SchweserNotes CFA Level 2 Book

http://www.freeaccountingbooks.com/schwesernotes-cfa-level-2-book/

Free Accounting books provides unlimited PDF books, notes & guides of #Financial, #cost and #management #accounting, #ACCA, #CFA, #CIMA, #CPA, #CMA, #FRM and many more .......
#freeaccountingbooks.com

Book 1 – Ethical and Professional
Standards, Quantitative Methods,
and Economics
Readings and Learning Outcome Statements .......................................................... 6
Study Session 1 – Ethical and Professional Standards ............................................ 14
Study Session 2 – Ethical and Professional Standards: Application....................... 110
Self-Test – Ethical and Professional Standards ..................................................... 128
Study Session 3 – Quantitative Methods for Valuation ........................................ 138
Self-Test – Quantitative Methods for Valuation ................................................... 254
Study Session 4 – Economics for Valuation ......................................................... 260
Self-Test – Economics for Valuation .................................................................... 354
Formulas ............................................................................................................ 357
Appendices ........................................................................................................ 361
Index ................................................................................................................. 370
SCHWESERNOTES™ 2011 CFA LEVEL 2 BOOK 1: ETHICAL AND PROFESSIONAL STANDARDS,
QUANTITATIVE METHODS, AND ECONOMICS
©2010 Kaplan, Inc. All rights reserved.
Published in 2010 by Kaplan Schweser.
Printed in the United States of America.
ISBN: 978-1-4277-2747-3 / 1-4277-2747-3
PPN: 3200-0068
If this book does not have the hologram with the Kaplan Schweser logo on the back cover, it was distributed without permission of Kaplan
Schweser, a Division of Kaplan, Inc., and is in direct violation of global copyright laws. Your assistance in pursuing potential violators of this
law is greatly appreciated.
Required CFA Institute® disclaimer: “CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute. CFA Institute
(formerly the Association for Investment Management and Research) does not endorse, promote, review, or warrant the accuracy of the
products or services offered by Kaplan Schweser.”
Certain materials contained within this text are the copyrighted property of CFA Institute. The following is the copyright disclosure for
these materials: “Copyright, 2011, CFA Institute. Reproduced and republished from 2011 Learning Outcome Statements, Level 1, 2,
and 3 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.”
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.
Disclaimer: The SchweserNotes should be used in conjunction with the original readings as set forth by CFA Institute in their 2011 CFA Level
2 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.
©2010 Kaplan, Inc. Page 3
Welcome to the 2011 Level 2
SchweserNotes™
Thank you for trusting Kaplan Schweser to help you reach your goals. We are all very
pleased to be able to help you prepare for the Level 2 CFA Exam. In this introduction,
I want to explain the resources included with the SchweserNotes, suggest how you
can best use Schweser materials to prepare for the exam, and direct you toward other
educational resources you will find helpful as you study for the exam.
Besides the SchweserNotes themselves, there are many educational resources available at
Schweser.com. Just log in using the individual username and password that you received
when you purchased the SchweserNotes.
SchweserNotesTM
These consist of five volumes that include complete coverage of all 18 Study Sessions
and all Learning Outcome Statements (LOS) with examples, Concept Checkers
(multiple-choice questions for every topic review), and Challenge Problems for many
topic reviews to help you master the material and check your progress. At the end of
each major topic area, we include a Self-test. Self-test questions are created to be examlike
in format and difficulty in order for you to evaluate how well your study of each
topic has prepared you for the actual exam. The Level 2 SchweserNotes Package also
includes a sixth volume, the Level 1 Refresher, a review of important Level 1 material.
Practice Questions
To retain what you learn, it is important that you quiz yourself often. We offer CD,
download, and online versions of the SchweserPro™ QBank, which contains thousands
of Level 2 practice questions, item sets, and explanations. Quizzes are available for each
LOS, topic, or Study Session. Build your own exams by specifying the topics and the
number of questions you choose.
Practice Exams
Schweser offers six full 6-hour practice exams. Practice Exams Volume 1 and Volume 2
each contain three full 120-question exams. These are important tools for gaining the
speed and skills you will need to pass the exam. Each book contains answers with full
explanations for self-grading and evaluation. By entering your answers at Schweser.com,
you can use our Performance Tracker to find out how you have performed compared to
other Schweser Level 2 candidates.
Schweser Library
We have created reference videos, some of which are available to all SchweserNotes
purchasers. Schweser Library volumes range from 20 to 60 minutes in length and cover
such topics as: “Introduction to Item Sets,” “Hypothesis Testing,” “Foreign Exchange
Basics,” “Ratio Analysis,” and “Forward Contracts.” The full Schweser Library is
included with our 16-week live or online classes and with our video instruction (online
or CDs).
Page 4 ©2010 Kaplan, Inc.
Welcome to the 2011 Level 2 SchweserNotes™
Online Schweser Study Planner
Use your Online Access to tell us when you will start and what days of the week you can
study. The online Schweser Study Planner will create a study plan just for you, breaking
each study session into daily and weekly tasks to keep you on track and help you
monitor your progress through the curriculum.
Additional Resources
Purchasers of the Essential Self-Study or Premium Instruction Packages also receive
access to our Instructor-led Office Hours. Office Hours allow you to get your questions
about the curriculum answered in real time and to see others’ questions (and instructor
answers) as well. Office Hours is a text-based live interactive online chat with our team
of Level 2 experts. Archives of previous Office Hours sessions can be sorted by topic or
date and are posted shortly after each session.
The Level 2 CFA exam is a formidable challenge (70 topic reviews and 475+ Learning
Outcome Statements), and you must devote considerable time and effort to be properly
prepared. There is no shortcut! You must learn the material, know the terminology and
techniques, understand the concepts, and be able to answer 120 questions quickly and
(at least 70%) correctly. Fifteen to 20 hours per week for 20 weeks is a good estimate
of the study time required on average, but some candidates will need more or less time,
depending on their individual backgrounds and experience.
To help you master this material and be well prepared for the CFA Exam, we offer
several other educational resources, including:
Live Weekly Classroom Programs
We offer weekly classroom programs around the world. Please check Schweser.com for
locations, dates, and availability.
16-Week Online Classes
Our 16-Week Online Classes are available at New York time (6:30–9:30 pm) or London
time (6:00–9:00 pm) beginning in January. The approximate schedule for the 16-Week
Online Classes (3-hour sessions) is as follows:
Class # Class #
1) Exam Intro/Ethical Standards SS 1, 2 9) Equity SS 11, 12
2) Quantitative Methods SS 3 10) Equity SS 12
3) Economics for Valuation SS 4 11) Alternative Asset Valuation SS 13
4) Financial Reporting & Analysis SS 5 12) Fixed Income SS 14
5) Financial Reporting & Analysis SS 6 13) Fixed Income SS 15
6) Financial Reporting & Analysis SS 7 14) Derivatives SS 16
7) Corporate Finance SS 8 15) Derivatives & Portfolio Management SS 17
8) Corporate Finance & Equity SS 9, 10 16) Portfolio Management SS 18
Archived classes are available for viewing at any time throughout the season. Candidates
enrolled in the 16-Week Online Classes also have full access to supplemental on-demand
video instruction in the Schweser Library and an e-mail address to use to send questions
to the instructor at any time.
©2010 Kaplan, Inc. Page 5
Welcome to the 2011 Level 2 SchweserNotes™
Late Season Review
Whether you use self-study or in-class, online, or video instruction to learn the CFA
curriculum, a late-season review and exam practice can make all the difference. Our
most complete late-season review courses are our residence programs in Windsor,
Ontario (WindsorWeek) and Dallas/Fort Worth, Texas (DFW 5-day program). Each
covers the entire curriculum at all three levels. We also offer 3-day Exam Workshops in
many cities (and online) that combine curriculum review with an equal component of
hands-on practice with hundreds of questions and problem-solving techniques. Please
visit us at Schweser.com for complete listings and course descriptions for all our lateseason
review offerings.
Mock Exam and Multimedia Tutorial
On May 21, 2011, the Schweser Mock Exam will be offered live in many cities around
the world and as an online exam as well. The optional Multimedia Tutorial provides
extended explanation and topic tutorials to get you exam-ready in areas where you
miss questions on the Mock Exam. Please visit Schweser.com for a listing of cities and
locations.
How to Succeed
There are no shortcuts; depend on the fact that CFA Institute will test you in a way
that will reveal how well you know the Level 2 curriculum. You should begin early and
stick to your study plan. You should first read the SchweserNotes and complete the
Concept Checkers and Challenge Problems for each topic review. You should prepare
for and attend a live class, an online class, or a study group each week. You should take
quizzes often using SchweserPro Qbank and go back to review previous topics and Study
Sessions as well. At the end of each topic area, you should take the Self-test to check
your progress. You should finish the overall curriculum at least four weeks (preferably
five weeks) before the Level 2 exam so that you have sufficient time for Practice Exams
and for further review of those topics that you have not yet mastered.
I would like to thank Kevin Rygg, CFA Content Specialist; Stephanie Downey, Director
of Print Production; and Jeff Faas, Lead Editor, for their contributions to the 2011
Level 2 SchweserNotes for the CFA Exam.
Best regards,
Bijesh Tolia
Dr. Bijesh Tolia, CFA
VP and CFA Level 2 Manager
Kaplan Schweser
Page 6 ©2010 Kaplan, Inc.
Readings and
Learning Outcome Statements
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 2
(CFA Institute, 2011)
1. Code of Ethics and Standards of Professional Conduct page 14
2. Guidance for Standards I–VII page 14
3. CFA Institute Soft Dollar Standards page 92
4. CFA Institute Research Objectivity Standards page 101
STUDY SESSION 2
Reading Assignments
Ethical and Professional Standards, CFA Program Curriculum, Volume 1, Level 2
(CFA Institute, 2011)
5. The Glenarm Company page 110
6. Preston Partners page 112
7. Super Selection page 115
8. Trade Allocation: Fair Dealing and Disclosure page 118
9. Changing Investment Objectives page 120
10. Prudence in Perspective page 121
STUDY SESSION 3
Reading Assignments
Quantitative Methods for Valuation, CFA Program Curriculum, Volume 1, Level 2
(CFA Institute, 2011)
11. Correlation and Regression page 138
12. Multiple Regression and Issues in Regression Analysis page 172
13. Time-Series Analysis page 218
©2010 Kaplan, Inc. Page 7
Book 1 – Ethical & Professional Standards, Quantitative Methods, and Economics
Readings and Learning Outcome Statements
STUDY SESSION 4
Reading Assignments
Economics for Valuation, CFA Program Curriculum, Volume 1, Level 2
(CFA Institute, 2011)
14. Economic Growth page 260
15. Regulation and Antitrust Policy in a Globalized Economy page 278
16. Trading with the World page 285
17. The Exchange Rate and the Balance of Payments page 296
18. Currency Exchange Rates page 307
19. Foreign Exchange Parity Relations page 327
20. Measuring Economic Activity page 348
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. Code of Ethics and Standards of Professional Conduct
The candidate should be able to:
a. state the six components of the Code of Ethics and the seven Standards of
Professional Conduct. (page 14)
b. explain the ethical responsibilities required by the Code and Standards.
(page 15)
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 of
Professional Conduct by applying the Code and Standards to specific situations.
(page 18)
b. recommend practices and procedures designed to prevent violations of the Code
of Ethics and Standards of Professional Conduct. (page 18)
The topical coverage corresponds with the following CFA Institute assigned reading:
3. CFA Institute Soft Dollar Standards
The candidate should be able to:
a. define soft-dollar arrangements and state the general principles of the Soft
Dollar Standards. (page 92)
b. critique company soft-dollar practices and policies. (page 93)
c. determine whether a product or service qualifies as “permissible research” that
can be purchased with client brokerage. (page 96)
Page 8 ©2010 Kaplan, Inc.
Book 1 – Ethical & Professional Standards, Quantitative Methods, and Economics
Readings and Learning Outcome Statements
The topical coverage corresponds with the following CFA Institute assigned reading:
4. CFA Institute Research Objectivity Standards
The candidate should be able to:
a. explain the objectives of the Research Objectivity Standards. (page 101)
b. critique company policies and practices related to research objectivity, and
distinguish between changes required and changes recommended for compliance
with the Research Objectivity Standards. (page 101)
STUDY SESSION 2
The topical coverage corresponds with the following CFA Institute assigned reading:
5. The Glenarm Company
6. Preston Partners
7. Super Selection
For each of these cases, the candidate should be able to:
a. critique the practices and policies presented. (pages 110, 112, 115)
b. explain the appropriate action to take in response to conduct that violates the
CFA Institute Code of Ethics and Standards of Professional Conduct.
(pages 110, 112, 115)
The topical coverage corresponds with the following CFA Institute assigned reading:
8. Trade Allocation: Fair Dealing and Disclosure
The candidate should be able to:
a. critique trade allocation practices, and determine whether compliance exists with
the CFA Institute Standards of Professional Conduct addressing fair dealing and
client loyalty. (page 118)
b. discuss appropriate actions to take in response to trade allocation practices that
do not adequately respect client interests. (page 119)
The topical coverage corresponds with the following CFA Institute assigned reading:
9. Changing Investment Objectives
The candidate should be able to:
a. critique the disclosure of investment objectives and basic policies and determine
whether they comply with the CFA Institute Standards of Professional Conduct.
(page 120)
b. discuss appropriate actions needed to ensure adequate disclosure of the
investment process. (page 120)
The topical coverage corresponds with the following CFA Institute assigned reading:
10. Prudence in Perspective
The candidate should be able to:
a. explain the basic principles of the new Prudent Investor Rule. (page 121)
b. explain the general fiduciary standards to which a trustee must adhere.
(page 122)
c. differentiate between the old Prudent Man Rule and the new Prudent Investor
Rule. (page 123)
d. explain the key factors that a trustee should consider when investing and
managing trust assets. (page 123)
©2010 Kaplan, Inc. Page 9
Book 1 – Ethical & Professional Standards, Quantitative Methods, and Economics
Readings and Learning Outcome Statements
STUDY SESSION 3
The topical coverage corresponds with the following CFA Institute assigned reading:
11. Correlation and Regression
The candidate should be able to:
a. calculate and interpret a sample covariance and a sample correlation coefficient,
and interpret a scatter plot. (page 138)
b. explain the limitations to correlation analysis, including outliers and spurious
correlation. (page 142)
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 143)
d. distinguish between the dependent and independent variables in a linear
regression. (page 144)
e. explain the assumptions underlying linear regression, and interpret the
regression coefficients. (page 146)
f. calculate and interpret the standard error of estimate, the coefficient of
determination, and a confidence interval for a regression coefficient. (page 150)
g. formulate a null and alternative hypothesis about a population value of a
regression coefficient, select the appropriate test statistic, and determine whether
the null hypothesis is rejected at a given level of significance. (page 152)
h. calculate a predicted value for the dependent variable, given an estimated
regression model and a value for the independent variable, and calculate and
interpret a confidence interval for the predicted value of a dependent variable.
(page 153)
i. describe the use of analysis of variance (ANOVA) in regression analysis, interpret
ANOVA results, and calculate and interpret an F-statistic. (page 154)
j. discuss the limitations of regression analysis. (page 159)
The topical coverage corresponds with the following CFA Institute assigned reading:
12. 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, determine the statistical
significance of each independent variable, and interpret the estimated
coefficients and their p-values. (page 173)
b. formulate a null and an alternative hypothesis about the population value of a
regression coefficient, calculate the value of the test statistic, determine whether
to reject the null hypothesis at a given level of significance by using a one-tailed
or two-tailed test, and interpret the results of the test. (page 175)
c. 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 the independent variables.
(page 179)
d. explain the assumptions of a multiple regression model. (page 181)
e. calculate and interpret the F-statistic, and discuss how it is used in regression
analysis. (page 181)
f. distinguish between and interpret the R2 and adjusted R2 in multiple regression.
(page 183)
Page 10 ©2010 Kaplan, Inc.
Book 1 – Ethical & Professional Standards, Quantitative Methods, and Economics
Readings and Learning Outcome Statements
g. infer how well a regression model explains the dependent variable by analyzing
the output of the regression equation and an ANOVA table. (page 185)
h. formulate a multiple regression equation by using dummy variables to represent
qualitative factors, and interpret the coefficients and regression results.
(page 189)
i. discuss the types of heteroskedasticity and the effects of heteroskedasticity and
serial correlation on statistical inference. (page 193)
j. describe multicollinearity, and discuss its causes and effects in regression
analysis. (page 199)
k. discuss the effects of model misspecification on the results of a regression
analysis, and explain how to avoid the common forms of misspecification.
(page 202)
l. discuss models with qualitative dependent variables. (page 206)
m. interpret the economic meaning of the results of multiple regression analysis and
critique a regression model and its results. (page 206)
The topical coverage corresponds with the following CFA Institute assigned reading:
13. 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 trend coefficients.
(page 218)
b. discuss the factors that determine whether a linear or a log-linear trend should
be used with a particular time series, and evaluate the limitations of trend
models. (page 224)
c. explain the requirement for a time series to be covariance stationary, and discuss
the significance of a series that is not stationary. (page 225)
d. discuss the structure of an autoregressive (AR) model of order p, and calculate
one- and two-period-ahead forecasts given the estimated coefficients. (page 226)
e. explain how autocorrelations of the residuals can be used to test whether the
autoregressive model fits the time series. (page 227)
f. explain mean reversion, and calculate a mean-reverting level. (page 228)
g. contrast in-sample and out-of-sample forecasts, and compare the forecasting
accuracy of different time-series models based on the root mean squared error
criterion. (page 229)
h. discuss the instability of coefficients of time-series models. (page 230)
i. describe the characteristics of random walk processes, and contrast them to
covariance stationary processes. (page 231)
j. discuss the implications of unit roots for time-series analysis, explain when 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 it can be analyzed with an AR
model. (page 232)
k. discuss the steps of the unit root test for nonstationarity, and explain the relation
of the test to autoregressive time-series models. (page 232)
l. discuss how to test and correct for seasonality in a time-series model, and
calculate and interpret a forecasted value using an AR model with a seasonal lag.
(page 235)
m. explain autoregressive conditional heteroskedasticity (ARCH), and discuss how
ARCH models can be applied to predict the variance of a time series. (page 239)
n. explain how time-series variables should be analyzed for nonstationarity and/or
cointegration before use in a linear regression. (page 240)
©2010 Kaplan, Inc. Page 11
Book 1 – Ethical & Professional Standards, Quantitative Methods, and Economics
Readings and Learning Outcome Statements
o. select and justify the choice of a particular time-series model from a group of
models. (page 242)
STUDY SESSION 4
The topical coverage corresponds with the following CFA Institute assigned reading:
14. Economic Growth
The candidate should be able to:
a. define the sources of economic growth, and discuss the preconditions for
economic growth. (page 261)
b. discuss how the one-third rule can be used to explain the contributions of labor
and technological change to growth in labor productivity. (page 262)
c. discuss how faster economic growth can be achieved by increasing the growth of
physical capital, technological advances, and investment in human capital.
(page 265)
d. compare and contrast classical growth theory, neoclassical growth theory, and
new growth theory. (page 265)
The topical coverage corresponds with the following CFA Institute assigned reading:
15. Regulation and Antitrust Policy in a Globalized Economy
The candidate should be able to:
a. explain the rationale for government regulation in the form of 1) economic
regulation of natural monopolies and 2) social regulation of nonmonopolistic
industries. (page 278)
b. discuss the potential benefits and possible negative side effects of social
regulation. (page 280)
c. differentiate between the capture hypothesis and the share-the-gains, share-thepains
theory of regulator behavior. (page 280)
The topical coverage corresponds with the following CFA Institute assigned reading:
16. Trading with the World
The candidate should be able to:
a. explain comparative advantage and how countries can gain from international
trade. (page 285)
b. compare and contrast tariffs, nontariff barriers, quotas, and voluntary export
restraints. (page 288)
c. critique the arguments for trade restrictions. (page 290)
The topical coverage corresponds with the following CFA Institute assigned reading:
17. The Exchange Rate and the Balance of Payments
The candidate should be able to:
a. define an exchange rate, and differentiate between the nominal exchange rate
and the real exchange rate. (page 296)
b. explain the factors that influence supply and demand in the foreign exchange
market. (page 297)
c. discuss how the supply and demand for a currency changes the exchange rate.
(page 299)
d. differentiate between interest rate parity and purchasing power parity.
(page 300)
e. describe the balance of payments accounts. (page 301)
Page 12 ©2010 Kaplan, Inc.
Book 1 – Ethical & Professional Standards, Quantitative Methods, and Economics
Readings and Learning Outcome Statements
f. describe the following exchange rate policies: flexible exchange rates, fixed
exchange rates, and crawling pegs. (page 302)
The topical coverage corresponds with the following CFA Institute assigned reading:
18. Currency Exchange Rates
The candidate should be able to:
a. define direct and indirect methods of foreign exchange quotations, and convert
direct (indirect) foreign exchange quotations into indirect (direct) foreign
exchange quotations. (page 307)
b. calculate and interpret the spread on a foreign currency quotation, and explain
how spreads on foreign currency quotations can differ as a result of market
conditions, bank/dealer positions, and trading volume. (page 309)
c. calculate and interpret currency cross rates, given two spot exchange quotations
involving three currencies. (page 310)
d. calculate the profit on a triangular arbitrage opportunity, given the bid-ask
quotations for the currencies of three countries involved in the arbitrage.
(page 312)
e. distinguish between the spot and forward markets for foreign exchange.
(page 313)
f. calculate and interpret the spread on a forward foreign currency quotation, and
explain how spreads on forward foreign currency quotations can differ as a result
of market conditions, bank/dealer positions, trading volume, and maturity/
length of contract. (page 314)
g. calculate and interpret a forward discount or premium and express it as an
annualized rate. (page 315)
h. explain interest rate parity, and illustrate covered interest arbitrage. (page 316)
i. distinguish between spot and forward transactions, calculate the annualized
forward premium/discount for a given currency, and infer whether the currency
is “strong” or “weak.” (page 318)
The topical coverage corresponds with the following CFA Institute assigned reading:
19. Foreign Exchange Parity Relations
The candidate should be able to:
a. explain how exchange rates are determined in a flexible (or floating) exchange
rate system. (page 327)
b. explain the role of each component of the balance of payments accounts.
(page 327)
c. explain how current account deficits or surpluses and financial account deficits
or surpluses affect an economy. (page 328)
d. describe the factors that cause a nation’s currency to appreciate or depreciate.
(page 328)
e. explain how monetary and fiscal policies affect the exchange rate and balance of
payments components. (page 329)
f. describe a fixed exchange rate and a pegged exchange rate system. (page 330)
g. discuss absolute purchasing power parity and relative purchasing power parity.
(page 331)
h. calculate the end-of-period exchange rate implied by purchasing power parity,
given the beginning-of-period exchange rate and the inflation rates. (page 331)
i. discuss the international Fisher relation. (page 333)
©2010 Kaplan, Inc. Page 13
Book 1 – Ethical & Professional Standards, Quantitative Methods, and Economics
Readings and Learning Outcome Statements
j. calculate the real interest rate, given nominal interest rates and expected inflation
rates, using the international Fisher relation and its linear approximation.
(page 333)
k. discuss the theory of uncovered interest rate parity, and explain the theory’s
relation to other exchange rate parity theories. (page 335)
l. calculate the expected change in the exchange rate, given interest rates and the
assumption that uncovered interest rate parity holds. (page 335)
m. discuss the foreign exchange expectation relation between the forward exchange
rate and the expected exchange rate. (page 337)
The topical coverage corresponds with the following CFA Institute assigned reading:
20. Measuring Economic Activity
The candidate should be able to:
a. distinguish between the measures of economic activity (i.e., gross domestic
product, gross national income, and net national income), including their
components. (page 348)
b. differentiate between GDP at market prices and GDP at factor cost. (page 349)
c. differentiate between current and constant prices, and describe the GDP
deflator. (page 350)
Page 14 ©2010 Kaplan, Inc.
The following is a review of the Ethical and Professional Standards principles designed to address the learning
outcome statements set forth by CFA Institute®. This topic is also covered in:
CFA Institute Code of Ethics and
Standards of Professional Conduct
Guidance for Standards I–VII
Study Session 1
Exam Focus
In addition to reading this review of the ethics material, we strongly recommend that
all candidates for the CFA® examination read the Standards of Practice Handbook 10th
Edition (2010) multiple times. As a Level 2 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: State the six components of the Code of Ethics and the seven
Standards of Professional Conduct.
Code of Ethics
Members of CFA Institute [including Chartered Financial Analyst® (CFA®)
charterholders] and candidates for the CFA designation (“Members and Candidates”)
must:1
Act with integrity, competence, diligence, respect, and in an 􀁳 ethical manner with
the public, clients, prospective clients, employers, employees, colleagues in the
investment profession, and other participants in the global capital markets.
􀁳 Place the integrity of the investment profession and the interests of clients above
their own personal interests.
􀁳 Use reasonable care and exercise independent professional judgment when
conducting investment analysis, making investment recommendations, taking
investment actions, and engaging in other professional activities.
􀁳 Practice and encourage others to practice in a professional and ethical manner that
will reflect credit on themselves and the profession.
􀁳 Promote the integrity of, and uphold the rules governing, capital markets.
􀁳 Maintain and improve their professional competence and strive to maintain and
improve the competence of other investment professionals.
The Standards of Professional Conduct
I: Professionalism
II: Integrity of Capital Markets
III: Duties to Clients
1. Copyright 2010, CFA Institute. Reproduced and republished from “The Code of Ethics,”
from Standards of Practice Handbook, 10th Ed., 2010, with permission from CFA Institute.
All rights reserved.
©2010 Kaplan, Inc. Page 15
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
IV: Duties to Employers
V: Investment Analysis, Recommendations, and Actions
VI: Conflicts of Interest
VII: Responsibilities as a CFA Institute Member or CFA Candidate
LOS 1.b: Explain the ethical responsibilities required by the Code and
Standards.
Standards of Professional Conduct2
I. PROFESSIO NALISM
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 any violation of laws, rules, or regulations and must disassociate themselves
from any such violation.
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.
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 commit any act that reflects
adversely on their professional reputation, integrity, or competence.
II. IN TEGRI TY OF CAPI TAL 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 with the intent to
mislead market participants.
2. Ibid.
Page 16 ©2010 Kaplan, Inc.
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
Study Session 1
III. DUT IES TO CLIEN TS
A. Loyalty, Prudence, and Care. Members and Candidates have a duty of loyalty
to their clients and must act with reasonable care and exercise prudent
judgment. Members and Candidates must act for the benefit of their clients
and place their clients’ interests before their 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, or engaging in other professional
activities.
C. Suitability.
1. When Members and Candidates are in an advisory relationship with a
client, they must:
a. Make a reasonable inquiry into a client’s or prospective clients’
investment experience, risk and return objectives, and financial
constraints prior to making any investment recommendation or taking
investment action and must reassess and update this information
regularly.
b. Determine that an investment is suitable to the client’s financial
situation and consistent with the client’s written objectives, mandates,
and constraints before making an investment recommendation or
taking investment action.
c. Judge the suitability of investments in the context of the client’s total
portfolio.
2. When Members and Candidates are responsible for managing a portfolio to
a specific mandate, strategy, or style, they must make only investment
recommendations or take investment actions that are consistent with the
stated objectives 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 the client or
prospective client,
2. Disclosure is required by law, or
3. The client or prospective client permits disclosure of the information.
©2010 Kaplan, Inc. Page 17
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
IV. DUT IES 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 their employer.
B. Additional Compensation Arrangements. Members and Candidates must not
accept gifts, benefits, compensation, or consideration that competes with, or
might reasonably be expected to create a conflict of interest with, their
employer’s interest unless they obtain written consent from all parties involved.
C. Responsibilities of Supervisors. Members and Candidates must make
reasonable efforts to detect and prevent violations of applicable laws, rules,
regulations, and the Code and Standards by anyone subject to their supervision
or authority.
V. INVESTMEN T ANALYSIS, RECOMMEN DAT IO NS, AN D AC T IO NS
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 investment analysis, recommendation, or action.
B. Communication with Clients and Prospective Clients. Members and
Candidates must:
1. Disclose to clients and prospective clients the basic format and general
principles of the investment processes used to analyze investments, select
securities, and construct portfolios and must promptly disclose any changes
that might materially affect those processes.
2. Use reasonable judgment in identifying which factors are important to their
investment analyses, recommendations, or actions and include those factors
in communications with clients and prospective clients.
3. Distinguish between fact and opinion in the presentation of investment
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.
Page 18 ©2010 Kaplan, Inc.
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
Study Session 1
VI. CO NFLIC TS OF IN TEREST
A. Disclosure of Conflicts. Members and Candidates must make full and fair
disclosure of all matters that could reasonably be expected to impair their
independence and objectivity or interfere with respective duties to their clients,
prospective clients, and employer. Members and Candidates must ensure that
such disclosures are prominent, are delivered in plain language, and
communicate the relevant 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.
VII. RESPO NSIBILI T IES AS A CFA INST I TUTE MEMBER OR CFA
CAN DIDATE
A. Conduct as Members and Candidates in the CFA Program. Members and
Candidates must not engage in any conduct that compromises the reputation
or integrity of CFA Institute or the CFA designation or the integrity, validity,
or security of the CFA examinations.
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 and Candidates must
not misrepresent or exaggerate the meaning or implications of membership in
CFA Institute, holding the CFA designation, 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.
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.
©2010 Kaplan, Inc. Page 19
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
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 in
all countries in which they conduct business. Members must comply with applicable
laws and regulations relating to their professional activity. Do not violate Code or
Standards even if the activity is otherwise legal. Always adhere to the most strict rules
and 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 (an extreme
case). While a member may confront the involved individual first, he must approach
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 assure that 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 themselves from
prohibited activity and encourage their employers to bring an end to such activity.
􀁳 There is no requirement under the Standards to report violations to governmental
authorities, but this may be advisable in some circumstances and required by law in
others.
􀁳 Members are strongly encouraged to report other members’ violations of the Code
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 and
regulations.
􀁳 Establish written procedures for reporting suspected violation of laws, regulations, or
company policies.
Members who supervise the creation and maintenance of investment services and
products should be aware of and comply with the regulations and laws regarding such
services and products both in their country of origin and the countries where they will
be sold.
Page 20 ©2010 Kaplan, Inc.
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
Study Session 1
Application of Standard I(A) Knowledge of the Law3
Example 1:
Michael Allen works for a brokerage firm and is responsible for an underwriting of
securities. A company official gives Allen information indicating that the financial
statements Allen filed with the regulator overstate the issuer’s earnings. Allen seeks the
advice of the brokerage firm’s general counsel, who states that it would be difficult for
the regulator to prove that Allen has been involved in any wrongdoing.
Comment:
Although it is recommended that members and candidates seek the advice of legal
counsel, the reliance on such advice does not absolve a member or candidate from the
requirement to comply with the law or regulation. Allen should report this situation to
his 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 10-
year return of a composite of its client accounts. However, Washington discovers that the
composite omits the performance of accounts that have left the firm during the 10-year
period and that this omission has led to an inflated performance figure. 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 she did
not calculate the performance herself, Washington would be assisting in violating this
standard if she were to use the inflated performance number when soliciting clients. She
must dissociate herself from the activity. She can bring the misleading number to the
attention of the person responsible for calculating performance, her supervisor, or the
compliance department at her firm. If her firm is unwilling to recalculate performance,
she must refrain from using the misleading promotional material and should notify
the firm of her reasons. If the firm insists that she use the material, she should consider
whether her obligation to dissociate from the activity would require her to seek other
employment.
Example 3:
An employee of an investment bank is working on an underwriting and finds out the
issuer has altered their financial statements to hide operating losses in one division.
These misstated data are included in a preliminary prospectus that has already been
released.
Comment:
The employee should report the problem to his supervisors. If the firm doesn’t get the
misstatement fixed, the employee should dissociate from the underwriting and, further,
seek legal advice about whether he should undertake additional reporting or other
actions.
3. Ibid.
©2010 Kaplan, Inc. Page 21
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
Example 4:
Laura Jameson, a U.S. citizen, works for an investment advisor based in the U.S. and
works in a country where investment managers are prohibited from participating in
IPOs for their own accounts.
Comment:
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 her
personal account.
Example 5:
A junior portfolio manager suspects that a broker responsible for new business from
a foreign country is being allocated a portion of the firm’s payments for third-party
research and suspects that no research is being provided. He believes that the research
payments may be inappropriate and unethical.
Comment:
He should follow his firm’s procedures for reporting possible unethical behavior and try
to get better disclosure of the nature of these payments and any research that is being
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 gifts
are permitted. Allocation of shares in oversubscribed IPOs to personal accounts is
NOT permitted. 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 with
investment bankers in “road shows” only when the conflicts are adequately and
effectively managed and disclosed. Be sure there are effective “firewalls” between
research/investment management and investment banking activities.
Page 22 ©2010 Kaplan, Inc.
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
Study Session 1
Guidance—Public Companies
Analysts should not be pressured to issue favorable research by the companies they
follow. Do not confine research to discussions with company management, but rather
use a variety of sources, including suppliers, customers, and competitors.
Guidance—Buy-Side Clients
Buy-side clients may try to pressure sell-side analysts. Portfolio managers may have large
positions in a particular security, and a rating downgrade may have an effect on the
portfolio performance. As a portfolio manager, there is a responsibility to respect and
foster intellectual honesty of sell-side research.
Guidance—Fund Manager Relationships
Members responsible for selecting outside managers should not accept gifts,
entertainment, or travel that might be perceived as impairing their objectivity.
Guidance—Credit Rating Agencies
Members employed by credit rating firms should make sure that procedures prevent
undue influence by the firm issuing the securities. Members who use credit ratings
should be aware of this potential conflict of interest and consider whether independent
analysis is warranted.
Guidance—Issuer-Paid Research
Remember that this type of research is fraught with potential conflicts. Analysts’
compensation for preparing such research should be limited, and the preference is for a
flat fee, without regard to conclusions or the report’s recommendations.
Guidance—Travel
Best practice is for analysts to pay for their own commercial travel when attending
information events or tours sponsored by the firm being analyzed.
Recommended Procedures for Compliance
Protect the integrity of opinions—make sure 􀁳 they are unbiased.
􀁳 Create a restricted list and distribute only factual information about companies on
the list.
􀁳 Restrict special cost arrangements—pay for one’s own commercial transportation
and hotel; limit use of corporate aircraft to cases in which commercial transportation
is not available.
􀁳 Limit gifts—token items only. Customary, business-related entertainment is okay
as long as its purpose is not to influence a member’s professional independence or
objectivity. Firms should impose clear value limits on gifts.
􀁳 Restrict employee investments in equity IPOs and private placements. Require preapproval
of IPO purchases.
􀁳 Review procedures—have effective supervisory and review procedures.
©2010 Kaplan, Inc. Page 23
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
Firms should have formal written policies on independence 􀁳 and objectivity of
research.
􀁳 Firms should appoint a compliance officer and provide clear procedures for
employee reporting of unethical behavior and violations of applicable regulations.
Application of Standard I(B) Independence and Objectivity
Example 1:
Steven Taylor, a mining analyst with Bronson Brokers, is invited by Precision Metals to
join a group of his peers in a tour of mining facilities in several western U.S. states. The
company arranges for chartered group flights from site to site and for accommodations
in Spartan Motels, the only chain with accommodations near the mines, for three nights.
Taylor allows Precision Metals to pick up his tab, as do the other analysts, with one
exception—John Adams, an employee of a large trust company who insists on following
his company’s policy and paying for his hotel room himself.
Comment:
The policy of the company where Adams works complies closely with Standard I(B) by
avoiding even the appearance of a conflict of interest, but Taylor and the other analysts
were not necessarily violating Standard I(B). In general, when allowing companies to pay
for travel and/or accommodations under these circumstances, members and candidates
must use their judgment, keeping in mind that such arrangements must not impinge
on a member or candidate’s independence and objectivity. In this example, the trip was
strictly for business and Taylor was not accepting irrelevant or lavish hospitality. The
itinerary required chartered flights, for which analysts were not expected to pay. The
accommodations were modest. These arrangements are not unusual and did not violate
Standard I(B) so long as Taylor’s independence and objectivity were not compromised.
In the final analysis, members and candidates should consider both whether they can
remain objective and whether their integrity might be perceived by their clients to have
been compromised.
Example 2:
Walter Fritz is an equity analyst with Hilton Brokerage who covers the mining industry.
He has concluded that the stock of Metals & Mining is overpriced at its current level,
but he is concerned that a negative research report will hurt the good relationship
between Metals & Mining and the investment-banking division of his firm. In fact, a
senior manager of Hilton Brokerage has just sent him a copy of a proposal his firm has
made to Metals & Mining to underwrite a debt offering. Fritz needs to produce a report
right away and is concerned about issuing a less-than-favorable rating.
Comment:
Fritz’s analysis of Metals & Mining must be objective and based solely on consideration
of company fundamentals. Any pressure from other divisions of his firm is inappropriate.
This conflict could have been eliminated if, in anticipation of the offering, Hilton
Brokerage had placed Metals & Mining on a restricted list for its sales force.
Example 3:
Tom Wayne is the investment manager of the Franklin City Employees Pension Plan.
He recently completed a successful search for firms to manage the foreign equity
Page 24 ©2010 Kaplan, Inc.
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
Study Session 1
allocation of the plan’s diversified portfolio. He followed the plan’s standard procedure
of seeking presentations from a number of qualified firms and recommended that his
board select Penguin Advisors because of its experience, well-defined investment strategy,
and performance record, which was compiled and verified in accordance with the
CFA Institute Global Investment Performance Standards. Following the plan selection
of Penguin, a reporter from the Franklin City Record called to ask if there was any
connection between the action and the fact that Penguin was one of the sponsors of an
“investment fact-finding trip to Asia” that Wayne made earlier in the year. The trip was
one of several conducted by the Pension Investment Academy, which had arranged the
itinerary of meetings with economic, government, and corporate officials in major cities
in several Asian countries. The Pension Investment Academy obtains support for the cost
of these trips from a number of investment managers, including Penguin Advisors; the
Academy then pays the travel expenses of the various pension plan managers on the trip
and provides all meals and accommodations. The president of Penguin Advisors was one
of the travelers on the trip.
Comment:
Although Wayne can probably put to good use the knowledge he gained from the trip
in selecting portfolio managers and in other areas of managing the pension plan, his
recommendation of Penguin Advisors may be tainted by the possible conflict incurred
when he participated in a trip paid for partly by Penguin Advisors and when he was in
the daily company of the president of Penguin Advisors. To avoid violating Standard
I(B), Wayne’s basic expenses for travel and accommodations should have been paid
by his employer or the pension plan; contact with the president of Penguin Advisors
should have been limited to informational or educational events only; and the trip, the
organizer, and the sponsor should have been made a matter of public record. Even if his
actions were not in violation of Standard I(B), Wayne should have been sensitive to the
public perception of the trip when reported in the newspaper and the extent to which
the subjective elements of his decision might have been affected by the familiarity that
the daily contact of such a trip would encourage. This advantage would probably not be
shared by competing firms.
Example 4:
An analyst in the corporate finance department promises a client that her firm will
provide full research coverage of the issuing company after the offering.
Comment:
This is not a violation, but she cannot promise favorable research coverage. Research
must be objective and independent.
Example 5:
An employee’s boss tells him to assume coverage of a stock and maintain a buy rating.
Comment:
Research opinions and recommendations must be objective and independently arrived
at. Following the boss’s instructions would be a violation if the analyst determined a buy
rating is inappropriate.
©2010 Kaplan, Inc. Page 25
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
Example 6:
A money manager receives a gift of significant value from a client as a reward for good
performance over the prior period and informs her employer of the gift.
Comment:
No violation here since the gift is from a client and is not based on performance going
forward, but the gift must be disclosed to her employer. If the gift were contingent on
future performance, the money manager would have to obtain permission from her
employer. The reason for both the disclosure and permission requirements is that the
employer must ensure that the money manager does not give advantage to the client
giving or offering additional compensation, to the detriment of other clients.
Example 7:
An analyst enters into a contract to write a research report on a company, paid for
by that company, for a flat fee plus a bonus based on attracting new investors to the
security.
Comment:
This is a violation because the compensation structure makes total compensation depend
on the conclusions of the report (a favorable report will attract investors and increase
compensation). Accepting the job for a flat fee that does not depend on the report’s
conclusions or its impact on share price is permitted, with proper disclosure of the fact
that the report is funded by the subject company.
Example 8:
A trust manager at a bank selects mutual funds for client accounts based on the profits
from “service fees” paid to the bank by the mutual fund sponsor.
Comment:
This is a violation because the trust manager has allowed the fees to affect his objectivity.
Example 9:
An analyst performing sensitivity analysis for a security does not use only scenarios
consistent with recent trends and historical norms.
Comment:
This is a good thing and is not a violation.
Page 26 ©2010 Kaplan, Inc.
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
Study Session 1
I(C) Misrepresentation. Members and Candidates must not knowingly make any
misrepresentations relating to investment analysis, recommendations, actions, or
other professional activities.
Guidance
Trust is a foundation in the investment profession. Do not make any misrepresentations
or give false impressions. This includes oral and electronic communications.
Misrepresentations include guaranteeing investment performance and plagiarism.
Plagiarism encompasses using someone else’s work (e.g., reports, forecasts, models, ideas,
charts, graphs, and spreadsheet models) without giving them credit. Knowingly omitting
information that could affect an investment decision is considered misrepresentation.
Models and analysis developed by others at a member’s firm are the property of the firm
and can be used without attribution. A report written by another analyst employed by
the firm cannot be released as another analyst’s work.
Recommended Procedures for Compliance
A good way to avoid misrepresentation is for firms to provide employees who deal with
clients or prospects a written list of the firm’s available services and a description of the
firm’s qualifications. Employee qualifications should be accurately presented as well.
To avoid plagiarism, maintain records of all materials used to generate reports or other
firm products and properly cite sources (quotes and summaries) in work products.
Information from recognized financial and statistical reporting services need not be
cited.
Members should encourage their firms to establish procedures for verifying marketing
claims of third parties whose information the firm provides to clients.
Application of Standard I(C) Misrepresentation
Example 1:
Allison Rogers is a partner in the firm of Rogers and Black, a small firm offering
investment advisory services. She assures a prospective client who has just inherited
$1 million that “we can perform all the financial and investment services you need.”
Rogers and Black is well equipped to provide investment advice but, in fact, cannot
provide asset allocation assistance or a full array of financial and investment services.
Comment:
Rogers has violated Standard I(C) by orally misrepresenting the services her firm can
perform for the prospective client. She must limit herself to describing the range of
investment advisory services Rogers and Black can provide and offer to help the client
obtain elsewhere the financial and investment services that her firm cannot provide.
Example 2:
Anthony McGuire is an issuer-paid analyst hired by publicly traded companies to
electronically promote their stocks. McGuire creates a Web site that promotes his
research efforts as a seemingly independent analyst. McGuire posts a profile and a strong
buy recommendation for each company on the Web site, indicating that the stock is
©2010 Kaplan, Inc. Page 27
Study Session 1
Cross-Reference to CFA Institute Assigned Readings #1 & 2 – Standards of Practice Handbook
expected to increase in value. He does not disclose the contractual relationships with
the companies he covers on his Web site, in the research reports he issues, or in the
statements he makes about the companies on Internet chat rooms.
Comment:
McGuire has violated Standard I(C) because the Internet site and e-mails are misleading
to potential investors. Even if the recommendations are valid and supported with
thorough research, his omissions regarding the true relationship between himself and the
companies he covers constitute a misrepresentation. McGuire has also violated Standard
VI(C) by not disclosing the existence of an arrangement with the companies through
which he receives compensation in exchange for his services.
Example 3:
Claude Browning, a quantitative analyst for Double Alpha, Inc., returns in great
excitement from a seminar. In that seminar, Jack Jorrely, a well-publicized quantitative
analyst at a national brokerage firm, discussed one of his new models in great detail,
and Browning is intrigued by the new concepts. He proceeds to test this model, making
some minor mechanical changes but retaining the concept, until he produces some
very positive results. Browning quickly announces to his supervisors at Double Alpha
that he has discovered a new model and that clients and prospective clients alike should
be informed of this positive finding as ongoing proof of Double Alpha’s continuing
innovation and ability to add value.
Comment:
Although Browning tested Jorrely’s model on his own and even slightly modified it, he
must still acknowledge the original source of the idea. Browning can certainly take credit
for the final, practical results; he can also support his conclusions with his own test. The
credit for the innovative thinking, however, must be awarded to Jorrely.
Example 4:
Paul Ostrowski runs a 2-person investment management firm. Ostrowski’s firm
subscribes to a service from a large investment research firm that provides research
reports that can be repackaged by smaller firms for those firms’ clients. Ostrowski’s firm
distributes these reports to clients as its own work.
Comment:
Ostrowski can rely on third-party research that has a reasonable and adequate basis,
but he cannot imply that he is the author of the report. Otherwise, Ostrowski would
misrepresent the extent of his work in a way that would mislead the firm’s clients or
prospective clients.
Example 5:
A member makes an error in preparing marketing materials and misstates the amount of
assets his firm has under management.
Comment:
The member must attempt to stop distribution of the erroneous material as soon as
the error is known. Simply making the error unintentionally is not a violation, but
Page 28 ©2010 Kaplan, Inc.