Free CFA Level I Exam Flashcards

Members and candidates must put client interests and the integrity of the investment profession ahead of personal interests. The exam often tests this as a duty of conduct, not as a return-maximization rule.

Follow the strictest applicable rule when laws, regulations, and the CFA Institute Standards differ. When uncertain, seek guidance and avoid conduct that may violate the applicable standard.

Investment professionals owe loyalty to the client or beneficiary whose assets they manage. For pension assets, that duty runs to plan participants and beneficiaries, not merely to the plan sponsor.

Clients must be treated fairly and objectively when recommendations are made or investment actions are taken. Fair dealing allows different actions for different mandates, but not favoritism in access or execution.

Information is material if a reasonable investor would consider it important, and nonpublic if it has not been broadly disseminated. Trading or causing others to trade on it violates market integrity duties.

Cash flows are comparable only after moving them to the same date with compounding or discounting. A higher discount rate lowers present value, while more frequent compounding raises future value for a stated annual rate.

The arithmetic mean summarizes a single-period average return. The geometric mean captures compound growth over multiple periods and is lower when returns vary across periods.

Variance measures average squared dispersion from the mean. Standard deviation is the square root of variance, so it returns risk to the same units as the original return series.

A p-value is the probability of observing a result at least as extreme as the sample result if the null hypothesis is true. A smaller p-value gives stronger evidence against the null.

Correlation measures the direction and strength of a linear relationship between two variables. It is unitless, bounded from -1 to +1, and does not by itself prove causation.

Elasticity compares percentage change in quantity demanded with percentage change in price. Demand is more elastic when buyers have close substitutes, time to adjust, or a large budget impact.

A perfectly competitive firm is a price taker and maximizes profit where marginal revenue equals marginal cost. In long-run equilibrium, economic profit is competed away.

Expansionary policy is intended to increase aggregate demand by easing financial conditions. It may lower interest rates, encourage credit creation, and weaken the currency relative to tighter policy.

Purchasing power parity links exchange-rate changes to inflation differences. A country with higher inflation is expected to see its currency depreciate over time, all else equal.

Crowding out occurs when government borrowing pushes up interest rates and reduces private investment. The effect is more likely when the economy is near capacity and capital markets are sensitive to rates.

Accrual accounting records revenue when earned and expenses when incurred, not necessarily when cash moves. This creates timing differences that analysts must reconcile with cash flow.

The indirect method starts with net income, adds back noncash expenses, and adjusts for working capital changes. Increases in operating assets reduce CFO; increases in operating liabilities increase CFO.

When input prices rise, FIFO reports lower cost of goods sold and higher ending inventory than LIFO. Analysts compare methods because inventory accounting affects margins, taxes, and working capital ratios.

DuPont analysis decomposes return on equity into profitability, efficiency, and leverage drivers. It helps identify whether ROE changed because margins, asset turnover, or financial leverage changed.

High-quality reporting faithfully represents economic performance and is sustainable. Warning signs include aggressive revenue recognition, delayed expense recognition, unusual related-party transactions, and weak disclosure.

A project with positive NPV is expected to add value because discounted future cash flows exceed the initial investment. NPV is preferred because it measures value in currency terms.

IRR is the discount rate that sets project NPV to zero. It is intuitive but can mislead when projects are mutually exclusive, have unusual cash flow signs, or differ in scale.

WACC blends the required returns of debt and equity using market-value weights. After-tax cost of debt is used because interest expense usually creates a tax shield.

Working capital management balances liquidity against return. More inventory and receivables can support sales, but they also tie up cash and may signal collection or demand problems.

Financial leverage uses fixed financing costs to magnify changes in returns to equity. It can raise expected ROE when operating returns exceed borrowing costs, but it also increases downside risk.

A market-cap weighted index gives larger companies more influence because weights are based on total market value. Rebalancing is limited, but concentration can rise when a few large stocks dominate.

Weak-form efficiency reflects past market data, semi-strong reflects public information, and strong-form reflects public and private information. The stronger the form, the harder it is to earn abnormal returns from information.

The Gordon model values equity as next period dividend divided by required return minus constant growth. It is most appropriate for stable dividend payers with sustainable growth below the required return.

The P/E multiple compares share price with earnings per share. A high P/E may reflect growth expectations, lower risk, or overvaluation, so analysts compare it with fundamentals and peers.

Common stock usually carries voting rights and residual claims. Preferred stock typically has dividend and liquidation priority over common stock but often has limited voting rights.

Bond prices move inversely with required yields. When market yields rise, existing fixed coupon payments become less attractive, so the bond price falls.

Duration estimates a bond price's sensitivity to a change in yield. Higher duration means greater interest-rate risk, especially for longer maturities and lower coupon bonds.

Convexity captures curvature in the bond price-yield relationship. Positive convexity means price gains from falling yields are larger than price losses from equal-sized yield increases, all else equal.

A credit spread is the yield premium over a benchmark bond for credit and liquidity risk. Wider spreads generally signal higher perceived default risk or weaker market liquidity.

A callable bond lets the issuer redeem debt before maturity. The call feature benefits the issuer, so investors usually require compensation through a higher yield or lower price.

A forward contract is a private agreement to buy or sell an asset at a set price on a future date. It is customized and exposes each party to counterparty risk.

A futures contract is standardized and exchange traded, with margin and daily settlement. These features reduce counterparty risk compared with a customized forward contract.

A call option gives the holder the right to buy the underlying asset at the exercise price. At expiration, its payoff is positive only when the underlying price exceeds the exercise price.

A put option gives the holder the right to sell the underlying asset at the exercise price. At expiration, its payoff is positive only when the underlying price is below the exercise price.

In a plain interest rate swap, one party pays a fixed rate and receives a floating rate, while the other does the opposite. Swaps are often used to manage interest-rate exposure.

Hedge funds often use flexible strategies, leverage, derivatives, and short selling. They may offer diversification benefits, but investors must evaluate fees, liquidity limits, transparency, and manager risk.

Private equity invests in companies outside public markets or takes public companies private. Returns depend on operational improvement, leverage, exit valuation, and timing.

A capitalization rate converts expected property income into value. A lower cap rate implies a higher value for the same income stream, often reflecting lower required return or stronger growth expectations.

Commodity exposure can come from spot price changes, collateral return, and roll yield in futures-based strategies. Storage costs, convenience yield, and curve shape affect roll yield.

Many alternatives are less liquid than public stocks and bonds. Limited liquidity can support a return premium, but it also raises valuation, rebalancing, and redemption risk.

Diversification reduces unsystematic risk by combining assets whose returns are not perfectly correlated. It cannot eliminate market-wide systematic risk.

A risk-averse investor requires higher expected return to accept higher risk. This does not mean the investor avoids all risk; it means risk must be compensated.

Strategic allocation sets long-term policy weights based on objectives, constraints, and capital market expectations. It is the baseline portfolio plan rather than a short-term market call.

Tactical allocation is a deliberate short-term deviation from strategic weights to exploit perceived opportunities. It requires skill because wrong timing can add risk and costs.

Rebalancing restores portfolio weights toward policy targets after market movements. It controls unintended risk drift, though it may create transaction costs and taxes.