2018 CFA level 1 study note book1

2018 CFA level 1 study note book1 2018 CFA level 1 study note book12018 CFA level 1 study note book12018 CFA level 1 study note book12018 CFA level 1 study note book12018 CFA level 1 study note book12018 CFA level 1 study note book12018 CFA level 1 study note book12018 CFA level 1 study note book1 2018 CFA level 1 study note book1 2018 CFA level 1 study note book1

Table of Contents

1 Getting Started Flyer

2 Table of Contents

3 Page List

4 Book 1 – Ethical & Professional Standards and Quantitative Methods

5 Welcome to the 2018 SchweserNotes

6 Reading Assignments and Learning Outcome Statements

7 Ethics and Trust in the Investment Profession

1 LOS 1.a: Explain ethics

2 LOS 1.b: Describe the role of a code of ethics in defining a profession

3 LOS 1.c: Identify challenges to ethical behavior

4 LOS 1.d: Describe the need for high ethical standards in the investmentindustry

5 LOS 1.e: Distinguish between ethical and legal standards

6 LOS 1.f: Describe and apply a framework for ethical decision making

1 Answers – Concept Checkers

8 Code of Ethics and Standards of Professional Conduct

1 LOS 2.a: Describe the structure of the CFA Institute Professional ConductProgram and the process for the enforcement of the Code and Standards

2 LOS 2.b: State the six components of the Code of Ethics and the sevenStandards of Professional Conduct

3 LOS 2.c: Explain the ethical responsibilities required by the Code andStandards, including the sub-sections of each Standard

9 Guidance for Standards I-VII

1 LOS 3.a: Demonstrate the application of the Code of Ethics and Standards

of Professional Conduct to situations involving issues of professionalintegrity

2 LOS 3.b: Distinguish between conduct that conforms to the Code andStandards and conduct that violates the Code and Standards

3 LOS 3.c: Recommend practices and procedures designed to preventviolations of the Code of Ethics and Standards of Professional Conduct

4 Concept Checkers

1 Answers – Concept Checkers

10 Introduction to the Global Investment Performance Standards (GIPS)

1 LOS 4.a: Explain why the GIPS standards were created, what parties theGIPS standards apply to, and who is served by the standards

2 LOS 4.b: Explain the construction and purpose of composites in

11 The GIPS Standards

1 LOS 5.a: Describe the key features of the GIPS standards and the

fundamentals of compliance

2 LOS 5.b: Describe the scope of the GIPS standards with respect to an

investment firm’s definition and historical performance record

3 LOS 5.c: Explain how the GIPS standards are implemented in countries withexisting standards for performance reporting and describe the appropriateresponse when the GIPS standards and local regulations conflict

4 LOS 5.d: Describe the nine major sections of the GIPS standards

1 Answers – Concept Checkers

12 Self-Test Assessment: Ethical and Professional Standards

13 The Time Value of Money

1 Time Value of Money Concepts and Applications

2 LOS 6.a: Interpret interest rates as required rates of return, discount rates,

7 LOS 6.f: Demonstrate the use of a time line in modeling and solving timevalue of money problems

8 Key Concepts

1 LOS 6.a

1 Answers – Challenge Problems

14 Discounted Cash Flow Applications

1 LOS 7.a: Calculate and interpret the net present value (NPV) and the

internal rate of return (IRR) of an investment

2 LOS 7.b: Contrast the NPV rule to the IRR rule, and identify problems

associated with the IRR rule

3 LOS 7.c: Calculate and interpret a holding period return (total return)

4 LOS 7.d: Calculate and compare the money-weighted and time-weightedrates of return of a portfolio and evaluate the performance of portfoliosbased on these measures

5 LOS 7.e: Calculate and interpret the bank discount yield, holding periodyield, effective annual yield, and money market yield for US Treasury billsand other money market instruments

6 LOS 7.f: Convert among holding period yields, money market yields,

effective annual yields, and bond equivalent yields

1 Answers – Challenge Problems

15 Statistical Concepts and Market Returns

1 LOS 8.a: Distinguish between descriptive statistics and inferential statistics,between a population and a sample, and among the types of measurementscales

2 LOS 8.b: Define a parameter, a sample statistic, and a frequency

distribution

3 LOS 8.c: Calculate and interpret relative frequencies and cumulative

relative frequencies, given a frequency distribution

4 LOS 8.d: Describe the properties of a data set presented as a histogram or afrequency polygon

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5 LOS 8.e: Calculate and interpret measures of central tendency, includingthe population mean, sample mean, arithmetic mean, weighted average ormean, geometric mean, harmonic mean, median, and mode.

6 LOS 8.f: Calculate and interpret quartiles, quintiles, deciles, and percentiles

7 LOS 8.g: Calculate and interpret 1) a range and a mean absolute deviationand 2) the variance and standard deviation of a population and of a

11 LOS 8.k: Describe the relative locations of the mean, median, and mode for

a unimodal, nonsymmetrical distribution

12 LOS 8.l: Explain measures of sample skewness and kurtosis

13 LOS 8.m: Compare the use of arithmetic and geometric means when

analyzing investment returns

1 LOS 9.a: Define a random variable, an outcome, an event, mutually

exclusive events, and exhaustive events

2 LOS 9.b: State the two defining properties of probability and distinguishamong empirical, subjective, and a priori probabilities

3 LOS 9.c: State the probability of an event in terms of odds for and againstthe event

4 LOS 9.d: Distinguish between unconditional and conditional probabilities

5 LOS 9.e: Explain the multiplication, addition, and total probability rules

6 LOS 9.f: Calculate and interpret 1) the joint probability of two events, 2) theprobability that at least one of two events will occur, given the probability

of each and the joint probability of the two events, and 3) a joint

probability of any number of independent events

7 LOS 9.g: Distinguish between dependent and independent events

8 LOS 9.h: Calculate and interpret an unconditional probability using the totalprobability rule

9 LOS 9.i: Explain the use of conditional expectation in investment

applications

10 LOS 9.j: Explain the use of a tree diagram to represent an investment

problem

11 LOS 9.k: Calculate and interpret covariance and correlation

12 LOS 9.l: Calculate and interpret the expected value, variance, and standarddeviation of a random variable and of returns on a portfolio

13 LOS 9.m: Calculate and interpret covariance given a joint probability

function

14 LOS 9.n: Calculate and interpret an updated probability using Bayes’

formula

15 LOS 9.o: Identify the most appropriate method to solve a particular

counting problem and solve counting problems using factorial,

combination, and permutation concepts

1 Answers – Challenge Problems

17 Common Probability Distributions

1 LOS 10.a: Define a probability distribution and distinguish between discreteand continuous random variables and their probability functions.

2 LOS 10.b: Describe the set of possible outcomes of a specified discreterandom variable

3 LOS 10.c: Interpret a cumulative distribution function

4 LOS 10.d: Calculate and interpret probabilities for a random variable, givenits cumulative distribution function

5 LOS 10.e: Define a discrete uniform random variable, a Bernoulli randomvariable, and a binomial random variable

6 LOS 10.f: Calculate and interpret probabilities given the discrete uniformand the binomial distribution functions

7 LOS 10.g: Construct a binomial tree to describe stock price movement

8 LOS 10.h: Define the continuous uniform distribution and calculate andinterpret probabilities, given a continuous uniform distribution

9 LOS 10.i: Explain the key properties of the normal distribution

10 LOS 10.j: Distinguish between a univariate and a multivariate distributionand explain the role of correlation in the multivariate normal distribution

11 LOS 10.k: Determine the probability that a normally distributed randomvariable lies inside a given interval

12 LOS 10.l: Define the standard normal distribution, explain how to

standardize a random variable, and calculate and interpret probabilitiesusing the standard normal distribution

13 LOS 10.m: Define shortfall risk, calculate the safety-first ratio, and select anoptimal portfolio using Roy’s safety-first criterion

14 LOS 10.n: Explain the relationship between normal and lognormal

distributions and why the lognormal distribution is used to model assetprices

15 LOS 10.o: Distinguish between discretely and continuously compoundedrates of return and calculate and interpret a continuously compoundedrate of return, given a specific holding period return

16 LOS 10.p: Explain Monte Carlo simulation and describe its applications andlimitations

17 LOS 10.q: Compare Monte Carlo simulation and historical simulation

1 Answers – Challenge Problems

18 Sampling and Estimation

1 LOS 11.a: Define simple random sampling and a sampling distribution

2 LOS 11.b: Explain sampling error

3 LOS 11.c: Distinguish between simple random and stratified random

sampling

4 LOS 11.d: Distinguish between time-series and cross-sectional data

5 LOS 11.e: Explain the central limit theorem and its importance

6 LOS 11.f: Calculate and interpret the standard error of the sample mean

7 LOS 11.g: Identify and describe desirable properties of an estimator

8 LOS 11.h: Distinguish between a point estimate and a confidence intervalestimate of a population parameter

9 LOS 11.i: Describe properties of Student’s t-distribution and calculate andinterpret its degrees of freedom

10 LOS 11.j: Calculate and interpret a confidence interval for a populationmean, given a normal distribution with 1) a known population variance, 2)

an unknown population variance, or 3) an unknown variance and a largesample size

11 LOS 11.k: Describe the issues regarding selection of the appropriate samplesize, data-mining bias, sample selection bias, survivorship bias, look-aheadbias, and time-period bias

1 Answers – Concept Checkers

7 LOS 12.g: Identify the appropriate test statistic and interpret the results for

a hypothesis test concerning the population mean of both large and smallsamples when the population is normally or approximately normally

distributed and the variance is 1) known or 2) unknown

8 LOS 12.h: Identify the appropriate test statistic and interpret the results for

a hypothesis test concerning the equality of the population means of two

at least approximately normally distributed populations, based on

independent random samples with 1) equal or 2) unequal assumed

variances

9 LOS 12.i: Identify the appropriate test statistic and interpret the results for

a hypothesis test concerning the mean difference of two normally

distributed populations

10 LOS 12.j: Identify the appropriate test statistic and interpret the results for

a hypothesis test concerning 1) the variance of a normally distributedpopulation, and 2) the equality of the variances of two normally distributedpopulations based on two independent random samples

11 LOS 12.k: Distinguish between parametric and nonparametric tests anddescribe situations in which the use of nonparametric tests may be

4 LOS 13.d: Describe common chart patterns.

5 LOS 13.e: Describe common technical analysis indicators (price-based,momentum oscillators, sentiment, and flow of funds)

6 LOS 13.f: Explain how technical analysts use cycles

7 LOS 13.g: Describe the key tenets of Elliott Wave Theory and the

importance of Fibonacci numbers

8 LOS 13.h: Describe intermarket analysis as it relates to technical analysisand asset allocation

1 Answers – Concept Checkers

21 Self-Test Assessment: Quantitative Methods

22 Self-Test Assessment: Quantitative Methods Answer Key

23 Formulas

24 Appendix A: Areas Under The Normal Curve

25 Cumulative Z-Table

26 Appendix B: Student’s t-Distribution

27 Appendix C: F-Table at 5 Percent (Upper Tail)

28 Appendix D: F-Table at 2.5 Percent (Upper Tail)

29 Appendix E: Chi-Squared table

30 Copyright

B OOK 1 – E THICAL AND P ROFESSIONAL S TANDARDS AND Q UANTITATIVE M ETHODS

Reading Assignments and Learning Outcome Statements

Study Session 1 – Ethical and Professional Standards

Self-Test Assessment: Ethical and Professional Standards

Study Session 2 – Quantitative Methods: Basic Concepts

Study Session 3 – Quantitative Methods: Application

Self-Test Assessment: Quantitative Methods

Formulas

Appendices

W ELCOME TO THE 2018 S CHWESER N OTES ™

Thank you for trusting Kaplan Schweser to help you pass the Level I CFA exam Youhave made an exceptionally good decision, and we congratulate you for taking on thechallenge of earning your CFA charter

Your first step should be to view the “How to Pass the Level I CFA Exam” video in theCandidate Resource Library, in which we explain the structure of the exam, the

format of Level I exam questions, and topic area exam weights We also provideadvice on study techniques based on learning science research, interpreting the(500+) Level I CFA Learning Outcome Statements (LOS), and how to create an

effective study plan Understanding the exact nature of the challenge you have taken

on is an important first step toward passing the Level I CFA exam

The next step is to study and learn the material required for the exam The best time

to begin that study is today (regardless of when you are reading this) Less than 40%

of those who register for a Level I exam pass the exam (including exam re-takers) Formany, passing the exam is a formidable challenge, and one of the reasons candidatesgive most frequently for failing is “not starting early enough.”

Begin with Study Session 1, Ethical and Professional Standards, and progress throughStudy Session 18, Alternative Investments The five SchweserNotes books cover allthe LOS required for the exam While they provide an excellent summary of therequired material for Study Session 1, we strongly recommend that, for this material,all candidates also read the CFA Institute Standards of Practice Handbook (Reading 3

in the Level I CFA Curriculum, Volume 1) at the beginning of their study and againshortly before the exam Three of the ten topic areas will be the source for almosthalf (47%) of the Level I exam questions: Ethical and Professional Standards,

Quantitative Methods, and Financial Reporting and Analysis

For most candidates, repetition is essential to adequately learn and retain the

knowledge required for the exam across the ten diverse topic areas We providevideo instruction for all of the readings, to supplement your study of the

SchweserNotes The videos cover every LOS, in contrast to our classes, which focus

on the curriculum material candidates most often struggle with, include practicequestions and study tips, and develop links between different parts of the curriculum

To gauge your progress and help you learn and retain the material, there are reading questions and topic area self-assessment tests in the SchweserNotes

end-of-Additionally, our SchweserPro question bank (QBank) contains thousands of

questions for learning, practice, and review during your study period

It is very important to finish your initial study of the entire curriculum at least a

month prior to your exam date and to use this time for a review course, and to takeseveral practice exams including the SchweserMock exam, which is offered by CFA

Societies in over 100 locations around the world and online This final month is whenyou will get an indication of how effective your study has been and find out whichtopic areas require significant additional review on your part Additionally, practiceanswering exam-like questions across all topics and work on your exam timing Thesewill be important determinants of your success on exam day.

I would like to thank Craig Prochaska, CFA, who, as my assistant, has been invaluable

in the preparation of all our Level I study materials and candidate support for over 10years Craig and I will be answering your questions and supporting your study

throughout the exam season

Best regards,

Doug Van Eaton

Doug Van Eaton, PhD, CFA

R EADING A SSIGNMENTS AND L EARNING O UTCOME

Ethical and Professional Standards and Quantitative Methods, CFA Program Level I

2018 Curriculum (CFA Institute, 2017)

1 Ethics and Trust in the Investment Profession

2 Code of Ethics and Standards of Professional Conduct

3 Guidance for Standards I–VII

4 Introduction to the Global Investment Performance Standards (GIPS®)

5 The GIPS Standards

STUDY SESSION 2

Reading Assignments

Ethical and Professional Standards and Quantitative Methods CFA Program Level I

2018 Curriculum (CFA Institute, 2017)

6 The Time Value of Money

7 Discounted Cash Flow Applications

8 Statistical Concepts and Market Returns

9 Probability Concepts

STUDY SESSION 3

Reading Assignments

Ethical and Professional Standards and Quantitative Methods CFA Program Level I

2018 Curriculum (CFA Institute, 2017)

10 Common Probability Distributions

11 Sampling and Estimation

1 Ethics and Trust in the Investment Profession

The candidate should be able to:

a explain ethics (page 1)

b describe the role of a code of ethics in defining a profession (page 1)

c identify challenges to ethical behavior (page 2)

d describe the need for high ethical standards in the investment industry.(page 2)

e distinguish between ethical and legal standards (page 3)

f describe and apply a framework for ethical decision making (page 3)

The topical coverage corresponds with the following CFA Institute assigned 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 andthe process for the enforcement of the Code and Standards (page 8)

b state the six components of the Code of Ethics and the seven Standards ofProfessional Conduct (page 9)

c explain the ethical responsibilities required by the Code and Standards,including the sub-sections of each Standard (page 10)

The topical coverage corresponds with the following CFA Institute assigned 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.(page 14)

b distinguish between conduct that conforms to the Code and Standards andconduct that violates the Code and Standards (page 14)

c recommend practices and procedures designed to prevent violations of theCode of Ethics and Standards of Professional Conduct (page 14)

The topical coverage corresponds with the following CFA Institute assigned 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 (page 43)

b explain the construction and purpose of composites in performance

reporting (page 44)

c explain the requirements for verification (page 44)

The topical coverage corresponds with the following CFA Institute assigned reading:

5 The GIPS Standards

The candidate should be able to:

a describe the key features of the GIPS standards and the fundamentals ofcompliance (page 46)

b describe the scope of the GIPS standards with respect to an investmentfirm’s definition and historical performance record (page 48)

c explain how the GIPS standards are implemented in countries with existingstandards for performance reporting and describe the appropriate responsewhen the GIPS standards and local regulations conflict (page 48)

d describe the nine major sections of the GIPS standards (page 48)

STUDY SESSION 2

The topical coverage corresponds with the following CFA Institute assigned 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

opportunity costs (page 66)

b explain an interest rate as the sum of a real risk-free rate and premiums thatcompensate investors for bearing distinct types of risk (page 67)

c calculate and interpret the effective annual rate, given the stated annual

interest rate and the frequency of compounding (page 67)

d solve time value of money problems for different frequencies of

compounding (page 69)

e calculate and interpret the future value (FV) and present value (PV) of asingle sum of money, an ordinary annuity, an annuity due, a perpetuity (PVonly), and a series of unequal cash flows (page 70)

f demonstrate the use of a time line in modeling and solving time value ofmoney problems (page 84)

The topical coverage corresponds with the following CFA Institute assigned reading:

7 Discounted Cash Flow Applications

The candidate should be able to:

a calculate and interpret the net present value (NPV) and the internal rate ofreturn (IRR) of an investment (page 106)

b contrast the NPV rule to the IRR rule, and identify problems associated withthe IRR rule (page 109)

c calculate and interpret a holding period return (total return) (page 111)

d calculate and compare the money-weighted and time-weighted rates ofreturn of a portfolio and evaluate the performance of portfolios based onthese measures (page 111)

e calculate and interpret the bank discount yield, holding period yield,

effective annual yield, and money market yield for US Treasury bills andother money market instruments (page 115)

f convert among holding period yields, money market yields, effective annualyields, and bond equivalent yields (page 118)

The topical coverage corresponds with the following CFA Institute assigned reading:

8 Statistical Concepts and Market Returns

The candidate should be able to:

a distinguish between descriptive statistics and inferential statistics, between apopulation and a sample, and among the types of measurement scales.(page 131)

b define a parameter, a sample statistic, and a frequency distribution

(page 132)

c calculate and interpret relative frequencies and cumulative relative

frequencies, given a frequency distribution (page 134)

d describe the properties of a data set presented as a histogram or a frequencypolygon (page 137)

e calculate and interpret measures of central tendency, including the

population mean, sample mean, arithmetic mean, weighted average ormean, geometric mean, harmonic mean, median, and mode (page 138)

f calculate and interpret quartiles, quintiles, deciles, and percentiles

(page 143)

g calculate and interpret 1) a range and a mean absolute deviation and 2) thevariance and standard deviation of a population and of a sample (page 144)

h calculate and interpret the proportion of observations falling within a

specified number of standard deviations of the mean using Chebyshev’sinequality (page 148)

i calculate and interpret the coefficient of variation and the Sharpe ratio.(page 149)

j explain skewness and the meaning of a positively or negatively skewed returndistribution (page 151)

k describe the relative locations of the mean, median, and mode for a

unimodal, nonsymmetrical distribution (page 152)

l explain measures of sample skewness and kurtosis (page 153)

m compare the use of arithmetic and geometric means when analyzing

investment returns (page 155)

The topical coverage corresponds with the following CFA Institute assigned reading:

9 Probability Concepts

The candidate should be able to:

a define a random variable, an outcome, an event, mutually exclusive events,and exhaustive events (page 170)

b state the two defining properties of probability and distinguish among

empirical, subjective, and a priori probabilities (page 170)

c state the probability of an event in terms of odds for and against the event.(page 171)

d distinguish between unconditional and conditional probabilities (page 172)

e explain the multiplication, addition, and total probability rules (page 172)

f calculate and interpret 1) the joint probability of two events, 2) the

probability that at least one of two events will occur, given the probability ofeach and the joint probability of the two events, and 3) a joint probability ofany number of independent events (page 173)

g distinguish between dependent and independent events (page 176)

h calculate and interpret an unconditional probability using the total

probability rule (page 177)

i explain the use of conditional expectation in investment applications.

(page 181)

j explain the use of a tree diagram to represent an investment problem

(page 181)

k calculate and interpret covariance and correlation (page 182)

l calculate and interpret the expected value, variance, and standard deviation

of a random variable and of returns on a portfolio (page 186)

m calculate and interpret covariance given a joint probability function

STUDY SESSION 3

The topical coverage corresponds with the following CFA Institute assigned reading:

10 Common Probability Distributions

The candidate should be able to:

a define a probability distribution and distinguish between discrete and

continuous random variables and their probability functions (page 214)

b describe the set of possible outcomes of a specified discrete random

variable (page 214)

c interpret a cumulative distribution function (page 216)

d calculate and interpret probabilities for a random variable, given its

cumulative distribution function (page 216)

e define a discrete uniform random variable, a Bernoulli random variable, and

a binomial random variable (page 217)

f calculate and interpret probabilities given the discrete uniform and thebinomial distribution functions (page 217)

g construct a binomial tree to describe stock price movement (page 220)

h define the continuous uniform distribution and calculate and interpretprobabilities, given a continuous uniform distribution (page 221)

i explain the key properties of the normal distribution (page 223)

j distinguish between a univariate and a multivariate distribution and explainthe role of correlation in the multivariate normal distribution (page 223)

k determine the probability that a normally distributed random variable liesinside a given interval (page 224)

l define the standard normal distribution, explain how to standardize a randomvariable, and calculate and interpret probabilities using the standard normaldistribution (page 226)

m define shortfall risk, calculate the safety-first ratio, and select an optimalportfolio using Roy’s safety-first criterion (page 229)

n explain the relationship between normal and lognormal distributions andwhy the lognormal distribution is used to model asset prices (page 231)

o distinguish between discretely and continuously compounded rates of returnand calculate and interpret a continuously compounded rate of return, given

a specific holding period return (page 232)

p explain Monte Carlo simulation and describe its applications and limitations.(page 234)

q compare Monte Carlo simulation and historical simulation (page 235)

The topical coverage corresponds with the following CFA Institute assigned reading:

11 Sampling and Estimation

The candidate should be able to:

a define simple random sampling and a sampling distribution (page 250)

b explain sampling error (page 250)

c distinguish between simple random and stratified random sampling

(page 251)

d distinguish between time-series and cross-sectional data (page 252)

e explain the central limit theorem and its importance (page 252)

f calculate and interpret the standard error of the sample mean (page 253)

g identify and describe desirable properties of an estimator (page 255)

h distinguish between a point estimate and a confidence interval estimate of apopulation parameter (page 255)

i describe properties of Student’s t-distribution and calculate and interpret its

degrees of freedom (page 255)

j calculate and interpret a confidence interval for a population mean, given anormal distribution with 1) a known population variance, 2) an unknownpopulation variance, or 3) an unknown population variance and a largesample size (page 257)

k describe the issues regarding selection of the appropriate sample size, mining bias, sample selection bias, survivorship bias, look-ahead bias, andtime-period bias (page 262)

data-The topical coverage corresponds with the following CFA Institute assigned reading:

12 Hypothesis Testing

The candidate should be able to:

a define a hypothesis, describe the steps of hypothesis testing, and describeand interpret the choice of the null and alternative hypotheses (page 274)

b distinguish between one-tailed and two-tailed tests of hypotheses

(page 275)

c explain a test statistic, Type I and Type II errors, a significance level, and howsignificance levels are used in hypothesis testing (page 279)

d explain a decision rule, the power of a test, and the relation between

confidence intervals and hypothesis tests (page 281)

e distinguish between a statistical result and an economically meaningfulresult (page 283)

f explain and interpret the p-value as it relates to hypothesis testing.

(page 284)

g identify the appropriate test statistic and interpret the results for a

hypothesis test concerning the population mean of both large and smallsamples when the population is normally or approximately normally

distributed and the variance is 1) known or 2) unknown (page 285)

h identify the appropriate test statistic and interpret the results for a

hypothesis test concerning the equality of the population means of two atleast approximately normally distributed populations, based on independentrandom samples with 1) equal or 2) unequal assumed variances (page 288)

i identify the appropriate test statistic and interpret the results for a

hypothesis test concerning the mean difference of two normally distributedpopulations (page 292)

j identify the appropriate test statistic and interpret the results for a

hypothesis test concerning 1) the variance of a normally distributed

population, and 2) the equality of the variances of two normally distributedpopulations based on two independent random samples (page 296)

k distinguish between parametric and nonparametric tests and describe

situations in which the use of nonparametric tests may be appropriate.(page 302)

The topical coverage corresponds with the following CFA Institute assigned reading:

13 Technical Analysis

The candidate should be able to:

a explain principles of technical analysis, its applications, and its underlying

d describe common chart patterns (page 319)

e describe common technical analysis indicators (price-based, momentumoscillators, sentiment, and flow of funds) (page 321)

f explain how technical analysts use cycles (page 326)

g describe the key tenets of Elliott Wave Theory and the importance ofFibonacci numbers (page 326)

h describe intermarket analysis as it relates to technical analysis and assetallocation (page 327)

The following is a review of the Ethical and Professional Standards principles designed to address the learning outcome statements set forth by CFA Institute Cross-Reference to CFA Institute Assigned Reading #1.

E THICS AND T RUST IN THE I NVESTMENT P ROFESSION

Study Session 1

EXAM FOCUS

From this reading, candidates should learn the definitions of ethics and ethical

behavior presented by the authors and the arguments presented for having a code ofethics and following ethical principles Additionally, the arguments for integratingethics into the decision-making process include testable material

LOS 1.a: Explain ethics.

CFA ® Program Curriculum, Volume 1, page 6

Ethics can be described as a set of shared beliefs about what is good or acceptable

behavior and what is bad or unacceptable behavior Ethics also refers to the study ofgood and bad behavior Ethical conduct has been described as behavior that followsmoral principles and is consistent with society’s ethical expectations

Ethical conduct has also been described as conduct that improves outcomes for

stakeholders, who are people directly or indirectly affected by the conduct Examples

of stakeholders in the case of investment professionals include their clients,

co-workers, employers, and the investment profession as a whole Some decisions maybring positive results for you, but negative consequences for a stakeholder, such as aco-worker Ethical conduct is behavior that balances your self-interest with the

impact on others

LOS 1.b: Describe the role of a code of ethics in defining a profession.

CFA ® Program Curriculum, Volume 1, page 9

A code of ethics is a written set of moral principles that can guide behavior by

describing what is considered acceptable behavior Having a code of ethics is a way tocommunicate the values, principles, and expectations of an organization or othergroup of people and provides a general guide to what constitutes acceptable

behavior Some codes of ethics include a set of rules or standards that require someminimum level of ethical behavior

A profession refers to a group of people with specialized skills and knowledge who

serve others and agree to behave in accordance with a code of ethics A professionalcode of ethics is a way for a profession to communicate to the public that its

members will use their knowledge and skills to serve their clients in an honest andethical manner.

LOS 1.c: Identify challenges to ethical behavior.

CFA ® Program Curriculum, Volume 1, page 11

One challenge to ethical behavior is that individuals tend to overrate the ethicalquality of their behavior on a relative basis and overemphasize the importance oftheir own personal traits in determining the ethical quality of their behavior

It is claimed that external or situational influences are a more important determinant

of the ethical quality of behavior than internal (personal) traits that influence

behavior One situational influence is social pressure from others Loyalty to an

employer, supervisor, organization, or co-workers can cause individuals to act inunethical ways as they place more importance on their self-interest and short-termresults than on longerterm results and the ethical quality of their decisions and

behavior The prospect of acquiring more money or greater prestige can cause

individuals to engage in unethical behavior

Firms with strict rules-based compliance procedures run the risk of fostering a culturethat is so focused on adhering to compliance rules that individuals only ask

themselves what they can do The question of what behavior they should engage in,

based on ethical principles and longer-term results, is often not addressed in suchsituations

LOS 1.d: Describe the need for high ethical standards in the investment industry.

CFA ® Program Curriculum, Volume 1, page 15

Investment professionals have a special responsibility because they are entrustedwith their clients’ wealth The responsibility to use their specialized knowledge andskills to both protect and grow client assets makes high ethical standards all the moreimportant Investment advice and management are intangible products, makingquality and value received more difficult to evaluate than for tangible products such

as a laptop computer or a restaurant meal For this reason, trust in investment

professionals takes on an even greater importance than in many other businesses.Failure to act in a highly ethical manner can damage not only client wealth but alsoimpede the success of investment firms and investment professionals because

potential investors will be less likely to use their services

Unethical behavior by financial services professionals can have negative effects forsociety as a whole The financial services industry serves as an intermediary betweensavers and those seeking financing for their business activities A lack of trust infinancial advisors will reduce the funds entrusted to them and increase the cost ofraising capital for business investment and growth When investors cannot rely onthe information they receive from financial services professionals, this adds another

layer of risk on top of the investment risks that investors face Even the perception ofadditional risk will reduce the amounts invested and increase the returns required toattract investor capital Level

In addition to reducing the amount of investment overall, unethical behavior—such

as providing incomplete, misleading, or false information to investors—can affect theallocation of the capital that is raised Misallocation of capital to businesses otherthan those with the most potential for growth and societal benefit reduces the

growth of an economy and the well-being of its people When the allocation of

investment capital is constrained or inefficient, the negative consequences extend toall the participants in an economy

LOS 1.e: Distinguish between ethical and legal standards.

CFA ® Program Curriculum, Volume 1, page 17

Not all unethical actions are illegal, and not all illegal actions are unethical In someplaces it may be illegal to report one’s employer’s actions against the best interests ofclients by sharing what is considered private company information with authorities,but doing so may be considered ethical “whistleblowing” behavior by some Acts ofcivil disobedience that are illegal are also considered by many to be ethical behavior

On the other hand, recommending investment in a relative’s firm without disclosuremay not be illegal, but would be considered unethical by many

Ethical principles often set a higher standard of behavior than laws and regulations.New laws and regulations often result from recent instances of what is perceived to

be unethical behavior Just as the Securities Act of 1933, the Glass-Steagall Act, andthe Securities Exchange Act of 1934 followed the perceived bad behavior by

investment professionals and bankers leading to the 1929 market crash, the

Sarbanes-Oxley laws followed the accounting scandals at Enron and Worldcom, andthe Dodd-Frank Act followed the 2008 financial crisis New laws and regulations cancreate opportunities for different unethical behavior In general, ethical decisionsrequire more judgment and consideration of the impact of behavior on many

stakeholders compared to legal decisions

LOS 1.f: Describe and apply a framework for ethical decision making.

CFA ® Program Curriculum, Volume 1, page 20

Ethical decisions will be improved when ethics are integrated into a firm’s decisionmaking process This will allow decision makers and teams to consider alternativeactions as well as shorter- and longer-term consequences from various perspectives,improving the ethical aspects of their decisions To do this it is first necessary that thefirm adopt a code of ethics to guide the process

Such integration provides an opportunity to teach, practice, and reinforce ethicaldecision making This is an important part of developing an ethical culture The

support of senior management for integrating ethics into the decision-making

process is also very important in developing a culture and processes that will result inethical decision making.

Using a framework for ethical decision making helps individuals identify the

important issues involved, examine these issues from multiple perspectives, developthe necessary judgment and decision making skills required, and avoid unanticipatedethical consequences

The following ethical decision-making framework is presented in the Level I CFACurriculum,1

Identify: Relevant facts, stakeholders and duties owed, ethical principles,

conflicts of interest

Consider: Situational influences, additional guidance, alternative actions

Decide and act

Reflect: Was the outcome as anticipated? Why or why not?

In the first step, decision makers need to identify the facts they have to work with,and the facts they would like to have, before making a decision Stakeholders—thoseaffected by the decision—must be identified These stakeholders may include theemployer, clients, co-workers, self, family, and others in the industry, and the duties

to each stakeholder should be identified This part of the process will also help inexplicitly identifying potential conflicts of interest among the various stakeholders Atthis point the decision makers should be able to identify the ethical principles

involved in the decision, although greater clarity about those may also be gainedthroughout the process

In the second step, the framework suggests situational factors that may influencedecision makers should be identified and considered along with any personal biasesthat may come into play At this point, decision makers may seek outside guidancewhich can come from a mentor, colleagues, or friends who have shown good

judgment in the past Guidance may also be sought from the firm’s legal and

compliance departments This guidance from alternative sources will help to provide

a variety of perspectives from which the decision under consideration can be viewed,

as well as help in developing alternatives that should be considered Finally the

alternative actions that have been identified are all considered, taking into accountboth the short-term and long-term effects of each alternative action and any

potential but unanticipated ethical implications

In the final step, decision makers should evaluate the outcomes of the actions thatwere taken In particular, they should consider whether the decisions had their

intended results and whether appropriate consideration was given to ethical

principles, situational influences, and duties to clients and other stakeholders

“Ethics and Trust in the Investment Profession,” Bidhan L Parmar, PhD, Dorothy C Kelly, CFA, and David B Stevens, CFA, in CFA Program 2017 Level I Curriculum, Volume 1 (CFA Institute, 2016).

KEY CONCEPTS

LOS 1.a

Ethical behavior is that which conforms to a set of rules and moral principles based

on shared beliefs about what behavior is acceptable and what behavior is

CONCEPT CHECKERS

1 Ethics is least likely:

A the study of acceptable and unacceptable behavior

B the careful following of all laws and regulations

C a set of moral principles to guide behavior

2 A code of ethics:

A is a personal view of acceptable behavior

B encompasses current “best practices.”

C specifies a minimum level of acceptable conduct

3 A professional code of conduct:

A can increase public trust in the profession

B guarantees that members will adhere to a minimum level of ethicalconduct

C includes standards that provide guidance for specific behaviors

4 Situational factors that influence ethical behavior are least likely to include:

A social pressure

B large financial rewards

C a lack of ethical principles

5 Compared to complying with laws and regulations, complying with a code ofethics:

A is considered a lower standard

B often involves more judgment

C includes compliance with all laws and regulations

6 Employing a framework for decision making that includes the ethical aspects

of the decision is most likely to:

A lead to higher profits

B avoid any unintended ethical consequences of decisions

C balance the interests of various stakeholders

ANSWERS – CONCEPT CHECKERS

1 Ethics is least likely:

A the study of acceptable and unacceptable behavior

B the careful following of all laws and regulations.

C a set of moral principles to guide behavior

Simply following all laws and regulations is not as high a standard as ethicalbehavior Ethical principles typically involve more judgment than laws orregulations