I see this question all over the internet. While CFA versus MBA seems to be the most popular, it is followed closely by Continue reading
Last week, I listed out the things I wish I knew before each level of the CFA exams. For the most part, these were the general ideas that relate well across all three levels. This week, I am reminiscing back to those bygone days of the Level I CFA exam.
One of the most difficult aspects of the CFA exams is that you are basically on your own. Sure there are study groups but these are composed of candidates in the same exam level and probably making the same mistakes that you are making.
Last updated: December 22, 2016 at 8:11 am
Even with the change to topic area weights on the CFA exams this year, CFA 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.
Peeling back the cover on your CFA Level 1 books can be a shock at first. Thousands of pages and hundreds of CFA Level 1 formulas sit in front of you and can seem overwhelming.
This post is going to offer the most important advice on HOW to study for the Chartered Financial Analyst exams, or really any exam.
Reading through the LinkedIn group lately, someone was asking about the difficulty of the CFA Level 1 exam and how it related to another professional exam. A couple of candidates commented how tough the material was and how much there was of it.
I just had to smile.
At the end of this post, download 6 Free PDF files for your CFA Exam Level 1 December 2016.
First PDF file is Formula Sheet.
Next four PDF files are of CFA Exam No. 4 offered by FinQuiz. There are total six similar exams available on www.finquiz.com for purchase (In total 24 PDF files).
Last PDF file is a sample of ‘FinQuiz Smart Summaries’
Last updated: December 29, 2016 at 3:48 am
This is the fourth week of our CFA Level 1 review of the financial statement material. We look at the Statement of Cash Flows this week, a statement that shows the inflows and outflows of cash over the period. Actual cash flow is much harder to manipulate compared to the income statement so analysts use this statement heavily in their work. Make the Statement of Cash Flows your new best friend.
Check out the introduction to CFA Level 1 Financial Statements
Check out the CFA Level 1 Income Statement Review
Check out the CFA Level 1 Balance Sheet Review
Understanding the Statement of Cash Flows
Like the Income Statement, the Statement of Cash Flows shows activity over the period. Remember, this is different from the Balance Sheet which shows assets, liabilities and equity only at one point in time. To compare Cash Flow numbers with Balance Sheet data, you’ll need to take an average of the beginning and ending balance sheet number for an appropriate comparison.
Understand also that cash flow is not the same as net income. Income is an accounting idea based on revenue earned and matched expenses but may not mean the company is generating cash.
A company’s cash flows are separated into one of three sections; operating, investing and financing.
Cash Flow from Operations is the cash generated from normal day-to-day operations. Throughout the cash flow statement, it will be important to distinguish between inflows and outflows of cash. Cash inflows for operations include: collection on sales and accounts receivable, receipt of interest or dividends. Cash outflows for operations include: payments to suppliers and accounts payable, payments to employees, interest payments and payment of income taxes.
Cash Flow from Investing Activities is the purchase or sale of long-term assets, assets like PP&E or long-term investments that will help generate sales for years to come. Cash inflows for investing include sales of non-current assets. Cash outflows here include the purchase of non-current assets.
Cash Flow from Finance is the borrowing and repayment of debt, issuing stock or paying dividends. Cash inflows include issuing stock or bonds. Cash outflows include paying debt or dividends and buying back shares.
The Statement of Cash Flows is connected to the balance sheet through cash. The sum of the three cash sections on the statement, plus the beginning balance of cash from the balance sheet will equal the ending cash balance for the end of the period.
You are going to be spending a lot of your time working through cash flow statements as a new analyst. The Statement of Cash Flows can be constructed from information given on the other two financial statements. The best way to understand the statement, and a must-know topic for the CFA exams, is mastering the two methods for calculating and reporting the statement: the Direct and Indirect methods.
I’m not going to write out the methods here. It’s something you need to write out and study in detail and both methods are shown in the curriculum and in the Finquiz Notes. It can seem tedious to practice through the methods but you need to do it to learn how the statement is constructed through cash changes. Practice with real company financial statements to see if you come out with the same numbers.
Cash Flow Analysis
Performance ratios used with the Statement of Cash Flows include: cash flow to sales, cash return to assets or equity, and cash flow per share. These are all pretty easy to remember and not nearly as important as two other concepts in the reading.
Other than a basic understanding of the cash flow statement, the most important section in the reading is on Free Cash Flow to the Firm (FCFF) and Free Cash Flow to Equity (FCFE). You will use these two concepts throughout the curriculum and absolutely must master them.
Free Cash Flow to the Firm (FCFF) is the cash flow available to all capital providers (debt and equity) and equals:
Net income + Net noncash Charges (depreciation and amortization) – Investment in working capital – Investment in Fixed capital + after tax interest expense
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
Most CFA candidates haven’t had as much experience with the Statement of Cash Flows or haven’t taken time to really master the direct and indirect method so spend some time on the reading to really understand the statement.
‘til next time, happy studyin’
Joseph Hogue, CFA
Master this introductory material on the balance sheet in the 2016 CFA Level 1 curriculum to breeze through tougher concepts later
We begin on our review of the Balance Sheet, reading 26 of the CFA Level 1 curriculum, this week. The balance sheet is not quite as talked about among investors as the income statement but is no less important. Understand how the balance sheet relates to the other two statements, especially how assets are depreciated and expensed.
Understanding the Balance Sheet
The Balance Sheet financial statement is different from the other statements in that it is a snapshot in time rather than a presentation of activity over the period. The Balance Sheet shows assets, liabilities and owner’s equity as of the last day in the reporting period.
Assets represent economic resources of the company, resources that can be used to generate cash or sales. Liabilities are current or future obligations of the company, representing an outflow of economic benefit. Owner’s equity represents the remaining assets or economic resources after all creditors (liabilities) are paid. This gives rise to the balancing of the Balance Sheet with Assets equaling liabilities and equity.
Assets and liabilities are presented in terms of liquidity. Assets that are highly liquid like cash or those that can be converted to cash are show first. Those liabilities that are expected to be paid within a year are shown first in short-term liabilities. The remaining assets and liabilities are shown in long-term accounts because they are expected to be used or paid out over more than a year.
Understand that some of the assets on the Balance Sheet will have a contra-asset and the difference between historical value and net. Accounts receivable is offset by the allowance for doubtful accounts for Net Receivables. Property, Plant and Equipment is offset by depreciation for its net value.
There is a lot of accounting concepts on the balance sheet but you must know them to be a good analyst. You’ll go into more detail on how inventories, long-term assets and other accounts are depreciated, expensed and recorded in other readings. If you don’t have a strong background in accounting, it’s imperative that you spend the time necessary to master this introductory material so you can understand the more detailed readings.
The differences between U.S. GAAP and IFRS reporting can be tedious and confusing. It’s best if you put together a table for each financial statement. Label the different accounting items (inventory, PP&E, etc) down the left-side column followed by columns for GAAP and IFRS. This makes for a quick review of the differences that you can use a few times a day until you’ve got them committed to memory.
An important distinction on the Balance Sheet is the classification of financial assets. Financial assets (liquid assets in stocks and other securities) are either classified as Held-to-Maturity, Held-for-Trading, or Available-for-Sale. How the asset is classified will affect how it’s value is recorded and how the gains/losses show through to the income statement.
- Held-to-Maturity assets are measured at amortised or historical costs and no unrealized gains/losses are reported.
- Held-for-Trading assets are recorded at fair value and marked to market with unrealized gains/losses recognized as profit/loss on the income statement and in retained earnings.
- Available-for-Sale assets are recorded at fair value with unrealized gain/loss recognized on Other Comprehensive Income and accumulated within owner’s equity.
Balance Sheet Analysis
As with the reading on the Income Statement, the analysis here is fairly light with just some ratios. The reading is focused more on the accounting concepts for the Balance Sheet while other readings will go deeper into the analysis.
In ratio analysis, you must remember to adjust your Balance Sheet numbers when using them with numbers from the other financial statements. It’s easier than it sounds, you just need to take the average of the beginning and ending values for the Balance Sheet number.
For example, the Days Sales Outstanding ratio is found by taking the average of the beginning and ending receivables on the balance sheet and then dividing by sales or credit sales from the income statement.
Make sure you understand and remember the liquidity ratios and the solvency ratios. These are very basic and will be used throughout the CFA exams and your job as an analyst.
Liquidity Ratios: Current, Quick (acid-test), Cash
Solvency Ratios: Long-term Debt to Equity, Debt to Equity, Financial Leverage
We’ll continue with the Statement of Cash Flows next week and then a week for financial statement analysis. Make sure you are scheduling enough study time to read through the curriculum, work practice problems and then review study notes. It’s only this repetitive system of studying that will allow you to commit the material to memory.
‘til next time, happy studyin’
Joseph Hogue, CFA
We started our review of the CFA level 1 financial statement material last week with a basic understanding of the financial statements and the framework in analysis. A lot of this introductory material is extremely basic but you should resist the urge to speed through it. Financial Statement Analysis accounts for up to 20% of the points on all three CFA exams and you will need to use it every day during your career as an equity analyst. Most importantly, you’ll need most of this introductory material to understand more detailed concepts and formulas on the CFA Level 2 and Level 3 exams.
We jump right into it this week with a look at the income statement, the major accounting concepts and statement analysis. The income statement is likely the most talked about in the financial press of the three principal financial statements though you’ll spend just as much time as an analyst on the other two statements. We’ll be using the Finquiz notes to the CFA curriculum.
Understanding the Income Statement on CFA Level 1
The income statement represents the company’s profitability over a period of time, either a quarter or through the year. Analysts use the income statement to evaluate the quality of a company’s earnings and earnings growth rate.
You should remember the requirements for revenue recognition under IFRS and U.S. GAAP. The general rules plus recognition of special cases like long-term contracts is highly testable material, especially quick calculations like the percentage-of-sales methodology.
Income from operations is an important number because it shows the operational earnings power of the firm. The operating margin, operating profits divided by sales, can be used to judge the operational efficiency of the company compared to competitors. Operating earnings are sometimes referred to as Earnings Before Interest and Taxes (EBIT) and an important valuation multiple will be on EBITDA, which adds back depreciation and amortization.
Everything below net income from operations is referred to as “below the line” and includes many items that are not part of normal operational activities. The definition and reasons why an activity is reported below the line as non-operating items is very important. Understand the difference between Extraordinary Items (not allowed under IFRS) and Unusual or Infrequent Items.
- Extraordinary Items are both infrequent and unusual, such as losses on natural disasters and expropriations.
- Unusual or Infrequent Items are either/or and are generally reported as part of continuing operations of a company. Common items are restructuring charges or gains/losses on sales of an asset.
Expense recognition around inventory will be very important material so master the LIFO, FIFO and weighted-average costing methods. You’ll see whole readings on this later so getting the basics here will make the more detailed readings easier to grasp. An important point is the effect of different costing methodology on Cost of Goods Sold.
Understand how to calculate Weighted Average Number of Shares Outstanding over a period as well as the difference between a simple and complex capital structure. Understand the difference between basic EPS and diluted EPS along with which securities are used in the calculation of dilution (i.e. options, warrants, convertible debt, convertible preferreds).
CFA Level 1 Income Statement Analysis
The focus on the CFA level 1 exam is placed on understanding the layout and accounting of the income statement rather than detailed analysis. The analysis in Reading 25 is fairly basic and just covers common-size statements and margins.
Common-size financial statements are a way of comparing statement items against a major line item like sales or assets. In vertical common-size analysis, you find the percentage of each line item relative to sales for each year. This is helpful in seeing if particular expenses have become larger or smaller in significance. In horizontal common-size analysis, you base each line item off of itself in a common year. It helps to see changes in expenses over the years.
Three margin ratios are common in income statement analysis,
- Gross margin is the percentage of revenue after cost of sales and may help show different competitive strategies across companies
- Operating margin is the percentage of revenue after operating expenses and is valuable in showing how well management controls costs
- Net margin is income divided by sales and shows the overall income statement profitability
This basic statement analysis is detailed further in Reading 28 of the CFA level 1 curriculum which brings the financial statements together for a closer look at analysis and ratios. These are some of the most important readings you’ll cover within the curriculum and for your job as an analyst so make sure you spend as much time as it takes to master the material.
‘til next time, happy studyin’
Joseph Hogue, CFA
Don’t neglect this basic information on financial statements in the CFA curriculum
One of the most important topic areas in the CFA curriculum is Financial Statement Analysis, which accounts for upwards of 20% of each exam’s points. Reading 22 of the CFA Level 1 curriculum is your first step into the world of financial statement analysis and a critical skill you’ll need during your career.
I thought it would be helpful to point out some of the highlights of the Finquiz Study Notes on the reading and some other tips to the Level 1 CFA material within financial statement analysis. Over the next few weeks, we’ll cover the other key topic areas and readings in the CFA level 1 exam to help you get the most points possible.
An Introduction to Financial Statement Analysis
The Finquiz study notes for Reading 22 is eight pages long and covers all the learning outcome statements for the material. Rather than a substitute for the curriculum, Finquiz notes are meant to complement your reading of the CFA curriculum to make sure you cover all the material and reinforce the most important points.
The overview section on financial statements and supplementary information is a brief outline of purpose for the financial statements and other information you’ll need to research as an analyst.
Balance Sheet – a snapshot of the company’s financial position at one moment in time. The ‘snapshot’ idea is important because the other financial statements show activity over the entire period. Since the balance sheet differs in presentation, you’ll need to adjust the numbers when comparing against the other statements, i.e. taking an average of the beginning and ending balance sheet amounts.
The balance sheet categorizes everything broadly into assets, liabilities and owners’ equity. Within assets and liabilities, the items are also categorized by short-term and long-term in terms of liquidity.
The Income Statement is the financial results of a company over the quarterly or annual period. Revenues and expenses are recorded according to accrual accounting principles meaning they are matched appropriately though may not reflect actual cash activity.
Your first task will be to understand the difference between items that go in normal operating expenses and those that appear below because they are unusual or infrequent. You’ll also need to understand the general layout of the income statement and ratios like gross margin, operating margin and net margin.
While the income statement is popular with investors, you’ll spend much of your time on the Statement of Cash Flows as an analyst. The statement is an accounting of the actual cash flows of the business over the period. Since it represents actual cash flows, it is less easily manipulated by management compared to the income statement so a very valuable tool for analysis.
Cash flows are separated into three categories:
- Operating cash flows are generated from normal day-to-day business operations
- Cash flows from investing are attributed to the company’s long-term investing and disposal of assets
- Cash flows from financing are attributed to the company’s use and sources of capital like debt and returning cash to shareholders
The Statement of Changes in Owners’ Equity is not quite as important as the other financial statements but you will still need a basic understanding of the components and how it relates to the other statements. Components of the statement include: paid-in capital, retained earnings, minority interests and other comprehensive income.
Beyond these four statements, you will also need to remember what supplementary information can be found in the financial statement footnotes and the Management Discussion & Analysis. These supplementary schedules and items are not as important as the financial statements but you’ll need to know what they include.
You won’t use the Auditor’s Report for much of anything but need to know the layout of the report as well as the difference between the four types of opinion.
- Unqualified opinion – indicates that the financial statements appear to be free of material misstatements and are prepared in accordance with accounting principles
- Qualified opinion – indicates some exceptions to accounting standards and perhaps some concerns about the company
- Adverse opinion – indicates material misstatements and problems in the presentation according to accounting principles
- Disclaimer of opinion – is given when an auditor is unable to issue an opinion
CFA Level 1 Review: Financial Statement Analysis Framework
The steps in the analysis framework are not as important as the process itself. Working through the readings on each financial statement will give you a good idea of the process. You might want to briefly look over each of the six steps in the process but it is unlikely that you’ll be tested on knowing the name of a specific step.
- Articulate purpose and context of the analysis – why are you performing the analysis?
- Collect input data – from financial statements and other sources
- Process data – adjusting financial statements, ratios and comparing data on common-size
- Analyze and interpret – produce analytical results
- Develop and communicate conclusions
You’ll go into much more detail on the financial statements and FSA further into the curriculum. Some of this introductory material may seem overly simplified and unnecessary. If you have significant accounting or analysis experience, you can probably skim through it quickly but I would warn against skipping it entirely. The CFA curriculum is very well constructed to be a progressive learning process. Learning the basics in these introductory chapters will make subsequent chapters easier to understand. Skipping the seemingly easy stuff risks missing out on something you will need to know later in the curriculum.
‘til next time, happy studyin’
Joseph Hogue, CFA
By far the most common question we get at Finquiz is, “What does it take to pass the CFA level 1 exam?” It’s a valid question considering only 42% of CFA level 1 candidates passed the June 2015 exam.
How can more than half of the candidates taking an exam fail to achieve a passing score? What does the CFA Institute expect you to know before moving on to the second exam?
Of course, the Institute doesn’t make things any easier by not releasing their minimum passing score. We know that no candidate has failed any of the exams with a score of 70% or higher but we’re never given the minimum score for any testing year.
But there are ways to approach the exam to determine what you need to do to be confident of passing. Looking at the topic weights and understanding how the CFA level 1 curriculum is tested can give you the edge you need to push you above the mysterious passing score.
CFA Level 1 Most Important Topics
Every study plan should start off by looking at what is being tested and how important it is to the overall exam. The CFA Institute releases the topic weights for the three exams each year with changes occurring only rarely.
The CFA exam topic weights factor heavily into our study strategy to pass the CFA level 1 exam. Topic weights have changed only slightly since I studied for the level 1 exam in 2009 and the key topics haven’t changed. Ethics and Financial Reporting & Analysis continue to be the most tested topics. You should also notice that Equity Investments and Fixed Income, while only worth 10% of your level 1 exam are worth a much bigger percentage in the other two exams. Focusing on these other two topics as well will help you save time when you do pass the first exam.
It may be a little disappointing but there really is no secret to passing the CFA level 1 exam. The exam covers a huge range of topics and can seem overwhelming for many candidates. Fortunately, the test doesn’t get very far into the details of the subject matter. The curriculum is tested on a basic understanding, a mastery of the big picture and the relationships between different concepts.
This means that you shouldn’t spend too much time on any particular topic or reading. Make sure you master the four core topic areas in terms of weighting but read through the entire curriculum multiple times to get a strong overview of everything.
The CFA Institute regularly releases its candidate study survey that nearly always shows an average of 300 hours studying by successful candidates. While candidates in the level 2 exam might spend a majority of time on FRA and level 3 candidates probably spend more time on the essay section, level 1 candidates should spread their time out more evenly.
Trying to spend 300 hours reading through the same curriculum is only going to lead to burn out. You need to mix up your study resources so studying stays fresh enough that you don’t get bored. This means reading the curriculum, reviewing notes, working practice problems, studying flash cards and even reviewing difficult concepts on YouTube when available.
CFA Level 1 Study Plan: Tortoise or the Hare
If you are reading this for the 2015 December level 1 exam, just two months out from now, you may need to kick your study plan into overdrive depending on how far along you are in the curriculum. You will want to start taking mock exams and practice exams by November to gauge your progress. Aim for a target of 75% or better in each topic area to give yourself some room for error on the actual exam.
Multiple resources are the key for covering the material from different perspectives and reviewing the curriculum multiple times. With thousands of pages in the official curriculum, you may not have time to read through it again and still do the necessary practice problems and mock exams. Try shifting more time to review notes and flash cards to cover the material more quickly.
If you are studying for the 2016 CFA level 1 exam next June, then you’ve got more time to prepare. Start reading through the curriculum in December or January at the latest. Once you’ve worked through the official curriculum once, you can start reviewing using other resources to reinforce the material.
Given the low pass rates on the CFA exams, you’re best bet is to over-study for the test. Plan an aggressive study strategy and go into the exam super-confident that you know the material. It’s far better to over-study than to have to spend another year reviewing the material because you didn’t study enough.
‘til next time, happy studyin’
Joseph Hogue, CFA
With the start of the study season for the December Level 1 Exam comes a rush of calls for study groups in CFA groups on the internet and locally. Studying for the CFA exams can be an extremely solitary and uncertain pursuit so candidates look for help and confidence in groups.
But should you join a study group for the CFA exam? If you do join a group, how much time should you commit and what are the advantages or disadvantages?
We’ve posted a few articles on the Finquiz CFA blog about participating in groups but I thought I would reinforce some of the most important ideas. We’ll look at some study group options, benefits and risks to watch out for before tackling the question of whether you should join a study group for the CFA exams.
What are your options for CFA Study Groups?
I remember studying for the CFA exams, from 2009 through 2011, and joining study groups. Since then, technology has brought new options to CFA study groups but candidates are still using the old methods as well.
First, you’ve got the old school method of in-person study groups. Maybe I haven’t grown up with the technology that enables the other study groups but I still like in-person groups above all others. They take a little longer, through travel time, and a little more coordination to set up but these study groups can be an indispensable networking tool. Through your study time together, you’ve got a chance to develop a real friendship with some of the people that will lead the profession in your city or region.
There are live study groups that meet over Skype or Google Hangouts. This is the next best thing to the in-person groups. You lose a little of the interpersonal nature because you can’t really talk one-on-one with anyone but it’s still face-to-faces so you can build some good connections. Virtual groups can save a lot of travel time and are easier to put together than in-person groups.
Next you’ve got web-enabled study groups on Facebook and in other website forums. These can range in formality from an open forum that allows posting to a closed-group that controls the study plan and questions. You lose a lot of the networking benefit unless you interact with members outside the group. The benefit is that they allow everyone to post and reply on their own schedule.
Lastly, you’ve got the newest type of CFA study groups in messaging software like WhatsApp. These are so popular that they are continuously the most commented discussions in the CFA Candidates LinkedIn group. I’ve gotten mixed reviews from candidates about these groups. They can be helpful because you can multi-task while participating, checking in occasionally on new messages, but you lose all of the networking benefit to groups. I sat in on one of the groups a few times and the flow of messages can get overwhelming.
What are the risks you want to avoid in a CFA study group?
The biggest risk to any study group is going off-topic and letting the group go unorganized. It’s fine to trade a few off-topic comments here and there, that’s all part of being sociable, but it helps to set a schedule and bring the group back on topic quickly.
- Don’t make the same person act as schedule-keeper every meeting. Nobody wants to be the bad guy, constantly nagging the group to stay on topic. Rotate the role each time the group meets.
- Everyone in the group has to make the same commitment to the process and the schedule. You’re not accountable to anyone for grades like in school groups but the group breaks down if one or a few people are always missing or forget to read their assignment.
In-person groups and internet-live groups should probably be limited to about six people or less. This helps make sure that everyone has a chance to participate and that you don’t get too many people talking at once. Forum and chat groups can include more people but it still helps if there are a limited number of ‘virtual’ seats. Having hundreds of people participate makes it difficult to differentiate between the real contributors and those just hanging out.
Don’t be afraid to question someone’s answer or rationale behind an answer. You will either learn where you were wrong, improving your own score on the exam, or you will avoid everyone learning the wrong material which will improve everyone’s score. On the same note, don’t take it personally when someone questions one of your answers. You are all there to learn.
Should you join a CFA study group?
Now that you know your options, some of the benefits and the risks to joining a CFA study group, you can make a better decision whether to join one or not. Study groups can be an inefficient way of learning the material, eating up your time and possibly even giving you misinformation from wrong answers. They can also be great motivators through the group support system and an excellent way to network.
I participated in study groups and I would recommend everyone try them out at least once. Maybe I’m old fashioned but I still prefer the in-person groups to any other method. Try putting together a weekly or bi-weekly group in your area, close enough that no one has to travel more than 20 minutes for the group. Limit the group to under two hours and stay on schedule. Going out socially after the group can help keep group-time focused.
I would caution against participating in more than two groups. Spending more than a few hours a week in group is seriously going to cut into your study time. Groups can be great for discussing problems and questions but they are not as efficient as reading the material yourself and working end-of-chapter questions.
If you can’t manage to coordinate an in-person study group or a live-internet group, you might try one of the forum or chat groups. You might have better luck than I did with these groups but remember to keep it organized and on-topic.
I’d love to hear how you are using CFA study groups to further your studying and prepare for the exam. Let me know if I missed any pointers or any of the risks you’ve seen in groups.
‘til next time, happy studyin’
Joseph Hogue, CFA
There’s just 13 weeks left to the December level 1 CFA exam and you should be starting your preparation if you haven’t started already. Two deadlines have passed for registration and only the final deadline remains to get your seat at the exam.
We just finished up our review of the Code & Standards topic area of the exam but I thought I would start us off again with a few words on getting ready for the December exam. Despite the roughly 50% of candidates that do not pass any given exam, preparing for the three exams can actually be relatively easy if you know the process.
That’s not to say that studying and passing the exam will be easy but that too many CFA candidates make it more stressful than it needs to be. Understand how the Level 1 CFA exam is tested and build yourself an outline for your study plan and you’ll find it much easier to make it through the exam.
How to Pass the December Level 1 CFA Exam
It’s been said that the Level 1 CFA exam is like a lake one-mile wide and an inch deep. It’s an appropriate analogy because the breadth of the material in the curriculum can seem endless, but you will not drown in the details.
In this first exam, the CFA Institute wants to introduce you to the world of asset management and analysis. They do not expect you to be a world-class analyst after reading the curriculum but to have a good base of understanding on the many topic areas and how they fit together.
Your job is to keep this in mind when studying for the December level 1 CFA exam. Make sure you have a good understanding of all the topics and can begin to see how many of the topics relate to each other. The sheer volume of material will seem overwhelming sometimes but the difficulty of the questions is ultimately not a problem.
How do you build this idea into your study plans for the December level 1 CFA exam? You need to make it through the curriculum multiple times. This will help commit it to memory and will make sure you get a broad understanding of everything. Do not spend so much time on details or any one topic area that you cannot make it through all the material.
Besides the official curriculum, a set of study notes makes this more easily achievable. FinQuiz Notes are designed to be used with the curriculum instead of substituting for it. This means they’re shorter than other study notes packages and can help you get the broader picture of the material more quickly. Read through a topic or study session one week then follow it up with a review of the study notes the next week for better absorption.
Getting to December: An Outline for Study Plans
- Registration ends for the 2015 December CFA exam on September 16th, register here
- Plan out your study schedule
- You’ll want to read through the curriculum at least once with time enough to review over the last month
- Plan on working at least the end-of-chapter questions for each reading and consider a question bank with additional item sets
- Plan on at one or two days a week with no studying so you do not get burned out on the curriculum
- Try scheduling the entire last week off from work and devoting it to a last-week review
- Keep to your study schedule at all costs! It’s only a few months and the odds are high that you’ll have to retake if you do not take this seriously.
- Check your passport right now! The information must match that provided on your CFA exam registration and the passport must not expire before the exam date. Still time to get it fixed if you check now.
- Admission tickets will be available several weeks before the exam. Check the information on your ticket as soon as you receive it.
- One week before the exam, gather all the materials that you’ll take to the exam in one spot. Better to have these ready than to be looking for them the night before the exam.
- Several days before the exam, check the route to the testing location (if possible) for detours or road work. Ask a local candidate to check the route or if there are typically traffic problems on Saturday mornings.
- Plan on arriving at the testing center several hours early. This will allow you any last-minute problems and still get you to the exam on time.
We’ll cover parts of the CFA exam prep outline over the next few months to make sure you stay on track for the exam. Try to work a little ahead of your study schedule just in case something comes up to set you back a little. Too many candidates work right at their schedule or a little behind and then get set way back on any minor hurdle. Stay ahead of schedule and go into the exam with the confidence that you WILL pass.
‘til next time, happy studyin’
Joseph Hogue, CFA
We’ve covered eight practice problems in the CFA Level 1 ethics material over two prior posts, available by clicking CFA Level 1 Ethics and CFA Level 1 Ethics Practice. This post will wrap up our practice problem review and look at a few key points to the Ethics and Standards topic area.
At the very least, you need to cover every end-of-chapter question in the Ethics study sessions at least once during your CFA exam prep. You may also want to consider a question bank of item sets as well to get a little more practice. The Ethical & Professional Standards topic area accounts for 15% of your CFA level 1 score.
Not only will you need to master the material for the exam, you’ll see it again in the CFA level 2 and level 3 exams where it’s worth as much as 15% of your score on each. The fact that you could see questions on all three exams covering roughly the same material makes for a great opportunity. Learn the material early in level 1 and you will save a lot of study time leading up to the other exams.
CFA Level 1 Ethics Practice Problem Review
We’ll work two more practice problems in this post. Be sure to check out the prior two posts for eight more ethics practice problems. When you’re working the problems, make sure you read through the given answer to get an understanding for how the CFA Institute is looking at the ethical dilemmas.
CFA Ethics Question #1
Tom Hart works for IAM Investment Management, a struggling firm that is likely to close soon under the weight of redemptions. Tom wants to start a small independent practice so he will have something to work on if the firm closes. Which of the following statements is correct under the Code and Standards?
A. CFA Institute members and candidates are prohibited from pursuing independent practice that might be in competition with their employer.
B. Tom needs to obtain written consent from his employer for the independent practice since it could result in compensation or other benefits in competition with the firm.
C. Since the firm is likely to close, Tom does not need permission from his employer and can start his independent practice. He must disclose his independent practice only when he starts making money.
CFA Ethics Question #2
Meg and June have been good friends since high school and are sitting down to a cup of coffee. Meg, the CFO of a large retail clothing chain, mentions that sales are booming and the quarterly results should look very good. June, an investment adviser, writes a research report to clients suggesting they buy shares of a retail exchange traded fund on the potential for high industry sales this quarter. June also buys shares of the fund, which includes shares of Meg’s company, for her personal account.
A. June violated the Code and Standards by buying shares of the fund but not by making the recommendation to clients.
B. June did not violate the Code and Standards by either action because she did not directly act on the information by buying shares of Meg’s company.
C. June violated the Code and Standards by both actions, buying shares of the fund and recommending that clients do so.
Question #1 Answer: B
Under Standard IV – loyalty, members and candidates may undertake independent practice as long as they get written permission from their employer. The requirement is not contingent on actual compensation or benefits but the potential. This is like the ‘perception of conflict’ standard held by the Institute. All necessary disclosures and requirements must be upheld if there is the potential or perception of conflict in a scenario.
Question #2 Answer: C
June violated Standard II – material non-public information because both her purchase and recommendation appears directly related to the information she received from Meg. The information would likely influence the share price of the fund¸ making it material, and it is non-public because it has not yet been released.
Wrap-up of CFA Level 1 Ethics Practice
Many of the ethics questions on the exams will offer one answer that the action was not a violation and then two questions that claim a violation but for different reasons. For this reason, you not only have to know if an action is a violation of the Code and Standards but also why it is a violation. Practicing ethics problems will help to practice matching violations to specific Standards.
Another favorite of the CFA Institute is the problem where someone makes two statements and the candidate must decide whether one, both or neither statement is a violation of the Code and Standards. One statement is usually clearly a violation or not but the other is often ambiguous. For these, you really need to study the Standards for claims that can be made and things you can say.
The ethics material on the CFA exams is actually not too difficult if you spend a little extra time studying before the first exam. I earned 70% + on the topic in the second and third exam without spending a lot of time refreshing just because I drilled on the material extensively while studying for the first exam. Do the same and you shouldn’t have any problems.
‘til next time, happy studyin’
Joseph Hogue, CFA
Miss these CFA level 1 changes in the 2016 curriculum and risk missing out on those important few points that could get you a passing score
The CFA Institute has published its curriculum changes for the 2016 exams. The CFA level 1 changes for 2016 are relatively light compared to last year but still extremely important. I have always suggested candidates get a jump on studying by reviewing prior year curriculum before their own books arrive but you have to be ready for the changes.
You can download a pdf copy of the CFA level 1 changes for the 2016 curriculum by clicking through this link. The curriculum changes are available in a combined document or individually for each of the 18 study sessions.
CFA Level 1 Changes 2016 in General
Only one reading has been added this year and about half of the learning outcome statements (LOS) in the CFA level 1 curriculum have been affected with changes. There are 29 new LOS with 23 changed LOS and eight removed from the curriculum.
Fortunately, the CFA level 1 changes do not affect topic weights in the exam as they did last year. Last year’s CFA curriculum changes to the topic weights in each exam caught a lot of candidates off guard. The table below shows the topic weights for each CFA exam.
There is no real proof to say that you need to study new or changed curriculum material more than older material. It seems intuitive that the CFA Institute would want to highlight changes in the curriculum by putting it on the exam but there is no way of knowing for sure since we can’t talk about exam questions. There aren’t many changes to the 2016 CFA level 1 curriculum so take a little time to make sure you master them.
CFA Level 1 Changes to Curriculum
The 11th edition of the Standards of Practice Handbook, effective July 2014, is still relatively new so its no surprise that the Institute has not changed much from last year’s level 1 exam. There are no changes to the Ethical and Professional Standards study session on the exam.
The changes to the CFA level 1 2016 curriculum do not affect study session two or three of Quantitative Methods.
The changes to the CFA level 1 2016 curriculum do not affect study session four through six of Economics.
Study session seven, the introduction to Financial Reporting and Analysis, is the first part of the CFA level 1 2016 curriculum where we see any changes.
- LOS 7.2.1b and 7.2.2e have added or removed words but there is no change to the intent or the material you’ll need to study.
- LOS 7.2.2a is new: Describe how business activities are classified for financial reporting purposes
Study session eight includes a new LOS (8.2.1d): Describe key aspects of the converged accounting standards issued by the International Accounting Standards Board and Financial Accounting Standards Board in May 2014.
Study session nine is where we see the most CFA level 1 changes to the LOS
- 9.2.1c now asks you to “compare” the different inventory methods across perpetual and periodic inventory systems.
- 9.2.1d through 9.2.1h have been removed and replaced
- 9.2.1d through 9.2.1l are six new LOS
Make sure you spend some time on inventories section (Reading 29). There is a new focus on the material and it accounts for a big portion of the changes.
Reading 30 of study session nine on Long-Lived Assets has also been changed significantly
- 9.2.2c and 9.2.2d have been removed
- 9.2.2f now only asks you to describe the different amortization methods and calculate amortization expense
- 9.2.2 (b,c,d,e,g,k,o,p) are all new LOS on the 2016 CFA level 1 exam. That’s a quarter of the new LOS in just one reading so you can bet the Institute will be looking at the section for the exam.
Reading 31 (Income Taxes) has one change, LOS 9.2.3h has been changed to be more specific. You now need to, “Explain recognition and measurement of current and deferred tax items.”
The changes to the CFA level 1 2016 curriculum do not affect study session ten of Financial Reporting and Analysis.
The changes to the CFA level 1 2016 curriculum do not affect study session eleven of Corporate Finance.
Reading 42 (Risk Management: An Introduction) in study session 12 is new. The seven LOS for 12.2.1 are new so make sure you master the reading. You will revisit risk management in more depth during the CFA level 2 and level 3 exams so make sure you get a really good base of understanding in the first exam.
Study session 13 (Equity) includes one LOS change. LOS 13.2.1g has been replaced. You no longer have to compare behavioral finance with traditional finance but must instead describe behavioral finance and its relevance to market anomalies.
LOS 14.2.1 of study session 14 (equity) includes some wording change to d, g, h and j. Most of the changes do not affect what you need to learn. Make sure you understand how barriers to entry affect price competition and how the macroeconomic picture influences industry growth and risk.
LOS 14.2.2 f and g include some wording changes. Neither of the changes is really material but more to better define what you need to understand.
LOS 15.2.1 of study session 15 (Fixed Income) changes the word ‘functions’ for ‘content’ in the 2016 curriculum. It seems this a more general approach to the section.
LOS 15.2.2e is new and places a little more emphasis on sovereign bonds.
LOS 15.2.2f and 15.2.2i include wording changes to take the emphasis off sovereign bonds and highlight risks of repurchase agreements.
LOS 15.2.3 of Reading 55 (Intro to ABS) includes a lot of changes so make sure your pay attention to the section. LOS 15.2.3 (b, e, g, h, i) include wording changes but do not change the intent very much.
LOS 15.2.3 (c and f) are new while 15.2.3e has been replaced.
LOS 16.2.1 (d and e) include wording changes but do not materially affect your studying. You no longer have to explain how embedded options affect interest rate risk.
LOS 16.2.2b is new, you must now describe default probability and loss severity as components of credit risk.
LOS 16.2.2f includes a wording change but only to better define that you need to know the four Cs of credit analysis.
LOS 16.2.2i has been removed.
The changes to the CFA level 1 2016 curriculum do not affect study session 17 of Derivatives.
LOS 18.2.1 of Reading 61 (Intro to Alternative Investments) include wording changes but do not affect the material or what you need to learn.
The majority of the CFA level 1 changes to the 2016 curriculum occur in study sessions 7 and 9 (Financial Reporting), study session 12 (Portfolio Management), and study sessions 15 and 16 (Fixed Income). Most of the wording changes do not amount to much but pay attention to the new reading (SS 12) as well as the new LOS. The easiest way to do this is just to highlight the sections that include the new LOS and make sure you understand the material when you get there.
‘til next time, happy studyin’
Joseph Hogue, CFA
FinQuiz – Owned and operated by a team of CFA Charter holders.
Last updated: December 22, 2016 at 7:15 am
Last week, we talked about the importance of the Ethics & Standards topic area across all three CFA exams. Its importance in the CFA level 1 exam is heightened by the fact that new candidates may not know what they are up against within the topic.
Reading through the Code & Standards can seem obvious and many CFA candidates believe their moral compass will guide them to the most obvious answer on the exam. When they get to the exam, they’re surprised by the level of ambiguity in the questions and cannot decide between two seemingly correct and ethical answers.
We started working through a few ethics questions last week but will continue this week with five more. It is extremely important that you study these questions and the ones in the curriculum to learn how the CFA Institute asks questions within the Ethics topic and how it expects you to answer.
CFA Ethics Question #1
Roberts is in charge of a group of analysts at BB&T, only some of which are CFA charterholders or candidates. For a large project, he is delegating some of his supervisory duties to one of the analysts to lead the group. What are his responsibilities under the Code and Standards if he delegates tasks to the group.
A. His responsibilities under the Code and Standards apply to conduct of those with CFA designations but not to those that are not subject to the code. For those employees, only legal obligations apply.
B. He is no longer responsible for the group’s conduct because he delegated supervisory duties. That person is now responsible.
C. He is still responsible for all the analysts’ conduct under the Code and Standards.
Under Standard IV, Responsibilities of Supervisors, someone bound by the Code and Standards may delegate supervisory responsibilities but is still accountable for all actions of subordinates. Further, a supervisor is responsible to the Code and Standards for all actions whether their subordinates are bound by the Standards or not.
CFA Ethics Question #2
Babbitt & Coolidge Investments (B&C) has been hired to manage a follow-on issuance of shares for Argon Tech. The brokerage unit of B&C has a sell recommendation on Argon Tech but some fundamentals have improved and a review of the analysis is due. The head of the investment banking division has asked the reviewing analyst to look at the new information and upgrade the shares to buy. According to the Standards, what may the brokerage unit do?
A. Increase the recommendation but only to a hold since it is still a conservative recommendation
B. Place the company on a restricted list and only offer factual information in the report
C. Assign a new analyst that is willing to take the new information into account and assign a buy rating
Under Standard I, Independence and Objectivity, the firm should discontinue issuing recommendations on the stock to avoid the appearance of a conflict. Analysts must refuse any requests to change recommendations even if the change is only to a slightly higher recommendation. Changing the analyst assigned to the stock does not eliminate the conflict of interest.
CFA Ethics Question #3
Tye is an analyst for Buckmaster & Walters and is about to make a new recommendation. According to the Standards, which actions will help ensure fair treatment of brokerage clients?
A. Inform everyone in advance that a recommendation is about to be made so everyone can be ready
B. Since institutional clients need more time to review for suitability under their plans, they should receive the information before individual accounts
C. Time between the decision and dissemination of the recommendation should be reduced
The question deals with Standard III, Fair Dealing. Answer A may allow the recommendation to be leaked out since more people know about the coming release. Firms should limit the number of people that know a new recommendation release is eminent. Answer B is a clear violation as it discriminates between clients by size and assets. Reducing the time between the decision and dissemination of the recommendation helps to avoid it being leaked ahead of the release.
CFA Ethics Question #4
Portfolio Manager Jacob has done very well and one of his clients wants to keep the manager motivated. The client promises to compensate Jacob, above what the firm is paying him, if he can continue to beat the index each year. Jacob is a CFA charterholder and should:
A. Turn down the extra compensation because it could create a conflict with performance on other accounts
B. Turn down the extra compensation because it could lead him to unethical behavior by incentivizing the outperformance
C. Get written permission from his employer prior to accepting the agreement for extra compensation
Standard IV, additional compensation arrangements, does not prohibit compensation beyond that made by an employee’s firm. The employee is still bound by the Code and Standards to not let the additional compensation interfere with fair dealing among accounts and other ethical behavior but may accept additional compensation if it is disclosed and approval is granted in writing by the firm.
CFA Ethics Question #5
Redbeard, an advisor and CFA charterholder, recommends his client invests in U.S. Treasury bonds. The client accepts the advice based on two statements made by Redbeard.
I) The default risk on U.S. Treasuries is effectively zero since the bonds are backed by the U.S. government
II) Based on the historical return to U.S. Treasuries over the last twenty years, you are guaranteed to earn at least 5% over the next several years.
Did Redbeard violate the CFA Code and Standards with either statement?
A. Neither statement is a violation
B. Only statement I is a violation of the Code and Standards
C. Only statement II is a violation of the Code and Standards
Standard I, misrepresentation, requires that all those bound by the Code and Standards separate fact from opinion. The first statement is a fact given the government’s backing of the bonds. The second statement is an opinion based on historical performance and what the advisor thinks will happen in the future. Guarantees of future returns must not be made unless they are contractual within the investment.
Did any of these Code and Standards questions stump you? For the ones you missed, make sure you go back through the question and really understand the CFA Institute’s way of thinking. Don’t forget to review those questions where you guessed correctly. Working as many ethics questions from the curriculum is critical to learning how to answer the questions on the exams. We’ll cover a few more next week before moving on to other topics for the December CFA exam.
‘til next time, happy studyin’
Joseph Hogue, CFA
With just four months left to the December CFA Level 1 exam, it is time to start studying and there’s no better way to begin that talking about the ethics material. Readers of the blog will know that I am constantly reinforcing the importance of study session 1, the material on The Code & Standards.
The material is important for several reasons. First, the topic will be a considerable part of your exam score at all three levels. Ethical and Professional Standards is worth 15% of the CFA level 1 exam and between 10% and 15% of the other two exams. There are some additional readings to study for the level two and three exams but the core material will remain the same throughout. Learn the Code and Standards early and you’ll bank a ton of saved study time ahead of the other two exams.
A second reason for the topic’s importance is the fact that it catches so many CFA level 1 candidates off guard. Too many candidates go into the first exam thinking they can rely on a basic tenet of, “Don’t lie, cheat or steal,” to pick the most obvious answer to each question. They neglect to study the topic area and are horribly surprised when they see the exam questions.
The questions over ethics on the exam do not have obvious answers! Even the ethical person will need to study the example questions in the curriculum to understand how to answer the section.
Finally, the CFA Institute is explicit that the ethics section is used as a tie-breaker for any candidate score that is close to the pass-fail mark. Do well on this section and it might just pull you up from a band 10 fail.
Studying Ethics for the CFA Exam
With the importance of the ethics material, you want to give it plenty of time in your study schedule. We have studied the material in several posts, outlining the most important parts of the Professional Conduct Program (PCP), the Components of the Code and the seven standards.
We won’t go over the three segments of the material because I want to get to the most important part of your study for the ethics section, working problems. You will need to commit the components and the standards to memory, click through here to read our outline of the CFA ethics and standards, but working problems is extremely important.
It’s only through working problems from the end-of-chapter curriculum that you will get a feeling for the actual exam questions. Work enough of these and the correct answer will start to become clearer. Neglect these questions and every multiple choice may sound like a viable answer.
For copyright reasons, we won’t be able to reproduce the question from the end-of-chapter questions. We will instead change the content of the question but keep the intent and the methodology for the answer.
CFA ethics question #1
A research analyst decides to change his recommendation for Greenway Corporation from a buy to a sell. He emails his recommendation change to all the firm’s clients on Monday. The day after the email, a client calls with a buy order for Greenway. The research analyst should:
A. Accept the order
B. Advise the client on the change in recommendation before accepting
C. Not accept the order because it is against the firm’s recommendation
Correct answer: B
Standard III, fair dealing requires that clients be notified fairly of all changes recommendations. The client may not have seen the notification and must be informed. If he still wants to make the trade, he must be allowed to do so even if it is against the firm’s recommendation.
CFA ethics question #2
A research analyst for Broward Brokerage & Investment Banking is asked to write a research report on Brown Forman Corporation. Howard B&I has represented Brown Forman’s acquisitions for the past 20 years. Several senior officers of Howard B&I are also directors of companies with which Brown Forman has business relationships. What is the best course of action for the analyst?
A. Write the report but must refrain from expressing any opinions because of the special relationships between companies.
B. Should not write the report because the Howard B&I officers’ service as directors to Brown Forman subsidiaries.
C. May write the report if the special relationships are disclosed in the report.
Correct answer: C
Standard VI – Disclosure of Conflicts states that all conflicts of interest must be disclosed in research and recommendations. An analyst is not prevented from writing a report because of conflicts but must disclose them in the report. The fact that no opinions are expressed does not clear the analyst of the responsibility to disclose conflicts.
CFA ethics question #3
Jameson is an advisor to the board of trustees of a non-profit foundation. The trustees have given Jameson all the fund’s financial information including planned expenditures. A wealthy contributor to the foundation phones Jameson to say that he has found a potential contributor but needs to show him the foundation’s financial information by the end of the day. Jameson does not have time to contact the trustees, he should:
A. Send the alumni the information because disclosure would benefit the endowment fund
B. Not send the information because it is confidential
C. Send the alumni the information but promptly notify the trustees
Correct answer: B
Standard III establishes the preservation of confidential information to a client. Confidential information cannot be released without permission, regardless of whether the disclosure may benefit the fund. Information can only be released, without permission, if it concerns illegal activities or disclosure is required by law. Information may also be disclosed on an inquiry from the CFA Institute’s Professional Conduct Program.
We will work through more questions over the next couple of weeks to give you a better idea of what the CFA Institute is looking for from the material on the Code and Standards. I cannot stress enough the importance that candidates for the CFA level 1 exam study the actual ethics questions in your curriculum. These are going to be very much like what you see on the exam and the correct answer will not always be obvious.
‘til next time, happy studyin’
Joseph Hogue, CFA
Last updated: July 18, 2016 at 16:35 pm
While the June CFA exams are just behind us, I’m already getting emails from CFA Level 1 candidates asking when they should start studying for the December CFA exam. It’s a common question, whether ahead of the December or June exam, and really depends on your own schedule and study style.
The easiest (and probably best) answer I can give you is…start studying right now! I have been a big advocate on the blog of making your CFA study schedule a part of continuous and life-long professional development. As a professional, you don’t get summer break or extended vacations. You need to constantly be learning and building your skills as an analyst, or face the chopping block the next time job cuts hit the office. The CFA curriculum is the best in the industry and it doesn’t hurt to start early and really master the material.
But if you’ve already got other projects on your schedule then it’s a relevant question to ask when you need to start studying for the December CFA exam.
How much time do you need to study for the December CFA exam
The average of 300 hours spent by most successful candidates to pass a CFA exam is a pretty good metric from which to start. Your own experience of how quickly you learn new material might guide you higher or lower but I would caution candidates against thinking they need less than 200 hours of study time. This will be your first CFA exam and most are surprised at the level of difficulty. Looking at the 10-year average pass rate of just 39% for the level one exam should give you an indication of how many are caught off-guard by its difficulty.
Most candidates for the June CFA exam start mid-February which leaves about three and a half months to study. That still means about 20 hours of studying each week over 15 weeks to reach 300 hours, a pace that most probably would have trouble keeping. For the December CFA exam, I have heard a lot of candidates wait until sometime in August to start their study schedule.
Realistically though, can you really fit more than 10 to 15 hours of studying into your weekly schedule? Even full-time students have to contend with their university exam schedule. Adult CFA candidates have to balance family-life, work and everything else with studying for the CFA. Budgeting 15 hours a week for studying means you’ll need to start in a few weeks to get 20 weeks of studying in before the exam.
You might be able to make up some lost time with a few days or even a week of intense studying. Taking off work the last week before the exam can net you upwards of 50 hours or more for studying. A lot of candidates plan on studying large blocks of time over the weekends but who wants to work all week and then study all weekend?
I would say plan on starting your December CFA study schedule by the second or third week of July, at the latest. That will give you 20 weeks before the exam. You may not need all the time but it’s far better to overstudy than to not study enough.
As for How to Pass the CFA Level 1 Exam, check out some of the posts here on the blog. The first exam is extremely broad-based but you do not need much detail in each topic area. Make sure you read the curriculum and supplement it with a quick reference guide like the FinQuiz Notes. This strikes a balance between getting the detail you need and the ability to cover the material multiple times through notes.
We’ll start covering topics specific to the CFA Level 1 exam in the coming weeks. Let me know if you have any questions on how to prepare for the exam or what to study.
‘til next time, happy studyin’
Joseph Hogue, CFA
Last updated: July 18, 2016 at 16:01 pm
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.
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.
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
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
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