s equity? You will use the DuPont formula later to look further into ROE but make sure you understand this book value formula and what it implies.

Introduction to Industry and Company Analysis

Another largely conceptual reading and more akin to an MBA course than the CFA curriculum in my opinion. The material on industry analysis revolves around the idea that different industries react differently to the macro-economic environment. Analysis of this helps to assess profitability and leads to an industry or sector rotation strategy.

Businesses can be grouped through their product or service or by the correlation of their sales to the business cycle. Grouping by products or services puts companies in a similar industry and a sector. While grouping by business cycle separates companies into cyclical and non-cyclical stocks.

Cyclical companies have a positive correlation with the business cycle. When the economy is expanding and business/consumer spending is rising, these companies see higher sales. Demand for their product/service is elastic and more discretionary.

Non-cyclical companies do not have as positive a correlation with the business cycle. They sell products/services that are necessities (non-elastic) and demand is more stable. Sales may still rise or fall with the economic cycle, just not as much as cyclical companies.

As always, remember the advantages and weaknesses of business-cycle classifications. The grouping helps to differentiate risk associated with the business cycle but is somewhat arbitrary. Since economic cycles differ across countries, international companies (even cyclical ones) may be able to smooth their revenues. Some industries may have characteristics or products/services that makes it difficult to group them as either cyclical or non-cyclical.

The material on industry classification systems is secondary so just understand the main ideas. Make sure you understand the material on the grouping by sector, then by industry and the steps in constructing a peer group.

Spend a little extra time on the principals of strategic analysis, especially Porter’s Five Forces. The material is highly testable and you will see it again in the CFA Level II exam.

  • Threat of substitutes – the more substitues a product has then the more elastic its demand will be and the lower the company’s ability to increase prices
  • Bargaining power of buyers – when there are fewer buyers that control a large part of the product’s demand then those buyers will be better positioned to bargain for lower prices and concessions
  • Bargaining power of suppliers – similarly if there are only a few suppliers of raw materials, they can more easily demand higher prices or restrict supply. Conversely, if there are many suppliers or it is a commondity material then they will have lower bargaining power
  • Threat of new entrants – this depends on barriers to entry like the cost to start a business, any regulations or laws around the product. If there are high barriers to entry then the existing companies are better protected and face less competition
  • Rivalry among existing firms – the more competitive the industry then the less ability the company will have to raise prices and profits. This tends to happen when the industry is fragmented (many small companies), has high fixed costs and sells an undifferentiated product

Remember the five stages of the industry life-cycle; embryonic, growth, shakeout, mature and decline as well as the basic forces within each stage.

Equity Valuation: Concepts and Basic Tools

Understand the differences and advantages/limitations of each of the three major categories of valuation models:

1)      Present value or DCF models provide an intrinsic value estimate of the shares as the sum of future cash flows.

  1. Understand the Gordon growth model and its assumptions, i.e. growth remains constant indefinitely, dividends grow at a constant rate, and the growth rate is less than the required rate of return. A multi-stage DDM is necessary when growth is not constant.
  2. Pay attention to the FCFE model and how it can be used on non-dividend paying stocks

2)      Market multiple models estimate value through a multiplier with earnings, sales, enterprise value or asset-values. These can be applied on a trailing or forward basis.

  1. These are fairly easy to understand but you need to know the limitations, i.e. the multiples are based on trailing (past) data and may not be a good predictor of the future, the multiples reflect relative valuation compared to peers or the index but not intrinsic value.
  2. Understand the difference between the trailing multiple (past data) and the justified (forward) multiple which is based on forecasted data.

Price-to-Cash Flow Ratios

There are several of these ratios listed in the curriculum but the most attention is given to Free Cash Flow-to-Equity (FCFE). You should already be familiar with FCFE and FCFF from the corporate finance material as well as in other parts of the equity curriculum. For the other P/Cash Flow ratios, just remember some of the adjustments that are typically made like non-cash charges and financing. Cash Flow metrics are preferred because it is not as easily manipulated by management as earnings numbers.

Free Cash Flow-to-Equity (FCFE)

The calculation for FCFE is fairly easy but you need to make sure not to get the components confused with FCFF. FCFE is CFO minus investments in fixed capital plus net borrowing, or the cash flow available to common equity holders without placing a burden on operations.

FCFE can be more volatile than other cash flow measures because of the capital expenditures spending, so you might have to use a multi-year average if the test question mentions it. Though you will probably not be asked to do so on the test, some analysts adjust CFA for nonrecurring expenses before calculating FCFE. A big focus in the CFA curriculum is conservative practices, almost always favored when a choice is given. Adjusting items for non-recurring events and taking the average of volatile accounts over a period of time are more conservative and provide a more stable estimate.

Make sure you can go from FCFF to FCFE or can get there from multiple routes. Thinking through the various accounts and why they are included will help get these concepts down. PRACTICE, PRACTICE, PRACTICE.

FCFF = CFO + interest(1-tax rate) – Fixed Capital Investment

FCFF = EBITDA(1-tax rate)+depreciation expense(tax rate) + (increase in deferred tax) – (investments in fixed and working capital)

FCFE = FCFF – interest(1-tax rate) + net borrowing

Enterprice Value-to-EBITDA

EV is the total value of firm in excess of cash and investments. This is the market value of debt plus common and preferred equity, minus cash and investments. We use the market value of debt because it is a more realistic amount that someone would pay for the firm, when combined with equity. Earnings before interest, depreciation and amortization (EBITDA) measures the potential cash flow to all providers of capital, so by taking a ratio of the two we find a market driven valuation of the firm.

The advantages of the metric are that it is more appropriate when valuing capital-intensive companies or those with differing amounts of leverage (because it is a pre-interest and depreciation measure). The metric is also useful when earnings are negative and P/E cannot be used.

The main disadvantage is that it does not account for several adjustments that should be made for good measures of operational cash flows. Different revenue recognition practices will change results as well as trends in working capital.

We’ll hit study session 13 next week with a review of market structure, indices and efficiency. It is completely conceptual and of secondary importance compared to SS14 so should be a pretty easy week. You might want to plan on reading through SS13 quickly to leave time to review the important material from this week’s SS14 readings.

‘til next time, happy studyin’
Joseph Hogue, CFA

Warning: Do Not Neglect the CFA Curriculum



The actual length of the CFA curriculum varies a little each year but it’s generally between 2,500 and 3,200 pages. When you get the books in the mail, or receive the digital version, that may seem like a monstrous task. Over the three years of studying for the exams, I think my upper body strength grew just as much as my financial knowledge just from carrying the books around.

Study guides meant to substitute for the curriculum vary but generally range between 1,400 and 1,700 pages. At under two-thirds the length of the official curriculum, it seems like a no-brainer and I know many candidates who have only rarely even peaked inside their curriculum books.

And many of them are still candidates.

Do Not Neglect the Official Curriculum!

Candidates that have tried to substitute the CFA curriculum with study guides have come to me afterwards with their horror stories. My reply is always the same, “I wish we had talked before because if you do the math then the answer is pretty obvious.” The minimum passing score for the exams is never released but I would guess it is around sixty-five percent. No candidate has failed with a score of 70% or better and I doubt if the Institute would want to charter someone that knows less than two-thirds of the subject matter.

Even the most gifted candidates are going to miss points. If about half the candidates fail the exam every year, I am guessing that most miss at least a tenth of the points and probably much more. We have no way of knowing but it’s obvious that you need every point you can get.

Now, I have seen pretty much all the study guides commercially available. There are some that do a pretty good job of condensing the material but none are able to get everything in a packet that is half the length of the curriculum. It’s impossible and information is going to get left out. Try to fit nearly 3,000 pages of information in less than 2,000 pages of notes and I would say you’re lucky if 20% of the information isn’t lost.

So if you neglect the official curriculum completely, you are already out something like 20% or more of the points. Now you need to remember at least 80% of the material just for a score of 64% on the exam.

Most of you have taken practice exams through test banks or the CFA Institute. How many have scored better than 80% on these? I know reading all those books is a daunting task but you just cannot afford to leave points on the table by neglecting the official curriculum.

I don’t talk about the FinQuiz study notes much here on the blog other than to reference specific sections of the notes and the curriculum. I don’t want candidates to think I am being biased by pushing one particular study provider over another. But I can say, without any bias, that the FinQuiz notes have at least one big advantage over other study products, that they are meant to be used as a complement to the curriculum instead of a substitute.

The FinQuiz notes vary by length as well but are generally around 600 pages, formatted by Learning Outcome Statement. By basing the notes on each individual LOS, FinQuiz condenses the information down to just enough to clarify the curriculum and make sure candidates check and understand each LOS. You will still need the curriculum, but the notes provide a brief explanation on each of the LOS so you can reference if you need additional help. It’s really the best of both worlds, you get 100% of the information from the curriculum and additional condensed explanations where you need them.

Free examples of the FinQuiz notes are available for download on the website. Take a look and compare them with the curriculum. FinQuiz regularly offers discounts on products and packages so you may want to contact the provider to get the best deal possible.

‘til next time, happy studyin’
Joseph Hogue, CFA

Candidate Warning: Use WhatsApp Carefully



I have been amazed at the growth of WhatsApp study groups just over the last year. Six of the top ten most popular posts on the LinkedIn CFA Candidates group are calls for a WhatsApp group, including the most popular post which has 369 comments.

The draw of the application is that users can send text messages without paying the SMS fees associated with most carriers. With over 118,000 candidates across the globe, there is no lack of members eager to connect especially when there is not much of a local group.

I contacted a few candidates that have used the WhatsApp groups for their insight into the phenomenon. The response was almost entirely positive from the group with a few big caveats.

Avoid common problems with messaging groups

The group members I talked to generally said that their experience with WhatsApp groups was positive but had a few warnings for those considering the groups. Some are specific to the CFA exam while other problems are more common to groups in general.

WhatsApp may be a great resource for asking questions and sharing insight into those tough topics, but don’t forget that the best way to prepare for the CFA exams is still through practice problems. I always set a goal for at least 2,400 practice problems, ten times the amount on the exam, for my test preparation. Doing these problems gets you physically ready to handle a six-hour test and helps to convert the material to long-term memory through repetition.

Make sure you are not spending too much time on the WhatsApp group. Studying for the CFA exams can be incredibly isolating and candidates have a tendency to confront this by spending lots of time in groups and searching through forum topics. Spending a little time each week socializing with local candidates can be a great way to avoid this and can also help make connections that will help you down the road.

Make sure you double-check answers you receive with the curriculum or study guides. There is nothing that guarantees the answer you receive from other candidates is correct. Problems with incorrect answers are not generally a problem with larger groups since the consensus usually corrects the misinformation.

Some caveats to groups in general include:

  • Avoid the temptation to use the group for a conversation with one member. Unless you are answering a specific question that is relevant to the entire group, these conversations are best left to private messaging.
  • Make sure you keep the conversation relevant. This is tied to the caveat above but can often envelope several members and steer the group off topic. There are plenty of forums for discussing your love of cheese (or whatever), you are here to help each other pass the CFA exams.
  • Don’t assume that everyone understands your short-hand text messages. Whole dictionaries could be written on the jumbled mix of letters that have come to be used for text conversations. Some users may not understand your use of acronyms or abbreviations.

It has also struck me how freely candidates share their WhatsApp number on the web. I asked a few candidates and no one expressed any concerns with privacy. I imagine the risk to posting on a very specific forum like the CFA Candidates group would be minimal but I am still interested in hearing if anyone has had a problem with the dissemination of their number. Use the comment section below.

We’ll continue our review of the Level 1 CFA exam next week for December candidates. For those not planning on sitting for the December exam, enjoy your break!

‘til next time, happy studyin’
Joseph Hogue, CFA

CFA Level 1 Review: Financial Reporting Quality



Study session ten in the CFA Level 1 curriculum concludes the material on FSA with reporting quality and some applications in three readings (33-35). Towards the end of the week, after you’ve read through the study session, it would be a good idea to take a small mock-exam over the FSA topic area. Use the end-of-chapter problems or a question bank to work through 100-200 questions. If you do not score at least 65% or better, you may want to build in some FSA review over the next couple of weeks. The topic is probably the most important in the curriculum and to your career.

Financial Reporting Quality

The reading, and much of the curriculum in FSA, revolves around your ability to understand aggressive and questionable accounting practices. Companies using more conservative accounting practices are more likely to surprise on the upside while those using aggressive assumptions may be signaling weakness.

A lot of the aggressive practices are highlighted elsewhere in the curriculum but are reiterated here. Motivation to artificially increase earnings could be to meet expectations, meet debt covenants or to improve incentive compensation. Understand that management might have an incentive to manipulate earnings lower as well, possibly to smooth higher earnings in the current quarter into weaker quarters.

The list material behind red flags is fairly testable so understand the risks. The curriculum describes the ‘Fraud Triangle’ and three conditions that are generally present when it occurs.

  • Incentives and pressures include pressure on management to meet expectations, financial targets, debt covenants, and their own financial well-being
  • Opportunities include the nature of the industry, a complex organizational structure, ineffective monitoring, a significant number of estimates build into the accounting system, high turnover or ineffective audit staff
  • Attitudes and rationalizations include the use of inappropriate accounting, poor communication channels, failure to correct reportable conditions, and a history of violations

The most important material is the specific warning signs and the measures to spot them.

  • aggressive revenue recognition (bill-and-hold sales, sale-leaseback, swaps and barter to generate sales)
  • operating cash flow out of line with earnings, i.e. if earnings are increasing or positive while operating cash flow is decreasing or negative may be an indication that management is manipulating earnings (CFO/Net Income)
  • Classification of expenses as extraordinary or nonrecurring
  • LIFO liquidations occur when management uses the LIFO method and runs the balance lower to year-end. Watch the LIFO reserve for clues of LIFO liquidation.
  • Margins significantly out of line with peers without other explanations – overstatement of inventory or capitalization of costs is a clue that management is using aggressive accounting with expenses. Check the company’s margins against prior years and quarters as well.
  • Assumptions behind depreciation – using a longer life estimate for machinery than peers will lower depreciation expense and increase earnings but may not appropriately match costs with sales.
  • Assumptions used in pension accounting – Using a higher discount rate or higher expected return on plan assets will decrease pension expense but may lead to a problem down the road when the assumptions are corrected. As with most of the warning signs, compare assumptions with peers in the industry
  • Fourth quarter surprises that cannot be attributable to seasonality
  • Excessive use of operating leases or other off-balance sheet financing – the company may be guaranteeing some contracts or receiving financing that is not accounted for on the balance sheet, this reduces liabilities relative to peers and makes the balance sheet look more healthy than reality.

Accounting Shenanigans on the Cash Flow Statement

Understand that the cash flow statement is less easily manipulated but management can still distort the various accounts.

  • Stretching out payables (look for a trend in days sales payable) – accounts payable increases and may indicate problems paying suppliers
  • Using a third-party to pay payables and then accounting for payment as a financing cash outflow in subsequent periods – this is basically taking out a loan to pay for current expenses. The problem is that it does not appropriately match expenses with sales and later quarters will be affected
  • Securitization of receivables and whether it is through a bankruptcy-remote VIE – The problem here, and with many of the other questionable accounting tactics, is sustainability. Securitizing (selling off your receivables) increases cash flow for the current quarter but the company may still be responsible for collecting those sales. The company may have to pay back some of the proceeds in subsequent periods if default on receivables is higher.
  • Treatment of tax benefit on the cash flow statement and sustainability as an increase in cash from operations
  • Stock buybacks to offset dilution – Since buybacks are listed under financing cash flows, analysts need to reclassify net cash paid to buyback shares from financing outflow to operating cash outflow.

Financial Statement Analysis: Applications

Really nothing new in this reading, just a review of the previous material. The reading gets into a little more detail but remember that the Level 1 exam is all about the basic ideas and reasons. Start with understanding the processes for evaluating past performance and projecting financial performance then move on to ratios.

Remember what accounts you use as the denominator for pro forma financial statements (sales and total assets), using the ratios from past periods is how you will estimate going forward. Remember the accounts and rationale behind analyst adjustments (FIFO balance sheets, LIFO income statements), adjustments to PP&E, goodwill and bringing off-balance sheet financing on the books.

Four general categories for quantitative credit analysis:

  • Scale and diversification: purchasing power from scale and product/geographic diversification
  • Tolerance for leverage:
    • Retained cash flow (RCF)/total debt
    • (RCF – capex)/total debt
    • Total debt/EBITDA
    • (EBITDA – capex)/interest
    • EBITDA/interest is the most well known and used formula of the four
  • Operational efficiency leads to lower costs and higher margins
    • EBITDA margin
    • Operating margin
  • Margin stability is measured through average % change in EBITDA margin

Remember the basic screens for different equity strategies, i.e. growth versus value investing, and the limitations of back-testing.

We are going to skip over some topics and begin our coverage of Equity Investments next week. The topic area is covered in two study sessions and will become increasingly important in the next two exams. Building a good base of knowledge from Level 1 material is absolutely critical to doing well on the other exams.

Only a few months left to the December exam. If you haven’t already, assess how you are doing with a mock exam or some practice problems over the material you have covered. If you are not through at least a few study sessions or are not retaining much of the information, you may need to step up your schedule. Stay strong, we’ll get there.

‘til next time, happy studyin’
Joseph Hogue, CFA

CFA Level 1 Review: Balance Sheet



Study Session 9 is really your first look into the detail in the financial statements. There are four readings, covering inventories, income taxes, non-current liabilities and non-current assets. The material may seem a little boring at times and is largely a review of accounting issues. Resist the urge to just go through the motions and memorize enough to pass the test on these topics, here and in the other readings on the financial statement accounts. Learning the intricacies within the individual line items in the financial statements is your life as an analyst and really separates the good from the great.

It may be easy to fall into a trance-like state while reading through the material. You really need to stop every once in a while to think back on what you’ve read and review the important points.

Inventories

The material revolves around the choices for inventory accounting (FIFO, LIFO, Weighted Average, and Specific ID). You absolutely must know the FIFO AND LIFO concepts as well as how the choice affects ratios and the income statement. You will need this going into the CFA level 2 exam so don’t ignore it.

FIFO expenses the first items purchased for cost of goods sold, which are usually cheaper given inflation. This will lead to higher earnings from the lower expense. Ending inventory, working capital, shareholders’ equity, earnings, current ratio, ROA, ROE and the profit margin are usually higher using FIFO accounting. The advantage of FIFO is that the ending inventory will represent current replacement costs.

LIFO expenses newer inventory first so ending inventory will usually be lower in an environment of increasing prices. Understand what happens in an inventory liquidation and what it means for taxes, cash flow and earnings. After-tax cash flow, debt-to-equity, and asset turnover are usually higher under LIFO accounting. The advantage of LIFO is that it better matches current costs in goods sold with revenues.

The weighted average costing method is fairly straight forward and just the total cost of units available for sale divided by the total number of units available for sale in the period. It is not quite as commonly used and the Institute does not spend nearly as much time on it as the other two methods. The advantage of average costing is that it smoothes any price changes.

Understand how to convert LIFO to FIFO statements. Add the ending LIFO reserve to inventory. Subtract the change in LIFO reserve from the COGS for FIFO cost of goods sold. Adjust the LIFO net profit by the change in LIFO reserve and the tax rate for the FIFO net profit.

For the exam, you need to understand how the inventory costing methods result in different valuations in other accounts (i.e. gross/operating/net profits, ending inventory, cost of goods, taxes). The table below shows the costing method affects in a (normal) rising price environment. You may be asked how this would differ when prices are falling which would mean that the opposite would happen. More important that memorizing the table is understanding what is happening.

A table with LIFO and FIFO across the top and all the relevant ratios/financial statement line items down the side makes it easier to see how the two methods can cause differences in your analysis. Rather than just writing higher or lower, understand why the effect happens (i.e. shareholders’ equity is usually higher with FIFO because earnings and inventories are higher).

Long-lived Assets

Much of the reading revolves around the capitalizing/expensing debate. Understand the rules for capitalizing and how/why managers might want to bend them.

On acquisition, all tangible assets (physical assets) are recorded at cost on the balance sheet. This is capitalization because the company creates a capital asset that will be used in the business. It appears as an increase in the asset and shareholder’s equity (balance sheet) and a cash outflow in investing (Statement Cash Flows). The company will then depreciate the value of the asset by expensing a certain amount on the income statement each quarter and increasing the accumulated depreciation account on the balance sheet.

The company may also choose to expense an asset if its usefulness is used entirely in the current period. This means no change on the balance sheet and higher expenses on the income statement. Since this results in lower net income (in the current period) and lower assets, management may choose to capitalize an asset when it can.

Your job as an analyst will be to decide if the decision was appropriate and adjust the financial statements if necessary. The material on the adjustments is important and you should remember how to adjust the interest coverage ratio (add depreciation expense to EBIT and the capitalized interest to interest expense) and the net profit margin.

You may also want to adjust the statements for capitalized interest by: add capitalized interest back to interest expense, reclassify capitalized interest from investing to operations on the cash flow statement, remove capitalized interest from depreciation expense.

Understand how the financial statement accounts and ratios differ under capitalizing or expensing. A table makes it easy to remember with capitalization on one side and expensing on the other. Return on equity, ROA, profit margin, pretax cash from operations, earnings, and shareholders’ equity will be higher under capitalization. Cash from investing, asset turnover, and debt-to-equity will be higher under expensing.

Remember the difference and how to calculate the methods of depreciation: straight-line, accelerated, and units-of-production and be able to estimate the age of fixed assets.

Straight-line depreciation is relatively easy and just the original cost minus salvage value, divided by useful life. The biggest hurdle is remembering to reduce by salvage value because many candidates forget the step.

Accelerated depreciation for each year is = (2/asset life) multiplied by the year’s beginning book value of the asset. The method books higher depreciation expense earlier in the asset life.

Debt-to-equity and asset turnover will be higher under an accelerated method of depreciation while ROE, ROA, profit margin, shareholders’ equity, and earnings are higher under straight-line.

The units-of-production method is = (number of units produced/number of total units asset will produce over useful life) times the cost minus salvage value.

Intangible assets are those like patents and goodwill that do not have a physical nature. The most important material here is the difference between IFRS and GAAP in the recognization and accounting for intangible assets. There are separate rules for an internally-generated asset (i.e. through R&D) and an acquired asset. Again, a table with IFRS and GAAP next to each other makes it easiest to compare and remember the material.

Income Taxes

You will need to know the difference between accounting profit and taxable income and how to calculate deferred tax assets and liabilities. A deferred tax liability is taxes that will be paid in the future because the company reported lower taxable income than profits, while a DTA is taxes that will be saved in the future. The material can be a little confusing so you may need to spend a little extra time.

On these more difficult concepts, I like to look for a YouTube video that may help explain things. If you are a visual learner like me, it may help to see the material from a different perspective. Allen Mursau provides a good overview of deferred taxes at https://www.youtube.com/watch?v=45PARid_erY

Understand the concept behind temporary and permanent differences. Tax-exempt interest, allowable tax credits and life insurance premiums are the usual examples for permanent differences.

Be able to determine the income tax expense under the liability method: Taxes payable + change in DTL – Changes in DTA net of valuation allowance.

Non-Current Liabilities

You need to be able to work through the calculation for interest expense, coupon payment and the ending carrying value of a bond. It can be a pain at first isn’t too difficult once you understand what is happening.

The interest expense is just the ending carrying value times the market rate times ½ for semiannual bonds. Reduce this by the interest payment (face value * coupon rate*1/2) for the change in the liability. The prior ending carrying value plus the change in liability is your new carrying value.

Understand how a change in interest rates affects the market value of debt and economic gains. An increase in rates will decrease the value of debt and lead to an economic gain.

Remember the five main debt covenants: limitations on asset disposal, restrictions on debt issuance, limits on use of borrowed funds, collateral maintenance, and dividend restrictions.

Study session ten in the CFA Level 1 curriculum concludes the material on FSA with reporting quality and some applications.

‘til next time, happy studyin’
Joseph Hogue, CFA

CFA Level 1 Review: Cash Flows and Financial Analysis



We covered the first half of study session eight last week with a review of the Balance Sheet and Income Statement. We wrap up our review this week with the Statement of Cash Flows and Financial Analysis Techniques.

Cash Flows are an Analyst’s Best Friend

The Statement of Cash Flows is where you will likely spend much of your time in your first years as an analyst. This reconciliation of cash in and out of a business over a period can be constructed completely from the other two statements. It is also less easily manipulated than the income statement and provides a powerful check against aggressive accounting assumptions on the income statement.

There are two methods of constructing the Statement of Cash Flows, direct and indirect. While it may be tempting to pick one method of cash flow statement construction, you absolutely must know both methods. There is no better practice to understand how the company operates, i.e. how the company uses assets, liabilities and income to generate cash for equity holders. Knowing the power of cash flows over reported income will make you a superb analyst.

Cash versus Accrual Accounting

While the other two statements follow an accrual method of matching expenses and revenues made during the period, the Statement of Cash Flows shows the cash receipts and payments during the period. It is a reconciling statement in the company’s cash and cash equivalents during the period. Because it shows actual inflows and outflows, it is much more difficult to manipulate by management and widely used by analysts.

The general structure for the statement is that,

  • Change in Cash = Cash from operations (CFO) + Cash from Investing (CFI) + Cash from Financing (CFF) + any effects of exchange rates

There is a lot of material here but the first thing you need to master is distinguishing between a cash outflow and a cash inflow. It is all about whether an account is a source of cash or a use of cash. Once you’ve got that understood, everything else is intuitive and more easily understood.

Assets are sources of cash, if you see a decrease in an asset (on the balance sheet) that means the company converted that asset to cash, i.e. cash inflow.

Liabilities are a use of cash, a decrease in a liability account means the company used cash to pay for that decrease, i.e. cash outflow.

Cash Flow from Operations

Besides cash from sales of goods or services, an important part of CFO is the adjustments from items on the balance sheet and income statement. These adjustments happen because of the accounting difference between accrual-based and cash accounting.

  • Depreciation for assets, expensed on the income statement as a use of a capital asset, is not a use of cash so must be added back to net income. This account is extremely important for a lot of capital-intensive sectors like energy and real estate. The company’s continual investment in new equipment or depreciable assets will be an important check against depreciation.
  • Change in operating assets and liabilities that have already been accounted for on the balance sheet but had not yet settled in cash, i.e. accounts receivable, inventories, accounts payable, etc. This is the company’s ‘working capital’ and is important in analyzing the true efficiency of operations. These are all short-term assets and liabilities used in the day-to-day operation of the enterprise.
  • One confusing aspect of the statement is remembering how dividends and interest are shown. Dividends received and interest received and paid are shown as cash flow from operations, while dividends paid are shown as financing.

Cash Flow from Investing

While operating assets and liabilities, or working capital, is shown as cash flow from operations, cash flows for the purchase or sale of long-term assets is shown as investing. This makes intuitive sense if you think of these assets as an investment in long-term production. Items include fixed assets, long-term investments and business acquisitions or divestitures.

Cash Flow from Financing

Financing includes borrowing or repaying debt principal but not interest which is taken as a cost of operations and shown under CFO. Similarly, since equity capital (common and preferred stock) is raised as a financing vehicle, issuing or repurchasing shares and paying dividends is shown as CFF.

Converting the Statement to Direct Method

Most firms use the indirect method to prepare cash flows so the most common need is to convert the statement to the direct method. Firms reporting under the direct method must also present a reconciliation to the indirect method ( U.S. GAAP). The direct method details the firm’s operating cash receipts and payments from customers, suppliers, employees, etc. while removing a lot of the effects of accrual accounting. CFI and CFF are the same for both methods.

You must be able to arrive at CFO using the direct method.

The general formula for the direct method is:

Net Cash from Operations =
Cash Collected from Customers
- Cash paid to suppliers
- Cash paid to employees
- Cash paid for operating expenses
- Cash paid for interest
+ Cash received from dividends and interest

Start with Revenues
+/- change in unearned revenue
+/- Change in Accounts Receivable
= Cash collected from customers

Cost of goods sold
+/- change in inventory
+/- change in accounts payable
= Cash paid to suppliers

Salaries and wages expense
+/- change in wages payable
= Cash paid to employees

Other operating expenses
+/- change in prepaid expenses
+/- change in accrued liabilities
= Cash paid for other operating expenses

Interest expense
+/- change in interest payable
= Cash paid for interest

Dividend and interest income
+beginning interest receivable
- Ending interest receivable
= Cash received from dividends and interest

The Indirect Method

Since most statements use this method, you will not usually have to do the work but it is important to know how to put it together. The method starts with net income and adjusts for cash and non-cash items.

Net Income
+ Non-cash charges (depreciation, amortization, depletion expense)
+ increases in current operating liabilities
+ decreases in current operating assets
+ increases in deferred income tax liability
- increases in current operating assets
- decreases in current operating liabilities
- decreases in deferred tax liability

+ any losses on investing or financing activities (loss on sale or write-downs, loss on debt retirement)
- any gains on investing or financing activities

= Net cash from operations

Free Cash Flow

Free cash flow is an extremely important measurement and you will need it extensively in the equity section of the exam, especially at level II. It represents the cash available to either equity investors or all capital providers after all working capital and fixed capital needs have been accountable. Basically, it is the extra cash available to owners (of debt or equity) after the company’s future operations have been funded.

Free Cash Flow to the Firm (FCFF) is the cash flow available to all capital providers (debt and equity) and equals:

Net income + Net noncash Charges (depreciation and amortization) – Investment in working capital – Investment in Fixed capital + after tax interest expense

Free Cash Flow to Equity (FCFE) is the cash flow available to common shareholders and equals:

Net income + Net noncash Charges (depreciation and amortization) – Investment in working capital – Investment in Fixed +/- net borrowing

  • Notice that FCFE is FCFF except without adding back interest expense and taking net borrowing into account.
  • Understand how to arrive at FCFE or FCFF with CFO
  • FCFF = CFO + INT (1-t) – invest fixed capital
  • FCFE= CFO – invest fixed capital +/- net borrowing

There are a few performance and coverage ratios you should remember as well. Most are relatively simple, just the CFO over an account from one of the other statements. Remember that any account from the balance sheet must be averaged between the beginning and ending value since the balance sheet is a point-in-time estimate rather than activity over the period.

GAAP and IFRS Differences

The difference in cash flow reporting for GAAP and IFRS are extremely testable so you must remember them for the exam. The material is relatively brief and lends itself easily to a flash card.

Interest paid – can be classified as operating or financing cash flows in IFRS but only as operating cash flows under GAAP.

Interest and dividends received – can be classified as operating or investing cash flows under IFRS but only as operating cash flows under GAAP.

Dividends paid – can be classified as operating or financing cash flows under IFRS but only as financing cash flows under GAAP.

Companies reporting under IFRS need to separate their income tax account if possible under operating, investing or financing while all income taxes are reported under operating cash flows in GAAP.

The direct method is preferred under both IFRS and GAAP but the indirect method may also be used. Under GAAP, a company must also provide a reconciliation to the indirect method if the direct method is used in the statements.

Financial Analysis Techniques

The introductory material on ratios, common-size techniques, regression analysis and the use of graphs is probably secondary to actually understanding the formulas that follow and what they mean. Understand the basic concept behind the broad range of techniques and any advantages/limitations to each.

There are an immense number of formulas shown, I counted more than 50 in the FinQuiz study notes including multiple ways to get at the same idea. The likelihood of seeing any individual formula on the exam is relatively small so I would spend more time on the bigger picture and the three financial statements. Make a flash card for each formula and run through them until you are familiar with the concept and inputs to each formula. Once you’ve got a particular formula, put the card in your secondary pile which you may only need to review every month or so. This should be enough to reproduce it on the exam if needed.

Study Session 9 digs deeper into the balance sheet with readings on inventories, income taxes, and non-current assets and liabilities.

‘til next time, happy studyin’
Joseph Hogue, CFA

CFA Level 1 Review: Financial Statements



Study session eight in the curriculum is your first real look at the three financial statements and some techniques in analysis. I won’t say that the material absolutely must be a pleasure but this is going to be a big part of your job as an analyst. If you are not the slightest bit interested in dissecting the financial statements and analyzing what you find…you might want to consider another career path.

The study session is a long one and important enough to take a little extra time to work through. We’ll cover the first two readings this week and then finish up next week.

It’s hard to distinguish any significantly important material in the curriculum covering the financial statements because it is all extremely important.

  • Understand each individual line item that shows up on the statements,
  • which accounts can be manipulated by management and how,
  • how each account is valued,
  • which accounts are used in ratio and other financial analysis, and
  • how the three financial statements are related to each other.

Understanding Income Statements

The income statement measures the company’s performance over a period of time. The main point is that revenues and related expenses are matched during the period in which they occur, i.e. accrual accounting. This is supposed to give a better measure of performance than a cash accounting because cash does not always come in at the same time as the work is done. The problem is that management often has a strong incentive to manipulate the revenues, expenses and other items to show earnings in a different light.

It’s important to understand the basic structure of the statement and what each line item represents:

  • Net Sales is gross revenue minus any allowances for returns
  • Cost of goods sold is really what it sounds like and is the inventory cost, here it is important to understand inventory accounting procedures like LIFO, FIFO, or average cost to understand how management is expensing it
  • Gross Profit is the difference between net revenue and COGS (also used to find Gross Margin) and is your first measure of profitability
  • Selling, General & Administrative is all direct and indirect expenses that can be linked to operations (salaries, rent, utilities, marketing, pretty much everything that is not associated with the cost of inventory itself)
  • Operating income (profit) is the result of operations and your second measure of profitability. This is also sometimes referred to as EBIT or earnings before interest and taxes. (profit margin = operating income/ net revenue)
  • Interest expense is just the interest on debt for the period
  • Nonrecurring items- discussed below
  • Provision for income taxes represents the estimated tax liability and gives an indication of the effective tax rate
  • Net income is your final measure of profitability (net margin = net income/net revenue)

Firms with a controlling interest in a subsidiary will also report the amount of net income from the subsidiary on their own income statement. You will see much more detail on how and when this income is consolidated on the parent company’s statements in Level 2. For the first exam, just remember the basic definitions for minority interest and consolidation.

A theme throughout the curriculum is the preference for conservative accounting principles, as opposed to aggressive practices. Conservative principles are those that take the ‘safe’ bet when recognizing revenues or expenses (and usually less favorable to short-term reporting). The idea is that if management is taking a conservative approach on some accounting practices, they are less likely to be trying to manipulate the data to show the financials in a better light.

There is quite a bit of information on revenue recognition. Start with remembering the ‘criteria’ for recognizing different types of revenue and the ‘procedural steps’ for recognition. This kind of list material is easily testable.

Understand how to calculate the two methods for revenue recognition of long-term projects and the SEC’s four criteria for revenue recognition:

  • Legitimate arrangement between buyer and seller
  • Delivered or rendered the product or service
  • Price is or can be determined
  • The seller can be reasonably assured of collection

Revenue recognition for long-term contracts is particularly important for the idea of accrual accounting, i.e. matching revenue with appropriate expenses in the current period. Remember the steps to the different methods:

  • Percentage of completion
    • Percent complete = total costs to date/total expected costs
    • Recognizable revenue total = estimated total revenue * percent complete
    • Current period revenue = Recognizable revenue total – prior revenue recognized
  • When the expenses and sales for a project cannot be measured until completion, U.S. GAAP allows the completed-contract method. All billings and expenses are capitalized on the balance sheet until the project is completed then everything is moved to the income statement.
  • Percentage of completion method is more aggressive because revenues are booked immediately even if they will not actually be received until later. It is also subject to considerable assumptions and shows smoother earnings.

The material on LIFO and FIFO is extremely important and you will need this introductory knowledge for detailed analysis in the Level 2 exam.

  • FIFO expenses the oldest inventory on the income statement first (first-in, first out). This means that ending inventory (the materials still held for production after the current period) better matches current replacement costs.
  • LIFO expenses the newest inventory on the income statement first (last-in, first-out). The method is permitted under U.S. GAAP but not IFRS. It better matches current costs with revenues.
  • Weighted Average Costs is not used as much in the curriculum as LIFO or FIFO but you still need to know how it is calculated and how it relates to the other two methods.

** Understand the implication of these three costing methods on Net Income, Ending Inventory and Cost of Goods Sold in two scenarios (rising prices and falling prices).

  • FIFO reports the highest net income and ending inventory but the lowest cost of goods in an environment of rising prices. This is because older (cheaper) inventory is expensed first.
  • LIFO reports the highest net income and ending inventory but the lowest cost of goods in an environment of falling prices. This is because newer (cheaper) inventory is expensed first.
  • Weighted Average Cost always reports NI, EI and cost of goods in the middle of these two in both pricing environments

Depreciation is another topic where you will need to master the introductory information to do well on the Level 2 exam. The three methods are easily testable because they lend themselves well to quick calculations.

  • Straight line depreciation spreads the value out over the useful life = (cost – residual value)/useful life
  • Accelerated depreciation takes higher depreciation charge earlier in the equipment’s life = (2/remaining       useful life)*(cost – accumulated depreciation)
  • Units of production matches the depreciation with production

Nonrecurring items that are unusual or infrequent (but not both) are reported as part of earnings from continuing operations and are often a way for management to take large expenses up front instead of in the future. Examples are: restructuring costs, asset impairment charges, gains or losses on sale of long-lived assets.

Those nonrecurring items that are unusual and infrequent (extraordinary) or discontinued operations are reported net of taxes below income from continued operations. Because these are so out of the ordinary, analysts do not normally consider them against performance. As with those nonrecurring items included in continuing operations, analysts must decide whether they are appropriately reported.

Remember that some items are not reported on the income statement but go “direct to equity” as other comprehensive income. The easiest way to remember these is by the PUFE acronym for:

  • Pensions or additional minimum pension liability
  • Unrealized gains or losses on available for sale securities
  • Foreign currency exchange translations on hedging
  • Effective portion of cash flow hedges

You are not asked to do much with the Statement of Comprehensive Income at level I but just understand the basic relationship and what each of the four items represents.

Understand which changes to accounting standards must be reported retrospectively (changes to accounting principles) and which must be treated prospectively with no adjustments to prior periods (changes to estimates) and that corrections of prior period errors require a restatement of financial statements.

Be able to calculate earnings per share for both a simple (just NI minus preferred dividends over weighted average common shares) and complex capital structure (basic EPS adjusted for After-tax interest on convertible and common share adjustments for assumed conversions).

Understanding Balance Sheets

Unlike the other two statements, the balance sheet is a ‘snapshot’ in time. The figures reflect the state of accounts at that moment, the last day of the quarter or year. The other two statements represent activity over the period. For this reason, and this is very important, when you perform ratio analysis comparing numbers across the statements you will take an average of the beginning and ending figures for balance sheet accounts. For example, the cash debt coverage is cash-flow from operations divided by average total debt from beginning and ending balance sheet date.

You’re going to get tired of people saying, “Assets = Liabilities + Equities.” This is the basic balance sheet equation and around which much of the material will revolve around. Understand what it shows when you change around the equation (i.e. A-L = E) and you’ll get the importance of the concept.

Account Valuations

One of the most important topics on the statement is valuation. Some accounts are shown at historical or amortized price, while others are shown at fair (market) value. Obviously this makes a big difference in overall valuation and when comparing numbers. Further, analysts often will adjust the numbers to arrive at a number they feel is more realistic or comparable. You aren’t asked to do this but just to understand where it might be needed and why. The definitions below will each describe the method of valuation for the account.

Assets

Assets represent a future probable economic benefit and could be accumulated items, amounts spent but not yet expensed (matched with revenues) or amounts earned but not yet received (accounts receivable).

Current assets are the most liquid and are accumulated or planned to be used in the ‘current’ operating period. Normally recorded at fair market value.

Cash or cash equivalents- is usually short-term money market, CDs, commercial paper or treasuries that can be converted to cash quickly. This is used in all your liquidity ratios and is (duh) valued at market.

Accounts receivable- Sales made on credit but not collected, usually offset by an allowance for uncollectable (estimated) but shown net realizable (fair) value. Trends in AR are an important indication of performance and estimates.

Inventories- A key item and one you’ll spend a lot of time on through the curriculum. Reported at lower of cost or market on the balance sheet but estimated through different practices (LIFO, FIFO, or average). Could be broken down into three sub-accounts: raw materials, work-in-process, and finished goods.

Prepaid expenses- Where the company has paid in advance for a service or product, i.e. insurance and rent. Valued at market with an adjustment when they are expensed through the income statement.

Long-term assets have a useful life of more than a year (or operating cycle) and are usually not going to be sold to customers. These accounts are usually recorded at cost and then depreciated or amortized over the estimated life.

Property, Plant, & Equipment – valued at cost and depreciated over its estimated useful life, shown as net. These are also referred to as ‘tangible’ assets because they generally have physical substance and are easily counted.

Goodwill & other intangibles- Goodwill is the amount paid for acquisitions above their market value. It is basically a premium paid for things like brand and proprietary technology. It is recorded at cost and tested annually for impairment, which is an estimation of the value that no longer exists.

Liabilities

Liabilities are future probable sacrifices from obligations or transactions and could be: amounts received but not earned yet as revenue, amounts received that must be repaid or amounts expensed on the income statement but not yet paid (accounts payable, accruals, etc).

Current liabilities are those that will be paid or settled in the ‘current’ operating cycle.

Accounts Payable- suppliers have sold something to the company on credit that must be repaid. As with AR, you’ll look for trends in this to see that the company is not taking longer to pay. Valued at market.

Accrued liabilities- Those items expensed in the current period but that will not be paid until the next period, kind of a carry-over effect of timing, i.e. wages and interest owed but not paid yet. Valued at market.

Short-term debt- includes lines of credit and notes with an original maturity of less than a year (negotiated debt).

Current portion of long-term debt – principal portion of long-term notes including any capital lease obligations.

Unearned revenue- sales collected in advance but not yet earned so they sit here until delivered or performed. Settled as revenue on the income statement instead of through a cash adjustment.

Long-term liabilities is often a single line item for debt but can also be broken out into items like: bonds and notes payable, long-term lease obligations, deferred taxes and pension liabilities.

Stockholder’s Equity

Equity is the residual after assets and liabilities and that which is due the owners of the company. It includes: capital contributed by owners through stock, recognized on the income statement but not yet paid out to owners (retained earnings) and adjustments to assets or liabilities that did not go through the income statement (see other comprehensive income in prior post).

Contributed capital- is supplied by stockholders and broken into common, preferred and additional paid-in-capital.

Minority interest – This is the cumulative, noncontrolling ownership held in other companies.

Retained earnings- accumulated net income due to owners but not yet paid out.

Treasury stock – amount paid to repurchase company stock usually shown as a negative number because it decreases equity.

There differences between IFRS and U.S. GAAP are probably the most important here on the balance sheet and you should try to remember the list material for the exam. Make out a flash card for each line item where valuation or reporting differ between the two (Inventories, PP&E, Intangible assets, goodwill). Place U.S. GAAP standards on one half with IFRS next to it to quickly compare the differences.

The three types of financial assets (Held-to-Maturity, Held-for-Trading, Available-for-Sale) are important to understand. Remember the criteria for each, how it is valued on the balance sheet and how unrealized gains are reported.

Deferred tax assets and liabilities will also be a big section on the next exam but you only need the basic definition for the first exam.

That is a ton of information for a blog post and only the high-level stuff you need to know about financial statements. Take the extra time on these next few study sessions and master the material. We will wrap up SS8 next week with a review of the Statement of Cash Flows and an introduction to Financial Analysis Techniques.

‘til next time, happy studyin’
Joseph Hogue, CFA

Level 3 CFA Curriculum Changes 2015



 

The readings and Learning Outcome Statements (LOS) are out for the 2015 CFA curriculum and there have been some significant changes. Make sure you download the curriculum outline and new LOS from the CFA Institute website.

The most surprising change has been a modification of the topic area percentage weights on the exams. The previous topic weights had been the same for years, before I was a candidate, and no one really saw the changes coming. The actual changes are relatively marginal but still surprising. While new topic weights were given to many topics in the first two exams, it looks like the weights have been removed altogether from the Level 3 exam.

At first glance there appears to be huge changes to the Level 3 curriculum this year but closer inspection reveals less new information and a simple reshuffling of study sessions and readings. The Institute has changed study sessions around, condensing some and separating others.

Private Wealth Management has been separated into two study sessions. Economics and Capital Market Expectations were two study sessions last year but have been rolled up into SS7 this year. Asset Allocation has been separated into two study sessions, eight and nine, this year. Equity Portfolio Management has been condensed from two study sessions to just one. There are also readings that have been moved from one study session to another.

After all that, only one new reading has been added (asset allocation) and three readings have been removed (one in Ethics and two in Equity Investments).

The new (11th) edition of the Code and Standards is not materially different from the previous edition. Some of the standards have been modified to include a more proactive requirement, i.e. the need for supervisors to take positive steps to promote compliance rather than disciplinary action.

New readings:
(20) Market Indexes and Benchmarks

Dropped readings:
(3) Ethics in Practice(24) International Equity Benchmarks
(25) Corporate Performance, Governance and Business Ethics

The removal of topic weights from the exam is not necessarily a big change. Suggested topic weights for the Level 3 exam always had a large range and were not very useful anyway. Portfolio management, i.e. individual and institutional, are still going to be major sections and worth every minute of study time.

The Level 3 CFA exam is still all about the essay portion and the best way to approach it is still by going through old exams released by the Institute. The guideline answers to the essay exams reference a specific reading from the curriculum so make sure that reading is still included in the curriculum. We’ll cover several essay questions from prior exams in our review leading up to the 2015 exam.

‘til next time, happy studyin’
Joseph Hogue, CFA

Level 2 CFA Curriculum Changes 2015



The readings and Learning Outcome Statements (LOS) are out for the 2015 CFA curriculum and there have been some significant changes. Make sure you download the curriculum outline and new LOS from the CFA Institute website.

The most surprising change has been a modification of the topic area percentage weights on the exams. The previous topic weights had been the same for years, before I was a candidate, and no one really saw the changes coming. The actual changes are relatively marginal but still surprising.

Level 2 Changes

The topic weight for Ethics & Professional Standards has increased from a fixed 10% weight to a range of 10% to 15% on the exam. The range on Financial Reporting & Analysis has been tightened to 15% to 20% of your exam score, slightly decreasing its potential importance from a high of 25%. The importance of Equity Investments has also decreased with a new weighting range of 15% to 25%, from 20% to 30% previously. The range on Alternative Investments decreased to 5% to 10% (5% to 15% previously) while the range for Fixed Income Investments increased to 10% to 20% (from 5% to 15% previously).

There are six new readings to the Level 2 exam (one in FRA, one in Corporate Finance and four in Fixed Income) while 10 readings have been removed (two in Ethics, two in FRA, one in Alternative Assets and five in Fixed Income).

New Readings:

(20) Evaluating Quality of Financial Reports
(25) Corporate Performance, Governance and Business Ethics
(42) Term Structure and Interest Rate Dynamics
(43) Arbitrage-Free Valuation Framework
(44) Valuation and Analysis: Bonds with Embedded Options
(46) Introduction to Asset-Backed Securities

Dropped Readings:
(3) CFA Institute Soft Dollar Standards
(10) Prudence in Perspective
(22) The Lessons We Learn
(23) Evaluating Financial Reporting Quality
(43) Investing in Hedge Funds: A Survey
(46) Term Structure and Volatility of Interest Rates
(47) Valuing Bonds with Embedded Options
(48) Mortgage-Backed Sector of the Bond Market
(49) Asset-Backed Sector of the Bond Market
(50) Valuing Mortgage-Backed and Asset-Backed Securities

The Ethics & Professional Standards topic has gotten a little easier with the removal of some supplementary readings. You still have the case studies but almost all the material is a repeat of what you saw at the Level 1 curriculum. The new edition of the Code and Standards is not materially different from the previous edition. Some of the standards have been modified to include a more proactive requirement, i.e. the need for supervisors to take positive steps to promote compliance rather than just prevention. The new chapter on ‘Ethics and the Investment Industry’ provides a strong argument for ethical conduct and integrity of the markets.

If you compare last year’s readings with the 2015 readings, you’ll notice that many have been changed rather than necessarily added or dropped entirely. This is good news for repeat candidates since it means that the LOS have not changed as dramatically as the readings. Of all the changes, I would probably pay the most attention to Fixed Income. The readings have been changed significantly and the topic weight on the exam has increased as well.

The common belief is that there is a higher chance of new material, i.e. new readings, appearing on the exams. I am not sure this is true or if it is even intentional by the Institute if it does happen. I would still recommend focusing on those topic areas with the most weighting whether they include new readings or not. The Level 2 CFA exam is all about the details and formulas. Where the Level 1 exam was about ‘why’ things are done, the Level 2 exam is about ‘how’ they are done so make sure you are able to work through formulas and processes.

‘til next time, happy studyin’
Joseph Hogue, CFA

Level 1 CFA Curriculum Changes 2015



The readings and Learning Outcome Statements (LOS) are out for the 2015 CFA curriculum and there have been some significant changes. We are covering the changes over the next three days. Make sure you down load the curriculum outline and new LOS from the CFA Institute website.

The most surprising change has been a modification of the topic area percentage weights on the exams. The previous topic weights had been the same for years, before I was a candidate, and no one really saw the changes coming. The actual changes are relatively marginal but still surprising.

Level 1 Changes

The weight to Corporate Finance decreased 1% to 7% of your Level 1 CFA exam score. Portfolio Management has increased in importance, rising from 5% to 7% of your score. Fixed Income has also decreased in importance, dropping 2% to 10% of your total score while Alternative Investments has picked up a percentage to become 4% of the exam.

A total of three readings have been added in Financial Reporting & Analysis, Fixed Income and Derivatives while the Ethical & Professional Standards have been updated to the 11th edition. Six readings have been removed, two in FRA and four in Derivatives.

New readings:
(33) Financial Reporting Quality
(54) Introduction to Asset-Backed Securities
(58) Basics of Derivatives Pricing and Valuation

Dropped readings:
(33) Financial Reporting Quality: Red Flags and Accounting Warning Signs
(34) Accounting Shenanigans on the Cash Flow Statement
(58) Forward Markets and Contracts
(59) Futures Markets and Contracts
(60) Option Markets and Contracts
(61) Swap Markets and Contracts

The new edition of the Code and Standards is not materially different from the previous edition. Some of the standards have been modified to include a more proactive requirement, i.e. the need for supervisors to take positive steps to promote compliance rather than just prevention. The new chapter on ‘Ethics and the Investment Industry’ provides a strong argument for ethical conduct and integrity of the markets. There are no new LOS for the topic area so nothing materially different.

There are 38 new LOS while 39 have been dropped and six amended. Most of the new or removed LOS have to do with new or removed readings, so fairly easy to spot. New LOS have been added to Economics, FRA, Corporate Finance, Fixed Income and Derivatives. LOS have been removed from FRA, Corporate Finance and Derivatives.

Derivatives looks to have become less detailed which will be a welcome change for many candidates. Often material is not dropped entirely but just moved to another exam so watch for changes to the Level 2 exam.

The common belief is that there is a higher chance of new material, i.e. new readings, appearing on the exams. I am not sure this is true or if it is even intentional by the Institute if it does happen. I would still recommend focusing on those topic areas with the most weighting whether they include new readings or not. The Level 1 CFA exam is all about broad understanding, so make sure you have a basic understanding of the why throughout the readings, new or otherwise.

‘til next time, happy studyin’
Joseph Hogue, CFA

CFA Level 1 Review: FRA and the Most Important Topic Area



Study session seven in the CFA Level 1 curriculum begins your study into Financial Reporting & Analysis, arguably the most important topic across the curriculum and your career. The session includes three readings covering an introduction, the mechanics of FRA and the two international accounting standards. It is all basic material and probably repeat for those with a finance background.

Financial Statement Analysis

This is really basic material and fairly intuitive. If you’ve got a background in finance, I would skim it while checking off the Learning Outcome Statements to make sure you have the general idea. There’s no calculations and you’re more likely to get questions from other sections of FRA.

Understand why different entities may have different uses for the statements; i.e. creditors, analysts and investors.

The balance sheet is a point in time measure of the firms assets, liabilities and equity capital. The numbers presented are as of a certain date. This is important because the other statements are presented for activity in the period. For many of the ratios, you will be using an average of the beginning and ending value to get a better representation of the account over the period. Another important thing to remember is that values on the balance sheet do not necessarily reflect fair market value. You will spend a lot of time learning how each line item is recorded and held on the books.

The income statement is a report of the firm’s operations over the period. How many sales they recorded and what it cost to make those sales. The most important thing to remember here is that sales do not mean cash flow. Understand the concept of the accrual method of accounting and how revenues and expenses are matched.

The statement of cash flows is a reconciliation of the other two accounts and reports how the firm’s cash changed over the period. You will be shown how to construct the statement two different ways, direct and indirect. Resist the temptation to just learn one way and hope that you don’t need to use the other. Understanding how cash payments and receipts are reported is one of the best ways to understand the company and will pay off big time in your analysis.

Beyond the three statements, the curriculum constantly emphasizes the importance of the Notes and Supplementary Information. The real detail in a company’s statements are buried within the notes so understand that you need to check there throughout your analysis. The curriculum spends some time on Other Comprehensive Income but only the basic need behind the statement.

Understand what an audit is and what kind of internal controls the company has, i.e. an independent board that is available to the auditors. Remember the basic language given in the four types of auditor reports:

  • Unqualified opinion – the most common and indicates no material misstatements and in accordance with GAAP.
  • Qualified opinion – some exceptions or limitations to accounting standards, possibly concerns to assumptions or valuations of certain items.
  • Adverse opinion – Not presented fairly or are materially misstated or not in accordance with GAAP
  • Disclaimer of opinion – the auditor is unable to issue an opinion

Understand that there are also other sources of information including: interim reports, proxy statements, the company’s website and press releases.

Financial Reporting Mechanics

The reading covers the standard conventions for developing the financial statements and is a great primer for deeper study. If you do not have a background in accounting or finance, this reading is a lifesaver because it will help get you up to speed.

The balance sheet is broken into current and non-current assets, current and non-current liabilities, and stockholder’s equity. Assets, whether current or not, are the resources the company uses in its operations. Current assets are those that the company plans to use or convert to cash within a year. Long-term assets are longer-lived and include PP&E, intangible assets and goodwill.

Liabilities are creditors’ claims on assets, and are drawn against assets to find the amount left to the owners. The curriculum does not spend quite as much time with Owner’s Equity. Just remember that it is contributed capital plus retained earnings and understand the basics behind the accounts.

Understand the difference between operating, investing and financing activities. This is the key to analyzing how the business works. Operating activities are the core business including sales and how those sales are made. Investing activities relate to the acquisition of long-term assets and investments and help to generate more operations in the future. Financing activities relate to the firm’s capital transactions involving equity or debt.

As part of learning the cash flow statement, remember the difference between a source of cash and a use of cash, and how it relates to the other statements. An increase in liabilities or equity or a decrease in assets is a source of cash because either an asset is being converted to cash or a liab/equity is being accrued in exchange for cash now. On the other hand, an increase in assets or a decrease in liab/equity is a use of cash. Buying an asset or paying off a liability/equity account decreases cash.

The Accounting Process is about a year’s worth of accounting classes packed into one reading. It is general information and you shouldn’t have too much trouble understanding it. While important, it’s secondary to the financial statement material.

The section on Accruals and Valuation Adjustments is very important and core to your job. As an analyst, you need to see through the ways management adjust accounts and be able to arrive at a fair value. Understand unearned (deferred) revenue and prepaid expenses and the assumptions/adjustments made for both in the income statement.

Lastly, understand how the three statements are related. The income statement flows through to the balance sheet through retained earnings. The cash flow statement relates to the balance sheet through change in cash. Additionally, there are many accounts that are linked (i.e. depreciation, working capital).

Financial Reporting Standards

While you will need to understand how the statements are reported differently under IFRS and GAAP, a lot of this background information is secondary to the mechanics. Understand the relationship between each framework and the private sector organizations that establish rules (FASB and IASB) and the difference in framework between IFRS and GAAP.

Knowing some of the forms will be necessary in your professional life, even if you don’t see a specific question on the exam. 10-K is the annual report to the SEC while 10-Q is a quarterly report. Material events outside of the quarterly or annual reports are required in an 8-K form. Forms 3, 4 and 5 are required to report changes in ownership.

Remember, IFRS does not permit LIFO as an inventory costing method and uses a single-step method for impairment rather than the two-step method used in GAAP. IFRS also requires capitalization of development costs when certain criteria are met.

An important difference between GAAP and IFRS is the difference between a principles-based method, providing a broad reporting framework and more judgment, and a rules-based method which provides specific rules for each transaction and requires less judgment.

Study session eight gives you your first glimpse into the financial statements and is extremely important. Be ready to spend a lot of time and master the material or you will not only have problems on the first exam, will need to relearn the material for the other two exams.

‘til next time, happy studyin’
Joseph Hogue, CFA


CFA Level 1 Review: Quant Methods, Building Blocks going Forward



This week we begin our review of some of the most important topic areas for the Level 1 exam. We may not cover every study session before the December exam but we will hit the most important areas and try to make sure you get all the points possible.

You’ll notice that we are skipping over one of the most important topic areas in the exam, Ethics and Professional Standards. If you’ve been following the blog, you know how important this topic is but also that it does not change much from year to year. We’ve covered the Ethics section several times and you can find the most recent post by clicking here. Remember, don’t just read through the material on Ethics and the Standards. You really need to be practicing those end-of-chapter and test bank problems to get a feel for how it will be tested on the exam.

Quantitative Methods: Lower points but absolutely essential

The Quant Methods topic area may represent one of the secondary topics by points on the first exam, only accounting for 12% of your total score, but the material is absolutely critical to your success across the exams and as a professional. You may be able to get through the exams and your career with just a basic understanding of other topics (i.e. derivatives) but try being an analyst without mastering discounted cash flows and statistical concepts and it will be a short career.

Unfortunately, the section is avoided by many candidates. As someone who never really liked math in school, I can relate to the desire to avoid quant methods. Realize as I did though, you are in an analytical field and you need to embrace mathematics. Trust me, math can actually be enjoyable and you can learn to love it. Spend a little time and you will be amazed at how quickly you start understanding more complex concepts. A little effort to break an old perspective will go a long way and will help you immensely.

Quant methods are covered in two study sessions in the Level 1 exam, Basic Concepts and Application, with four readings in each study session. The first study session will be repeat material for anyone with an educational background in finance and should be fairly easy to understand for just about anyone else. Study Session 3 is a little more difficult but still manageable. Of the readings, I would say all but technical analysis are equally important and testable. Ideas like time value of money, probability and quant testing are fundamental to the curriculum and you’ll need to be able to do the math in just about every other topic area.

Make sure you have a basic understanding of technical analysis but it is probably the least important. The Institute has never really put much faith in technical analysis so you will likely only see basic questions on the exam, if at all.

Time Value of Money

The most important thing here is be able to use your calculator to solve for any one of the missing variables. Note that the Institute usually keeps problems within the realm of possible reality so if you get an answer that seems extremely high or low then you need to go back through the calculation to make sure you did it correctly.

Make sure you divide the annual rate by the number of times it is compounded within your formula. (i.e. $100 at 8% compounded quarterly for two years = $100 (1.02)8 is different than simply $100 (1.08)2

Most calculators calculate cash flows as an ordinary annuity, where payments come at the end of the period. Make sure you set the “begin” key for any annuity due problems where payments come at the beginning of the period. Also, remember that the payment and present value inputs will have opposite signs (i.e. since the payment represents an outflow use a negative sign).

**Important** Get in the habit of clearing out your calculator before or after you work a problem. It is as easy as two quick keystrokes (2nd and Clr Wk) and can save you points on the test.

The future value of cash flows is
FVN=PV(1+r)N

i.e. if your savings account earns interest at a 5% rate and you have $100 deposited, how much will it be worth in 20 years?

FV20=$100(1+.05)20
=$265.33

This is a fairly basic calculation with no payments and you’re more likely to see something more difficult on the exam. It is relatively easy to work through but learn to do it on your time value buttons,

PV = 100
I/Y = 5
PMT = 0
N = 20
CPT –>FV

Whether you input the present value as a negative or not doesn’t matter much here since there are no payments. For other problems, just remember that outflows (deposits and payments into an investment or account) should be negative while inflows (money you receive or value) should be positive. One of the cash flows must be negative (outflow).

The future value of a series of cash flows is only slightly more difficult but easily understandable if you think of each payment as a single future value calculation. Don’t forget the note on changing your calculator for an annuity due.

Example: The same savings account as above has $100 deposited but you plan on depositing an additional $100 per year at the end of the year. What will the balance be at the end of 20 years?

PV= -100
PMT = -100
N = 20
I/Y = 5
CPT–>FV
FV = $3,333

Make sure you understand how to solve for each variable in the equation when given the other variables.

Note: I set my calculator to four decimal places which is usually more than you will need for the exam.

Discounted Cash Flow

This is arguably the most important reading in the study session and you will see the concepts across all three exams.The first section covers NPV and IRR which are really two sides of the same coin. NPV is the value today of the series of cash flows at a discount rate. IRR is the discount rate at which NPV is zero. Either one can be used in a budgeting decision. As with much of the material, understand the situations where each is more appropriate and the strengths/weaknesses of each concept.

Both NPV and IRR are found easily with the calculator. Remember that a key assumption of IRR is that cash flows are reinvested at the rate, which may not be realistic. Also, if there are multiple cash outflows, there will be multiple IRRs or none at all. There may be a conflict between NPV and IRR when projects are mutually exclusive or when there are multiple cash outflows. In this case, NPV is preferred.

Using the calculator is relatively easy,
The initial project cost or investment is a negative (outflow) as CF0
CO1 through x are the stream of cash flows and entered as a positive (inflow)
If cash flows are an equal amount, you can enter them as F (frequency)
Press the NPV button and enter the interest rate
Down arrow
CPT–> NPV
For IRR, just press the IRR button and CPT

Time-weighted returns measure the rate of growth over a defined period between cash flows. It should be used when the portfolio manager does not control cash in and out of the account (as is usually the case). Money-weighted returns can be done easily using the cash flow function on your calculator but may not be as applicable unless you have discretion on cash flows.

Know the difference and how to calculate the material in money market yields section (i.e. money market yield, bond equivalent yield, and HPY). These are good formulas for flash cards if you’re having problems.

Statistical Concepts and Market Returns

As with much of the quant methods material, you should start with an understanding of the basic concepts before worrying too much about the different variations. It is much more important to master the concept of standard deviation than to work through the material too quickly trying to get a vague idea of everything.

Geometric and Arithemetic averages are important. The arithmetic mean is simply the sum of observations divided by the number of observances while the geometric mean is the compound return by taking the nth root of the product.

The material on measures of dispersion is extremely important and will feed into the concept of risk. Even though you will be able to calculate variance and standard deviation on your calculator, spend the time to learn the formulas.

The Sharpe ratio is a key concept throughout the curriculum and you need to understand what it means as well as how to calculate it. It measures the excess return on an investment or portfolio and can be used to rank opportunities. You will use iterations of this formula in many other concepts (i.e. Roy’s Safety First). The drawback is that, since it uses standard deviation as a measure of risk, it is most applicable for symmetric distributions and may overstate risk-adjusted performance.

Understand that the mean, median and mode are the same in a normal distribution but different with skewness. Don’t worry too much about calculating kurtosis or skewness, just understand the their implication. (i.e. how it affects dispersion and returns)

Probability Concepts

The most important material here is covariance, correlation and being able to do the calculations for expected value, variance and standard deviation for a two-asset portfolio. The formulas can get kind of long but they are pretty basic. This is the material that will be used most through the other levels of the exams as well.

Remember, the expected return is just the weights of each asset times their respective expected returns.

Correlation between two assets is the covariance divided by the product of the two standard deviations.
Correlation = COV(X,Y) / STDev (x) STDev (y)

Correlation ranges from -1 (perfect negative relationship) and +1 (perfect positive relationship).

Common Probability Distributions

Most of the introductory material here is fairly unimportant as it isn’t used much in other parts of the curriculum. The binomial distribution is a little more important because it relates to some of the derivatives material. The normal distribution is really where you want to spend your time.

Remember that 90% of the distribution will be between 1.65 standard deviations, 95% within 1.96 deviations and 99% within 2.58 deviations. You will be given a z-table but need to know the formula and the applicable number of standard deviations. You need to pay attention to the question and look for which part of the curve you are being asked to measure. Do you need an interval around the mean or just one side? All the stuff around the z-score (the formula and finding probabilities) is fairly basic so spend some time and master it.

The information covering Monte Carlo simulations is important but just definitional and advantages/disadvantages against other analytical methods.

Sampling and Estimation

Again, fairly unimportant material but it is mostly conceptual so it should be easier to remember. You won’t need much in the way of formulas but will want to understand the ideas and differences between the different sampling plans. Remember that a good estimator is unbiased, efficient and consistent.

  • Understand the difference between simple random, systematic and stratified sampling as well as advantages/disadvantages around each.
  • A carryover from the previous reading, be able to calculate and interpret confidence intervals for the different distributions. Remember, if the sample size is larger than 30 then the z-score can be used as a proxy for the t-score.
  • Probably the most important material in the reading is that on data mining, sample selection, survivorship, look-ahead and time-period biases. Understand these and the different situations in which they might occur.

Hypothesis Testing

  • Understand the difference between the null and alternative hypothesis and be able to calculate the test statistic. The p-value is the lowest level of significance at which the null hypothesis is rejected.
  • Understand the difference between a Type I and Type II error
    • Type I is where you reject the true null hypothesis (i.e. saying that the statistic falls outside of the confidence interval in a normal distribution when it does not)
    • Type II is where you do not reject a false null hypothesis (i.e. saying that the statistic lies within the confidence interval when it does not)
    • Remember the rules for setting a low or high level of significance (1% or 10%) depending on the penalty for committing either error (i.e. 1% significance if you do not want to make Type I error, 10% significance if you do not want to make Type II error)

Technical Analysis

Again, not as important as the other readings but make sure you have a basic understanding in case you see something on the exam. Understand the assumptions, especially how they relate to the theory of efficient markets, and the comparison to fundamental analysis. It does look like the Institute is putting in more charting information in the curriculum so understand the basic definitional ideas around the vocabulary (i.e. head and shoulders, double tops, neckline, etc.)

Understand what volume says about technical analysis, i.e. intensity of confidence in an up or down move.

The technical indicators are of relatively more importance than the material on charting. Understand the concept behind the price-based indicators, momentum oscillators, sentiment and flow-of-funds indicators and whether an indicator is giving a bullish or bearish signal.

That is a lot to take in for one week so you will probably want to cover one study session per week. It is pretty basic stuff if you have at least an understanding of basic statistics and algebra. We’ll start on the Financial Reporting material next week.

‘til next time, happy studyin’
Joseph Hogue, CFA

December CFA Exam Must-Know Strategy



Following our discussion last week on taking the December and June exams, we thought it would be a good time to start a series of posts to prepare December candidates for the exam. This week we will cover the basic strategy and helpful tips for the first CFA exam. Over the next couple of months, we will cover specific topic-level information within the first exam.

Follow those topic weights

The CFA Institute does not disclose the minimum passing score on any exam but has said that no one with a score of 70% or greater has ever failed. The Institute does release a topic-level breakdown of the question weights you will see on the exam, shown in the graphic below. While you cannot afford to neglect any particular topic, one of the best things you can do while studying is focus on the high-point areas on each exam.

It will do you no good to spend half your time studying Corporate Finance, even if that is what it takes to master the information, if it means performing poorly in other areas.

cfa topic weights

Looking at the chart, it should be clear that you need to focus on three or four topic areas for the first exam.

You absolutely must master the material in Ethical and Professional Standards. Not only is it carry the second most questions on the exam but it will be 10% of your next two exams as well. You’ll see additional material in the other two exams but the Code and Standards do not change so learn them early. The most challenging aspect for most candidates is that they underestimate the difficulty of the exam questions. Candidates reason that they are more or less honest people and so will intuitively know the answers to the ethics questions.

WRONG! You only need to read through a few of the end-of-chapter questions in the curriculum to see how difficult and confusing the Institute can make these questions. My suggestion, make flashcards for each professional standard for quick review. Then spend most of your time practicing questions. The best resource will be your curriculum book or those from prior years. Try getting the book from last year or the year before for another set of questions. Test bank questions are also a good resource. By practicing as many questions as possible, you will start to get a feel for how they might appear on the actual exam.

Financial Reporting & Analysis is likely the most important topic area in the curriculum across all three exams. You are testing for the designation of Chartered Financial Analyst, so you better master the topic to pass the exams and succeed in your career. There are four study sessions covering FRA for the first exam. I would say SS8, the material on the financial statements, is probably the most important.

A few keys to passing the FRA material

  • Understand how items are recorded on the financial statements – Are they historical costs or market values, are they point-in-time values or for the entire period
  • Understand the relationships between the financial statements – These are absolutely critical to your success as an analyst. Building your first proforma model will mean linking the three financial statements to your projections flow through and tell you where the company is going.
  • Understand how to adjust and analyze the financial statements through ratios, earnings quality and backing out different items. This is really the Holy Grail of the analyst’s job and you won’t be expected to do it on your first CFA exam but you will be expected to understand the very basics.

We’ll cover FRA in more detail through our topic-level breakdowns. Just remember to leave yourself plenty of study time for the topic when you are planning your schedule.

The time you spend on Quantitative Methods will depend on your prior experience with statistics. While the points in the topic are not huge over the first two exams, understanding the Level 1 material can make the material on the second exam much easier. For this reason, I would suggest spending a little more time to get it down. Study Session 2 is relatively basic material but absolutely fundamental to our industry so you need to understand it.

While Equity Investments is only 10% of your first exam, I would recommend spending more time here as well because it will save you a lot of time on the next exam. Study Session 14 is the more important but SS13 is relatively basic and should be easy enough to get the general ideas. In particular, the material on Industry and Company Analysis (reading 50) and Equity Valuation (reading 51) are extremely important and very testable.

If you do not have a background in debt instruments, you’ll need to spend a little extra time in Fixed Income as well even if it is not a lot of points on the first exam. The basics on pricing and valuation that you learn on the first exam will be needed to understand the material in the other two exams.

Key Resources

While the curriculum is the last word for exam prep, it is simply too long to make it your only resource.

I would recommend you read through a study guide for each topic before you read through the curriculum. This is going to help you quickly get the basic ideas and will help speed your reading through the long curriculum readings. A lot of the curriculum is academic and a little dense so without a quick primer, you could find yourself re-reading passages just to understand what you’re looking at.

Flash cards are another key resource. These are a great resource to carry around with you and get a little extra studying in whenever you have down-time. Don’t buy your flashcards though. Half the benefit is from writing the problems out so you will want to make your own. I talk through how to make a set of quality flash cards in a prior post.

Practice problems, whether from the end-of-chapters or a study bank, are likely the number one reason candidates pass the exam or not. Sitting there reading the curriculum, and other passive learning techniques, will only help you retain about 20% of the material. Actively working through practice problems can help you retain at least 80% and get you well on your way to passing the exam.

As in the ethics material, a lot of candidates underestimate the difficulty of exam questions. You really need to study the practice problems to see what you will be up against for those six hours in December. I usually recommend doing at least 900 practice problems throughout your study plan.

A basic strategy

It is said that the human brain needs to see/experience something upwards of six or seven times to assimilate it into long-term memory. You’ve likely seen this in your daily life. Do you usually remember a phone number by just seeing it one time? No, you need to say it and see it a couple of times before you are able to remember it later.

The same can be said for preparing for the CFA exams. Plan on seeing or practicing the material at least 5-7 times before the exam. If you are breaking the study sessions into a weekly plan, it may look something like this:

Monday: Read study guide material
Tuesday: Practice problems and flash cards
Wednesday: Read curriculum and 30 minutes practice problems
Thursday: Finish curriculum and 30 minutes practice problems
Friday: Test over the material and flash cards
Saturday: Review study guide material and 30 minutes practice problems

By combining study guides, flash cards, practice problems and the curriculum you will be able to cover the material multiple times. By using multiple resources, you avoid getting bored looking at the exact same material every time. Notice, even on the reading days, I have added some practice problems. This is to reinforce the material you learned with active engagement.

I was quite surprised how general the questions were when I took the Level 1 exam. The first exam is an indoctrination into the industry and you are not expected to know all the details. Start by understanding the reasoning and basic ideas within each topic area and then move on to get the details. Understanding the basic reasoning in each Learning Outcome Statement (LOS) will usually help you eliminate at least one of the three answers provided.

Next week, we will start working through some of the topic areas on the Level 1 exam. We will spend most of our time focusing on core topics like Ethics, Financial Reporting, Quantitative Methods and Equity Investments but will try to touch on each topic over the next couple of months.

‘til next time, happy studyin’
Joseph Hogue, CFA

Preparing for the December Exam with a Jump on Next June



One of the most common questions I get from new CFA candidates is if it is possible to take the December Level 1 exam and then sit for the Level 2 CFA exam the following June.

To which I reply, “Possible, of course. Recommended, maybe.”

What’s the hurry?

Maybe the three years that have passed since I was a candidate have made me forget how anxious candidates are to be done with the exams. I understand that, like any academic credential, completion of the program is a big step in your career and you just want to get through it.

But are you taking the exams just to pass or are you taking them to learn how to be a better analyst? Trying to fit so much material in so little time may mean you will miss an important opportunity to really master the details. There is a ton of material in the CFA curriculum, written by some of the best minds in the industry, but a lot of it will go in one ear and out the other if you do not take your time.

Taking both the December and June exams makes for a tough schedule as well. Upwards of 600 hours studying over about nine months means a minimum of 15 hours per week devoted to the curriculum. Studying for 15 hours a week is achievable but you are going to risk some massive burnout trying to do it for such an extended period.

Even passing both the December and June exams will only get you the charter a year earlier, and that is if you will have the necessary work experience requirement.

Passing in the fast lane

For those of you intent on getting through the exams as quickly as possible, there is still time for a December and June exam schedule. You’ve got 18 weeks to the December exam which means you can accumulate the 300 hours of minimum study with a little over 15 hours per week. Some will be able to pass on less than 300 hours but many will not and it is much better to over-study than to fail an exam.

There is one advantage to the quickened strategy, that you will not need to review the Level 1 material while studying for the second exam. A lot of the material in the Level 2 exam is repeated or closely builds from the first exam. Many candidates find themselves having to review before going on to new information because of the six-month hiatus from studying.

Paying attention to the topic weights for each exam will help immensely. The first exam heavily weights Ethics and Financial Reporting. The second exam heavily weights Financial Reporting and Equity Investments. The material on Ethics and Professional Standards does not change much across each exam so spending extra time mastering it for the first exam could save you a lot of time studying for the Level 2 exam. I would also spend a lot of time studying Financial Reporting and Equity Investments within the Level 1 curriculum. You absolutely must master the material on financial statements in the first exam to be able to understand the Level 2 Financial Reporting and Equity Investments material.

You cannot afford to neglect any of the topic areas but spending the majority of your time during your Level 1 studying in these three topics will help give you a head start on the second exam.

After the Level 1 exam, taking at least a few weeks off is probably a good idea but you will want to start studying for the June exam as soon as possible. The Level 2 CFA exam is regarded as the most difficult by many candidates, especially for its huge amount of formulas.

I guess there is nothing wrong with a December-June exam schedule if you do not mind studying overtime for the better part of a year. Even if you are not successful on one of the exams, time spent studying is time well-spent and will help you in your career. Just remember not to neglect other aspects of professional development like networking or taking on more responsibility at work.

‘til next time, happy studyin’
Joseph Hogue, CFA

Professional Networking in the Virtual Age



I have a confession to make. I am one of the worst offenders of what I am about to post but I bet I’m not alone. I have 810 connections on LinkedIn and according to the site that puts more than 14.7 million other professionals in my network.

But would I be able to tell you anything about 90% of those first-level connections? Probably not.

And that is where many find themselves, with a huge virtual network but no real connections to help manage their professional career.

Maybe networking is not supposed to be this easy

While traditional networking should not be the painful process that many see it as, I’m not sure that it should be as easy as clicking ‘accept’ with no exchange between yourself and another. Sure, there are clear benefits to expanding your network through virtual platforms. We are able to build relationships with people that we would otherwise never meet. My ‘network’ spans nearly every country and just about every industry. Virtual networks help us keep in touch with our connections on a much more frequent basis than we probably could otherwise as well. A quick scan through profile changes lets me stay updated on what people in my network are doing.

But then there are the obvious disadvantages and traps we fall into as well. The ease of virtual networking has given us a false sense of connection and made it easy to neglect establishing stronger relationships. After all, why do I need to work to establish 10 strong connections when I can set up a network of 14.7 million with the click of the mouse?

Having too many ‘connections’ will make it impossible to really keep up with the connections you need to manage your career. Most of the social platforms are set up to run a news feed of things happening in your network. Are the important events and updates in your network getting buried under a pile of news from people you barely know?

Ultimately networking is about using those connections to help each other professionally, whether directly or indirectly through a second-level connection. Do you think you could do this with most of your connections? Would you feel comfortable recommending the people in your network based upon what you know about each of them? You are the only one that can answer the question, “How many connections are too many.”

Time to develop real connections

The benefits of virtual platforms for networking are too good to let them go to waste by superficially building your network so make a commitment to take advantage of them.

I know a lot of people will recommend going through your connections and deleting anyone that isn’t directly relevant to your professional sphere. It depends on how many connections you have but this might not be altogether necessary. If your list is still relatively manageable, you might just try categorizing people into spheres of importance. People with which you want to build a strong relationship would go in one folder and all others in another folder.

Once you’ve cleaned up your network, it is time to work on those relationships like you should have at the beginning. Browse through everyone’s profile and categorize connections within groups of experience, topic of expertise or anything else that might make it easier to organize. The idea is that when you have a question or want to talk to someone about a specific topic, you can quickly look through your network for the right person. This will not only help you answer your questions more quickly but will also help you get to know people in your network.

You probably do not need to talk to everyone in your network every week, maybe not even every month, but you should make it a point to interact with them. Before you go to a presentation or other professional event, send out a personal invite to the connections that might be interested. Regularly check up with your connections to get their opinion on the most important news and event for their sector.

Maybe it’s just that virtual networking is still so new for many of us that we have not learned to use it effectively. I know I’ve got a lot of cleaning up to do.

‘til next time, happy networkin’
Joseph Hogue, CFA

Life and the CFA Professional



We finished up our series on career management last week and candidates still have upwards of six months until the study season begins for next year’s exam. It is usually this time of year that I am urging candidates to stay active professionally and academically, but let’s get real here… you busted your butt to prepare for the CFA exam and many of you did it while juggling family and a job.

You deserve a break.

Give the numbers a break

A friend recently confessed to me that he has focused solely on his professional life for so long that he is having trouble disconnecting and just having fun. For the last ten years, he has been singularly driven to improve himself as a professional analyst.

He spends upwards of 50 or 60 hours a week working as an analyst in a Chicago commodities firm, usually spending a few hours at home each night to finish up on some reading. The books he reads during his free-time are usually somehow related to work, i.e. financial history, commodities and other concepts in investing. He goes out once or twice a week but much of the time it is to networking or other professional social events. His life has become so limited that, when he does go out with friends, the only thing they talk about is work.

I can sympathize with his plight and can see a lot of myself in the story. The industry is extremely demanding and sometimes being successful means sacrificing other parts of our lives but it should not become your life 24/7 and 365 days. Maybe the biggest challenge many of us face is limiting the time spent working or in professionally-related activities during those periods of the year where we can have some real free-time.

You need a hobby

There are a million-and-one hobbies and things you can do to take your mind off of the industry. If you’re having trouble thinking of an activity or hobby, try a web search for bucket lists. These lists of things people want to do before they die can be a great resource for one-time events or things you can do on a regular basis.

One of the most detailed bucket lists I’ve found is at:

http://bucketlistjourney.net/2012/01/543-bucket-list-ideas/

I like to exercise as one of the things to take my mind off of work. I know a lot of analysts that become extremely competitive in their sport or activity, almost taking it to the professional level. Even if you don’t push yourself to the limit, challenging yourself physically can really take your mind off of everything else.

Cooking is another hobby I’ve tried to pick up. In our hectic lives where time is money, it can be too easy to order out every night. It’s nice to relax and take the time to create a truly amazing dinner.

Your hobby doesn’t have to be something mainstream or recurring, just something that you might enjoy doing in any particular week. Make a point to spend some time with friends or family. Visit the local museum or a park every once in a while.

‘til next time, relax.
Joseph Hogue, CFA