# CFA Level I Review, Study Session 3

Study session three in the Level I CFA Program curriculum wraps up quantitative methods topic. The readings here are, in my opinion, not as important as the material in study session two. You may see a question or two but the concepts, other than the normal distribution, are not used as much in other topic areas.
That said you still need to spend some time understanding the basic concepts and rules. For me, this study session was part of my (secondary) group of curriculum. I spent most of my time on core areas like Ethics, FSA, Equity & Fixed Income along with miscellaneous readings from the other topics. In these core areas, I would work to at least 80% on practice problems and mock exams. For the remainder of the curriculum, I aimed for maybe 70% mastery of the material. Don’t neglect the secondary material but do not dwell on it at the expense of your core areas.
Common Probability Distributions
Most of the introductory material here is fairly unimportant. The binomial distribution is a little more important because it relates to some of the derivatives material. The normal distribution is really where you want to spend your time.
Remember that 90% of the distribution will be between 1.65 standard deviations, 95% within 1.96 deviations and 99% within 2.58 deviations. You will be given a z-table but need to know the formula and the applicable number of standard deviations. You need to pay attention to the question and look for which part of the curve you are being asked to measure. Do you need an interval around the mean or just one side? All the stuff around the z-score (the formula and finding probabilities) is fairly basic so spend some time and master it.
Understand the applications, limitations and differences between Monte Carlo Simulation and Historical Simulation.
Sampling and Estimation
Again, fairly unimportant material but it is mostly conceptual. You won’t need much in the way of formulas but will want to understand the ideas and differences between the different sampling plans. Remember that a good estimator is unbiased, efficient and consistent.

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

Hypothesis Testing

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

Technical Analysis
Most of the curriculum puts little faith in technical analysis and refutes much of it in the efficient market hypothesis. The reading is basically a list of points that you should be familiar with just to have a basic understanding of what technicians do. Throw the material on some flash cards (no more than a couple of sentences on the definition side), review them a few times and it should be a few easy points on the exam.
Study session four in the CFA level 1 curriculum starts the economics topic area. It is not a core area but is mostly conceptual and some easy points. We’ll hit microeconomics next week and then macro in study session five.
‘til next time, happy studyin’
Joseph Hogue, CFA

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