on 28-Mar-2016 (Mon)

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Discounted Cash Flow Applications
#analyst #has-images #notes #quantitative-methods-basic-concepts

Holding Period Return

When analyzing rates of return, our starting point is the total return, or holding period return (HPR). HPR measures the total return for holding an investment over a certain period of time, and can be calculated using the following formula:

• Pt = price per share at the end of time period t
• P(t-1) = price per share at the end of time period t-1, the time period immediately preceding time period t
• Pt - Pt-1 = price appreciation of the investment
• Dt = cash distributions received during time period t: for common stock, cash distribution is the dividend; for bonds, cash distribution is the coupon payment.

It has two important characteristics:

• It has an element of time attached to it: monthly, quarterly or annual returns. HPR can be computed for any time period.
• It has no currency unit attached to it; the result holds regardless of the currency in which prices are denominated.

Example

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 Subject 5. Orders #analyst-notes #market-organization-and-structure Orders are instructions to trade. They always specify instrument, side (buy or sell), and quantity. Bid price: the highest price that a buyer wants to pay for the instrument. The best bid is the highest bid in the market.Ask price: the lowest price a seller is willing to accept for the instrument. Also called offer price. The best offer is the lowest in the market.Bid-ask spread: the difference between the best bid and the best offer. Orders usually also provide several other instructions. Execution Instructions They indicate how to fill the order. Market orders are simple buy or sell orders that are to be executed immediately at current market prices. They provide immediate liquidity for someone willing to accept the prevailing market price. A limit order is an order that sets the maximum or minimum at which you are willing to buy or sell a particular stock. For instance, if you want to buy stock ABC, which is trading at $12, you can set a limit order for$10. This guarantees that you will pay no more than $10 to buy this stock. Once the stock reaches$10 or less, you will automatically buy a predetermined amount of shares. On the other hand, if you own stock ABC and it is trading at $12, you could place a limit order to sell it at$15. This guarantees that the stock will be sold at $15 or more. The primary advantage of a limit order is that it guarantees that the trade will be made at a particular price; however, it's possible that your order will not be executed at all if the limit price is not reached. Traders choose order submission strategies on the basis of how quickly they want to trade, the prices they are willing to accept, and the consequences of failing to trade. Validity Instructions They indicate when the order may be filled. A day order (the most common) is a market or limit order that is in force from the time the order is submitted to the end of the day's trading session. A good-till-canceled order requires a specific canceling order. It can persist indefinitely (although brokers may set some limits, for example, 90 days). An immediate-or-cancel order (IOC) will be immediately executed or canceled by the exchange. Unlike a fill-or-killorder, IOC orders allow for partial fills. An order may be specified on the close or on the open, then it is entered in an auction but has no effect otherwise. Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you place a stop or limit order, you are telling your broker that you don't want the market price (the current price at which a stock is trading), but that you want the stock price to move in a certain direction before your order is executed. With a stop order, your trade will be executed only when the security you want to buy or sell reaches a particular price (the stop price). Once the stock has reached this price, a stop order essentially becomes a market order and is filled. For instance, if you own stock ABC, which currently trades at$20, and you place a stop order to sell it at $15, your order will only be filled once stock ABC drops below$15. Also known as a "stop-loss order", this allows you to limit your losses. However, this type of order can also be used to guarantee profits. For example, assume that you bought stock XYZ at $10 per share and now the stock is trading at$20 per share. Placing a stop order at $15 will guarantee profits of approximately$5 per share, depending on how quickly the market order can be filled. Stop orders are particularly advantageous to investors who are unable to monitor their stocks for a period of time, and brokerages may even set these stop orders for no charge. One disadva...

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 Subject 6. Primary security markets #analyst-notes #market-organization-and-structure The primary markets are those in which new issues of bonds, preferred stock, or common stock are sold by government units, municipalities, or companies to acquire new capital. New issue.Key factor: issuer receives the proceeds from the sale. Two important rules in the primary capital markets: Rule 415 allows large firms to register security issues and sell them in piecemeal over the following two years. Such issues are called shelf-registration. It allows a single registration document to be filed that permits the issuance of multiple securities.Rule 144A allows corporations (including non-U.S. firms) to place securities privately with large, sophisticated investors. The issuer of a private placement reduces issuing costs because it does not have to complete the extensive registration documents. However, investors will require a higher return since no secondary market exists and thus the liquidity risk is high. New stock issues are divided into two groups: Initial public offerings (IPOs). These are new shares that a firm offers to the public for the first time. They are typically underwritten by investment bankers through negotiated arrangements (the most common form), competitive bids and best-effort arrangements (investment bankers act as brokers, not taking the price risk).Seasoned equity issues. These are new shares issued by firms that already have stocks outstanding. A rights issue is an option that a company can opt for to raise capital under a secondary market offering or seasoned equity offering of shares to raise money. It is a special form of shelf offering or shelf registration. With the issued rights, existing shareholders have the privilege to buy a specified number of new shares from the firm at a specified price within a specified time. Government bond issues are sold at Federal Reserve auctions.

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 Subject 8. Well-functioning financial systems #analyst-notes #market-organization-and-structure Well-functioning financial systems have the following characteristics: Complete markets. The instruments needed to solve investment and risk management problems are available to trade. Liquidity. As asset can be bought and sold quickly (that is, it has marketability, which means an asset's likelihood of being sold quickly.) at a price close to the prices for previous transactions (price continuity), assuming no new information has been received. In turn, price continuity requires depth, which means the numerous potential buyers and sellers must be willing to trade at prices above and below the current market price. Operational efficiency. Low transaction costs (as a percentage of the value of the trade) include the cost of reaching the market, the actual brokerage costs, and the cost of transferring the asset. This attribute is often referred to as internal efficiency. Informational (or external) efficiency. Timely and accurate information is available on the price and volume of past transactions and the prevailing bid-price and ask-price. Prices rapidly adjust to new information; thus the prevailing price is fair because it reflects all available information regarding the asset. Prices will be most informative in liquid markets because information-motivated traders will not invest in information and research if establishing positions based on their analysis is too costly. A well-functioning financial system promotes wealth by ensuring that capital allocation decisions are well made. It also promotes wealth by allowing people to share the risks associated with valuable products that would otherwise not be undertaken.

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 Subject 9. Market regulation #analyst-notes #market-organization-and-structure Regulators generally seek to promote fair and orderly markets in which traders can trade at prices that accurately reflect fundamental values without incurring excessive transaction costs. Governmental agencies and self-regulating organizations of practitioners provide regulatory services that attempt to make markets safer and more efficient. The objectives of market regulation are to: control fraud. Customers may not know how to protect themselves since the financial markets are quite complex.control agency problems. Financial agents often have different goals from their customers. How to effectively measure the services they provide?promote fairness. For example, insider trading is prohibited in most markets as it offends basic notions of fairness.set mutually beneficial standards. Common financial standards allow investors to compare companies easily.prevent undercapitalized financial firms from exploiting their investors by making excessive risky investments.Regulators generally require that financial firms to maintain minimum levels of capital to reduce the probability that these firms will fail and hurt their customers.ensure that long-term liabilities are funded. Insurance companies and pension funds need to maintain adequate reserves to ensure they can pay their liabilities when due.

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 Subject 1. Index definition and calculations of value and returns #analyst-notes #has-images #security-market-indices A security market index is a means to measure the value of a set of securities in a target market, market segment or asset class. The constituent securities selected for inclusion in the security market index are intended to represent the target market. There are usually two versions of the same index: The price return takes into account only the capital gain on an investment. A price return index reflects only the prices of the constituent securities. The income generated by the assets in the portfolio, in the form of interest and dividends, is ignored. The value of a price return index is calculated as: ni: the number of units of security i in the index portfolio. Pi: the unit price of security i. D: the value of divisor. The total return takes into account not only the capital appreciation on the portfolio, but also the income received. A total return index reflects the prices and the reinvestment of all income received since the inception of the index. Single Period Returns The single period price return of an index is the weighted average of price returns of the individual securities: or, Since the total return of an index includes price appreciation and income, we need to add the weighted average of income to the above formula to calculate the single period total return: or, Multiple-Period Returns The single period returns should be linked geometrically. Similarly, to calculate the total return over multiple periods:

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 Subject 3. Standard I (C) Misrepresentation #analyst-notes #guidance-for-standards-i-vii I. PROFESSIONALISM C. Misrepresentation. Members and Candidates must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities. Members and candidates shall not make any statements, orally or in writing, that misrepresent: The services that they or their firms are capable of performing.Their qualifications or the qualifications of their firms.Their academic or professional credentials. A misrepresentation is any untrue statement of a fact or any statement that is otherwise false or misleading. This standard relates to misrepresentations by members about their qualifications and services, and it disallows any misleading guarantees about investments and their returns. Members and candidates shall not make or imply, orally or in writing, any assurances or guarantees regarding any investment except to communicate accurate information regarding the terms of the investment instrument and the issuer's obligations under the instrument. It prohibits statements or assumptions that an investment is "guaranteed," or that superior returns can be expected based on the member's past success. This standard applies to oral representations, advertising, electronic communications (including web pages and emails) and written materials (whether publicly disseminated or not). Note: This standard does not rule out correct statements that some investments are actually guaranteed in some way with guaranteed returns. Examples of these types of investments would be insurance contracts or short-term treasury securities. This standard also prohibits plagiarism in the preparation of material for distribution to employers, associates, clients, prospects or the general public. Plagiarism involves copying or using substantially the same materials as those prepared by others without acknowledging the source of that material. The only exception is copying factual information, as published by several recognized financial institutions, as well as statistical information. Members and candidates should always attribute quotations, projections, data, model/product ideas, and methodologies to their sources and/or authors.This standard applies to written materials, oral communications, visits with clients, use of audio/video media, and electronic data transfer.Members and candidates can use recognized sources (S&P, Moody's) of factual information (information that is already in the public realm) without acknowledgement.Situations to which this Standard applies also depend on whom the member is representing. Members are not required to attribute ideas, methodologies, etc. developed by people within their firms when speaking with clients and prospects.Members and candidates should keep copies of materials used in preparing research reports. In ethical terms, a member or candidate indulging in plagiarism is not conducting himself or herself with integrity. By plagiarizing, he or she is not only stealing the ideas of others, but also exposing himself or herself to violations of other standards by making recommendations that may not have a reasonable basis and may not avoid material misrepresentations. Procedures for compliance Members can prevent unintentional misrepresentations of the qualifications of services the member or the member's firm is capable of performing if each member understands the limit of the individual's or firm's capabilities and the need to be accurate and complete in presentations. Firms can provide guidance for employees who make written or oral presentations to clients or potential clients by providing a written list of the firm's available services and a description of the firm's qualification, and compensations that are both accurate and suitab...

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 Subject 4. Standard I (D) Misconduct #analyst-notes #guidance-for-standards-i-vii I. PROFESSIONALISM 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 reputations, integrity, or competence. Members and candidates shall not compromise the integrity of the CFA designation, or the integrity or validity of the CFA examinations. Standard I (A) states the obligation to comply with all applicable laws and regulations. This standard addresses personal behavior that will reflect poorly on the profession as a whole. Any act that involves lying, cheating, stealing, or other dishonest conduct, if the offence reflects adversely on a member or candidate's professional (not personal) activities, would violate the standard. Procedures for compliance Members and candidates should encourage their employers to: Adopt a Code of Ethics to which every employee must subscribe. Make clear that any personal behavior that reflects poorly on the individual involved, the institution as a whole, or the investment industry will not be tolerated.Disseminate to all employees a list of potential violations and associated disciplinary sanctions, up to and including dismissal from the firm.Conduct background checks on potential employees to ensure that they are of good character and not ineligible to work in the investment industry because of past infractions of the law. Example 1 An investment advisor executes excessive trading volume to generate fees. He tells clients that the high level of trading in their discretionary accounts is needed to maintain proper diversification. If this statement is misrepresentative, the advisor is clearly engaging in professional misconduct. Example 2 A portfolio manager has three martinis at lunch and returns to the office to resume his regular duties. If the manager's judgment is impaired and he is engaging in investment decision-making activities, he is in violation of this standard.

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 Subject 7. Standard III (A) Loyalty, Prudence, and Care #analyst-notes #guidance-for-standards-i-vii III. DUTIES TO CLIENTS 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. This standard relates principally to members who have discretionary authority over the management of client's assets. Fiduciary duty refers to the obligations of loyalty and care in regard to the responsibility of managing someone else's assets. A fiduciary duty is a position of trust. A fiduciary is someone with the duty of acting for the benefit of another party.Loyalty is owed to clients and prospects.Clients' interests come before yours.A heightened level of fiduciary duty arises if the fiduciary has "custody" or effective control of the client's assets.Governing documents (e.g., trust documents and investment management agreements) are primary determinants of a fiduciary's powers and duties. Fiduciary standards apply to a large number of persons in varying capacities, but exact duties may differ in many respects, depending on the nature of the relationship with the client or the type of account under which the assets are managed. The first step in fulfilling a fiduciary duty is to determine what the responsibility is and the identity of the "client" to whom the fiduciary duty is owed. When managing personal assets of an individual, the investment manager owes loyalty to that individual (i.e., the client).When managing the portfolios of a pension plan or trust, the investment manager owes loyalty to beneficiaries of the plan or trust (i.e., the "client"), not the person who hires the manager. A fiduciary must make investment decisions in the context of the portfolio as a whole rather than by individual investments within the portfolio. The fiduciary should thoroughly consider the risk of loss, potential gains, diversification, liquidity and returns. Often a manager may direct clients' trades through a particular broker because an investment manager often has discretion over the selection of brokers. The broker may provide research services that provide a broad benefit to the manager. The manager has thus used "soft dollars" to purchase beneficial services through brokerage, which is an asset to the manager's clients. Since the manager would expect to purchase research services anyway, the soft dollar arrangement is not necessarily inappropriate. The manager must seek the best price and execution, and disclose any soft dollar arrangements. Procedures for compliance Follow all the applicable laws and rules.Establish the investment objectives of the client, taking into account: The client's needs and circumstances.The investment's basic characteristics. Diversification. All portfolios should be adequately diversified, unless the plan guidelines state otherwise.Deal fairly with all clients.Conflicts of interest. All conflicts must be disclosed.Disclose compensation agreements.Proxy solicitations. Proxies must be voted in the best interest of the beneficiaries.Confidentiality. Members must maintain the confidentiality of their dealings at all times.Best execution. The best execution that is reasonably available should be provided to all clients.Loyalty - members must always act in the best interest of their clients. Example 1 A client anxiously tells you that he needs to liquidate a bond portfolio immediately because he needs funds to pay for an operation for a relative. The bonds are highly liquid, but ...

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 Subject 10. Standard III (D) Performance Presentation #analyst-notes #guidance-for-standards-i-vii III. DUTIES TO CLIENTS D. Performance Presentation. When communicating investment performance information, Members and Candidates must make reasonable efforts to make sure that this information is fair, accurate, and complete. In the past there have been several practices that have hindered performance presentation and comparability, such as: Representative accounts - only the best results are presented.Survivorship bias - accounts that have been terminated are excluded from the results presented.Portability of investment results - results from previous employment are disclosed.Varying time periods - only the results for the good time periods are reflected. A firm cannot claim that they are/were in compliance with CFA Institute's standards unless they comply in allmaterial respects with CFA Institute's standards. Procedures for compliance Misrepresentations about the investment performance of the firm can be avoided if the member maintains data about the firm's investments performance in written form and understands the classes of investments or accounts to which those data apply and the risks and limitations inherent in using such data. In analyzing information about the firm's investment performance, the member should ask the following questions: How many years of past performance does this information reflect?Does it reflect performance for the prior year only, after several years of poor performance, or an average of several years of performance?Has the performance been measured in accordance with CFA Institute's standards?Does investment performance vary widely among different classes of funds or accounts? If so, the member must describe investment performance by classes rather than by an overall average figure and accurately explain what the performance figures represent. Example Your bond fund has generated a below average performance for four of the past five years. You use this as the basis for expectations of an above-average performance for the upcoming year. If your average or expected performance is properly determined, you should have a 50% probability of meeting or exceeding that average. Thus, it is inappropriate to declare that because performance was below average last year it is likely to be above average next year.

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 Subject 14. Standard IV (C) Responsibilities of Supervisors #analyst-notes #guidance-for-standards-i-vii IV. DUTIES TO EMPLOYERS 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. If you supervise large numbers of employees, you may not be able to evaluate the conduct of each employee. In this case, you may delegate supervisory duties; however, such delegation does not replace supervisory responsibilities. A supervisory member should rely on reasonable procedures to detect and prevent violations. The presence of a compliance policy manual and/or compliance department, however, does not remove his or her supervisory responsibilities. Procedures for compliance A supervisor complies with Standard IV (C) by identifying situations in which legal violations or violation of the Code and Standards are likely to occur, and establishing and enforcing compliance procedures to prevent such violations. If a firm does not have a compliance system, or the system is not adequate, members or candidates should decline in writing to accept supervisory responsibility until the firm adopts reasonable procedures to allow them to adequately exercise such responsibility. Adequate compliance procedures should: Be drafted so that the procedures are easy to understand.Designate a compliance officer and clearly define the officer's authority and responsibility.Outline the scope of the procedures.Outline permissible conduct.Delineate procedures for reporting violations and sanctions. Once a compliance program is in place, a supervisor should: Disseminate the contents of the program to appropriate personnel.Periodically update procedures to ensure that the measures are adequate under the law.Continually educate personnel regarding the compliance procedures.Issue periodic reminders of the procedures to appropriate personnel.Incorporate a professional conduct evaluation as part of the employee's performance reviews.Review the actions of employees to ensure compliance and identify violators.Take the necessary steps to enforce procedures once a violation has occurred. Once a violation is discovered, a supervisor should take the following actions: Respond promptly.Conduct a thorough investigation of the activities to determine the scope of the wrong-doing.Increase supervision or place appropriate limitations on the wrongdoer pending the outcome of the investigation. If a supervisory member was unable to detect violations, he or she may not violate the standard if he or she takes steps to institute an effective compliance program AND adopts reasonable procedures to prevent and identify violations. Example 1 A supervisor in an investment management firm concludes that since all five equity analysts working for her are CFA charterholders, she can trust them to refrain from violations of laws, regulations, and the Code and Standards. While she can trust them to refrain from such violations, this does not constitute reasonable supervision. Example 2 You are offered a promotion to supervise all investment managers involved in discretionary trading. You are told that there have been instances of improper trading in some accounts and that at least one manager is likely performing additional investment services for several of his clients. However, the operation is highly profitable, so senior management has no immediate concern regarding these issues. You are responsible for prevention of violations of the Code and Standards. If there are known violations and little or no control over the investment process, you should decline ...

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 Subject 15. Standard V (A) Diligence and Reasonable Basis #analyst-notes #guidance-for-standards-i-vii V. INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTIONS A. Diligence and Reasonable Basis. Members and Candidates must: Exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions.Have a reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation, or action. Members must perform the diligent and thorough investigations necessary to make an investment recommendation or to take investment action. Three factors determine the nature of the diligence, thoroughness of the research, and level of investigation required by the standard: Investment philosophy followed.The role of the member or candidate in the investment decision-making process.The support and resources provided by the employer. Members must establish a reasonable basis for all investment recommendations and actions. Diligence must be exercised to avoid any material misrepresentation. In other words, members cannot be quick or negligent in making investment recommendations. Example You are very excited about a small high-tech firm that is developing a new method of making Internet connections more efficient. You advise your clients to buy this security and tell them that a full report will be available shortly. Your recommendation is neither diligent nor thorough. You have not provided reasonable basis for the recommendation. It is impossible to distinguish between fact and opinion without further information. Using secondary or third-party research Secondary research: research conducted by someone else in the member or candidate's firm. Third-party research: research conducted by entities outside the member or candidate's firm. Members and candidates should check if research is sound. Examples of criteria include the assumptions used, the rigor of analysis, the timeliness of the research, and the objectivity and independence of recommendations. If the research is suspected to lack a sound basis, members and candidates should refrain from relying on it. Applications: A quantitative analyst recommends an out-of-favor stock based on analysis of its 3-year records: the recommendation is not based on thorough quantitative work. A longer time period should be covered. Because of restrictions from the firm's executives, an analyst cannot obtain the information necessary to perform analysis: the analyst must let the client know when he/she is "conflicted" or "restricted." Because of the lack of sufficient research resources, an analyst decides to estimate IPO prices based on the relative size of each company and justify the pricing later when she has time: her analysis is not based on thorough research with reasonable basis. She should take on the work only when she can adequately handle it. An investment banker presses a securities issuer to project the maximum production level. He then uses these numbers as the base-case production levels during sales pitches: he misrepresents the chances of achieving that production level. He should have given a range of production scenarios during the pitch. An analyst recommends purchasing what the market, in general, has christened "hot" stocks without further research: conventional wisdom of the markets does not form a reasonable and adequate basis. After a discussion with the vice president of a company, a senior analyst discovers that there is a good chance that this company will be awarded a large contract (thus pushing up the stock price). The analyst then publishes a report to his clients indicating that they must all purchase the stock ba...

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 Subject 16. Standard V (B) Communication with Clients and Prospective Clients #analyst-notes #guidance-for-standards-i-vii V. INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTIONS B. Communication with Clients and Prospective Clients. Members and Candidates must: 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.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.Distinguish between fact and opinion in the presentation of investment analysis and recommendations. All important factors relating to the investment recommendation must be included in the report. Members must include known limitations in the analysis and conclusions in the report and consider all risks associated with the investment. Members should consider including the following information in research reports: Expected annual rate of return, taking into account cash flows and expected price changes during the holding period.Annual amount of income expected (current and future).Current rate of income return or yield to maturity.Degree of uncertainty associated with cash flows.Degree of marketability / liquidity.Business, financial, political, sovereign, and market risks. A report can be given in many forms: a written report, in-person communication, telephone conversation, media broadcast, or transmission by computer (e.g., on the Internet or by email). Opinions should be distinguished clearly from facts. Specifically: Past should be separated from future. Past represents facts, while forecast on future represents opinions.In the case of quantitative analysis, facts should be separated from statistical conjecture. Procedures for compliance The selection of relevant factors is an analytical skill, and determination of whether a member is in compliance depends heavily on case-by-case review. To assist the after-the-fact review of a report, the member must maintain records indicating the nature of the research and should, if asked, be able to supply additional information to the client (or any user of the report) about factors not included.Members must take reasonable steps to assure themselves of the reliability, accuracy, and appropriateness of the data included in each report. If the data has been processed in any way (e.g., into financial ratios), a member should ascertain that such processing has been done in a manner consistent with the member's analytical purposes.Acknowledgment of the source(s) should be made when appropriate. Example 1 To simplify his report, an analyst leaves out details of the valuation models. He violates this standard because clients need to fully understand the analyst's process and logic in order to implement the recommendation. Example 2 An analyst issues a "buy" recommendation on a stock, mainly based on his optimistic assessment of the company's operation. He violates this standard by failing to distinguish between opinions and facts; his optimistic assessment of the company is his own opinion. Example 3 An analyst issues a report promoting a firm's new investment strategy. The report stresses the likelihood of high returns. However, it does not describe the strategy in detail. The analyst violates this standard because his report fails to describe properly the basic characteristics of the investment strategy. Example 4 An analyst has a duty to gather information about a company in o...

Annotation 1329413360908

 Subject 17. Standard V (C) Record Retention #analyst-notes #guidance-for-standards-i-vii V. INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTIONS 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. Members and candidates should maintain files to support investment recommendations. In addition to furnishing excellent reference materials for future work, research files play a key role in justifying investment decisions under later scrutiny. Files can serve as the ultimate proof that recommendations and actions, good or bad, were made based on the same methodology that drove the analyst's decisions. Records can be maintained either in hardcopy or electronic form (soft copy).CFA Institute recommends maintaining records for at least seven years.Records are the property of the member's or candidate's firm. Example If an analyst writes investment recommendations based on many sources, such as stock exchange data, interviews with senior management, onsite company visits, and other third party research, he or she should document and keep copies of all the information that goes into recommendations.

Annotation 1329415195916

 Subject 18. Standard VI (A) Disclosure of Conflicts #analyst-notes #guidance-for-standards-i-vii VI. CONFLICTS OF INTEREST A. Disclosure of Conflicts. Members and Candidates must make full and fair disclosure of all maters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their clients, prospective clients, and employers. Members and Candidates must ensure that such disclosures are prominent, are delivered in plain language, and communicate the relevant information effectively. Conflicts can occur between the interest of clients, the interests of employers, and the member's or candidate's own personal interest. In the investment industry, a conflict or the perception of a conflict often cannot be avoided and full disclosure is required. 1. Disclosure to Clients Members shall disclose to their clients and prospects all matters, including beneficial ownership of securities or other investments, that reasonably could be expected to impair the members' ability to make unbiased and objective recommendations. A member must disclose to clients/prospects the following conflicts: Material ownership in the member's firm's investment account.Market-making activities.Corporate finance relationships.Directorships. The most obvious conflict that arises is when members own stocks in a company that they recommend to their clients. Sell-side members must disclose any material beneficial ownership in a security. A sell-side analyst working for a broker or dealer may be enticed, for example, by corporate issuers to write research reports about certain companies.Buy-side members should disclose their procedures for reporting requirements for personal transactions. A buy-side analyst will be faced with similar conflicts as banks exercise their underwriting and security-dealing powers. The marketing division may ask an analyst to recommend the stock of a certain company in order to obtain business from that company. Service as a director of another firm poses three possible conflicts: A possible conflict between the director's fiduciary duty to his or her clients and the director's duty to the shareholders of the firm.A director may receive options to purchase securities or actual securities in his or her firm as part of a remuneration package. This may entice the director to push up the price of the firm's securities.A director is likely to become aware of material nonpublic information, which may place him or her in a position of possible conflict. Members should also disclose, with approval from their employers, special compensation arrangements with the employer that might conflict with clients' interests, such as bonuses based on short-term performance, commissions, performance fees, incentive fees, and referral fees. Procedures for compliance Many firms require employees and their families to report all transactions by employees and their families for purposes of detecting conflicts of interest and trading on material nonpublic information. Whether such requirements exist or not, members should report to employers, clients, and prospective clients any material beneficial interest they may have in securities and any corporate directorships or other special relationships they may have with the companies they are recommending. Members should make the disclosures before they make any recommendations or take any action regarding such investments. There are two approaches to avoid potential conflicts of interest: Avoidance: Personal investment through "blind trust" or "mutual fund," in which you have no influence on investment decisions.Disclosures: As soon as the member has made full disclosure of the potential conflict, the client has all the relevant information to allow...

Annotation 1329418865932

 Subject 20. Standard VI (C) Referral Fees #analyst-notes #guidance-for-standards-i-vii VI. CONFLICTS OF INTEREST C. Referral Fees. Members and Candidates must disclose to their employers, clients, and prospective clients, as appropriate, any compensation, consideration, or benefit received by or paid to others for the recommendation of products or services. Such disclosure should help the client evaluate any possible partiality shown in any recommendations of services as well as evaluate the full cost of services. Members and candidates are required to: Disclose the existence and terms of any referral fee agreements to all clients or prospects who have been referred under such agreements.Describe the nature of the consideration and its estimated dollar value in this disclosure. Consideration includes all fees, whether paid or not (in cash, in soft dollars, or in kind).Consult a supervisor and legal counsel concerning any prospective arrangement regarding referral fees. Example 1 You provide investment counseling on a fee-for-services basis. You encourage all of your clients to place trades through a particular broker: Richard Jones. You have known Mr. Jones for many years and feel that he is an excellent broker with fees and services that are competitive for the type of clients you typically work with. Mr. Jones also provides you with a "finder's fee" for each client you refer to him. Even if the services recommended are reasonable and appropriate, you must still disclose the referral fee. Example 2 ABC Firm has an agreement with XYZ Firm that ABC will recommend prospective pension clients to XYZ and in return XYZ will give ABC free research. ABC does not disclose the arrangement to prospective clients. ABC violates this standard for not disclosing the arrangement to prospective clients.

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 Subject 21. Standard VII (A) Conduct as Members and Candidates in the CFA Program #analyst-notes #guidance-for-standards-i-vii VII. RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CFA CANDIDATE 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. This standard applies to anyone who cheats, or helps other people to cheat, on the CFA examination or any other examination. Improperly using the CFA designation is also prohibited by this standard. Example Melissa White, CFA, runs her own investment advisory firm and serves as a proctor for the administration of the CFA examination in her city. She receives copies of the Level II CFA examination many days before the exam day. On the evening prior to the exam, she provides information concerning the examination questions to two stressed candidates whom are also her best-performing advisors. White and the two candidates violated the standard. Although it does not involve clients' money or an investment recommendation, White and the two members undermined the integrity and validity of the examination.

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 Subject 22. Standard VII (B) Reference to CFA Institute, the CFA Designation, and the CFA Program #analyst-notes #guidance-for-standards-i-vii VII. RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CFA CANDIDATE 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. CFA Institute's members, CFA charterholders, and candidates in the CFA program must utilize their designation in the correct manner so as not to mislead the investing public. Since achievement of the CFA charter signifies a certain degree of knowledge, the public and clients expect a certain degree of knowledge when encountering the CFA designation. CFA Institute membership Requirements to be granted the right to use the CFA or Chartered Financial Analyst designation: Pass all three levels of the CFA program.Receive the charters.Make an ongoing commitment to abide by the requirements of CFA Institute's Professional Conduct Program (including filing an annual professional conduct statement).Due-paying (every year) and good standing. If a member fails to meet any of these requirement, he or she cannot claim him- or herself to be a member. Members should reference membership in a dignified and judicious manner; if necessary, this would include an accurate explanation of the requirements for obtaining membership. Using the Chartered Financial Analyst designation CFA charterholders may use the term "Chartered Financial Analyst" or "CFA" in a proper, dignified, and judicious manner (if necessary, with an accurate explanation of the requirements for obtaining the right to use the designation). Referencing candidacy in the CFA Program CFA candidates may reference their participation in the CFA Program, but the reference must clearly state that an individual is a CFA candidate and cannot imply that the candidate has achieved any type of partial designation. To be a candidate, a person's application should have been accepted, and he or she should be enrolled to sit for a specified exam (for which he or she has not received exam results or failed to sit).There is no designation for someone who has passed Level I, II or III of the CFA examinations.Candidates may indicate that they have completed Level I, II or III of the CFA program. However, candidates cannot imply that they have achieved partial designation even if they have passed all three levels of the exam. About the CFA mark It is registered in many countries (along with Chartered Financial Analyst).It does not serve as an acronym, cannot be used as a noun, and should never be used in the plural or the possessive.Only CFA or Chartered Financial Analyst should appear after the charterholder's name. "John Smith, CFA," or "John Smith, Chartered Financial Analyst," is correct. Applications Advertisements: can mention that an individual has passed all three exams on the first try, but cannot mention that an individual has accomplished what few others have done, or that the designation implies superior performance capabilities.Placing "CFA Level II Candidate" after a candidate's name implies that this a partial designation, which is a violation.The designation "CFA" cannot be listed in a typeset larger than that used for the charterholder's name. Examples: Richard is a CFA (or Chartered Financial Analyst): WRONG!Richard is a CFA charterholder. He earned the right to use the Chartered Financial Analyst designat...

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 Subject 1. Why were the GIPS Standards Created? #analyst-notes #gips #introduction-to-the-global-investment-performance-standards The financial markets and investment management industry has become increasingly global in nature. A common problem when reporting investment performance across different borders is that some countries have performance measurements and disclosures that are tailored specifically to them but that differ greatly from those in other countries. Some countries do not even have any standardized approaches for investment firms to follow to ensure fair representation and full disclosure of performance information. In the past, making meaningful comparisons on the basis of accurate investment performance data was difficult because of some misleading practices, such as: Representative accounts. Only the results of the best portfolio or securities are presented. Survivorship bias. For example, many mutual fund databases provide historical data about only those funds that are currently in existence. As a result, funds that have ceased to exist due to closures or mergers do not appear in these databases. Generally, funds that have ceased to exist have lower returns relative to the surviving funds. Therefore, the analysis of a mutual fund database with survivorship bias will overestimate the average mutual fund return because the database only includes the better-performing funds. Varying time periods. Only the results for profitable time periods are reflected. The GIPS standards lead investment management firms to avoid misrepresentations of performance and to communicate all relevant information that prospective clients should know in order to evaluate past results.

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 Subject 2. Parties Affected by GIPS #analyst-notes #introduction-to-the-global-investment-performance-standards-gips 1. Firms The GIPS standards apply primarily to investment management firms. The performance results of firms adopting GIPS will be more readily comparable. However, while firms are encouraged to adopt GIPS, the standards arevoluntary. 2. CFA Institute's Members, CFA Charterholders, and CFA Candidates GIPS are a way of ensuring that no material misrepresentation of performance takes place.GIPS satisfy Standard V (B) Communication with Clients and Prospective Clients.Members, charterholders and candidates should inform employers of GIPS and encourage their adoption (though this is not mandatory). 3. Prospective and Current Clients They are the primary beneficiaries of GIPS.GIPS allow effective comparisons; they can directly compare the performance results of firms adopting GIPS.Clients must still use due diligence.

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 Subject 3. Composites #analyst-notes #introduction-to-the-global-investment-performance-standards-gips A composite is defined as a group of portfolios that are managed with the same strategy or objective. Rather than presenting the performance of each individual portfolio, the firm can simply disclose the composite return of the portfolios as a group. The determination of which portfolios to include in the composite should be done according to pre-established criteria (i.e., on an ex-ante basis), not after the fact. This prevents a firm from including only their best-performing portfolios in the composite. The composite return is the asset-weighted average of the performance results of all the portfolios in the composite. The following is not required for the Level I candidate but is provided as a reference only. Composite construction All actual, fee-paying, discretionary portfolios must be included in at least one composite.Firm composites must be defined according to similar investment objectives and strategies.Composites must include new portfolios on a timely and consistent basis soon after the portfolio is being managed.Terminated portfolios must be included in the historical record up to the last full measurement period that the portfolio was under management.Portfolios must not be switched from one composite to another unless this change is documented in the client guidelines or if there is a redefinition of the composite. The historical results must remain with the old composite.Convertible and other hybrid securities must be treated consistently across time and within composites.Before January 1, 2010, if a single asset class was carved out of a multiple-asset portfolio and the returns presented as part of a single-asset composite, cash must be allocated to single-asset returns and the allocation method must be disclosed.From January 1, 2010 on, carved-out returns must not be included in single-asset-class-composite returns unless the assets are actually managed separately and have their own cash allocations.No model or simulated performance may be linked to actual performance. Composites must include only assets under management.

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 Subject 4. Verification #analyst-notes #introduction-to-the-global-investment-performance-standards-gips Verification refers to the independent review of a firm's performance measurement processes and procedures. Verification applies to the firm as a whole, not to individual composites. Verification tests: Whether the firm has complied with GIPS composite construction requirements on a firm-wide basis.Whether the firm's processes and procedures are designed to calculate and present GIPS-compliant performance results. Again, the focus of verification is not on individual composites, but on the processes the firm follows to form composites and calculate and report performance. At this point, verification is not mandatory, but it is strongly recommended. Firms may claim compliance, but independently-verified compliance adds credibility to those claims. It is recommended that firms have all years for which they are claiming compliance verified.

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 Subject 2. The Scope of GIPS Standards with Respect to Definition of the Firm, Historical Performance Record, and Compliance #analyst-notes #global-investment-performance-standards-gips Definition of the Firm It is intended that GIPS compliance be available to any firm. A firm must comply with GIPS on a firm-wide basis to claim compliance with the standards. All actual, fee-paying, discretionary portfolios managed by the firm must be included in the performance-measurement process. To be in compliance, an entity must state how it defines itself as a firm. A firm may be defined as an investment firm, subsidiary or division held out to be a distinct business unit for managing investment assets. It could be part of a larger organization.Total firm assets must be the aggregate of the fair value of all discretionary and nondiscretionary assets under management within the defined firm. This includes both fee-paying and non-fee-paying assets.Firms must include the performance of assets assigned to a sub-advisor in a composite, provided that the firm has discretion over the selection of the sub-advisor.Changes in a firm's organization are not permitted to lead to alteration of historical composite results. Historical Performance Record Firms should present their long-term performance records. To be in compliance, a firm must: Initially present a minimum of five years of compliant annual investment performance results, except for composites which have been in existence for less than five years (in which case, composite performance since inception must be presented).Add an additional year of compliant performance results each year until they reach 10 years of results. The goal is to have 10 years of GIPS-compliant performance results presented. To encourage firms to participate, GIPS only requires five years of data to initially come into compliance, allowing the full 10 years of performance results to be built over time. There is nothing to prevent a firm from initially presenting a full 10 years of compliance results. To maintain compliance, a firm presenting less than 10 years of performance results must increase the number of years of performance results presented. Claim of Compliance Which version of GIPS standards should firms comply with? The revised GIPS standards were adopted in 2010 and became effective on January 1, 2011. Although early adoption of these revised GIPS standards is encouraged, firms can still use the old version for performance presentations that include results through December 31, 2010. In order to claim compliance, a firm must meet ALL the requirements set forth in GIPS. Firms that fully comply with GIPS may use the following compliance statement in their performance presentations: "[Name of the firm] has prepared and presented this report in compliance with the Global Investment Performance Standards (GIPS)." With regard to compliance, a firm is either in compliance or not in compliance. Firms may not make any claims to being "in compliance except for..." Appropriate disclosure when the GIPS standards and local regulations are in conflict: GIPS standards serve as minimum worldwide standards. If local laws are stricter than GIPS, local laws should be applied. If local laws don't exist or are less strict than the GIPS, the GIPS should apply. In cases of conflicts with GIPS, the standards require that local laws and regulations take precedence over GIPS. Firms should disclose any conflicts.