I see this question all over the internet. While CFA versus MBA seems to be the most popular, it is followed closely by Continue reading
I wrote yesterday about the importance of reading the entire CFA curriculum and that too many candidates miss out of valuable points due to only relying on study guides. If my inbox is any indication,
Logging in to the CFA Program Candidates group on LinkedIn last week, the first post I saw was a common question I get from candidates. The candidate had been preparing for the Level 3 CFA exam and was wondering how it compared to the first two exams.
I get this question, or variations of it, quite a bit. Candidates want to know what they’re up against with the next exam and everyone wonders which is most difficult.
As usual, candidates on the LinkedIn Group came through for their peer and the post had 21 replies in about a week. I thought I would address the question here on the blog as well.
Are the CFA exams as easy as 1 -2 -3?
My own experience was that the first CFA exam actually seemed fairly easy. The second exam, living up to what I had heard from most other candidates, was much harder. The amount of formulas and detail you are expected to remember seems to increase by ten-fold from the first to the second exam. Unlike the third CFA exam, where you know some topics will appear in the morning section, you really have no idea what will be on the level 2 exam. This means you really need to spend a lot of time covering as much of the curriculum and in as much detail as possible.
I’ve heard a lot of candidates say that the level 3 CFA exam seemed more difficult than the second exam. I think this depends greatly on your preparation and comfort for the essay section of the exam. The afternoon section of the level 3 exam is no different than the second exam in format or difficulty (in my opinion). As for the morning essay section, I was actually surprised how easy it seemed after studying prior years’ exams.
You’re experience may be different but I would say the second exam was clearly the most difficult for me. The level 1 CFA exam was the second most difficult but only because you have no idea what to expect so you’ll need to study more to cover the uncertainty. The third exam can actually be relatively enjoyable if you study the prior years’ essays.
Do you need the same amount of studying on each CFA exam?
When it comes down to answering how much time is needed for each exam, it’s not really about time but about how you study. Each exam is a little different and requires a different approach to studying.
I spent way more time than was necessary studying for the first CFA exam, but then it is always hard to say how much is going to be enough. Between reading the curriculum, study notes and watching videos, I covered the material seven times and that’s not counting practice problems. When I got to the exam, I was surprised how easy and generalized the questions seemed. Knowing now that the CFA level 1 exam focuses on general concepts, I would suggest that you cover everything multiple times but don’t worry as much about the details. Understand the idea behind each LOS and broad concepts in each section.
The CFA level 2 exam is very different from the first. You will need to know deep details in the LOS to do some of the longer calculations and process. For this exam, I would concentrate on really mastering the more important topic areas. Using the topic weights for the exam, make sure you are scoring above 80% or higher on the most important topics. To get to this level of mastery, you might have to spend a little less time on other topics.
Responses from CFA level 3 candidates on the forum post were typical of what I usually hear and easily remedied with a smart adjustment to your study plans. More than a few of the candidates ran out of time or did really poorly on the morning essay section of the exam. While I thought the CFA level 3 exam was much easier than the second exam, it would have been impossible if I hadn’t spent so much time practicing prior years’ essay questions. This is something we talked about in last week’s post and absolutely critical to your success on the last CFA exam. If you spend your time studying the essay questions from prior exams, you can spend less total time than on other exams and still do well.
Last month ahead of the exam. You’re almost there!
‘til next time, happy studyin’
Joseph Hogue, CFA
Last updated: July 18, 2016 at 16:22 pm
I have a confession to make. I am one of the worst offenders of what I am about to post but I bet I’m not alone. I have 810 connections on LinkedIn and according to the site that puts more than 14.7 million other professionals in my network.
But would I be able to tell you anything about 90% of those first-level connections? Probably not.
And that is where many find themselves, with a huge virtual network but no real connections to help manage their professional career.
Maybe networking is not supposed to be this easy
While traditional networking should not be the painful process that many see it as, I’m not sure that it should be as easy as clicking ‘accept’ with no exchange between yourself and another. Sure, there are clear benefits to expanding your network through virtual platforms. We are able to build relationships with people that we would otherwise never meet. My ‘network’ spans nearly every country and just about every industry. Virtual networks help us keep in touch with our connections on a much more frequent basis than we probably could otherwise as well. A quick scan through profile changes lets me stay updated on what people in my network are doing.
But then there are the obvious disadvantages and traps we fall into as well. The ease of virtual networking has given us a false sense of connection and made it easy to neglect establishing stronger relationships. After all, why do I need to work to establish 10 strong connections when I can set up a network of 14.7 million with the click of the mouse?
Having too many ‘connections’ will make it impossible to really keep up with the connections you need to manage your career. Most of the social platforms are set up to run a news feed of things happening in your network. Are the important events and updates in your network getting buried under a pile of news from people you barely know?
Ultimately networking is about using those connections to help each other professionally, whether directly or indirectly through a second-level connection. Do you think you could do this with most of your connections? Would you feel comfortable recommending the people in your network based upon what you know about each of them? You are the only one that can answer the question, “How many connections are too many.”
Time to develop real connections
The benefits of virtual platforms for networking are too good to let them go to waste by superficially building your network so make a commitment to take advantage of them.
I know a lot of people will recommend going through your connections and deleting anyone that isn’t directly relevant to your professional sphere. It depends on how many connections you have but this might not be altogether necessary. If your list is still relatively manageable, you might just try categorizing people into spheres of importance. People with which you want to build a strong relationship would go in one folder and all others in another folder.
Once you’ve cleaned up your network, it is time to work on those relationships like you should have at the beginning. Browse through everyone’s profile and categorize connections within groups of experience, topic of expertise or anything else that might make it easier to organize. The idea is that when you have a question or want to talk to someone about a specific topic, you can quickly look through your network for the right person. This will not only help you answer your questions more quickly but will also help you get to know people in your network.
You probably do not need to talk to everyone in your network every week, maybe not even every month, but you should make it a point to interact with them. Before you go to a presentation or other professional event, send out a personal invite to the connections that might be interested. Regularly check up with your connections to get their opinion on the most important news and event for their sector.
Maybe it’s just that virtual networking is still so new for many of us that we have not learned to use it effectively. I know I’ve got a lot of cleaning up to do.
‘til next time, happy networkin’
Joseph Hogue, CFA
We finished up our series on career management last week and candidates still have upwards of six months until the study season begins for next year’s exam. It is usually this time of year that I am urging candidates to stay active professionally and academically, but let’s get real here… you busted your butt to prepare for the CFA exam and many of you did it while juggling family and a job.
You deserve a break.
Give the numbers a break
A friend recently confessed to me that he has focused solely on his professional life for so long that he is having trouble disconnecting and just having fun. For the last ten years, he has been singularly driven to improve himself as a professional analyst.
He spends upwards of 50 or 60 hours a week working as an analyst in a Chicago commodities firm, usually spending a few hours at home each night to finish up on some reading. The books he reads during his free-time are usually somehow related to work, i.e. financial history, commodities and other concepts in investing. He goes out once or twice a week but much of the time it is to networking or other professional social events. His life has become so limited that, when he does go out with friends, the only thing they talk about is work.
I can sympathize with his plight and can see a lot of myself in the story. The industry is extremely demanding and sometimes being successful means sacrificing other parts of our lives but it should not become your life 24/7 and 365 days. Maybe the biggest challenge many of us face is limiting the time spent working or in professionally-related activities during those periods of the year where we can have some real free-time.
You need a hobby
There are a million-and-one hobbies and things you can do to take your mind off of the industry. If you’re having trouble thinking of an activity or hobby, try a web search for bucket lists. These lists of things people want to do before they die can be a great resource for one-time events or things you can do on a regular basis.
One of the most detailed bucket lists I’ve found is at:
I like to exercise as one of the things to take my mind off of work. I know a lot of analysts that become extremely competitive in their sport or activity, almost taking it to the professional level. Even if you don’t push yourself to the limit, challenging yourself physically can really take your mind off of everything else.
Cooking is another hobby I’ve tried to pick up. In our hectic lives where time is money, it can be too easy to order out every night. It’s nice to relax and take the time to create a truly amazing dinner.
Your hobby doesn’t have to be something mainstream or recurring, just something that you might enjoy doing in any particular week. Make a point to spend some time with friends or family. Visit the local museum or a park every once in a while.
‘til next time, relax.
Joseph Hogue, CFA
Last updated: January 23, 2017 at 8:31 am
Each year, thousands of candidates take the CFA exams and I get a lot of emails from those with good outcomes and those with outcomes that were not so great. One thing always seems to separate the passing candidates from those in one of the fail bands, practice problems.
Now it felt like I did a million practice problems and problem sets every year that I took the exam but the average I get from most passing candidates seems to be around 900 problems. Yes, of the candidates that tell me they passed, the average number of practice problems completed is around 900. Of those in the fail bands, it seems the average is just under 500 problems.
Not a formal study and probably some biases in the data (you tell me which ones), but there is definitely a difference. It doesn’t take any leap of imagination to figure it out. Practice makes perfect, right? 900 practice problems is about five full exams worth of problems. If you can do this many practice problems, learning from your mistakes, then you should have picked up enough to get more than two-thirds on the actual exam. Of course, learning from your mistakes is important. Sitting there getting 30% on each round of practice problems without reviewing the answers isn’t going to help anyone, but that’s another topic.
Your challenge for the next exam!
My challenge to you is this, for the next exam, do 1,440 practice problems. That’s about 8 full-length tests and more than 1.5 times the average number reported to me by successful candidates. It may seem like a lot but its still less than half the number of practice problems in the Finquiz Web-based Test Banks. For the first four, do not worry too much about your score. Do the practice problems and review any incorrect answers. Make sure you review the questions that you guessed correctly as well because you may not be as lucky the next time around.
After your first four exams, start keeping track of your overall score and your percentage score within each topic area. Plan out your study schedule so you finish the last set of practice problems approximately two weeks before the exam.
If you finish the last problems with an average score of at least 75% over the last 360 questions (2 full exams), then you can relax and just do some maintenance studying up to the exam. I hesitate to talk about an alternative because if you have finished more than 1,400 problems and are not scoring very well then a few more hundred problems are probably not going to help.
You will want to check your average scores in the individual topic areas. If you are scoring less than 60% in any one area then you’ll need to work on it regardless of your overall score, but after 1,440 practice problems I have gotta believe that you are going to be golden for the exam.
I can’t give you any guarantees but if I wanted just one way to assure myself that I would pass the exam, it would be the 1,440 challenge. For you December testers, that’s about 40 problems a day with a week left to the exam. For June testers, you could start in February and do just 96 problems a week.
You will need to do the readings or at least read the study guides to be able to work the practice problems but achieving your 1,440 should be the goal.
That’s it. Seems easier when you can focus on just one goal rather than trying to elaborate on a lengthy and intricate study plan. Work those practice problems, meet your goal and you will not be disappointed!
‘til next time, happy studyin’
Joseph Hogue, CFA
Last updated: July 18, 2016 at 16:41 pm
This week’s blog post comes in the form of a question rather than my usual ranting monologue. After having made it through another arduous study season, fighting fatigue and frustration at every turn, what would you have done differently if given the chance?
Right now, when the tension over exam scores is at its highest and candidates are biting their fingernails down in anticipation, hindsight may be even more acute than 20/20. Asked the question, many will give the standard response of starting earlier or staying on schedule. Candidates often wish they had paid more attention to specific sections or formulas.
But what else could you have done? Is there a way you could have used the process to help your chances getting a job later? Is there a way you could have studied that would have helped retention?
For my part, I passed the Level 3 CFA exam in 2011 but can still remember the long hours spent at the library and away from family and friends. I usually started studying in the fall of the prior year, around September or October, and would start with a fairly relaxed five hours a week studying. This meant that I could get through the curriculum once before January but really didn’t have to worry much about burnout or a schedule. Because I started so early, I was usually able to get through the curriculum multiple times (whether the official curriculum, study guides or other resources) so I always felt prepared for the exam.
As with many candidates, I did face burnout towards the end of each study season, usually around March or April. One thing I wish I had done was have a plan for it rather than struggle through my schedule. I think most candidates plan an extremely tough schedule, more than 10-15 hours a week, without planning for any rest through the exam. The CFA exams are tough and you need to study, but planning on taking a few days or a week removed from the curriculum can help keep your focus and return stronger than ever.
Use the process as a networking tool
I wish I had used the process to better get to know other candidates and professionals in the industry. I was active on the internet forums and volunteered for the local CFA society but did not build as many connections as I would have liked. Talk with other candidates, preferably local, about studying and how they are doing. You might also try talking to local charterholders about how they approached the exams. At minimum, they might be able to offer some good advice on the exams but they also might be able to offer help getting a job as well.
What are one or two things that you wish you had done differently?
‘til next time,
Joseph Hogue, CFA
I just wanted to be the first to congratulate you for another tough season of studying. You’re probably just a teensy bit nervous right now and thinking congratulations are a little soon but you’ve put in your time and I’m confident that you will do well.
I know it’s tough not to be nervous but I want you to go into the exam confident and proud of yourself, and there’s one reason why. Whatever may happen on Saturday, you’ve already tested yourself with upwards of 300 hours of studying. That’s 300 hours of sacrificing time that could have been spent with friends and family. Finding the motivation and persevering through this kind of a self-study program is not easy but you’ve made it and pass or fail you are now a better person and a better professional for it.
One last task…
If you haven’t already put everything you’re going to take to the test in a bag, go ahead and do it now. If you’re not sure, check out the Institute’s page on exam policies. Also, make sure you have your passport and admission ticket. Put everything together so you don’t have to search for it on test day. If you are at all unfamiliar with the city in which you’ll be testing, I would map out the route as well as where you might go for lunch. Doing it now just leaves less to worry about on Saturday.
Beyond that, SMILE. RELAX. Know that you’ve done all you can. If maybe you haven’t studied as much as you would have liked, don’t worry about it. There never seems to be enough time so just know that you’ve done what you could.
The test is just like the many others you’ve taken, pencil and paper and a few questions. Nothing more and nothing to get overly anxious about.
Good luck on Saturday.
Joseph Hogue, CFA
With a little over a month left to the tests, I started to get nostalgic for the bygone days of last-minute cramming for the CFA exams. I always took the last week before the exam off from work to dedicate my time to studying. A 40-hour plus week of mock exams, flash cards and review sheets may not sound like a vacation, but it beats the normal 9-5 routine and the curriculum can be pretty interesting if you let it. My full schedule is described in a prior post and linked here.
Instead of rehashing my own schedule for the last week, I thought I would pass along an idea from a friend in Chicago on how he spent his last week before the exams. I’ve talked to others about their last-week plans, but his yearly ritual wins hands-down.
Instead of staying in Chicago and locking himself away at the library for the six days before the exam, my usual approach, he would hop a flight to San Diego for a real vacation. He still put in the 8-10 hours of studying but spent it relaxing in the park or at the beach. Mornings would start early with a run on the beach at 6am followed by breakfast and studying by 8am. He would study through the day to about 4-5pm, stopping an hour for lunch. After relaxing for a few hours, he would put in another hour or two studying before bed.
Talking through his daily routine, it struck me that it really wasn’t that different from others. Mock exams every other day help to fine-tune the review and focus on those topics where you need the most work. Flash cards and condensed summary sheets help to break up the monotony of practice problems and reading. There are a lot of advantages to going away on a trip though.
First, all your meals are prepared for you so that’s one less thing to worry about or on which to spend time. Your friends and family know you are away so they don’t expect you to go out and party (I had more than a few friends that couldn’t understand why I wouldn’t want to stay out later during a week off from work when I was studying). Finally, you’ve spent the last five months (more or less) studying in the same place. Spending that last week studying at home as well can be extremely boring.
Of course there are risks to the vacation plan. My friend said he did enjoy a drink or two at night but never gave in to temptation and drank too much. A couple of drinks isn’t going to kill too many brain cells but be careful not to stay out too late. Don’t spend too much time worrying about where you are going to study or what you want to see. Pay a little extra for a nice hotel that is well-centered on the places you want to go. One caveat is to plan on coming back home Thursday to make sure flight cancellations do not keep you from getting home on time.
The idea is to relax and have as much fun as possible over that last week while still hitting the curriculum hard for those last points to put you over. Going into the test with burnout and just ready to get it over with isn’t going to help you pass.
‘til next week, happy studyin’
Joseph Hogue, CFA
With just six weeks left to the exam, candidates are asking themselves if they have studied enough and what their chances are at passing the exam. For those that have followed our 21-week study plan, you should be starting the last few study sessions and tracking your progress through practice problems.
There are many candidates who have just recently started working through the curriculum and are wondering if six weeks is enough time. The short answer is probably not unless you are able to completely devote yourself to the exam over that period. Remember, the average candidate spends about 300 hours studying for each exam. Even if you are particularly bright, and not just overconfident and can get by on 250 hours, that is still more than 40 hours a week.
Even candidates that have been studying over the last several months may want to re-evaluate their progress. Our study plan has covered to study sessions 14 in the exams but this is still just the first time through the material. Candidates retesting material seen in the first couple of study sessions may find that they have forgotten some of the important concepts.
This is why you may want to change things up for this last six weeks and incorporate a few other resources. You’ll still need to finish the curriculum to the last study session, but you need to revisit the concepts in earlier study sessions through practice problems, flash cards and study notes.
The resources below are some of my favorite for quick review and being able to get the most important parts of the curriculum in the most condensed form:
- Study guides are still going to be your ‘core’ resource. Hopefully, you don’t need to re-read all the material but you should try to get through your problem areas again.
- Flash cards! I’ve covered these in a previous post. This is one of the most useful resources at this point because you can carry them around easily and focus on specific questions/formulas.
- Topic area summaries are worth the cost for their portability. Not quite as useful for formulas (practice is best) but you can easily review a summary page a few times a day and get core concepts down.
- I would be spending the majority of time on practice problems and mock exams. Don’t just grade your answers but study the guideline answer for those you got wrong. I cannot think of a better way of focusing in on the stuff you don’t know yet.
For the most efficient use of your study time, I would start doing at least one mock exam or practice test each week. Sit down with a question bank of practice problems in the approximate weights from the exam and complete two, three-hour sessions. For each topic area, you need to be aiming for at least 70% but you’ll want to score higher in the core areas like ethics, financial statements, and equity analysis. Knowing approximately how well you are doing in each topic area will help you to allocate your study time over the next week.
Of course, the last week before the exam is still the ‘superman’ week. You might want to consider taking the entire week off from work and planning an intensive review of the material. We’ll cover how to plan the last week in a coming post. Let me know if you have any questions or comments.
‘til next week, happy studyin’
Joseph Hogue, CFA
Last updated: October 1, 2016 at 3:25 am
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
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
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!
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.
- 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
- 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
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.
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.
Joseph Hogue, CFA
Last updated: December 22, 2016 at 7:58 am
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
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
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:
- 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):
+ 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.
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.
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)
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
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
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
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
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.
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
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
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.
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.
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
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
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.
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>