All CFA Institute members and candidates are

required to comply with the Code and Standards

The CFA Institute Bylaws
Basic structure for enforcing
primary principles Fair process to member and candidate
the Code and Standards
Based on two
Rules of Procedure Confidentiality of proceedings

Maintains oversight and responsibility

The CFA Institute Is responsible for the
Board of Governors enforcement of the
Through the Disciplinary
Professional Conduct Review Committee (DRC) Code and Standards
Structure of the CFA program (PCP)
Institute Professional Conducts professional
The CFA Designated
Conduct Program conduct inquiries
Officer Directs professional conduct staff

An inquiry can be prompted
by several circumstances
a.
Selfdisclosure
Written complaints
Evidence of misconduct
Report by a CFA exam proctor

Requesting a written explanation

1. Code Of Ethics And
Standards Of
Professional Conduct
Process for the enforcement
of the Code and Standards
The Professional
Conduct staff conducts
an investigation that
may include
When an
inquiry is
initiated
Upon reviewing the
material obtained during
the investigation, the
Designated Officer may
from the member or candidate
The member or candidate
Interviewing Complaining parties
Third parties
Collecting documents and records in support of its investigation
Conclude the inquiry with no disciplinary sanction
Issue a cautionary letter
If finding that a violation of
the Code and Standards
occurred, the Designated Accepted by member
Officer proposes a The matter is referred to a
Continue proceedings
disciplinary sanction hearing by a panel of CFA
to discipline the
member or candidate Rejected by member Institute members

Act with integrity, competence, diligence,

respect and in an ethical manner
Integrity of investment profession &
interest of clients above personal interest

Six components of Care & judgment

the Code of Ethics Practice ethics & encourage others to practice
Integrity & rules of capital markets
Professional competence
b,c.
Professionalism
Integrity of Capital markets
Duties of Clients
Duties to Employers
Seven Standards of
Professional Conduct Investment analysis, Recommendations & Actions
Conflict of interest
Responsibilities as a CFA Institute
member or CFA Candidate

1. Code Of Ethics And Standards Of Professional Conduct - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate
 Understand and comply with
applicable laws and regulations

Code and Standards vs. Local law Follow stricter law and regulation

Responsible for violations in which they

knowingly participate or assist
Dissociate from illegal,
unethical activities Leave employers (in extreme case)

Attempt to stop the behavior by bringing it to the attention of

Guidance employer through a supervisor or compliance department
Participation or association
May consider directly confronting
with violations by others
Intermediate steps the involved individuals
If not successful,--> step away and Removing their name from written reports
dissociate from the activity by
Asking for a different assignment

A. Knowledge Inaction with continued association may be construed as knowing participation

of the law Not required reporting violations to government, CFAI,
but advisable in some cases or required by laws in others

Stay informed
Review procedures
Members and Maintain current files
candidates
When in doubt, seek advice of
compliance personnel or legal counsel
When dissociating from violations, --> Document
Recommended any violations and urge firms to stop them
procedures for
compliance (RPC) Develop and/or adopt a code of ethics
Make available to employees info that
Firms highlights applicable laws and regulations
Establish written procedures for reporting suspected
violation of laws, regulations or company policies
Application

Maintain independence and

objectivity in professional activities
Gifts, Invitations to lavish
functions, Tickets, Favors, Job referrals,
By benefits Allocation of shares in oversubscribed IPOs...
External
pressures
From public companies To issue favorable reports

From Buyside clients May try to pressure sellside analysts

From their e.g. to issue favorable research reports/

own firms recommendations for certain companies
Internal
pressures to issue favorable research on current or
Investmentbanking prospective investmentbanking clients
How to cope with external and
relationships
internal pressures Conflicts of interest

Modest gifts and entertainment are

acceptable but special care must be taken must disclose to employers

Best practice: reject any offer of gifts,

threatening independence and objectivity
Guidance
convey true opinions
--> free of bias from pressures
Recommendations must
be stated in clear
B. Independence and unambiguous language
and objectivity Portfolio managers must respect and
foster honesty of sellside research

Is fraught with conflicts

2.1 Standard I Must engage in thorough,
PROFESSIONALISM independent, and unbiased analysis
Must fully disclose potential conflicts,
including the nature of compensation
Issuerpaid research Must strictly limit the type of compensation
Analysts they accept for conducting research
Accept only flat fee for their
work prior to writing the report
Best practice Without regard to conclusions
or recommendations

Protect integrity of opinions

Create a restricted list
Restrict special cost arrangements
Limit gifts
Equity IPOs
RPC Restrict employee investments
Private placements
Review procedures
Written policies on independence
and objectivity of research

Definition of any untrue statement or omission of a fact

"Misrepresentation"
or any false or misleading statement

Must not knowingly make

oral representations, advertising
misrepresentation or give
false impression in electronic communications
written materials

qualifications or credentials, services

performance record
Must not misrepresent Without regard to conclusions or
Guidance any aspect of practice, including recommendations
characteristics of an investment
any misrepresentation relating to
C. Misrepresentation member's professional activities
Must not guarantee clients specific return
on investments that are inherently volatile
Standard I(C) prohibits plagiarism in preparation
of material for distribution to employers, associates,
clients, prospects, general publish

Written list of available services, description of firm's qualification

Designate employees to speak on behalf of firm
Prepare summary of qualifications and experience,
list of services capable of performing
RPC
Maintain copies
To avoid plagiarism Attribute quotations
Attribute summaries

Address conduct related to professional life

Any act involving lying, cheating, stealing, other dishonest conduct that
reflects adversely on member's professional activities would be violation
Conduct damaging trustworthiness or competence (include behaviour may
not be illegal but negatively affect a member to perform responsibility such
Guidance as abusing alcohol during lunch hours)
Violations
D. Misconduct Abuse of the CFA Institute Professional Conduct Program
Involved in personal bankruptcy is not automatically assumed to be in violation but
bankruptcy involve fraudulent or deceitful business conduct may be a violation

Develop and/or adopt a code of ethics

Disseminate to all employee a list of potential violations
RPC
Check references of potential employees

2.1 Standard I PROFESSIONALISM - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate

Definition of "Material
nonpublic information"
its significant impact to the price
of security if it is disclosed
Reasonable investors would like
Material information
to know for making decision
The reliability of the information

disseminated to the market place and

Non-public until
effficient time for investors to react

Must be particularly aware of info

Guidance selectively disclosed by corporations
Analysis of Public info + nonmaterial
nonpublic info --> Investment conclusion
Mosaic Analysts are free to act on this collection
Theory of info without risking violation
Analysts should save and
A. Material non-public document all their research
information (MNI)
Make reasonable efforts to achieve
public dissemination of material info
Must communicate the info only to the designated
If public dissemination supervisory and compliance personnel within the firm
is not possible,
Must not take investment action on the basis of the info
Must not knowingly engage in conduct
2.2 Standard II inducing insiders to privately disclose MNI
INTEGRITY OF RPC
adopt compliance procedures
CAPITAL MARKETS preventing misuse of MNI
develop & follow disclosure policies
Encourage firms to
to ensure proper dissemination
use "firewall"
Prohibition of all proprietary trading while firm
is in possession of MNI may be inappropriate

Distort prices or artificially inflate trading volume

with the intent to mislead market participants
Definition
Transactions that artificially
distort prices or volume
transactions that deceive
market participants Securing a controlling, dominant position in a
financial instrument to exploit and manipulate
B. Market price of a related derivative/or underlying asset
manipulation can be related to
dissemination of false including spreading false rumors
or misleading info to induce trading by others

prohibit legitimate trading strategies

Standard II(B) not meant to prohibit transactions done for tax purposes
The intent of action is critical to determining
whether it is a violation of this Standard

2.2 Standard II INTEGRITY OF CAPITAL MARKETS - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate
 The financial markets and
investment management industry
are becoming increasingly global
a1. Why were the GIPS Standards created?
Only investment management firms
that actually manage assets
a2. Who can claim compliance?
Note: GIPS standards are printed in their Prospect clients and investment
entirety in the readings, but the Level I management firms
candidate is required only to know the a3. Who benefit from Compliance?
Fundamentals and Compliance material through the end of Section II.0
Consistency of input data is critical to "Fundamental of Compliance." A composite is an aggregation of discretionary
effective compliance with GIPS and portfolios into a single group that represents a
establish a foundation for full, fair and particular investment objectives or strategy
comparable performance presentations
Input data A composite must include all actual, fee-paying
discretionary portfolios managed in accordance
Uniformity in methods used to with the same investment objective or strategy
calculate returns to achieve
comparability among firms Introduction to Global Composites must include new portfolios on a
Calculation methodology Investment Performance timely and consistent basis after the portfolio
b. Construction & purpose of Composites comes under management
composite return is the Standards (GIPS)
asset-weighted average of all the Firms may set minimum asset levels for inclusion in
portfolios' performance results a portfolio, but changes to a composite-specific
Composite construction minimum asset level are not permitted retroactively.
allow firms to elaborate on the raw Terminated portfolios must be included in the
numbers and give the end user the historical returns of appropriate composites
proper context to understand
No "negative assurance" is needed increase the level of confidence that a firm claiming
Disclosures Major sections of
for non-applicable disclosures GIPS compliance did adhere to GIPS
Presentation and reporting
GIPS standards Improve a firm's internal policies and procedures with
Real estate regard to all aspects of complying with the GIPS standards.

Refers to investments in non-public Firms are encouraged but not required

companies that are in various stages of to undertake the verification process
development and venture investing, c. Verification
A single verification report is issued for the entire firm.
buyout investing and mezzanie financing
Private equity Verification cannot be carried out for a single composite
Firms that have been verified are encouraged to add a disclosure to composite presentations or
Wrap fees are a type of bundle fee and are advertisements stating they have been verified: "[name of firm] has been verified for the periods
specific to a particular investment product [insert dates] by [name of verifier]. A copy of the verification report is available upon request."
is charged by a wrap fee sponsor for investment
management services and included trading
expenses that cannot be separately identified To obtain global acceptance of calculation and presentation
standards in a fair, comparable format with full disclosure
can be all-inclusive, asset-based fees and may include Wrap Fee/ Separately Managed
a combination of investment management fees, trading To ensure consistence, accurate investment performance data
Account (SMA) portfolios.
expenses, custody fees and/or administration fees
3+4 GIPS GIPS Objectives To promote fair competition among investment management firms
A wrap fee portfolio is sometimes
referred to as a "separately managed To promote global "self regulation"
account (SMA) or "managed account"
To claim GIPS, investment management
firms must define its "firm"
Comply with local law or
Require Firms to include all actual fee paying,
regulation conflicts with GIPS discretionary portfolios in composites defined
How are GIPS standards
Make full disclosure of the conflict according to similar strategy/investment objectives
implemented in countries
Note: this differs from Standards of If local/country specific law or Rely on integrity of input data
Professional Conduct in which the
with existing standards Key characteristics
regulation conflicts with GIPS If an investment firm applies GIPS in a performance situation that is
stricter of local laws or Standards of for performance reporting not addressed specifically by GIPS/ is open to interpretation,
Professional Conduct prevails disclosures other than those required by GIPS may be necessary
GIPS do not address every aspect of performance
measurement, valuation, attribution or cover all asset classes
Firms from any country may come into compliance with GIPS
Compliance cannot be achieved on a
GIPS must be applied on the firm-wide basis. Firm must be defined as an investment
single product, portfolio, or composite
firm, subsidiary, or division held out to clients as a distinct business entity Firms must meet full
Total firm assets must be the aggregate of the market value of Investment firm definition compliance to claim GIPS
all discretionary and non-discretionary assets under management. Key features of the The effective date of the revised Standards is 1 Jan 2011.
This includes both fee-paying and non-fee-paying assets GIPS standards & Presentations that include performance results for periods after 31
Firms must initially show GIPS compliant history for a minimum of 5 years, or fundamentals of Dec. 2005 must meet all the requirements of the revised GIPS.
Performance presentations that include results through 31 Dec. 2005
since inception if the firm has been in existence for less than 5 years. compliance maybe prepared in compliance with the 1999 version of GIPS.
After 5-year compliant history has been achieved, firms must Effective date
add an additional year of performance each year until The scope of the GIPS
10-year performance record is established, at a minimum Firms must document, in writing, their polices and
procedures used in establishing and maintaining
only GIPS compliant performance is
compliance with all requirements of GIPS
presented for periods after 1 Jan. 2000;
and A firm may link non-GIPS Documents policies and procedures
compliant performance to its Historical performance record
Firm discloses non-compliance period Once a firm has meet all the required requirements of GIPS , use this
compliant history as long as
and explain how it is not in compliance statement to declare: "[Insert name of firm] has prepared and presented this
with GIPS report in compliance with the Global Investment Performance Standards (GIPS)."

Firms previously claiming compliance with an Investment Performance If not meet all the requirements, cannot state:"...in compliance with GIPS except for..."
Council-endorsed Country Version of GIPS are granted reciprocity to Statements referring to the calculation methodology used in a composite
claim compliance with GIPS for historical periods prior to 1 Jan. 2006 presentation as being "in accordance [or compliance] with the Global
Claims of compliance Investment Performance Standards" are prohibited .
Statements referring to the performance of a single, existing client as being "calculated in
accordance with the Global Investment Performance Standards" are prohibited except when a
GIPS complaint firm reports the performance of an individual account to the existing client

provide a compliant presentation to all prospect clients, cannot

choose to whom they want to present compliant performance
must list discontinued composites on
Firm fundamental provide a complete list and description of all of the firms' the firms' list of composites for at
responsibilities composites to any client that makes such a request least 5 years after discontinuation

3+4 GIPS - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate

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 to solve many types of time
value of money problems
Find PMT
Find N
Loan payment
Find I/Y and Amortization
Amortization table
Rate of compound growth
Number of periods for specific growth
Other applications
Funding a future obligation
the sum of the present values of the cash Rows is the present value of the
series. The sum of the future values (at some future time = n) of a series of
cash flows is the future value of that series of cash flows.
The cash flow additivity principle refers to the fact that present value of any Connection between
stream of cash flows equals the sum of the present values of the cash flows PV, FV & series of CF
equilibrium interest rate for a
particular investment
Required rate of return
a. Interest rate,
for calculating the present value of
considered as
future cash flows
Discount rate
f1. Use time line Opportunity cost
real risk-free rate is a theoretical
rate on a single-period loan when
there is no expectation of inflation.
Nominal risk-free rate = real risk-free rate
+ expected inflation rate
a borrower will not make the promised
default risk payments in timely manner

b. Interest rate
receiving less than fair value if an
5. TIME VALUE liquidity risk investment must be sold for cash quickly
Future value Several risks of securities
OF MONEY
Longer-term bonds have more risk
Present value maturity risk than shorter-term bonds

FV of Annuity Due = FV of Ordinary
Annuity x (1+ I/Y)
PV of Annuity Due = PV of Ordinary
Annuity x (1+ I/Y)
a series of equal cash flows that occurs
at evenly spaced intervals over time.
occur at the en d of each time period. Ordinary Annuity
occur at the beg inning of each time period. Annuity Due
PV of a Perpetuity
Discount each individual cash flows
Use CF function in Calculator
-->The required rate of return on a security = real risk-free rate + expected inflation rate
+ default risk premium + liquidity premium + maturity risk premium
represents the annual rate of return actually being earned after
adjustments have been made for different compounding periods
Annuity e. CF calculations
Where:
Periodic rate = stated annual rate/m
m = the number of compounding periods per year
c,d. EAR
divide the stated annual interest rate by the number of compounding
periods per year, m, and multiply the number of years by the number
of compounding periods per year
Non-annual time value of
money problems
Uneven CF

5. TIME VALUE OF MONEY - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate
 the PV of the cash flows less the initial (time = 0) outlay
where:
CFt = the expected net cash flow at time t
N = the estimated life of the investment
r = the discount rare (opportunity cosr of capital)

NPV
Accept projec ts with a positive NPV

Convert among these yields Reject projects with a negative NPV

Decision rules
Two mutually exclusive projects:
accept higher positive NPV

is the discount rate that make the

NPV of a project equal to zero

1. Based on face value, not price Different project size: the smaller projects may have
Calculate,
2. Use 360-day higher IRR but their contribution to the firm value
Not much meaningful Interpret, Conflict with may be smaller compared to the larger projects
3. Use simple interest, ignore Decision rule NPV due to
reinvestment of interest Differen timing of cash flows

Multiple IRR or No IRR When CFA pattern is unconventional

Problems
IRR IRR method: project cash flows are
Bank discount yield assumed to reinvest at IRR while with NPV
Where:
r BD = the annualized yield on a bank discount basis it is assumed to reinvest at market rate
D = the dollar discount, which is equal to the difference
6. DISCOUNTED Unrealistic assumptions
--> at the bottom lines: use NPV
between the face value of the bill and the purchase price CASH FLOW
F = the face value (par value) of the bill APPLICATIONS Accept projects with an IRR > the firm's
t = number of days remaining until maturity (investor's) required rate of return.
360 = bank convention of number of days in a year Decision rules Reject projects with an IRR < the firm's
(investor's) required rate of return.
Yields of T-bills For single project, IRR and NPV
lead to exactly the same decision
Where:
Po = initial price of the the instrument Holding period yield is the percentage change in an
P1 = price received for instrument at maturity HPR investment over the period of holding
D1 = interest payment (distribution)

defined as the IRR

More appropriate if manager has
Effective annual yield Money Weighted
complete control over cash in/out

rMM = HPY x (360/t) measures compound growth

Money market yield
Portfolio Not affected by cash in/out
BEY = 2 x semi annual discount rate rate of return Preferred method
Bond equivalent yield Value the investment immediately after
Time weighted
any withdrawals or deposits, divide the
(chain-link)
overall investment horizon into subperiods
3 steps Calculate HPR for each subpediod
Compute the geometric mean

6. DISCOUNTED CASH FLOW APPLICATIONS - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate

Excess kurtosis = sample kurtosis - 3
Leptokurtic: more peaked, fatter tails
(excess kurtosis > 0) --> more risk
Platykurtic: less peaked (excess kurtosis < 0)
Mesokurtic: identical (excess kurtosis = 0)
Symmetrical
mean=median=mode
the frequency of experiencing
losses and gains are the same
No nsymmetrical (Skewness)
Positively skewed (Sk>0) Types
(because of outliers)
Negatively skewed (Sk<0)
--> more risk
CV (Coefficient of Variation)
Negative Sharpe ratio
Limitations Sharpe Ratio / Reward-to-Variability ratio
Not suitable with asymmetric return distribution
For any distribution with finite variance, the
percentage of observations lie within k standard
deviation of the mean is at least 1-1/(k^2)
36%: +/-1.25k
56%: +/-1.50k
75%: +/-2k
89%: +/-3k
94%: +/-4k
Easy to compute
affected by extreme value
Range = Max - Min
no info on how data is distributed
better than range
less sophisticated than Var and Sd
Population
Variance & Standard deviation
Sample
Semivariance and
semideviation
7. Statistical Concepts and Market Rerurns - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate
Statistics is used to refer to
data and to the methods we
use to analyze date
to summarized the important
Descriptive statistics characteristics of large data sets
Statistical methods
pertain to the procedures used to
make forecasts, estimates, or
Inferential statistics judgement about a large set of data
A population is defined as the set of all
possible members of a stated group Population parameters
Sample statistics
A sample is defined as a subset of mean (measures of central tendency)
Population vs. Sample the populations of interest which addresses return
a. The most frequently concerned Var (measures of variation around
Calculate center) which addresses risk
l. Kurtosis Classify or count observations with no
Nominal scales particular or ranking
Compared with
Specified characteristics are used to
normal distribution
categorize observations band involve ranking
Ordinal scales
no information on the difference among categories
Like ordinal scales + the differences
Types of measurement scales between scale values are equal -> scale
values can be added and subtracted
Interval scales cannot build meaningful ratios
No true zero point
Provide ranking, equal differences
between scale values and true zero point
Ratio scales
A parameter is a measure used to
describe a characteristic of a population
A sample statistic is used to
Parameter vs. Sample statistic
measure a characteristic of a sample
A tabular presentation of statistical data
b. that aids the analysis of large data sets
Definition
j,k. Shape of distribution
1. Define interval
Frequency distribution Construction of a
3 steps 2. Tally the observations
frequency distribution
3. Count the observations and then calculate
Absolute frequency
calculated by dividing the absolute
frequency of each return interval by
the total number of observations.
Relative frequency
c. summing the absolute frequencies starting at the
Cumulative absolute lowest interval and progressing through the highest.
frequency
summing the relative frequencies starting at the
7. Statistical Concepts
lowest interval and progressing through the highest.
and Market Returns Cumulative relative frequency
bar chart
Histogram
d.
line chart
i. Relative dispersion Frequency polygon
Population mean
Sample mean
h. Chebyshev's inequality the measure of central tendency
for w hich the sum of the deviations
from the mean is zero
Arithmetic mean
Weighted mean
Mean (portfolio return)
(compound growth)
Geometric mean
e. Measures of (return data set)
central tendency Use of arithmetic or geometric mean
when determining investment returns
Harmonic mean
g. Dispersion
(cost of shares)
(measure of risk)
Harmonic < geometric < arithmetic
value of middle item in a set of sorted items
Median not affected by extreme value but
more difficult to find out
No mode
Unimodal, bimodal, trimodal
--> the only measure can be
used with nominal scale
Mode
Model interval -->
for continuous distribution
value at or below which a portion of the data distribution lies
into quarters
Quartiles
into fifths
f. Quantile Quintile
into tenths
Decile
Ly =(n+1) xy/100
Percentile (100)
To be continued…
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 F.Stm
Element Additional disclosures required by regulatory
Any commentary by management

FR Financial position
Useful to a wide range of users in
Role of FR Firm's performance making economic decisions
Roles of FR & FSA
Changes in financial position

> To evaluate past, current, and prospective

Use info in a company's Fin Statements performance & fin position
Roles of FSA Use other relevant info > To make economic decisions

Revenues
Expenses
Income Statement
Gains and Losses

Assets
Liabilities
Role of key FS Balance Sheet (A=L+OE)
Owners' equity

CFO
CFI
CF statement
CFF
Statement of changes in Owners' equity

disclose the basis of preparation for FS

(e.g: accounting methods, assumptions,...)
acquisitions or disposals
legal actions
employee benefit plans
Additional items: contingencies and commitments
FS notes (footnotes)
significant customers
sales to related parties
segments of firm
are audited

not audited
operating income or sales by region
or business segments
Supplementary schedules reserves for an oil and gas company
info about hedging activities and
financial instruments
Importance of
assessment of financial performance and condition of a
company from the perspective of its management
22. FSA Results from operations, with trends
Introduction in sales and expenses
Publicly held companies in US Capital resources and liquidity, with trends in CF
General business overview
discuss accounting policies that require
significant judgements by management
discuss significant effects of trends, events, uncertainties
MD&A
liquidity and capital resource issues, transactions
or events with liquidity implications
Discontinued operations, extraordinary
items, unusual or infrequent events
Extensive disclosures in interim financial statements
disclosure of a segment's need for CF
or its contribution to revenues or profit

= independent review of an entity's FS

objective: auditor's opinion on fairness
and reliability of FS, "no material errors"
Independent review though FS prepared by mgmt and are its responsibility
3 parts Reasonable assurance of no material errors (follow generally accepted auditing standards)
FS prepared in accordance with accepted accounting principles, reasonable accounting principles and estimates, consistency
Explanatory paragraph: when a material loss is probable but
d. Audits of FS
amount cannot be reasonably estimated. Uncertainties
may relate to the going concern assumption --> signal serious
Standard auditor's opinion problems and need close examination by analyst
(under US GAAP): Opinion on internal controls
Unqualified opinion: auditor believes statements are free from material omissions and errors
3 types of Opinions Qualified opinion: if statements make any exceptions to accounting principles --> explain these exceptions
Adverse opinion: if statements are not presented fairly or are materially nonconforming with accounting standards

Interim reports Quarterly or semi- reports (NOT audited)

About election of board members, compensation, management and qualifications

Other info sources and issuance of stock options
Proxy statements Filed with SEC

Corporate reports and press releases Viewed as PR or sales materials

1. Articulate the Purpose & Context of analysis

2. Collect data
3. Process data
FSA framework
4. Analyze/interpret data
5. Report the conclusions or recommendations
6. Update the analysis

22. FSA Introduction - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate
 Operating activity: activities that are part of the day-to-day business function of an entity
Classification Investing activity: activities associated with acquisition & disposal of long-term asset
Financing activity: activities related to obtaining or repaying capital from shareholders or creditors

Assets
Liabilities
Elements Equity
Revenue
FS elements
& accounts Expense

Account & financial Chart of accounts : set forth the actual accounts used in a company's accounting system
Accounts
statement Contra account: offset or deducted from other accounts

Liabilities
Assets Contributed capital
Accounting equation Owners' equity
Retained earning

23. Financial reporting Expanding: A = L + Contributed capital + BGN Retained earnings + Rev - Exp - Dividend
mechanics
Unearned (Deffered) revenue
Cash movement prior to Acct. recognition
Prepaid expense
Accruals & Valuation
Accruals Unbilled (Accrued) revenue (when billing, Un.Rev decrease & Receivables increase)
adjustment Cash movement after Acct. recognition
Accrued expense
Valuation adjustment: made to company's A or L so that account records current market value (not Historical cost)

1. Journal entries & Adjusting entries (record=time)

2. General ledger & T-accounts (record=order)
Accounting system Flow of information 3. Trial balance (list account balances at a particular point in time)
4. Fin. statement
Debit & Credit

Using fin. statement Analyst uses FS to judge the fin. health of the company
in security analysis Analyst can use his understanding to detect misrepresentation

23. Financial reporting mechanics - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate
 Objective of FR: provide fin. info about the reporting entity
Overview FRS
Importance of reporting standards in security analysis and valuation

IASB (International Accounting Standards Board)

Standard-setting bodies
(establishing standards) US FASB (Financial Accounting Standards Board)

IOSCO (international): not a regulatory, but its members regulate significant portion
Standard setting &
Regulatory bodies FSA (in UK)
Regulatory authorities 1. Protect investors
(enforcing standards) SEC (in USA) 2. Ensure: market is fair, efficient, transparent
3. Reduce systematic risk

Status of global convergence of accounting standards

standard setting bodies
c. disagree
regulatory authorities
Barriers to developing one universally accepted set of financial reporting standards
political pressures from business groups and others

Understandability
Verifiability
Relevance
Enhancing Comparability (consistent among firms and time periods)
Qualitative Faithful presentation
characteristics (complete, neutral, free from error) Timeliness

Trade off across Enhancing characteristics (reliability and relevance: timely)

Cost
Constraints
Non-quantifiable info: omitted

of Financial position: A, L, E
Measurements
of performance: Income, Expense
IFRS framework
Accrual basis
Assumptions
Going concern

Cost can be reliable measured

Recognition principal
Probably future economic benefit will flow to entity
Elements of FS
Historical cost : amount originally paid for the asset
Current cost : would have to pay today for the same asset
Measurement bases Realizable value: amount for which firm could sell the asset
Present value : discounted future cash flows
Fair value : 2 parties in an arm's length transaction would exchange the asset

BS, IS, CFS, OE, Explanatory notes (inclu. accounting policies)

Required financial statements

Fair presentation
24. Financial Going concern basis
Reporting Standards Accrual basis
General requirements Aggregation
for FS under IFRS
No offsetting
Principles for PREPARING
Consistency
Materiality
Comparative information
Frequency of reporting

IASB requires mgmt to consider the

framework if no explicit standard exists
Purpose of framework

IASB same objective

Objectives of financial statements FASB different objectives for biz and non-biz

IASB emphasizes going concern

Assumptions
FASB: relevance, reliability
Primary characteristics
Qualitative characteristics IASB: comparability, understandability also

IFRS (by IASB) #

IASB: income+expenses
US GAAP (by FASB)
Performance FASB: Revenues, Expenses, Gains,
Losses, comprehensive income

IASB: resource from which future

economic benefit is expected
Asset definition
FASB: future economic benefit
Financial statement elements
IASB: define criteria for recognition
"Probable"
FASB: define assets and liabilities

Values of assets to be IASB: allow

adjusted upward
FASB: not allow

Transparency
Characteristics of a coherent Comprehensiveness
financial reporting framework Consistency

Valuation
IFRS
Principles-based
Effective FR relies on broad framework

FASB in the past

Barriers to creating a coherent Standard setting Rules-based
financial reporting framework specific guidance how to classify trx

FASB moving now

Objectives oriented
blend the other two
Measurement

24. Financial Reporting Standards - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate
 Def: represent Financial performance
Expense (ordinary)
Expenses
Loss (Invest, Finance)

Overview IS Elements Revenues (ordinary)

Income
Gain (Invest, Finance)

Multi-steps (include: Gross Profit)

Formats Single-step

Accrual accounting
1. seller can collect the price
IASB 2. evidence of transfer ownership
3. cost can be reliably measured
General principles Revenue recognition 1. evidence of arrangement btw buyer and seller
2. product delivered or service rendered
SEC
3. price is determined or determinable
4. seller reasonably sure of collecting money

%-of-completion method (reliably measures outcome)

1. Long term contracts US GAAP: no income 'til completing
Completed-contract method
IFRS: rev=exp (profit=0)

Revenue includes:
1. Sale price: at the date of sales
Revenue recognition IFRS 2. Interest income: recognise over time

2. Installment sales
Installment method: recognise profit according to cash receipt in relation to selling price
US GAAP Cost recovery: no profit 'til cash receipt > cost
Sale basis:

Special cases 1. Revenue: is based on FV of a non-barter transaction with unrelated parties

IFRS 2. Other cases: no revenue; net off Rev & Exp
3. Barter transactions
(no cash changes)
1. Rev: record if a company has transaction with cash payment for such services
US GAAP 2. Otherwise, Rev=Carrying amount of asset surrendered

Uses Gross Rev when:

1. Primary obligator
4. Gross revenue reporting 2. Bear inventory & credit risk
(vs. net revenue reporting) 3. Ability to choose supplier
US GAAP 4. Reasonable latitude to establish prices

Inventories

Matching principle Depreciation

(report expense when have Rev) Long-lived assets Depletion
Amortization
General Bad debt, warranty expenses estimation

25. Understanding
The Income Statement
Period costs
Expense recognition (not directly related to Rev) Admin cost
Doubtful accounts: estimated cost (expense, not directly reduce Rev)
Warranties:
1. When sell: estimated cost
Issue 2. When repair: actual cost
SLM
Depreciation & amortisation
Accelerated depreciation (residual value is NOT used to calculate)

Company disposes of 1 of its component & operation

1. Discontinued operations Condition: separate physically & operationally
Implication: should remove from IS for analyzed

FR treatment & analysis of
IFRS: prohibit
2. Extraordinary items Unusual in nature + infrequent in frequency
US GAAP
Non-recurring Report separately on IS
non-operating items
3. Unusual or infrequent items IFRS + US GAAP: report above IN from continuing operations

Change in accounting principle

4. Changes in accounting standards Change in accounting estimate
Prior-period adjustment

Operating components
Distinguish
Nonoperating components

Simple
Capital structure Complex

NI Pref ered dividend

Basic EPS= Weighted average number of common shares outstanding

Formula:
Basic EPS

Stock split + stock dividend

EPS
Affected by New issuance
Treasury stock

Common shares
Preferred shares/convertible
Complex capital structure
Convertible bond
Stock option
Diluted EPS
Diluted EPS > Basic EPS => Anti-dilutive: don't calculate Diluted EPS
Treasury stock method
Method
If-converted method (preferred convertible; convertible bond)

Common size analysis of IS: convert items in IS into % of total Rev

Others Analysis of IS

25. Understanding The Income Statement - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate
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 Corporations
Sovereign national government
Non-sovereign Gov
Bond issuer
Quasi-government entity
Supranational entity

Time remaining til maturity: Term To Maturity

Maturity date Bonds have no maturity: Perpetual Bonds
Basic features
Price>Par: Premium Bond
Par value Price<Par: Discount Bond

Fix counpon rate: Plain Vanilla Bond

Coupon rate Have no coupon: Zero-counpon Bond

Dual-currency bond
Payment currency Currency option bond

Negative covernant (prohibition from Borrower)

Indenture
Affirmative covernant (promission from Borrower)

E.g: a bond issued by a Chinese firm that is

denominated in Yen & traded outside Japan
Bearer bond (adv: avoid tax)
Eurobonds 2 forms
Register bond

Special Purpose Entity (SPE): also

called bankruptcy remote vehicle
Issuing entities
Sources of repayment
Secured Bond (backed by specific assets)
Types
Unsecured Bond (represent a claim)

Overcollateralization (collateral has a greater value than Par)

Internal Excess spread (yield on the fin. A is greater than bond yield)
52. F.I securities:
Tranches
Defining elements Collateral & Credit enhancement
Credit enhancement Surety bond (issued by insurance companies & promise to
make up shortfall in the cash available to service the debt)

External Bank guarantee (same)

Letter of credit (a promise to lend money to the issuing entity)

Municipal bond (exempt fr. national+issuing state income tax)

Taxation of Bond Income Capital gain (taxed at a lower rate than ordinary income)

Factors affecting Bullet structure Ballon pmt: the final installment of a loan that is larger than regular installment
issuance & trading
Sinking fund provisison
of F.I Amortizing
Accelerated sinking fund provision

Floating-Rate note (cap & floor; collar)

Step-up coupon bond
Credit-linked coupon bond
Payment-in-kind (PIK)
CF of fixed-income structure
Deferred coupon bond
Types of bond
Capital-indexed bond
Indexed-annuity bond Principal protected bond: not pay less than
Inflation-indexed Par even when the index has decreased
Index-linked bond Indexed zero-coupon bond
Interest-indexed bond

Equity-linked notes

American style: can be called anytime after 1st call

European style: only be called at specified call date
Benefit issuer Call option
Bermuda style

Contingency provision
Put option
Benefit bondholder Convertible bond + Contingent Convertible Bond
Warrants

52. F.I securities. Defining elements - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate
 Type of issuer
Credit quality
Original maturities
Global markets Coupon structure
classification Currency denomination
Geography
Indexing
Tax status

Reference rate in Most used : LIBOR

floating-rate debt

1. Determining funding needs

Mechanism for issuing
bonds in primary market
2. Structuring the debt security
3. Creating the bond indenture
4. Naming a bond trustee
5. Registering the issue with securities regulators
6. Assessing demand & pricing the bonds given market conditions
Underwritten offering (purchase & sell)
Best effort offering
7. Selling the bonds
Auction

Def: the trading of previously trading bond

Gov. Bond: T+1
Secondary markets for bonds
Corporate Bond: T+3
Settlement time
Some money market securities: T+0
53. F.I markets:
Issuance, Trading &
Fixed-rate
Funding Backed by the Taxing Power of government
Floating-rate
Sovereign bonds
Inflation-indexed bond
Securities issued
by some entities Tax-backed debt
Nonsovereign government bonds Revenue bond
Agency bonds (issued by those created by national governments for specific purposes)
Supranational bonds (e.g: IMF, WB, ADB...)

Bank debt
Difficulties:
1. Deterioration in a company's actual
When mature: "Rolled over" 2. Significant systemic financial distress
Types of debt issued
Commercial paper
by corporation US: %discount from FV
Quoted price EU: add-on yield

Corporate bond
Medium-term Note (not necessarily medium-term) *

Customer deposits
Short-term funding
Certificates of deposit
alternatives available to
Interbank fund
banks
Central bank fund market

Higher, the longer the repo term

Lower, the higher the credit quality of the collateral security
Repo Repo rate Lower when the collateral security is delivered to the lender
Higher when the interest rates for alternative sources of funds are higher

53. F.I markets. Issuance, Trading & Funding - CFA Mind Map Level 1 - 2014 - Copyright by BL KAte
 Its return is based on another
instrument (underlying assets)
Physical
Definition
Finance The biggest trading volume
Underlying assets
Event

Organized market -> liquid

Buy an asset at one price Standard terms
Concurrently sell it at higher price Exchange No default risk
Arbitrage
-> Riskless profit without investment Arbitrage & the law of one price Daily settlement
Where derivatives are traded?
NO arbitrage opportunities exist private between 2 parties -> illiquid
The law of one price Customized terms
OTC default risk & legal risk
Difficult to understand
Complex at the end of the contract: settlement
Criticism
Zero-sum game
Legal gambling 57. Overview of Firm and binding agreement -> obligation
derivatives Forward commitment No premium paid up front
Information about underlying price Characteristics
The long has the flexibility -> options
Price discovery
Contingent claims Premium is paid up front by the long
Control risk
Risk management
Purposes of derivatives market Exchange, OTC, Forward commitment
Mispriced -> adjust quickly -> Forwards
market efficiency
Market efficiency Exchange, Forward commitment
Futures
Low tnx cost
Trading efficiency Exchange, OTC, Contingent Claims
Options
Types of derivatives OTC, Forward commitments
Swaps
a contract that provides a bondholder
(lender) with protection against a
downgrade or a default by the borrower
Credit default swap (CDS) -> most common
Credit derivatives Types
Credit spread option

57. Overview of derivatives - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate
 Euro dollar: USD deposit outside USA
LIBOR: Eurodollar market rate
in Frankfurt
by European Central Bank Euribor: Euro lending rate
Underlying: interest rate/payment

Definition
FRA (Forward
rate agreement)

No money is paid upfront (t=0)

58. Forward Forward commitment 2 parties are obligated to execute the tnx (T)
contract
Private agreement
Illiquid
Characteristics
rate increases -> long benefits Customized terms
rate decreases -> short benefits OTC Credit risk/default risk exists
Settlement at the end of the
Coupon payment
contract (time T)
Bond forward expires before bond matures
Special features: callable, Banking/non banking institutions
convertible
Bond forward Bond forward Take a risk from an end user/dealer and
zero coupon: discounted rate pass it on to another end user/dealer
Price vs stock forward Dealer
coupon: yield to maturity default risk related to bond
make profit on the bid/ask spread
Participants
Corporate/NGO/Government
dividend payment
Stock forward To hedge out the risk of an existing position
Expires at any time end-user
Reduce/mitigate the risk

Equity/index
Bond
Interest (FRA) Types
Currency
Commodity

58. Forward contract - CFA Mind Map Level 1 - 2014 - Copyright by BL Kate
To be continued…
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