A fews words on Level 1

Good evening everyone! It’s 5 weeks before the exam, time to grind out all reading material and start doing practice questions. This week marks the ending of many companies fiscal year end, busy earning seasons and market news flying across screens. As a passive investor myself, I made a few trades and exited my positions just before market took off later the week, if only I knew… oh well, market timing is not for everyone. 

Hope the studying for everyone is going well. In light of the fast approaching exam day and a few requests before, I will make the next couple of post focusing around the key concepts for level 1 and 2. Keep in mind I took the first two levels a few years ago, there may be some changes to the curriculum but the key concepts should still be relevant. I won’t attempt to cover everything in the curriculum but list what I’ve remembered in my review. 

First of all, I can stress more on the LOS command words, so you don’t get overwhelmed with all the stuff included. Don’t let where you are in your studying or the amount of material remaining frustrate you or make you feel hopelessly buried. Know what you are required to know, nothing more nothing less. 

In Macroeconomics you should be aware of how important an understanding of macroeconomics is to successful investment management, portfolio construction, country allocations, and the relative attractiveness of equities vs. bonds vs. cash vs. physical assets.  Relating to recent world economic growth which is slowing down, aggregate demand and incomes are down and monetary policy has been eased to reduce short-term interest rates to very low levels (injection ended this month, creates more pressure on rates). It’s easy to say low interest rates are driving to restore aggregate demand to full employment levels, it is not the only factor. As the world has seen Japan’s effort to add stimulus, the US market has reacted positively, but this is also backed by the improved GDP and a strong dollar.

Financial Reporting and Analysis will be 20% of the exam, that translates to 48 questions, it’s make or break type of deal. Practice this stuff inside-out, it will be tested extensively and you will need it for Level 2 and 3. Try to relate this stuff to a financial analyst to understand financial statements and to know where to look for company information and how to analyze it. A financial analyst should be able to read and understand financial statements. You will not find it easy in securities analysis and portfolio management if you don’t understand financial statements really well. The materials will come together for you now as you complete the readings. Try to get through the income statement, the balance sheet and the cash flow statement, but more importantly understand how it all links to each other and use them to analyze a security. At the end of the day, this part counts for most of the FA (financial analyst) in CFA.

With respect to ratios in accounting, make sure you know whether higher or lower ratios are generally preferred, what types of changes would change the ratios, and finally how differences in accounting methods and estimates affect the ratios.  This last part is important when doing many types of financial analysis. Review and practice capital (finance) leases, on income taxes, on capitalization, depreciation, and impairment, and on ratio analysis. For income tax accounting, it may help to keep these two key concepts in mind: 1) At any point in time, accumulated asset depreciation for tax minus the accumulated depreciation on financials, times the expected tax rate, is the DTL. 2) Expenses that are accrued on the financial statements, but not yet actually incurred so they have not reduced taxes, increase DTAs.

In the year I wrote my l1, IFRS/U.S. GAAP differences were a big deal. The curriculum focus on IFRS has been getting stronger each year. With respect to income tax, memorize that “tax expense = taxes payable + the change in DTL – the change in DTA” and build on that.  You need to know how accelerated depreciation for tax creates a DTL and how accrual accounting for warranty expense creates a DTA.  Once you are really clear on those points, pick up a few of the details and you’ll be in good shape.  You will also be able to pick up the rest of the details when you do practice exams.

First make sure you can do any calculations required by the LOS (the ones with the word calculate in them), then focus on the conceptual stuff, and finally do the Corporate Governance stuff.  Don’t be surprised if this Governance material is tested out of proportion to its content.  More concepts to review include Capital Budgeting and Cost of Capital, Cash conversion cycle, liquidity ratios, yield calculations, and sales-based forecasts, Operating cycle and evaluation of working capital performance. 

In Equity Investments, which includes securities markets and equity analysis and valuation. This topic takes around 24 questions. The securities markets reading is basic knowledge you should have, particularly types of orders, short sale details, stock indexes, and the concept of informationally efficient market prices. The market efficiency analysis is very likely to be tested, so I would review and practice on that. The material on anomalies is also worth to review where it covers the types of things equities managers must consider when evaluating research results, investment strategies based on those results, and the possible returns to such strategies.

As part of the valuation of equities, the dividend discount model is the backbone of financial analysis and you should learn it well enough to be comfortable with any questions you get on it. Other important aspects of stock selection, including the different types of equity (common vs. preferred, domestic vs. foreign, public vs. private); industry and company analysis (industry and peer groups, competitive forces, industry life cycle, impact of structural changes in the economy); and valuation models based on price multiples, enterprise value, and firm assets. The difference between absolute and relative valuation methods is a key point here.  You will also need to master equities terminology, indexes, and equities valuation.  For Debt Securities (around 24 questions), with the news on MBS, ABS, CMOs, and CDOs this last few years, they will test this stuff and it won’t be just calculations; it will be the terminology, the concepts, and how the concepts all tie together. In your review and practices, pay attention to the bond basics and terminology, and on bond valuation, yield calculations, and spreads.

Derivatives can be confusing, especially if you haven’t worked with them at all.  The good news is that, for l1, you just have to know the terminology and basic characteristics of options, swaps, forward contracts, and listed futures, and how to value them at expiration or settlement.  For each derivative security you should first focus on what must happen for the long to have gains (if the opposite happens the short position will have gains).  Same old l1 story, nothing too terribly complex, but it takes a lot of practice. 

 

For Portfolio Management and Alternative Investments, while both study sessions are short, Portfolio will be 5-7% of the CFA Exam and Alternative will be 4% of the exam.  I would not spending too much time on these topics if I am short on time, but definitely do questions and cover the characteristics of hedge funds, mutual funds, and ETFs, along with a bit of real estate valuation and a few words on the valuation of closely-held companies and commodities as an investment. At this point, you need to prioritize and clear out the most heavily tested areas like FRS, ethics, quant, equity/fixed income etc.  

Be sure to focus on the Learning Outcome Statements and to not get bogged down in small points to the extent you miss the big ones.  And remember which topics have the big weights: 20% for FR&A, 15% for Ethics, 12% for Quant, 10% for Economics, 10% for Fixed income, 10% for Equities, and 7% for Corporate Finance.  

Five weeks to the exam, so I know you are all planning your final study strategies.  I hope they involve lots of practice at answering multiple choice questions quickly and correctly. Once again, you will want to sit through a few real practices before the actual exam. You can time a 6 hour exam on Saturdays and go through all questions on Sunday, you will be able to get through 4,5 exams that way.  

Have a good and productive weekend, stay calm, and enjoy.