CFA 2018 level 2 schweser notes book 1

LOS 4.b: Explain the appropriate action to take in response to conduct thatviolates the CFA Institute Code of Ethics and Standards of ProfessionalConduct.. LOS 5.b: Explain the appropria

5 Welcome to the 2017 Level II SchweserNotes™

6 Readings and Learning Outcome Statements

7 Code of Ethics and Standards of Professional Conduct

1 LOS 1.a: Describe the six components of the Code of Ethics and the sevenStandards of Professional Conduct

2 LOS 1.b: Explain the ethical responsibilities required of CFA Institute

members and candidates in the CFA Program by the Code and Standards

3 LOS 2.a: Demonstrate a thorough knowledge of the Code of Ethics andStandards of Professional Conduct by applying the Code and Standards tospecific situations

4 LOS 2.b: Recommend practices and procedures designed to prevent

violations of the Code of Ethics and Standards of Professional Conduct

5 Key Concepts

1 LOS 1.a, b

6 Concept Checkers

1 Answers – Concept Checkers

8 CFA Institute Research Objectivity Standards

1 LOS 3.a: Explain the objectives of the Research Objectivity Standards

2 LOS 3.b: Evaluate company policies and practices related to researchobjectivity, and distinguish between changes required and changes

recommended for compliance with the Research Objectivity Standards

3 Key Concepts

1 LOS 3.a

2 LOS 3.b

4 Concept Checkers

1 Answers – Concept Checkers

9 The Glenarm Company

1 LOS 4.a: Evaluate the practices and policies presented

2 LOS 4.b: Explain the appropriate action to take in response to conduct thatviolates the CFA Institute Code of Ethics and Standards of ProfessionalConduct

10 Preston Partners

1 LOS 5.a: Evaluate the practices and policies presented

2 LOS 5.b: Explain the appropriate action to take in response to conduct thatviolates the CFA Institute Code of Ethics and Standards of Professional

11 Super Selection

1 LOS 6.a: Evaluate the practices and policies presented

2 LOS 6.b: Explain the appropriate action to take in response to conduct thatviolates the CFA Institute Code of Ethics and Standards of ProfessionalConduct

12 Trade Allocation: Fair Dealing and Disclosure

1 LOS 7.a: Evaluate trade allocation practices and determine whether theycomply with the CFA Institute Standards of Professional Conduct

addressing fair dealing and client loyalty

2 LOS 7.b: Describe appropriate actions to take in response to trade

allocation practices that do not adequately respect client interests

13 Changing Investment Objectives

1 LOS 8.a: Evaluate the disclosure of investment objectives and basic policiesand determine whether they comply with the CFA Institute Standards ofProfessional Conduct

2 LOS 8.b: Describe appropriate actions needed to ensure adequate

disclosure of the investment process

14 Self-Test: Ethics and Professional Standards

1 Self-Test Answers: Ethics and Professional Standards

15 Correlation and Regression

1 LOS 9.a: Calculate and interpret a sample covariance and a sample

correlation coefficient and interpret a scatter plot

2 LOS 9.b: Describe limitations to correlation analysis

3 LOS 9.c: Formulate a test of the hypothesis that the population correlationcoefficient equals zero and determine whether the hypothesis is rejected

at a given level of significance

4 LOS 9.d: Distinguish between the dependent and independent variables in

a linear regression

5 LOS 9.e: Describe the assumptions underlying linear regression and

interpret regression coefficients

6 LOS 9.f: Calculate and interpret the standard error of estimate, the

coefficient of determination, and a confidence interval for a regressioncoefficient

7 LOS 9.g: Formulate a null and alternative hypothesis about a populationvalue of a regression coefficient and determine the appropriate test

statistic and whether the null hypothesis is rejected at a given level ofsignificance

8 LOS 9.h: Calculate the predicted value for the dependent variable, given anestimated regression model and a value for the independent variable

9 LOS 9.i: Calculate and interpret a confidence interval for the predictedvalue of the dependent variable

10 LOS 9.j: Describe the use of analysis of variance (ANOVA) in regressionanalysis, interpret ANOVA results, and calculate and interpret the F-

1 Answers – Challenge Problems

16 Multiple Regression and Issues in Regression Analysis

1 LOS 10.a: Formulate a multiple regression equation to describe the relationbetween a dependent variable and several independent variables anddetermine the statistical significance of each independent variable

2 LOS 10.b: Interpret estimated regression coefficients and their p-values

3 LOS 10.c: Formulate a null and an alternative hypothesis about the

population value of a regression coefficient, calculate the value of the teststatistic, and determine whether to reject the null hypothesis at a givenlevel of significance

4 LOS 10.d: Interpret the results of hypothesis tests of regression

coefficients

5 LOS 10.e: Calculate and interpret 1) a confidence interval for the

population value of a regression coefficient and 2) a predicted value for thedependent variable, given an estimated regression model and assumedvalues for the independent variables

6 LOS 10.f: Explain the assumptions of a multiple regression model

7 LOS 10.g: Calculate and interpret the F-statistic, and describe how it is used

10 LOS 10.j: Formulate a multiple regression equation by using dummy

variables to represent qualitative factors and interpret the coefficients andregression results

11 LOS 10.k: Explain the types of heteroskedasticity and how

heteroskedasticity and serial correlation affect statistical inference

12 LOS 10.l: Describe multicollinearity and explain its causes and effects inregression analysis

13 LOS 10.m: Describe how model misspecification affects the results of aregression analysis and describe how to avoid common forms of

misspecification

14 LOS 10.n: Describe models with qualitative dependent variables

15 LOS 10.o: Evaluate and interpret a multiple regression model and its

1 LOS 11.a: Calculate and evaluate the predicted trend value for a time

series, modeled as either a linear trend or a log-linear trend, given theestimated trend coefficients

2 LOS 11.b: Describe factors that determine whether a linear or a log-lineartrend should be used with a particular time series and evaluate limitations

of trend models

3 LOS 11.c: Explain the requirement for a time series to be covariance

stationary and describe the significance of a series that is not stationary

4 LOS 11.d: Describe the structure of an autoregressive (AR) model of order pand calculate one- and two-period-ahead forecasts given the estimatedcoefficients

5 LOS 11.e: Explain how autocorrelations of the residuals can be used to testwhether the autoregressive model fits the time series

6 LOS 11.f: Explain mean reversion and calculate a mean-reverting level

7 LOS 11.g: Contrast in-sample and out-of-sample forecasts and compare theforecasting accuracy of different time-series models based on the rootmean squared error criterion.

8 LOS 11.h: Explain the instability of coefficients of time-series models

9 LOS 11.i: Describe characteristics of random walk processes and contrastthem to covariance stationary processes

10 LOS 11.j: Describe implications of unit roots for time-series analysis, explainwhen unit roots are likely to occur and how to test for them, and

demonstrate how a time series with a unit root can be transformed so itcan be analyzed with an AR model

11 LOS 11.k: Describe the steps of the unit root test for nonstationarity andexplain the relation of the test to autoregressive time-series models

12 LOS 11.l: Explain how to test and correct for seasonality in a time-seriesmodel and calculate and interpret a forecasted value using an AR modelwith a seasonal lag

13 LOS 11.m: Explain autoregressive conditional heteroskedasticity (ARCH)and describe how ARCH models can be applied to predict the variance of atime series

14 LOS 11.n: Explain how time-series variables should be analyzed for

nonstationarity and/or cointegration before use in a linear regression

15 LOS 11.o: Determine an appropriate time-series model to analyze a giveninvestment problem and justify that choice

1 Answers – Concept Checkers

18 Probabilistic Approaches: Scenario Analysis, Decision Trees, and Simulations

1 LOS 12.a: Describe steps in running a simulation

2 LOS 12.b: Explain three ways to define the probability distributions for asimulation’s variables

3 LOS 12.c: Describe how to treat correlation across variables in a simulation.

4 LOS 12.d: Describe advantages of using simulations in decision making

5 LOS 12.e: Describe some common constraints introduced into simulations

6 LOS 12.f: Describe issues in using simulations in risk assessment

7 LOS 12.g: Compare scenario analysis, decision trees, and simulations

1 Answers – Concept Checkers

19 Self-Test: Quantitative Methods for Valuation

1 Self-Test Answers: Quantitative Methods for Valuation

20 Currency Exchange Rates: Understanding Equilibrium Value

1 LOS 13.a: Calculate and interpret the bid–offer spread on a spot or forwardcurrency quotation and describe the factors that affect the bid–offer

4 LOS 13.d: Calculate the mark-to-market value of a forward contract

5 LOS 13.e: Explain international parity conditions (covered and uncoveredinterest rate parity, forward rate parity, purchasing power parity, and theinternational Fisher effect)

6 LOS 13.f: Describe relations among the international parity conditions

7 LOS 13.g: Evaluate the use of the current spot rate, the forward rate,

purchasing power parity, and uncovered interest parity to forecast futurespot exchange rates

8 LOS 13.h: Explain approaches to assessing the long-run fair value of anexchange rate

9 LOS 13.i: Describe the carry trade and its relation to uncovered interestrate parity and calculate the profit from a carry trade

10 LOS 13.j: Explain how flows in the balance of payment accounts affectcurrency exchange rates

11 LOS 13.k: Explain the potential effects of monetary and fiscal policy onexchange rates

12 LOS 13.l: Describe objectives of central bank or government interventionand capital controls and describe the effectiveness of intervention andcapital controls

13 LOS 13.m: Describe warning signs of a currency crisis.

1 Answers – Challenge Problems

21 Economic Growth and the Investment Decision

1 LOS 14.a: Compare factors favoring and limiting economic growth in

developed and developing economies

2 LOS 14.b: Describe the relation between the long-run rate of stock marketappreciation and the sustainable growth rate of the economy

3 LOS 14.c: Explain why potential GDP and its growth rate matter for equityand fixed income investors

4 LOS 14.d: Distinguish between capital deepening investment and

technological progress and explain how each affects economic growth andlabor productivity

5 LOS 14.e: Forecast potential GDP based on growth accounting relations

6 LOS 14.f: Explain how natural resources affect economic growth and

evaluate the argument that limited availability of natural resources

constrains economic growth

7 LOS 14.g: Explain how demographics, immigration, and labor force

participation affect the rate and sustainability of economic growth

8 LOS 14.h: Explain how investment in physical capital, human capital, andtechnological development affects economic growth

9 LOS 14.i: Compare classical growth theory, neoclassical growth theory, andendogenous growth theory

10 LOS 14.j: Explain and evaluate convergence hypotheses

11 LOS 14.k: Describe the economic rationale for governments to provideincentives to private investment in technology and knowledge

12 LOS 14.l: Describe the expected impact of removing trade barriers oncapital investment and profits, employment and wages, and growth in theeconomies involved

1 LOS 15.a: Describe classifications of regulations and regulators.

2 LOS 15.b: Describe uses of self-regulation in financial markets

3 LOS 15.c: Describe the economic rationale for regulatory intervention

4 LOS 15.d: Describe regulatory interdependencies and their effects

5 LOS 15.e: Describe tools of regulatory intervention in markets

6 LOS 15.f: Explain purposes in regulating commerce and financial markets

7 LOS 15.g: Describe anticompetitive behaviors targeted by antitrust lawsglobally and evaluate the antitrust risk associated with a given businessstrategy

8 LOS 15.h: Describe benefits and costs of regulation

9 LOS 15.i: Evaluate how a specific regulation affects an industry, company,

1 Answers – Concept Checkers

23 Self-Test: Economics for Valuation

1 Self-Test Answers: Economics for Valuation

24 Formulas

25 Appendix A: Student’s T-Distribution

26 Appendix B: F-Table at 5 Percent (Upper Tail)

27 Appendix C: F-Table at 2.5 Percent (Upper Tail)

28 Appendix D: Chi-Squared Table

29 Appendix E: Critical Values for the Durbin-Watson Statistic

30 Copyright

B OOK 1 – E THICAL AND P ROFESSIONAL S TANDARDS ,

Readings and Learning Outcome Statements

Study Session 1 – Ethical and Professional Standards

Study Session 2 – Ethical and Professional Standards: Application

Self-Test: Ethical and Professional Standards

Study Session 3 – Quantitative Methods for Valuation

Self-Test: Quantitative Methods for Valuation

Study Session 4 – Economics for Valuation

Self-Test: Economics for Valuation

Formulas

Appendices

W ELCOME TO THE 2017 L EVEL II

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These notes consist of five volumes that include complete coverage of all 17 StudySessions and all 465 Learning Outcome Statements (LOS) Examples, Concept Checkers(multiple-choice questions), and Challenge Problems are provided along the way, tohelp you master the material and check your progress At the end of each major topicarea, you can take a self-test for that topic area Self-test questions are created to beexam-like in format and difficulty, to help you evaluate how well your study of eachtopic has prepared you for the actual exam

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The Level II CFA exam is a formidable challenge (52 topic reviews and 465 LearningOutcome Statements), so you must devote considerable time and effort to be properlyprepared There is no shortcut! You must learn the material, know the terminology andtechniques, understand the concepts, and be able to answer 120 questions quickly andmostly correctly Fifteen hours per week for 25 weeks is a good estimate of the studytime required on average, but different candidates will need more or less time,

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There is no way around it; CFA Institute will test you in a way that will reveal how wellyou know the Level II curriculum You should begin early and stick to your study plan.Read the SchweserNotes and complete the Concept Checkers and Challenge Problemsfor each topic review Prepare for and attend a live class, an online class, or a studygroup each week Take quizzes often using SchweserPro Qbank and go back to reviewprevious topics regularly At the end of each topic area, take the online Self-test tocheck your progress You should try to finish reading the curriculum at least four weeksbefore the Level II exam so that you have sufficient time for Practice Exams and forfurther review of those topics that you have not yet mastered

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Dr Bijesh Tolia, CFA, CA

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R EADINGS AND L EARNING O UTCOME S TATEMENTS

READINGS

The following material is a review of the Ethical and Professional Standards,

Quantitative Methods, and Economics principles designed to address the learning outcome statements set forth by CFA Institute.

STUDY SESSION 1

Reading Assignments

Ethical and Professional Standards, CFA Program Curriculum, Volume 1, Level II (CFA

Institute, 2017)

1 Code of Ethics and Standards of Professional Conduct (page 1)

2 Guidance for Standards I–VII (page 1)

3 CFA Institute Research Objectivity Standards (page 80)

STUDY SESSION 2

Reading Assignments

Ethical and Professional Standards, CFA Program Curriculum, Volume 1, Level II

(CFA Institute, 2017)

4 The Glenarm Company (page 90)

5 Preston Partners (page 92)

6 Super Selection (page 95)

7 Trade Allocation: Fair Dealing and Disclosure (page 98)

8 Changing Investment Objectives (page 100)

STUDY SESSION 3

Reading Assignments

Quantitative Methods for Valuation, CFA Program Curriculum, Volume 1, Level II (CFA

Institute, 2017)

9 Correlation and Regression (page 111)

10 Multiple Regression and Issues in Regression Analysis (page 146)

11 Time-Series Analysis (page 194)

12 Excerpt from “Probabilistic Approaches: Scenario Analysis, Decision Trees,and Simulations” (page 231)

STUDY SESSION 4

Reading Assignments

Economics for Valuation, CFA Program Curriculum, Volume 1, Level II (CFA Institute,

2017)

13 Currency Exchange Rates: Understanding Equilibrium Value (page 246)

14 Economic Growth and the Investment Decision (page 284)

15 Economics of Regulation (page 305)

LEARNING OUTCOME STATEMENTS (LOS)

The CFA Institute Learning Outcome Statements are listed below These are repeated in each topic review; however, the order may have been changed in order to get a better fit with the flow of the review.

STUDY SESSION 1

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

1 CFA Institute Code of Ethics and Standards of Professional Conduct

The candidate should be able to:

a describe the six components of the Code of Ethics and the seven Standards

of Professional Conduct (page 1)

b explain the ethical responsibilities required of CFA Institute members andcandidates in the CFA Program by the Code and Standards (page 2)

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

2 Guidance for Standards I–VII

The candidate should be able to:

a demonstrate a thorough knowledge of the Code of Ethics and Standards ofProfessional Conduct by applying the Code and Standards to specific

situations (page 5)

b recommend practices and procedures designed to prevent violations of theCode of Ethics and Standards of Professional Conduct (page 5)

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

3 CFA Institute Research Objectivity Standards

The candidate should be able to:

a explain the objectives of the Research Objectivity Standards (page 80)

b evaluate company policies and practices related to research objectivity,and distinguish between changes required and changes recommended forcompliance with the Research Objectivity Standards (page 81)

STUDY SESSION 2

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

4 The Glenarm Company

The candidate should be able to:

a evaluate the practices and policies presented (page 90)

b explain the appropriate action to take in response to conduct that violatesthe CFA Institute Code of Ethics and Standards of Professional Conduct.(page 90)

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

5 Preston Partners

The candidate should be able to:

a evaluate the practices and policies presented (page 92)

b explain the appropriate action to take in response to conduct that violatesthe CFA Institute Code of Ethics and Standards of Professional Conduct(page 92)

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

6 Super Selection

The candidate should be able to:

a evaluate the practices and policies presented (page 95)

b explain the appropriate action to take in response to conduct that violatesthe CFA Institute Code of Ethics and Standards of Professional Conduct.(page 95)

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

7 Trade Allocation: Fair Dealing and Disclosure

The candidate should be able to:

a evaluate trade allocation practices and determine whether they complywith the CFA Institute Standards of Professional Conduct addressing fairdealing and client loyalty (page 98)

b describe appropriate actions to take in response to trade allocation

practices that do not adequately respect client interests (page 99)

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

8 Changing Investment Objectives

The candidate should be able to:

a evaluate the disclosure of investment objectives and basic policies anddetermine whether they comply with the CFA Institute Standards ofProfessional Conduct (page 100)

b describe appropriate actions needed to ensure adequate disclosure of theinvestment process (page 100)

STUDY SESSION 3

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

9 Correlation and Regression

The candidate should be able to:

a calculate and interpret a sample covariance and a sample correlationcoefficient and interpret a scatter plot (page 111)

b describe limitations to correlation analysis (page 115)

c formulate a test of the hypothesis that the population correlation

coefficient equals zero and determine whether the hypothesis is rejected

at a given level of significance (page 116)

d distinguish between the dependent and independent variables in a linearregression (page 117)

e explain the assumptions underlying linear regression and interpret

regression coefficients (page 119)

f calculate and interpret the standard error of estimate, the coefficient ofdetermination, and a confidence interval for a regression coefficient

(page 123)

g formulate a null and alternative hypothesis about a population value of aregression coefficient and determine the appropriate test statistic andwhether the null hypothesis is rejected at a given level of significance.(page 125)

h calculate the predicted value for the dependent variable, given an

estimated regression model and a value for the independent variable.(page 126)

i calculate and interpret a confidence interval for the predicted value of thedependent variable (page 126)

j describe the use of analysis of variance (ANOVA) in regression analysis,

interpret ANOVA results, and calculate and interpret the F-statistic.

(page 128)

k describe limitations of regression analysis (page 133)

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

10 Multiple Regression and Issues in Regression Analysis

The candidate should be able to:

a formulate a multiple regression equation to describe the relation between

a dependent variable and several independent variables and determine thestatistical significance of each independent variable (page 147)

b interpret estimated regression coefficients and their p-values (page 148)

c formulate a null and an alternative hypothesis about the population value

of a regression coefficient, calculate the value of the test statistic, anddetermine whether to reject the null hypothesis at a given level of

significance (page 149)

d interpret the results of hypothesis tests of regression coefficients

(page 149)

e calculate and interpret 1) a confidence interval for the population value of

a regression coefficient and 2) a predicted value for the dependent

variable, given an estimated regression model and assumed values for theindependent variables (page 153)

f explain the assumptions of a multiple regression model (page 155)

g calculate and interpret the F-statistic, and describe how it is used in

regression analysis (page 155)

h distinguish between and interpret the R2 and adjusted R2 in multiple

regression (page 157)

i evaluate how well a regression model explains the dependent variable byanalyzing the output of the regression equation and an ANOVA table

(page 159)

j formulate a multiple regression equation by using dummy variables torepresent qualitative factors and interpret the coefficients and regressionresults (page 164)

k explain the types of heteroskedasticity and how heteroskedasticity andserial correlation affect statistical inference (page 167)

l describe multicollinearity and explain its causes and effects in regressionanalysis (page 174)

m describe how model misspecification affects the results of a regressionanalysis and describe how to avoid common forms of misspecification.(page 177)

n describe models with qualitative dependent variables (page 180)

o evaluate and interpret a multiple regression model and its results

(page 181)

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

11 Time-Series Analysis

The candidate should be able to:

a calculate and evaluate the predicted trend value for a time series, modeled

as either a linear trend or a log-linear trend, given the estimated trendcoefficients (page 194)

b describe factors that determine whether a linear or a log-linear trendshould be used with a particular time series and evaluate limitations oftrend models (page 200)

c explain the requirement for a time series to be covariance stationary anddescribe the significance of a series that is not stationary (page 201)

d describe the structure of an autoregressive (AR) model of order p and

calculate one- and two-period-ahead forecasts given the estimated

coefficients (page 202)

e explain how autocorrelations of the residuals can be used to test whetherthe autoregressive model fits the time series (page 203)

f explain mean reversion and calculate a mean-reverting level (page 204)

g contrast in-sample and out-of-sample forecasts and compare the

forecasting accuracy of different time-series models based on the rootmean squared error criterion (page 206)

h explain the instability of coefficients of time-series models (page 207)

i describe characteristics of random walk processes and contrast them tocovariance stationary processes (page 207)

j describe implications of unit roots for time-series analysis, explain whenunit roots are likely to occur and how to test for them, and demonstratehow a time series with a unit root can be transformed so it can be analyzedwith an AR model (page 208)

k describe the steps of the unit root test for nonstationarity and explain therelation of the test to autoregressive time-series models (page 208)

l explain how to test and correct for seasonality in a time-series model andcalculate and interpret a forecasted value using an AR model with a

seasonal lag (page 212)

m explain autoregressive conditional heteroskedasticity (ARCH) and describehow ARCH models can be applied to predict the variance of a time series.(page 216)

n explain how time-series variables should be analyzed for nonstationarityand/or cointegration before use in a linear regression (page 217)

o determine an appropriate time-series model to analyze a given investmentproblem and justify that choice (page 219)

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

12 Excerpt from “Probabilistic Approaches Scenario Analysis, Decision Trees, and Simulations”

The candidate should be able to:

a describe steps in running a simulation (page 231)

b explain three ways to define the probability distributions for a simulation’svariables (page 231)

c describe how to treat correlation across variables in a simulation

(page 231)

d describe advantages of using simulations in decision making (page 233)

e describe some common constraints introduced into simulations (page 234)

f describe issues in using simulations in risk assessment (page 235)

g compare scenario analysis, decision trees, and simulations (page 236)

STUDY SESSION 4

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

13 Currency Exchange Rates: Understanding Equilibrium Value

The candidate should be able to:

a calculate and interpret the bid–offer spread on a spot or forward currencyquotation and describe the factors that affect the bid–offer spread.

d calculate the mark-to-market value of a forward contract (page 253)

e explain international parity conditions (covered and uncovered interestrate parity, forward rate parity, purchasing power parity, and the

international Fisher effect) (page 255)

f describe relations among the international parity conditions (page 261)

g evaluate the use of the current spot rate, the forward rate, purchasingpower parity, and uncovered interest parity to forecast future spot

exchange rates (page 262)

h explain approaches to assessing the long-run fair value of an exchangerate (page 262)

i describe the carry trade and its relation to uncovered interest rate parityand calculate the profit from a carry trade (page 263)

j explain how flows in the balance of payment accounts affect currencyexchange rates (page 264)

k explain the potential effects of monetary and fiscal policy on exchangerates (page 266)

l describe objectives of central bank or government intervention and capitalcontrols and describe the effectiveness of intervention and capital controls.(page 269)

m describe warning signs of a currency crisis (page 270)

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

14 Economic Growth and the Investment Decision

The candidate should be able to:

a compare factors favoring and limiting economic growth in developed anddeveloping economies (page 284)

b describe the relation between the long-run rate of stock market

appreciation and the sustainable growth rate of the economy (page 285)

c explain why potential GDP and its growth rate matter for equity and fixedincome investors (page 286)

d distinguish between capital deepening investment and technological

progress and explain how each affects economic growth and labor

productivity (page 286)

e forecast potential GDP based on growth accounting relations (page 289)

f explain how natural resources affect economic growth and evaluate theargument that limited availability of natural resources constrains economicgrowth (page 290)

g explain how demographics, immigration, and labor force participationaffect the rate and sustainability of economic growth (page 291)

h explain how investment in physical capital, human capital, and

technological development affects economic growth (page 292)

i compare classical growth theory, neoclassical growth theory, and

endogenous growth theory (page 293)

j explain and evaluate convergence hypotheses (page 295)

k describe the economic rationale for governments to provide incentives toprivate investment in technology and knowledge (page 296)

l describe the expected impact of removing trade barriers on capital

investment and profits, employment and wages, and growth in the

economies involved (page 297)

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

15 Economics of Regulation

The candidate should be able to:

a describe classifications of regulations and regulators (page 305)

b describe uses of self-regulation in financial markets (page 306)

c describe the economic rationale for regulatory intervention (page 306)

d describe regulatory interdependencies and their effects (page 307)

e describe tools of regulatory intervention in markets (page 308)

f explain purposes in regulating commerce and financial markets (page 308)

g describe anticompetitive behaviors targeted by antitrust laws globally andevaluate the antitrust risk associated with a given business strategy

(page 310)

h describe benefits and costs of regulation (page 310)

i evaluate how a specific regulation affects an industry, company, or security.(page 311)

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 & 2.

Edition (2014) multiple times As a Level II CFA candidate, it is your responsibility to

comply with the Code and Standards The complete Code and Standards are reprinted

in Volume 1 of the CFA Program Curriculum

LOS 1.a: Describe the six components of the Code of Ethics and the seven Standards

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

manner with the public, clients, prospective clients, employers, employees,colleagues in the investment profession, and other participants in the globalcapital markets

Place the integrity of the investment profession and the interests of clientsabove their own personal interests

Use reasonable care and exercise independent professional judgment whenconducting investment analysis, making investment recommendations, takinginvestment actions, and engaging in other professional activities

Practice and encourage others to practice in a professional and ethical mannerthat will reflect credit on themselves and the profession

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

ultimate benefit of society

Maintain and improve their professional competence and strive to maintainand improve the competence of other investment professionals.

THE STANDARDS OF PROFESSIONAL CONDUCT

7 Responsibilities as a CFA Institute Member or CFA Candidate

LOS 1.b: Explain the ethical responsibilities required of CFA Institute members and candidates in the CFA Program by the Code and Standards.

CFA ® Program Curriculum, Volume 1, page 15

STANDARDS OF PROFESSIONAL CONDUCT 2

1 PROFESSIONALISM

A Knowledge of the Law Members and Candidates must understand

and comply with all applicable laws, rules, and regulations (including

the CFA Institute Code of Ethics and Standards of Professional

Conduct) of any government, regulatory organization, licensing

agency, or professional association governing their professionalactivities In the event of conflict, Members and Candidates mustcomply with the more strict law, rule, or regulation Members andCandidates must not knowingly participate or assist in and mustdissociate from any violation of such laws, rules, or regulations

B Independence and Objectivity Members and Candidates must use

reasonable care and judgment to achieve and maintainindependence and objectivity in their professional activities

Members and Candidates must not offer, solicit, or accept any gift,benefit, compensation, or consideration that reasonably could beexpected to compromise their own or another’s independence andobjectivity

C Misrepresentation Members and Candidates must not knowingly

make any misrepresentations relating to investment analysis,recommendations, actions, or other professional activities

D Misconduct Members and Candidates must not engage in any

professional conduct involving dishonesty, fraud, or deceit or commitany act that reflects adversely on their professional reputation,integrity, or competence

2 INTEGRITY OF CAPITAL MARKETS

A Material Nonpublic Information Members and Candidates who

possess material nonpublic information that could affect the value of

an investment must not act or cause others to act on the

information

B Market Manipulation Members and Candidates must not engage in

practices that distort prices or artificially inflate trading volume withthe intent to mislead market participants

3 DUTIES TO CLIENTS

A Loyalty, Prudence, and Care Members and Candidates have a duty

of loyalty to their clients and must act with reasonable care andexercise prudent judgment Members and Candidates must act forthe benefit of their clients and place their clients’ interests beforetheir employer’s or their own interests

B Fair Dealing Members and Candidates must deal fairly and

objectively with all clients when providing investment analysis,

making investment recommendations, taking investment action, orengaging in other professional activities

2 Determine that an investment is suitable to the client’sfinancial situation and consistent with the client’s writtenobjectives, mandates, and constraints before making aninvestment recommendation or taking investmentaction

3 Judge the suitability of investments in the context of theclient’s total portfolio

2 When Members and Candidates are responsible for managing aportfolio to a specific mandate, strategy, or style, they must

make only investment recommendations or take onlyinvestment actions that are consistent with the statedobjectives and constraints of the portfolio.

D Performance Presentation When communicating investment

performance information, Members or Candidates must make

reasonable efforts to ensure that it is fair, accurate, and complete

E Preservation of Confidentiality Members and Candidates must keep

information about current, former, and prospective clients

confidential unless:

1 The information concerns illegal activities on the part of theclient or prospective client,

2 Disclosure is required by law, or

3 The client or prospective client permits disclosure of the

information

4 DUTIES TO EMPLOYERS

A Loyalty In matters related to their employment, Members and

Candidates must act for the benefit of their employer and not

deprive their employer of the advantage of their skills and abilities,divulge confidential information, or otherwise cause harm to theiremployer

B Additional Compensation Arrangements Members and Candidates

must not accept gifts, benefits, compensation, or consideration thatcompetes with or might reasonably be expected to create a conflict

of interest with their employer’s interest unless they obtain writtenconsent from all parties involved

C Responsibilities of Supervisors Members and Candidates must make

reasonable efforts to ensure that anyone subject to their supervision

or authority complies with applicable laws, rules, regulations, and theCode and Standards

5 INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTIONS

A Diligence and Reasonable Basis Members and Candidates must:

1 Exercise diligence, independence, and thoroughness in

analyzing investments, making investment recommendations,and taking investment actions

2 Have a reasonable and adequate basis, supported by

appropriate research and investigation, for any investmentanalysis, recommendation, or action

B Communication with Clients and Prospective Clients Members and

Candidates must:

1 Disclose to clients and prospective clients the basic format andgeneral principles of the investment processes they use toanalyze investments, select securities, and construct portfoliosand must promptly disclose any changes that might materiallyaffect those processes

2 Disclose to clients and prospective clients significant limitationsand risks associated with the investment process

3 Use reasonable judgment in identifying which factors are

important to their investment analyses, recommendations, oractions and include those factors in communications withclients and prospective clients

4 Distinguish between fact and opinion in the presentation ofinvestment analysis and recommendations

C Record Retention Members and Candidates must develop and

maintain appropriate records to support their investment analysis,recommendations, actions, and other investment-related

communications with clients and prospective clients

6 CONFLICTS OF INTEREST

A Disclosure of Conflicts Members and Candidates must make full and

fair disclosure of all matters that could reasonably be expected toimpair their independence and objectivity or interfere with

respective duties to their clients, prospective clients, and employer.Members and Candidates must ensure that such disclosures areprominent, are delivered in plain language, and communicate therelevant information effectively

B Priority of Transactions Investment transactions for clients and

employers must have priority over investment transactions in which

a Member or Candidate is the beneficial owner

C Referral Fees Members and Candidates must disclose to their

employer, clients, and prospective clients, as appropriate, any

compensation, consideration, or benefit received by, or paid to,others for the recommendation of products or services

7 RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CFA CANDIDATE

A Conduct as Participants in CFA Institute Programs Members and

Candidates must not engage in any conduct that compromises thereputation or integrity of CFA Institute or the CFA designation or theintegrity, validity, or security of CFA Institute programs

B Reference to CFA Institute, the CFA Designation, and the CFA

Program When referring to CFA Institute, CFA Institute membership,

the CFA designation, or candidacy in the CFA Program, Members andCandidates must not misrepresent or exaggerate the meaning orimplications of membership in CFA Institute, holding the CFAdesignation, or candidacy in the CFA Program

LOS 2.a: Demonstrate a thorough knowledge of the Code of Ethics and Standards of Professional Conduct by applying the Code and Standards to specific situations.

LOS 2.b: Recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.

CFA ® Program Curriculum, Volume 1, page 21

I Professionalism

I(A) Knowledge of the Law Members and Candidates must understand and comply with all applicable

laws, rules, and regulations (including the CFA Institute Code of Ethics and Standards of Professional Conduct) of any government, regulatory organization, licensing agency, or professional association governing their professional activities In the event of conflict, Members and Candidates must comply with the more strict law, rule, or regulation Members and Candidates must not knowingly participate or assist

in and must dissociate from any violation of such laws, rules, or regulations.

Professor’s Note: While we use the term “members” in the following, note that all of the Standards apply to candidates as well.

Guidance—Code and Standards vs Local Law

Members must know the laws and regulations relating to their professional activities inall countries in which they conduct business Members must comply with applicablelaws and regulations relating to their professional activity Do not violate Code orStandards even if the activity is otherwise legal Always adhere to the most strict rulesand requirements (law or CFA Institute Standards) that apply

Guidance—Participation or Association With Violations by Others

Members should dissociate, or separate themselves, from any ongoing client or

employee activity that is illegal or unethical, even if it involves leaving an employer (anextreme case) While a member may confront the involved individual first, he mustapproach his supervisor or compliance department Inaction with continued

association may be construed as knowing participation

Recommended Procedures for Compliance—Members

Members should have procedures to keep up with changes in applicable laws,rules, and regulations.

Compliance procedures should be reviewed on an ongoing basis to ensurethat they address current law, CFAI Standards, and regulations

Members should maintain current reference materials for employees to

access in order to keep up to date on laws, rules, and regulations

Members should seek advice of counsel or their compliance department when

in doubt

Members should document any violations when they disassociate themselvesfrom prohibited activity and encourage their employers to bring an end tosuch activity

There is no requirement under the Standards to report violations to

governmental authorities, but this may be advisable in some circumstancesand required by law in others

Members are strongly encouraged to report other members’ violations of theCode and Standards

Recommended Procedures for Compliance—Firms

Members should encourage their firms to:

Develop and/or adopt a code of ethics

Make available to employees information that highlights applicable laws andregulations

Establish written procedures for reporting suspected violation of laws,

regulations, or company policies

Members who supervise the creation and maintenance of investment services andproducts should be aware of and comply with the regulations and laws regarding suchservices and products both in their country of origin and the countries where they will

Comment:

Although it is recommended that members and candidates seek the advice of legalcounsel, the reliance on such advice does not absolve a member or candidate from therequirement to comply with the law or regulation Allen should report this situation tohis supervisor, seek an independent legal opinion, and determine whether the

regulator should be notified of the error

Example 2:

Kamisha Washington’s firm advertises its past performance record by showing the year return of a composite of its client accounts However, Washington discovers thatthe composite omits the performance of accounts that have left the firm during the10-year period and that this omission has led to an inflated performance figure

10-Washington is asked to use promotional material that includes the erroneous

performance number when soliciting business for the firm

Comment:

Misrepresenting performance is a violation of the Code and Standards Although shedid not calculate the performance herself, Washington would be assisting in violatingthis standard if she were to use the inflated performance number when solicitingclients She must dissociate herself from the activity She can bring the misleadingnumber to the attention of the person responsible for calculating performance, hersupervisor, or the compliance department at her firm If her firm is unwilling to

recalculate performance, she must refrain from using the misleading promotionalmaterial and should notify the firm of her reasons If the firm insists that she use thematerial, she should consider whether her obligation to dissociate from the activitywould require her to seek other employment

Example 3:

An employee of an investment bank is working on an underwriting and finds out theissuer has altered their financial statements to hide operating losses in one division.These misstated data are included in a preliminary prospectus that has already beenreleased

Jameson must comply with the strictest requirements among U.S law (where her firm

is based), the CFA Institute Code and Standards, and the laws of the country where she

is doing business In this case that means she must not participate in any IPOs for herpersonal account

Example 5:

A junior portfolio manager suspects that a broker responsible for new business from aforeign country is being allocated a portion of the firm’s payments for third-partyresearch and suspects that no research is being provided He believes that the researchpayments may be inappropriate and unethical

Comment:

He should follow his firm’s procedures for reporting possible unethical behavior andtry to get better disclosure of the nature of these payments and any research that isbeing provided

I(B) Independence and Objectivity Members and Candidates must use reasonable care and judgment

to achieve and maintain independence and objectivity in their professional activities Members and Candidates must not offer, solicit, or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another’s independence and objectivity.

Guidance

Do not let the investment process be influenced by any external sources Modest giftsare permitted Allocation of shares in oversubscribed IPOs to personal accounts is NOTpermitted Distinguish between gifts from clients and gifts from entities seeking

influence to the detriment of the client Gifts must be disclosed to the member’s

employer in any case, either prior to acceptance if possible, or subsequently

Guidance—Investment Banking Relationships

Do not be pressured by sell-side firms to issue favorable research on current or

prospective investment-banking clients It is appropriate to have analysts work withinvestment bankers in “road shows” only when the conflicts are adequately and

effectively managed and disclosed Be sure there are effective “firewalls” betweenresearch/investment management and investment banking activities

Guidance—Public Companies

Analysts should not be pressured to issue favorable research by the companies theyfollow Do not confine research to discussions with company management, but ratheruse a variety of sources, including suppliers, customers, and competitors

Guidance—Buy-Side Clients