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Ethical and Professional
Standards
T his study session introduces ethics, related challenges to ethical behavior, and the
role played by ethics and professionalism in the investment industry. A framework to support ethical decision-making is provided to help guide behavior. The CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards) are examined, with attention given to each standard and its application. The session concludes with coverage of the Global Investment Performance Standards.
READING ASSIGNMENTS
Reading 1 Ethics and Trust in the Investment Profession by Bidhan L. Parmar, PhD, Dorothy C. Kelly, CFA, and David B. Stevens, CIMC, CFA Reading 2 Code of Ethics and Standards of Professional Conduct Standards of Practice Handbook, Eleventh Edition Reading 3 Guidance for Standards I–VII Standards of Practice Handbook, Eleventh Edition Reading 4 Introduction to the Global Investment Performance Standards (GIPS) Reading 5 Global Investment Performance Standards (GIPS)
LEARNING OUTCOMES
READING 1. ETHICS AND TRUST IN THE INVESTMENT
PROFESSION
The candidate should be able to: a explain ethics;
b describe the role of a code of ethics in defining a profession; c describe professions and how they establish trust; d describe the need for high ethical standards in investment management; e explain professionalism in investment management; f identify challenges to ethical behavior; g distinguish between ethical and legal standards; h describe a framework for ethical decision making.
READING 2. CODE OF ETHICS AND STANDARDS OF
PROFESSIONAL CONDUCT
The candidate should be able to: a describe the structure of the CFA Institute Professional Conduct Program and the process for the enforcement of the Code and Standards; b state the six components of the Code of Ethics and the seven Standards of Professional Conduct; c explain the ethical responsibilities required by the Code and Standards, includ- ing the sub-sections of each Standard.
READING 3. GUIDANCE FOR STANDARDS I–VII
The candidate should be able to: a demonstrate the application of the Code of Ethics and Standards of Professional Conduct to situations involving issues of professional integrity; b distinguish between conduct that conforms to the Code and Standards and conduct that violates the Code and Standards; c recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.
READING 4. INTRODUCTION TO THE GLOBAL INVESTMENT
PERFORMANCE STANDARDS (GIPS)
The candidate should be able to: a explain why the GIPS standards were created, what parties the GIPS standards apply to, and who is served by the standards; b explain the construction and purpose of composites in performance reporting; c explain the requirements for verification.
READING 5. GLOBAL INVESTMENT PERFORMANCE STANDARDS
(GIPS)
The candidate should be able to: a describe the key features of the GIPS standards and the fundamentals of compliance;
Quantitative Methods (1)
T his study session introduces quantitative concepts and techniques used in financial
analysis and investment decision making. The time value of money and discounted cash flow analysis form the basis for cash flow and security valuation. Descriptive statistics used for conveying important data attributes such as central tendency, location, and dispersion are presented. Characteristics of return distributions such as symmetry, skewness, and kurtosis are also introduced. Finally, all investment forecasts and decisions involve uncertainty: Therefore, probability theory and its application quantifying risk in investment decision making is considered.
READING ASSIGNMENTS
Reading 6 The Time Value of Money by Richard A. DeFusco, PhD, CFA, Dennis W. McLeavey, DBA, CFA, Jerald E. Pinto, PhD, CFA, and David E. Runkle, PhD, CFA Reading 7 Statistical Concepts and Market Returns by Richard A. DeFusco, PhD, CFA, Dennis W. McLeavey, DBA, CFA, Jerald E. Pinto, PhD, CFA, and David E. Runkle, PhD, CFA Reading 8 Probability Concepts by Richard A. DeFusco, PhD, CFA, Dennis W. McLeavey, DBA, CFA, Jerald E. Pinto, PhD, CFA, and David E. Runkle, PhD, CFA
LEARNING OUTCOMES
READING 6. THE TIME VALUE OF MONEY
The candidate should be able to: a interpret interest rates as required rates of return, discount rates, or opportu- nity costs; b explain an interest rate as the sum of a real risk-free rate and premiums that compensate investors for bearing distinct types of risk; c calculate and interpret the effective annual rate, given the stated annual interest rate and the frequency of compounding; d solve time value of money problems for different frequencies of compounding; e calculate and interpret the future value (FV) and present value (PV) of a single sum of money, an ordinary annuity, an annuity due, a perpetuity (PV only), and a series of unequal cash flows; f demonstrate the use of a time line in modeling and solving time value of money problems.
READING 7. STATISTICAL CONCEPTS AND MARKET RETURNS
The candidate should be able to: a distinguish between descriptive statistics and inferential statistics, between a population and a sample, and among the types of measurement scales; b define a parameter, a sample statistic, and a frequency distribution; c calculate and interpret relative frequencies and cumulative relative frequencies, given a frequency distribution; d describe the properties of a data set presented as a histogram or a frequency polygon; e calculate and interpret measures of central tendency, including the population mean, sample mean, arithmetic mean, weighted average or mean, geometric mean, harmonic mean, median, and mode; f calculate and interpret quartiles, quintiles, deciles, and percentiles; g calculate and interpret 1) a range and a mean absolute deviation and 2) the variance and standard deviation of a population and of a sample; h calculate and interpret the proportion of observations falling within a specified number of standard deviations of the mean using Chebyshev’s inequality; i calculate and interpret the coefficient of variation; j explain skewness and the meaning of a positively or negatively skewed return distribution; k describe the relative locations of the mean, median, and mode for a unimodal, nonsymmetrical distribution; l explain measures of sample skewness and kurtosis; m compare the use of arithmetic and geometric means when analyzing investment returns.
Quantitative Methods (2)
T his study session introduces the common probability distributions used to describe
the behavior of random variables, such as asset prices and returns. How to estimate measures of a population (mean, standard deviation) based on a population sample is shown. The study session ends with a framework for hypothesis testing, used for validating dataset hypotheses, along with techniques to test a hypothesis.
READING ASSIGNMENTS
Reading 9 Common Probability Distributions by Richard A. DeFusco, PhD, CFA, Dennis W. McLeavey, DBA, CFA, Jerald E. Pinto, PhD, CFA, and David E. Runkle, PhD, CFA Reading 10 Sampling and Estimation by Richard A. DeFusco, PhD, CFA, Dennis W. McLeavey, DBA, CFA, Jerald E. Pinto, PhD, CFA, and David E. Runkle, PhD, CFA Reading 11 Hypothesis Testing by Richard A. DeFusco, PhD, CFA, Dennis W. McLeavey, DBA, CFA, Jerald E. Pinto, PhD, CFA, and David E. Runkle, PhD, CFA
LEARNING OUTCOMES
READING 9. COMMON PROBABILITY DISTRIBUTIONS
The candidate should be able to: a define a probability distribution and distinguish between discrete and continu- ous random variables and their probability functions;
b describe the set of possible outcomes of a specified discrete random variable; c interpret a cumulative distribution function; d calculate and interpret probabilities for a random variable, given its cumulative distribution function; e define a discrete uniform random variable, a Bernoulli random variable, and a binomial random variable; f calculate and interpret probabilities given the discrete uniform and the bino- mial distribution functions; g construct a binomial tree to describe stock price movement; h define the continuous uniform distribution and calculate and interpret proba- bilities, given a continuous uniform distribution; i explain the key properties of the normal distribution; j distinguish between a univariate and a multivariate distribution and explain the role of correlation in the multivariate normal distribution; k determine the probability that a normally distributed random variable lies inside a given interval; l define the standard normal distribution, explain how to standardize a random variable, and calculate and interpret probabilities using the standard normal distribution; m define shortfall risk, calculate the safety-first ratio, and select an optimal portfo- lio using Roy’s safety-first criterion; n explain the relationship between normal and lognormal distributions and why the lognormal distribution is used to model asset prices; o distinguish between discretely and continuously compounded rates of return and calculate and interpret a continuously compounded rate of return, given a specific holding period return; p explain Monte Carlo simulation and describe its applications and limitations; q compare Monte Carlo simulation and historical simulation.
READING 10. SAMPLING AND ESTIMATION
The candidate should be able to: a define simple random sampling and a sampling distribution; b explain sampling error; c distinguish between simple random and stratified random sampling; d distinguish between time-series and cross-sectional data; e explain the central limit theorem and its importance; f calculate and interpret the standard error of the sample mean; g identify and describe desirable properties of an estimator; h distinguish between a point estimate and a confidence interval estimate of a population parameter; i describe properties of Student’s t-distribution and calculate and interpret its degrees of freedom;
Economics (1)
T his study session begins by introducing fundamental concepts of demand and
supply analysis for individual consumers and firms. Also covered are the various market structures (perfect competition, oligopoly, monopoly) in which firms operate. Key macroeconomic concepts and principles then follow, including aggregate output and income measurement, aggregate demand and supply analysis, and analysis of economic growth factors. The study session concludes with coverage of the business cycle and its effect on economic activity.
READING ASSIGNMENTS
Reading 12 Topics in Demand and Supply Analysis by Richard V. Eastin, PhD, and Gary L. Arbogast, PhD, CFA Reading 13 The Firm and Market Structures by Richard Fritz, PhD, and Michele Gambera, PhD, CFA Reading 14 Aggregate Output, Prices, and Economic Growth by Paul R. Kutasovic, PhD, CFA, and Richard Fritz, PhD Reading 15 Understanding Business Cycles by Michele Gambera, PhD, CFA, Milton Ezrati, and Bolong Cao, PhD, CFA
LEARNING OUTCOMES
READING 12. TOPICS IN DEMAND AND SUPPLY ANALYSIS
The candidate should be able to: a calculate and interpret price, income, and cross-price elasticities of demand and describe factors that affect each measure;
b compare substitution and income effects; c distinguish between normal goods and inferior goods; d describe the phenomenon of diminishing marginal returns; e determine and interpret breakeven and shutdown points of production; f describe how economies of scale and diseconomies of scale affect costs.
READING 13. THE FIRM AND MARKET STRUCTURES
The candidate should be able to: a describe characteristics of perfect competition, monopolistic competition, oli- gopoly, and pure monopoly; b explain relationships between price, marginal revenue, marginal cost, economic profit, and the elasticity of demand under each market structure; c describe a firm’s supply function under each market structure; d describe and determine the optimal price and output for firms under each mar- ket structure; e explain factors affecting long-run equilibrium under each market structure; f describe pricing strategy under each market structure; g describe the use and limitations of concentration measures in identifying mar- ket structure; h identify the type of market structure within which a firm operates.
READING 14. AGGREGATE OUTPUT, PRICES, AND ECONOMIC
GROWTH
The candidate should be able to: a calculate and explain gross domestic product (GDP) using expenditure and income approaches; b compare the sum-of-value-added and value-of-final-output methods of calcu- lating GDP; c compare nominal and real GDP and calculate and interpret the GDP deflator; d compare GDP, national income, personal income, and personal disposable income; e explain the fundamental relationship among saving, investment, the fiscal bal- ance, and the trade balance; f explain the IS and LM curves and how they combine to generate the aggregate demand curve; g explain the aggregate supply curve in the short run and long run; h explain causes of movements along and shifts in aggregate demand and supply curves; i describe how fluctuations in aggregate demand and aggregate supply cause short-run changes in the economy and the business cycle; j distinguish between the following types of macroeconomic equilibria: long-run full employment, short-run recessionary gap, short-run inflationary gap, and short-run stagflation;
Economics (2)
T his study session begins with monetary and fiscal policy, including their use by
central banks and governments. Economics in a global context is then introduced. Next follows a discussion on the flows of goods and services and physical and finan- cial capital that occur across national borders. Highlighted in the discussion are the relationships between different types of flows and the benefits of trade to trade part- ners. Finally, given that operations and investments in global markets involve foreign exchange (currency) risk, the session concludes with an overview of currency market fundamentals.
READING ASSIGNMENTS
Reading 16 Monetary and Fiscal Policy by Andrew Clare, PhD, and Stephen Thomas, PhD Reading 17 International Trade and Capital Flows by Usha Nair-Reichert, PhD, and Daniel Robert Witschi, PhD, CFA Reading 18 Currency Exchange Rates by William A. Barker, PhD, CFA, Paul D. McNelis, and Jerry Nickelsburg
LEARNING OUTCOMES
READING 16. MONETARY AND FISCAL POLICY
The candidate should be able to: a compare monetary and fiscal policy; b describe functions and definitions of money;
c explain the money creation process; d describe theories of the demand for and supply of money; e describe the Fisher effect; f describe roles and objectives of central banks; g contrast the costs of expected and unexpected inflation; h describe tools used to implement monetary policy; i describe the monetary transmission mechanism; j describe qualities of effective central banks; k explain the relationships between monetary policy and economic growth, infla- tion, interest, and exchange rates; l contrast the use of inflation, interest rate, and exchange rate targeting by central banks; m determine whether a monetary policy is expansionary or contractionary; n describe limitations of monetary policy; o describe roles and objectives of fiscal policy; p describe tools of fiscal policy, including their advantages and disadvantages; q describe the arguments about whether the size of a national debt relative to GDP matters; r explain the implementation of fiscal policy and difficulties of implementation; s determine whether a fiscal policy is expansionary or contractionary; t explain the interaction of monetary and fiscal policy.
READING 17. INTERNATIONAL TRADE AND CAPITAL FLOWS
The candidate should be able to: a compare gross domestic product and gross national product; b describe benefits and costs of international trade; c distinguish between comparative advantage and absolute advantage; d compare the Ricardian and Heckscher–Ohlin models of trade and the source(s) of comparative advantage in each model; e compare types of trade and capital restrictions and their economic implications; f explain motivations for and advantages of trading blocs, common markets, and economic unions; g describe common objectives of capital restrictions imposed by governments; h describe the balance of payments accounts including their components; i explain how decisions by consumers, firms, and governments affect the balance of payments; j describe functions and objectives of the international organizations that facili- tate trade, including the World Bank, the International Monetary Fund, and the World Trade Organization.
Financial Reporting
and Analysis (1)
T his study session introduces the principal information sources used to evaluate a
company’s financial performance. Primary financial statements (income statement, balance sheet, cash flow statement, and statement of changes in equity) in addition to notes to these statements and management reporting are examined. A general framework for conducting financial statement analysis is provided. The session also includes a description of the roles played by financial reporting standard-setting bodies and regulatory authorities.
READING ASSIGNMENTS
Reading 19 Introduction to Financial Statement Analysis by Elaine Henry, PhD, CFA, and Thomas R. Robinson, PhD, CFA Reading 20 Financial Reporting Standards by Elaine Henry, PhD, CFA, Jan Hendrik van Greuning, DCom, CFA, and Thomas R. Robinson, PhD, CFA
LEARNING OUTCOMES
READING 19. INTRODUCTION TO FINANCIAL STATEMENT
ANALYSIS
The candidate should be able to: a describe the roles of financial reporting and financial statement analysis; b describe the roles of the statement of financial position, statement of compre- hensive income, statement of changes in equity, and statement of cash flows in evaluating a company’s performance and financial position;
Note: Changes in accounting standards as well as new rulings and/or pronouncements issued after the publication of the readings on financial reporting and analysis may cause some of the information in these readings to become dated. Candidates are not responsible for anything that occurs after the readings were published. In addition, candidates are expected to be familiar with the analytical frameworks contained in the readings, as well as the implications of alternative accounting methods for financial analysis and valuation discussed in the readings. Candidates are also responsible for the content of accounting standards, but not for the actual reference numbers. Finally, candidates should be aware that certain ratios may be defined and calculated differently. When alternative ratio definitions exist and no specific definition is given, candidates should use the ratio definitions emphasized in the readings.
c describe the importance of financial statement notes and supplementary infor- mation—including disclosures of accounting policies, methods, and estimates— and management’s commentary; d describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls; e identify and describe information sources that analysts use in financial statement analysis besides annual financial statements and supplementary information; f describe the steps in the financial statement analysis framework.
READING 20. FINANCIAL REPORTING STANDARDS
The candidate should be able to: a describe the objective of financial reporting and the importance of financial reporting standards in security analysis and valuation; b describe the roles of financial reporting standard-setting bodies and regulatory authorities in establishing and enforcing reporting standards; c describe the International Accounting Standards Board’s conceptual framework, including qualitative characteristics of financial reports, constraints on financial reports, and required reporting elements; d describe general requirements for financial statements under International Financial Reporting Standards (IFRS); e describe implications for financial analysis of alternative financial reporting systems and the importance of monitoring developments in financial reporting standards.
LEARNING OUTCOMES
READING 21. UNDERSTANDING INCOME STATEMENTS
The candidate should be able to: a describe the components of the income statement and alternative presentation formats of that statement; b Describe general principles of revenue recognition and accounting standards for revenue recognition; c calculate revenue given information that might influence the choice of revenue recognition method; d describe general principles of expense recognition, specific expense recogni- tion applications, and implications of expense recognition choices for financial analysis; e describe the financial reporting treatment and analysis of non-recurring items (including discontinued operations, unusual or infrequent items) and changes in accounting policies; f distinguish between the operating and non-operating components of the income statement; g describe how earnings per share is calculated and calculate and interpret a com- pany’s earnings per share (both basic and diluted earnings per share) for both simple and complex capital structures; h distinguish between dilutive and antidilutive securities and describe the impli- cations of each for the earnings per share calculation; i convert income statements to common-size income statements; j evaluate a company’s financial performance using common-size income state- ments and financial ratios based on the income statement; k describe, calculate, and interpret comprehensive income; l describe other comprehensive income and identify major types of items included in it.
READING 22. UNDERSTANDING BALANCE SHEETS
The candidate should be able to: a describe the elements of the balance sheet: assets, liabilities, and equity; b describe uses and limitations of the balance sheet in financial analysis; c describe alternative formats of balance sheet presentation; d distinguish between current and non-current assets and current and non- current liabilities; e describe different types of assets and liabilities and the measurement bases of each; f describe the components of shareholders’ equity; g convert balance sheets to common-size balance sheets and interpret common- size balance sheets; h calculate and interpret liquidity and solvency ratios.
READING 23. UNDERSTANDING CASH FLOW STATEMENTS
The candidate should be able to: a compare cash flows from operating, investing, and financing activities and clas- sify cash flow items as relating to one of those three categories given a descrip- tion of the items; b describe how non-cash investing and financing activities are reported; c contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and US generally accepted accounting principles (US GAAP); d distinguish between the direct and indirect methods of presenting cash from operating activities and describe arguments in favor of each method; e describe how the cash flow statement is linked to the income statement and the balance sheet; f describe the steps in the preparation of direct and indirect cash flow state- ments, including how cash flows can be computed using income statement and balance sheet data; g convert cash flows from the indirect to direct method; h analyze and interpret both reported and common-size cash flow statements; i calculate and interpret free cash flow to the firm, free cash flow to equity, and performance and coverage cash flow ratios.
READING 24. FINANCIAL ANALYSIS TECHNIQUES
The candidate should be able to: a describe tools and techniques used in financial analysis, including their uses and limitations; b classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios; c describe relationships among ratios and evaluate a company using ratio analysis; d demonstrate the application of DuPont analysis of return on equity and calcu- late and interpret effects of changes in its components; e calculate and interpret ratios used in equity analysis and credit analysis; f explain the requirements for segment reporting and calculate and interpret segment ratios; g describe how ratio analysis and other techniques can be used to model and forecast earnings.
