Reading 51: An Introduction to Asset Pricing Models

SCW: 13 pages

Lessons Learned

• I really enjoyed the sections on systematic and unsystematic risk, I can’t wait to tackle more risk concepts with PRM later on.
• I had quite a bit of trouble with expected return of a portfolio and portfolio standard deviation
• I am still trying to sort out CAPM v CML v SML in my head
• The formulas in this chapter looked really big, but they can be shortened to fairly small equations, making them easier to memorize
• Efficiency frontier is a set of portfolios that give you the highest return at a given level of risk
• Total risk = systematic risk + unsystematic risk****
• Definitely know the formula for CAPM
• Using the CAPM to identify mispriced securities is an essential review topic for the exam, know it well.

Reading 50: An Introduction to Portfolio Management

CFAI: 22 pages, SCW: 13 pages

Lessons Learned:

• Markowitz model was easy to understand, but lacked some needed details for additional clarification
• I definitely overestimated my knowledge in this area, there is a lot of work-ins with quant
• I hate hate hate covariance and correlation
• After writing that down in my notebook, I decided to revisit the relationship between covariance, correlation, variance, and standard deviation…with the help of my trusty friend google
• Although I do find the math tricky, I like how it is practical and real world
• Risk means the uncertainty of future outcomes (in financial application)
• Markowitz showed that the variance of the rate of return was a meaningful measure of portfolio risk under a reasonable set of assumptions (5 to be exact)
• Standard deviation is a statistical measure of the dispersion of returns around the expected value whereby a larger variance or standard deviation indicated a greater dispersion
• The more disperse the expected returns, the greater the uncertainty of future returns
• The weights are the proportion of the total value for the individual investment
• I had to make a lot of notes on the process to calculate the covariance with historical date, but once you break it down into 4 steps its fairly easy to do and remember (way to much typing to indicate this process, check out page 121 in schweser)
• The optimal portfolio is the efficient portfolio that has the highest utility for a given investor
• It lies at the point of tangency between the efficient frontier and the I1 curve with the highest possible utility

Reading 14: Efficiency and Equity

SCW (8 Pages), CFAI (23 Pages)

Lessons Learned:

• Originally, I had real trouble grasping the idea behind consumer/producer surplus
• Deadweight loss cleared up any confusion on that topic
• A surprising change, schweser made this topic much more confusing.  I used CFAI to clarify a lot of concepts
• Demand curve = marginal benefit to society
• Supply curve = marginal cost to society
• Consumer and producer surplus can be used to measure the efficiency of the market

Post-Tests:

• Schweser: 62%
• CFAI 33%

Primary Quant Weaknesses

When I was progressing through the material I made sure to jot down a lot of side notes on my struggles with concepts or my thoughts about a particular topics/sentence/chart….etc.  This has helped me to formulate a strategy to attack quant in May so I can really nail down the concepts needed to vault myself above the 70% mark.  Don’t get me wrong, I am not aiming for a 70%, but it is a benchmark minimum.  I am not going to take much time to introduce the list, instead i’ll just through it out in bullet form.  The list is a representation of my anticipated weaknesses in the quantitative methods section of the CFA curriculum:

• Identifying the problem:  Executing the formula is not a problem, and I typically can memorize them quite quickly, however, I do foresee a fundamental weakness of my approach is identifying which formula to use where.  I don’t think this will be hard to correct, but is a weakness nonetheless.
• Making stupid mistakes: These are just small errors I need to drill into my brain through constant practice of problems.  An example of this would be taking the calculator out of BGN mode.
• Over-analyzing the problem: There has been times where I have gone way above and beyond what is asked of me, and i’ve typically taken the “long road”.  I need to focus on efficiency, and getting to the answer in the shortest amount of steps possible.  This can also be corrected through constant problems.
• Time: This is my biggest concern.  Typically a quant problem will take me from 2- 7 minutes to complete.  I need to get this down to around 90 seconds, give or take an additional 30 – 45 seconds.  This does not include those problems that Schweser gives that are heavily formula based and wont be on the exam, as I have read time and time again in the forums.

So there it is, a list of my weaknesses. Overall the review process for quant will be more on memorization then it will be on comprehension.  I do feel like I have a fairly strong grasp of the material, I just need to work more on applying it in the appropriate context.

Quant: Schweser v. CFAI

I just wanted to mention a quick, yet fundamental, difference between the Schweser and CFA Curriculum in regards to Quant reading 5. I haven’t read through Schweser yet, so I will likely comment on this more when I do.  However, I did review some concepts in Schweser today for additional understanding, and one thing I am pleased about is Schwesers focus on teaching the keystrokes.  Instead of teaching you how to calculate the formula, schweser focuses on teaching you how to obtain the same answer using the functions in the calculator.  I personally believe you need a sound foundation in the theory and the process of the formula, instead of relying all on a piece of technology, but that is a personal preference.  Come exam time I will be using the calculator, but I will also be able to decipher what the calculator is doing and why.

This makes it even more relevant that I go through the material with both sources, as now I can really build layers of understanding on each LOS.

- Steve

Quant: SS4 – Reading 5

Reading #5: The Time Value of Money

Pages: 41

% of SS4: 21%

Hours to Completion: 15

I have written in great detail about my experience with this chapter in a previous post, so I will spend a short time recapping the content and some thoughts I had on it here.  The chapter is broken up into seven sections, which did make it easier to comprehend how the pieces fit together.  In my review process I will likely revise these headings to ensure I understand more of the “big picture”.

Section 1

• General Overview section

Section 2

• Basic concepts I have seen before
• Most I had learned from the CSC
• Regardless of their familiarity, they were very fundamental to later sections.

Section 3

• Had some initial troubles getting the (t=x) relationship sorted out in my head, but later examples reinforced it nicely
• This entire section I was able to calculate the correct answers to the examples before I read the solution on the first try
• This section inevitably lead to false confidence and a friendly visit from karma.
• I say I am being detail oriented, but it took me this long into the book to realize that the writers had given each formula a number (5-1, 5-2……5-15).  I found this very useful in isolating the important data, as well as referring to multiple formulas from pages back in different questions.

Section 4

• This is the section of the angry EAR……bad joke I know, but seriously, I hit a brick wall here
• I initially had trouble sorting out the fundamental differences between some basic conceptual definitions and how they differed.  Investorwords.com, investopedia.com and AnalystForums helped me solve this.
• Secondly, I had quite a bit of trouble wrapping my head around what EAR was, what it was trying to do, and in what practical situation I would need to use it.  I eventually figured all this out but it was a shock to the system that it didn’t come more natural, especially things like definitions which are typically cut and dry.

Section 5

• Kept getting better at this point, I began realizing my wrong answers were the direct result of minute details that I had missed or excluded (i.e., Rule of 72)
• I found this section particularly hard as every single example I calculated took me 2 – 3 tries, typically reverse engineering an answer and the process to get there.
• If you have any natural math ability, you are laughing at me right about now.

Section 6

• Rise of the “t”…..this guy came out of nowhere and would not leave me alone
• Time-lines became essential to sort out the question in my head, which worries me that I wont have enough time to process each question.  A focus on this section later will be on speed as much as attention to detail.
• I didn’t find anything particularly complex in this, but I think the problem with this section will be remembering what formula to use when.  Use the PV to discount and the FV to determine a number of different pre-formula amounts on the timeline…and so on.

Section 7

So, right after I crawled through the last six sections, the book basically tells me that “now that the easy stuff is over, real world situations don’t give you the interest, number of periods or annuity amount.  You have to solve that.”

My thoughts after chuckling to myself was (a) I just laughed at a quote from a finance book, which makes me mentally unstable and (b) where do I find the application to live in the un-real world where they just give you this freakin information.

• This section nearly killed me; I would do one sub-section then take a break.  I think it was mere frustration at this point coming into the 13 hour mark.  By the end I was ready to throw the book at the wall, but I didn’t…….yet.
• I found the content to be a tad tricky with its approach, but it was more of a conceptual section that brought together the concepts from previous sections in some sort of problem orgy.  One of the problems that stretched 3 pages was actually fairly easy once you broke it down, which was a relief….of sorts.
• I didn’t even bother getting a good grasp of the cash flow additivity principle, at that point a quick review was all I was willing to do.  I was willing to sacrifice this small half-page section because I will review it, most likely in better presentation terms, with Schweser.

Dear Quant: Please jump off a tall bridge and plumet to your untimely demise…..thanks.

Disclaimer:  I had originally intended for this to be a one post deal, but the content was just way to large, so I intend to split it up into three posts: (1) this one, (2) Quant: Schweser v. CFAI (3) Quant: SS2 – Reading 5 notes

I take back whatever I said about quant in the past. Reading 5 was, simply, ridiculous.  I spent time figuring out the process to each example on all 41 pages of reading 5 in the CFA Curriculum. This was the original plan and I knew it would extend my overall projected time.   I think it really helped with my retention and understanding of the material, however it took me approximately 15 hours over two days to complete.  15 hours to cover 41 pages is by any measure, absolutely ridiculous, redundant and most importantly, extremely frustrating.  I finished the reading around 4 PM today, at which point I was supposed to move on to reading 6, but frankly, I was much to frustrated and discouraged to move on tonight.  It’s not that I found any of the content in this chapter relatively complex (although some minor details did give me some trouble at times), but its just the depth of the material and content inside this reading was immense.  Some of these issues stemmed from simple misunderstandings with basic mathematical principles and rules, while others required me to change variables and settings on my BA II Plus.

I am aware that we will not have to do these combersome questions on the exam, but I wanted to learn it for a number of reasons:

1. To increase my knowledge base
2. To prepare for more advanced quant I will be studying for FRM in November
3. To prepare for more advanced quant in CFA-L2

Quant in finance is a fundamental component of any valuation and analysis, and I knew I had a long road ahead of me before I truly mastered quant the way I want to.  However, truly mastering the minute details associated with each formula was a daunting task.  This chapter is supposed to be a fundamental part of the course, as well as the CAIA and CFP designations I will be taking in the near future.  So justifying the time is not the problem.  However, I am also under time constraints and my study schedule has now be severely altered.  I am also not sure if this chapter is a representative of the amount of time I need to put into every reading to gain this level of mastery or not.  These questions are causing a little bit of anxiousness and nervousness when looking at the overall study plan.  What makes me more nervous is the relative amount of content I have to cover.  I assume this is a natural feeling, and it will dissipate once I get through Quant, Economics & FSA.  However, at this pace quant would take 18 days for the curriculum material alone, which is not acceptable.  Its the not knowing that drives me nuts, so I hope I can get a feeling of my overall progress in this section soon.

For me, the ultimate frustration came in that, every single example I went through I had some sort of problem with. Whether it was my calculator rounding up, or entering in the wrong numbers, misreading the question, recalling the purpose of the formula or how to calculate a portion of a larger formula. I am usually a fairly patient guy, but when every single problem presents some sort of issue, I begin to get a tad bit irritated.  I am sure other people have similar issues, this is just me venting my own personal opinions.  Ultimately I feel that at the end of this painful process, I will be much better off.  Being done reading 5 I am fairly confident that I can score a 60% and above without having any revision or looking at the schweser notes.  This may not sound very good to some of you, but a 60% for me in quant is a significant improvement.  With my process (described in other posts) and thorough review, I think this painful approach will pay off. Not only do I review the extend content, but I review the narrowed down content (schweser notes & secret sauce), memory retention (cue cards) and practice (end of chapter problems, calculating examples, qbank).  This process for quant will be cumbersome and difficult to make it through, but I think I can really nail the concepts to my goal of 80%.  I also must say that these frustrating rants may continue while I am in quant, if these circumstances continue as well.

- Steve

Use of Notebooks

I thought i’d give a quick mention to the notebook system I have set up.  It seems to work for me so far, especially in quant.

Formula Notebook

• Every formula in the book I write in the notebook with a short description and a legend.

Review Notebook

• I list any topics that I want to come back and review because it is (a) hard or (b) I am not 100% confident
• I wont use this as a conclusive review guide, but I will use it to start off my review process by drilling down on the weakest areas and moving on from there

Rough Work

• I use this to record rough work, including every example inside the text(s) that I work out manually.

Notepad

• Here I keep a running list of things to do that pop into my head when studying. It can be about CFA or anything else.  I try to clean this list up every 1 – 3 days.
• I also keep a list here about topics on the blog, notes on a post and so on….

Duo-tang of CBOK

• To give myself and overview of the macro based concepts of the course, and an idea of how i’m progressing

Schweser Library Videos (Free)

I just wanted to make a quick note on the three free videos that come with you Schweser subscription:

• CFA Level 1 Exam Overview
• Code & Standards Overview
• Level 1 GIPS

I can’t speak to the rest of Schweser videos, but these were just terrible.  I didn’t even make it half way through the Code & Standards and its not because it was boring.  It was terribly organized, slow and generally uninformative.  Maybe other people found them useful, but I didn’t think it was worth my time even watching.

- Steve

Done Ethics

So I am officially done ethics, here is a list of what I completed:

• CFA Curriculum SS1
• Schweser Study Notes SS1
• Schweser Secret Sauce SS1
• All chapter quizzes and knowledge checks in both books
• 20 questions from QBANK
• ALL the Ethics Stalla Cue-Cards
• AnalystForums (posts on ethics – about 10 minutes worth)

I decided not to do additional QBANK questions for Ethics, since I scored above 80% on three separate tests (CFAC, Schweser, QBANK).  I will save a majority of those questions for the review process or maybe a refresher exam after Quant.  The schweser test was surprisingly difficult, but I appreciated that.  You could tell the material was geared towards the new exam format, as there was only 3 answers to choose from and there was a lot of “least likely”, “most likely” style questions.  I still squeaked by at 80%.  I got 10 questions wrong, which shows me I am indeed around a 70% on ethics.  I am now moving on to Quant for the next week or so.  I will have a better idea of the time I will dedicate to it after today.

- Steve