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

Well I’ve just ordered my new business cards…

It’s a joke! It’s a joke! I know that’s not ethical!!

For non-insiders, the CFA Institute specifically prohibits creating any sort of intermediate title for yourself, like “CFA Level II”. You either are or are not a charterholder, and only charterholders in good standing are allowed to put CFA after their names.

Yes friends, I managed to pass. It appears that neither a business degree nor third party study materials nor a TI BAII+ are required to sneak through the CFA exams - at least for Level I.

The CFA Institute sent out a link a few weeks back that it said would give you your test results at 9:00 AM EST on July 29. I clicked on it then and it said - surprise! - to check back at 9:00 AM EST on July 29. I clicked on it yesterday and early this morning and it said the same thing.

I clicked on it slightly after 9:00 AM today and it still said the same thing!! I hit reload a couple times and was finally greeted with a username and password field along with an ominous line of text:

To be honest, I hadn’t been nervous at all these last few weeks while waiting for results. But when I saw the 35% I had trouble keeping my fingers from shaking while logging in.

And just like that a new page opens with your results. I was going to just do a screen capture but remembered that thing I signed about not giving away details of the test, and the exam results do give the breakdown as to how many points came from which section.

So I’ve reproduced only my scores below. In fact, you don’t get a score but rather a Pass or Fail and what range your scores fell in for the tested categories:

This is very good news indeed as my wife and I are about to take off to Finland and I was wondering what I was going to do about needing to start preparing to re-take Level I in December versus the logistics of bringing all the study guides with me.

Speaking of the study guides, since taking the test on June 7, I haven’t opened them once. This really surprised me as I actually loved most of the material. I guess I either just needed a break or somewhere deep in the subconscious was the knowledge that I had passed.

So, I will be registering for Level II soon and continue the blogging. Thanks to all of you who have kept in touch through the comments - let me know how you did! And many thanks to my wife for the red bulls, encouragement, and space to prepare.

Should thank the poodle too. The dog walks really helped to break up the blocks of study time…

See you all again soon.

Technorati Tags: CFA, Chartered Financial Analyst, Investing, Stock Market

Note: Please read the disclaimer. The author is not providing professional investing advice or recommendations.

While waiting for results from the CFA exam to come in, I thought I’d cover an example of a trading technique I’ve recently begun test driving, pairs trading.

Pairs trading was something I thought I’d invented! Alas like many of my so-called brilliant flashes of insight, a little googling revealed that not only had others come up with it decades earlier, but their techniques were more elegant and robust than my first stab.

The basic idea behind pairs trading is this:

1. Find a pair of stocks (or ETFs) whose prices tend to move together.

2. If the price movements are indeed highly correlated, then on most days the price per share of Stock A divided by the price per share of Stock B should come out to be about the same number, within a small range.

3. But occasionally, you might notice a significant divergence from this “average” ratio. If you do, enter a pairs trade. This will involve simultaneously shorting one of the stocks while taking a long position in the other.

4. At some time in the future when the price ratio (hopefully) reverts to the mean, exit the pair trade, wire that (almost) riskless profit to your checking account, and take your wife out to a nice dinner.

Now anyone familiar with the basic workings of the stock market knows that you can make money in either an up or down market, by using both long and short positions. But the catch is, you have to know which way the market is heading in order to know which to use. Easier said that done, even for the pros.

But with pairs trading, you are performing trades that are (theoretically, at least) market neutral. As long as the pair ratio reverts to the mean, you make money - regardless of whether you re-arrive at the mean by the short decreasing in price, the long increasing in price, or both. You don’t have to know or even care which way the market is heading.

A second benefit is that pair trade positions can be viewed as a nice additional asset class for one’s portfolio, since they should be relatively uncorrelated with your traditional asset classes consisting of long positions in various domestic and international indexes.

So let’s illustrate pair trading by an example.

It’s January 1, 2007 and I’m thinking of trying out some pair trading in the new year. Now I could code up a script to perform correlations between the historical price movements of hundreds of stocks in order to find those that move together, but I have a simpler idea.

I have an inkling that Lowe’s (LOW) and Home Depot (HD) might be highly correlated. To me at least, they are roughly equivalent businesses, and which one I go to depends solely on which one is closer when I need something. Let’s examine their closing price-per-share data from the previous year…

They definitely do seem to move together. And I could compute a correlation on the price movements to confirm what I see visually. But perhaps a more important question is not is the relationship between LOW and HD highly correlated, but rather is it mean-reverting. Because my making a profit depends upon this.

So I now plot the price of LOW divided by the price of HD, what we’ll call the LOW/HD pair ratio…

…and this indeed seems to be what I was looking for - a price ratio (blue curve) that appears to oscillate around a mean (purple line). And I’ve also added the 1-, 2-, and 3-standard deviation lines just to get a feel for how far away from the mean the oscillations might go.

So, we appear to know the habits and patterns of this animal. Time to set a trap and lie in wait…

But this creature is dangerous and could eat us alive, so we have to be careful. We see that in 2006 the pair ratio often makes excursions 1 or 2 standard deviations above or below the mean. We could spring the trap then but we might end up making lots of trades for tiny profits, and the commissions could eat us alive too.

Examining the figure above, we do see one time when the ratio appeared to go almost 3 standard deviations from the mean. Therefore that will be our criteria for 2007. If we see an excursion +/- 3 standard deviations from the mean, we’ll enter a pair trade. And whenever the ratio returns to the mean, we’ll exit both positions.

And here’s what 2007 ended up looking like.

On July 10, the LOW/HD ratio fell 3 standard deviations below the mean, so we buy LOW long at $29.46 and sell HD short at $38.98.

And a little over a month later, on August 16, 2007, the ratio reverted to the mean so we exited both positions. This turned out to mean selling LOW at $26.42 and covering our HD short at $31.79.

So our long LOW position was a 10.3% loss but the short HD position was a 22.6% gain. Therefore our equal dollar positions averaged out to a 6.1% gain.

We’re now back in cash and ready to spring the trap again should a new opportunity arise.

And indeed it shortly does. On September 24, 2007 the ratio has now gone 3 standard deviations above the mean. So this time we end up doing the reverse as the previous time. We take a long position in HD at $33.02 and sell short LOW at $30.10.

And a little less than 2 months later, the ratio has once again reverted to the mean. On November 20, 2007 we sell our long HD position at $27.78 and cover our short LOW position at $22.25.

So we take a 15.9% loss on HD but get a 35.3% gain on LOW. This averages to a 9.7% gain.

And this is the last time we get to pounce in 2007. Thus our two pair trades compounded to a +16.5% annual return! Not bad, considering buy-and-hold would have given you a 27% loss in LOW and 31% loss in HD. (I told you their prices move together…)

And further, we were only committed to a pair trade about 3 months of the whole year. While we were waiting we could have kept our money in a low-volatility bond index fund (e.g. VFISX or VBMFX) to generate fixed income in the mean time. I haven’t run the exact dates but these returned 8% and 7% respectively if you’d held them for all of 2007. So maybe it isn’t unrealistic to assume that this would have pushed our +16.5% past the 20%+ return mark.

In balance, though this example used real historical data, it’s probably making pair trading look easier than it is. Some companies diverge and don’t mean revert. And should your mean and standard deviations be based on last year or multiple years? A fixed start and stop date or a moving average? Should you jump in at 2, 2.5, or 3 standard deviation excursions - and when do you exit (for both profit and for stop loss).

Backtest to derive your own optimized parameters and have fun.

Technorati Tags: Investing, Pairs Trading, Statistical Arbitrage, Stock Market

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

Well I’m cooling my gray cells in upstate NY now, but I thought I better log in and give a quick retrospective of what exam day was like before I forget!

Day Before Test Day: 3:00 PM
Load up car with backpack of 6 volumes and test-taking gear and depart for city where exam is held, 2 hours away. Unzip outside pocket periodically to insure admission ticket is in fact still there like it was 15 minutes ago. Wife drives while I study.

5:00 PM
GPS takes us directly to test location first. The CFA Institute had recommended driving by the day before so that you don’t end up lost on exam day. There are supposed to be signs directing candidates where to go but I don’t see any up yet. Ghost town…

Ground Zero

6:00 PM
Arrive at hotel a few miles from test site. Unpack sandwiches from ice chest and have quick dinner in room with wife before settling in for the last bit of studying. No wine with dinner…

7:00 PM
Break out the 6 volumes and continue the same ol’ infinite loop of working problems. Interlace this with review of missed questions from free online sample exam.

10:00 PM
Can’t believe how quickly the last 3 hours have gone by! Wife went to sleep long ago. Decide I’ve done enough and pack it in, brush teeth, get in bed.

11:00 PM
Still awake. Not nervous or worried, just can’t seem to fall to sleep. Try some deep breathing…

Test Day: 12:23 AM
Still awake. Though maybe I’d drifted off for few minutes? Why can’t I sleep? Maybe I should have had some vino after all…

2:00 AM
AND MORE RAIN IN THE NORTHEAST! - SORRY NEW YORK! - WITH THIS STALLED AREA OF LOW PRESSURE.. Inexplicably the hotel TV turns on by itself with volume at full blast. Stumble and trip my way to the set to turn it off but can’t find any buttons. Locate remote back on nightstand where I started and silence the Weather Channel’s irrepressible Jim Cantore. Wife mumbles something.

2:10 AM
The good news - the TV had woken me so I definitely had fallen asleep. Bad news - up again, blinking at ceiling, wondering if room next door has remote on same infrared code. Awake for some time expecting TV to turn back on at any moment. In “ready to pounce” mode…

4:18 AM
Awake spontaneously feeling like I had LOTS of wine last night. Tired, dehydrated. Lie in bed awake from then on…

5:45 AM
Wife begins to stir.

5:46 AM
Incredibly, she remembers nothing about TV turning on in middle of the night…

6:30 AM
Breakfast in hotel restaurant. Quite good. Decide to stop at 2 cups of coffee - enough to be awake but not jittery. Switch to water.

7:40 AM
En route to exam test center, which is a relatively new local high school. Wife throws me an ice cold sugar-free Red Bull. Have I told you how much I love her? Feeling good despite lack of sleep.

7:55 AM
Wife drops me off at main entrance. Still see no CFA signs?! I know we’re not allowed to bring cellphones into the exam room so I’ve left mine at the hotel. Since I have no way of calling in case of emergency, I tell her to wait outside 10 minutes in highly visible location in case I run out screaming “OH MY GOD!! ADMISSION TICKET!!! I FORGOT MY ADMISSION TICKET ON THE BACK SEAT!!!”

8:00 AM
Go into lobby. Lots of sleepy-looking young people. Ah well, maybe most candidates are still in college. Get in line.

8:03 AM
Woman comes up to me and says “CFA?”. I nod and she tells me to step out of line and follow her. I was in the wrong place after all and all the kids ahead of me really are in high school.

8:05 AM
Check in. Calculators are examined and compared by security (no guns) to black and white mug shots of the 12C and BAII+. Admission ticket and passport are checked and I’m sent off to find a numbered classroom.

8:10 AM
Decide to make detour to bathroom before entering classroom. The CFAI website explicitly states that you can’t bring bags into the exam room. This didn’t sound like a problem at first but I overdid it a little on the survival gear and am cradling: admission ticket, pack of pencils, two pencil sharpeners, passport, driver’s license, calculator #1, calculator #2, extra batteries, earplugs. No surface looks large or clean enough to temporarily stow gear. Ridiculously stuff pockets with everything in order to be able to use bathroom.

8:15 AM
Arrive at classroom. Admission ticket is re-inspected along with passport and calculator case. Get assigned to desk #6. Only every other desk is being assigned a candidate. Decide this is because Cheating Threat Level must be at either orange (high) or red (severe). Sitting in desk is not as comfortable as it could be as wallet is bulging with extra folded up copy of admission ticket “just in case”.

8:20 AM
Look around at desks of neighbors. Many simply brought two mechanical pencils instead of my pack of wooden ones along with the cumbersome sharpeners. Never thought of that. Keep waiting for guffaws from other test-takers at my HP 12C, like showing up at a break with 14-ft. gun when all the locals are riding 5-ft. potato chips. But no one seems to notice. Everyone very serious and reserved - not talking to or even looking at anyone else.

8:35 AM
My body is telling me that the 1 bathroom break might not have been enough. Think about stepping out again but as test-time is nearing my amygdala has awoken and decided to take over calculations:
Doors close in 10 minutes…
Bathroom takes 30 seconds to walk to..
30 seconds to go…
30 seconds to walk back…
TOO RISKY!! STAY IN SEAT!!

8:42 AM
One relaxed candidate with a Martha’s Vineyard t-shirt gets up to go to bathroom… Envy the nerve.

8:44 AM
Candidate arrives back. Is challenged by young proctor to show ID like she’s never seen him before. Reacts with a snort and a point “it’s over there, on my desk”. Proctor fronts a bit and appears iffy but ultimately decides this really is the same guy who left 2 minutes ago, and relents.

8:45 AM
Door closes, proctor begins reading instructions and we bubble in our name, candidate #, etc. We also bubble in acceptance to something about not revealing anything about the test, so I regret I can’t blog much about the test itself.

8:55 AM
Knock on door. Whispers in hall. Someone saying something about leaving ID at restaurant. She’s ultimately allowed in with many caveats and disclaimers from proctors that they’re not sure whether her test will even be graded.

Part I: 9:00 AM
Morning exam begins. There are maybe 12 of us in the room. Mostly us young white guys aged 26-36 but one African-American woman, one European-American woman, one Asian woman, and one guy from India.

10:00 AM
Silence mostly prevails here, but sometimes the proctors talk amongst themselves in too-loud whispers. And one candidate appears to be under the impression that the harder he hits his calculator keys, the greater the possibility of a correct answer. ..tap-tap-tap-tap… tap! (loud sigh) …TAP-TAP-TAP-TAP … TAP!!! YES! (loud whisper). I don’t find the earplugs necessary - it’s easy enough to just plug your ears with your fingers when it gets noisy.

10:45 AM
More whispers. Look up and girl who forgot ID is talking with proctors. She hands them her exam, gets up and leaves in a rush. Gosh, I think, they let her sit there and take the test for almost 2 hours before deciding they wouldn’t let her write the exam after all without ID! Tough luck.

11:00 AM
I’m done with Part I an hour early! At least I’ve answered all the questions. I have an hour to review so I use it doing just that. Going back to a few of the questions that seemed hard and spending extra time checking my work. I wouldn’t say I got 100% but I’ve very surprised at how easy the morning test has seemed.

End of Morning Section: 12:00 PM
“STOP! PUT DOWN YOUR PENCILS. IF YOU ARE STILL WRITING YOU ARE IN VIOLATION OF THE CFA INSTITUTE’S CODE OF…” We all file out while the proctors tell us that even though it says be back by 1:00 PM, feel free to take an extra 15 or 20 minutes since the test doesn’t begin till 2:00.

12:05 PM
Walk outside where wife is waiting with a sandwich from a nearby grocery store. She’s also has had a look around and managed to find a wonderful picnic area in a new park only minutes away overlooking a small body of water and produces another icy Red Bull.

Chomp… Read…

12:30 PM
Finish sandwich. Begin reading a bit about deferred tax credits and liabilities in Financial Statement Analysis Volume but it just doesn’t feel right. Decide relaxing the brain is better, even though the hardest part of the morning test was waiting 3 hours to go to the bathroom.

1:15 PM
Hanging with the other candidates back outside the test classroom. Unlike morning, everyone’s chatty and cheery now - talking about how easy they found the morning exam. I decide from the accent that the guy I thought was Indian is actually Persian. He’s a new graduate with a master’s in mathematics and looking to enhance the resume for job searching. Everyone else works at some financial firm and most seem to not have a choice in whether or not to earn the CFA, but their employers are at least picking up the tab.

1:25 PM
More candidate chatter inside the classroom. Up until this point, I’ve been under the impression that there was no curve for the test and 70% was the pass/fail point. Now I’m being told that there are various ways they decide who passes and who fails. There is controversy between candidates over whether those who registered but didn’t show up get graded as 0% and therefore lower the pass/fail point. Some candidates have taken a week’s vacation prior to the exam in order to study as much as possible. Lots of talk about how they (the test-makers) are really gonna sock it to us this afternoon because the morning test was just too easy.

1:40 PM
We’re all seated again and it’s like a totally different classroom from morning - people telling jokes and one guy elaborating on how drunk he’s going to get tonight. Other proctors wander in to chat with ours and comment that they’ve never seen such a large percentage of registered candidates not show up. Suspicions that many registered under duress from their employers, but have since lost those jobs in the slowing economy and no longer feel pressure to sit. One class was supposed to have 22 test-takers, but only ended up with 5. Another two classes were combined because both had about 50% absenteeism. Those candidates who believe these will be zeros that lower the curve are very happy to hear this. To others, this seems too good to be true.

1:42 PM
Wait a minute! The girl who forgot her ID is back for Part II in the afternoon. Turns out she was not thrown out of the first half of the exam but in fact finished early and burned the break high-tailing it to wherever-and-back she needed to go to retrieve her driver’s license.

Part II: 2:00 PM
Same instructions have been read and the second half is beginning. People wishing each other luck.

2:49 PM
Same guy is tapping calculator keys louder than ever. But now that I got to know him and like him, it no longer bothers me and I find it welcome comic relief.

3:45 PM
She did it again! Same previously ID-less girl who finished early in the morning section has handed in her test and left again with over an hour to spare. Either she’s brilliant or the ID fiasco so discombobulated her concentration during the morning part that she sees little point in checking her work and just wants to be done.

4:20 PM
I’ve now answered all questions for Part II but it’s been brutal. I spend the next 40 minutes checking my work but it’s mostly to no avail. I could leave early but was always taught in school to spend all remaining time checking my work so I do so.

5:00 PM
“STOP! PUT DOWN YOUR PENCILS. IF YOU ARE STILL WRITING YOU ARE IN VIOLATION OF THE CFA INSTITUTE’S CODE OF…” No one’s speaking but I make a gesture like I’m drinking a beer to the guy who was so verbal about getting drunk. He responds with multiple handed left-right, left-right downing of shots. He’s going to be in a lot of pain tomorrow morning…

5:05 PM
Wife says everyone coming out was shaking their heads and saying that there was no way that they passed. We start the 2 hour drive back home.

7:00 PM
Arrive home. Wife produces more-expensive-than-normal bottle of Rioja she’d been hiding for me. With a glass in hand, I check the blog comments and add my two cents. What a great bunch of people I’ve shared this process with, whom I’ve never even met - from so many different countries.

A final note about two surprises regarding the exam. One, I never expected to have so much time left over after making the first pass through all the questions. I thought I’d be calculating furiously right up until stop time.

And second, while I definitely encountered my share of problems I had trouble answering, it most certainly was not due to insufficient material in the study guides. I think I knew how to work every exam problem at some point during my study cycle. I just couldn’t retain all of it with the number of hours I put in.

End of July is when we find out the results. But I’ll probably re-start Level I preparation in about a week just to get a head-start in case I’m sitting again in December. Enjoy the break everyone!

Technorati Tags: CFA, Chartered Financial Analyst, Investing, Stock Market

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

On the day of the CFA Level One exam, I arrived 30 minutes early at the testing center so that I’d have time to print out my admission ticket at the computer lab across the street.

But then, I couldn’t get the blasted thing to print! The work-study student running the lab was no help. I realized that it was now all over before it had even begun. I’d failed Level One without so much as seeing the first test question because I’d been too lazy to print out my admission ticket ahead of time like I’d been told.

Then, a dark realization dawned and really shivered me timbers. Months ago, I had stopped going to, and dropped, all of my university engineering classes because I’d decided to bet the farm on the CFA and a future career in investment banking…

…except I’d just remembered that I forgot to drop the labs that go with the classes. And the drop deadline had now passed. I was going to have a slew of straight F’s averaged in to my university GPA along with my admission ticket failure fiasco! Lose-lose!

Study Group

GLORY BE to the the wrens who finally signaled dawn, rousing me from my nightmare. They say dreams are only interesting to the people who have them, so I’ll spare you the details of the other two very similar ones I’ve also had in the past week. I’m just waiting for the one where I’ve been dropped off at school only to realize I forgot to put on clothes…

So, here we all are - just days before the June exam! Unlike in dreamworld, I have my supplies gathered and admission ticket printed. I’ve even booked a hotel nearby the evening before because I don’t want to have to get up at 4AM to drive to Jacksonville - where I will be taking the exam. What if there were a traffic jam?! Flat tire?! Alligator uprising?!

I went to Office Depot to buy a second HP 12C but for some reason the price has increased dramatically. They now want $86 for the 12C versus $40 for the TI-BA II+! Well HP, you’re not OPEC, and you can only hope to gain a cost-push inflationary advantage when no comparable alternatives exist. I am therefore now the proud owner of a TI. I’ve given it a short test drive but it’s obviously only in case of an exam emergency. Switching to the BA now would be like buying a new brand of shoes on the eve of the Badwater 135.

So how have I spent my study time since finishing my first pass through all the material about a month ago? Mostly in the infinite loop of working random problems that I mentioned in my last post.

I had to alter the strategy slightly to save time and keep from having to lug all 6 volumes with me wherever I go. I just randomly reordered the 76 chapters that comprise Level One and have been proceeding sequentially, working all problems of whatever chapter I’m on. You can see how far I’ve made it…


32 40 22 34 35 6 55 3 68 16 69 11 54 30 45 60 74 72 62 70 51 33 7 38 58 76 42 28 17 41 47 14 46 56 63 8 67 59 5 48 53 29 21 25 52 37 64 31 49 27 61 50 26 43 19 44 15 73 1 36 71 23 65 2 4 18 75 24 39 13 9 66 20 57 10 12


No way I’ll complete a full second pass before test day. But I did start with a brand new pen and worked so many problems that I ran it out of ink. I showed my wife and she said “Wowwwww!!!” with much more enthusiasm than she was actually feeling. Bless her. I still haven’t thrown the pen away.

I also finally got around to taking the free online sample exam that you get when you register. My results:

Overall: 55% (need > 70% to pass)

So, it’s not looking promising. Unless the actual exam turns out to be easier than the practice problems and sample test, I expect my infinite loop of working random problems - possibly with supplementary 3rd party material - to continue until I have the chance to try again in December.

Two final thoughts before closing.

First, a long time ago, when I was taking jiu-jitsu, the instructor would tell us that we needed to show up for every single belt testing whether we felt ready and prepared or not.

Apart from the cost of testing being a great source of extra income for his martial arts school, he was trying to impart a certain attitude. Don’t stress about tests that have no penalty for failing. Stress only comes when you’re trying to pass yourself off as more prepared, intelligent, or skilled than you really are. Just always show up, demonstrate where you’re at, and if it’s your time, you’ll be recognized and bumped up. That’s how I feel about this coming Saturday.

At least I hope that thought keeps the nightmares at bay…

Second point. I’m just recalling the way I felt the day I earned my master’s degree in electrical engineering. At that age, ego reigned supreme and my primary reason for pursuing the degree was to have another piece of paper demonstrating that I was in some way special. Except on the day of completion, I realized that I’d actually found the bachelor’s to be more of a challenge. When I looked at my framed master’s, I hoped others would be impressed… but I wasn’t.

Based on my experience so far, I don’t think I’m going to feel that way the day I become a charterholder.

I wish all of you candidates great success and razor-sharp concentration. No stress for this exam! We just show up and demonstrate how much of Level One we’ve internalized.

For me, that’ll probably be about 55%…

Technorati Tags: CFA, Chartered Financial Analyst, Investing, Stock Market

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

Can’t believe I did it.

As of a few minutes ago, I can officially say that I’ve read all chapters and worked all problems from all six Level One CFA study guides. Now I have roughly 40 days and 40 nights for review until exam day.

I feel like I’ve finished War & Peace. Wait, Amazon only puts it at a measly 1300 pages and the Level One curriculum is more than twice that!

Many thanks to those who have written wondering where I’ve been and if I’ve given up. On the contrary, I’ve just chosen over and over again to use free time studying instead of blogging.

Been there…

Based on a little web surfing, the consensus seems to be that what I should do now is enter a semi-infinite loop of:


1: Take a practice test.
2: Review material of section where scored lowest.
3: Goto 1


That might be fine for Vulcans (minimizing error, how very logical), but it sounds painful - continual focus on the stuff that’s not fun. I’ve come up with an alternate review formula that I think will work better with my psychology. Wanna hear it, here it go…

Using a random number generator such as Excel or Matlab…


1: Pick one of the 76 chapters at random.
2: Pick a problem from that chapter at random.
3: Re-work and thoroughly understand said problem.
4: Goto 1


Not the most efficient use of time, but I get to (a) work some problems that I’m already good at (for positive feedback) and (b) review all sections simultaneously.

Does this make sense? Maybe not, but I’ve been bad about taking advice so far. After all, I’m still using the HP 12C instead of the TI BAII+ and I haven’t ordered a single third-party review product yet. Perhaps a failure on test day in June will jolt me out of my stubbornness.

The upside of putting blogging temporarily on sleep mode was that I managed to make it through all six volumes. The downside, I wasn’t writing when I hit some of the sections I enjoyed the most, which was in Volume 5 (Equities and Fixed Income).

I have so many underlined sentences from these readings that I should probably come back and touch on them in a separate post. But let me give a quick summary.

Regarding Volume 5: Along the way of reading some of the more popular value investing books, I’ve been given the impression that Efficient Market Theory has a stranglehold on academia, so I expected the same for the CFA program. I was wrong. Vol. 5 has extensive treatment of security valuation models and findings of numerous academic studies regarding when EMT holds, when it doesn’t, and what it takes to “beat the market”.

Regarding Volume 6: (Derivatives and Alternative Investments): Had a foreboding about this volume as derivatives are often described as “complicated” and “involving complex mathematics” and my poor little HP 12C just didn’t look up to the task - not enough special buttons with special Greek letter functions. But the material turned out to be a cake walk! Secretly suspect they’re saving the hard stuff for Levels Two and Three…

Was also suprised to find myself learning how to evaluate real estate in Vol. 6. The applications of Time Value of Money seem endless. And after reading somewhere else (an earlier volume?) about how semi-uncorrelated asset classes can all suddenly become very correlated when the market goes bad, it was neat to learn about gold’s special negative correlation properties.

Well I’d love to stay and chat but I’m off to work my first problem for the second time. Random number generator says it will be Practice Problem #2 from Chapter 51 (An Introduction to Asset Pricing Models).

So it’s back to the CAPM, eh? Someone want to tell me again why we’re studying this when the relationship between beta and rate of return seems to have disappeared since 1962?!

Technorati Tags: CFA, Chartered Financial Analyst, Investing, Stock Market

Somewhere in Texas, a city is missing its economist…

My father sent me a link to this article, about how Dallas, along with many other cities across the nation, is turning off their traffic cameras that catch red light runners, because they are too effective at keeping people from breaking the law, resulting in significantly reduced revenue for the city’s budget.

A couple years ago, I probably would have read the article with interest, gotten a good chuckle, and tossed it aside. But I see things differently now, either due to my studying to be a Chartered Financial Analyst or reading Freakonomics.

Either way, here’s my pro bono for Dallas…

This isn’t a pass/fail problem. This is an elasticity of demand optimization problem.

Now clearly you can make more money by charging people higher prices for things they either can’t do without (food) or feel like they can’t do without (cigarettes). But red-light running fits neither of these and is therefore an elastic activity.

I know the article didn’t say that they raised ticket fines, but charging people the same amount while increasing the probability of catching them seems like the same thing as:

So, before turning off the cameras…

(1) … experiment with lowering the ticket fine

Just as businesses set prices in order to maximize revenue, so should Dallas. You don’t start selling a new product for $100 and then quickly discontinue it because it’s not selling in the volume you hoped for. Publicly announce a sale on red light fines and monitor resulting change in volume. Repeat until price point for revenue maximization is found.

(2) … lower the odds of getting a ticket

It may turn out that traffic violations will continue to stay very low, even if the cost is $1 per infraction, if people know they will be caught. In that case you need to change tactics. Publicly announce that only 3 out of every 4 violations captured will actually be issued a ticket. And again, iterate to find the odds that yield maximize profitability. Many people just plain feel lucky even when the odds are against them. Works for Vegas.

(3) … optimize both probability and cost

A no brainer, and just what it says. Streamlining both variables may result in even higher revenue than optimizing one alone.

(4) … entice people to break the law!

Ultimately to maximize revenue, you need people to break the law as much as possible. So keep the optimized fine and probability points, but for each ticket issued throw in 10 free lottery tickets. You’ll probably find that you’ll then be able to raise both fine amount and probability of issuance.

(5) … verify that remaining demand is not inelastic

Installing cameras definitely seemed to get rid of the elastic red-light runners, but what if the remaining come from an inelastic group? Those would be fathers rushing soon-to-be mothers to the hospital, out-of-towners unfamiliar with the cameras, or the rich and/or unintelligent. In any case, the point is they might be able to increase their revenue by 10x by raising the cost per infraction to $1000 from $100.

One final suggestion (which may already be in practice) is to allow lawbreakers to finance their fines. But then they’d have a new optimization problem on their hands. The interest rate…

Technorati Tags: Economics, Texas

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

Priorities, Priorities…

Day after day, day after day,
We stuck, nor breath nor motion;
As idle as a painted ship
Upon a painted ocean.

Water, water, everywhere,
And all the boards did shrink;
Water, water, everywhere,
Nor any drop to drink.

Yes I felt like the ancient mariner whilst in the doldrums of the 700-page Volume III. As idle as a painted CFA candidate, enrolled in a painted program…

But things ended on a high note. Apologize for all the whining in my last post. Growing pains…

Shortly after writing that, I reached Volume III’s Reading #42, Financial Statement Analysis: Applications.

Now the first part of this chapter was quite enjoyable in that it delved into a key area of personal interest, evaluating past financial performance and projecting what will probably happen in the future.

Then the reading drifted into stock screening (with which I had become totally disillusioned, you’ll recall) and mentioned something that really lifted my spirits.

They give a great example. If, in the attempt to find value stocks, you screen for low P/E alone, a screener may return a mix of indeed unfairly beaten-down healthy stocks, but also fairly beaten-down unhealthy stocks. However if you add some additional criteria, say requiring future projected EPS and dividend yields to be positive, along with some minimum requirements for one or two financial leverage ratios, the screener should then start to separate the value traps from the value plays.

At least in theory…

Shortly after that, Reading #42 concludes with a section called Analyst Adjustments to Reported Financials. This is a 16-page summary of the earlier 250 horrendous pages that made me cry for my blankie. But seeing it again at the 10,000-foot level, well, somehow it all just made sense and didn’t seem as complicated anymore.

Volume III concludes with a spread on how IFRS and GAAP are converging! So while we present candidates have to be familiar with two sets of accounting rules, future generations will only have to know one. A bit of a downer, but something we’ll no doubt wear as a badge of honor when talking to young CFA candidates decades from now.

And before I knew it, I had reached the halfway point in the study guides. It had taken me a little over 5 months.

Shortly after finishing Volume III, a friend handed me her copy of Disney’s annual report because she thought I might find it “interesting”. I open it, scan the financial highlights, and give a pro bono…

“At first glance, EPS grew substantially over the prior year - from $1.64 to $2.25. Wait… (scan footnotes) …the earnings were biased by a handful of items, including a pile of cash they obtained by selling some of their business stakes. Removing the effects of these you get a better look at earnings growth from just normal day-to-day operations, which is still an impressive 24%. …And even though when you think of Disney you probably don’t think of Desperate Housewives, I see here that most of their revenue comes from their media networks, not their theme parks…”

“Wow, you’re really learning a lot,” she says. I decide to stop there, close the report, and hand it back. Premium content is for paying subscribers…

…and if I say much else, she might take an interest and start asking questions I can’t answer, blowing my cover.

So now I’m already 75 pages into the next study guide, Volume IV: Corporate Finance and Portfolio Management. Weighing in at 300 pages, it feels pamphlet-sized next to the previous volume’s 700 pages. IV starts with readings on how businesses plan which projects they’ll use their limited resources to pursue, which is mostly the same ol’ NPV and IRR “time value of money” stuff already covered in study guide Volume I.

I’m in the middle of “cost of capital” right now. Not terribly exciting but does begin to touch on some subjects I’ve been dying to learn, like the capital asset pricing model which, I understand, to also be of use in constructing portfolios. I think I can predict how…

Currently biding my time until page 195, where the true portfolio management topics begin. And unfortunately less than 100 pages are devoted to this - what I expect to be a favorite topic! But at least it gets a healthier treatment than Volume I’s microscopic section on Technical Analysis.

Speaking of health, short & sweet might be just what the doctor ordered given that after finishing the remaining 200 pages of Volume IV, I still have the 500-page Volume V and the 250-page Volume VI to plow through in order to have worked each practice problem and read each page of the study guides once.

Then review begins to really burn to disk. Three months till test day…

Technorati Tags: Accounting, CFA, Chartered Financial Analyst, Investing, Stock Market

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

This is not what was supposed to happen.

I started the CFA program in order to replace my ad hoc investing education (gleamed mostly from bestselling finance books) with something more in-depth and comprehensive.

One reason for doing this is to gain credentials for a possible future career change. My primary reason though was to fill knowledge gaps in order to simply become a better investor.

So in my pre-enrollment crystal ball, I saw myself gradually transforming my current (no doubt elementary) stock-trading algorithms into something more sophisticated and professional as I acquired a proper investing education while working my way through the CFA study guides.

Until recently, my vision matched the reality. The quantitative and statistical material from Volume I was very helpful since my present investing style relies heavily on number-crunching.

Economics in Volume II didn’t seem as useful, but it was nice to understand the terminology and unspoken reasons behind some of Bernanke’s statements while testifying to congress a few weeks back.

Incidentally, ’twas also neat to see which of the questioning senators appeared to have a decent economics background (Paul Ryan).

But something has since gone horribly wrong. I’m now in the middle of a the more I learn, the less I realize I know paradox. And it all started with Financial Statement Analysis, which is Volume III of the CFA study guides.

Pakhto aw Englisi khwagey zhabey di!

Financial Statement Analysis (FSA) was initially a pleasant experience.

The first 300 pages or so found me becoming increasingly able to decipher income / cash flow statements and balance sheets - documents that previously may as well have been written in Pashto.

And as I got deeper into Volume III, I had a chuckle at how naive my current method of screening stocks was starting to appear, which is based mostly on crunching historical ratios such as EPS, P/E, ROIC, and BV/S while totally the ignoring financial statements they come from.

But as I progressed beyond page 300, I became increasingly less amused. Volume III shifts here from teaching you how to simply read these statements into the myriad ways that what appears in them may be misleading and therefore needs to be adjusted in order to get the true picture.

And this continues, subsection after subsection, for about the next 250 freaking pages…

In some cases, adjustments are required just to get two companies’ statements drawn up by the same set of rules. Elsewhere, something seemingly minor, mentioned in a footnote, results in your doing some recalculations and seeing a company’s solvency in a totally different light.

So this should have been a happy time for me, right? Wasn’t that my goal, to become a more intelligent investor?

In truth, by the time I came through the other side of all these manipulations and re-adjustments around page 550, I was thoroughly demoralized.

With each passing chapter, I realized that my halcyon days of being able to decide in mere minutes whether or not to invest in a stock flagged by my screener were over.

I no longer trust my stock screeners to filter out bad stocks.

I no longer trust my stock screeners to NOT filter out good ones.

I no longer trust my computer scripts to crunch ratios to perform proper valuation to identify bargain buys.

And thanks very much Volume III for planting an additional seed of doubt. I’ve always liked businesses with consistent earnings, sales, and equity increases from year to year, because that told me that the biz had an economic moat and therefore a predictable future series of cash flows.

But you had to go and say that while that may be true, it can also be a sign that management is playing accounting tricks in order to smooth the annual numbers.

Yes, my whole investing modus operandi is in ruin. Sure I can still use my favorite parameters to make investing decisions, but I need to compute my own ratios which will come from my own adjusted financial statements for every bleeping company I look at.

The good news is that the CFA program has provided me with the tools to do this. The bad news is that you really have to dig to find the gotchas and then hope the ginkgo biloba helps you figure out what to do with them. I see little hope in automating this process.

So what do I do in the mean time?

Twice last week, I ended up selling stocks that were fully valued (though how can I be sure any longer?). But whereas I usually immediately replace one stock position with another, this time…

I ran my stock screener.

I examined the cheapest of what came out.

I crunched numbers.

I glanced at the companies’ financial statements.

I remembered the American Airlines example on page 527 of Volume III, where $10 billion of off-balance sheet debt changes the purported 0.9 debt-to-equity ratio to a hefty 2.3 instead.

I threw up my hands and bought a broad index ETF instead.

Bernstein would probably say I did the right thing. But me! Index funds! Oh the humanity…

I kept hearing a phrase from Joel Greenblatt’s Magic Formula book going through my head:

It’s not that I’m too lazy to do the financial statement digging and recalculations. But this is going to take some time to learn to do properly and efficiently. Till then I’m paralyzed!

For those following, I’m currently on pg. 637 of the massive 700 (content) pages of Volume III. I’m loving the readings on how to combine all the profitability, liquidity, and solvency ratios for thorough analysis. Even if my confidence in getting accurate ratios from the likes of any investing websites has been utterly destroyed.

One last admission. Those ETFs I bought? They were bond ETFs.

Utterly destroyed, I tell you!

Technorati Tags: Accounting, CFA, Chartered Financial Analyst, Investing, Stock Market

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

About 10 days back I finally finished up Economics (Volume II), took a hard look at the remaining 4 volumes, and wondered how in the world I could possibly be ready by test day (June 7).

So I did what thousands of Level One candidates before me have probably done. I wrote to the CFA Institute to ask if I could move my test date from June to December!

They quickly wrote back to let me know my options.

Can you “move out” your test date - from June to December?
No. You can however withdraw from the one you’re currently signed up for and register for the later one.

Do I get some or all of my money back?
Of course not. But Diermeier is getting some new shoes!

So what’s in it for me?
By withdrawing now, you are free to register for the December exam as soon as your form is processed (1-2 weeks). And as the Fee Schedule shows, the earlier you register, the less it costs. If you don’t withdraw, you have to wait until 60 days after the June exam before signing up.

Do I have to buy the study guides again?!
CFAI knows you’ve already got the 2008 curriculum. So regardless of whether you sign up for the December exam due to withdrawing from or failing June’s exam, they give you a US$50 credit to account for their not having to send you the study guides a second time.

More complete info regarding withdrawing can be found here.

Well-Rounded Candidate: Early A.M.

I haven’t decided yet what I’m going to do. Will probably give June a shot just for the practice - can’t imagine passing.

But a lot has happened in the past 10 days. I’m already about halfway through Financial Statement Analysis (Volume III) at page 355.

FSA has turned out to be much less dry than I expected. And it seems more applicable to day-to-day trading than Economics (which I still think is better suited for future business owners or Fed chairmen).

Apart from being more applicable, Volume III also has a fair dose of figures, tables, and optional sections that make the pages go by quickly.

I was expecting it to basically be a crash course in accounting. In part it is, but just when it starts to grow boring, they throw you a bone. Like taking a closer look at a set of example financial statements to see that even though a company is growing assets at a double-digit rate, equity is at a standstill (so liabilities are growing double-digit too).

I must give kudos to Jayanta Sen’s free CFA video lectures for giving me the right mindset for FSA. In one of his Accounting 101 videos he says there are two approaches to learning the material:

(1) Memorize all the rules in an ad hoc fashion

(2) Understand the basic concepts first, worry about the exact rules later

Well-Rounded Candidate: Late P.M.

It is so obvious in hindsight that (2) is the way to go.

But when you have your head down trying to cram for a test, like we all are, your brain tends to take the approach of “what do I need to memorize here for the exam”. That would be (1), definitely the hard way considering the quantity of rules - US and international.

There are grueling parts to FSA. The whole LIFO / FIFO conversion thing really slowed me to a crawl.

But it’s important to know how some of these parameters can calculate out to different values depending upon the accounting technique used. I’ve always plugged my parameter ranges into Yahoo Finance’s stock screener and accepted whatever it spits out pretty much at face value.

In conclusion, it’s very cool to begin to be able to decipher financial statements - especially looking up those of stocks you already own (favorite new diversion). I find it a lot like trying to read a newspaper in a foreign language that you’re learning. Some parts jump out and make perfect sense - others still a mystery until you’ve learned more.

Four months till test day!

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

Technorati Tags: Accounting, CFA, Chartered Financial Analyst, Investing, Stock Market

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

Sometimes I feel like I work for the CFA Institute’s Department of Propaganda…

Jeff Diermeier is the president and CEO of the CFA Institute. I found a couple of links this morning to interviews with him that I think both prospective & current CFA candidates might find interesting. I had never heard him speak before and thought he came across as a quiet professional, versus the shameless überpromoter other CEOs can be of their respective organizations.

The first is an audio podcast which you can get (hopefully) from
this link. If that doesn’t work click here, then download the episode called Bloomberg Interview: Jeff Diermeier, CFA.

The interview is from February 2006, about 15 minutes long, and covers such items as:

How many people who begin the CFA program complete it?
1 in 5

How has the exam changed over time?
Less economics now. Glad I waited!

Where is the biggest growth area in people pursuing the CFA?
Asia, which now has the same # of candidates as the USA. And since the test is only given in English, having a CFA designation can also be used to demonstrate English proficiency.

How do they decide how to update the curriculum?
They send out surveys to employers & charterholders. Most at the time of this interview were responding that the program should cover more on derivatives.

And what about the difference between a CFA and MBA?
Both are generalist programs, with the CFA being a generalist program within the investing field whereas the MBA is a generalist program in basic business management. Diermeier has both and thinks that’s a good combination in moving down a path of specialization.

And in a short discussion about Sarbanes-Oxley, Diermeier mentions something I didn’t know, that the vast majority of earnings restatements come from small cap companies.

The second link is a more recent Bloomberg interview, this time with video. It covers the same sort of topics but hits on a few new areas. A bit frustrating to watch actually, as they were obviously pressed for time so Diermeier is often interrupted.

Some highlights:

Charterholders earn >50% than those without the designation.
Unfortunately this isn’t really expanded upon. Assume this is on average?

Pass rates have trended downward in the last 3 decades. Why?
According to Diermeier, it’s due to 2 factors. One is that the investment industry has gotten harder with more topics like the derivatives, global aspects, etc., so the material is a bit harder. But he also seems to start to say that a second reason is because people don’t appear to be studying the curriculum as thoroughly, but gets interrupted. The average pass rate for all 3 tests is 50%.

With new material being added to the curriculum, what is getting dropped?
Diermeier just gives an example - that economics & accounting used to be on all 3 tests and now they’re only on 2 to leave more room for the broader forms of portfolio management. He seems to imply that some areas are cut to more of a “tool level” as opposed to perhaps coverage-in-full per a university course.

Best case scenario, how quickly can you pass all 3 tests?
2 years, but that’s only for passing the tests, not fulfilling the work experience requirements.

Is there a curve for the tests? Could everyone pass?
There is no curve. Theoretically everyone could pass if they knew the material, but the probability of that is low.

What is the average pay of a CFA charterholder?
Speaking purely in terms of average, $240,000 per year. Compare to average salary of a lawyer, which is $160,000 per year.

Motivated now?

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

Technorati Tags: CFA, Chartered Financial Analyst, Economics, Investing, Stock Market