The Chartered Financial Analyst (CFA) is one of the more frequently sought after designations for investment professionals. However, becoming a CFA charter holder is not for the faint-hearted nor the uninterested. The journey to becoming a CFA charter holder is long, and it tests not only your knowledge of the subject, but also your endurance, diligence, and will. According to the CFA Institute, the current program is best described as a self-study, distance-learning program that takes a generalist approach to investment analysis, valuation and portfolio management, and emphasizes the highest ethical and professional standards.
The CFA program consists of three exams: CFA Level I, Level II and Level III. As a CFA candidate, you are required to pass each of these exams and you must meet certain work requirements as set out by the CFA Institute. In December 2017, the passing rate for the Level I exam was 43%.
The curriculum for each of these three levels is designed to test you on a broad array of skills considered to be most relevant for investment professions. In this article, we will focus on the CFA Level I exam.
The exam is a six-hour exam, broken into a morning and afternoon session, each being three hours long. The exam consists of 240 multiple-choice questions: 120 questions in the morning session and 120 questions in the afternoon session. You should allow approximately 90 seconds per question, depending on how well you know the topics. All of the multiple-choice questions are free-standing (i.e., they are not dependent on each other). For each question, there are three possible choices provided. The questions are crafted intelligently, such that the incorrect choices reflect common mistakes in calculation or logic. So, you have to be very careful while selecting the right choice. Aim to answer all questions, as there is no penalty for incorrect answers. Additionally, become comfortable with your calculator and its functions, as its features will be needed to complete some of the questions.
The exam focuses on basic knowledge and comprehension of tools and concepts of investment valuation and portfolio management. The curriculum consists of 10 topics that are grouped into four areas, specifically: ethical and professional standards, investment tools, asset classes, and portfolio management and wealth planning.
The following table provides the weights of these topics and broad areas for the Level I exam.
|Topic Area||Level I|
|Ethical and Professional Standards (total)||15|
|Investment Tools (total)||50|
|Financial Reporting and Analysis||20|
|Asset Classes (total)||30|
|Portfolio Management and Wealth Planning (total)||7|
Let's take a brief look at each of these 10 topics.
Ethics and Professional Standards
This section covers the code of ethics, professional standards and the Global Investment Performance Standards (GIPS). This is a very important section and you will be asked approximately 36 questions on the subject. The Institute itself takes this section very seriously. If you score low or close to the minimum passing score on all other topics, then your score on ethics could determine whether you pass or fail. One advantage of studying ethics well is that it also helps with your Level II and III exam preparation.
While ethics is more scenario-oriented and easy to follow, this section could be intimidating for some students. You don't need a Ph.D. in mathematics to do well in quants, but having a stats background will certainly be helpful. You can expect around 28 to 30 questions related to quants. The topics covered are geared toward providing you the knowledge of analytical tools that are essential for material on fixed income, equities and portfolio management. The key topics covered are time value of money, performance measurement, statistics and probability basics, sampling and hypothesis testing and correlation and linear regression analysis.
The economics section tests your knowledge on basic micro and macroeconomic concepts. If you studied economics in college, then you will find this material very familiar. Without a background in economics, this material can be challenging, especially macroeconomics, which employs the use of graphs and x and y curves to illustrate concepts related to the economy. Economics comprises 10% of the syllabus.
Financial Reporting and Analysis
This is probably the largest section on the exam, with 20% of the questions being on this topic. Reporting and analysis are also weighted about the same for the Level II course, so it's important to spend enough time studying this area to build a solid foundation for subsequent exams. You will be asked to interpret the three financial statements (balance sheet, income statement and cash flow statement), know the ratios and many other advanced concepts such as revenue recognition, inventory analysis, long-term assets, and taxes. Since the exam is a global exam, it does not cover local accounting practices. The focus is more on widely accepted standards such as U.S. GAAP and IFRS.
After financial reporting and analysis comes corporate finance. This is a short section with only a 7% weight. The key topics include agency problems related to agency-principal relationship, capital budgeting, cost of capital, leverage and working capital management.
The Level I exam only introduces you to the basics of portfolio management. The important concepts are Modern Portfolio Theory and the Capital Asset Pricing Model. There will be about 17 questions in this section. This section acts as a preparation for Levels II and III, where the focus is more on the application of all your knowledge on portfolio management.
You can expect about 10% of questions to be on equities. The curriculum for equities covers equity markets and instruments, and tools and techniques for valuing companies. The majority of the questions will be focused on valuing and analyzing companies.
After equities, the exam deals with fixed income markets and its instruments. You are required to understand the characteristics of various fixed income securities and how to price them. Some important concepts are the yield measures and duration and convexity. This section also discusses structured products such as mortgage-backed securities and collateralized mortgage obligations, among others. Fixed Income comprises 10% of the exam.
Similar to portfolio management, derivatives are only introduced in Level I. You will be tested on the basics of futures, forwards, swaps, options and hedging techniques using these derivatives. This section only has a 5% weightage, that's about 12 questions.
This section focuses on alternative investments including real estate, private equity, venture capital, hedge funds, closely held companies, distressed securities and commodities. There will be about seven to eight questions from this section and will be more conceptual in nature. There is special consideration to commodity investments, so get familiar with concepts such as backwardation and contango.
The Bottom Line
Overall, the CFA Level I exam is well-balanced, with a wide spectrum of topics. Some topics may require proportionally more time to study than others; however, what's important is to plan your studies and stay with the plan.