Contents Welcome to the 2019 SchweserNotes™ Learning Outcome Statements (LOS) Study Session 1—Ethical and Professional Standards Reading 1: Ethics and Trust in the Investment Profession Exam Focus Module 1.1: Ethics and Trust Key Concepts Answer Key for Module Quiz Reading 2: Code of Ethics and Standards of Professional Conduct Exam Focus Module 2.1: Code and Standards Answer Key for Module Quiz Reading 3: Guidance for Standards I–VII Exam Focus Module 3.1: Guidance for Standards I(A) and I(B) Module 3.2: Guidance for Standards I(C) and I(D) Module 3.3: Guidance for Standard II Module 3.4: Guidance for Standards III(A) and III(B) Module 3.5: Guidance for Standards III(C), III(D), and III(E) Module 3.6: Guidance for Standard IV Module 3.7: Guidance for Standard V Module 3.8: Guidance for Standard VI 10 Module 3.9: Guidance for Standard VII 11 Answer Key for Module Quizzes Reading 4: Introduction to the Global Investment Performance Standards (GIPS®) Exam Focus Module 4.1: Introduction to GIPS Key Concepts Answer Key for Module Quiz Reading 5: The GIPS Standards Module 5.1: The GIPS Standards Key Concepts Answer Key for Module Quiz Topic Assessment: Ethical and Professional Standards Topic Assessment Answers: Ethical and Professional Standards Study Session 2—Quantitative Methods (1) Reading 6: The Time Value of Money Exam Focus Module 6.1: EAY and Compounding Frequency Module 6.2: Calculating PV and FV Module 6.3: Uneven Cash Flows Key Concepts Answer Key for Module Quizzes Reading 7: Discounted Cash Flow Applications Exam Focus Module 7.1: NPV, IRR, and HPR Module 7.2: Returns and Yields Key Concepts Answer Key for Module Quizzes Reading 8: Statistical Concepts and Market Returns Exam Focus Module 8.1 Describing Data Sets Module 8.2: Means and Variance Module 8.3: Skew, Kurtosis, and Sharpe Ratio Key Concepts Answer Key for Module Quizzes Reading 9: Probability Concepts Exam Focus Module 9.1: Conditional and Joint Probabilities Module 9.2: Conditional Expectations, Correlation Module 9.3: Portfolio Variance, Bayes, and Counting Problems Key Concepts Answer Key for Module Quizzes Study Session 3—Quantitative Methods (2) Reading 10: Common Probability Distributions Exam Focus Module 10.1: Uniform and Binomial Distributions Module 10.2: Normal Distributions Module 10.3: Lognormal Distribution, Simulations Key Concepts Answer Key for Module Quizzes Reading 11: Sampling and Estimation Exam Focus Module 11.1: Central Limit Theorem and Standard Error Module 11.2: Confidence Intervals and t-Distribution Key Concepts Answer Key for Module Quizzes Reading 12: Hypothesis Testing Exam Focus Module 12.1: Hypothesis Tests and Types of Errors Module 12.2: Tests of Means and p-Values Module 12.3: Mean Differences, Difference in Means Key Concepts Answer Key for Module Quizzes Reading 13: Technical Analysis Exam Focus Module 13.1: Technical Analysis 10 11 Key Concepts Answer Key for Module Quiz Topic Assessment: Quantitative Methods Topic Assessment Answers: Quantitative Methods Formulas Appendices Appendix A: Areas Under The Normal Curve Cumulative Z-Table Appendix B: Student’s t-Distribution Appendix C: F-Table at 5% (Upper Tail) Appendix D: F-Table at 2.5% (Upper Tail) Appendix E: Chi-Squared table List of pages 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 i iv ix x xi xii xiii xiv xv 10 11 12 13 14 15 16 17 18 19 20 21 23 24 25 26 27 28 29 30 31 32 33 34 35 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 53 54 55 56 57 58 59 60 61 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 84 85 86 87 88 89 90 91 92 93 94 95 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 119 120 121 122 123 124 125 126 127 128 129 130 131 135 136 137 138 139 140 141 142 143 144 145 146 147 148 149 150 151 152 153 154 155 156 157 158 159 160 161 162 163 164 165 166 167 168 169 170 171 172 173 174 175 176 177 178 179 180 132 133 134 135 136 137 138 139 140 141 142 143 144 145 146 147 148 149 150 151 152 153 155 156 157 158 159 160 161 162 163 164 165 167 168 169 170 171 172 173 175 176 177 178 179 181 181 182 183 184 185 186 187 188 189 190 191 192 193 194 195 196 197 198 199 200 201 202 203 204 205 206 207 208 209 210 211 212 213 214 215 216 217 218 219 220 221 222 223 224 225 226 182 183 184 185 186 187 188 189 190 191 192 193 194 195 196 197 198 199 200 201 202 203 205 206 207 208 209 210 211 212 213 214 215 216 217 218 219 220 221 222 223 224 225 226 227 228 227 228 229 230 231 232 233 234 235 236 237 238 239 240 241 242 243 244 245 246 247 248 249 250 251 252 253 254 255 256 257 258 259 260 261 262 263 264 265 266 267 268 269 270 271 272 229 230 231 232 233 234 235 236 237 238 239 240 241 242 243 244 245 246 247 248 249 250 251 252 253 254 255 256 257 258 259 260 261 262 263 264 265 266 267 269 270 271 272 273 274 275 TOPIC ASSESSMENT ANSWERS: QUANTITATIVE METHODS B The harmonic mean of the 12 purchase prices will be his average price paid per share (Study Session 2, Module 8.1, LOS 8.e) C The unconditional probability of a tax increase is: 0.2(0.32) + 0.8(0.6) = 54.4%.The joint probability that the Wigs will be elected and there will be no tax increase is: 0.8(0.4) = 32% The sum is: 54.4 + 32 = 86.4% (Study Session 2, Module 9.1, LOS 9.f) B A portfolio that has a higher Sharpe ratio will have a lower probability of generating returns less than the risk-free rate With a target return equal to the risk-free rate, the safety-first ratio for a portfolio is (E[Rp] – Rf) / σp, which is also the Sharpe ratio Portfolio will have a lower probability of returns less than the risk-free rate Because both portfolios are well diversified and Portfolio has a lower Sharpe ratio than Portfolio 2, any allocation to Portfolio would decrease the overall portfolio’s Sharpe and safety-first ratios, increasing the probability of returns less than the risk-free rate (Study Session 2, Module 8.3, LOS 8.i) B Step 1: Calculate the amount needed at retirement at t = 15, with your calculator in BGN mode N = 25, FV = 0, I/Y = 8, PMT = 37,000, CPT PV = –426,564 Step 2: Calculate the required deposits at t = 0,1,….,14 to result in a time 15 value of 426,564, with your calculator still in BGN mode PV = –121,000, N = 15, I/Y = 8, FV = 426,564, CPT PMT = –$1,457.21 (Study Session 2, Module 6.2, LOS 6.e) A E[R] = (0.4)(10) + (0.4)(12.5) + (0.2)(30) = 15% Variance = (0.4)(10 − 15)2 + (0.4)(12.5 − 15)2 + (0.2)(30 − 15)2 = 57.5 Standard deviation = = 7.58% (Study Session 2, Module 8.2, LOS 8.g) B The interest portion of the first payment is simply principal × interest rate = (15,000 × 0.11) = 1,650 Using a financial calculator: PV = 15,000, FV = 0, I/Y = 11, N = 7, CPT PMT= $3,183 Principal = payment − interest = 3,183 − 1,650 = 1,533 (Study Session 2, Module 6.2, LOS 6.f) C A standard normal probability distribution has a mean of zero, so subtracting the mean from a normal random variable before dividing by its standard deviation is necessary to produce a standard normal probability distribution (Study Session 3, Module 10.2, LOS 10.l) A The change in polarity principle is the idea that a breached resistance level becomes a support level, and vice versa Here, Smith is projecting that the historical high of 25, having been breached, will act as a support level if the price decreases from 30 (Study Session 3, Module 13.1, LOS 13.c) B The probability of X or Y is P(X) + P(Y) − P(XY) 0.3 + 0.4 − (0.3)(0.4) = 58% (Study Session 3, Module 10.1, LOS 10.f) 10 B Because the money market yield is the holding period yield times 360 / number of days, HPY × 360 / 360 = HPY = MMY (Study Session 2, Module 7.2, LOS 7.f) 11 A The standard error of a 5-year average of earnings changes is = 5.366% 15.5% is = 1.96 standard errors above the mean, and the probability of a 5year average more than 1.96 standard errors above the mean is 2.5% for a normal distribution (Study Session 3, Module 11.1, LOS 11.f) 12 A A lognormal distribution is skewed to the right (positively skewed) (Study Session 3, Module 10.3, LOS 10.n) FORMULAS nominal risk-free rate = real risk-free rate + expected inflation rate required interest rate on a security = nominal risk-free rate + default risk premium + liquidity premium + maturity risk premium effective annual rate = (1 + periodic rate)m − continuous compounding: er − = EAR FV = PV(1 + I/Y)N general formula for the IRR: bank discount yield 365 / t effective annual yield = (1 + HPY) money market yield population mean: sample mean: –1 geometric mean return (RG): harmonic mean: weighted mean: position of the observation at a given percentile, y: range = maximum value – minimum value excess kurtosis = sample kurtosis – coefficient of variation: joint probability: P(AB) = P(A | B) × P(B) addition rule: P(A or B) = P(A) + P(B) – P(AB) multiplication rule: P(A and B) = P(A) × P(B) total probability rule: P(R) = P(R | S1) × P(S1) + P(R | S2) × P(S2) + + P(R | SN) × P(SN) expected value: E(X) = ΣP(xi)xi = P(x1)x1 + P(x2)x2+ … + P(xn)xn Cov(Ri,Rj) = E{[Ri – E(Ri)][Rj – E(Rj)]} portfolio expected return: = w1E(R1) + w2E(R2) + … + wnE(Rn) portfolio variance: where Bayes’ formula: combination (binomial) formula: permutation formula: binomial probability: for a binomial random variable: E(X) = np; variance = np(1 – p) for a normal variable: 90% confidence interval for X is X – 1.65s to X + 1.65s 95% confidence interval for X is X – 1.96s to X + 1.96s 99% confidence interval for X is X – 2.58s to X + 2.58s SFRatio = continuously compounded rate of return: for a uniform distribution: sampling error of the mean = sample mean – population mean = x – μ standard error of the sample mean, known population variance: standard error of the sample mean, unknown population variance: confidence interval: point estimate ± (reliability factor × standard error) confidence interval for the population mean: tests for population mean = μ0: test for equality of variances: , , where paired comparisons test: t-statistic = test for differences in means: t-statistic = (sample variances assumed unequal) t-statistic = (sample variances assumed equal) APPENDICES APPENDIX A: AREAS UNDER THE NORMAL CURVE Most of the examples in this book have used one version of the z-table to find the area under the normal curve This table provides the cumulative probabilities (or the area under the entire curve to left of the z-value) Probability Example Assume that the annual earnings per share (EPS) for a large sample of firms is normally distributed with a mean of $5.00 and a standard deviation of $1.50 What is the approximate probability of an observed EPS value falling between $3.00 and $7.25? If EPS = x = $7.25, then z = (x − μ)/σ = ($7.25 − $5.00)/$1.50 = +1.50 If EPS = x = $3.00, then z = (x − μ)/σ = ($3.00 − $5.00)/$1.50 = –1.33 Solving Using The Cumulative Z-Table For z-value of 1.50: Use the row headed 1.5 and the column headed to find the value 0.9332 This represents the area under the curve to the left of the critical value 1.50 For z-value of –1.33: Use the row headed 1.3 and the column headed to find the value 0.9082 This represents the area under the curve to the left of the critical value +1.33 The area to the left of –1.33 is − 0.9082 = 0.0918 The area between these critical values is 0.9332 − 0.0918 = 0.8414, or 84.14% Hypothesis Testing—One-Tailed Test Example A sample of a stock’s returns on 36 nonconsecutive days results in a mean return of 2.0% Assume the population standard deviation is 20.0% Can we say with 95% confidence that the mean return is greater than 0%? H0: μ ≤ 0.0%, Ha: μ > 0.0% The test statistic = z-statistic = = (2.0 − 0.0) / (20.0 / 6) = 0.60 The significance level = 1.0 − 0.95 = 0.05, or 5% Because we are interested in a return greater than 0.0%, this is a one-tailed test Using the Cumulative Z-Table Because this is a one-tailed test with an alpha of 0.05, we need to find the value 0.95 in the cumulative z-table The closest value is 0.9505, with a corresponding critical z-value of 1.65 Because the test statistic is less than the critical value, we fail to reject H0 Hypothesis Testing—Two-Tailed Test Example Using the same assumptions as before, suppose that the analyst now wants to determine if he can say with 99% confidence that the stock’s return is not equal to 0.0% H0: μ = 0.0%, Ha: μ ≠ 0.0% The test statistic (z-value) = (2.0 − 0.0) / (20.0 / 6) = 0.60 The significance level = 1.0 − 0.99 = 0.01, or 1% Because we are interested in whether or not the stock return is nonzero, this is a two-tailed test Using the Cumulative Z-Table Because this is a two-tailed test with an alpha of 0.01, there is a 0.005 rejection region in both tails Thus, we need to find the value 0.995 (1.0 − 0.005) in the table The closest value is 0.9951, which corresponds to a critical z-value of 2.58 Because the test statistic is less than the critical value, we fail to reject H0 and conclude that the stock’s return equals 0.0% Cumulative Z-Table Appendix B: Student's t-Distribution APPENDIX C: F-TABLE AT 5% (UPPER TAIL) APPENDIX D: F-TABLE AT 2.5% (UPPER TAIL) APPENDIX E: CHI-SQUARED TABLE All rights reserved under International and Pan-American Copyright Conventions By payment of the required fees, you have been granted the non-exclusive, non-transferable right to access and read the text of this eBook on screen No part of this text may be reproduced, transmitted, downloaded, decompiled, reverse engineered, or stored in or introduced into any information storage and retrieval system, in any forms or by any means, whether electronic or mechanical, now known or hereinafter invented, without the express written permission of the publisher SCHWESERNOTES™ 2019 LEVEL I CFA® BOOK 1: ETHICAL AND PROFESSIONAL STANDARDS AND QUANTITATIVE METHODS ©2018 Kaplan, Inc All rights reserved Published in 2018 by Kaplan, Inc Printed in the United States of America ISBN: 978-1-4754-7871-6 These materials may not be copied without written permission from the author The unauthorized duplication of these notes is a violation of global copyright laws and the CFA Institute Code of Ethics Your assistance in pursuing potential violators of this law is greatly appreciated Required CFA Institute disclaimer: “CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by Kaplan Schweser CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.” Certain materials contained within this text are the copyrighted property of CFA Institute The following is the copyright disclosure for these materials: “Copyright, 2018, CFA Institute Reproduced and republished from 2019 Learning Outcome Statements, Level I, II, and III questions from CFA® Program Materials, CFA Institute Standards of Professional Conduct, and CFA Institute’s Global Investment Performance Standards with permission from CFA Institute All Rights Reserved.” Disclaimer: The SchweserNotes should be used in conjunction with the original readings as set forth by CFA Institute in their 2019 Level I CFA Study Guide The information contained in these Notes covers topics contained in the readings referenced by CFA Institute and is believed to be accurate However, their accuracy cannot be guaranteed nor is any warranty conveyed as to your ultimate exam success The authors of the referenced readings have not endorsed or sponsored these Notes ... 13 4 13 5 13 6 13 7 13 8 13 9 14 0 14 1 14 2 14 3 14 4 14 5 14 6 14 7 14 8 14 9 15 0 15 1 15 2 15 3 15 5 15 6 15 7 15 8 15 9 16 0 16 1 16 2 16 3 16 4 16 5 16 7 16 8 16 9 17 0 17 1 17 2 17 3 17 5 17 6 17 7 17 8 17 9 18 1 18 1 18 2 18 3 18 4 18 5... 13 5 13 6 13 7 13 8 13 9 14 0 14 1 14 2 14 3 14 4 14 5 14 6 14 7 14 8 14 9 15 0 15 1 15 2 15 3 15 4 15 5 15 6 15 7 15 8 15 9 16 0 16 1 16 2 16 3 16 4 16 5 16 6 16 7 16 8 16 9 17 0 17 1 17 2 17 3 17 4 17 5 17 6 17 7 17 8 17 9 18 0 13 2 13 3 13 4... 12 9 13 0 13 1 13 2 13 3 13 4 84 85 86 87 88 89 90 91 92 93 94 95 97 98 99 10 0 10 1 10 2 10 3 10 4 10 5 10 6 10 7 10 8 10 9 11 0 11 1 11 2 11 3 11 4 11 5 11 6 11 7 11 9 12 0 12 1 12 2 12 3 12 4 12 5 12 6 12 7 12 8 12 9 13 0 13 1 13 5