Five Reasons CFA Candidates Fail the CFA Exams (Part 5)

This post wraps up our five-part series on the most common hurdles facing candidates for the CFA designation. The first reason was too much time spent studying about studying, posted here. The second reason, planning a schedule around life and burnout, is a big one for those of us with a family and a full-time job. The difference between active and passive studying, is probably the biggest hurdle to success for most candidates. Last we looked at the myriad of resources available to candidates and using the right ones.

Today’s hurdle could just as easily have been titled, “I’m an ethical person, so why study ethics?” While the material on Ethics and Professional Standards is not the only one neglected by candidates, it is probably the most avoided. Sure, you need to have a good understanding of the entire curriculum but a look at the topic weights provided by the Institute makes it clear that some topics are a source of some major points.

Ethics, the easiest and most difficult topic on the exams


Candidates have a big opportunity with the ethics section though it still presents a problem for most. The topic area is tested at each level and is worth at least 10% of your exam points. The opportunity comes in the fact that the topic is the only one that really does not change much as you progress. You’ll see a couple of additional sections but these are relatively secondary against the core Code and Standards, which do not change. For candidates that give the topic its due at level I, the next two levels are that much easier.

The problem with the ethics material is twofold. Some candidates consider themselves to be fairly ethical people and so think that the answers on the exam will be intuitive. They neglect the topic and end up failing on the exam. Other candidates read the material, to the point of memorizing the Code and Standards, but neglect to do practice problems.

There are two types of ethics questions on the exam, those with no answer and those that seem to have two correct answers. You absolutely must practice the ethics problems provided by the Institute at the end of the chapters. You’ll be surprised by the level of ambiguity in some of the problems and how minute details can make the difference between one answer versus another. Don’t let the first time you are surprised by this be at the exam.

You need to know Financial Reporting & Analysis for the CFA designations??? Who Knew?


If not of equal importance to the ethics material, I would put FRA a close second. Unfortunately, a lot of candidates avoid this section as well. The material, much of it focused on accounting issues, may not be as interesting for some. It can also get extremely complicated and detailed on the level II exam.

Anyone that works in the industry, whether a charter holder or not, will tell you that understanding the financial statements is of the highest priority. As an analyst, you will need to develop models and an expert knowledge of how the company is reporting its business and how it all flows together. Spending extra time on the material will not only help you pass the exams, it will make your life so much simpler further down the road.

Equity and Fixed Income: The fun parts that aren’t so much fun anymore


Many candidates start the path to the charter because the love analyzing investments, whether in the equity or fixed income market. When they realize that it is a little more than just calculating the price-earnings ratio for the stock everyone is talking about… it becomes less fun.

The two topics can get extremely formula-intensive and most candidates only have experience in one of them. Avoid the temptation of only studying the topic in which you currently work or in which you think you want to work. First, you’ll need the points from each section to pass the exam. Also important though is the fact that you never know how your career will unfold or when you might want to work in another asset class.

Each level has its own idiosyncrasies and no one topic area will get you through every exam. The four topic areas above are extremely important but you still shouldn’t neglect the other five topics. Other posts on the blog talk about specific strategies for each level and can help you further focus your study plans.

Are there any hurdles to passing the exams that I forgot? What tripped you up the most? Let me know if you have any questions about the last five posts.

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

Last updated: August 1, 2016 at 5:13 am

The Most Important Blog Post You Will Ever Read

It’s the second week in June and I can hear crickets chirping in the background. Most CFA candidates are taking a well-deserved vacation from anything CFA-related and it will be several months before they start thinking about what’s next.

That makes this post all the more important for you few candidates that are reading it.

In fact, this post may be one of the most important you read during your time as a CFA candidate or as you progress through your professional career as an asset manager.

Frankie Goes to the CFA

If I were to tell you that now is the time to really start taking advantage of the opportunity to reach out to the CFA network or to develop your professional skills, most of you would think me a sadist. At minimum, you’d probably quote a little from Frankie Goes to Hollywood with, “Relax, Don’t do it!”

And you deserve a little rest and relaxation. You’ve been through a third of one of the most difficult professional designations and you’re probably feeling a bit more than tired.

Take a couple of weeks to reconnect with friends and family. Maybe even take an actual vacation (unless you spent your vacation time on an awesome CFA study vacation).

Then get back to work…and don’t take a few months to do it! Taking advantage of the next six months can make the difference between having a good career and having a great career.

First, you’ve got about six months before the rest of your CFA candidate peers even start thinking about their next exam. The industry is an extremely competitive one and you need to set yourself up as something different, a true asset to your employer. Unless you’re a genius or have some kind of natural gift, the way you do this is by working just a little harder than the next guy.

The second reason you need to take advantage of the post-exam lull in your responsibilities is to get into the frame of mind as a real professional. If you’ve got a full-time job then you probably realize this already but many people take summer breaks or other extended-time vacations for granted. Real professionals don’t get weeks off around the holiday or months off during the summer. I’m not saying you shouldn’t enjoy your college years or should become a workaholic, but you need to get it in your head that professional development is continuous and never-ending.

How to Use your Next Few Months before the next CFA Season

It doesn’t mean you have to pick up the curriculum to the next level of the CFA exams just yet. Six months of studying is generally all most need for the exams so you can wait until January if you like.

There are other ways you can use this time though, some of which could actually be a lot of fun.

  • Don’t pass up the opportunity to get involved in your local CFA society. Most societies plan monthly or regular social events and offer a great way to start networking for your career.
  • Read through some of the published research from the CFA Research Foundation or even better, submit a research proposal and get your work published.
  • There are more than 200 books listed on the CFA Institute website, many worth continuing education credits. Read through special topics that will give you an insight and advantage over peers, or just read a few for interest.
  • The CFA curriculum is an excellent academic program but it lacks some of the real practical experience you’ll need in the industry. Take a cash flow or valuation modeling course and learn how to put together your own model in excel.

None of these tasks take a seriously long time and can be pretty enjoyable if you put your mind to it. Being a professional doesn’t mean foregoing everything else in life but it does mean putting challenges in front of yourself even outside your normal schedule.

Put together a healthy mix of projects to keep your mind sharp and keep developing your skills.

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

Will the CFA Charter Get Me a Job?

Probably the most pressing question on candidates’ minds during those three years of studying for the CFA exams is, “Will the CFA charter get me a job?” It’s definitely the most common question, in its various forms, I get from readers.

There are a lot of things that being a CFA charterholder will help you to do and the benefits go well beyond landing a job but the question itself is a tricky one. Asked outright whether you will get a job solely based on being a charterholder or having passed one or more of the CFA exams, the answer is obviously in the negative. But if you rephrase the question a little or ask what the CFA can do for you, then I think you’ll find the answer much more positive.

What the CFA will Not Do for You

First, the charter or having passed any of the CFA exams will not guarantee you a job. After all the time and dedication it takes to pass the exams, I think a lot of candidates are disappointed that the charter is not a golden ticket that opens all doors. You have to remember a couple of things, even being a charterholder only means you are one of more than 125,000 others around the globe. Your hard work and dedication sets you apart from many but does not make you unique.

While you and other charterholders know exactly what kind of rigor goes into earning the CFA charter, others may not have the same appreciation. The CFA Institute does a good job of supporting the CFA brand and marketing it to organizations but employers will not stand up in awe over your accomplishment.

So, unfortunately, just being a charterholder is not going to get you a job in analysis or asset management.

What the CFA will Do for You

Holding the CFA charter or having passed the exams will help your job prospects. Given two candidates with relatively similar experience, most employers I’ve talked to have said that they would prefer someone with some study in the CFA curriculum. Many employers have told me that they would even choose a CFA candidate or charterholder over another job candidate with slightly better experience on the basis of what the charter implies.

Holding the charter or being a candidate for the exams opens up a network of comradery as well. Other charterholders are not going to jump through rings of fire to help you but you do share a sense of accomplishment and that counts for something. I would say that I generally trust other charterholders a little more than other analysts and that I feel they are more reliable in their analysis. Of course, all this is my own opinion and I’m probably a little biased as a charterholder.

Let’s not overlook the most important aspect of being a CFA charterholder, affirming your commitment to being a better professional. Putting more than a thousand hours into earning a professional designation is no small accomplishment and is a decision that needs to be based on more than just, “Will it get me a job quick.” Spending half that time networking would land you several job offers so pursuing the CFA charter means more than just the job prospects it brings.

Wondering the value of all those hours spent studying is a legitimate concern and a necessary question before you begin studying for the CFA exams. There are a lot of benefits, both tangible and intangible, but it is not for everyone. Do you need the CFA charter to be successful? No. Will the CFA charter guarantee you success? The answer here is also no.

Will the CFA charter help make you a better professional and open up a world of opportunities to your career? Yes, if you put in the time to master the material and use the charter for everything it can offer. After you’ve made the decision to pursue the CFA charter, commit to finishing it. Don’t let doubts and naysayers get you off course. When you’re ready to use the charter to improve your career choices, understand exactly what the charter can help you do and use other resources within your search.

Ask the right questions and do a little networking and I think you’ll find all the answers are very positive.

‘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

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

CFA Level III Essay Practice: Question #4 2011 Exam

Last year’s economics question for the essay portion of the level III CFA exam covered all new material. The material for this year’s test (2012) has not changed much, the requirement to evaluate the sensitivity of equity market value estimates to changes in assumptions has been dropped but you now need to be able to critique the use of the DDM and macroeconomic forecasts to estimate the intrinsic value of the market. The rest of the changes between last year’s and this year’s exams are minor wording changes.

Please download the essay portion of the exam, along with the guideline answers from the CFA Institute website to follow along with the post. We won’t be going over the actual answers here, but how to arrive at them and the important ideas you need to remember from the material.

A lot of the economics material revolves around a few concepts. Understand the Cobb-Douglas production function and how it’s used in equity market valuation. Be able to compare and contrast some of the economic characteristics between emerging and developed markets. Understand and be able to calculate both the Fed and Yardeni models.

Last year’s question #4 was worth a total of 23 points, or about 6.4% of the total exam points. While the topic area isn’t necessarily a make or break part of the exam, getting the concepts down is fairly easy and shouldn’t take much time.

Part A. The Cobb-Douglas is fairly simple and used to estimate a projected annual real GDP growth rate. It describes the relationship between the growth in labor, growth in capital, productivity and the general rate of growth in the economy.

GDP growth = (growth in Total Factor Productivity)+((Output Elasticity of Capital)(Growth in Capital)) +((1- Output Elasticity of Capital)(Growth in Labor Inputs))

Remember that the Output Elasticity of Capital and the Output Elasticity of Labor will equal 1 so if you are only given one of the data points then you must find the other. In contrast to the above formula, you might be given the Output Elasticity of Labor.

* Rather than spending too much time on how the mathematical formula is derived, understand how events and regulations affect the TFP and growth in capital or labor. These may include:

  • Major changes in political or regulatory structures
  • Liberalization in trade or investment
  • Increase or decrease in tax burden on business
  • Depletion or degradation of natural resources
  • Regulations that materially affect immigration or retirement

Part B. When asked how events or regulations affect GDP growth, don’t overthink it. The most direct effect is usually the correct answer, despite any secondary effects that might occur. Question #4b(1) is a good example of this. The guideline answer is that the increase in total fixed costs due to new regulations will lower the country’s GDP trend. I can guarantee though that some candidates missed the question by saying no change and citing the ‘long-term’ effects of improved productivity through updated machinery (as referred to in second half of answer provided).

Part C. I avoided the H-model almost entirely through my studying for the level III exam. It looked too complicated and I was hoping that chances were slim that I would see it on the exam. Fortunately, a week before the test I put it on a flash card and committed to learning it. As with most of the complex formulas, try to think through it intuitively and you should be able to pick enough up to make an educated guess on the exam.

Basically, the H-model is taking a basic DDM (initial dividend rate divided by discount rate minus long-term growth) but multiplies in a bonus because of supernormal growth (the difference in rates times half the years plus the long-term growth rate). The second part of the equation is a mathematical attempt at estimating a linear (straight line) decline in growth.

If you’re looking for more practice on the Cobb-Doublas or the H-model and its use in market valuation, you may want to check out the mock exams put out by FinQuiz. (Be ready though, its a tough one!)

Part D. The Fed model describes a relationship between the earnings yield on equities (forward operating earnings divided by price) and the yield on the 10-year treasury note. Though flawed, which will be addressed in the Yardeni model, the research behind the Fed model is really interesting right now given a earnings yield around 7% for equities and a 10-yr note at only 2%!

* What you need to remember about the model is what it says about market valuations, given the comparative yields, and that it is flawed because it ignores the equity risk premium, inflation and earnings growth.

The Yardeni model, actually named for the same guy as the Fed model, tries to fix some of the flaws in the prior model. It uses the Moody’s A-rated bond to account for risk in equities (though this is default risk, not equity risk) and the consensus five-year earnings growth forecast for the S&P500. As with the Fed model, be able to state what the model says about the current market valuation and compare it to other valuation models listed in the economics section.

Again, the economics material is not usually given a large weighting on the exam but most of the stuff is fairly conceptual or easily calculable. It is not a topic area in which you will need to focus, like individual asset management, but you should go over it a few times to pick up those easy points.

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

Juggling Family and a Social Live with the CFA Exams

I was always impressed by fellow CFA candidates managing to study for the exams while also making time for their families. I worked throughout the three years, but was only married just after the level II exam. I didn’t have to face disappointed children each weekend when I would retreat to my office to study.

Then again, I was also a little jealous of the candidates still in college that seemingly had all the time in the world to study. The fact is, we all have social lives that are going to be vying for attention during the process. Some people have a greater demand from others (wife & kids), but we all need to find that happy medium.

Two issues are important though, one is being around someone who is going to be supportive of your goals and willing to sacrifice a little for what you need. Finding your ‘soulmate’ and keeping friendships is important, but those true friends or partners are going to be there through the tough times as well. If they expect you to put aside your goals for the sake of a little extra time now, expect to do that for the rest of your life and never achieve what you need.

The other, more important issue, is spending time with those that will support you and will sacrifice a little time for your needs. This doesn’t mean completely neglect them for the next three years while you are studying. Here, you are going to need to make sacrifices as well. Whereas before I was married, I could study for the exam any time of day, during the level III exam I rearranged my study hours to late night or early mornings on the weekend. Waking up at 7am on Saturday is no fun, but it can get you a couple of extra hours. You may also try starting the curriculum earlier in the year. Starting a couple of months earlier lets you spread your time out to maybe 5-10 hours per week instead of cramming everything into the last few months.

As I’ve recommended in a prior post, encouraging the family to get involved in their own extracurricular activities can grab another few hours of study time per week as well. You may also need to study somewhere other than home. A wife or friends can understand if you need a little quiet time to study, kids won’t. Little Johnny will understand that mommy is at work, but may not understand if she is at home but cannot play right now.

The old cliché of ‘quality’ time is important here. Just as spending time interacting with your friends and family in a meaningful way justifies fewer total hours with them, you need to be focusing your study time in a meaningful way. I know the ‘purist’ route is to rely on the official curriculum but, in my experience, it is just too long. I could work through study guides at least twice in the amount of time it usually took to get through the curriculum books. That, combined with the fact that the curriculum is extremely dry (academic) at points, and I never made it entirely through the curriculum books for any of the three levels.

Studying for the CFA exams does not mean the end of your social world. Even the most committed candidate probably doesn’t need more than about 15 hours a week studying. Juggling a social life and the CFA might be a little harder for some, but it just means keeping a strict schedule and using the best resources possible.

Wednesday, we’ll cover the capital market/portfolio management section of the level II and look at the economics essay question in last year’s level III exam. ‘til then, happy studyin’.
Joseph Hogue, CFA

Level III CFA Exam: essay question #3 2009

Question three on the 2009 Level III exam was worth 24 points, or almost 7% of the total exam points available. Combined with question #4, another on institutional portfolio management worth 11 points, the material on institutional pm was worth close to a tenth of the exam.

This post will complete the series of six blog posts, reviewing the last three years’ individual and institutional essay questions. Please download the exams and guideline answers from the CFA Institute and go over these questions again before June. The first two questions, always individual and institutional portfolio management, are usually worth around 15% of your total score and you WILL NOT PASS without good points here.

Question #3 in 2009 was a defined benefit pension vignette about Wirth-Moore company and the Foundation-for-the-Future (FF) foundation. As always, I skimmed through the questions before reading the vignette.

  1. The first question asks for a return objective and REQUIRES calculations. Pay attention whether a question says, “show your calculations,” or not. Return objectives for institutionals are usually pretty easy and come from a few items straight from the vignette. The standard form is: (required distributions or return)*(appropriate inflation rate)*(management expenses). Adding the three numbers will get you points but the multiplicative approach is technically accurate.

Don’t forget to throw in a few qualitative statements as well, usually something like preserving real value of the portfolio. Also, be sure to use the appropriate inflation rate or that which is most directly related to spending. The traditional example is healthcare or educational inflation being higher than general consumer inflation.

  1. We’ve covered ability and willingness to tolerate risk quite a bit in other posts. Ability is usually tied to some quantitative measure like how high is spending relative to total portfolio assets? Willingness for risk almost always comes out of qualitative statements made in the vignette or by the participants like desiring a high return or previous experience with loss.

Foundations usually have a greater ability for risk because they are not contractually obligated to make payments as are banks/insurance/pensions, nor does the charitable cause depend on them for spending needs like endowments.

  1. Liquidity needs for an institution are all contributions minus spending needs for the year. Since foundations have a certain percentage they must spend to avoid taxes, this is usually the spending needs plus management fees.

Time horizons for institutionals are almost always single stage, long-term if they are to remain a going concern. Look for clues in the vignette for whether the company will stay in business or may close.

  1. The smoothing rules are fairly important but you really only need to know a few things. Understand how to calculate the geometric and the rolling three-year rules.  Understand the order in which each is when it comes to volatility of spending (single-year most volatile) and that using a smoothing rule increases the institution’s tolerance for risk because of the lowered volatility.
  2. Part E is a little harder here only because you have to get all your info from the vignette rather than using a few rules-of-thumb concepts. Look to the quantitative information for quick clues (i.e. the five-year lockup on funds and the $2.5 million minimum).

After reading through the questions, you are ready to read the case and make notes when something looks relevant or important. For pensions, you always want to look for the proportion of active to retired lives and whether the payments are inflation-adjusted. Fewer active workers will mean lower risk tolerance and adjusting payments for inflation will mean you need some equities or TIPS in the portfolio to hedge price increases. The financial health of the company and cyclical correlation between company/pension assets is usually important as well.

***Watch for contradictory or changing information in the follow-up questions. I got a question last week on one of the individual pm essay questions. The guideline answer did not make sense from data provided initially in the case. What the candidate did not see was the information update just before the question. Notice that on many of the questions, there is a small paragraph of additional information (i.e. just before questions D and E on page 16 of the exam). Use this information for the question, even if some of it contradicts or changes data previously written in the vignette.

For the rest of the level III posts until June, we’ll cover a few of the other essay questions from the last three years’ exams. Let me know if there is any particular question you are having trouble with and I’ll try to cover it.

Thanks and happy studyin’
Joseph Hogue, CFA

Formulas on the CFA Exam: Which do I REALLY need?

This is something that all candidates come up against, especially while studying for the Level II CFA exam which is extremely formula-intense. Whether there are in fact ‘unnecessary’ formulas or not, the temptation is strong to ‘game’ the exam and only focus on the stuff with higher odds of showing up in questions.

The short answer is DON’T DO IT! The curriculum states in the front of the books that, “every question on the CFA examination is based on a specific page in the required readings and on one or more LOS. Frequently, an examination question is also tied to a specific example highlighted within a reading or to a specific end of reading question and its solution.”

Though, it appears that the exams focus strongly on actual LOS the above paragraph leads me to believe that anything in the readings is possible exam questions. Further, though an LOS may not explicitly require calculating something it might be implicitly necessary to arrive at a decision or to understand the LOS. With around 50% of candidates failing each exam in any given year, you need all the points you can get and can’t afford to miss from guessing wrong at which formulas might show up. The time spent studying to earn your CFA designation is miniscule relative to the big picture. Spend the time necessary to learn this material, no matter how long it takes and be a stronger professional for having done it.

The long answer, of course, is more complicated. The fact is, unless you’re one of those quant geeks that I secretly envy but openly deride, you are not going to be able to memorize all the formulas in the curriculum. There is an element of gaming the exam in that you have to spend the time on the topics and formulas that you will be able to pick up and less time on those where time is less well-spent.

There are really two issues here. One, some formulas within the curriculum don’t seem to be a focus or are not explicitly mentioned in any learning outcome statements (LOS). With so much material, why would you spend time on stuff with a lower probability of being tested? Secondly, some of the formulas are extremely intense and difficult, and the range of material is extensive. It is tempting to skip material that is more difficult.

The problem with the first issue is that, despite what you may hear from other candidates or through rumors, since we can’t talk about questions on the exams you really can’t know what will be on the test or not. I would play it conservative and say that ANYTHING written in the curriculum is testable despite not being explicitly mentioned in an LOS.

The problem with the second issue is that, after dismissing a topic or formula, it becomes extremely tempting to dismiss others. Before you know it, you are only reading half of the topic areas and neglecting a large section of the curriculum. Try looking for help on internet forums or from other candidates that have tackled the formula. Check out some of the study notes or summary sheets that might be able to explain it a different way.

I ran into this myself on the level II exam. After several hours on swaptions pricing and valuation, I still was not confident that I could replicate the procedure on the exam. I could have spent a few more hours on the topic, but chose to spend the time on other areas. I got the general concept down so I might be able to make an educated guess on the test, then moved on to other topics.

Before totally dismissing a formula, at least try to get the concept of what is happening. One, this will most likely make it easier to memorize the formula since its not just rote learning. Second, you may be able to make a better educated guess on the exam.

The best advice I can offer is that which you’ve already heard. Focus on end of chapter questions and blue-box examples. These should give you plenty on which to concentrate. Work your practice exams and make sure you have at least 70% or higher in all topic areas. Will you see every formula on the exam, no. Do you need to be able to answer every formula that even makes it to the tests, no. You need to get 70% or better on the exam and you need to spend your time getting the most information learned as possible. If this involves just getting the general idea on some material to be able to quickly move on to other areas, then so be it.  

All for today. ‘til next time, happy studyin’
Joseph Hogue, CFA

CFA Level III Essay Practice: 2009 Question #1

Question #1 was, as always, an individual portfolio management question. In 2009 it was worth 26 points, or about 7.2% of your total exam points. Download the exam and guideline answers from the CFA Institute to follow along with the discussion.

We’ve covered the individual and institutional portfolio management essay questions in the 2011 and 2010 Level III exams already. See prior posts for practice and a general strategy.

Skimming over the questions, I know that I need to look for:

Ai. Don’t forget to explicitly write out a return objective! Look for copy/paste stuff from the vignette like estate gifts, funding expenses and preserving capital after inflation, and any special inflows/outflows mentioned. The objective is anything the investor wants or needs to do with their money. When I took the exam, I did this one after the return calculation so I could also put in the relevant figures (i.e. total assets, return % needed, expenses, etc.), it’s not always required in the guideline answer but it can’t hurt.

Aii. A few clues should jump out in the question, ‘pre-tax nominal’ and ‘first year’. Pre-tax means you are going to need to gross up the net income needed for taxes. The tax rate is always given so just divide income needs by (1-tax rate).

‘First year’ signals one of two questions you will definitely be getting on the exam, a one-year return needed for retirement. The other question is the multi-year return needed for retirement in the future and one where you will use your calculator (covered in previous essay posts).

Do Not Forget to Show Your Calculations!! Don’t throw away easy partial credit! Even if you miss the final answer, you will still get some points for having: Cash Inflows, Outflows (expenses), Investable Assets (minus debt payoff), Return Calculation (with inflation). Of the twelve points available for Part A, I would guess about 3 points are for the return objective and nine are for the return calculation (but only 3-5 are for the correct final answer, meaning you may still get 4-6 points even with a wrong return).

Practice setting your calculations up exactly as they are shown in the guideline answer, with headings and format.

Bi. Ability to take risk is usually going to be more quantitative information. What is proportion of expenses to total assets? (Around 5% or less will be higher tolerance).  Will they have any other funds besides investments? How important are planned spending needs? (They don’t necessarily NEED that vacation home in Malibu, so higher tolerance). Is retirement within a couple of years?

Bii. Willingness to take risk is usually explicit statements by the participants in the vignette. Look for past experiences that might make them fearful of losses, conservative or risk-taking behavior, attitude toward loss.

Ci. Liquidity constraints are debt and/or expenses stated in the vignette. The typical needs are paying off home-mortgage and paying for children’s tuition.

Di. Always talk of time horizon in ‘stages’ separated by significant life and spending events. Events that usually delineate stages are: working career (accumulation), paying for tuition, and retirement. Always list out the relevant time in years for each stage as shown in guideline answer (retirement is usually set at 25 or more years, we don’t need to put an explicit time on their death).

We’ve now covered the last three years essay questions for individual portfolio management. I would recommend working through them one more time along with making sure you understand the key concepts for the topic area. This first question on the exam can be EASY POINTS! The range of questions is fairly limited to return objective statements, calculating returns, and describing risk tolerance and constraints. There may be some tax or wealth transfer stuff thrown in for good measure, but you should be able to pick up some good points here. BE READY!

Please let me know if you have any questions. This is important stuff and can be some seriously easy points! ‘til next time, happy studyin’

Joseph Hogue, CFA

Using that Last Week Before the Exam

There are all kind of exam strategies floating around the web. Some are great, others not so much. As I’ve recommended in other posts, it’s usually more about what you feel comfortable with doing and what fits well with your learning style.

One recommendation I always ignored was to not do any studying the week before the exam. This one has different time periods associated (i.e. don’t study… the day before, the morning of, the whole week before, etc). While I usually took the day before the exam off, Friday was usually my day off anyway, I always hit the rest of the week before the exam extremely hard.

The last week before the exam was my ‘superman’ week. I would take the week off from work and go to my fortress of solitude each day for about 8-10 hours of studying. The CFA curriculum and test is your ‘job’ for that week and you should treat it as such. DO NOT STAY HOME! You really need to go a place where you will not be distracted and can concentrate for the full day. The library is the obvious choice if you can keep from people watching or taking time out to read the magazines.

I would start each day with a 3-hour exam using the topic weights. This would help to see in which topics I needed more studying. Within those areas where I was scoring around 80% or above, I would probably just review the topic summaries or review my flash cards quickly.

The rest of the day, I was focusing on those topic areas or specific points where I was not scoring as high.

My goal for the week was not necessarily to review the entire curriculum. You need to understand what parts of the curriculum are giving you trouble. Within each ‘problem’ topic, is it formulas or general concepts? Is it the amount of information or the depth?

My problem areas were usually the detailed formulas, especially within derivatives and fixed-income. I would review the material quickly if I felt there were any concepts I was missing, but most of the time I just needed to get the process for the calculations. Writing and reviewing detailed flash cards for the topic or formula always helped, so I would spend a couple hours on that. I would usually spend another 45 minutes going through question bank problems as well, reviewing the solutions to those I missed.

If I didn’t score better in the topic area the next day, or made the same mistakes, then I had to make the decision to hit the topic some more or write it off as ‘concept’ points. This is a tricky subject and we’ll go over it in another post. There are some areas or formulas where you are just not going to grasp even with a great deal of studying. For me it was swaptions and some of the other detailed derivative calculations. It may not make sense to spend three times the amount of study time on something that may or may not be worth a few points on the exam. For these areas, I made sure to understand the concept and enough of the calculation to make an educated guess among three choices.

Some will say that spending the week before the exam studying, or spending so much time studying, will lead to burnout before the exam. I always found that taking Friday off was more than enough time to relax and avoid burnout. I can understand the burnout fear but also realize that the time you are studying for the CFA exams is a miniscule period over your entire career. I think a lot of people ‘blame’ burnout for a simple lack of determination and heart. So you’re tired, so what, there will be plenty of time to relax after the exam.

That last week of studying always reminded me of the Crucible in Marine Corps recruit training, a 54-hour culmination of the three-month boot camp. Over the 2+ days, recruits push through sleep deprivation, hunger and over 40 miles of forced march before they earn the right to the title, United States Marine. That last week of studying is going to be hard, it will tax you mentally, but it will also get you those final points necessary and prepare you for the exam. Don’t pass up this opportunity to earn your CFA charter.

Good luck, and happy studyin’

Joseph Hogue, CFA

Will the CFA Charter Get Me a Job???

This is probably the question I see most often from candidates. The CFA exams can be extremely demanding and candidates want to know that their efforts will be rewarded.

There are two problems with the question though. First, it always seems to get asked most in the months leading up to the exam. It isn’t a legitimate question as much as it is fear of failure trying to give you a reason to give up, something I addressed in detail in a prior post. Ask yourself if you are dedicated enough for the exams before you begin level 1 (and at latest maybe before level 2 now that you know what you are up against), then stick to your decision.

Before I address the second problem with the question, we’ll cut to the answer. For those of you looking for a silver bullet in landing a job, the CFA designation alone will not get you a job. But then there are few things, when considered alone, that will get you that offer letter (short of marrying the boss’ daughter).  Even those with advanced degrees are looking at a 3.3% unemployment rate. You still need to use a comprehensive strategy to get that job (networking, education, experience). Will the CFA designation help to land an interview, yes! Will the designation help you stand out in a foot-deep stack of resumes, yes! Will it help you understand the industry/investment management so you can rock out on your interview, definitely!

Now that we know that it is a trick question, the second problem is that it really doesn’t matter. The designation isn’t about just getting a job. It is about making you the best (analyst, portfolio manager, advisor, etc) and being able to compete in an industry where people bite and claw for 50 basis points above the benchmark. If you are just looking for a ‘job’, there are easier ways than spending upwards of 1200 hours studying over 3+ years for just three little letters after your name.

If you are looking for a way to become a world-class professional in the field of asset management and analysis, then the Chartered Financial Analyst curriculum is second to none. *I was going to end that sentence with, “then stop asking stupid questions and get to studying,” but thought I would be nice for a change.

I could wrap this up with all kinds of clichés or analogies like, “the road less traveled,” but I’ll spare both of us. The golden gates will not open up on the day you get your charter nor will Bill Gross call and welcome you to the club, begging you to work for PIMCO. The charter is about placing a premium on your expertise and the value you can bring to your clients and employer, so in that respect…yeah maybe it will get you a job.

‘til next time. Happy studyin’
Joseph Hogue, CFA

P.S. Bill, call me!

2010 CFA Level 3 Exam Essay Question #1

The individual and institutional questions for the level 3 CFA exam in 2010 were worth almost a quarter of the entire test! The first question, individual portfolio management, was worth about 19.4% of the essay portion while the institutional question was worth 27.2% (along with behavioral).

This is not far from the historical averages for these questions. You will get massive points on the exam if you master these two topic areas of the curriculum! We are covering some of the last three years’ essay questions here, but you need to go to the Institute’s website and download the exams to work them on your own.

Question 1 has five parts (A,B,C,D,E) for a total of 35 minutes.

You know the first two questions will be individual and institutional problems and will be fairly intense. In 2010, they totaled 84 points/minutes (that is more than an hour of intense CFA exam fun, so be ready!).

Again, I skim through the questions quickly to see what I need. For this one, we can see that we need:

  • A- Liquidity and Time constraints
  • B- Return objective and calculate the required annual pretax nominal rate SHOW YOUR CALCULATIONS!
  • C- Two factors that increase ABILITY to take risk for each person
  • D- Determine which has greater willingness to take risk with one reason
  • E- How much of bonds/equities to sell or buy for tax efficiency

We won’t go over the general advice here (like paying attention to where you write your answers) so you need to check the other blog posts for the level 3 exam and the other essay questions.

This gives us a great idea of what we are looking for in the vignette.

  • Liquidity constraints are almost always <1yr spending needs and planned debt/giving
  • Time constraints are going to be the time horizon for any large outlays or life events (college, retirement, etc)
  • MAKE SURE YOU WRITE A RETURN OBJECTIVE! This is an explicit statement of need and usually is cut and paste from vignette. You already know some of it from the next part of the question!! “earn a pretax nominal rate to retire in 25 years”
  • Remember, pretax and nominal! Add inflation to your return needs and watch for tax information.
  • Ability to take risk is usually things like: proportion of spending needs to assets, time horizon, importance of spending needs. You only need two for each person
  • Willingness for risk is almost always explicit statements in the vignette. Things like, “I am comfortable living on less,” or “I would be really stressed if we lost any principal.” You only need one.

Now, as you are reading through the vignette you can highlight/underline any relevant information as you come to it.

A- We see that Lima wants to pay education costs in one year (large cash outlay so liquidity needs). For time constraints, always explicitly state whether it is single- or multi-stage and approximate years in each and long- or short-term.  (last stage usually in retirement and just written as >25 years)

B-  Objective is usually something like, “grow investments to (specific objectives like protect purchasing power in retirement and leave amount to charity)” plus any relevant numerical info like how much spending is needed on how large of an asset base.

  1. a.       ** This is one of two types of return problems you will get. You must know both. Show all steps of calculation (as shown in guideline answer). Even if you mess up the final calculation, you will still get some credit for your work along the way. Remember: Current investable assets, cashflows, expenses & debt repayment
  2. b.      These long-term required return calculations can be done on your calculator with the appropriate (PV), (FV), etc written on test as shown. **FOR ALL ESSAY QUESTIONS, circle and/or double underline your final answer. Make it easy for the grader to find your answer!

C- The guideline answers show four possible answers, you only need two. Factors that are going to INCREASE ability to take risk are: longer time horizon, low % of spending needs to assets, flexibility in spending needs, importance of spending needs, amount of debt

D- Factors that INCREASE willingness to take risk are usually explicit statements in vignette showing confidence or fear of investor.

E-  Past essay exams have included questions like these that often hinge on taxes paid now or later and possible tax law changes. The tax section is fairly quantitatively intense but it seems like the exam tests the concepts in tax management rather than the more intense calculations. Make sure you understand the basic ideas behind deferment, taxable/non-taxable accounts, and the different types of taxes.

Other than part E, the question was fairly easy if you understand the IPS and can do basic return calculations.  You need to work through the last three years’ individual and institutional essay questions at least twice before the actual exam. Doing this will not only help you to learn the material but will boost your confidence through the first (and most important) points on the exam.

‘til next time, let me know if you have any questions.  Happy studyin’
Joseph Hogue, CFA

CFA Level 2 – Balance Sheet and Cash Flow Statement Accruals

While most of the level 2 Financial Reporting Analysis is quantitatively intense, there are a couple of sections that are more conceptual and include only basic formulas. Even the formulas within the material can be remembered through a basic understanding of the cash flow statement or balance sheet.

The Learning Outcome Statements and curriculum for evaluating financial reporting quality are fairly easy points if you get down the general concepts and remember a few relationships. In the 2012 curriculum, these are LOS 25a-26f and are available here.

The readings revolve around manipulation of earnings, where to look for it and how to measure quality of earnings. The income statement lends itself to management manipulation in quite a few areas so most of the reading focuses on the statement.

** You need a solid base of understanding in the Financial Statements** If you cannot reconstruct the basic framework for the balance sheet, income statement and cash flows and understand what everything is and where it comes from, time would be VERY well spent by reviewing this material. You are going to need it throughout the level 2 and into the level 3 exam as well (besides most likely in your job).

Discretion in Accrual Basis Accounting

Remember that the accrual basis of accounting more accurately reflects the company’s financial performance because revenues and expenses are more closely matched. The disadvantage, relative to cash basis accounting, is that accrual basis lends itself to management discretion in matching and possibly manipulation of earnings.

For the income statement, understand management discretion in the line items: EBITDA, Operating Income, EBIT, Income from continuing, Income before extraordinary, and Net Income

While the curriculum reminds candidates to check Management’s MD&A and footnotes for a number of issues, you are never really shown how to do this. For the exam, your really only need to know that a lot of information can be buried here and that you should look it over skeptically.

Some areas where discretion in reporting may lead to manipulation:

  • Revenue recognition: sales can be booked too early, too late, or smoothed over a period to change the company’s revenue picture
  • Expenses: accounting for costs in the current period or over time by capitalizing expenses
  • Depreciation: management selects the method of calculating depreciation as well as the useful life of the assets
  • Inventory: the determination of cost flow assumption (LIFO, FIFO, or weighted average) is a big part of the curriculum here and elsewhere
  • Classifying events as continuing operations, non-recurring, or extraordinary
  • Calculation and impairment of goodwill and other intangibles
  • Assumptions in post-retirement benefit accounting

Management Incentives to Cheat

This section covers basic reasons management might want to manipulate earnings and what companies do to avoid the problem. Again, just high-level conceptual stuff and fairly intuitive.

There is pressure on management to meet or beat expectations set by the market. Management will try to speed up revenue recognition or delay expenses if it looks like results will come in below expectations. Conversely, management may actually slow down revenue recognition or pay for future expenses in order to smooth earnings into upcoming quarters.

The curriculum talks about contract-based incentives in a few different places. While tying management compensation to performance is a good way to promote shareholder interests, it can also lead to earnings manipulation as management looks to make their bonus or an options payout. Covenants in debt instruments can also incentivize earnings manipulation to avoid default or rate adjustments.

Mechanisms to avoid earnings manipulation revolve mostly around outside supervision like corporate governance, external audits, and regulation. General market oversight by analysts is also mentioned as a balance to keep management from manipulating statements.

Balance-sheet and Cash-flow based Aggregate Accruals

The only quantitatively-based material in the section is the calculation of aggregate accruals and the net operating assets. The calculation and concept has a few steps and lends itself well to an item-set question. Aggregate accruals are used to measure the ‘discretionary’ component of earnings apart from cash earnings. Aggregate accruals are basically the current period’s change in non-cash balance sheet items. It excludes cash and debt because these accounts are subject to less manipulation.

The curriculum shows two ways to calculate aggregate accruals and net operating assets, through the balance-sheet and through the statement of cash flows.

Balance-Sheet Method

Aggregate Accruals = NOAt – NOA t-1
Where Net Operating Assets (NOA) =
(Total Assets – Cash) – (Total Liabilities – Total Debt)

The absolute measure of aggregate accruals, compared to previous periods, is used to measure the company’s earnings quality and to forecast possible reversion of earnings. If management is increasing the amount of overall earnings, not by actual cash earnings, but by accrual accounting manipulation then the possibility of a reduction in earnings or earnings growth is high. Conversely, a company with low or declining aggregate accruals should have more persistent earnings and higher quality.

The accrual ratio is used to compare companies of different sizes. This is just the aggregate accruals divided by the average net operating assets between the balance sheet periods. **Remember, since the balance sheet is a snapshot in time you need to take the average between current and last period for many of your ratios.

Accruals Ratio = (NOAt – NOA t-1)/ ((NOAt + NOA t-1)/2)

This ratio can then be compared across companies for a relative analysis of earnings quality.

Statement of Cash Flows Method

A preferred measure of aggregate accruals is found using the Statement of Cash Flows. The measure is found by reducing Net Income, which is highly susceptible to manipulation, by cash flows from operations and investing.

Aggregate Accruals = Nit – (CFOt + CFIt)

Again, the measurement can be standardized by taking the average net operating assets for the period to compare across companies.

Accruals Ratio = Nit – (CFOt + CFIt)/ (NOAt + NOA t-1)/2

The two measures of aggregate accruals will generally not give you the same result but will usually yield the same directional theme on earnings. The difference comes from noncash transactions and classification differences in accounts.

I have applied this measure of earnings quality in a recent post on the website Seeking Alpha. Click here to see the example of the calculation performed on the financial statements of Johnson & Johnson and several consumer staples companies.

Next week, we’ll look at the advantages and disadvantages of valuation multiples and some of the key takeaways you need for the level 2 CFA exam.

Happy Studyin’
Joseph Hogue, CFA

Last updated: December 22, 2016 at 7:58 am

How to Use Mock and Practice Exams to Pass the CFA Exams

With about nine weeks until the exam, you need to start incorporating mock exams into your study plans.

There may be a confusion in semantics here, I use the term ‘practice exam’ to mean a graded test over more than one topic area but not necessarily over all topics or for the six-hour exam format. ‘Mock’ exams, however, are graded tests that incorporate all topic areas at the CFA Institute area weightings and with the full six-hour time window. The difference in definitions may be minimal, but it’s important.

You should be using practice exams throughout your studying to gauge your retention of the material. Mock exams are particularly important for two reasons:

  • Getting used to sitting down for six-hours and putting your brain through some tough mental gymnastics. Don’t underestimate this. Fatigue can be a big problem with the exams and I have heard candidates say that by the last couple of hours, they were just writing in anything to get it over.
  • Mock exams will help you follow your progress through each topic area, refining your study in each topic where you are weak. The level 1 and 2 CFA exams have clearly defined topic weights with some areas clearly the focus of the exams.

Six Times a Charm

About nine weeks out from the exam, I would clear my dance schedule for Saturdays from 9am-4pm. Each Saturday I would take my laptop to the library and complete a mock exam using a question bank. After the exam was done, the scores for overall and within each topic area went into a spreadsheet to track my progress week to week.

Going to a quiet (non-home) location and completing the mock exam is important for another reason, state-dependent learning. This is a peculiar little trick your brain plays. State-dependent learning is a concept where you are better able to recall information when placed in similar situations in which you learned the info. We won’t go into all the biology, but you should study and practice in a similar environment where you will be taking the test. This means no more curling up in bed with the curriculum while the tv hums in the background.

I usually ended up taking at least six of these mock exams. As each progressed, I could build a confidence band around the estimate for my percentage in each topic area. While you may struggle on a particular exam and see your percentage fall in a topic, your averaged scores will be more accurate and reliable (gotta love that Quant Methods section). We know that no candidate with a score of 70% has ever failed the exam, so you should be aiming for something above this. I would aim for +80% in the core topics for the level 1 or 2 exams (Ethics, FRA, Equity, Fixed Income) while looking for at least 70-75% in the other topics. If my average in any topic fell below that target any given week, I would review it the next week.

This is in addition to other studying I would be doing these last couple of months. Flash-cards, talked about in last Friday’s post, are a great way to quickly work through the material and review. With the time left, you may not be able to work through the official curriculum but might be able to make another pass through condensed study guides or summaries.

Coming down to the wire, you really need to fine-tune your program to make sure you get max points on the exam.  This week, we’ll look at measures of earnings quality (level 2) and the IPS (level 2 and 3).

‘Til next time. Happy studyin’

Joe Hogue, CFA

Flash Cards- buy or build

With just a little over two months left to the exam, you need to focus on study methods that are going to hone in on the learning outcome statements and the topics in which you are struggling. Of the products available, flash cards were one of the most useful to me during the last months of study.

Let’s compare the ways to study:

  • Videos- Great for visual and kinesthetic learners, and a relatively quick way to get through the curriculum in a different medium but is inefficient passive learning
  • Study Groups- Good use of active learning and can provide a good support system, but can be slow and misinformation is possibility
  • Reading curriculum- Straight from the horse’s mouth, EVERYTHING on the exams will be here but the books may be better for building muscles than building exam scores
  • Reading 3rd party condensed study notes– My core mode of study. I went through condensed notes at least three times at each level but these are also passive learning so you need to supplement with active learning
  • Practice problems & mock exams– Second most useful method of studying for me. You need to read through curriculum/study notes to get a feel for the material but only practice problems and question banks will work it into your head and convert to long-term memory
  • Flash cards- These are really an extension of practice problems but are more portable and more easily focused

I used each of these, except study groups, for each level of the CFA exams (at least try a study group if you can find one in your area). Each method has its strengths and weaknesses and is most appropriate for the ‘stage’ within which you are studying. By stage, I mean either just getting into the material, reviewing, practicing, or wrapping up for test day. By now, you should be thinking about how you are going to wrap up your studying and carry it through to the exam date.

Flash cards are the most appropriate for focusing in on those last remaining areas in which you are having trouble or keeping those important formulas and processes fresh in your mind.

You can easily buy or borrow cards off the internet. Most providers sell sets for around $125-$175 or someone in your social network probably has some you could copy. The best way, though, is to make your own cards. It may take a little longer, but they will be customized for your learning and will provide the opportunity to write out the material.

When I made flash cards, I didn’t write out every LOS. You could, but I think it’s a waste of time for the easy and general stuff that you already know. Around this time every year, I skimmed through my curriculum notes again. Skimmed doesn’t mean read but it should take around a day for each study session. That way you get through the material in a month. While I worked through the material, I wrote out flash cards for:

  • Intense formulas or calculations that I wouldn’t easily remember
  • Important lists or procedures
  • Anything else that was just not sticking in my brain!

Your cards should have detailed practice problems for the formulas and calculation questions. Write out a short story problem on one side with necessary data or copy one of the harder problems directly from the curriculum. Don’t just write out a list of the data needed like: N= 30, i= .1, pv=100, find Fv

I’ll qualify this by saying that by this time in the year, I had been through the material at least four times (once through videos, once through the curriculum, and twice through study notes) so I had a good idea of where I needed to focus and what sections were giving me problems. If you have not yet been through the material at least twice, it may still be tough to skim through it and pick out the parts on which you need to focus.

After putting together your cards, try to get through them every two days. I usually had enough cards that it took from 1.5-3 hours to work through all of them. Don’t neglect your other forms of studying. Depending on how long it takes to get through your cards, spend some time reviewing your study notes, practice tests, and other methods as well. After you work through the cards a few times, you will be able to pass over some that have become easier and may want to add a few other cards in difficult topics.

It really comes down to practice and how many different ways you can hit the curriculum. Reading through the curriculum two or three times will not yield the results as working through it the same number of times but through different media (reading, practice problems, videos, etc.).

All for today. Looking forward to your comments. Don’t forget to let me know if there are topics that you would like to see covered in the blog. ‘Til next time, happy studying!

Joseph Hogue, CFA

Financial Reporting and Analysis: Post-Retirement Benefit Plans

Unfortunately, the limited time we have won’t allow us to go over everything you need to know within the topic areas of the Level 2 CFA exam. I will try to hit some of the more difficult areas and focus in on some of the stuff you need to know.

To me, the level 2 exam seemed extremely detailed and was quantitatively intense. This sucks when you are trying to cram everything into your brain for a six-hour test, but the curriculum has proved an excellent resource since the exam. Save your level 2 books or study notes, they will come in handy if you do any equity analysis. With the size and complexity of the material at level 2, I would suggest a condensed study notes provider to help work through the questions and formulas. (Obviously, we’re biased to FinQuiz here. Check out the free sample notes on the website.)

Pensions and pension reporting is a big section in the level 2 exam. Learn the differences between defined-benefit (DB)/defined-contribution (DC) in level 2 because you will need it for level 3 as well. Most of the curriculum deals with DB plans because the responsibility for assets remains with the corporation. You really only need to know the basic idea for DC plans.

For pension reporting at level 2 you need to understand and be able to calculate:

  • PBO
  • Pension Expense
  • Economic Expense
  • Reconciliation of Defined Benefit Obligation and Assets
  • Determine if the plan is Over/Under-funded
  • Impact of assumptions: discount rate, expected return of assets, growth rate of compensation

Start with pensions by understanding the three measures of plan liability: projected benefit obligation (PBO), accumulated benefit obligation (ABO), and vested benefit obligation (VBO). The PBO is the present value of nested and non-vested benefits based on projected salaries and what you will use for most calculations.

The ABO is the benefit obligation at current salaries while the VBO is only the obligations for vested employees and at current salaries. Understand these two measures, but focus on PBO.

There are (5) five components of Pension Expense. You need to understand each of these and be able to calculate pension expense for the current period.

Current Service Cost
+ Interest Costs
– Expected Return on Plan Assets
+/- Amortization Past Service Cost or Benefit
+/- Amortization of Actuarial Losses or Gains
= Pension Expense

Reconciliation of Plan Assets is pretty straight forward and just adds the actual returns on assets and employer contributions to the beginning fair value of assets, then deducts any benefits paid to arrive at the end-of-period fair value of assets.

Reconciliation of Defined Benefit Obligation (disclosed in the footnotes):
DBO, beginning
+ Service Costs
+ Interest Costs
+ Past Service Costs (from Changing Amendments)
+/- Actuarial Losses or Gains
– Benefits Paid
= DBO, end

Differences between IFRS and GAAP is pretty important at level 2 and you’ll see a lot of stuff here in pensions. In the curriculum, the calculation stuff seemed to center around GAAP treatment while you were only expected to know the reporting differences between GAAP and IFRS.

Assumptions:

Discount Rate- Used to determine the DBO (increases in discount rate–> decrease in DBO and increase plan funded status)

Expected Return on Plan Assets– Understand how manipulation of this can lead to manipulation in earnings (increasing expected return–> decreases pension expense on income statement and increases reported earnings)

Compensation Growth Rate- Affects service costs and pension obligation (increase compensation growth –> increases both service costs and pension obligation)

Really the key to the level 2 exam is practice problems. There is so much material and so many formulas that you cannot just expect to memorize them with flash cards or reading.  I hated pension material and really put off doing practice problems until the last couple of weeks. It seems like you are being asked to be an accountant, but this stuff is important to analyzing the future responsibilities of companies.

The best way to approach the FRA material and calculations in level 2 is to first UNDERSTAND what is happening and the relationships. Why would a company want to increase/decrease the expected return assumed? How would this change the income statement and balance sheet? Unless you are some kind of savant, trying to memorize the formulas is a ticket to the bottom 50%. Understanding the ‘why’ will help to make sense out of the calculations.

The fortunate part here, and with a lot of the detailed FRA material on the CFA level 2, is that it will truly make you a better analyst. I’ve seen a lot of equity research that doesn’t begin to scratch the surface of the Financial Reporting & Analysis covered in the level 2 curriculum. Dig into this stuff and you will add value for your employer and your clients.

Looking forward to your comments,
Joseph Hogue, CFA

P.S. be sure to let me know if there is a particular topic area you want covered. Thanks.

Question #3 2011 CFA Level III

You will always have an institutional portfolio management question in the essay portion. Last year’s was worth 26 points (14.4% of morning session and 7.2% of total exam points). I found the readings on institutional a little harder than individual portfolio management but not too bad.

Please download the essay and guideline answers from the CFA Institute’s website here.

With institutional investors you have sections on Pension Plans (mostly about defined benefit), foundations, endowments, insurance companies and banks. Each has their special characteristics though there are points of similarities. Banks and Insurance companies are basically about asset-liability matching while foundations and endowments are about spending needs. We’ll leave the specific points of each to your review of the curriculum or study notes and just address last year’s question here.

Last year’s question had five parts, each with a couple of sub-questions. I read the questions quickly to find out the specific data for which I am looking.

Skimming the questions, we see that we need:

  • Return objective- *** Remember, this is an explicit statement of what the investor needs or wants. Just writing out a numerical return percentage won’t cut it. These are easy points, most of the objective will be a cut and paste from within the vignette.
  • Calculate a required return- the instructions say SHOW YOUR CALCULATIONS for a reason. Show all steps to make sure you at least get some partial credit.
  • Factors in Risk Tolerance
  • Liquidity and Time Horizon constraints for the IPS
  • Spending rule affect on goals and funding
  • More risk tolerance factors

Some notes on endowments & foundations:

  • Know the spending rules: volatility/riskiness in funding and why would you choose each
  • Difference between endowments/foundations
  • Factors for risk tolerance (portion of spending budget for endowments, unlimited time horizon)

Part A-

i. Most endowments and foundations, unless explicitly stated in vignette, are going to want to maintain REAL VALUE OF ASSETS. This means they must earn a return high enough to satisfy spending needs and inflation.

ii. The Institute will give you points for a geometric or arithmetic return (but we’re all professionals and can do simple multiplication, so use the geometric return).

Required return is going to be = spending rate * inflation rate * management expenses.
     * remember- the correct inflation rate is that applicable to spending (this case higher education) not necessarily general inflation
     * Know how to calculate your spending rate from the three spending rules

Part B-
Worth six points: one point for circling the correct answers in middle box, two points for ONE REASON stated in third column. ** Remember– graders are only going to look at your first response. Don’t waste your time putting down more than one response.

The guideline answer shows two possible responses, only one was asked for.

– For endowments, generally as funding increases, risk tolerance increases because spending needs are lower proportion of total assets.

– As inflation increases, risk increases as well because it becomes harder to protect REAL VALUE of assets in portfolio and also satisfy spending needs

Part C-
Remember TUTLL, IPS constraints are just as important for institutionals as for individuals

Time- will generally be infinite (perpetuity) unless explicit in case

Unique- usually explicit in case as well (endowments and foundations often have prohibitions against investing in ‘vice’ stocks, so Socially-Responsible Investing)

Taxes- Endowments/Foundations are tax exempt, Banks and Insurance are Taxable

Liquidity- Annual spending needs for Endowment/Foundations, Very important for Banks/Insurance

Legal- UMIFA for Endowments/Foundations, Highly-regulated (usually state) banks/Insurance

Part D-
i. primary goal for endowment is usually spending with protection of real value- reducing portfolio risk will also reduce expected return and make it harder to cover spending and inflation
ii. LEARN THE SPENDING RULES! Three-year average rule will smooth needs thus lowering volatility

Part E-
Again, ONLY WRITE WHAT IS ASKED FOR. The questions asks for 3 factors (don’t write six and hope the grader will look for the best 3, they don’t do this)

Guideline answer provided by Institute shows 7 possible answers, you only need 3

– Risk tolerance for endowment is highly dependent on proportion of spending needs to total assets
– Spending rule and volatility of spending needs affects risk tolerance greatly
– Look for stability and momentum of funding/donation sources

We’ll cover insurance companies and pensions with the 2010 essay question in a future post. Looking forward to your comments.

Thanks for readin’
Joseph Hogue, CFA

P.S. let me know if you are having a hard time on any particular topic areas and maybe we’ll try to cover them in a post.

2011 Essay Question #2 Individual Portfolio Management

Question #2 on the 2011 Level 3 CFA exam (really a continuation of the Individual Portfolio Management questions in #1) is extremely important. The question was worth 23 points (12.8% of total essay points) and combined with #1 made individual portfolio mgmt more than 10% of the total level 3 exam. The essay along with guideline answers is available on the CFA Institute’s website. Please download a copy to follow along.

** Pay attention** The first question on the essay section will always be individual portfolio management and it will be one of two types of calculations…

  • Single-period return like 2011: Look for clues like, “first year of retirement,” or, “cash flow required one-year from now.”  As with both types, SHOW ALL STEPS OF YOUR CALCULATIONS!
     – Make sure you include all cash inflows: pension, salary
     – Minus all cash outflows: living expenses, mortgage & debt repay, gifts
     – Investable assets: (do NOT include primary residence unless otherwise instructed)
    – When the time period is in one year and nominal:  Add the rate of inflation to the real return as in guideline answer (should be geometrically but graders usually give credit for added as well). Remember “real” return is without inflation.

        ** Pay attention to the question– “After-tax nominal return” means you do NOT gross up for    taxes (as in last year’s question), “Pre-tax nominal return” means you need to account for the tax rate by grossing up the required cash flows. Example: If the Beckers had needed a pre-tax return (assuming 35% tax rate) à yr 1 required cash flow $209,500/(1-tax rate)= $322,307 à $322,307/$4.35 million= 7.4% plus inflation= 10.4% pre-tax nominal rate of return

        – Rates of return on these questions are usually within the realm of reason (around 4-6% real, 6-10% nominal) so if you work the problem and get something like 15% or more, go over your calculations because you might have something wrong

  • Multi-period required return like 2010 essay: (we’ll cover this next week when we do the problem)

These questions will also include questions on the IPS statement.

** Though 2011 does not ask for it, many years will ask you to, “State the return objective portion of the IPS.” A lot of candidates miss easy points because they either forget this or think that the return calculation will do satisfy it. NO! YOU MUST STATE A RETURN OBJECTIVE! Easy points, most of the objective is just copying from the vignette. Example: The Beckers’ objective is to retire at the end of one year and live off of investments after paying debts.
     – Include in return objective: the investor’s age and stage of life, inflation concerns, needed % required, other relevant facts of the case
     – Do the return calculation before the return objective, as this will help with numerical requirements of return objective

Part B: Remember risk tolerance has two components (ability and willingness)

Factors affecting ability: long-term versus short-term (long-termà higher ability to TOLERATE RISK), Importance of goals (high importanceà lower ability), size of income needs to portfolio size (very high % à lower ability)

Factors affecting willingness: These are usually statements in vignette (past losses and fear of future loss, desire a conservative approach)

** Remember: When the ability and willingness to tolerate risk are in conflictà go with less overall risk tolerance. Example: high willingness but low abilityà investors have low overall portfolio risk tolerance.

Part C: Remember TUTLL
TUTLL!
TUTLL!
TUTLL!

Time– length of life stages is important as well as children’s ages, explicitly write how many stages and whether long-term or short-term (usually long-term)

Unique– large stock holdings or insider positions, client behavioral characteristics (socially responsible investing), any contradictions in the case

Taxes- tax-free investments, types of taxes (wealth, capital gains, income, estate)

Legal- Trusts, prudent investor rules

Liquidity- short-term living expenses, emergency cash, plans to pay off debt

Part D: Choosing a portfolio

– Choose from the portfolios that will satisfy minimum return requirements first (in this case, portfolio B has a chance of falling to 0 so is inappropriate)

We’ll cover more on individual portfolio management in other posts, but be sure to study the old exams on the Institute’s website.

Let me know if you have any questions,

Joe Hogue, CFA

Learning Outcome Statement Changes: Level 2 and 3 CFA Exam 2011-2012

An important, but often overlooked, resource for candidates is the changes to curriculum Learning Outcome Statements (LOS). The changes are important for repeat candidates because they present the new and removed material from what the candidate studied the prior year. The changes are also important, however because they help highlight new directions in which the Institute wants to take the exams. **While it can’t be proven because the actual exams are not public knowledge, it is rumored that the Institute likes to test new material on the exams. Whether this is to ‘test’ repeat candidates or to highlight the change is up for debate.

Every year presents some changes to the curriculum at all three levels, but rarely do they change a great deal. A complete list of LOS changes are available for each level of the CFA exams on the FinQuiz website. Looking through the list at least once is an absolute MUST for all candidates.

Wording Changes

Looking through the list, you will notice two types of changes. The most common are wording changes to the learning outcome statements. These are usually just changes to the ‘command’ words like changing Evaluate to Analyze. There may be some use here in observing the changes where the candidate does or does not need to calculate something. For the most part, I think the Wording Changes are fairly unimportant. The overall objective of the LOS remains the same so your strategy for addressing the topic will probably remain the same as well.

Curriculum Changes

The more important changes are where the curriculum has been removed or added. Sometimes LOS changes come from the same reading but an emphasis on different parts, while sometimes LOS changes are a result of completely new readings. If you are a new candidate to the specific level and using only current year materials, you probably just need to check out the LOS statements added for that particular year. As mentioned, it’s rumored that the Institute likes to test these so make sure you understand the topic.

Candidates repeating an exam level must read through the changes to understand what has changed from the prior year. Special emphasis may be needed for those new topics and reading since they will be completely new to the candidate.

Level II Changes 2011-2012 (click here for complete list)

Curriculum changes in the level 2 CFA exam this year are fairly light and fall in economics, equity, alternative investments and fixed income.

There is less emphasis on the conceptual foreign exchange and interest rate material in economics with the removal of 4.17 from last year. These LOS were much more esoteric and less-quantifiable. Candidates are still required to work calculations in forex.

LOS 10.36 from last year, dealing with execution costs and some foreign equity issues, was removed.

Removing LOS 11.39d and adding LOS 11.36d looks like a semantic change to me. The LOS is basically the same but more generalized in scope to changes in the industry structure rather than just eliminating rivals (think changes from entrants AND exits to industry)

The ‘stock screen’ LOS always seemed a bit of a side-note to the curriculum and has been removed.

All mention of commodities has been removed from the LOS and replaced with more material on hedge funds.

A couple of LOS in Fixed Income have been removed. These seem more relevant to the last few years’ economic problems and may not be deemed as relevant going forward.

Level III Changes 2011-2012 (click here for complete list)

The removal of Ethics LOS 1.1c from last year’s curriculum seems a little unnecessary as you still need to know the code and standards, including sub-sections to answer the rest of Ethics material. I don’t know that this really changes anything.

The big change to level 3 this year is the all new readings in Behavioral Finance. It looks like less emphasis is placed on individual/specific behavioral biases (i.e. being able to spot or explain representativeness, overconfidence, anchoring, etc) and more emphasis on being able to explain behavioral finance in a generalized way. ** Be sure you read and understand the new readings.

A few LOS have been removed from the private wealth management section mostly dealing with using lifestyle goals and cash-flow matching instead of traditional measures of risk/return. This section seemed to conflict with the rest of the curriculum.

A couple of miscellaneous LOS have been added to the Capital Markets section dealing with macro economic issues.

The need to explain the GIPS standards specific to private equity has been removed but candidates still need to explain the provisions that apply to real estate and private equity together, so not much different here.

Not knowing the curriculum changes probably isn’t going to be something that will make or break you come test time, but it may get you some extra points. LOS changes are more important for repeat candidates but also worth the time for first-time candidates within their level as well. Spend half an hour to look over the changes and understand where the Institute wants to take the curriculum.

‘til next time, thanks for reading.

Joe Hogue, CFA

This Person Will Keep you from Passing the CFA Exams

Your greatest hurdle preparing for the CFA exams is not going to be your new job, your newborn that wants 100% of your attention, or giving up any semblance of a social life. As cliche as it may be, your biggest challenge for passing the exams is YOU.

You are going to get in the way of earning the charter by being lazy and by letting fear keep you from doing what needs to be done.

Did He Just Call Me Lazy??
By lazy I don’t mean everyone is slothful vagrants, sitting around doing nothing. I mean that it is easy to lose focus and your commitment to the process. We’ve already talked about the effectiveness of active learning and doing practice problems but many will still choose  the easy route of simply reading through the curriculum or watching a few videos on the topics.  I know because I caught myself doing it every year and had to make myself take the harder route. It’s much easier to relax during the week and ‘plan’ on studying over the weekend.

We’ll talk more about ways to keep your focus in future posts. For now, just remember three years is a miniscule amount of time compared to the big picture. You’ve already chosen the road less traveled, now stick with it and push through to your reward. It’s a tough choice and will get tougher, but it is all worth it!

Stepping on Your own Foot
The subject here is letting your fear keep you from succeeding. Over the three years of studying for the CFA exams, I spent hours on internet forums or wondering to myself if it was worth it to pursue the designation. I’m a fairly confident man and aware of my abilities but every once in a while that self-doubt would creep in and make me question whether to continue. Fortunately, what I discovered early is that this is just my mind playing tricks on me. It’s a tough process and the fear of failure is going to try to keep you down. The cruel irony is that if candidates spent the time studying instead of worrying and searching for ‘is it worth it’ type questions, more would pass the exams.

The important thing is to recognize when this self-doubt is happening. It won’t always come in the form of fear about your preparedness but could be thoughts like:

  • Is the CFA designation even worth the trouble?
  • When am I ever going to use… (fill in the blank: bond pricing, Black-Scholes, APT, etc.)
  • It’s too late this year, I’ll get to it next year.
  • I’m too old for the charter.

I’m not saying that pursuing the Chartered Financial Analyst designation is an easy decision or that everyone should do it, but you need to understand the difference between objectively analyzing the cost-benefit of the charter versus fear and self-doubt holding you back. Just understand that these questions are not legitimate reasons for not finishing but just fear manifesting itself.  Make the decision to pass the exams and collect your charter, then do not let anything stand in your way!

A few suggestions to wrap it up:

  • Surround yourself with a strong support system- Let your friends and family know how difficult the exams are and how important they are to you. When times get tough, their encouragement will help guide you.
  • Stay active in study groups and forums- Surrounding yourself with others working toward the same goal helps immensely. There’s strength in numbers!
  • Start early- Poor preparation and not having a plan is the quickest way to self doubt. Write down a rigorous study program and stick to it, leaving yourself time for those what-if scenarios.
  • Repetition- Knowing that you’ve been through the material a couple of times and can summarize the important points will boost your confidence. While this might be tough to do with the entire curriculum, there are options for condensed versions. FinQuiz offers both a curriculum-based study guide and topic summaries to help you move through the material multiple times and grasp the important stuff.

All for today. As always, I look forward to seeing your comments, suggestions, gripes and grievances.

Joe Hogue, CFA

As an added bonus for reading through my ramblings, I thought the quote below was especially relevant. Any time you can fit in a quote from Rocky has gotta be a good day!

“Your best friend is a guy named Frankie Fear. You see Fear is a fighters best friend you know, it aint nothin to be ashamed of, you see Fear keeps you sharp, it keeps you awake you know what I mean it makes you want to survive, you know what I mean. But the thing is you gotta learn how to control it alright, cause Fear is like this fire alright, and it’s burning deep inside, now if you control it, it’s gonna make you hot! Or if you see if this thing here controls you… it’s going to burn you and everything around you up!”
Rocky Balboa, Rocky V

Welcome to the FinQuiz Blog…Now Let’s Get Started!

Though this isn’t the inaugural post on the blog, I am new and will be administrating posts so though I would introduce myself. I passed the Level 3 exam in June of 2011 and was awarded (EARNED!) the charter last September. I am the Communications Chair on the Board of the CFA Society of Iowa and an economist for the State of Iowa. I lived in Colombiafor two years as a business consultant and provide 3rd party research to advisor firms.

This blog is going to be informal and interactive. We’ve got a comment/question button at the top right of every post, so don’t be afraid to let me know what you think, good or bad. We’re here to help you pass the exams. We might field some other questions, but the primary focus is on getting you through the exams the first time and with as little stress as possible. As someone who has been through the process, I can tell you it is NOT easy. You have to intensely prepare and use your time efficiently at EACH level.

The blog will be separated into three basic sections. We’ll address general preparation for the exams in the first section. This will be preparation tips and strategy that will carry you through all three Chartered Financial Analyst exams. We’ll also cover details specific to level 2 and level 3 in their own sections. The level 2 CFA exam is very quantitatively-focused and is the first time you will confront item set questions. The level 3 exam will bring the essay questions, a section that can make or break you depending on your preparation.

The most important issue, especially at this stage of the game, is using your time efficiently. With about 12 weeks left, you do not have time to waste. If you haven’t already worked through the official curriculum yet, your best bet is going to be a condensed study guide. Of course, in the interest of disclosure, I am biased toward the FinQuiz Curriculum Notes.  The notes are built around the CFA curriculum instead of on individual LOS so you get a more complete understanding of the topics instead of a collection of ideas. This is very important at level 2, and more so at level 3 as you are expected to put the curriculum together and synthesize ideas. The team here at FinQuiz has done a great job of highlighting key concepts and working through the tough stuff.

Best of all, FinQuiz is operated by CFA charter holders. We know what you are going through. We know what you need to do to work through the exams.

To get this thing rolling, I need you to do something. To make these posts as effective as possible, I need to know where you are at in your preparation. What level are you taking? How long have you been preparing? What study materials are you using? How many hours a week are you studying? What are your top concerns (specific study sessions in the curriculum, item sets, essays, time management, etc.)?

Don’t be shy. You are all in the same boat and it’s a shaky one. Statistically, three months from now half of you will be in a good mood and about half will be…otherwise. Stick with it, stick with us here at FinQuiz.com, and your effort WILL be rewarded.

Happy Studying,
Joseph Hogue, CFA
FinQuiz Blog Administrator

This week, I am going to cover what you need to know and specific strategies for the level 2 and 3 CFA exams as well as the most important advice I can give you on HOW to study. Don’t miss it!

<span class="updated">Last updated: July 18, 2016 at 15:21 pm</span>