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CFA Level I - Cheatsheet

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Section 1

CFA Level I - Cheatsheet

STUDY GUIDE

๐ŸŽ“ CFA Level I - Study Guide

๐Ÿ“‹ Course Structure

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๐Ÿ“š CFA Level I โ”œโ”€โ”€ ๐Ÿ“– Chapter 1: Alternative Investments - Features, Methods, and Performance โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Features and Categories of Alternative Investments โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Investment Methods: Direct, Co-Investment, and Fund Investment โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Investment Ownership and Compensation Structures โ”‚ โ””โ”€โ”€ ๐Ÿ”น Performance Appraisal and Return Calculations โ”œโ”€โ”€ ๐Ÿ“– Chapter 2: Investments in Specific Alternative Assets โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Private Capital: Equity and Debt โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Real Estate and Infrastructure โ”‚ โ””โ”€โ”€ ๐Ÿ”น Natural Resources and Digital Assets โ”œโ”€โ”€ ๐Ÿ“– Chapter 3: Portfolio Risk and Return - Foundations โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Characteristics of Major Asset Classes โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Risk Aversion and Portfolio Selection โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Portfolio Statistics: Mean, Variance, Covariance, and Correlation โ”‚ โ””โ”€โ”€ ๐Ÿ”น Portfolio Risk Reduction and the Efficient Frontier โ”œโ”€โ”€ ๐Ÿ“– Chapter 4: Portfolio Risk and Return - Advanced Concepts โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Systematic and Unsystematic Risk โ”‚ โ”œโ”€โ”€ ๐Ÿ”น The Capital Asset Pricing Model (CAPM) and the Security Market Line (SML) โ”‚ โ””โ”€โ”€ ๐Ÿ”น Performance Evaluation: Sharpe Ratio, Treynor Ratio, M-squared, and Jensen's Alpha โ”œโ”€โ”€ ๐Ÿ“– Chapter 5: Portfolio Management Process and Investor Types โ”‚ โ”œโ”€โ”€ ๐Ÿ”น The Portfolio Management Process โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Types of Investors and Their Characteristics โ”‚ โ””โ”€โ”€ ๐Ÿ”น Pension Plans and the Asset Management Industry โ”œโ”€โ”€ ๐Ÿ“– Chapter 6: Portfolio Planning and Construction - Behavioral Finance and Risk Management โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Developing an Investment Policy Statement (IPS) and Understanding Investment Constraints โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Integrating ESG Considerations into Portfolio Planning โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Behavioral Biases and Their Impact on Investment Decisions โ”‚ โ””โ”€โ”€ ๐Ÿ”น Risk Management Principles and Techniques โ”œโ”€โ”€ ๐Ÿ“– Chapter 7: Ethical and Professional Standards - Foundations โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Ethics and Trust in the Investment Profession โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Challenges to Ethical Behavior and Professionalism โ”‚ โ””โ”€โ”€ ๐Ÿ”น Ethical vs. Legal Standards and a Framework for Ethical Decision Making โ”œโ”€โ”€ ๐Ÿ“– Chapter 8: The CFA Institute Code of Ethics and Standards of Professional Conduct โ”‚ โ”œโ”€โ”€ ๐Ÿ”น Structure and Enforcement of the Code and Standards โ”‚ โ”œโ”€โ”€ ๐Ÿ”น The Code of Ethics โ”‚ โ”œโ”€โ”€ ๐Ÿ”น The Standards of Professional Conduct - I to III โ”‚ โ””โ”€โ”€ ๐Ÿ”น The Standards of Professional Conduct - IV to VII โ””โ”€โ”€ ๐Ÿ“– Chapter 9: Ethics Application and Case Studies โ””โ”€โ”€ ๐Ÿ”น Application of the Code and Standards Through Case Studies
Section 2

๐Ÿ“– Chapter 1: Alternative Investments - Features, Methods, and Performance

What this chapter covers: This chapter introduces alternative investments, contrasting them with traditional investments. It explores various categories like private capital, real assets, and hedge funds, detailing their characteristics and investment methods. It also discusses performance appraisal and return calculations specific to alternative investments, highlighting the J-curve effect and the impact of fees.

๐Ÿ”‘ Essential Concepts & Applications

Concept/PrincipleDefinition/ExplanationApplicationsExam Relevance
Alternative InvestmentsAssets beyond traditional cash, stocks, bonds. Includes private equity, real estate, hedge funds.Portfolio diversification, higher potential returns.Identifying characteristics, differentiating from traditional assets.
J-Curve EffectInitial negative returns followed by increasing returns in alternative investments.Performance appraisal, understanding early-stage losses.Interpreting return patterns, understanding illiquidity.
Management FeesFees charged by fund managers, typically based on committed capital (private equity) or AUM (hedge funds).Calculating investor returns, comparing fund costs.Calculating after-fee returns, analyzing fee structures.

๐Ÿ› ๏ธ Problem Solving

Problem Type A: Calculating After-Fee Returns Setup: "Given management fees, performance fees, hurdle rates, and fund returns." Method: Calculate management fees, subtract from gross return, apply hurdle rate (if applicable), calculate performance fee, subtract from net return. Example: A hedge fund has a 30% return before fees. Management fee is 1.5% on end-of-year value, and a 15% incentive fee with an 8% hard hurdle rate. Calculate the return after fees.

Problem Type B: Identifying Investment Methods Setup: "Given a scenario describing an investment in an alternative asset." Method: Determine if the investment is direct, co-investment, or fund investment based on the level of control and involvement. Example: A sovereign wealth fund directly investing in agricultural land is an example of direct investing.

๐Ÿงฎ Solved Example

Problem: A hedge fund has a value of 110millionatinitiation.Itchargesa2110 million at initiation. It charges a 2% management fee based on assets under management at the beginning of the year and a 20% performance fee with a 5% soft hurdle rate. The year-end value before fees is 119 million. Calculate the total fees and the investor's after-fee return.

Given: Initial Value: 110millionManagementFee:2PerformanceFee:20HurdleRate:5Yearโˆ’EndValue:110 million Management Fee: 2% Performance Fee: 20% Hurdle Rate: 5% Year-End Value: 119 million

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โœ…
Solution: 1. Management Fee = 0.02 * 110million=110 million = 2.2 million
  1. Return Before Performance Fee = 119millionโˆ’119 million - 110 million - 2.2million=2.2 million = 6.8 million
  2. Hurdle Amount = 0.05 * 110million=110 million = 5.5 million
  3. Performance Fee = 0.20 * (6.8millionโˆ’6.8 million - 5.5 million) = $0.26 million
  4. Total Fees = 2.2million+2.2 million + 0.26 million = $2.46 million
  5. After-Fee Return = (119millionโˆ’119 million - 110 million - 2.46million)/2.46 million) / 110 million = 5.85%
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โœ…
Answer: The total fees are $2.46 million, and the investor's after-fee return is 5.85%.

โš ๏ธ Common Mistakes

โŒ Mistake 1: Forgetting to subtract management fees before calculating performance fees. โœ… How to avoid: Always calculate and subtract management fees before applying hurdle rates and calculating performance fees.

โŒ Mistake 2: Misinterpreting hurdle rates (hard vs. soft). โœ… How to avoid: Understand the difference. Hard hurdle means performance fees are only earned on returns above the hurdle. Soft hurdle means performance fees are earned on all returns if the hurdle is met.

๐Ÿฆ Erik's Tip

Pay close attention to the fee structures and how they impact investor returns. Practice calculating after-fee returns under different scenarios to master this concept.

๐Ÿ“– Chapter 2: Investments in Specific Alternative Assets

What this chapter covers: This chapter explores specific alternative investments, including private capital (equity and debt), real estate, infrastructure, natural resources, and digital assets. It outlines the features, investment characteristics, and potential benefits and risks associated with each asset class.

๐Ÿ”‘ Essential Concepts & Applications

Concept/PrincipleDefinition/ExplanationApplicationsExam Relevance
Leveraged Buyout (LBO)Acquisition of an established company using debt financing.Private equity investing, increasing company value.Identifying LBO characteristics, understanding exit strategies.
Real Estate Investment Trust (REIT)A company that owns or finances income-producing real estate.Indirect real estate investing, generating income from properties.Differentiating REITs from direct real estate investments.
Digital AssetsIncludes cryptocurrencies, tokens, and digital collectibles, secured by blockchain technology.Diversifying portfolios, investing in emerging technologies.Understanding cryptocurrency types, assessing risks and returns.

๐Ÿ› ๏ธ Problem Solving

Problem Type A: Evaluating Exit Strategies for Private Equity Setup: "Given a scenario describing a private equity investment." Method: Determine the most suitable exit strategy (trade sale, IPO, recapitalization, secondary sale) based on the company's performance and market conditions. Example: A private equity firm invests in a technology company and plans to exit after 5 years. The company has strong growth and profitability. An IPO might be a suitable exit strategy.

Problem Type B: Assessing Infrastructure Investment Risks Setup: "Given a description of an infrastructure project." Method: Identify the key risks associated with the project, such as construction risk, regulatory risk, and demand risk. Example: A greenfield infrastructure project involves building a new toll road. Construction delays and cost overruns are potential risks.

๐Ÿงฎ Solved Example

Problem: A private equity fund invests 50millioninacompany.After5years,thecompanyissoldfor50 million in a company. After 5 years, the company is sold for 150 million. Calculate the multiple of invested capital (MOIC).

Given: Investment: 50millionSaleValue:50 million Sale Value: 150 million

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โœ…
Solution: MOIC = Sale Value / Investment = 150million/150 million / 50 million = 3.0
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โœ…
Answer: The multiple of invested capital is 3.0.

โš ๏ธ Common Mistakes

โŒ Mistake 1: Confusing greenfield and brownfield infrastructure investments. โœ… How to avoid: Remember that greenfield projects involve new construction, while brownfield projects involve existing assets.

โŒ Mistake 2: Overlooking the risks associated with digital assets. โœ… How to avoid: Understand that digital assets are highly volatile and subject to regulatory uncertainty.

๐Ÿฆ Erik's Tip

Focus on understanding the unique characteristics and risks of each alternative asset class. Be prepared to compare and contrast different investment options.

๐Ÿ“– Chapter 3: Portfolio Risk and Return - Foundations

What this chapter covers: This chapter lays the groundwork for portfolio management by examining the characteristics of major asset classes, exploring risk aversion, and detailing the process of selecting an optimal portfolio. It introduces key concepts such as the capital allocation line and the calculation of portfolio statistics.

๐Ÿ”‘ Essential Concepts & Applications

Concept/PrincipleDefinition/ExplanationApplicationsExam Relevance
Risk AversionThe degree to which an investor dislikes risk.Portfolio selection, determining asset allocation.Understanding investor preferences, identifying suitable investments.
Capital Allocation Line (CAL)Represents the possible combinations of risk and return achievable by combining a risky portfolio with a risk-free asset.Portfolio construction, optimizing risk-return tradeoff.Identifying the optimal portfolio on the CAL.
CovarianceMeasures the extent to which two variables move together.Portfolio diversification, reducing portfolio risk.Calculating portfolio variance, understanding correlation.

๐Ÿ› ๏ธ Problem Solving

Problem Type A: Calculating Portfolio Standard Deviation Setup: "Given the weights, standard deviations, and correlation of two assets." Method: Use the formula for portfolio standard deviation: ฯƒp = โˆš(w1^2ฯƒ1^2 + w2^2ฯƒ2^2 + 2w1w2ฯ1,2ฯƒ1ฯƒ2) Example: Calculate the standard deviation of a portfolio with 60% in stocks (ฯƒ = 15%) and 40% in bonds (ฯƒ = 5%), with a correlation of 0.3.

Problem Type B: Identifying the Optimal Portfolio on the CAL Setup: "Given an investor's risk aversion and the characteristics of the CAL." Method: Choose the portfolio on the CAL that maximizes the investor's utility, considering their risk aversion. Example: An investor with high risk aversion will prefer a portfolio with a lower allocation to the risky asset on the CAL.

๐Ÿงฎ Solved Example

Problem: Calculate the expected return of a portfolio with 70% in stocks (expected return = 10%) and 30% in bonds (expected return = 3%).

Given: Stock Weight: 70% Stock Return: 10% Bond Weight: 30% Bond Return: 3%

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โœ…
Solution: Portfolio Return = (0.70 * 0.10) + (0.30 * 0.03) = 0.07 + 0.009 = 0.079
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โœ…
Answer: The expected return of the portfolio is 7.9%.

โš ๏ธ Common Mistakes

โŒ Mistake 1: Using simple weighted average for portfolio standard deviation (ignoring correlation). โœ… How to avoid: Remember to use the correct formula that includes covariance or correlation.

โŒ Mistake 2: Misinterpreting risk aversion and its impact on portfolio selection. โœ… How to avoid: Understand that more risk-averse investors prefer portfolios with lower risk.

๐Ÿฆ Erik's Tip

Master the formulas for calculating portfolio statistics. Practice applying these formulas to different portfolio scenarios.

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