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Learning Outcome Statements for CFA Level 1

Learning Outcome Statements for CFA Level 1

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The practitioner should be able to:

• Describe the structure of the CFA Institute Professional Conduct Program and

the process for the enforcement of the Code and Standards

• State the six components of the Code of Ethics and the seven Standards of

Professional Conduct

• Explain the ethical responsibilities required by the Code and Standards,

including the multiple sub-sections of each Standard

The practitioner should be able to:

• Demonstrate a thorough knowledge of the Code of Ethics and Standards of

Professional Conduct by applying the Code and Standards to specific

situations presenting multiple issues of questionable professional conduct

• Distinguish between conduct that conforms to the Code and Standards and

conduct that violates the Code and Standards

• Recommend practices and procedures designed to prevent violations of the

Code of Ethics and Standards of Professional Conduct

The practitioner should be able to:

• Explain why the GIPS standards were created, what parties the GIPS

standards apply to, and who is served by the standards

• Explain the construction and purpose of composites in performance reporting

• Explain the requirements for verification of compliance with GIPS standards

The practitioner should be able to:

• Describe the key characteristics of the GIPS standards and the fundamentals

of compliance

• Describe the scope of the GIPS standards with respect to an investment firm’s

definition and historical performance record

• Explain how the GIPS standards are implemented in countries with existing

standards for performance reporting and describe the appropriate response

when the GIPS standards and local regulations are in conflict

• Characterize the eight major sections of the GIPS standards

“The Time Value of Money”

The practitioner should be able to:

• Explain an interest rate as the sum of a real risk-free rate, expected inflation,

and premiums that compensate investors for distinct types of risk

• Calculate and interpret the effective annual rate, given the stated annual

interest rate and the frequency of compounding, and solve time value of

money problems when compounding periods are other than annual

• Calculate and interpret the FV and PV of a single sum of money, ordinary

annuity, a perpetuity (PV only), an annuity due, or a series of uneven cash

flows

• Draw a time line, specify a time index, and solve problems involving the time

value of money as applied, for example, to mortgages and savings for college

tuition or retirement

The practitioner should be able to:

• Calculate and interpret the net present value (NPV) and the internal rate of

return (IRR) of an investment, contrast the NPV rule to the IRR rule, and

identify any problems associated with the IRR rule

• Define, calculate and interpret a holding period return (total return)

• Calculate, interpret, and distinguish between the money-weighted and time-

weighted rates of return of a portfolio and appraise the performance of

portfolios based on these measures

• Calculate and interpret the bank discount yield, holding period yield, effective

annual yield, and money market yield for a U.S. Treasury bill; and interpret

and convert among holding period yields, money market yields, effective

annual yields and the bond equivalent yields

The practitioner should be able to:

• Differentiate between descriptive statistics and inferential statistics,

population and a sample, and among the types of measurement scales

• Explain a parameter, a sample statistic, and a frequency distribution

• Calculate and interpret relative frequencies and cumulative relative given a

frequency distribution, and describe the properties of a dataset as a

histogram or a frequency polygon

• Define, calculate, and interpret measures of central tendency, including

population mean, sample mean, arithmetic mean, weighted average or

including a portfolio return viewed as a weighted mean), geometric mean,

mean, median, and mode

• Describe, calculate, and interpret quartiles, quintiles, deciles, and percentiles

• Define, calculate, and interpret 1) a range and a mean absolute deviation,

the variance and standard deviation of a population and of a sample

• Calculate and interpret the proportion of observations falling within number

of standard deviations of the mean, using Chebyshev’s inequality

• Define, calculate, and interpret the coefficient of variation and the Sharpe

ratio

• Define and interpret skewness, explain the meaning of a positively skewed

return distribution, and describe the relative locations of the median, and

mode for a nonsymmetrical distribution

• Define and interpret measures of sample skewness and kurtosis

“Probability Concepts”

The practitioner should be able to:

• Define a random variable, an outcome, an event, mutually exclusive events,

and exhaustive events

• Explain the two defining properties of probability, and distinguish among

empirical, subjective, and a priori probabilities

• State the probability of an event in terms of odds for or against the event

• Distinguish between unconditional and conditional probabilities

• Calculate and interpret 1) the joint probability of two events, 2) the

probability that at least one of two events will occur, given the probability of

each and the joint probability of the two events, and 3) a joint probability of

any number of independent events

• Distinguish between dependent and independent events

• Calculate and interpret, using the total probability rule, an unconditional

probability

• Explain the use of conditional expectation in investment applications

• Diagram an investment problem, using a tree diagram

• Calculate and interpret covariance and correlation

• Calculate and interpret the expected value, variance, and standard deviation

of a random variable and of returns on a portfolio

• Calculate and interpret covariance given a joint probability function

• Calculate and interpret an updated probability, using Bayes’ formula

• Identify the most appropriate method to solve a particular counting problem,

and solve counting problems using the factorial, combination, and

permutation notations

“Common Probability Distributions”

The practitioner should be able to:

• Explain a probability distribution and distinguish between discrete and

continuous random variables

• Describe the set of possible outcomes of a specified discrete random variable

• Interpret a probability function, a probability density function, and a

cumulative distribution function, and calculate and interpret probabilities for

a random variable, given its cumulative distribution function

• Define a discrete uniform random variable and a binomial random variable,

calculate and interpret probabilities given the discrete uniform and the

binomial distribution functions, and construct a binomial tree to describe

stock price movement

• Describe the continuous uniform distribution, and calculate and interpret

probabilities, given a continuous uniform probability distribution

• Explain the key properties of the normal distribution, distinguish between a

univariate and a multivariate distribution, and explain the role of correlation

in the multivariate normal distribution

• Construct and interpret a confidence interval for a normally distributed

random variable, and determine the probability that a normally distributed

random variable lies inside a given confidence interval

• Define the standard normal distribution, explain how to standardize a random

variable, and calculate and interpret probabilities using the standard normal

distribution

• Define shortfall risk, calculate the safety-first ratio, and select an optimal

portfolio using Roy’s safety-first criterion

• Explain the relationship between normal and lognormal distributions and why

the lognormal distribution is used to model asset prices

• Distinguish between discretely and continuously compounded rates of return,

and calculate and interpret a continuously compounded rate of return, given

a specific holding period return

• Explain Monte Carlo simulation and historical simulation, and describe their

major applications and limitations

“Sampling and Estimation”

The practitioner should be able to:

• Define simple random sampling, sampling error, and a sampling distribution,

and interpret sampling error

• Distinguish between simple random and stratified random sampling

• Distinguish between time-series and cross-sectional data

• Interpret the central limit theorem and describe its importance

• Calculate and interpret the standard error of the sample mean

• Distinguish between a point estimate and a confidence interval estimate of a

population parameter

• Identify and describe the desirable properties of an estimator

• Explain the construction of confidence intervals

• Describe the properties of Student’s t-distribution, and calculate and interpret

its degrees of freedom

• Calculate and interpret a confidence interval for a population mean, given a

normal distribution with 1) a known population variance, 2) an unknown

population variance, or 3) an unknown variance and the sample size is large

• Discuss the issues regarding selection of the appropriate sample size, data-

mining bias, sample selection bias, survivorship bias, look-ahead bias, and

time-period bias

“Hypothesis Testing”

The practitioner should be able to:

• Define a hypothesis, describe the steps of hypothesis testing, interpret and

discuss the choice of the null hypothesis and alternative hypothesis, and

distinguish between one-tailed and two-tailed tests of hypotheses

• Define and interpret a test statistic, a Type I and a Type II error, and a

significance level, and explain how significance levels are used in hypothesis

testing

• Define and interpret a decision rule and the power of a test, and explain the

relation between confidence intervals and hypothesis tests

• Distinguish between a statistical result and an economically meaningful result

• Identify the appropriate test statistic and interpret the results for a hypothesis

test concerning 1) the population mean of a normally distributed population

with a) known or b) unknown variance, 2) the equality of the population

means of two normally distributed populations, based on independent

random samples with a) equal or b) unequal assumed variances, and 3) the

mean difference of two normally distributed populations (paired comparisons

test)

• Identify the appropriate test statistic and interpret the results for a hypothesis

test concerning 1) the variance of a normally distributed population, and 2)

the equality of the variances of two normally distributed populations, based

on two independent random samples

• Distinguish between parametric and nonparametric tests and describe the

situations in which the use of nonparametric tests may be appropriate

“Technical Analysis”

The practitioner should be able to:

• Explain the underlying assumptions of technical analysis

• Discuss the advantages of and challenges to technical analysis

• List and describe examples of each major category of technical trading rules

and indicators

“Elasticity”

The practitioner should be able to:

• Calculate and interpret the elasticities of demand (price elasticity, cross

elasticity, income elasticity) and the elasticity of supply, and discuss the

factors that influence each measure

• Calculate elasticities on a straight-line demand curve, differentiate among

elastic, inelastic, and unit elastic demand and describe the relation between

price elasticity of demand and total revenue

The practitioner should be able to:

• Explain allocative efficiency, marginal benefit and marginal cost, and

demonstrate why the efficient quantity occurs where marginal benefit equals

marginal cost

• Distinguish between the price and the value of a product and explain the

demand curve and consumer surplus

• Distinguish between the cost and the price of a product and explain the

supply curve and producer surplus

• Discuss the relationship between consumer surplus, producer surplus, and

equilibrium

• Explain 1) how efficient markets ensure optimal resource utilization and 2)

the obstacles to efficiency and the resulting underproduction or

overproduction, including the concept of deadweight loss

• Explain the two groups of ideas about the fairness principle (utilitarianism

and the symmetry principle) and discuss the relation between fairness and

efficiency

“Markets in Action”

The practitioner should be able to:

• Explain market equilibrium, distinguish between long-term and short-term

impacts of outside shocks, and describe the effects of rent ceilings on the

existence of black markets in the housing sector and on the market’s

efficiency

• Describe labor market equilibrium and explain the effects and inefficiencies

of a minimum wage above the equilibrium wage

• Explain the impact of taxes on supply, demand, and market equilibrium, and

describe tax incidence and its relation to demand and supply elasticity

• Discuss the impact of subsidies, quotas, and markets for illegal goods on

demand, supply, and market equilibrium

“Organizing Production”

The practitioner should be able to:

• Explain the types of opportunity cost and their relation to economic profit,

and calculate economic profit

• Discuss a firm’s constraints and their impact on achievability of maximum

profit

• Differentiate between technological efficiency and economic efficiency, and

calculate economic efficiency of various firms under different scenarios

• Explain command systems and incentive systems to organize production, the

principal-agent problem, and measures a firm uses to reduce the principal-

agent problem

• Describe the different types of business organization and the advantages and

disadvantages of each

• Characterize the four market types

• Calculate and interpret the four-firm concentration ratio and the Herfindahl-

Hirschman Index, and discuss the limitations of concentration measures

• Explain why firms are often more efficient than markets in coordinating

economic activity

The practitioner should be able to:

• Differentiate between short-run and long-run decision time frames

• Describe and explain the relations among total product of labor, marginal

product of labor, and average product of labor, and describe increasing and

decreasing marginal returns

• Distinguish among total cost (including both fixed cost and variable cost),

marginal cost, and average cost, and explain the relations among the various

cost curves

• Explain the firm’s production function, its properties of diminishing returns

and diminishing marginal product of capital, the relation between short-run

and long-run costs, and how economies and diseconomies of scale affect

long-run costs

"Perfect Competition"

The practitioner should be able to:

• Describe the characteristics of perfect competition, explain why firms in a

perfectly competitive market are price takers, and differentiate between

market and firm demand curves

• Determine the profit maximizing (loss minimizing) output for a perfectly

competitive firm, and explain marginal cost, marginal revenue, and economic

profit and loss

• Describe a perfectly competitive firm’s short-run supply curve and explain the

impact of changes in demand, entry and exit of firms, and changes in plant

size on the long-run equilibrium

• Discuss how a permanent change in demand or changes in technology affect

price, output, and economic profit

"Monopoly"

The practitioner should be able to:

• Describe the characteristics of a monopoly, including factors that allow a

monopoly to arise, and monopoly price-setting strategies

• Explain the relation between price, marginal revenue, and elasticity for a

monopoly, and determine a monopoly’s profit-maximizing price and quantity

• Explain price discrimination, and why perfect price discrimination is efficient

• Explain how consumer and producer surplus are redistributed in a monopoly,

including the occurrence of deadweight loss and rent seeking

• Explain the potential gains from monopoly and the regulation of a natural

monopoly

The practitioner should be able to:

• Describe the characteristics of monopolistic competition and oligopoly

• Determine the profit-maximizing (loss-minimizing) output under monopolistic

competition and oligopoly, explain why long-run economic profit under

monopolistic competition is zero, and determine if monopolistic competition

is efficient

• Explain the importance of innovation, product development, advertising, and

branding under monopolistic competition

• Explain the kinked demand curve model and the dominant firm model, and

describe oligopoly games including the Prisoners’ Dilemma

The practitioner should be able to:

• Explain why demand for the factors of production is called derived demand,

differentiate between marginal revenue and marginal revenue product (MRP),

and describe how the MRP determines the demand for labor and the wage

rate

• Describe the factors that cause changes in the demand for labor and the

factors that determine the elasticity of the demand for labor

• Describe the factors determining the supply of labor, including the

substitution and income effects, and discuss the factors related to changes in

the supply of labor, including capital accumulation

• Differentiate between physical capital and financial capital, and explain the

relation between the demand for physical capital and the demand for

financial capital

• Discuss the role of the present value technique in determining the demand

for capital

• Explain the factors that influence the supply of capital

• Differentiate between renewable and non-renewable natural resources and

describe the supply curve for each

• Differentiate between economic rent and opportunity costs

The practitioner should be able to:

• Describe the phases of the business cycle, define an unemployed person, and

interpret the main labor market indicators and their relation to the business

cycle

• Define aggregate hours and real wage rates, and explain their relation to

gross domestic product (GDP)

• Explain the types of unemployment, full employment, the natural rate of

unemployment, and the relation between unemployment and real GDP

• Explain and calculate the consumer price index (CPI), describe the relation

between the CPI and the inflation rate, and explain the main sources of CPI

bias

“Aggregate Supply and Aggregate Demand”

The practitioner should be able to:

• Explain the factors that influence real GDP and long-run and short-run

aggregate supply, explain movement along the long-run and short-run

aggregate supply curves (LAS and SAS), and discuss the reasons for changes

in potential GDP and aggregate supply

• Explain the components of and the factors that affect real GDP demanded,

describe the aggregate demand curve and why it slopes downward, and

explain the factors that can change aggregate demand

• Differentiate between short-run and long-run macroeconomic equilibrium,

and explain how economic growth, inflation, and changes in aggregate

demand and supply influence the macroeconomic equilibrium and the

business cycle

• Compare and contrast the Keynesian, Classical, and Monetarist schools of

macroeconomics

The practitioner should be able to:

• Explain the functions of money

• Describe the components of the M1 and M2 measures of money, and discuss

why checks and credit cards are not counted as money

• Describe the economic functions of and differentiate among the various

depository institutions, and explain the impact of financial regulation,

deregulation, and innovation

• Discuss the creation of money, including the role played by excess reserves,

and calculate the amount of loans a bank can generate, given new deposits

• Explain the goals of the U.S. Federal Reserve (Fed) in conducting monetary

policy and how the Fed uses its policy tools to control the quantity of money,

and describe the assets and liabilities on the Fed’s balance sheet

• Describe the monetary base, and explain the relation among the monetary

base, the money multiplier, and the quantity of money

The practitioner should be able to:

• Explain the factors that influence the demand for money, and describe the

demand for money curve, including the effects of changes in real GDP and

financial innovation

• Explain interest rate determination and the short-run and long-run effects of

money on real GDP

• Discuss the quantity theory of money and its relation to aggregate supply

and aggregate demand

"Inflation"

The practitioner should be able to:

• Differentiate between inflation and the price level, and calculate an inflation

rate

• Describe and distinguish among the factors resulting in demand-pull and

cost-push inflation, and describe the evolution of demand-pull and cost-push

inflationary processes

• Explain the effects of unanticipated inflation in the labor market and the

market for financial capital

• Distinguish between anticipated and unanticipated inflation, and explain the

costs of anticipated inflation

• Explain the impact of inflation on unemployment, and describe the short-run

and long-run Phillips curve, including the effect of changes in the natural rate

of unemployment

• Explain the relation among inflation, nominal interest rates, and the demand

and supply of money

"Fiscal Policy"

The practitioner should be able to:

• Explain supply-side effects on employment, potential GDP, and aggregate

supply, including the income tax and taxes on expenditure, and describe the

Laffer curve and its relation to supply-side economics

• Discuss the sources of investment finance and the influence of fiscal policy on

capital markets, including the crowding-out effect

• Discuss the generational effects of fiscal policy, including generational

accounting and generational imbalance

• Discuss the use of fiscal policy to stabilize the economy, including the effects

of the government purchases multiplier, the tax multiplier, and the balanced

budget multiplier

• Explain the limitations of discretionary fiscal policy, and differentiate between

discretionary fiscal policy and automatic stabilizers

"Monetary Policy"

The practitioner should be able to:

• Discuss the U.S. Federal Reserve’s primary goal of price stability, the

secondary goal of maintaining sustainable real GDP growth, and the

intermediate targets of monetary policy, and compare and contrast the

policies that can be used to achieve price level stability

• Compare and contrast fixed-rule and feedback-rule monetary policies to

stabilize aggregate demand, and explain the problem of monetary policy lags

• Discuss the fixed-rule and feedback-rule policies to stabilize aggregate supply

in response to a productivity shock and a cost-push inflation shock

• Discuss the importance of policy credibility in monetary policy

implementation

• Compare and contrast the new monetarist and new Keynesian feedback rules

"Financial Statement Analysis: An Introduction"

The practitioner should be able to:

• Discuss the roles of financial reporting and financial statement analysis

• Discuss the role of key financial statements (income statement, balance

sheet, cash flow statement and statement of changes in owners’ equity) in

evaluating a company’s performance and financial position

• Discuss the importance of financial statement notes and supplementary

information (including disclosures of accounting methods, estimates and

assumptions), and management’s discussion and analysis

• Discuss the objective of audits of financial statements, the types of audit

reports, and the importance of effective internal controls

• Identify and explain information sources other than annual financial

statements and supplementary information that analysts use in financial

statement analysis

• Describe the steps in the financial statement analysis framework

The practitioner should be able to:

• Identify the groups (operating, investing, and financing activities) into which

business activities are categorized for financial reporting purposes and

classify any business activity into the appropriate group

• Explain the relationship of financial statement elements and accounts, and

classify accounts into the financial statement elements

• Explain the accounting equation in its basic and expanded forms

• Explain the process of recording business transactions using an accounting

system based on the accounting equations

• Explain the need for accruals and other adjustments in preparing financial

statements

• Prepare financial statements, given account balances or other elements in

the relevant accounting equation, and explain the relationships among the

income statement, balance sheet, statement of cash flows, and statement of

owners’ equity

• Describe the flow of information in an accounting system

• Explain the use of the results of the accounting process in security analysis

"Financial Reporting Standards"

The practitioner should be able to:

• Explain the objective of financial statements and the importance of reporting

standards in security analysis and valuation

• Explain the role of standard-setting bodies, such as the International

Accounting Standards Board and the U.S. Financial Accounting Standards

Board, and regulatory authorities such as the International Organization of

Securities Commissions, the U.K. Financial Services Authority, and the U.S.

Securities and Exchange Commission in establishing and enforcing financial

reporting standards

• Discuss the ongoing barriers to developing one universally accepted set of

financial reporting standards

• Describe the International Financial Reporting Standards (IFRS) framework,

including the objective of financial statements, their qualitative

characteristics, required reporting elements, and the constraints and

assumptions in preparing financial statements

• Explain the general requirements for financial statements

• Compare and contrast key concepts of financial reporting standards under

IFRS and alternative reporting systems, and discuss the implications for

financial analysis of differing financial reporting systems

• Identify the characteristics of a coherent financial reporting framework and

barriers to creating a coherent financial reporting network

• Discuss the importance of monitoring developments in financial reporting

standards and evaluate company disclosures of significant accounting

policies

"Understanding the Income Statement"

The practitioner should be able to:

• Describe the components of the income statement and construct an income

statement using the alternative presentation formats of that statement

• Explain the general principles of revenue recognition and accrual accounting,

demonstrate specific revenue recognition applications (including accounting

for long-term contracts, installment sales, barter transactions, and gross and

net reporting of revenue), and discuss the implications of revenue recognition

principles for financial analysis

• Discuss the general principles of expense recognition, such as the matching

principle, specific expense recognition applications (including depreciation of

longterm assets and inventory methods), and the implications of expense

recognition principles for financial analysis

• Determine which method of depreciation, accounting for inventory, or

amortizing intangibles is appropriate, based on facts that might influence the

decision

• Demonstrate the depreciation of long-term assets using each approved

method, accounting for inventory using each approved method, and

amortization of intangibles

• Distinguish between the operating and nonoperating components of the

income statement

• Discuss the financial reporting treatment and analysis of nonrecurring items

(including discontinued operations, extraordinary items, and unusual or

infrequent items), and changes in accounting standards

• Describe the components of earnings per share and calculate a company’s

earnings per share (both basic and diluted earnings per share) for both a

simple and complex capital structure

• Distinguish between dilutive and antidilutive securities, and discuss the

implications of each for the earnings per share calculation

• Evaluate a company’s financial performance using common-size income

statements and financial ratios based on the income statement

• State the accounting classification for items that are excluded from the

income statement but affect owners’ equity, and list the major types of items

receiving that treatment

• Describe and calculate comprehensive income

The practitioner should be able to:

• Illustrate and interpret the components of the assets, liabilities, and equity

sections of the balance sheet, and discuss the uses of the balance sheet in

financial analysis

• Describe the various formats of balance sheet presentation

• Explain how assets and liabilities arise from the accrual process

• Compare and contrast current and noncurrent assets and liabilities

• Explain the measurement bases (e.g., historical cost and fair value) of assets

and liabilities, including current assets, current liabilities, tangible assets, and

intangible assets

• Discuss off-balance-sheet disclosures

• Demonstrate the appropriate classifications and related accounting

treatments for marketable and non-marketable financial instruments held as

assets or owed by the company as liabilities

• List and explain the components of owners’ equity

• Interpret balance sheets, common-size balance sheets, the statement of

changes in equity, and commonly used balance sheet ratios

"Understanding the Cash Flow Statement"

The practitioner should be able to:

• Compare and contrast cash flows from operating, investing, and financing

activities, and classify cash flow items as relating to one of these three

categories, given a description of the items

• Describe how noncash investing and financing activities are reported

• Compare and contrast the key differences in cash flow statements prepared

under international financial reporting standards and U.S. generally accepted

accounting principles

• Demonstrate the difference between the direct and indirect methods of

presenting cash from operating activities and explain the arguments in favor

of each

• Demonstrate how the cash flow statement is linked to the income statement

and balance sheet

• Demonstrate the steps in the preparation of direct and indirect cash flow

statements, including how cash flows can be computed using income

statement and balance sheet data

• Describe the process of converting a statement of cash flows from the direct

to the indirect method of presentation

• Analyze and interpret a cash flow statement using both total currency

amounts and common-size cash flow statements

• Explain and calculate free cash flow to the firm, free cash flow to equity, and

other cash flow ratios

“Analysis of Inventories”

The practitioner should be able to:

• Compute ending inventory balances and cost of goods sold using the LIFO,

FIFO, and

average cost methods to account for product inventory and explain the

relationship among and the usefulness of inventory and cost of goods sold

data provided by the LIFO, FIFO, and average cost methods when prices are

1) stable or 2) changing

• Analyze the financial statements of companies using different inventory

accounting

methods to compare and describe the effect of the different methods on cost

of goods sold and inventory balances, discuss how a company’s choice of

inventory accounting method affects other financial items such as income,

cash flow, and working capital, and compute and describe the effects of the

choice of inventory method on profitability, liquidity, activity, and solvency

ratios

• Discuss the reasons that a LIFO reserve might decline during a given period

and discuss the implications of such a decline for financial analysis

• Discuss how inventories are reported in the financial statements and how the

lower of cost or market principle is used and applied

"Long-Term Assets”

The practitioner should be able to:

• Describe the factors that distinguish long-term assets from other assets and

identify the common types of long-term assets and how carrying value is

determined on the balance sheet

• Determine the costs that are capitalized to property, plant and equipment

and determine which costs are expensed as incurred

• Explain depreciation accounting (including the reasons for depreciation),

calculate depreciation using the straight-line, production (also known as

units-of-production), and declining-balance methods, and calculate

depreciation after revising the estimated useful life of an asset

• Describe how to account for the sale, exchange, or disposal of depreciable

assets, and determine whether a gain or loss is recorded

• Identify assets that should be classified as natural resources, determine their

carrying values on the balance sheet and calculate depletion

• Identify the types of intangible assets and describe how the accounting

treatment for goodwill under U.S. GAAP differs from the accounting treatment

for other intangible assets

The practitioner should be able to:

• Compute and describe the effects of capitalizing versus expensing on net

income, shareholders’ equity, cash flow from operations, and financial ratios

including the effect on the interest coverage ratio (times interest earned) of

capitalizing interest costs

• Explain the circumstances in which intangible assets, including software

development costs and research and development costs are capitalized

• Calculate and describe both the initial and long-term effects of asset

revaluations on financial ratios

Impairment”

The practitioner should be able to:

• Identify the different depreciation methods and discuss how the choice of

depreciation method affects a company’s financial statements, ratios, and

taxes

• Explain the role of depreciable lives and salvage values in the computation of

depreciation expenses, and compute and describe how changing depreciation

methods or changing the estimated useful life or salvage value of an asset

affects financial statements and ratios

• Discuss the use of fixed asset disclosures to compare companies’ average

age of depreciable assets, and calculate, using such disclosures, the average

age and average depreciable life of fixed assets

• Define impairment of long-lived assets and explain what effect such

impairment has on a company’s financial statements and ratios

• Discuss the liability for closure, removal, and environmental effects of long-

lived operating assets, and discuss the financial statement impact and ratio

effects of that liability

"Financial Analysis Techniques"

The practitioner should be able to:

• Evaluate and compare companies using ratio analysis, common-size financial

statements, and charts in financial analysis

• Describe the limitations of ratio analysis

• Explain and demonstrate the classification of financial ratios

• Calculate and interpret activity, liquidity, solvency, profitability, and valuation

ratios

• Demonstrate how ratios are related and how to evaluate a company using a

combination of different ratios

• Demonstrate the application of DuPont analysis (the decomposition of return

on equity)

• Calculate and interpret the ratios used in equity analysis, credit analysis, and

segment analysis

• Describe how the results of common-size and ratio analysis can be used to

model and forecast earnings

The practitioner should be able to:

• Evaluate a company’s past financial performance and explain how a

company’s strategy is reflected in past financial performance

• Prepare a basic projection of a company’s future net income and cash flow

• Describe the role of financial statement analysis in assessing the credit

quality of a potential debt investment

• Discuss the use of financial statement analysis in screening for potential

equity investments

• Determine and justify appropriate analyst adjustments to a company’s

financial statements to facilitate comparison with another company

The practitioner should be able to:

• Identify and explain the major international accounting standards for each

asset and liability category on the balance sheet and the key differences from

U.S. generally accepted accounting principles (GAAP)

• Identify and explain the major international accounting standards for major

revenue and expense categories on the income statement, and the key

differences from U.S. GAAP

• Identify and explain the major differences between international and U.S.

GAAP accounting standards concerning the treatment of interest and

dividends on the cash flow statement

• Interpret the effect of differences between international and U.S. GAAP

accounting standards on the balance sheet, income statement, and the

statement of changes in equity for some commonly used financial ratios

"Capital Budgeting"

The practitioner should be able to:

• Explain the capital budgeting process, including the typical steps of the

process, and distinguish among the various categories of capital projects

• Discuss the basic principles of capital budgeting, including the choice of the

proper cash flows and determining the proper discount rate

• Explain how the following project interactions affect the evaluation of a

capital project: (1) independent versus mutually exclusive projects, (2)

project sequencing, and (3) unlimited funds versus capital rationing

• Calculate and interpret the results using each of the following methods to

evaluate a single capital project: net present value (NPV), internal rate of

return (IRR), payback period, discounted payback period, average accounting

rate of return (AAR), and profitability index (PI)

• Explain the NPV profile, compare and contrast the NPV and IRR methods

when evaluating independent and mutually exclusive projects, and describe

the problems that can arise when using an IRR

• Describe and account for the relative popularity of the various capital

budgeting methods, and explain the relation between NPV and company

value and stock price

"Cost of Capital"

The practitioner should be able to:

• Calculate and interpret the weighted average cost of capital (WACC) of a

company

• Describe how taxes affect the cost of capital from different capital sources

• Describe alternative methods of calculating the weights used in the weighted

average cost of capital, including the use of the company’s target capital

structure

• Explain how the marginal cost of capital and the investment opportunity

schedule are used to determine the optimal capital budget

• Explain the marginal cost of capital’s role in determining the net present

value of a project

• Calculate and interpret the cost of fixed rate debt capital using the yield-to-

maturity approach and the debt-rating approach

• Calculate and interpret the cost of noncallable, nonconvertible preferred

stock

• Calculate and interpret the cost of equity capital using the capital asset

pricing model approach, the dividend discount model approach, and the

bond-yield-plus risk-premium approach

• Explain the country equity risk premium in the estimation of the cost of

equity for a company located in a developing market

• Describe the marginal cost of capital schedule, explain why it may be

upward-sloping with respect to additional capital, and calculate and interpret

its breakpoints

• Explain and demonstrate the correct treatment of flotation costs

"Working Capital Management"

The practitioner should be able to:

• Calculate and interpret liquidity measures using selected financial ratios for a

company and compare the company with peer companies

• Evaluate overall working capital effectiveness of a company, using the

operating and cash conversion cycles, and compare the company’s

effectiveness with other peer companies

• Classify the components of a cash forecast and prepare a cash forecast, given

estimates of revenues, expenses, and other items

• Identify and evaluate the necessary tools to use in managing a company’s

net daily cash position

• Compute and interpret comparable yields on various securities, compare

portfolio returns against a standard benchmark, and evaluate a company’s

short-term investment policy guidelines

• Evaluate the performance of a company’s accounts receivable, inventory

management, and accounts payable functions against historical figures and

comparable peer company values

• Evaluate the choices of short-term funding available to a company and

recommend a financing method

The practitioner should be able to:

• Calculate, interpret, and discuss the DuPont expression and extended DuPont

expression for a company’s return on equity and demonstrate its use in

corporate analysis

• Demonstrate the use of pro forma income and balance sheet statements

The practitioner should be able to:

• Define and describe corporate governance

• Discuss and critique characteristics and practices related to board and

committee independence, experience, compensation, external consultants,

and frequency of elections, and determine whether they are supportive of

shareowner protection

• Describe board independence and explain the importance of independent

board members in corporate governance

• Identify factors that indicate a board and its members possess the experience

required to govern the company for the benefit of its shareowners

• Explain the provisions that should be included in a strong corporate code of

ethics and the implications of a weak code of ethics with regard to related-

party transactions and personal use of company assets

• State the key areas of responsibility for which board committees are typically

created, and explain the criteria for assessing whether each committee is

able to adequately represent shareowner interests

• Evaluate, from a shareowner’s perspective, company policies related to

voting rules, shareowner-sponsored proposals, common stock classes, and

takeover defenses

“The Asset Allocation Decision”

The practitioner should be able to:

• Describe the steps in the portfolio management process, and explain the

reasons for a policy statement

• Explain why investment objectives should be expressed in terms of risk and

return, and list the factors that may affect an investor’s risk tolerance

• Describe the return objectives of capital preservation, capital appreciation,

current income, and total return

• Describe the investment constraints of liquidity, time horizon, tax concerns,

legal and regulatory factors, and unique needs and preferences

• Describe the importance of asset allocation, in terms of the percentage of a

portfolio’s return that can be explained by the target asset allocation, and

explain how political and economic factors result in differing asset allocations

by investors in various countries

The practitioner should be able to:

• Define risk aversion and discuss evidence that suggests that individuals are

generally risk averse

• List the assumptions about investor behavior underlying the Markowitz model

• Compute and interpret the expected return, variance, and standard deviation

for an individual investment and the expected return and standard deviation

for a portfolio

• Compute and interpret the covariance of rates of return, and show how it is

related to the correlation coefficient

• List the components of the portfolio standard deviation formula, and explain

the relevant importance of these components when adding an investment to

a portfolio

• Describe the efficient frontier, and explain the implications for incremental

returns as an investor assumes more risk

• Explain the concept of an optimal portfolio, and show how each investor may

have a different optimal portfolio

The practitioner should be able to:

• Explain the capital market theory, including its underlying assumptions, and

explain the effect on expected returns, the standard deviation of returns, and

possible risk/return combinations when a risk-free asset is combined with a

portfolio of risky assets

• Identify the market portfolio, and describe the role of the market portfolio in

the formation of the capital market line (CML)

• Define systematic and unsystematic risk, and explain why an investor should

not expect to receive additional return for assuming unsystematic risk

• Explain the capital asset pricing model, including the security market line

(SML) and beta, and describe the effects of relaxing its underlying

assumptions

• Calculate, using the SML, the expected return on a security, and evaluate

whether the security is overvalued, undervalued, or properly valued

“Organization and Functioning of Securities Markets”

The practitioner should be able to:

• Describe the characteristics of a well-functioning securities market

• Distinguish between primary and secondary capital markets, and explain how

secondary markets support primary markets

• Distinguish between call and continuous markets

• Compare and contrast the structural differences among national stock

exchanges, regional stock exchanges, and over-the-counter (OTC) markets

• Compare and contrast major characteristics of exchange markets, including

exchange membership, types of orders, and market makers

• Describe the process of selling a stock short and discuss an investor’s likely

motivation for selling short

• Describe the process of buying a stock on margin, compute the rate of return

on a margin transaction, define maintenance margin, and determine the

stock price at which the investor would receive a margin call

“Security-Market Indexes”

The practitioner should be able to:

• Compare and contrast the characteristics of, and discuss the source and

direction of bias exhibited by, each of the three predominant weighting

schemes used in constructing stock market indexes, and compute a price-

weighted, valueweighted, and unweighted index series for three stocks

• Compare and contrast major structural features of domestic and global stock

indexes, bond indexes, and composite stock-bond indexes

• State how low correlations between global markets support global investment

The practitioner should be able to:

• Define an efficient capital market and describe and contrast the three forms

of the efficient market hypothesis (EMH)

• Describe the tests used to examine each of the three forms of the EMH,

identify various market anomalies and explain their implications for the EMH,

and explain the overall conclusions about each form of the EMH

• Explain the implications of stock market efficiency for technical analysis,

fundamental analysis, the portfolio management process, the role of the

portfolio manager, and the rationale for investing in index funds

• Define behavioral finance and describe overconfidence bias, confirmation

bias, and escalation bias

The practitioner should be able to:

• Explain the three limitations to achieving fully efficient markets

• Describe four problems that may prevent arbitrageurs from correcting

anomalies

• Explain why an apparent anomaly may be justified, and describe the common

biases that distort testing for mispricings

• Explain why a mispricing may persist and why valid anomalies may not be

profitable

The practitioner should be able to explain the top-down approach, and its

underlying logic, to the security valuation process.

“Industry Analysis”

The practitioner should be able to describe how structural economic changes (e.g.,

demographics, technology, politics, and regulation) may affect industries.

The practitioner should be able to:

• Classify business cycle stages and identify attractive investment

opportunities for each stage

• Discuss, with respect to global industry analysis, the key elements related to

return expectations

• Describe the industry life cycle and identify an industry’s stage in its life cycle

• Discuss the specific advantages of both the concentration ratio and the

Herfindahl index

• Discuss, with respect to global industry analysis, the elements related to risk,

and describe the basic forces that determine industry competition.

The practitioner should be able to:

• Differentiate between 1) a growth company and a growth stock, 2) a

defensive company and a defensive stock, 3) a cyclical company and a

cyclical stock, 4) a speculative company and a speculative stock, and 5) a

value stock and a growth stock

• Describe and estimate the expected earnings per share (EPS) and earnings

multiplier for a company and use the multiple to make an investment

decision regarding the company

The practitioner should be able to:

• State the various forms of investment returns

• Calculate and interpret the value both of a preferred stock and a common

stock using the dividend discount model (DDM)

• Show how to use the DDM to develop an earnings multiplier model, and

explain the factors in the DDM that affect a stock’s price-to-earnings (P/E)

ratio

• Explain the components of an investor’s required rate of return (i.e., the real

riskfree rate, the expected rate of inflation, and a risk premium) and discuss

the risk factors to be assessed in determining a country risk premium for use

in estimating the required return for foreign securities

• Estimate the implied dividend growth rate, given the components of the

required return on equity and incorporating the earnings retention rate and

current stock price

• Describe a process for developing estimated inputs to be used in the DDM,

including the required rate of return and expected growth rate of dividends

"Introduction to Price Multiples"

The practitioner should be able to:

• Discuss the rationales for, and the possible drawbacks to, the use of price to

earnings (P/E), price to book value (P/BV), price to sales (P/S), and price to

cash flow (P/CF) in equity valuation

• Calculate and interpret P/E, P/BV, P/S, and P/CF

The practitioner should be able to:

• Explain the purposes of a bond’s indenture, and describe affirmative and

negative covenants

• Describe the basic features of a bond, the various coupon rate structures, and

the structure of floating-rate securities

• Define accrued interest, full price, and clean price

• Explain the provisions for redemption and retirement of bonds

• Identify the common options embedded in a bond issue, explain the

importance of embedded options, and state whether such options benefit the

issuer or the bondholder

• Describe methods used by institutional investors in the bond market to

finance the purchase of a security (i.e., margin buying and repurchase

agreements)

The practitioner should be able to:

• Explain the risks associated with investing in bonds

• Identify the relations among a bond’s coupon rate, the yield required by the

market, and the bond’s price relative to par value (i.e., discount, premium, or

equal to par)

• Explain how features of a bond (e.g., maturity, coupon, and embedded

options) and the level of a bond’s yield affect the bond’s interest rate risk

• Identify the relationship among the price of a callable bond, the price of an

option-free bond, and the price of the embedded call option

• Explain the interest rate risk of a floating-rate security and why such a

security’s price may differ from par value

• Compute and interpret the duration and dollar duration of a bond

• Describe yield curve risk and explain why duration does not account for yield

curve risk for a portfolio of bonds

• Explain the disadvantages of a callable or prepayable security to an investor

• Identify the factors that affect the reinvestment risk of a security and explain

why prepayable amortizing securities expose investors to greater

reinvestment risk than nonamortizing securities

• Describe the various forms of credit risk and describe the meaning and role of

credit ratings

• Explain liquidity risk and why it might be important to investors even if they

expect to hold a security to the maturity date

• Describe the exchange rate risk an investor faces when a bond makes

payments in a foreign currency

• Explain inflation risk

• Explain how yield volatility affects the price of a bond with an embedded

option and how changes in volatility affect the value of a callable bond and a

putable bond

• Describe the various forms of event risk

“Overview of Bond Sectors and Instruments”

The practitioner should be able to:

• Describe the features, credit risk characteristics, and distribution methods for

government securities

• Describe the types of securities issued by the U.S. Department of the

Treasury (e.g., bills, notes, bonds, and inflation protection securities), and

differentiate between on-the-run and off-the-run Treasury securities

• Describe how stripped Treasury securities are created and distinguish

between coupon strips and principal strips

• Describe the types and characteristics of securities issued by U.S. federal

agencies

• Describe the types and characteristics of mortgage-backed securities and

explain the cash flow, prepayments, and prepayment risk for each type

• State the motivation for creating a collateralized mortgage obligation

• Describe the types of securities issued by municipalities in the United States,

and distinguish between tax-backed debt and revenue bonds

• Describe the characteristics and motivation for the various types of debt

issued by corporations (including corporate bonds, medium-term notes,

structured notes, commercial paper, negotiable CDs, and bankers

acceptances)

• Define an asset-backed security, describe the role of a special purpose

vehicle in an asset-backed security’s transaction, state the motivation for a

corporation to issue an asset-backed security, and describe the types of

external credit enhancements for asset-backed securities

• Describe collateralized debt obligations

• Describe the mechanisms available for placing bonds in the primary market

and differentiate the primary and secondary markets in bonds

The practitioner should be able to:

• Identify the interest rate policy tools available to a central bank (e.g., the U.S.

Federal Reserve)

• Describe a yield curve and the various shapes of the yield curve

• Explain the basic theories of the term structure of interest rates and describe

the implications of each theory for the shape of the yield curve

• Define a spot rate

• Compute, compare, and contrast the various yield spread measures

• Describe a credit spread and discuss the suggested relation between credit

spreads and the well-being of the economy

• Identify how embedded options affect yield spreads

• Explain how the liquidity or issue-size of a bond affects its yield spread

relative to risk-free securities and relative to other securities

• Compute the after-tax yield of a taxable security and the tax-equivalent yield

of a tax-exempt security

• Define LIBOR and explain its importance to funded investors who borrow

short term

“Monetary Policy in an Environment of Global Financial Markets”

The practitioner should be able to:

• Identify how central bank behavior affects short-term interest rates, systemic

liquidity, and market expectations, thereby affecting financial markets

• Describe the importance of communication between a central bank and the

financial markets

• Discuss the problem of information asymmetry and the importance of

predictability, credibility, and transparency of monetary policy

The practitioner should be able to:

• Explain the steps in the bond valuation process

• Identify the types of bonds for which estimating the expected cash flows is

difficult, and explain the problems encountered when estimating the cash

flows for these bonds

• Compute the value of a bond and the change in value that is attributable to a

change in the discount rate

• Explain how the price of a bond changes as the bond approaches its maturity

date, and compute the change in value that is attributable to the passage of

time

• Compute the value of a zero-coupon bond

• Explain the arbitrage-free valuation approach and the market process that

forces the price of a bond toward its arbitrage-free value, and explain how a

dealer can generate an arbitrage profit if a bond is mispriced

The practitioner should be able to:

• Explain the sources of return from investing in a bond

• Compute and interpret the traditional yield measures for fixed-rate bonds,

and explain their limitations and assumptions

• Explain the importance of reinvestment income in generating the yield

computed at the time of purchase, calculate the amount of income required

to generate that yield, and discuss the factors that affect reinvestment risk

• Compute and interpret the bond equivalent yield of an annual-pay bond and

the annual-pay yield of a semiannual-pay bond

• Describe the methodology for computing the theoretical Treasury spot rate

curve, and compute the value of a bond using spot rates

• Differentiate between the nominal spread, the zero-volatility spread, and the

option-adjusted spread

• Describe how the option-adjusted spread accounts for the option cost in a

bond with an embedded option

• Explain a forward rate, and compute spot rates from forward rates, forward

rates from spot rates, and the value of a bond using forward rates

“Introduction to the Measurement of Interest Rate Risk”

The practitioner should be able to:

• Distinguish between the full valuation approach (the scenario analysis

approach) and the duration/convexity approach for measuring interest rate

risk, and explain the advantage of using the full valuation approach

• Demonstrate the price volatility characteristics for option-free, callable,

prepayable, and putable bonds when interest rates change

• Describe positive convexity, negative convexity, and their relation to bond

price and yield

• Compute and interpret the effective duration of a bond, given information

about how the bond’s price will increase and decrease for given changes in

interest rates, and compute the approximate percentage price change for a

bond, given the bond’s effective duration and a specified change in yield

• Distinguish among the alternative definitions of duration, and explain why

effective duration is the most appropriate measure of interest rate risk for

bonds with embedded options

• Compute the duration of a portfolio, given the duration of the bonds

comprising the portfolio, and explain the limitations of portfolio duration

• Describe the convexity measure of a bond, and estimate a bond’s percentage

price change, given the bond’s duration and convexity and a specified

change in interest rates

• Differentiate between modified convexity and effective convexity

• Compute the price value of a basis point (PVBP), and explain its relationship

to duration

The practitioner should be able to:

• Define a derivative and differentiate between exchange-traded and over-the-

counter derivatives

• Define a forward commitment and a contingent claim, and describe the basic

characteristics of forward contracts, futures contracts, options (calls and

puts), and swaps

• Discuss the purposes and criticisms of derivative markets

• Explain arbitrage and the role it plays in determining prices and promoting

market efficiency

The practitioner should be able to:

• Differentiate between the positions held by the long and short parties to a

forward contract in terms of delivery/settlement and default risk

• Describe the procedures for settling a forward contract at expiration, and

discuss how termination alternatives prior to expiration can affect credit risk

• Differentiate between a dealer and an end user of a forward contract

• Describe the characteristics of equity forward contracts and forward contracts

on zero-coupon and coupon bonds

• Describe the characteristics of the Eurodollar time deposit market, define

LIBOR and Euribor

• Describe the characteristics of forward rate agreements (FRAs)

• Calculate and interpret the payoff of an FRA and explain each of the

component terms

• Describe the characteristics of currency forward contracts

“Futures Markets and Contracts”

The practitioner should be able to:

• Describe the characteristics of futures contracts, and distinguish between

futures contracts and forward contracts

• Differentiate between margin in the securities markets and margin in the

futures markets; and define initial margin, maintenance margin, variation

margin, and settlement price

• Describe price limits and the process of marking to market, and compute and

interpret the margin balance, given the previous day’s balance and the new

change in the futures price

• Describe how a futures contract can be terminated by a close-out (i.e., offset)

at expiration (or prior to expiration), delivery, an equivalent cash settlement,

or an exchange-for-physicals

• Describe the characteristics of the following types of futures contracts:

Eurodollar, Treasury bond, stock index, and currency

The practitioner should be able to:

• Define European option, American option, and moneyness, and differentiate

between exchange-traded options and over-the-counter options

• Identify the types of options in terms of the underlying instruments

• Compare and contrast interest rate options to forward rate agreements

(FRAs)

• Define interest rate caps, floors, and collars

• Compute and interpret option payoffs, and explain how interest rate option

payoffs differ from the payoffs of other types of options

• Define intrinsic value and time value, and explain their relationship

• Determine the minimum and maximum values of European options and

American options

• Calculate and interpret the lowest prices of European and American calls and

puts based on the rules for minimum values and lower bounds

• Explain how option prices are affected by the exercise price and the time to

expiration

• Explain put-call parity for European options, and relate put-call parity to

arbitrage and the construction of synthetic options

• Contrast American options with European options in terms of the lower

bounds on option prices and the possibility of early exercise

• Explain how cash flows on the underlying asset affect put-call parity and the

lower bounds of option prices

• Indicate the directional effect of an interest rate change or volatility change

on an option’s price

The practitioner should be able to:

• Describe the characteristics of swap contracts and explain how swaps are

terminated

• Define and give examples of currency swaps, plain vanilla interest rate

swaps, and equity swaps, and calculate and interpret the payments on each

“Risk Management Applications of Option Strategies”

The practitioner should be able to:

• Determine the value at expiration, profit, maximum profit, maximum loss,

breakeven underlying price at expiration, and general shape of the graph of

the strategies of buying and selling calls and puts, and indicate the market

outlook of investors using these strategies

• Determine the value at expiration, profit, maximum profit, maximum loss,

breakeven underlying price at expiration, and general shape of the graph of a

covered call strategy and a protective put strategy, and explain the risk

management application of each strategy

“Alternative Investments”

The practitioner should be able to:

• Differentiate between an open-end and a closed-end fund, and explain how

net asset value of a fund is calculated and the nature of fees charged by

investment companies

• Distinguish among style, sector, index, global, and stable value strategies in

equity investment and among exchange traded funds (ETFs), traditional

mutual funds, and closed end funds

• Explain the advantages and risks of ETFs

• Describe the forms of real estate investment and explain their characteristics

as an investable asset class

• Describe the various approaches to the valuation of real estate

• Calculate the net operating income (NOI) from a real estate investment, the

value of a property using the sales comparison and income approaches, and

the after-tax cash flows, net present value, and yield of a real estate

investment

• Explain the stages in venture capital investing, venture capital investment

characteristics, and challenges to venture capital valuation and performance

measurement

• Calculate the net present value (NPV) of a venture capital project, given the

project’s possible payoff and conditional failure probabilities

• Discuss the descriptive accuracy of the term “hedge fund,” define hedge fund

in terms of objectives, legal structure, and fee structure, and describe the

various classifications of hedge funds

• Explain the benefits and drawbacks to fund of funds investing

• Discuss the leverage and unique risks of hedge funds

• Discuss the performance of hedge funds, the biases present in hedge fund

performance measurement, and explain the effect of survivorship bias on the

reported return and risk measures for a hedge fund database

• Explain how the legal environment affects the valuation of closely held

companies

• Describe alternative valuation methods for closely held companies and

distinguish among the bases for the discounts and premiums for these

companies

• Discuss distressed securities investing and compare venture capital investing

with distressed securities investing

• Discuss the role of commodities as a vehicle for investing in production and

consumption

• Explain the motivation for investing in commodities, commodities derivatives,

and commodity-linked securities

• Discuss the sources of return on a collateralized commodity futures position

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