2020 CFA® Program Curriculum Level 2

© CFA Institute For candidate use only Not for distribution ETHICAL AND PROFESSIONAL STANDARDS, QUANTITATIVE METHODS, AND ECONOMICS CFA® Program Curriculum 2020 ã LEVEL II ã VOLUME â CFA Institute For candidate use only Not for distribution © 2019, 2018, 2017, 2016, 2015, 2014, 2013, 2012, 2011, 2010, 2009, 2008, 2007, 2006 by CFA Institute All rights reserved This copyright covers material written expressly for this volume by the editor/s as well as the compilation itself It does not cover the individual selections herein that first appeared elsewhere Permission to reprint these has been obtained by CFA Institute for this edition only Further reproductions by any means, electronic or mechanical, including photocopying and recording, or by any information storage or retrieval systems, must be arranged with the individual copyright holders noted CFA®, Chartered Financial Analyst®, AIMR-PPS®, and GIPS® are just a few of the trademarks owned by CFA Institute To view a list of CFA Institute trademarks and the Guide for Use of CFA Institute Marks, please visit our website at www.cfainstitute.org This publication is designed to provide accurate and authoritative information in regard to the subject matter covered It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service If legal advice or other expert assistance is required, the services of a competent professional should be sought All trademarks, service marks, registered trademarks, and registered service marks are the property of their respective owners and are used herein for identification purposes only ISBN 978-1-946442-82-6 (paper) ISBN 978-1-950157-06-8 (ebk) 10 © CFA Institute For candidate use only Not for distribution CONTENTS How to Use the CFA Program Curriculum   Background on the CBOK   Organization of the Curriculum   Features of the Curriculum   Designing Your Personal Study Program   Feedback   ix ix x x xii xiii Ethical and Professional Standards Study Session Ethical and Professional Standards   Reading Code of Ethics and Standards of Professional Conduct   Preface   Evolution of the CFA Institute Code of Ethics and Standards of Professional Conduct   Standards of Practice Handbook   Summary of Changes in the Eleventh Edition   CFA Institute Professional Conduct Program   Adoption of the Code and Standards   Acknowledgments   Ethics and the Investment Industry   Why Ethics Matters   CFA Institute Code of Ethics and Standards of Professional Conduct   Preamble   The Code of Ethics   Standards of Professional Conduct   5 6 10 10 11 11 15 15 15 16 Guidance for Standards I–VII   Standard I: Professionalism   Standard I(A) Knowledge of the Law   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard I(B) Independence and Objectivity   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard I(C) Misrepresentation   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard I(D) Misconduct   Guidance   Recommended Procedures for Compliance   Application of the Standard   21 21 21 21 26 27 30 30 35 36 43 43 46 48 53 53 54 54 Reading indicates an optional segment ii © CFA Institute For candidate use only Not for distribution Contents Standard II: Integrity of Capital Markets   Standard II(A) Material Nonpublic Information   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard II(B) Market Manipulation   Guidance   Application of the Standard   Standard III: Duties to Clients   Standard III(A) Loyalty, Prudence, and Care   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard III(B) Fair Dealing   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard III(C) Suitability   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard III(D) Performance Presentation   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard III(E) Preservation of Confidentiality   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard IV: Duties to Employers   Standard IV(A) Loyalty   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard IV(B) Additional Compensation Arrangements   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard IV(C) Responsibilities of Supervisors   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard V: Investment Analysis, Recommendations, and Actions   Standard V(A) Diligence and Reasonable Basis   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard V(B) Communication with Clients and Prospective Clients   Guidance   indicates an optional segment 56 56 56 60 63 68 68 69 73 73 73 77 78 82 82 84 86 90 90 93 94 97 97 98 98 101 101 103 103 105 105 105 109 109 116 116 116 116 118 118 120 122 126 126 126 130 130 137 138 Contents Reading © CFA Institute For candidate use only Not for distribution iii Recommended Procedures for Compliance   Application of the Standard   Standard V(C) Record Retention   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard VI: Conflicts of Interest   Standard VI(A) Disclosure of Conflicts   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard VI(B) Priority of Transactions   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard VI(C) Referral Fees   Guidance   Recommended Procedures for Compliance   Application of the Standard   Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate   Standard VII(A) Conduct as Participants in CFA Institute Programs    Guidance   Application of the Standard   Standard VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program   Guidance   Recommended Procedures for Compliance   Application of the Standard   Practice Problems   Solutions   140 141 146 146 147 148 149 149 149 152 152 157 157 158 160 162 162 162 162 165 165 165 167 Application of the Code and Standards: Level II   Introduction   QuantHouse   Case Questions   JR and Associates   Case Questions   Magadi Asset Management   Case Questions   Edvard Stark   Duties to Clients   Duties to Employers   Investment Analysis, Recommendations, and Actions   Conflicts of Interest   Subath Agarway   Professionalism   Conflicts of Interest   205 205 206 207 211 212 217 219 223 224 225 226 227 228 229 230 indicates an optional segment 170 170 172 173 175 193 iv © CFA Institute For candidate use only Not for distribution Contents Quantitative Methods Study Session Quantitative Methods (1)   235 Reading Introduction to Linear Regression   Introduction   Linear Regression   Linear Regression with One Independent Variable   Assumptions of the Linear Regression Model   The Standard Error of Estimate   The Coefficient of Determination   Hypothesis Testing   Analysis of Variance in a Regression with One Independent Variable   Prediction Intervals   Limitations of Regression Analysis   Summary   Practice Problems   Solutions   237 238 238 238 243 246 248 250 259 262 264 265 267 278 Reading Multiple Regression   Introduction   Multiple Linear Regression   Assumptions of the Multiple Linear Regression Model   Predicting the Dependent Variable in a Multiple Regression Model   Testing whether All Population Regression Coefficients Equal Zero   Adjusted R2   Using Dummy Variables in Regressions   Violations of Regression Assumptions   Heteroskedasticity   Serial Correlation   Multicollinearity   Heteroskedasticity, Serial Correlation, Multicollinearity: Summarizing the Issues   Model Specification and Errors in Specification   Principles of Model Specification   Misspecified Functional Form   Time-­Series Misspecification (Independent Variables Correlated with Errors)   Other Types of Time-­Series Misspecification   Models with Qualitative Dependent Variables   Summary   Practice Problems   Solutions   283 284 284 290 295 297 299 300 304 305 311 315 Time-­Series Analysis   Introduction to Time-­Series Analysis   Challenges of Working with Time Series   Trend Models   Linear Trend Models   375 376 378 379 379 Reading indicates an optional segment 318 319 319 320 328 332 332 335 339 364 Contents © CFA Institute For candidate use only Not for distribution v Log-­Linear Trend Models   Trend Models and Testing for Correlated Errors   Autoregressive (AR) Time-­Series Models   Covariance-­Stationary Series   Detecting Serially Correlated Errors in an Autoregressive Model   Mean Reversion   Multiperiod Forecasts and the Chain Rule of Forecasting   Comparing Forecast Model Performance   Instability of Regression Coefficients   Random Walks and Unit Roots   Random Walks   The Unit Root Test of Nonstationarity   Moving-­Average Time-­Series Models   Smoothing Past Values with an n-Period Moving Average   Moving-­Average Time-­Series Models for Forecasting   Seasonality in Time-­Series Models   Autoregressive Moving-­Average Models   Autoregressive Conditional Heteroskedasticity Models   Regressions with More than One Time Series   Other Issues in Time Series   Suggested Steps in Time-­Series Forecasting   Summary   Practice Problems   Solutions   382 388 389 390 391 394 395 398 400 403 403 407 411 412 414 416 422 423 426 430 431 432 436 452 Study Session Quantitative Methods (2)   461 Reading Machine Learning   Introduction   Machine Learning and Investment Management   What Is Machine Learning?   Defining Machine Learning   Supervised Learning   Unsupervised Learning   Deep Learning and Reinforcement Learning   Summary of ML Algorithms and How to Choose Among Them   Overview of Evaluating ML Algorithm Performance   Generalization and Overfitting   Errors and Overfitting   Preventing Overfitting in Supervised Machine Learning   Supervised Machine Learning Algorithms   Penalized Regression   Support Vector Machine   K-­Nearest Neighbor   Classification and Regression Tree   Ensemble Learning and Random Forest   Unsupervised Machine Learning Algorithms   Principal Components Analysis   Clustering   463 463 464 465 465 465 467 467 467 471 471 472 474 476 476 477 479 481 484 489 489 492 indicates an optional segment vi Reading Reading © CFA Institute For candidate use only Not for distribution Contents Neural Networks, Deep Learning Nets, and Reinforcement Learning   Neural Networks   Deep Learning Nets   Reinforcement Learning   Summary   Practice Problems   Solutions   499 499 503 504 507 510 514 Big Data Projects   Introduction   Big Data in Investment Management   Steps in Executing a Data Analysis Project: Financial Forecasting with Big Data   Data Preparation and Wrangling   Structured Data   Unstructured (Text) Data   Data Exploration Objectives and Methods   Structured Data   Unstructured Data: Text Exploration   Model Training   Structured and Unstructured Data   Financial Forecasting Project: Classifying and Predicting Sentiment for Stocks   Text Curation, Preparation, and Wrangling   Data Exploration   Model Training   Results and Interpretation   Summary   Practice Problems   Solutions   517 517 518 Excerpt from “Probabilistic Approaches: Scenario Analysis, Decision Trees, and Simulations”   Introduction   Simulations   Steps in Simulation   An Example of a Simulation   Use in Decision Making   Simulations with Constraints   Issues   Risk-­Adjusted Value and Simulations   An Overall Assessment of Probabilistic Risk Assessment Approaches   Comparing the Approaches   Complement or Replacement for Risk-­Adjusted Value   In Practice   Conclusion   Practice Problems   Solutions   indicates an optional segment 519 523 524 530 537 538 542 549 550 559 559 563 572 578 582 584 588 591 591 592 592 595 598 599 600 601 602 602 603 604 605 606 609 Contents © CFA Institute For candidate use only Not for distribution vii Economics Study Session Economics   613 Reading 10 Currency Exchange Rates: Understanding Equilibrium Value   Introduction   Foreign Exchange Market Concepts   Arbitrage Constraints on Spot Exchange Rate Quotes   Forward Markets   The Mark-­to-­Market Value of a Forward Contract   A Long-­Term Framework for Exchange Rates   International Parity Conditions   The Carry Trade   The Impact of Balance of Payments Flows   Current Account Imbalances and the Determination of Exchange Rates   Capital Flows and the Determination of Exchange Rates   Monetary and Fiscal Policies   The Mundell–Fleming Model   Monetary Models of Exchange Rate Determination   The Portfolio Balance Approach   Exchange Rate Management: Intervention and Controls   Warning Signs of a Currency Crisis   Summary   Appendix   Practice Problems   Solutions   615 616 616 620 624 628 632 633 648 651 Economic Growth and the Investment Decision   Introduction   Growth in the Global Economy: Developed vs Developing Economies   Savings and Investment   Financial Markets and Intermediaries   Political Stability, Rule of Law, and Property Rights   Education and Health Care Systems   Tax and Regulatory Systems   Free Trade and Unrestricted Capital Flows   Summary of Factors Limiting Growth in Developing Countries   Why Potential Growth Matters to Investors   Determinants of Economic Growth   Production Function   Capital Deepening vs Technological Progress   Growth Accounting   Extending the Production Function   Natural Resources   Labor Supply   Labor Quality: Human Capital   Capital: ICT and Non-­ICT   Technology   695 696 696 699 699 700 700 701 701 702 704 709 709 711 713 715 715 717 722 723 725 Reading 11 indicates an optional segment 652 655 660 661 663 666 669 672 676 681 682 690 viii Reading 12 © CFA Institute For candidate use only Not for distribution Contents Public Infrastructure   Summary   Theories of Growth   Classical Model   Neoclassical Model   Endogenous Growth Theory   Convergence Debate   Growth in an Open Economy   Summary   Practice Problems   Solutions   729 729 734 735 735 747 750 754 762 766 773 Economics of Regulation   Introduction   Economic Rationale for Regulation   Rationale for the Regulation of Financial Markets   Regulation of Commerce   Antitrust Regulation   Regulators and Regulatory Tools   Classification of Regulations and Regulators   Regulatory Interdependencies   Regulatory Tools   Analysis of Regulation   Basic Concepts of Cost–Benefit Analysis   Analysis of Regulation   Summary   Practice Problems   Solutions   777 777 778 779 782 783 784 784 788 792 795 795 798 802 805 809 Appendices   Glossary 811 G-1 indicates an optional segment ... Agarway   Professionalism   Conflicts of Interest   20 5 20 5 20 6 20 7 21 1 21 2 21 7 21 9 22 3 22 4 22 5 22 6 22 7 22 8 22 9 23 0 indicates an optional segment 170 170 1 72 173 175 193 iv © CFA Institute For candidate... Institute For candidate use only Not for distribution © 20 19, 20 18, 20 17, 20 16, 20 15, 20 14, 20 13, 20 12, 20 11, 20 10, 20 09, 20 08, 20 07, 20 06 by CFA Institute All rights reserved This copyright... Limitations of Regression Analysis   Summary   Practice Problems   Solutions   23 7 23 8 23 8 23 8 24 3 24 6 24 8 25 0 25 9 26 2 26 4 26 5 26 7 27 8 Reading Multiple Regression   Introduction   Multiple Linear Regression