Finance Notes > CFA Level 1 Notes
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CFA Level 1
CFA Level 1
Full Revision Package
Table of Contents
1. Ethical and Professional Standards....................1
2. Quantitative Methods....................................7
3. Economics...................................................20
4. Financial Reporting and Analysis................44
5. Corporate Finance........................................63
6. Equity Investments......................................72
7. Fixed Income...............................................79
8. Derivatives...................................................92
9. Alternative Investments...............................99
10. Portfolio Management and Wealth Planning. 105
Chapter 1
Ethical and Professional Standards
Professionalism
Knowledge of the Law
Comply with all applicable laws, rules, and regulations, codes and standards
Comply with the more strict ones in case of conflict
Not participate in any violation
Dissociate from any violation
Presumed to have knowledge of all applicable laws
Duties of Analysts
Stay Informed of changes in applicable laws
Review compliance procedures regularly
Maintain up-to-date reference copies of applicable laws and cases
Seek further legal advice when in doubt
Report violations to appropriate organization(s) or CFA Institute
Duties of Firms
Develop / adopt / adhere to a code of ethics
Keep staff informed of relevant laws
Establish written protocols for reporting suspected violations
Independence and Objectivity (IO)
Use reasonable care and judgment to achieve and maintain IO
Not offer, solicit or accept any benefit at the expense of IO
Avoid potential conflict of interest
Can accept modest gifts and entertainment
Disclose any benefits received and potential conflicts of interest
Give investment opinions free of bias
Use clear and unambiguous language to give investment opinions
Anticipate / Interpret / Assess a company in a factual manner
Duties of Firms
Maintain a culture supporting IO
Separate clearly authority and responsibility
Due Diligence
Gather info from a wide variety of sources
Disclose necessary info
Sources of Pressure threatening IO
Investment Banking Clients
Public Companies
Buy-side Clients (e.g. Portfolio managers)
Issuer-Paid Research
Buy-side Analysts
Hired by an entity, such as a mutual fund,
that invests on firm capital
Identify investment opportunities for their firm
Research usually unavailable to external parties
Sell-side Analyst
Hired by an entity, such as a brokerage firm,
that manages clients' money
Identify investment opportunities for their clients
Research usually available to external parties 1 CFA Level 1
Underwriter
An intermediary between an issuer of a security and the investor
Duties of Analysts
Adhere to strict standards of conduct
Engage in thorough, independent and unbiased analysis
Disclose potential conflicts
Analyze audited financial statements thoroughly
Provide thorough benchmarking and industry analysis
Conduct research in an objective manner
Distinguish facts and opinions in reports
Give reasonable conclusions supported by appropriate research
Accept only a flat fee prior to writing a report
Can revise outsourced research
Disclose any outsourced research
Not commit plagiarism in oral communications
Not use undocumented info
Reveal sources to bring responsibility back to the author
Duties of Firms
Limit capabilities of individual staff
Provide guidance for employees who make presentations to (potential) clients
Designate which employees can speak on behalf of the firm
Require staff to prepare a summary of their qualifications / experience
Monitor materials published on the web pages regularly
Maintain copies of all research reports /
articles
Duties of Firms
Establish policies to protect integrity of opinions
Created a restricted list to exclude controversial companies
Limit special cost arrangements (e.g. air travel) from clients
Limit gifts received from clients
Restrict personal investments (e.g. equity related IPOs)
Implement effective supervisory and review procedures
Establish a formal written policy on IO
Misconduct
Not engage in any professional conduct involving dishonesty / fraud / deceit
Not commit any act that adversely affects professional reputation / competence
Misrepresentation
Untrue statement or omission of facts
Omission of any statement that is otherwise false and misleading
Duties of Firms
Develop / Adopt a code of ethics
Disseminate to staff a list of potential violations and associated punishments
Check reference of potential staff
Duties of Analysts
Not knowingly make any misrepresentations relating to investment
Not misrepresent any aspect of their practice,
including qualifications
Not guarantee clients specific return on volatile investments
Can provide clients with info on return of investments with built-in guarantee
Not commit plagiarism when preparing investment materials
Acknowledge and identify the source of ideas from other parties
Duties of Analysts
Not commit any sort of unethical behaviour related to professional activities
Not commit any act that negative affects their ability to perform responsibilities
Not abuse CFA Conduct by actively seeking enforcement of CFA Conduct
Integrity
Material Nonpublic Info
Not act or cause others to act on material nonpublic investment info (inside info)
Material Info
Info that has an impact on the price of a security or affects investment decisions
Nonmaterial info
Low Reliability 2 CFA Level 1
Ambiguity of Effect
Available to General Investors
Examples of Material Info
Earnings
Mergers / Acquisition / Tender Offers / Joint
Ventures
Change in Assets
New Licenses / Patents / Trademarks
Development of Business
Changes in Management
Change in Auditor Notification
Events regarding the issuer's securities
Bankruptcies
Significant Legal Disputes
Gov Reports of Economic Trends
Orders for Large Trades before Execution
Separate physically incompatible departments (sell-side vs buy-side)
Limit staff exposure to incompatible jobs
Authorize compliance officers to handle conflicts
Circulate compliance policies and guidelines to all staff
Provide training programmes to staff
Can conduct proprietary trading even when possessing nonpublic info
Market Manipulation
Not engage in practices that distort prices
Not artificially inflate trading volume
Not disseminate false / misleading info
Not have the intent to deceive
Duties to Clients
Mosaic Theory
Collect public / non-public / nonmaterial info for forming recommendations
Recognized by CFA Institute as a valid method of analysis
Duties of Analysts
Collect info from sources other than the company in question
Document all research
Disclose the details of the info and methodology used
Not take investment action on the basis of material info
Make reasonable efforts to disseminate material info
Not induce company insiders to provide private info
Not share info with colleagues of other departments
Consult a designated compliance officer in case of doubt
Duties of Firms
Adopt and document compliance procedures
Develop and follow disclosure policies
Review employee and proprietary trading
(trading on firm capital for profit)
Require staff to make periodic trading reports
Supervise and control interdepartmental communications
Not discriminate among analysts in the provision of info
Issue press releases prior to analyst meeting
Restrict the flow of confidential info
Loyalty, Prudence, and Care
Be loyal to clients
Act with reasonable care
Exercise prudent judgment
Act for the benefit of clients
Place clients' interest first
Determine and comply with applicable fiduciary duty
Duties of Analysts
Follow investment guidelines set forth by clients and the firm
Adhere to any legally imposed fiduciary responsibility
Avoid all real / potential conflicts of interest
Ensure appropriate risks clients are exposed to
Ensure clients' objective and expectations are realistic
Establish and follow investment objectives of clients
Disclose investment methods / policies to clients
Disclose compensation arrangements
Disclose proxy-voting policies
Keep clients informed of any transactions
Diversify investment to reduce the risk of loss
Deal fairly with all clients with respect to investment actions
Maintain confidentiality
Seek best execution for clients
Fair Dealing 3 CFA Level 1
Deal fairly and objectively with all clients
Not discriminate against any clients
Duties of Analysts
Not take advantages of their positions
Give investment recommendations to all clients simultaneously
Take investment actions fairly to all clients
Duties of Firms
Design an equitable system to prevent selective/ discriminatory disclosure
Limit the no of people involved
Shorten the time frame between decision and dissemination
Publish personnel guidelines for predissemination
Maintain a list of clients and their holdings
Develop written trade allocation procedures
Disclose trade allocation procedures
Review clients' accounts on a regular basis
Disclose levels of service
Suitability
Make appropriate investment recommendations
Take appropriate investment actions
Duties of Analysts
Gather / Update clients' info
Assessing suitability based on info provided by clients
Info for Analyzing Clients' Suitability
Investment Experience
Risk and Return Objectives
Financial Constraints
Investment Objectives / Constraints /
Mandates
Complete Financial Portfolio
Financial Circumstances
Personal Data
Performance Presentation
Make efforts to ensure the fairness / accuracy
/ completeness of performance info
Maintain all data and records
Preservation of Confidentiality
Keep info about current / former /
prospective clients confidential
Exceptions
Info concerns illegal activities
Disclosure is required by law
Clients permit disclosure
Duties to Employers
Loyalty
Act for the benefit of employer
Not deprive employer of the advantage of their skills / abilities
Not divulge confidential info
Not cause harm to employer
Duties of Analysts
Place clients' interests above employer's
Comply with policies and procedures established by employer
Independent Practice
Abstain from any activity that conflicts with the interests of employer
Notify employer of personal independent undertakings
Not undertake independent practice until receiving consent from employer
Leaving an Employer
Continue to act in the interest of employer until resignation becomes effective
Not misappropriate trade secrets
Not misuse confidential info
Not solicit employer's clients prior to cessation of employment
Not misappropriate client lists
Not commit self-dealing (acting in his own interest in a transaction)
Duties of Analysts
Disclose investment performance data fully
Whistle-blowing
Can report dishonest / illegal practices of employer to authority
Duties of Firms
Comply with / Adhere to Global Investment
Performance Standards (GIPS)
Nature Employment
Employee - Fully bound by the Duties to
Employer 4 CFA Level 1
Independent Contractor - Depends on the terms of agreement
Additional Compensation Arrangements
Not accept gifts / benefits / compensation expected to create a conflict of interest
Duties of Analyst
Report to employer on any compensation to be received from other sources
Obtain written consent from all parties involved before receipt
Responsibilities of Supervisors
Detect and prevent violations by anyone under supervision
Duties of Supervisors
Exercise reasonable supervision
Establish and implement written compliance procedures
Ensure the procedures are followed through periodic review
Initiate an investigation into any violation detected
Flow of Compliance Procedures
Draft the procedure in plain language
Designate a compliance officer
Define the responsibility of the compliance officer
Implement a system of checks and balances
Outline permissible conduct
Outline reporting procedure in case of violation
Disseminate the procedures to relevant staff
Update the procedures regularly
Educate staff regarding the compliance procedures
Use periodic reminders
Evaluate staff based on their professional conduct
Review activities carried out by staff
Enforce the procedures in case of violation
Report violations promptly
Conduct a thorough investigation
Increase supervision
Investment analysis / Recommendations /
Actions
Diligence and Reasonable Basis
Exercise diligence / independence /
thoroughness
Have a reasonable / adequate basis supported by research / data
Duties of Analysts
Cover all pertinent issues
Provide supporting info to clients
Refrain from relying on info that lacks a sound basis
Document differing opinion with the research team
Can request to remove their names from the report due to differing opinions
Secondary Research
Research done by someone else inside the firm
Third Party Research
Research done by someone else outside the firm
Evaluation of Secondary Info
Review of the assumptions used
Rigor of analysis performed
Date / Timeless of research
Evaluation of the objectivity
Evaluation of the independence of recommendations
Duties of Firms
Require all reports and recommendations to have a reasonable / adequate basis
Research / Approve research reports /
recommendations
Establish due-diligence procedures
Develop measurable criteria for assessing the quality of research
Communication with Clients and Prospective
Clients
Disclose the basic format and general principles of investment
Inform clients of any material changes
Use reasonable judgment in identifying investment factors
Distinguish between fact and opinion
Can be any form of communication
Duties of Analysts
Develop / Maintain clear / frequent /
thorough communication practices
Inform clients of factors taken into account for forming investment decisions 5 CFA Level 1
Inform clients of the investment decision making process
Outline known limitations of the analysis and conclusions
Duties of Firms
Maintain records indicating the nature of the research
Record Retention
Develop / Maintain appropriate records to support investment analysis
Duties of Analyst
Comply with the firm's requirement of record keeping
Duties of Firms
Require staff to maintain records that support investment decisions
Conflicts of Interest
Disclosure of Conflicts
Make full and fair disclosure of all matters
Ensure timely, prominent and effective disclosures of info
(Potential) Conflicts of Interest
Stocking Holding
Job Position
Possession of Nonpublic Info
Receipt of Benefits
Business / Personal Relationship
Duties of Analysts
Avoid (potential) conflicts of interest
Disclose to (potential) clients and employers all (potential) conflicts
Duties of Firms
Evaluate reported (potential) conflicts of interest
Priority of Transactions
First Priority - Clients
Second Priority - Employer
Last Priority - Employee
Duties of Firms
Limited participation in equity IPOs
Restrict personnel acquisition of securities in private placement
Establish blackout / restrict periods
Establish reporting procedures for investment personnel
Reporting Procedures
Duplicate Confirmations of Transactions
Disclosure of Personal Holdings / Beneficial
Ownership
Preclearance of Securities Prior to Important
Dealings
Referral Fees
Disclose to employer / (potential) clients any compensation / consideration / benefit
Duties of Analysts
Disclose benefit received for referrals of clients
Disclose the nature of benefit received
Responsibilities as a CFA Institute Member or CFA Candidate
Not misrepresent / exaggerate CFA
qualification
Not over-promise the competency of an individual
Not over-promise future investment results
Can state facts (e.g. passed the 3 exams on first attempt)
CFA Institute Membership
Remit annually to CFA Institute a completed
Professional Conduct Statement
Pay applicable CFA Institute Membership dues
Proper Usage of the CFA Marks
Used after a charterholder's name or as adjectives
Used directly reference an individual charterholder
Global Investment Performance
Standards (GIPS)
Misrepresentation of Performance
Representative Accounts - Select the tip performing portfolio to represent overall results
Survivorship Bias - Exclude poor performance from an average performance history
Varying Time Periods - Present performance 6 CFA Level 1
for a selected time period
Features of Claiming Compliance with GIPS
On voluntary basis
Eligible for asset management firms
Firm-wide process
Fully compliance with all GIPS standards
Benefits from Compliance with GIPS
Facilitate comparison across firms
Increase clients' confidence
Composites
An aggregation of portfolios into a single group with the same objective
Verification
Firms are responsible for maintaining compliance
Can voluntarily hire an independent third party to verify compliance
The Structure of the GIPS Standards
Fundamentals of Compliance
Input Data
Calculation Methodology
Composite Construction
Disclosures
Presentation and Reporting
Real Estate
Private Equity
Reasons for Development of GIPS
Increasingly globalized investment management industry
Variation of regulation / performance measurement from country to country
Assurance of complete and fair presentation of investment info
Facilitation of performance comparison
Increase in clients' confidence in investment firms
Vision Statement
Present performance results readily comparable among firms
Facilitate communication of results with clients
GIPS Objectives
To obtain worldwide acceptance of a standard for investment measurement
To ensure accurate / consistent presentations of data
To promote fair global competition
To foster self-regulation
Features of GIPS
For Investment firm (distinct business entity)
Ethical standards
Requirements of GIPS
Disclose all actual fee paying discretionary portfolios in composites
Disclose investment performance records (5 years up to 10 years)
Use certain calculation / presentation methods
Maintain integrity
Provide provisions in investment report
Disclose fully / fairly
Adhere to GIPS Handbook
Comply with country-specific law /
regulation
Chapter 2
Quantitative Methods
Time Value of Money
Time Value of Money
Concern equivalence relationships between cash flows occurring on different dates
Roles of Interest Rate
Required rates of return
Discount rate
Opportunity cost
Premium
Required returns for bearing distinct types of risk
Composition of Interest Rate
Real risk-free interest rate
Inflation premium
Default risk premium
Liquidity premium
Maturity premium
Real Risk-free Interest Rate
Single-period interest rate for completely risk-free security
Reflect the time preference of individuals for current v. future consumption 7
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