cfa level 1 notes

Ethics

1.

Ethics

?

Shared beliefs. Ethics are important because the investment industry is built on

trust

.

?

Profession

: Specialized knowledge and skills, commitment to serve others, a shared

code of ethics.

?

Ethical and law:

有相同的地方，也有独立的地方。（比如举报老板可能是违法的）

?

Situational influences

(e.g. environmental and cultural elements) lead to unethical

behaviour than internal traits. Loyalty to employer/colleagues is powerful among them.

?

Ethical decision-making process: Identify-Consider-Decide, Act- Reflect

?

The code of ethics publicly communicates the established principles and expected

behaviour of its members, while the standards of conduct serve as benchmark for the

minimally acceptable behaviour of community members.

2.

The Code of Ethics

?

Act with integrity, competence, diligence, and respect and in an ethical manner

with the

participants in the global capital markets.

?

Place the integrity of the investment profession and the interests of clients above.

?

Reasonable care and independent professional judgment on professional activities.

?

Practice and encourage others to practice in a professional and ethical manner.

?

Promote the integrity and viability of the global capital markets for the ultimate benefit

of society.

?

Maintain and improve their professional competence.

3.

Standards of Professional Conduct

?

Professionalism: Knowledge of the law, independence, objectivity, no misrepresentation, no

misconduct (Breaking the law is related to civil obedience, not necessarily misconduct).

?

Integrity of capital market: Do not act on material non-public information (

包括无 意泄露，

而不是单纯考虑是否利用信息进行了套利

). No market manipulation. However, it is

acceptable to use public and nonmaterial non-public information to form the analysis which

can be material. (

Mosaic Theory

)

?

Duties to clients: Loyalty, prudence, care, fair dealing, suitability of advisory, performance

presentation, preservation of confidentiality. (

能自己支付的费用就自己付，不能因为

disclose

了就安然接受

)

?

Duties to employers: Loyalty, no additional compensation, supervision to their work. (Can

contact former clients in the absence of noncompetence agreements)

?

Investment analysis, recommendations, and actions: Diligence, reasonable basis,

communication with (prospective) clients, record retention.

?

Conflicts of interest: Disclosure of conflicts and referral fee, prioritize transaction.

?

CFA candidate: Not imply there is some sort of partial designation earned after passing a

level. (e.g. Tracy, CFA II is unethical)

4.

Global Investment Performance Standards (GIPS)

?

Firms must include all fee-paying, discretionary portfolios (

委托账户

) for at least 5

years or since inception, then build up to 10 years.

?

Sections: Fundamentals of compliance (total firm assets), input data (fair value),

calculation methodology (firmwide consistent), composite construction (asset value

weighted average), disclosure, presentation, real estate, private equity, wrap

fee/separately managed account (SMA) portfolios.

?

Compliance are recommended but not required to be verified by third party (excluding

the audit group).

Quantitative Methods

1.

Yield

a)

Interest rate

?

The interest rate, r, is the required rate of return; also called the discount rate or

opportunity cost. It can be viewed as the sum of the real risk-free interest rate and a set

of premiums: inflation, default risk, liquidity and maturity.

b)

Holding period return

?

(ending value

–

beginning value + cashflow received)/beginning value

c)

Bank discount yield

?

The bank for US Treasury bills (and other money-market instruments sold on a discount

basis) is given by r

BD

= (F ? P

0

)/F × 360/t , where F is the face amount to be received at

maturity, P

0

is the price of the Treasury bill, t is the number of days to maturity.

?

Money market/Bond equivalent yield r

MM

= HPY

×

360/t = (360 × r

BD

)/(360 ? t × r

BD

).

?

Discount yield =

贴现值

/

面值

×

360/n

Add-on yield =

贴现值

/

市价

×

365/n

d)

Continuous Compound

?

The stated annual interest rate is a quoted interest rate that

does not compound within

the year

. The periodic rate is the quoted interest rate per period, equalling the stated

annual interest rate divided by the number of compounding periods per year.

这里指的都是

，而不是连续复利

?

The effective annual rate

is the amount by which a unit of currency will grow in a year

with interest on interest included. We can use

discrete or continuous compounding

to

find a periodic rate that corresponds to a particular EAR. E.g. For an 8% annual interest

rate with semiannual compounding, the EAR is 8.16%. 1.00*(1.04)

2

= 1.0816

e)

Cost of trade credit

?

Credit term 2/10 means 2% discount

f)

Spread

?

G-spread: A yield spread over a government bond.

?

I-spread: interest rate swap in the same currency with the same tenor as a bond

?

Z-spread: add an equal amount to each benchmark spot rate and value the bond.

?

Option adjusted spread OAS = Z-spread

–

option value

2.

Annuity

?

An annuity is a finite set of level sequential cash flows.

?

Two types of annuities, the annuity due (a first cash flow that occurs immediately) and

the ordinary annuity (first cash flow occurs one period from the present).

?

The present value of a

perpetuity is A/r

. A is the periodic payment.

?

E.x. Pay nothing for three years, but then pay $$20,000 per year for four years.

20000

的年 金算完之后处以

3

年的

discoun t rate

而不是

4

年（答案

52585.46

）

3.

NPV and IRR

?

The net present value (NPV) of a project is the present value of its cash inflows minus

the present value of its cash outflows. The internal rate of return (IRR) is the discount

rate that makes NPV equal to 0.

?

The IRR rule is to accept all projects with an internal rate of return exceeding the

required rate of return. It can be affected by problems of scale and timing of cash flows.

If there are conflicts between the IRR and NPV method, use NPV.

?

Profitability index = NPV/CF

0

, accept if PI>1

4.

Statistics

a)

Summary Statistics

?

Population (all members of a specified group) VS Sample (subset of a population).

Population Variance

Sample Variance

?

Semivariance: the average squared deviation below the mean

Target semivariance: average squared deviation below a stated targe

Coefficient of variance

CV= sample standard deviation/sample mean

?

The geometric mean is always no larger than the arithmetic mean, and the difference

increases as the dispersion increases.

Harmonic mean

is even smaller.

?

Mean absolute deviation

MAD=

?

C

hebyshev’s inequality:

任意数据集，

位于其平均数

m

< br>个标准差范围内的比例总是至

少为（

1-

），

m< /p>

为大于

1

的任意整数。例：

36%

的观测量在平均值±

1.25

标准差

?

Location of the yth percentile: L

yn

=(n+1)*y/100

?

Sample skewness

s is the sample standard deviation

Positive skew: mean>median>mode, Negative skew: mean

?

Sample excess kurtosis.

The first term is sample kurtosis

A distribution that has fatter tails than the normal distribution is leptokurtic;

A distribution that has thinner tails than the normal distribution is platykurtic;

A distribution identical to normal distribution (relative weight in the tails) is mesokurtic.

b)

Probability

?

P(E) can be stated as

odds

for E = P(E)/[1 ? P(E)]

or odds against E = [1 ? P(E)]/P(E).

?

If S

1

, S

2

,

…

, S

n

are mutually exclusive and exhaustive scenarios or events, then

P(A) = P(A|S

1

)P(S

1

) + P(A|S

2

)P(S

2

)+ … + P(A|S

n

)P(S

n

).

Joint probability: P(AB)=P(A|B)P(B)

?

Covariance Cov(R

i

,R

j

) = E{[R

i

?

E(R

i

)][R

j

?

E(R

j

)]}.

Correlation is a number between ?1 and +1 that measures the co

-movement (linear

association) between two random variables: ρ(R

i

,R

j

) = Cov(R

i

,R

j

)/[σ(R

i

)

σ

(R

j

)] .

?

Portfolio variance of return

?

Bayes

’

formula

e.x. An analyst believes Davies Company has a 40% probability of earning more than $$2 per

share. The probability that

Davies Company’s credit

rating will be upgraded is 70% if its

earnings per share are greater than $$2 and 20% if its earnings per share are $$2 or less. Given

the information that Davies

Company’s credit rating has been upgraded, what is the updated

probability that its earnings per share are greater than $$2?

Denote B

i

as the event earnings per share are greater than $$2. A as upgraded credit rating.

P(B

i

|A)=P (B

i

)*P(A|B

i

)/P(A)=40%*70%/(40%*70%+60%*20%)

c)

Distribution

?

Binomial random variable: Mean=np and variance=

np(1 ? p).

?

For a normal random variable, ~68% outcomes are within

, ~95% within

.

Standardize normal random variable X: Z = (X

?

μ)/σ

, has a mean=0 and variance=1.

When we have a small sample from a normal population and only the sample standard

deviation (

除

n-1), we use t distribution to construct estimation.

?

Roy

’

s safety- first criterion, addressing shortfall risk (portfolio value will fall below some

minimum acceptable level), asserts that the optimal portfolio is the one that minimizes

the probability that portfolio return falls below a threshold level. If returns are normally

distributed, the safety-first optimal portfolio P is the one that maximizes the quantity

[E(R

P

) ? R

L

]/σ

P

, where R

L

is the minimum acceptable level of return. (

类似夏普比率

)

?

The lognormal distribution is a distribution skewed to the right.

?

A confidence interval is an interval for which we can assert with a given probability

1 ? α,

called the degree of confidence, that it will contain the parameter it is intended to

estimate. A 100(1 ? α)%

(

整个值称为置信度

) confidence interval for population mean

μ when sampling from a normal distribution with known variance σ

2

is given by

?

Bias: Survivorship bias, Data-mining bias (find models by repeatedly searching through

databases for patterns), Look-ahead bias (use data not available to market participants

at the time the market participants act in the model), Time-period bias, Backfill bias

(include previous data for firms recently add to the benchmark)

d)

Hypothesis testing

?

In reaching a statistical decision, we can make two possible errors: reject a true null

hypothesis (Type I error) or fail to reject a false null hypothesis (Type II error). The level

of significance of a test is the probability of a Type I error that we accept in conducting a

hypothesis test. Power of the test is the probability of rejecting the null hypothesis

when it is false, equalling to 1- Pr(Type II error)

?

When we reject the null hypothesis, the result is statistically significant.

The (1 ? α)

confidence interval represents the range of values of the test statistic for which the null

hypothesis will not be rejected at an α significance level.

?

The p-value is the smallest level of significance at which the null hypothesis can be

rejected. The smaller the p-value, the stronger the evidence against the null hypothesis.

?

T-test: The population variance is unknown. t

n-1

=

The variances of 2 populations are unknown but equal.

Df=n1+n2-2

The variances of 2 populations are unknown but unequal. (normally distribute)

?

Z-test: Test the mean of normally distributed population with known variance. Large

sample with unknown variance may also use z-test.

Z-statistic=

?

Chi-square test: Normal distribution.

?

F-test: Normal distribution.

F=s

1

2

/s

2

2< /p>

?

Spearman rank correlation coefficient: r

s

=1-

d

i

is the difference between the ranks of each pair of observations on X and Y.

Then we can test H0:

ρ

=0 with t-test t

n-2

=

?

A non- parametric test is used when the data are given in ranks.

e)

Technical Analysis

?

Under head and shoulder pattern, price target=neckline+(neckline- head)

?

Volatility index (VIX): The volatility of options on the S&P 500 stock index. High levels

suggest that investors fear decline in the market.

?

Short-term trading index

Greater than 1 indicates the majority stocks are declining.

?

Elliott Wave Theory assumes that markets form repetitive wave patterns, which are

themselves composed of smaller and smaller subwaves. The relationships among wave

heights are frequently Fibonacci ratios.

?

Decennial pattern theory: Years ending with a 5 will have the best of any 10 years while

years ending with a 0 have the worst.

Economics

1.

Demand and Supply

a)

Price Elasticity

?

Elasticity

is how sensitive quantity demanded is to changes in various variables.

?

Demand is elastic (absolute value>1) when quantity is very responsive to price and a fall

in price accompanies a rise in total expenditure (Q*P). Perfectly inelastic demand(=0):

△

P has no effect on Q. Perfectly elastic demand(=

∞

)any higher price will have 0 Q.

最后一项的计算可以理解为斜率乘以点坐标

?

Cross-price elasticity of demand =

If cross-price elasticity is positive (negative), they are substitutes (complements).

b)

Income Elasticity

?

Income elasticity of demand = %

△

Q/%

△

income.

?

The substitution effect: As a good

’

s price falls, more of this good is consumed.

?

The income effect: As a good

’

s price falls, real income rises and, if this good is normal,

more of it will be purchased. If the good is inferior, the income effect will partially or

fully offset the substitution effect.

?

Veblen goods are high-priced goods. Consumers tend to buy more if its price rises.

?

Giffen goods are highly inferior and make up a large portion of the consumer budget. As

price falls, the substitution effect tends to cause more of the good to be consumed, but

the highly negative income effect overwhelms the substitution effect. Demand curves

for Giffen goods are positively sloped.

c)

Market Structure

?

Herfindahl-Hirschman Index: sum

of the squares of largest firms’ market share

Breakeven point

Normal profit

Shutdown point

2.

Macro

a)

Gross Domestic Production

?

GDP is the market value of all final goods and services produced within a country in a

given time period.

?

Nominal GDP is the value of production using the prices of the current year. Real GDP

uses the constant prices of a base year. The GDP deflator= nominal GDP / real GDP.

?

Headline inflation includes

all goods’ prices

. Core inflation excludes food and energy.

Laspeyres index use a constant basket of goods. Paasche index use the current

consumption weight to calculate base and current basket of goods.

?

GDP= Consumption + Investment + Government purchase + (Export-Import)

= Consumption + Saving + Tax

(S=I+G-T+X-M)

Direct tax is on income, wealth and corporate profits. Indirect is on goods and service.

No momentary accommodation, GDP stimulus on government spending has the

greatest effect compared to tax or social transfer.

?

Personal income= National income

–

indirect business tax

–

corporate income tax

- undistributed corporate profit + transfer payment to household

?

CPI= cost of basket at current price/ cost of basket at base period price *100

b)

Monetary and fiscal policy

?

Money supply

×

Velocity=Price

×

Real output

Money multiplier= 1/reserve requirement

?

Monetary policy tools: Policy rate,

reserve requirement, open market operation

?

Fiscal multiplier=[1-MPC(1-t)]

-1

?

Ricardian equivalence: If taxpayers reduce current consumption and increase current

saving by just enough to repay the principal and interest on the debt the government

issued to fund the increased deficit, there is no effect on aggregate demand. If it holds,

the future impacts of fiscal policy changes are fully discounted by economic agents as

they rationally increase their savings.

c)

Aggregate demand and supply

?

Income-saving curve: Given planned income

Liquidity- money curve: Given money supply

?

The aggregate demand curve is downward sloping because a rise in the price level

reduces wealth, raises real interest rates and the price of domestic products versus

foreign goods. It assumes a constant money supply. The AD curve will shift right if there

is an increase in household wealth, expectations, capacity utilization, monetary policy,

fiscal policy,

depreciation of domestic currency

, and foreign GDP.

?

The aggregate supply curve is the relationship between the quantity of real GDP

supplied and the price level. The long-run aggregate supply curve is vertical because

input costs adjust to changes in output prices, leaving the optimal (full employment or

natural) level of output unchanged. The short-run supply curve will shift right because

of increase on potential GDP, domestic currency and expectations about future prices,

or decrease on input prices.

?

Stagflation:

P

↑

, Y

↓

, SRAS

左移，

high unemployment (no government intervention)

Decrease in input price:

P

↓

, Y

↑

, SRAS

右移

Recessionary gap:

P

↓

, Y

↓

, AD

左移

Inflationary gap:

P

↑

, Y

↑

, AD

右移

d)

Business cycle

?

注意低谷期（高峰期）会出现

GDP

增速

增加（放缓），理解为经济形势要逆转

经济低谷时劳动生产力最高

?

Neoclassical

–

temporary deviations from long-run equilibrium. Shifts in AD and AS

?

Keynesian -- shifts in aggregate demand due to changes in expectations.

?

Monetarists

–

variations in the growth rate of money supply. Let the economy find its

new equilibrium unassisted but ensure that the money supply growing at an even pace.

?

Austrian

–

government intervention

?

New Classical and Real Business Cycle (RBC)

–

fluctuations of aggregate supply (external

shocks). Government intervention is generally not necessary

?

Leading indicators: Wage cost, manufacturing, interest rate spread between 10-year

treasury yields and overnight borrowing rates

Coincident indicators: PPI, employees on non-agricultural payrolls, real income

Lagging: Unemployment, unit labour costs, inventory

–

sales ratio, bank prime lending

rate, consumer instalment debt to income, CPI

?

A sector rotation strategy involves investing in a sector by timing investment to take

advantage of business-cycle conditions.

?

Product lifecycle

3.

International trade

a)

Trade

?

Even if a country does not have an absolute advantage in the production of any good, it

can gain from trade by producing and exporting the good(s) in which it has a

comparative advantage. For example, UK should produce cloth as it has a comparative

advantage. (100/110<90/80) A country gains if trade increases its export price relative

to its imports as compared to its autarkic prices

?

Current account: flows of goods and service

Financial account: investment flows. Government-owned assets abroad and

foreign-owned assets in the country.

Capital account: capital transfers and the acquisition and disposal of non-produced,

non-financial assets.

?

Trading blocs

Free Trade Areas: No barriers to import and export among member countries.

Customs Union: FTA+ a common set of trade restrictions with non-members.

Common Market: Customs Union+ No barriers to labour and capital movement.

Economic Union: Common Market + common institutions and economic policy.

Monetary Union: Economic Union + a single currency.

Deadweight loss

Loss on consumer surplus

b)

Trade Deficit

?

X-M=private savings + government savings

–

investment

?

The elasticities approach, Marshall

–

Lerner condition: A depreciation of the domestic

currency will decrease a trade deficit.

(

- price elasticity of

demand for exports). Currency depreciation will result in a greater improvement in the

trade deficit when

ε

X

+ ε

M

> 1

.

?

The absorption approach focuses on the impact of exchange rates on aggregate

expenditure/saving decisions. A trade deficit must be exactly matched by an offsetting

capital account surplus.

c)

Exchange Rates

?

Direct quote: Domestic currency is the price currency rather than the base one.

?

Real exchange rate EUR/USD=nominal rate * CPI(base USD)/CPI(price EUR)

?

Forward/Spot (EUR/USD) = (1+ i

price

EUR) / (1+ i

base

USD)

Buy USD forward means you are receiving USD in the future.

Forward points= (forward rate

–

spot rate)*10,000

Financial Analysis

1.

Reporting

a)

A

uditor’s opinion

?

Unqualified (clean) opinion: Statements are free from material omissions and errors.

?

Qualified opinion: explain exceptions to the accounting principles.

?

Adverse opinion.

?

Disclaimer of opinion: the auditor is unable to express an opinion

b)

Characteristics

?

Fundamental qualitative: relevance and faithful representation

?

Enhancing qualitative: comparability, verifiability, timeliness, understandability

?

Effective financial reporting: transparency, comprehensiveness, consistency

c)

Changes in accounting policies

?

A change in accounting principle requires retrospective application.

?

A change in accounting estimate applied prospectively.

d)

Tax

?

Income tax expense = taxes payable +

△

Deferred tax liability -

△

DTA

?

If deferred tax items (

之前多交了税

) cannot be reserved, they will be classified as

equity.

The valuation allowance is taken when the company will “more

likely than not”

fail to earn sufficient income to offset the deferred tax asset. The reduction of DTA is on

the valuation allowance. It can be reserved by reduction in the income tax provision.

2.

Income Statement

a)

Income Statement

?

Net income = revenue

–

expenses + other income + gains

–

losses

b)

Revenue

?

When the outcome of long-term contracts can be reliably estimated, the

percentage-of-completion method is used (Total cost incurred to date divided by the

total expected cost). If the firm cannot measure the outcome, US GAAP uses

completed-contract method and IFRS recognize the revenue to the extend of contract

cost and the rest profit is recognized at completion.

c)

Instalment Sales

?

分期收款

are expected to be received over an extended period.

?

If collectability cannot be estimated, use instalment method. Profit is equal to cash

collected during the period multiplied by the total expected profit as a percentage of

sales. If collectability is highly uncertain, use cost recovery method. Profit is only

recognized when cash collected exceeds costs incurred.

?

Barter transaction or non-monetary exchange means two parties exchange goods or

service without cash payment. Under US GAAP, revenue can be recognized at fair value

only if the firm has historically received cash payments for that and use historical costs

to determine fair value. Otherwise, the revenue is recognized at the carrying value of

the asset surrendered. Under IFRS, revenue is based on fair value from similar

non-barter transactions with unrelated parties.

d)

EPS

?

?

A stock dividend is the distribution of additional shares to each shareholder in an

amount proportional to their current number of shares. A stock split refers to the

division of each “old” share into a specific number of “new”

(post-split) shares.