Study Strategies Level 3

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This section will focus on exam preparation for Level 3 specifically, for general preparation, please visit the General Exam Prep area.

The largest change for Level 3 is the format and content, is is a three hour essay section followed by a three hour multiple choice section.

Prep Providers[edit]

Materials become available once the previous years exams results have been released. With the registration fee, an eBook along with an online study resource including study resources, a large question bank, and mock exams. The eBook may be purchased in print for an additional $150. For the 6 topics covered there are 16 study sessions across 38 readings containing 2,564 pages of study content. 300 hours is the recommended study duration, but ultimately it will depend on each individuals own pace.

The candidate survey has insights on which providers past candidates have favored.

Topic Area[edit]

This section is populated with formulas and concepts that are significant, or frequently occurring, in the curriculum for their respective topic area. Additionally, other useful study recommendations are located here.

Ethics[edit]

Essay summary needed

Standard of Professional Conduct

Standard Substandard Key points
Standard I - Professionalism I A - Knowledge of Law Comply with local Laws, if Local law is less strict use CFAI Codes and Standards (C/S), if Local law is stricter than CFAI C/S follow the stricter law/set of rules.
I B - Independence and Objectivity Must maintain independence and objectivity in mind and appearance. Recall soft dollars
I C - Misrepresentation Untrue statements or Omissions, false or misleading statements, guarantees about investment performance must be avoided unless with caveats, plagiarism must be avoided.
I D - Misconduct Covers acts of dishonesty, fraud, deceit or any action that reflects adversely on professional reputation.
Standard II - Integrity of Capital Market II A - Material Non Public Information Must not act or cause others to act on Material Non Public Information. Can make a recommendation with the inclusion of non-public information, so long as it in non-material and combined with a sum of other information that is the use of non-material, non-public information Mosaic Theory. Example - you saw two CEOs having lunch, not overheard them or snoop on them, just by chance and based on this deduced. However it may not be objective to rely on this fact alone.
II B - Market Manipulation Avoid practices that distort prices or artificially inflate trading volume with intent to mislead market participants
Standard III - Duties of Clients III A - Loyalty, Prudence and care
  • Fiduciary duty is owed to the ultimate beneficiary, example - duty to pensioners and not the pension fund trustees
  • Duty to act with reasonable care and exercise prudent judgement.
  • Investment decisions should be in context of entire portfolio, for Level 3 only, think about the wealth perspective Financial capital + human capital.
III B - Fair Dealing
  • Fair does not mean equal. Recommendations should be sent to all clients as close to simultaneously as possible, subject to client interest and suitability.
  • Clients who submit orders prior to issue of changed recommendation must be informed of change before accepting order.
  • Oversubscribed issues should be awarded on pro rata basis.
III C - Suitability
  • Ensure a written IPS incorporating client's risk tolerance, return objectives and investment constraints.
  • Refuse trades that are not within agreed upon guidelines.
  • Ensure investments are consistent with the clients objectives and constraints before making the investment.
  • Index funds or mandate specific (rule based) funds must be managed to their mandate, it is not manager's responsibility to determine suitability of investors needs of participating investors.
III D - Performance Presentation Encourages adherence to GIPS which are voluntary, prohibits misrepresentation of past performance.
III E - Preservation of Confidentiality
  • Consult employer or third party counsel when unsure of action
  • members must disclose information if required by legal authority or CFAI for their investigation or when client requests/permits disclosure.
Standard IV - Duties to Employer IV A - Loyalty
  • Interest of Client is above Interest of employer.
  • May engage in competitive activities with prior {written} permission of employer
  • May make preparations for leaving employer during out of office hours while still employed, must not misappropriate company property.
  • May not take any records, files, or other company property when your contract is terminated with an employer. Reconstruction by memory is allowed, if done on your own time and using your own resources.
IV B - Additional Compensation
  • Must not accept gifts, compensation that may create conflict of interest with employer's interest.
  • Must get written consent from all parties (employer and third-party) before taking additional compensation that cold create a conflict with your employer.
IV C - Responsibilities of Supervisor Must make reasonable effort to detect and prevent violations of laws and code and standards by anyone subject to your supervision. You are responsible for violations by subordinates under your supervision.
Standard V - Investment Analysis, Recommendations and Action (IARA)(for simplicity) V A - Diligence and Reasonable Basis
  • Have a reasonable and adequate basis supported by research for any IARA
  • May rely on employer/firm approved 3rd party research
  • If disagree with team decision, document dissenting opinion
V B - Communication with Clients and Prospective clients
  • All changes to decision making process, investment strategies or portfolio must be communicated.
  • must provide clients with facts, limitations, assumptions of analysis
  • Clearly distinguish fact from opinion
V C - Record Retention CFAI suggests maintaining records for atleast 7 years
Standard VI - Conflicts of Interest VI A - Disclosure of Conflicts
  • Type of conflicts include - directorship, investment banking relationship, personal/corporate ownership, influence in company decisions.
  • Conflict of Interest in appearance only also requires disclosure. Disclose all conflicts of interests to employer and clients
VI B - Priority of Transactions
  • Client (incl. Family accounts which are client accounts) → employer → Self
  • Family members not living in your household (and paying the appropriate fee) should be treated fairly as clients. Those living with you are considered related-parties and should be treated as yourself.
VI C - Referral Fees Disclosure required for all considerations, performance bonus, soft dollars, flat fees whether in cash or kind.
Standard VII - responsibilities of members and candidates VII A - Conduct as Members and Candidates in CFA Program
  • Avoid action that would undermine public confidence in achivement of CFA Designation
  • Standard does not prohibit anyone from voicing dissenting opinion about CFAI policies or procedures
  • Does not prohibit personal political dissident behaviour (protest, legal action, bankruptcy) either as long as it is not breaking point 1
VII B - Reference to CFA Institute, CFA Designation and CFA Program Oh boy
  • CFA Designation is a trademark, cannot use it as a noun (example - "I am a CFA" is wrong usage, "I am a CFA Charterholder", is correct)
  • Do not predict your completion of CFA course professionally
  • Do not discuss CFA Exam questions or topics, can express opinion (as in I found exam difficult)
  • Cannot imply or state that being a CFA Charterholder gives an ability to provide superior performance (however true that may be)

Institutional IPS[edit]

Quantitative methods summary and recommendations needed

Formula / Concept Name Formula / Explanation Comments


Asset Allocation[edit]

Covers methods and guidance for allocating Investor's assets into broad asset classes such as debt, equity, real estate, etc,

Formula / Concept Name Formula / Explanation Comments
Methods of Rebalancing
  • Calendar Based
  • Range or corridor approach
    • Fixed Range
    • Proportionate range
    • Cost-Benefit Based range
Considerations for rebalancing
  • Transaction cost
  • Tax status
  • Risk aversion
  • correlation with other asset classes
  • Volatility of asset class
  • Analyst expectations and forecasts.
Economic Balance Sheet Wealth = Human Capital + Financial Capital. Understand that there are extended assets and liabilities that are non financial or non current but must be considered.
AA Approaches
  • Asset Only Approach
    • As name suggests, focuses on assets only, liabilities are ignored, goal is to get maximum return possible ignoring cash outflow needs.
  • Liability Relative Approach (LRA)
    • It is like ALM in Fixed income, asset classes are chosen with objective of funding liabilities,
    • Liability hedging, Surplus MVO, etc
  • Goal based Approach (GBA)
    • while LRA is mostly for Institutional clients, for individuals, we use Goal based approach,
    • Here the asset allocation is done for sub portfolios which are built to meet an individual goal, such as portfolio 1 for college fund, portfolio 2 for health cost, portfolio 3 for pure capital appreciation.
Differentiation between LRA and GBA
  • Liabilities of Institutions are legal and certain, goals are flexible and costs are generally not entirely certain.
  • Liabilities are generally uniform, goals may just be one off expense
  • Liabilities such as pension payments are subject to law of large numbers, duration, averaging can be used. Not for goals.
Greer Framework
  • Capital Asset - Source of value and income
  • Transformable Asset
  • Store of Value assets
  • Interest and dividend
  • Consumables
  • Bullion
Criteria for forming an asset class
  • Assets within an asset class should be homogeneous
  • Asset class should be mutually exclusive,
  • Asset classes should be diversifying
  • Asset class should cover a large investable wealth,
  • Asset class should have capacity to absorb meaningful portion of investor's portfolio
  • All equity can be 1 class, no mixing of equity and reits into one,
  • cannot have IG and HY as 2 classes, one Fixed income class
  • Check for correlation between A1, A2, A3
  • Cover as much as possible
  • There should be enough constituents, example, no point in allocating 10% of a $1bn portfolio to an asset class which only has $5m worth of assets worldwide
Risk Factors systematic risk factors (Inflation, volatility), they can affect multiple asset classes and such should be considered in portfolio construction recommended to use Risk Factor based asset allocation
Formula / Concept Name Formula / Explanation Comments

Economics[edit]

Economics summary and recommendations needed

Formula / Concept Name Formula / Explanation Comments


Corporate Finance[edit]

Corporate Finance summary and recommendations needed

Formula / Concept Name Formula / Explanation Comments


Equity Investments[edit]

Equity investment summary and recommendations needed

Formula / Concept Name Formula / Explanation Comments

Fixed Income[edit]

Introduction to Fixed Income Portfolio Management

Formula / Concept Name Formula / Explanation Comments
Role of Fixed Income in Portfolio
  • Diversification
  • Inflation Hedge
  • Regular Cash inflow
  • Low correlation with equity
  • TIPS can provide complete Inflation hedge, Floating rate bond can provide partial inflation hedge
  • Helps with Asset and Liability Matching
Benchmarking
  • Asset and Liability Matching
  • Index Benchmarked
  • Matching portfolio cash flows to meet liabilities
  • beat benchmark
Cash Flow Matching If you are unable to grasp cash flow matching, L3 isnt for you Important points to consider
  • Default risk, option risk,
  • Re-balancing may be required practically leading to liquidity risk
Duration Matching Bond Investment in a way that DurL = DurA and amount invested is PVL = PVA Is good for a one time small parallel shift in the yield curve, for large changes include convexity, if non parallel, include Key Rate Duration
Other ALM Strategies
  • Contingent Immunisation - an extra surplus amount used over Duration or cash flow matching.
  • Horizon matching - Short term Liabilities met with cash flow matching, long term via duration matching.
Important to consider which strategy has higher risk, expected return, initial investment
Bond Portfolio Return Decomposition Exp(r) for a bond Portfolio ignoring Taxes (but remember investor is concerned with after tax return) Yield Income + Roll down yield + Exp (Δ Price) based on forecast of yield & yield spread - Exp (Credit loss) ± Exp (Gain/loss from currency fluctuations)
Leverage rl = ru + (ru - i) (D / E) Leverage from Structured Finance Products, Bond Futures, Swaps, Repo agreements, Security borrowing

Liability Driven & Index based Strategies

Both are Passive Fixed Income porfrtolio management strategies. Reading shows ways to build portfolio to meet liabilities whose amount or timing may or may not be known. Focus on Immunisation of liabilities (single and multiple with calculations) w.r.t. flat or non flat yield curve. Methods are the ones discussed in earlier reading (Cash flow, duration matching etc). Liability Driven Strategy is explained via a Pension fund example, read it from the book (CFAI or Prep provider).

Formula / Concept Name Formula / Explanation Comments
Using Derivative contracts to re-balance duration matching No. of Bond Futures Contracts = (BPVL - BPVA) / BPVF BPVF = BPVCTD / Conversion factor
Risks in Liability driven Investing
  • Model Risk
    • Risks in assumptions, liability forecasts, use of CTD etc
  • Structural Risk
    • Cash Flow yield of Assets wont change as per YTM of ZCB
  • Spread Risk
  • Liquidity Risk
  • Convexity
Index Based Strategies
  • Pure Indexing
  • Enhanced Indexing
  • Active Portfolio management
  • Full replica of index, almost impossible, Russell index has 16000 constituents, most illiquid. (note - bond market is largely OTC)
  • Stratification, like with S&P500 indexed fund will not actually invest in all 500 companies, but close enough. Idea is to keep low tracking error while maintaining return if not improve it.
  • YOLO, super risky and high tracking error.
Special notes on Enhanced Indexing. To ensure Primary risk characteristics of target index, Portfolio Durations such as Key Rate, or Modified Duration are matched. Based on the duration and risk factors, sector and quality (ratings) of index is matched/considered as well as Issuer exposure.
Synthetic exposure to Fixed Income Mutual Funds, ETC or Derivatives (Russel futures) or Return Swaps
Benchmark Selection considerations Very Complex process to get the right benchmark,
  • Index keeps changing with issues getting repaid
  • Market value changes with changes in credit quality
  • If no new addition, duration of an index will fall constantly.
Consider following criteria for benchmark selection
  • Unambiguous
  • Measurable
  • Possibility of replicating index/benchmark.
Laddered Portfolios Consider scenarios where the following types can be suitable
  • Bullet
  • Laddered
  • Barbell
  • Single maturity
  • Roughly equal amounts at different maturities (say annual or quarterly)
  • Equal investment in Short term and Long term maturities, such that duration remains same.

Yield Curve Strategies

Either Yield curve will change or remain unchanged.

Formula / Concept Name Formula / Explanation Comments
For unchanged yield curve
  • Buy and Hold
  • Ride the Yield curve
  • Carry Trade
  • currency Swap
  • Sell Convexity
  • Use Option bond or MBS
  • Selling put increases portfolio duration, selling call reduces it and so on.
For Change in Yield curve (Parallel shift or steepening)
  • Duration Adjustment
  • Convexity Adjustment
  • Barbell vs Bullet vs Ladder

Credit Strategies

This reading talks about construction of credit portfolios, considering quality of issuer, spreads, approaches and various risks to be considered.

  • Credit risk is important for High Yield (HY) Portfolio managers, for Investment Grade (IG) interest rate risk, spread risk and credit quality (issuer quality) risk.
  • Spread Duration is measure of risk in IG bond portfolio. Risk free rate and Credit Spreads are negatively correlated, so spread duration over-estimates Interest rate risk.
  • HY are less liquid than IG
    • More return volatility
    • Smaller Inventory of HY than IG in OTC market
    • HY market size is smaller.

Formula / Concept Name Formula / Explanation Comments

Derivatives[edit]

Derivatives summary and recommendations needed

Analyst Prep Essential Review


Formula / Concept Name Formula / Explanation Comments

Alternative Investments[edit]

Alternatives summary and recommendations needed

300 hours summary

Formula / Concept Name Formula / Explanation Comments


Portfolio Management[edit]

Portfolio Management summary and recommendations needed

Formula / Concept Name Formula / Explanation Comments

Performance Presentation[edit]

Popular Mnemonics[edit]

Many Mnemonics may be found in the Wiki Mnemonic. Below are some selected by candidates as being particularly helpful


Emotions are for L O S E R S: Emotional bias types

Loss Aversion, Overconfidence, Self Control, Endowment, Regret Aversion, Status Quo

All other biases are cognitive

Topic Area: Behavioral Finance


Grinold Kroner DIGS PE: Grinold and Kroner Model formula

Dividend Yield + Inflation + Growth - Shares + PE Ratio

Topic Area: Economics

References[edit]