Make Study Groups Fun with the CFA Trivial Pursuit Game

I’ve always had a mixed opinion on study groups for the CFA exams. They can be a great resource, breaking up the monotony of self-study and making the time more enjoyable. They can also be time-consuming between traveling and those tangent conversations too many groups fall into.

Talking to a candidate this week about working in a group, an idea occurred to me on how to really focus your study time and make the study session more fun.

Why not make a game out of it?

Introducing the CFA Trivial Pursuit Game

One of the biggest problems for study groups is that it is so easy for conversation to start on unrelated topics and to eat up your study time. By making a game of it, you have a goal to work to and may be able to stay focused.

The idea for the game is based on the board game Trivial Pursuit. In fact, you might want to grab the Trivial Pursuit game so you can use the board and the playing pieces.

In the game, each person gets an empty playing piece with six spots for the wedges. In the original game, the six pieces represent: geography, entertainment, history, arts & literature, science & nature and sports. In our CFA game, each of the wedges will represent three of the 18 study sessions.

The board is divided into colored spaces, with an equal number of spaces for each color. Players roll a die and move their piece around the board. The color of the space they land on will determine the study session for their question. Instead of trivial pursuit questions, you will need flashcards with questions from each study session in the curriculum. You will need at least 15 flash cards from each study session and more if you plan on playing multiple games. Players must answer a question from each of the three study sessions to collect a colored wedge.

Games of trivial pursuit can easily go about an hour with 30 questions or so during the game. You can play in teams or individually and the game is suited for as many players as are in your group. You can fine-tune the game with your own details like how to determine which of the three study sessions to choose when a candidate lands on each color. Play with one die instead of two so the game will last a little longer.

As with normal use of flash cards, work through the problem and make sure you discuss any incorrect answers.

I’m not calling up Milton Bradley just yet to sell the idea but I think it’s an interesting idea to build into your study plans. Studying for the CFA exams is too solitary at times and you need the interaction and support system you get with groups. By playing a CFA trivia game, you help to keep the group focused on studying and it sets a defined goal for the study period.

Try it out and let me know what you think.

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

4 CFA Study Websites You Will Love After Valentine’s Day

One of the hardest things about studying for the CFA exams is that you’ll have to go much of the journey on your own. There are study groups and boot camps but it is still largely a self-study course.

Outside of studying though you will find a really helpful and interactive community of charterholders and candidates. Through the four websites below, you’ll have the potential to meet professionals at the top of their game and establish some great connections. Maybe its because the program is self-study and you can get a sense of isolation that people go out of their way to interact and help out.

So next time you’ve got a question or just need to talk to someone that has been through the same professional struggles, look up one of the four websites and become a part of a great community.

LinkedIn

There are more than 187 monthly unique visitors across 200 countries on the professional social networking site. The general site is a great place to start growing your professional network and thinking about your career post-CFA exams. Of more interest to candidates is the CFA Program Candidates group, a discussion group of more than 125,000 members. You’ll find just about everything in the group, from candidates asking questions and offering advice to service providers and general analysis.

Analyst Forum

The Analyst Forum hosts group discussions on the CFA exams, careers, investments and even a couple of forum groups for the CAIA and FRM exams. Participation is anonymous so you get some wild characters sometimes but the information is generally very good. There are more than 858,000 posts across the four CFA forum groups so you are pretty much guaranteed to find an answer for any question.

CFA Institute

The CFA Institute website isn’t necessarily an interactive community like LinkedIn or Analyst Forum but it is a great website for exploring the larger world of the designation. Beyond the pages for the CFA program, you’ll find a host of other topics and information. Candidates have access to the JobLine which posts opportunities from employers that know the value of the CFA designation. The Career Centre offers individual assistance from consultants as well as resume creation tools.

Regular readers of the blog will know I’m a big fan of the Institute’s Insights and Learning page on the website. As a member of the community, you get access to thousands of articles, multimedia and models in research. In fact, there is so much information available that it can be a little overwhelming sometimes.

Local societies

It always surprises me that candidates do not use their local CFA society more often. Most larger cities have a society that hosts networking events and professional presentations. While it’s not really a website, I had to include local societies in the list because they can be a great resource for candidates. You’ll need a letter of sponsorship from a member of the local society when you apply for the charter so it’s best to reach out now before you come asking for the favor.

It seemed a little self-serving to include the FinQuiz Blog on the list of CFA websites you’ll love, especially considering that you’re already there, but I just couldn’t resist. Over the last three years, we’ve posted more than 433 pages of ideas and advice on how to pass the CFA exams. It’s been a great time talking with candidates and seeing them achieve the designation and I look forward to another three years and beyond.

We’re coming up on just four months before the exam. If you haven’t started studying yet, you’ll need to plan a pretty aggressive study plan to get everything in. Check out our 2015 CFA study schedule to get your plans started.

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

Getting Side Tracked on Your Way to the CFA

Any kind of independent study program is tough but studying for the CFA exams is even more difficult. You are going to be spending upwards of 300 hours studying for your exam over the next four months. A lot of the material is academic or theoretical and it will be very easy to let your mind wander.

Distractions come in all shapes and sizes and it is hard to say really how much time is wasted needlessly. Consider this, if you are studying for 18 weeks and spend a total of 300 hours then you are studying for about 17 hours a week. That is about six days a week at three hours each day. If you let yourself get distracted and it costs you just 20 minutes each study session, you will have wasted more than 100 minutes a week and nearly 40 hours total over the 18 weeks!

Don’t Sweat the Little Things

There are really two types of distractions when studying for the CFA exams. Short-term annoyances that take your mind off the material or put you on a digression, and the bigger distractions that deal with real decisions and sacrifices.

The smaller distractions are usually fairly easy to counter with a change to your studying or making a rule for yourself. The real distractions, the things that really matter in your life but that need to take a back seat while studying, are harder to confront.

If you are as passionate about finance as I am then you always want to know what is happening in the markets and in the financial press. This is a great hunger to have when you are working and integrating news into your analysis, it’s not so great when you are trying to stay focused on the exams. If you are reading from the curriculum then this problem can be limited by keeping away from the internet or a television. Sometimes you have to be at the computer to work a question bank or other digital materials.

If you find yourself surfing around the internet while you are supposed to be studying, there are some applications that might help. The website HackmyStudy shows several applications or temporary changes to your computer that will block certain sites from your browser or disallow the internet all together.

While CFA-related blogs can be a great resource for your exam prep, especially this one, they can also be a huge distraction while you are studying. There are really two problems here. First, the forums and blogs can be a distraction while you are studying. You might be tempted to check on a post to which you replied or to look for an explanation to a learning outcome statement. The problem is that once you are there, it is easy to look around for hours and never get back to studying.

The second problem with CFA-related blogs is called meta-studying. This is studying about studying and the exams in general. You are meta-studying right now by learning about distractions to studying, a little ironic but anyway. Obviously you need to know about the exams and learning how to efficiently prepare can save you a lot of time later, but there is a limit. I have talked to candidates that were so unsure about the exams that they spent all their time reading blogs and hanging out on the forums and very little time actually studying for the tests. Spend an hour a week checking in on the CFA blogs and forums and then get back to real studying.

Noise can be another minor distraction that ends up costing you a lot of time. It breaks your attention and you end up having to review stuff you previously read just to get back into your flow. The best way to handle noise distractions is to find your own private place to study. It might be a pain to go to the local library instead of studying at home but you will save a ton of time by avoiding multiple distractions. Some libraries may even offer private study rooms where you can close the door and won’t be bothered by the general public.

Food was a big distraction for me while studying for the exams. Not because I have any kind of an eating problem but because it is an easy excuse to take a break. You are doing well studying and suddenly the idea pops into your head, “hey, I think I’ll go get a snack.” Even if your intention is to get the snack and eat while studying, you’ve still distracted yourself and lost at least 15 minutes. Those little breaks add up if they happen every time you study. Take a five minute break every hour to stretch and relax, then get back to work. Every few hours, I would suggest taking a longer 15-minute break to refresh yourself. Other than those two scheduled breaks, make a commitment not to stop for anything.

Spend 15 minutes thinking about the minor distractions that waste your time. Don’t spend too long, it could be a distraction in itself. Then make a solid commitment or do what you need to avoid letting those distractions break your attention while studying.

The “distraction” of friends and family is the big one you have to deal with while studying for the CFA exams. I use the quotation marks because those closest to you are not really a distraction but you do need to learn how to juggle the exams with your social life. I wrote a post last year that offered five tips for finding more time without sacrificing too much of your family life.

  • Lunchtime and other quick breaks – Study for the exams when you have short breaks throughout the day like at lunch or while waiting for something. Flash cards are a great resource because you can carry them around and use them even when you’ve got just a few minutes to spare.
  • Travel time – If you have the opportunity to take public transportation, it can provide a solid hour of study time while you let someone else do the driving.
  • Learn to be a night owl – You may just have to learn to sleep less for the next couple of months. I love sleep but cut back to about five or six hours a night while studying for the exams. That extra two hours a night studying after everyone else has gone to bed may be all you need.

Whether you are dealing with little distractions or big ones, take a quick look at how much time you lose while studying and commit to saving that time. It’s a tough four months ahead of you but the right focus will get you to the exam with all the confidence you need and it will all be worth it.

Good luck candidates. Now get back to studying!
‘til next time, happy studyin’
Joseph Hogue, CFA

10 Minute Review of CFA Ethics and Standards

Even with the change to topic area weights on the CFA exams this year, Ethics and Professional Standards remain extremely important. It is a lot of material but fortunately doesn’t change much from year to year and you’ve got a real opportunity to carry over some points to each exam if you learn it early.

Before we get into a quick review of the key points I want to stress one thing: Do NOT underestimate the topic area and the need to work practice problems! The topic is worth between 10% and 15% of your total score on each exam. A lot of candidates scan the readings and then neglect doing any real studying or problems.

The problem is that the Ethical and Professional Standards all seem pretty obvious. Everyone knows you shouldn’t take advantage of clients and trade on inside information. Candidates look at the material and think, “I’m a pretty ethical person. I don’t lie, cheat or steal. The correct answer on the exam will be obvious to me.” Then they get to the exam and have a heart attack!

The CFA Institute is surprisingly good at designing questions where two of the answer choices seem possible, even to someone with a good moral compass. That is why it is absolutely a must to work practice problems in the topic area. Learn how the Institute writes out the vignette and what to look for in the correct answer.

The Professional Conduct Program (PCP)

The PCP is not usually a big focus of the exams but you might get a question. Remember where the complaint can come from: media scrutiny, exam proctors, written notes or self-disclosure. Understand that while your subordinates might not be held to the Code and Standards, a supervisor with the CFA designation is still responsible for their actions.

After an inquiry is started, information is collected and one of three outcomes occurs. There may be no sanctions recommended, a cautionary letter could be issued or the inquiry is sent to the next level for further work. You can accept or contest the outcome and request that it be escalated to a panel.

Components of the Code

I’ve always used the acronym SPAMED to remember components of the code. The truth is that you probably won’t get a question on one of the six codes but will instead see questions on application of the Code and Standards.

  • Subordinate personal interests
  • Promote the integrity of and uphold rules governing capital markets
  • Act with integrity, competence, diligence and respect
  • Maintain and improve professional competence
  • Exercise reasonable care and independent judgment
  • Demonstrate ethical practice and professionalism

I’ve run through the standards below. This is a very brief overview and hits on just the bullet points. You still will need to read through the curriculum to get the detail and make sure to work those problems.

Standard I Professionalism

Remember that you are bound my the most strict law between the code and local laws. If the local law allows something that the code and standards do not, you must still follow the code and standards. Ignorance is no excuse either. If you should have known that an action was breaking the law or was unethical, then you could be punished for it. This is an important concept in the supervisory section.

Know the procedure for informing supervisor, firm and compliance about any activities. You are not required to inform law enforcement, unless the law requires it, but you do need to disassociate from the firm and activities if they are not corrected.

Independence & Objectivity

  • Pay your own expense to meetings and other trips when possible. Do not accept anything more than a token gift from a third-party. The Institute does not put a dollar value on what is considered token but a non-token gift on the exam will probably be something costing more than a few hundred dollars.
  • Issuer-paid research must be disclosed and should only be on an upfront fee. Ratings cannot be tied to the payment or promised in any way.

Misrepresentation

  • No returns can ever be guaranteed unless the investment is backed by the government or an institution backs losses.
  • Informational sources must be directly credited and not listed generically as “analysts” or “experts”

Misconduct

  • You must not engage in something, even if it is legal, that may reflect poorly on the CFA designation or on your firm. Drinking alcohol is the most often used example. You are legally-able to drink but if excessive drinking leads to a loss of confidence then it could be punishable under the code.
  • Civil disobedience is not misconduct, i.e. protesting

Standard II Integrity of Capital Markets

Use of material, non-public information (insider trading) is a big issue and you could see questions on the exam. Remember that the info must be BOTH material and non-public.

  • You can use the mosaic theory to use non-public/non-material information or material/public information
  • You must not ‘cause’ others to use material, non-public information either, i.e. giving someone a tip about the info.
  • Company conference calls and meetings are not a public release and should be made public at the same time.

Standard III Duties to Clients

Remember the chain of priorities for duties: Client, Firm, Self

Fair Dealing

  • All clients must be treated fairly and equally. You can offer different service levels but they must be disclosed and available to everyone
  • Allocations should be on a pro-rata basis and only to suitable portfolios
  • The method of communication is important. You cannot send a traditional mail update to some and make a personal phone call to others. Contact methods must be uniform across all clients.

SuitabilityUnderstand each client’s risk tolerance and return requirements, along with objectives and constraints to determine suitability. Investment suitability should be judged in the whole portfolio context.

Performance Presentation must be (FACT) Fair, Accurate, Complete and Timely

Standard IV Duties to Employers

Loyalty

  • You must not take any records, files or other company property when your contract is terminated with an employer. Besides being punishable under the code, you will also likely be criminally prosecuted. You can reconstruct the material from memory but cannot use any tangible records.
  • Any preparation for another job or information can be made before leaving your current employer but must be done on your own time.

Additional Compensation

  • You must get written consent from all parties before taking additional compensation that could create a conflict with your employer. It must be in writing and from everyone (employer and other third-party).

Supervisor Responsibilities

  • This is another big one on the exams but can be confusing. Understand that supervisors must have procedures in place so they know what their subordinates are doing. Again, not knowing is not an excuse if appropriate policies would have uncovered the activity.
  • You must inform the company in writing of any insufficient compliance policies and decline a supervisory position until the procedures are improved.
  • You are responsible, under the code, for the activities of non-charterholder subordinates as well

Standard V Investment Analysis, Recommendations and Actions

  • You must not rely on outside information unless it can be verified and you trust the reliability of the source.
  • You can be a part of a group and not agree with a recommendation but you should document your disagreement

Communication with Clients

  • You must distinguish between fact and opinion when talking with clients or potential clients
  • A statement of the basic factors and process you used to arrive at a recommendation must be disclosed

Record Retention

  • Keep all records and analysis for seven years
  • Records are the property of your employer and its responsibility if you leave the firm

Standard VI Conflicts of Interest

  • You must disclose any material ownership or ownership of anyone living in your household. The Institute does not put a dollar amount on ‘material’ but it will likely be more than a couple thousand dollars or a significant control over business decisions
  • Remember , disclosures must be made for any actual or potential conflicts

Priority of Transactions

  • Remember the priority list: Client, Firm and then Self. Clients should get all requested (if suitable) shares, followed by Firm and yourself only if there is enough leftover.
  • Family members not living in your household should be treated fairly as clients. Only those living with you are considered related-parties and treated as yourself.
  • Oversubscribed investments should be distributed on a pro-rata basis in priority order (clients first)

Referral Fees

  • Any compensation for referral must be disclosed, including non-monetary benefits

Standard VII Responsibilities of charterholders and candidates

  • The CFA designation can only be used by a person and cannot be used on company letterhead or attached to the company’s logo.
  • Your dues must be up-to-date and you must sign the annual standards compliance to use the designation

Memorizing the Code and Standards is not enough. You need to understand the intent behind each key point and be able to apply it given a situational problem. Again, the best way to learn this is by doing practice problems. It isn’t too difficult once you’ve learned how questions are asked and the reasoning behind the correct answer. The great part is that if you learn this material while studying for the CFA Level I exam, you’ve pretty much got 10% of free points on the other two exams.

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

Your 2015 CFA Study Schedule

The end of January marks the unofficial launch of the 2015 CFA Exam Study Season. You’ve got just four months to soak in all that great information, shunning friends and family alike to get one step closer to the designation.

While many will choose to wait a little longer, despite the considerable risk of waiting too long, the 18 weeks you’ll have starting February is just enough for a low-stress study schedule. Eighteen study sessions and 18 weeks left…seems like an obvious choice to me.

Changing up the Schedule

I posted last week on how the changes to the 2015 CFA curriculum could change your study plans for the exams. While most years do not see enough changes to the curriculum to really make a difference, we saw some big changes to the upcoming June exams. Besides a change to some of the readings at each exam level, the CFA Institute changed the topic area weights as well.

For the most part, changes to topic weights leveled the playing field for the topics in the exams. Those topics that always got a big weighting were mostly downgraded while previously less important topics picked up a few percent of your total score. This may mean that you need to spend less time on any one or two topics and spread your study time out evenly. No longer can you spend all your time on a focus-topic and rely on a big win there to cover a potentially lower score in other topics.

Fight Burnout with Diverse Resources

One of the biggest challenges you’ll face in your study for the CFA exams is burnout. An 18-week study schedule requires around 15 hours per week of studying to even approach the average 300 hours most candidates spend studying. After a full day of work, another few hours of reading and problem sets can seem like capital punishment.

Of course, you’ll enthusiastically dive into your CFA texts for the first couple of weeks. You’ve had months to relax and now you are ready to dive back into the professional course. It’s usually in the fourth or fifth week that candidates start feeling the sting of burnout.

Everyone faces burnout and you’ll need some strategies to control it when it happens but there is one way to delay or minimize curriculum fatigue, mixing up the resources you use in studying.

Anybody trying to read the 1,000+ pages of curriculum every day and doing nothing else is going to get burnt out very quickly. The CFA curriculum is written by some of the best minds in finance but can get extremely dry and academic in some places. You need to be able to put the books down and still study for the exam.

One of my favorite resources for studying is flashcards. I highlighted how to make your own flashcards in another post but the process is pretty easy. The idea in making flashcards is that you first get exposure to the problem by writing out the card, then later by working the problem. Make sure you write out a full question problem just like you’d see on the exam. Flash cards are great because you can carry them around and get some valuable study time in whenever you’ve got a couple of minutes.

Study groups are another good resource to break up the monotony but can be time-consuming. Keep your group small, less than five or six people, and make sure you stay on task. Talking about your job or other things is fine but save it for after the study session. Online study groups have been popular lately but I still prefer in-person groups. They are easier to manage and you get the chance to network with other professionals in your community.

Studying for the CFA exams is all about working practice problems and they are a great way to break up your time from reading. Stop to do some practice problems for every 30 minutes of reading. It will help reinforce the concepts and avoid going into that zombie-like reading trance where you really don’t remember what you read.

Videos are a great way to use another medium to help explain tough concepts. Almost every concept on the exams has a YouTube video that will help walk you through it. I would look for shorter videos that just help with the general idea. You don’t want to waste 20 minutes on a video that really wasn’t worth watching.

FinQuiz offers condensed study notes for each CFA exam. The study notes are unique from other providers because they are meant to be used in conjunction with the curriculum instead of replacing it. Don’t expect study notes (from any provider) to be able to cover all the curriculum material. Read the curriculum and use study notes for review.

CFA Study Schedule Blueprint

After six years, three as a candidate and three writing about the exams, I’ve crafted a pretty good blueprint for a CFA study schedule. You’ll want to modify your own schedule to fit your needs but this blueprint works pretty well for most.

I’ve found that a five- or six-day schedule is the best since it allows for at least one day of rest and doesn’t require long hours of studying. If you plan for a five-day schedule, stagger your days off so they are not together.

I always like to make one study session the focus each week and another study session a secondary review. By including the secondary study session, you get a chance to review the material you studied in the prior week. I’ve seen a lot of candidates go the entire 18 weeks studying one session per week and never reviewing, only to find in June that they’ve forgotten the material from the earliest study sessions.

A good plan might go something like:

Day 1: Reading curriculum
Day 2: Review study notes for the previous day’s curriculum and practice problems
Day 3: Make flashcards of most difficult material and review the focus study session
Day 4: Practice problems on focus study session and review study notes on secondary SS
Day 5: Practice Problems on secondary SS and study notes for focus study session
Day 6: Take a practice test on both study sessions from question bank or practice problems

This format gives you exposure to each study session twice and helps emphasize actually working the problems and testing yourself. A review of your flashcards is not included in the schedule because they can be reviewed during the normal course of your day. Make it a point to carry some flashcards around with you and review them quickly when you have a minute or two.

I’ve gotta say, even though I’m not a candidate anymore, I am excited to get the 2015 study season underway. It is going to be a tough road along the way but it is so very much worth it. You are going to be opening yourself to a whole new level of professional knowledge. Stick with it even when you feel burnout creeping up behind you and you’ll make it through to June. Start early enough and stick to a sensible plan and you’ll go into the exam with the full confidence that you’ll pass.

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

How do Curriculum Changes affect your CFA Study Plan?

For the most part, your CFA study plan probably hasn’t changed over the last few years. The curriculum usually only changes by minor details from year-to-year and the format of the exams remains the same. This year brought the biggest curriculum changes I’ve ever seen as well as changes to topic weights.

Is it time to reassess our basic study strategies?

Changes to the 2015 CFA Curriculum

We detailed changes to the CFA curriculum across each exam in August of last year. The Level 1 CFA curriculum saw six readings dropped and added three new readings. Ten readings were dropped from the Level 2 CFA curriculum while six were added. The Level 3 CFA curriculum saw relatively minor changes with two dropped readings and one added reading.

While these changes will certainly affect your study plans, especially if you are repeat tester, it is the change in topic weights that will drive the biggest transformation in your study.

In the Level 1 and Level 2 exams, almost all the changes made bring the topic weights closer together. The topics that have historically been core areas for focus had their weightings come down slightly while secondary topic areas rose in importance.

On the Level 1 CFA exam, Fixed-Income (one of the most heavily weighted topics in the past) dropped to 10% of the test while historically less influential topics on the exam like Portfolio Management and Alternative Investments both increased in importance.

On the Level 2 CFA exam, Financial Reporting and Equity Investments (the two most important topics in the past) both saw their potential weightings decrease. Fixed Income and Ethics both increased in importance while Alternative Investments decreased in weighting.

The topic weights for the Level 3 exam did not change much either so there will probably not be much need to change your study strategy.

2015 CFA Exam Topic Weights

2015 CFA Exam Topic Weights

Changes to our Basic CFA Study Plan

The format of the exams has not changed. The CFA Level 1 exam is still 240 multiple choice questions, each with three possible answers. The CFA Level 2 exam is still 20 vignettes of six multiple-choice questions each for a total of 120 questions. The CFA Level 3 exam is still an essay in the morning followed by 10 vignettes of six questions each in the afternoon.

The change to your study plan will come from the fact that you may no longer be able to focus on just a few topic areas. Portfolio Management, Alternative Investments, Derivatives and Corporate Finance are still secondary topic areas in the Level 1 exam but now there are six topics that each account for a tenth or more of your total score. Every topic in the Level 2 exam has the potential of being a tenth or more of your total score and you’re guaranteed to see at least 10% of the questions in four topics.

Ethics continues to be a very important topic area, especially since the readings really don’t change for each level so you can really get a head-start by focusing on it for the first exam. Financial Reporting continues to be an important topic as well though a topic weight isn’t given for the third exam. While their importance may be lower in the first exam, Equity and Fixed-Income Investments continue to be relatively important to the final two exams.

The CFA exams saw some of their biggest curriculum changes in years for 2015 and you should take it into account when planning your study schedule. While many of the important focus topics are still relatively high-value, you might have to spend a little more time on other topics. Check out the changes to readings in our post for each specific exam for clues on what subjects within the topics are being favored.

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

The Ultimate Guide to the CFA Exam

I talked to a candidate the other day that was a big fan of the Finquiz blog but had one complaint…there is just so much posted that it’s difficult for new readers to look at everything.

I heard him loud and clear and decided to post this roundup of some of the best posts we’ve ever written on the blog. Some of the posts are specific to different levels of the exams but most will apply to all candidates. The posts cover the range of things you’ll need to be successful on the exams from basic strategy to general how-to and motivational.

Where to Start

Our basic strategy posts are always a good start when first coming to the blog. I usually update these posts every couple of years but the basic strategy for passing each of the exams does not change much. I posted a basic strategy for passing the exams in general that is a great overview to get you started.

For passing specific levels of the CFA exams, check out our strategy on passing:

Our most popular posts over the last year have been those detailing the changes to the 2015 CFA curriculum. This year, the curriculum has undergone the most drastic changes I’ve ever seen in more than six years. Not only have readings been added, deleted and modified but the topic weights in the exams have changed. Different topic weights mean a different study strategy because you’re more likely to see questions from different topics than you saw in previous years.

Check out the changes to the 2015 CFA Level I Curriculum
Check out the changes to the 2015 CFA Level II Curriculum
Check out the changes to the 2015 CFA Level III Curriculum

Most Common Candidate Questions

There are some questions that every candidate has and they are the most often we get here at FinQuiz. Below are some of the posts I’ve written to address your most common questions about the CFA.

Probably the most popular question surrounds the idea of using the CFA designation to get a job. A lot of candidates incorrectly assume that the exams and the designation is a golden ticket to any job they want. Nearly 11,000 candidates have viewed our post, “I’ve passed the CFA Level 1 Exam, Why don’t I have a job?” You can certainly leverage your CFA progress into getting a job and it will help but you have to follow traditional steps like networking and outreach.

Candidates are always asking which CFA exam is the most difficult. I fully understand the question since I asked it myself but does it really matter? You have to take all three exams anyway but I guess it helps to know what is coming in each exam. For me, it was the second exam but many have more difficulty with the third exam.

After the exams each year, I often get a lot of questions about the passing score. The CFA Institute does not publish the minimum passing score needed but there are guidelines you can use. There is also one key trick that I use to work my scores into a personalized study strategy.

General Advice on How to Pass the Exams

Many of our most popular posts are those that offer general advice that covers passing all three exams. Many of these posts address emotional and mental roadblocks to passing the CFA exams.

I showed candidates how to remember 90% of what they studied in one of our very first posts, viewed by nearly 8,000 candidates. Active learning techniques are not as easy as passively reading the curriculum but they are an absolute must for your exam prep. Another post on active learning included some specific action steps that you can follow to pass the exams.

Read this if you absolutely must pass the CFA exams! This was a short post but included four of the most important points to passing the exams and sums up the key things to remember.

Another of our first posts revealed the person that is most likely to keep you from passing the CFA exams. Resist the temptation to second-guess your commitment to being a better professional and follow these steps to stay on the right path.

I offered a tortoise and hare study plan for passing the exams a couple of years ago and candidates really appreciated the two different perspectives. I prefer the slow-and-steady approach to studying but some like a short-and-sweet approach.

Motivational

Some of the posts that I have had the most fun writing are those where I talk directly to candidates about the exams and help them get through this tough challenge.

Having passed the CFA Level III exam more than three years ago, there are things I wish I could do differently and things I wish I knew before starting the CFA exams.

Easily my favorite post was written when proctoring a mock exam in 2012. I realized that there is an overlooked benefit to the CFA exams that most people don’t realize. The CFA exams are truly the great equalizer in our industry and give everyone the opportunity to succeed.

If you’re looking for a specific topic or idea, remember that you can use the search box at the top-right of the screen to find posts. Check out the Popular Posts on the right-side of the screen for more of our most recommended articles.

Just a few weeks until the 2015 CFA Exam Study Season kicks into full gear, get ready!

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

CFA Level 1 Exam Results and How to Deal with a Fail

The time between taking the CFA exam and the release of results can be excruciating. The CFA Institute has not yet released the estimated date of December exam results yet but you’ve likely still got a couple of weeks to wait.

Results of the December CFA exam are usually emailed to candidates later in January, around the second to last week. For some reason, the Institute generally releases results on a Tuesday so I’m guessing that results will be out on the 20th this year. Emails will start going out at 9am eastern standard but it may take several hours to receive your email.

How can you use the exam results to prepare for your next exam? How could you possibly deal with the results if you end up in one of the fail bands?

Decoding Exam Results

Results will look like the graphic below with your percentage range in each topic within one of the three ranges. The graphic is actually from my Level 3 exam results but the format is the same for all three exams (I didn’t save my exam results for the Level I which seems a million years ago).

cfa exam resultsThe asterisks mark the range in which you scored. The CFA Institute does not release an exact score or a minimum passing score for the exam but you can still use your results for some useful information.

I scored greater than 70% in five of the eight topic areas on the item-set portion of the exam and between 51% to 70% in the remaining three topic areas. If these were results of a Level I exam, I would look closely at the three topic areas and their relative weight on the Level II exam.

For example, I know that Equity Investments is a very important part of the second exam and is worth between 15% and 25% of your total exam score. I might want to consider spending some time before my CFA Level II studies to review some of the Level I equity material to make sure I have a good base of understanding.

Check out the curriculum changes to the CFA Level II 2015 exam for a review of topic weights and changes to the readings. This year marked an uncharacteristic change to the topic weights across the exams so you’ll want to pay special attention to the importance of each topic area. We published a basic strategy for the Level II CFA Exam which you might want to review.

How to deal with a CFA Exam Fail

Getting the email from the Institute saying you failed the exam is like getting punched in the gut. Your stomach sinks, you start to feel queasy and some even break down into tears.

You will hear all kinds of excuses and complaints about the designation and the CFA Institute after results are released. Some blame the questions, others try to make themselves feel better by saying that the designation doesn’t matter to their segment of the industry. These are all common coping mechanisms to deal with the results but you need to resist the urge. Your reasons behind taking the exam and the value of the designation have not changed and neither should your attitude.

Resist the urge to get mad at yourself or at the CFA Institute. Half or more of the candidates that take any given exam do not pass. The exams are tough and that is what makes the designation so valuable and will be a source of pride when you do pass.

Take an honest look at how you prepared for the exam and ask yourself where you could have improved your efforts. For most candidates, it is a matter of simply not devoting enough time to study the curriculum. Others may have done really well in a few topic areas but so poorly in core topics that it put them in a fail band. Either way, use the information in your exam results to see where you need to improve.

On the bright side, having taken the December exam means you are still able to register for the June exam and have a good chance at success. The Institute does not publish pass rates for repeat test takers but I have to believe that it is much higher than the general pass rates.

Contrary to what you may be thinking, it is not really too difficult telling friends, family and coworkers about the exam results. If not passing an exam is the worst thing to happen in your life, you are either very sheltered or not challenging yourself enough. Your friends and family understand that the CFA is important to you and will go out of their way to empathize.

If others in your office have taken the exam, they will know full well how difficult the test is and will not hold it against you. Unless you completely blew off studying, there are bound to be some topics in which you did well and can highlight your success in those areas. Take an honest approach and admit that you just have to work a little harder in the topics where you didn’t score as well.

We’re always excited to get word from candidates on how they did so drop us a note or a comment on the blog when you get your exam results. We’re going to be kicking the June 2015 study season off pretty soon and getting back into the curriculum. Let me know if there is anything in particular you want to see covered.

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

Studying for the CFA Exam without knowing your studying

It’s not even January yet and the last thing many of you want to think about is studying for the CFA exams in June. I always liked to start early and set a relaxed study schedule but I’m not going to tell you that you need to get busy studying immediately.

What I can tell you is that there is a way you can actually keep your skills fresh while waiting for later to really start studying. It’s a little thing I like to call stealth studying and everyone should work it into their daily routine.

CFA Institute Resources

Your first stop will be some of the great resources on the CFA Institute website and the Enterprising Investor blog. The Institute’s Publications & Multimedia page sports a seemingly infinite amount of research and resources. Resources are indexed by asset class and topic area with separate sections for career advice like networking, management and current topics. A lot of the resources are quick presentation-type material so you can look through it within a few minutes to get the general idea. It’s a great way to generate ideas for your own work.

Must Read Books

The Enterprising Investor blog also offers regular reviews for books related to the industry. Within the reviews, you’ll find a mix of educational books to further your skills and books that will entertain. I just finished Alan Blinder’s, “After the Music Stopped,” after reading the review on the site and really enjoyed the insightful analysis of the financial crisis.

Of course, Graham’s timeless book, “The Intelligent Investor,” is always a good start for those that haven’t yet read it. After months of detailed and rigorous study of the CFA curriculum, it’s nice to sit down with a relatively straight-forward and simple tome.

Networking with colleagues

Readers of the blog will know that I’m a big advocate of active involvement in your local CFA society. Most likely, you are going to want to approach these people for a job opportunity in the future so it’s best to get to know them first. Networking with other candidates and charterholders serves another function, getting some of the best insight from some of the best minds in the business.

So stealth studying isn’t really anything new, it’s just keeping involved in your industry. Reading books, whether for information or entertainment, watching presentations from other professionals and connecting with others in the field will all help to keep your mind sharp.

Whether you are working in investment analysis and management yet or not, it’s best to start thinking of yourself as a professional. You’ve committed to one of the most difficult professional designations out there and just the Level I CFA curriculum puts you well on your way. As a professional, it’s also best to stop thinking in terms of a period to study for the exams and the rest of the year in which you get to relax. Being a professional is about constant improvement and keeping up to date with the industry.

The resources above will not only help you prepare for your next CFA exam but will help you become a better professional.

‘til next time, happy…studying?
Joseph Hogue, CFA

Relaxing after the CFA December Exam – but for how long?

Congratulations to all the candidates that sat for the CFA Level 1 exam last Saturday. As I wrote in last week’s post, you’ve already shown your worth in the perseverance and dedication to professionalism and I welcome you to our group of CFA candidates and charterholders.

Many of you are now looking to the next step, the CFA Level 2 exam in June and wishing you had enough time to relax and reconnect with friends and loved ones.

There are advantages and disadvantages to jumping right back into the curriculum and you might just decide that you have more time to relax than you thought.

Sitting for the June exam after December’s Test

As December candidates, you’ve got a pretty unique opportunity to finish up the CFA exams earlier. Trying to think back on my own experience, I had not decided to pursue the designation until November so really didn’t have the option. If you’ll have the experience requirement fulfilled by late 2016 then you could potentially shave six months time off the process compared to peers.

Reasons to take the June exam after a December exam

  • A lot of the CFA Level 2 curriculum builds heavily off of concepts learned in the level 1 curriculum. In fact, many of the sections in the curriculum start off with optional refresher pages to remind you. Going straight into studying for the second exam helps to avoid losing any of that information in a year’s worth of partying and working (ok, partying for the younger candidates, working for the old timers).
  • The level 2 curriculum really gets into the detail of financial analysis and working through a company’s financial statements. A lot of candidates are pumped up about hitting the books, even after a grueling few months of studying for the first exam. The curriculum is also undeniably good for your career and the sooner you learn the material, the sooner you can impress your boss with your expertise in analysis.
  • You could easily wait until late January when December exam results come out to register and being studying for the second exam. This gives you nearly two months to enjoy with your family and friends. Believe me, you’re first few years as an equity analyst will be busier than that.

Don’t forget that the application deadline for the CFA Awareness Scholarship is February 2nd so you may want to get started on that ahead of time. This scholarship is for key influencers in the academic and financial communities and reduces the registration fee to $350, including the curriculum ebook. Check your local CFA society as well, many offer scholarships for local candidates.

The registration deadline for the standard fee on the June exam is the 18th of February though you have until March 18th as a late-register.

What’s the rush?

Whether you’ve considered it or not, there is nothing wrong with taking a year and a half to sit for the CFA Level 2 exam either. I know everyone wants to get through the exams as soon as possible but there are also advantages to taking your time.

  • You can still start your study for the Level 2 exam by borrowing curriculum from other candidates or getting it from the local library. Make sure the readings are up to date but the curriculum really doesn’t change that much so most will still be applicable.
  • Even if you set a study schedule that takes you to the June 2016 exam, you can still sit for the 2015 exam to see how it is. You only pay for the enrollment fee once but will have to pay the registration fee again.
  • Burn out is a big problem for candidates and you might not feel like a couple of months is enough to spend with family and friends after taking the Level 1 exam.
  • The CFA Level 2 exam is, in my opinion, by far the most difficult of the three. The detail and the number of formulas are intense, reasons why the average pass rate is only 44% over the last ten years. Spreading your Level 2 studies out over 18 months means you can really take your time with the material and master it.
  • Many candidates will not complete the experience requirements by late 2016 anyway and will need to wait to use the designation. If you are not working in analysis or asset management now, it might be a good idea to find a job that will move you in that direction. Starting a new job takes time but a relaxed Level 2 study schedule will mean more time to learn your new responsibilities.

I know it is unlikely that many December candidates will consider foregoing the 2015 exam to take the 2016 exam instead but I thought I would outline the advantages and disadvantages of each option. Whichever you choose, make the commitment to do it well and continue being the professional you have shown yourself to be.

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

Last Week to the CFA Exam, Welcome to the Club

Just one more week to the December level 1 CFA exam, can you believe it? The time seemed to fly by every year I was a candidate and as much as I wanted to get through the exams, I always wished for just one more week of preparation.

But win, lose or draw next Saturday you’ve already shown the heart and discipline to make yourself a better professional. For that, I say, “Welcome to the club of CFA Candidates and Charterholders!”

You see, being a CFA charterholder isn’t about passing a couple of tests. It isn’t even about just being able to put those three little letters after your name. Being a charterholder is about being a true professional and being part of a network of professionals.

Through the CFA Institute and your network of other candidates or charterholders, you’ve got access to some of the best minds and information in the industry. Asset management gurus like Bill Gross, Abby Joseph Cohen and Ben Graham, all charterholders!

The Institue also offers a knowledge library on the website filled with some of the best published material and media in the industry. It’s easy to forget so set a regular reminder to check in on the site for new information and professional development. The website is pretty user-friendly. You can browse research by topic or by area of work. There are also some marketing templates for brochures, pitchbooks and mailers that you can use for your job.

Many of you are just starting your careers and will want to login to the Institute’s Jobline. Through the portal, you’ll find nearly 900 current listings from more than 200 employers all looking for CFA charterholders or candidates.

I got an email invitation last week to be a judge in next year’s CFA Institute Research Challenge, an annual global competition in equity analysis. The research challenge is a great way to get that initial experience into equity research and feedback from professionals. At events like this or one of the many networking events through your local society, you’ll find all the opportunity you need for professional development and to advance your career.

I am going to level with you. Your #1 goal in life may seem to be passing that exam on Saturday but at this point, it really doesn’t mean as much as you think. You have taken the first step to becoming a true professional in the field and your score on one test will not change that.

So take the rest of the week to kick it into high gear and get those last few points you’re going to need to pass the exam on Saturday. After Saturday, login to the CFA Institute’s website or your local society’s website and start looking around. You’ve got at least a month before you need to start thinking about the June exam. Use that time to develop your network and really get to know what it means to be a part of this club of finance professionals.

Good luck on Saturday candidates!

‘til next time, happy testing!
Joseph Hogue, CFA

Getting the most of Mock and Practice Exams

Two weeks before the CFA December exam and candidates are starting to get nervous. Results of recent mock exams and practice tests are coming out and the outlook does not look good for everyone. I surveyed a group of candidates that had taken mock exams recently, both those provided by Finquiz and mock exams from other providers, and the average across the group was about 60% with a fairly wide range.

But how much faith should you place in these scores and how should you be using mock exams leading up to the test?

Survey says –

I wasn’t surprised at the range of results I saw from the ten candidates I surveyed about mock exams. The sample size wasn’t very large and results tend to vary quite a bit at this point. At about a month to the exam, there are candidates that are very well prepared and then there are those that need to step up the pace quite a bit.

You should actually be thinking about two resources here, practice tests and mock exams. To me, the difference has always seemed a matter of semantics. Practice exams are shorter than the actual exam and normally based on a specific topic area. Mock exams are full six-hour long exams that cover all the topic areas and are meant to be taken as you would the actual CFA exam.

In talking with candidates and through my own personal experience, I have found that mock exams are a good source for studying but not necessarily a good predictor of success on the actual CFA exam. It is one thing if you consistently score very high (>75%) or very low (<50%) on mock exams. This would likely confirm what you already know anyway, that you have been diligently studying or that you need more work. Results on any one mock exam can vary widely though and I would use it more as guidance than a predictor of how you will do on the December exam.

Mock exam difficulty tends to vary from year to year and by provider. The mock exams I have seen from the CFA Institute seem to typically be more difficult than the exam while other third-party exams vary. A limited number of practice and mock exams are available on the CFA Institute website now and included in the price of your registration. Finquiz has available six full-length CFA mock exams for candidates of the CFA Level I exam as well as a question bank that can be used to construct your own practice tests and additional mock exams.

A tool for CFA exam prep, both mental and physical

Mock exams should be one of your biggest resources right now. These tests are going to help you see how mentally and physically prepared you are for the December exam. You can break them up and take several 3-hour exams but you should take at least two full-length six-hour exams. Taking a six-hour test with just a small break for lunch is nothing to underestimate. You need to develop your endurance through practice or you might just find yourself struggling during the real test.

Besides testing yourself physically, the benefit to mock exams is that they test your retention across all the topics at once. Many candidates approach the CFA exam by only doing practice problems related to a specific topic directly after studying that topic. Of course you are going to remember something if you test it alone and immediately after studying.

I recommend taking at least five or six mock exams over your last couple of weeks. Each one can be used to guide your study plan over the subsequent few days, making sure you cover topics where you scored poorly. You can also average the scores together to get a more stable idea of where your score is across the topic areas and on the overall exam.

I usually recommend you take practice tests earlier in the season, after studying the specific topic areas. You also need to be using them in these last two weeks though to really focus on a few topics where you need the most help. If you are regularly scoring less than 70% on mock exams within core topic areas like ethics, financial statement analysis, and equity investments then you need to hit these individually with a practice exam.

For practice and mock exams both, remember it isn’t enough to just take the exam. You need to go back through the questions you missed and those where you only guessed to master the concept. Failure to learn from your mistakes means you are just going to repeat them on the actual exam.

If possible, you should be thinking about taking the week off work next week to really put your nose in the books and get those last few points you need. We’ll do a quick summary next Monday and cover some key points to get you ready for the exam.

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

CFA Exam Day Emergency Preparedness Kit

Three weeks to the December CFA Level 1 Exam and you are probably nose-deep in your curriculum books trying to get those last few points. Well, I want to take your mind off of studying for just a second to talk about a different kind of exam preparation, preparing for that first Saturday in December with a CFA Exam Day Emergency Preparedness Kit.

You might not have thought much about it yet but just assumed you would gather up the necessary things a couple of days before the exam and everything would be alright. After all, how difficult can it be? You just need your identification, admission ticket, a calculator and a few other incidentals, right?

Over my three years of testing I saw candidates bring along a lot of things to the exam, from tiny sandwich bag size packs to backpacks full of resources. Every year there was more than one candidate, in fact usually quite a few, that was turned away for lack of the right materials or that left the test center near tears because their lack of preparedness cost them the success for which they had worked so hard.

Emergency Preparedness Kit for Candidates

Most likely you’ve heard of having an emergency kit in the car in case you get stranded somewhere. It’s probably got flares, a blanket, some water and maybe a little food. But do you really need an emergency preparedness kit for the CFA exam?

You’ve just spent 300+ hours of your life over a short period of time, sacrificing a social life and time with your family just to pass this exam. Nearly 50% of all candidates fail their exam any given year and the difference between passing and band ten is razor thin. You tell me, do you think it is serious enough to have an emergency kit?

There are two categories of items that will go into your kit, required materials and emergency goods. The required materials are going to be things like your admission ticket, a calculator and your passport. You won’t even be able to get into the exam or to have any hope of passing without these. It’s not stuff that you would normally put in an emergency kit, but there’s no sense in having two kits for the exam so I’m keeping everything together. The emergency items in your kit are things that you don’t necessarily need and may not even use but you will thank your prospective deity if you end up needing them.

  • International Passport – You must have a valid government-issued passport to get into the testing center. There are no exceptions and I can almost guarantee that there will be someone at your testing center that gets turned away. Physically check your passport; today, no right now to make sure the expiration date is after the exam day and that all your information matches that of your admission ticket. With three weeks left, you should still have time to get your passport changed if you need to but you cannot afford to wait.
  • Admission Ticket – This is another required item and it must be printed on clean, unused paper. Do not mark anywhere on your admission ticket, front or back. The information on your ticket must match what is on your passport so you might as well check it now while you are checking your passport. Admission tickets are now available on the CFA Institute website for printing.
  • Pencils – CFA Level 1 candidates only need to bring pencils to the exam. I have seen candidates forget pencils and I have seen candidates bring boxes of more than 10 pencils. I recommend bringing five pencils, not that you will probably need more than one or two but it could save you the time of sharpening them. Take a manual pencil sharpener as well. This is one of those emergency items. I always had enough pencils that I never used my sharpener but you should definitely take one.
  • Calculator – I always used the Texas Instruments BA II Plus but I know people that swear by the HP calculator as well. It’s your choice just as long as you have one in your kit. I have seen candidates take two calculators, just in case. I never did but it does make sense, especially if you have extras anyway. Changing batteries can take time and you will need to reconfigure the calculator. If nothing else, you should have an extra battery in your emergency kit and a small screwdriver. You will almost certainly not need it but it is much better to have it than need it.
  • Medical products – We start getting into the true emergency items with things like aspirin, cough drops, tissues, wet wipes and band aids. You might not need any of them but can you imagine trying to grind your way through a six-hour test with a throbbing headache? Coughing and wiping your nose on your sleeve for six hours is not going to help your score any either.
  • Wristwatch – Some people like to keep an eye on the time while others feel it is more of a distraction. I would recommend taking a watch even though the proctors post the time left at the front of the test center. Time management is critical and you will want to know exactly how much time is left.
  • Earplugs – You only need to hear stories of loud traffic or lawn mowers outside the exam site to know that earplugs are a good idea. Even if you are not normally distracted by ambient noises, you might as well take a pair just in case.
  • Extra money for a taxi – This one depends on how far you live from the test site and how you plan on getting there on exam day. You need to plan for two ways of getting to the exam, just in case your primary transportation fails. Know the bus schedule or someone that you can call at the last minute for a ride. It only takes a few minutes and can save you the agony of missing the exam completely because you were a few minutes late to the testing center.

Don’t count on putting any of this stuff together the day of the exam or even the day before the exam. Test day is stressful enough without having to worry about finding some cough drops or realizing that you misplaced your passport. There will be an area outside of the exam room where you can store your personal items or you can just leave them in your car if you drive.

We will never know how many candidates miss the exam each year because some unforeseeable circumstance kept them from success. We will also never know how many candidates were too distracted by bad circumstances to be able to think clearly and pass the exam. These things do happen, just make sure they don’t happen to you.

Just three weeks left. Good job, you’re almost there.

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

Your Last Month CFA Study Plan

Just five weeks remain to the December CFA level 1 exam and that pounding noise you hear is the sound of your heart beating. Ok, maybe it’s not so dramatic as that but I certainly had a few sleepless nights heading into the first exam.

The last month before the CFA level 1 exam does not have to be a stressful time. If you have followed our Level 1 basic strategy and have done the readings then there is only a few things you need to do to prepare. If you have not yet made it through all the readings at least once, there is still plenty of time to prepare but you’ll have to kick it into high gear.

Must have tools and resources

Instead of measuring your preparedness by the time you have spent studying, you really need to know where you are at in terms of practice problems and mock exams. Three- or six-hour long practice tests will be your most powerful tool over the next month. The easiest way to take these is through question banks but you can also make your own through practice problems at the end of the chapters.

I recommend taking at least one six-hour practice test a week, either in one or two sittings. Even if you have scored pretty well taking tests of individual topic areas, combining all the topics into an exam will help you to measure how well you are retaining the curriculum as a whole. Your performance on these tests every week will help you plan how much studying you need to do and in which topics. Remember, you should be targeting at least 70% on each topic area and I would target at least 75% before I set any topic aside to focus on others.

Since time is a factor now, you will also want to focus on notes and other resources. Flash cards are invaluable at this point for getting those last tricky formulas. I recommend making your own flashcards which will help you remember by writing the material as well as working the problem. Make sure you write the problem out like it is done in the end of chapter problems, in a short vignette. Carry your flash cards everywhere and work through as many as you can throughout the day.

Finquiz study notes are also a good resource to use for getting the most information in a limited amount of time. The notes are designed to be used in conjunction with the curriculum, so make sure you have read through the curriculum.

Week 1-3

I usually tried to study between 15 to 20 hours a week over the last month. I worked a full-time job but did not have kids when I was a candidate so your own schedule may differ. I tried to fit studying in six days a week, usually taking one of the weekdays off so I could just relax for a night.

The week would begin with a practice test on Saturday morning with topic area weights according to the Institute. Pay special attention to your score in core topic areas like: Ethics, Financial Reporting & Analysis, and Equity Investments. These three topics alone are nearly half your total score and you must do well if you want to pass.

Sunday was spent reviewing one or two topic areas where I needed the most work. If you work a full day during the week, you are going to be tired during your weekday study so you really need to take advantage of Sundays.

Monday through Thursday studying would involve some curriculum reading but most of my time spent was on condensed study notes, flash cards and practice problems. When you are working practice problems, it is absolutely imperative that you work through the solutions to the ones you missed and the ones on which you weren’t sure. Guessing correctly on a practice problem does not mean you will be as lucky on the actual test.

Over the three weeks, I would cover all 18 study sessions. Pick six study sessions each week, three that you score really well on the practice tests and the three that are giving you the most problem. This will help balance easy subjects with difficult subjects. You don’t necessarily have to spend an equal amount of time on each study session. I would spend about 75% of my time on the three difficult ones and 25% on the easier ones.

Week 4

I always took the last week off from work to fully commit to the exam. The CFA curriculum is your job this week and you need to spend a full 40 hours or more. Plan on taking the Friday before the exam off to relax so you need to fit your study time in the remaining days.

Each day starts with a practice exam, these can be shorter two-hour exams but you should aim for 120 questions. You can either make the test a mix of all the topic areas or make it a mix of the topic areas you studied the day before. I usually made my tests a mix of the topics I studied on the previous day or the day before. This is a good way to remind yourself of the information and helps commit it to memory.

After the practice test, I would spend the rest of the day really focusing on the topics where I was having the most difficulty. You do not have to cover every study session or every topic in the last week. If you are scoring above 80% in a topic on practice exams then you can probably set it aside and work on another topic.

Mix the day’s study up between practice problems, study notes, flash cards and maybe a little curriculum reading. Trying to study from one resource all day is just going to put you to sleep and you won’t remember as much as from a more dynamic approach.

Nearly half of the candidates fail their exam each year. That doesn’t mean you have to be one of them. Using your time wisely over the last month before the exam can mean the difference between passing to the Level 2 exam or ending up in one of the fail bands.

Stay strong, just a few more weeks. Good luck.

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

CFA Level 1 Review: Fixed Income

Study Session 16 in the CFA Level 1 curriculum concludes the Fixed Income topic area with two readings, one on risk and return concepts and another on basic credit analysis. The credit analysis reading is completely conceptual and probably secondary to the first reading.

When I took the Level 1 exam, I was surprised by how conceptually-focused it was and how many of the formulas that I had studied for hours were not tested. They say the Level 1 exam is a mile wide and an inch deep because the curriculum touches a seemingly endless number of areas but does not go into much detail. For this reason, I always recommend to Level 1 candidates to focus on getting the main ideas and reasoning behind the concepts then to work on learning formulas.

This is especially true in SS16 with quite a few new formulas on duration and convexity. You will definitely need the basic duration and convexity formulas for the level 2 exam, so spend a little extra time here. You may or may not need to remember the formula for Macaulay duration, I would consider it of secondary importance to the others. Whatever you do, make sure you understand the concept of duration and convexity above all else.

Understanding Fixed Income Risk and Return

There are three sources of return for a bond; coupons, reinvestment and the return of face value. It is imperative that you understand how rising or falling rates affect the value of coupons and reinvestment opportunities.

If rates increase, the value of a bond decreases to make the yield competitive (i.e. since the coupons do not change, new investors/demand for the bond will require a market competitive yield so the price must change). If rates fall, the value of the bond increases but investors are exposed to reinvestment risk because of lower rates.

Understand how the time to maturity affects these concepts as well. The value of a long-term bond will rise and fall more with changes in interest rates because the change in reinvestment return has longer to affect the value.

This idea of rate risk on a bond’s price is known as Yield Duration (or just Duration). There are four measures: Macaulay, Modified, Effective, dollar and Price value of a basis point. The modified, effective, and dollar duration and PVBS are probably the most important to remember for the exam.

Modified Duration is the price of the bond at the lower rate minus the price of the bond at the higher rate (PVlow –Pvhigh) divided by two times the change in yield times the initial price (2*Yieldchg*PV0). It is a fairly easy formula to remember if you think about the concept first. You are measuring rate sensitivity so the numerator is the change in value with a change in rates. The denominator is the initial price times how much the rate change caused yield to change and multiplied by two. It may take a few practice problems but make a flash card and you’ll get it.

Effective Duration is basically the same formula but using the yield curve instead of the change in the bond’s yield. Understand that the Modified and Effective Duration will be different but will move closer together when: yield curve is flatter, maturity is shorter, price of bond is closer to par.

Understand the advantages and limitations to each method of measure for portfolio duration.

You will definitely need dollar duration for the second and third exam. Fortunately, once you have the basic duration formulas down then dollar duration is easy to remember.

The price value of a basis point is an estimate of the change in price when YTM changes one basis point. It’s a pretty quick and easy formula; the change in price with high and low rates (PVlow –Pvhigh) divided by two. Don’t forget that a basis point is one-hundreth of a percent (0.0001).

Convexity is also a very important concept in the reading. While duration only estimates the change in price from changes in rates, convexity measures the difference in that estimate on rate changes. Convexity will differ from duration the most when rates are much higher or much lower. Understand that callable bonds have negative convexity at lower rates because of the call option.

Fundamentals of Credit Analysis

The reading is like a 101 on credit analysis and good for your general knowledge of the industry. There are a few important concepts but they are all overall general concepts.

Understand the forms of credit risk:

  • Spread risk is the loss of value from an increase in yield spread over other bonds due to the perceived increase in default risk of the issuer, notice it is from the perception of risk but not necessarily an actual downgrade
  • Downgrade risk is the loss when an issuer is downgraded by an agency due to creditworthiness
  • Market liquidity risk is the loss due to lack of sufficient participation to buy/sell the bonds in the quantity desired

Understand the difference between equity and credit analysis, and the four Cs of Credit

  • Capacity is the ability of the borrower to meet debt obligations
  • Collateral is the quality and value of the assets supporting the debt
  • Covenants are the terms and conditions in a bond agreement
  • Character is the quality of management and willingness to satisfy debt obligations

The curriculum throws a ton of ratios at you to measure liquidity and financial strength but they are all discussed in more detail in other sections. Quickly understand how the ratio shows higher or lower credit risk but I wouldn’t spend too much time here. Study them in the equity and FRA topic areas where more detail is provided.

Know the difference between affirmative covenants (obligations the company must hold like paying interest, taxes and submitting audited statements) and negative covenants (limitations on the company like debt ratios and the amount of cash that can be paid out to equity holders).

Just a month and a half left to the exam. You should be well on your way to finishing your first pass through the curriculum and ready for a review of the more difficult/important topics. Start taking mock exams built off of question banks and end-of-chapter questions as well to start getting ready for the long 6-hour exam. These mock exams will help measure how you do when you have to sit down and test every topic area at once instead of individually.

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

Does a Change in the Curriculum Make it Even More Important?

We started our CFA Level 1 Review post this week with an important message about the curriculum. Candidates studying for the December exam have an extra incentive to do well and move on to the second exam. They are studying from the 2014 curriculum and all levels will change to the 2015 curriculum come June.

If they do not pass in December, they will need to read three new readings in the 2015 curriculum and will have wasted their time with six readings that have been dropped.

That is a pretty big incentive, but what do the curriculum changes mean for other candidates?

More than you may think.

CFA curriculum in flux

While the official CFA curriculum does not normally change much from year to year, the Institute made some sweeping changes this year for the 2015 curriculum. In all, there are 10 new readings across the three exam levels and nineteen readings have been dropped. While some of the readings have shifted from one exam to another, this is still an extremely big change for the curriculum.

But that isn’t even the biggest change. I was surprised to see that the CFA Institute is changing the topic weights in the 2015 curriculum as well. The relative weights for each topic have been the same since before I was a candidate in 2009 and I don’t think anyone saw the change coming. While most of the weights only changed by a few percentage points, if any, it still means a lot on an exam where half the candidates do not pass and you need every point possible.

If you have made it through any of the exams by only reading study guides in prior years, you may want to rethink the strategy if you are taking the exam next summer.

First, there is a lot of new material in the curriculum. The Institute will not say whether it makes a point of testing new curriculum material but the general consensus among candidates is that it is highly testable information. If the Institute thought it was important enough to include the new material, sometimes at the cost of pushing out older information, then it could very well want to highlight it on the exam.

I have been working with third-party providers for more than two years now and can tell you that preparation of study guides after curriculum changes is an insanely detailed and difficult job. Each page of the curriculum has to be reviewed for changing Learning Outcome Statements and changing readings. If some material is missed when preparing study guides during normal years, it is even worse during years where the curriculum has changed so significantly. You absolutely must read the curriculum if you want the opportunity at 100% of the exam material. FinQuiz offers a happy medium with study notes that are designed to complement the curriculum, not replace it.

We went through the changes to the three curriculum levels in prior posts.

Click here for a review of changes to the CFA Level 1 exam.
Click here for a review of changes to the CFA Level 2 exam.
Click here for a review of changes to the CFA Level 3 exam.

We’ll continue next week with our review of the CFA Level 1 for the December exam. For the rest of you, enjoy your break, it will be time to pick up those books again soon enough.

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

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

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