Table Of Content

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ETHICAL AND PROFESSIONAL STANDARDS, QUANTITATIVE METHODS, AND ECONOMICS CFA® Program Curriculum 2018 • LEVEL II • VOLUME 1 CONTENTS How to Use the CFA Program Curriculum ix Curriculum Development Process ix Organization of the Curriculum x Features of the Curriculum x Designing Your Personal Study Program xii Feedback xiii Ethical and Professional Standards Study Session 1 Ethical and Professional Standards 3 Reading 1 Code of Ethics and Standards of Professional Conduct 5 Preface 5 Evolution of the CFA Institute Code of Ethics and Standards of Professional Conduct 6 Standards of Practice Handbook 6 Summary of Changes in the Eleventh Edition 7 CFA Institute Professional Conduct Program 9 Adoption of the Code and Standards 10 Acknowledgments 10 Ethics and the Investment Industry 11 Why Ethics Matters 11 CFA Institute Code of Ethics and Standards of Professional Conduct 15 Preamble 15 The Code of Ethics 15 Standards of Professional Conduct 16 Reading 2 Guidance for Standards I–VII 21 Standard I: Professionalism 21 Standard I(A) Knowledge of the Law 21 Guidance 21 Recommended Procedures for Compliance 26 Application of the Standard 27 Standard I(B) Independence and Objectivity 30 Guidance 30 Recommended Procedures for Compliance 35 Application of the Standard 36 Standard I(C) Misrepresentation 43 Guidance 43 Recommended Procedures for Compliance 46 Application of the Standard 48 Standard I(D) Misconduct 53 Guidance 53 Recommended Procedures for Compliance 54 Application of the Standard 54 indicates an optional segment ii Contents Standard II: Integrity of Capital Markets 56 Standard II(A) Material Nonpublic Information 56 Guidance 56 Recommended Procedures for Compliance 60 Application of the Standard 63 Standard II(B) Market Manipulation 68 Guidance 68 Application of the Standard 69 Standard III: Duties to Clients 73 Standard III(A) Loyalty, Prudence, and Care 73 Guidance 73 Recommended Procedures for Compliance 77 Application of the Standard 78 Standard III(B) Fair Dealing 82 Guidance 82 Recommended Procedures for Compliance 84 Application of the Standard 86 Standard III(C) Suitability 90 Guidance 90 Recommended Procedures for Compliance 93 Application of the Standard 94 Standard III(D) Performance Presentation 97 Guidance 97 Recommended Procedures for Compliance 98 Application of the Standard 98 Standard III(E) Preservation of Confidentiality 101 Guidance 101 Recommended Procedures for Compliance 103 Application of the Standard 103 Standard IV: Duties to Employers 105 Standard IV(A) Loyalty 105 Guidance 105 Recommended Procedures for Compliance 109 Application of the Standard 109 Standard IV(B) Additional Compensation Arrangements 116 Guidance 116 Recommended Procedures for Compliance 116 Application of the Standard 116 Standard IV(C) Responsibilities of Supervisors 118 Guidance 118 Recommended Procedures for Compliance 120 Application of the Standard 122 Standard V: Investment Analysis, Recommendations, and Actions 126 Standard V(A) Diligence and Reasonable Basis 126 Guidance 126 Recommended Procedures for Compliance 130 Application of the Standard 130 Standard V(B) Communication with Clients and Prospective Clients 137 Guidance 138 indicates an optional segment Contents iii Recommended Procedures for Compliance 140 Application of the Standard 141 Standard V(C) Record Retention 146 Guidance 146 Recommended Procedures for Compliance 147 Application of the Standard 148 Standard VI: Conflicts of Interest 149 Standard VI(A) Disclosure of Conflicts 149 Guidance 149 Recommended Procedures for Compliance 152 Application of the Standard 152 Standard VI(B) Priority of Transactions 157 Guidance 157 Recommended Procedures for Compliance 158 Application of the Standard 160 Standard VI(C) Referral Fees 162 Guidance 162 Recommended Procedures for Compliance 162 Application of the Standard 162 Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate 165 Standard VII(A) Conduct as Participants in CFA Institute Programs 165 Guidance 165 Application of the Standard 167 Standard VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program 170 Guidance 170 Recommended Procedures for Compliance 174 Application of the Standard 174 Practice Problems 177 Solutions 196 Reading 3 CFA Institute Research Objectivity Standards 209 Guiding Principles 209 Comparison with the New York Stock Exchange and National Association of Securities Dealers Rules 210 Overview of the CFA Institute Research Objectivity Standards 210 Definitions 211 Investment Banks, Broker- Dealers and Other Firms That Sell Research 213 Requirements 213 Recommended Procedures for Compliance 215 Practice Problems 222 Solutions 224 Study Session 2 Ethical and Professional Standards: Application 225 Reading 4 The Glenarm Company 227 Case Facts 227 Sherman’s Background 227 Glenarm 228 indicates an optional segment iv Contents The Transition 228 Case Discussion 229 Loyalty to One’s Employer 229 Disclosure of Additional Compensation and Conflicts 230 Reading 5 Preston Partners 233 Case Facts 233 Case Discussion 235 Responsibilities to Clients and Interactions with Clients 235 Allocation of Trades 236 Responsibilities of Supervisors 237 Reading 6 Super Selection 239 Case Facts 239 Case Discussion 240 Responsibilities of Supervisors 241 Employees and the Employer/Supervisor 241 Reasonable Basis 242 Duties to Clients 242 Investment Recommendations and Actions 243 Priority of Transactions 243 Reading 7 Trade Allocation: Fair Dealing and Disclosure 245 Reading 8 Changing Investment Objectives 249 Quantitative Methods Study Session 3 Quantitative Methods for Valuation 253 Reading 9 Correlation and Regression 255 Introduction 256 Correlation Analysis 256 Scatter Plots 256 Correlation Analysis 257 Calculating and Interpreting the Correlation Coefficient 260 Limitations of Correlation Analysis 262 Uses of Correlation Analysis 265 Testing the Significance of the Correlation Coefficient 274 Linear Regression 277 Linear Regression with One Independent Variable 278 Assumptions of the Linear Regression Model 281 The Standard Error of Estimate 284 The Coefficient of Determination 287 Hypothesis Testing 289 Analysis of Variance in a Regression with One Independent Variable 297 Prediction Intervals 300 Limitations of Regression Analysis 303 indicates an optional segment Contents v Summary 303 Practice Problems 306 Solutions 315 Reading 10 Multiple Regression and Issues in Regression Analysis 319 Introduction 320 Multiple Linear Regression 320 Assumptions of the Multiple Linear Regression Model 326 Predicting the Dependent Variable in a Multiple Regression Model 331 Testing whether All Population Regression Coefficients Equal Zero 333 Adjusted R2 335 Using Dummy Variables in Regressions 336 Violations of Regression Assumptions 340 Heteroskedasticity 341 Serial Correlation 347 Multicollinearity 351 Heteroskedasticity, Serial Correlation, Multicollinearity: Summarizing the Issues 354 Model Specification and Errors in Specification 355 Principles of Model Specification 355 Misspecified Functional Form 356 Time- Series Misspecification (Independent Variables Correlated with Errors) 365 Other Types of Time- Series Misspecification 368 Models with Qualitative Dependent Variables 368 Summary 371 Practice Problems 375 Solutions 400 Reading 11 Time- Series Analysis 411 Introduction to Time- Series Analysis 412 Challenges of Working with Time Series 414 Trend Models 415 Linear Trend Models 415 Log- Linear Trend Models 418 Trend Models and Testing for Correlated Errors 424 Autoregressive (AR) Time- Series Models 425 Covariance- Stationary Series 426 Detecting Serially Correlated Errors in an Autoregressive Model 427 Mean Reversion 430 Multiperiod Forecasts and the Chain Rule of Forecasting 431 Comparing Forecast Model Performance 434 Instability of Regression Coefficients 436 Random Walks and Unit Roots 439 Random Walks 439 The Unit Root Test of Nonstationarity 443 Moving- Average Time- Series Models 447 Smoothing Past Values with an n-Period Moving Average 448 Moving- Average Time- Series Models for Forecasting 450 indicates an optional segment vi Contents Seasonality in Time- Series Models 452 Autoregressive Moving- Average Models 458 Autoregressive Conditional Heteroskedasticity Models 459 Regressions with More than One Time Series 462 Other Issues in Time Series 466 Suggested Steps in Time- Series Forecasting 467 Summary 468 Practice Problems 471 Solutions 487 Reading 12 Excerpt from “Probabilistic Approaches: Scenario Analysis, Decision Trees, and Simulations” 495 Introduction 495 Simulations 496 Steps in Simulation 496 An Example of a Simulation 499 Use in Decision Making 502 Simulations with Constraints 503 Issues 504 Risk- Adjusted Value and Simulations 505 An Overall Assessment of Probabilistic Risk Assessment Approaches 506 Comparing the Approaches 506 Complement or Replacement for Risk- Adjusted Value 507 In Practice 508 Conclusion 509 Economics Study Session 4 Economics for Valuation 513 Reading 13 Currency Exchange Rates: Understanding Equilibrium Value 515 Introduction 516 Foreign Exchange Market Concepts 516 Arbitrage Constraints on Spot Exchange Rate Quotes 520 Forward Markets 524 The Mark- to- Market Value of a Forward Contract 528 A Long- Term Framework for Exchange Rates 532 International Parity Conditions 533 The Carry Trade 548 The Impact of Balance of Payments Flows 551 Current Account Imbalances and the Determination of Exchange Rates 552 Capital Flows and the Determination of Exchange Rates 555 Monetary and Fiscal Policies 561 The Mundell–Fleming Model 561 Monetary Models of Exchange Rate Determination 563 The Portfolio Balance Approach 566 Exchange Rate Management: Intervention and Controls 569 Warning Signs of a Currency Crisis 572 indicates an optional segment