Not Treading Lightly

For a chronological index of my path to the CFA, click here.

I’m plowing through Volume II and learning a lot about economics (currently on page 91 of 488). Haven’t had to pull out the calculator much in Volume II as, except for computing elasticity, the economics readings haven’t really required much math so far.

I must say I’m a bit surprised at the language used for the economics sections. Maybe I should first back up a step and say that the last chapter of Volume I, Technical Analysis, was worded in a “careful” manner. Though investment companies employ teams of technical analysts no one seems to be able to prove conclusively whether they earn their keep or not!

So the language in the TA chapter was never “when price drops below the 50-day moving average, this indicates…”, but rather “when price drops below the 50-day moving average, technicians believe that this indicates…”. Reminded me of wording used in comparative religion textbooks. No one’s right and no one’s wrong.

Surprisingly though, the economics volume so far has touched on a number of issues that are highly political and, some would say, subjective – but the readings often do actually take a side as to who they think is right.

Back to Work!
Dog-eat-Dog Good for Business & Social Interest! – Vol.II

Now there is a short blurb on the top of page 49 that acknowledges there are differing opinions on these subjects, so my brain was all set to read sentences starting with “some economists believe…”

But instead we get:

    “Taxing people’s income from employment makes them work less.” – pg. 50

    “A dollar taken from a rich person does not end up as a dollar in the hands of a poorer person.” – pg. 51

    “…taxpayers hire accountants, auditors, and lawyers to help them ensure that they pay the correct amount of taxes. These activities use skilled labor and capital resources that could otherwise be used to produce goods and services that people value.” – pg. 51 (Ouch!)

    Discussing reallocation of scarce resources, “It is fair that she should help… She owns the water. But it is not fair that she should be compelled to help.” – pg. 53

    “Buyers and sellers acting in their self-interest end up promoting the social interest.” – pg. 57

    “The bottom line is that in principle and in practice, rent ceilings are inefficient and unfair. They prevent the housing market from operating in the social interest.” – pg. 66

    “The minimum wage frustrates the market mechanism and results in unemployment – wasted labor resources – and an inefficient amount of job search.” – pg. 69

    “So despite Congress’s desire to split the Social Security tax equally between workers and employers, the burden of this tax falls mainly on workers.” – pg. 75

And we have similar wording in the subsidies and quotas sections pointing toward how they create inefficient & unnatural shortages and surpluses.

One cool tidbit is that these readings actually give some sort of framework with which to answer the age-old debates about (a) whether a government should increase or decrease taxes to increase government revenue and (b) who pays the burden of a tax increase. As is obvious (now), it all depends on elasticity of supply and demand. So the answer varies depending upon the good or service being taxed, but if you have the data to compute a product’s elasticity, you can answer the question for a given case!

And the section on drug laws is very interesting. One can reduce drug consumption in two ways: (1) make drugs illegal or (2) legalize them but tax them heavily. The book makes an interesting point that while the heavy tax option tends to also create a black market, at least the government is generating some revenue to fund the policing of the tax code. Smart!

You could almost draw the conclusion – at least from what I’ve reported so far – that Volume II was written solely by Libertarians or even anarchists! And that the message is that whenever the government interferes with the free market in an effort to make things more fair, it ends up doing more harm than good.

That’s not really true though. The study guide also targets monopolies as barriers to fairness & efficiency as well as external costs and external benefits. It states that “competitive markets would produce too small a quantity of public goods” because of free-riders (pg. 47) and that competitive markets generally lead to the overuse of resources that nobody owns (like fish in the ocean).

So no particular belief system appears to have cornered the market on truth in CFA world, but I’d guess that Socialists wouldn’t particularly enjoy these readings. There are some intelligent arguments presented concerning the benefits of redistribution of wealth (maximizing happiness, since a poor person values a received dollar more than the rich person who loses it) but a strong rebuttal follows most of these.

First the CFA program improved my engineering skillset and now with my newly-acquired economic theory and political talking points, a 2008 presidential bid just might be within reach.

Knowledge is indeed power. Vote for Lumilog! 🙂

15 thoughts on “Not Treading Lightly”

  1. Hey,

    No surprise there. The authors of these books are the same people who recite passages from Milton Freedman’s Freedom, Liberty and Capitalism, and most notably Adam Smith’s Invisible hand, day in and day out. By the end of this book, you’ll probably be talking like a supply sider about how lower tax rates increase revenues and free markets benefit the poor. By the end of the CFA you will be a strong advocate of NAFTA and FDI deregulation. All to say, that the CFA curriculum doesn’t whish only to educate individuals on finance but to turn them into ferocious capitalists with strong business acumen and unbridle greed for the pursuit of profit.
    Quite different from electrical engineering J

    Nice blog!

  2. Hey, thanks for the head’s up Pablo!

    Yes in engineering world the optimum solution to many problems can be mathematically formulated in an airtight fashion. And the only reason NOT to choose the optimum solution in a particular situation is if its complexity and/or cost of implementation is too high.

    Very interesting to enter this nebulous world of investing where everything is not so cut-and-dried, perhaps because an influential variable here is the wild card of human psychology.

    Will purchase bib to control capitalist foaming-at-the-mouth brought on by later chapters!

    – Lumilog

  3. The problem with finance is that it has no theory of its own. Maybe stochastic calculus comes closest but it is sometimes as good as guessing. And what makes it even more difficult is that you cant carryout controlled experiments because you only have one historical path in time. As you say things are not so cut-and-dried, which reminds me of a professor who once told me that the signal-to-noise ratio in finance is very very low. Note: I still havent forgotten your question about lag in NNs. Maybe this weekend!

  4. aiQuant! Nice to hear from you. Wow that senfinance site looks like the motherload. Thank you so much! Downloading the first lecture right now…

    Love the signal-to-noise analogy. You’ve been posting some very interesting stuff on your blog recently. Makes me want to fire up Matlab and dust off the old neural nets and genetic algorithms. Do you do this stuff for a living?

    One frustrating hurdle I’d run into with my trading models was survivorship bias since I only use free resources for historical data (yahoo finance, which only has data for companies still alive today). And of course for most companies that have been around for a few years and are still trading today, it was very, very, very hard for me to come up with anything that would beat buy-and-hold. 🙁


  5. Lumilog, I, too, have an undergrad in EE and an MS in Comp. Eng. and passed the CFA level-1 exam in December, 2006. I started in May, 2006 using the Schweser Notes because in 2006, the CFAI didn’t require candidates to buy the official curriculum.

    I would encourage you to get Schweser or Stalla Notes because the notes are much more organized to help you learn. The questions at the end of each reading is more consistent and more closely related to the topic that you have just finished reading. I found out because for level 2, the CFAI made the official curriculum a required purchase. The readings are great, but some chapters don’t actually have questions at the end.

    I hope you the best of luck. It takes a lot of courage and determination to decide to climb to the top of the hill — someone else’s hill no less.

  6. Hey PW, congrats on passing Level 1. Yes I’ll probably break down and eventually delve into some of the second-party study notes after the first of the year. They certainly can’t hurt. Thanks for the well-wishes!


  7. I came to your log through wikipedia and found it to be very interesting. Earlier this week registered myself for the jun 2008 level 1 exam and should be getting my books tomorrow. I have a BS in Business Mngmnt with concentration in Finance, currently working as a “quant”. One advice many of my peers gave me and I will pass on to you is; get the Schweser notes along with TI calculator (which many say is much easier to use than the HP). Goodluck n lets stay in touch~!

  8. Lumilog:
    Are you planning to take the Essential pack or the Premium pack from Schweser. I also didnt research where you live. If you live in west coast (CA) Los Angeles CFA charter (also OC charter) do weekend long 9am – 5pm prep classes for 4 months starting jan ( i wasnt sure whether to go for that one or Scheweser. If you are in the US, check your local CFA charter if they do prep classes. in LA its about 1500$/level.

  9. Hey Quant – thanks a lot for the tips and good luck next June! Yes I’ve all but decided to buy a BAII – just procrastinating since I haven’t needed a calculator much for the Econ stuff so far.

    Drymartini – haven’t made a decision yet as to what I’ll do re: non-CFA Institute preparation materials. What I’ll probably mostly be after is just a larger bank of practice problems & old test questions to re-work, re-work, re-work. Haven’t really started researching this yet to know what to buy and who to buy from…

    Thanks for writing!

  10. Hello Lumilog,
    Thank you for your time and efforts to produce this very informative blog.
    I too enjoy math as a second language. I have recently begun a certified financial planner program ( that is part of a local graduate school. That has created an interest in the cfa program. If you could point me to a download of relevant case study problems and recommend some study materials (Schweser Notes?) it would help me see if I have the mental apptitude (and intestinal fortitude) to engage the clearly more rigorous cfa program.
    I am a mechanical guy. That path began as a wood patternmaker for the U.S. Navy back in the 70’s. I originally signed up for electrical training, that changed after a physical showed defective color perception. It turned out ok as I discovered a real gift for spacial relations. Most of my career has been designing and programing patterns, molds and dies. Now I write macros and program 5 axis milling machines for an areospace company.
    Its owned by GE and they are funding my finance education.
    My degrees are in Industrial Engineering and Marketing/Sales.
    As for investing, I am a buy and hold, leave your emotions at the door, go against the flow contraian.
    I have one tip for you. I just purchased the BA II from circuit city online for $45. A price you won’t get at the store. It arrved in only a few days with standard shipping (no cost) You can order one here:
    Thanks again, I look forward to your next entry.
    Best regards,

  11. Hey 3d!

    Great to hear from you & congrats on the CFP track! I’m afraid when you were in the Navy in the 70’s I’m was only a Navy brat at that time…

    You can find some example CFA study chapters for download here.

    Considering what you’ve already accomplished, you could probably hack the CFA program. The great thing is you’re only tested on one level at a time, can take each level as many times as necessary, and there’s no penalty (like a GPA) for requiring multiple tries to pass each level.

    As I think I’ve written before, the material isn’t abstract or complex. It’s quite straightforward – it’s just the fact that you have to memorize it that makes it more challenging.

    Thanks for the tip on the BAII and best of luck to you!

  12. Lumilog:

    Very informative blog! I’m also headed for the June 2008 Level I … I must have been drunk or something when I signed up, as my background is Arts Management … basically art and business/management all in the blender. Like you, I basically wanted to study the curriculum, so I’m not too stressed about the test, although I plan on requesting a change of date for my exam to December just so that I can have more time to absorb the material. I am planning on reading a bunch of “business mathematics” books on the side … don’t know if that’ll help, but for me it’ll actually be fun.

    Anyways, good luck on your studying, and good luck to all the people who posted comments, all very informative. Oh, if you’re still looking for the BAII, Amazon has the professional one for about $33 right now. It seems to be a better buy since the regular BAII sells for about $30 at Target.

    Keep up the hard work!!


  13. Lumilog, have you thought about future directions of your career? Before I took the exam, I thought that I would end up working in banking, but after working as an intern for a commercial bank, I realized that I’m still a tech guy, but the one thing I realized with the MBA, M.Sc., and CFA (still in the works) combo, I’m actually better suited to being in the tech startup/VC arena than in pure finance. Where do you see yourself? It’s just something to think about.

    I second your observation that understand the financial and business context of how decisions are made makes me a better tech guy. I no longer see the typical engineer’s rant against the system as something amusing because there is a reason (though not always the best reason) that business decisions are made.

  14. Thanks for the comments and BAII tip Roman. Yes, we must have been drinking the same thing…

    PW – I can’t say I’ve given the career side too much thought. Working as an engineering contractor now, I must say I enjoy working for myself. There seem to be quite a number of ex-engineers running asset management firms using their technical backgrounds (e.g. artificial intelligence). Probably whatever I end up doing will have to have some technical or algorithm development side to it or I’ll get bored. 🙂

    All the best!

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