2018 CFA level 2 study note book1 unprotected

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Getting Started Flyer
Table of Contents
Page List
Book 1: Ethical and Professional Standards, Quantitative Methods, and
Economics
Welcome to the 2017 Level II SchweserNotes™
Readings and Learning Outcome Statements
Code of Ethics and Standards of Professional Conduct
1. LOS 1.a: Describe the six components of the Code of Ethics and the seven
Standards of Professional Conduct.
2. LOS 1.b: Explain the ethical responsibilities required of CFA Institute
members and candidates in the CFA Program by the Code and Standards.
3. LOS 2.a: Demonstrate a thorough knowledge of the Code of Ethics and
Standards of Professional Conduct by applying the Code and Standards to

specific situations.
4. LOS 2.b: Recommend practices and procedures designed to prevent
violations of the Code of Ethics and Standards of Professional Conduct.
5. Key Concepts
1. LOS 1.a, b
6. Concept Checkers
1. Answers – Concept Checkers
CFA Institute Research Objectivity Standards
1. LOS 3.a: Explain the objectives of the Research Objectivity Standards.
2. LOS 3.b: Evaluate company policies and practices related to research
objectivity, and distinguish between changes required and changes
recommended for compliance with the Research Objectivity Standards.
3. Key Concepts
1. LOS 3.a
2. LOS 3.b
4. Concept Checkers
1. Answers – Concept Checkers
The Glenarm Company
1. LOS 4.a: Evaluate the practices and policies presented.
2. LOS 4.b: Explain the appropriate action to take in response to conduct that
violates the CFA Institute Code of Ethics and Standards of Professional
Conduct.
Preston Partners
1. LOS 5.a: Evaluate the practices and policies presented.
2. LOS 5.b: Explain the appropriate action to take in response to conduct that
violates the CFA Institute Code of Ethics and Standards of Professional


Conduct.
11. Super Selection

1. LOS 6.a: Evaluate the practices and policies presented.
2. LOS 6.b: Explain the appropriate action to take in response to conduct that
violates the CFA Institute Code of Ethics and Standards of Professional
Conduct.
12. Trade Allocation: Fair Dealing and Disclosure
1. LOS 7.a: Evaluate trade allocation practices and determine whether they
comply with the CFA Institute Standards of Professional Conduct
addressing fair dealing and client loyalty.
2. LOS 7.b: Describe appropriate actions to take in response to trade
allocation practices that do not adequately respect client interests.
13. Changing Investment Objectives
1. LOS 8.a: Evaluate the disclosure of investment objectives and basic policies
and determine whether they comply with the CFA Institute Standards of
Professional Conduct.
2. LOS 8.b: Describe appropriate actions needed to ensure adequate
disclosure of the investment process.
14. Self-Test: Ethics and Professional Standards
1. Self-Test Answers: Ethics and Professional Standards
15. Correlation and Regression
1. LOS 9.a: Calculate and interpret a sample covariance and a sample
correlation coefficient and interpret a scatter plot.
2. LOS 9.b: Describe limitations to correlation analysis.
3. LOS 9.c: Formulate a test of the hypothesis that the population correlation
coefficient equals zero and determine whether the hypothesis is rejected
at a given level of significance.
4. LOS 9.d: Distinguish between the dependent and independent variables in
a linear regression.
5. LOS 9.e: Describe the assumptions underlying linear regression and
interpret regression coefficients.
6. LOS 9.f: Calculate and interpret the standard error of estimate, the

coefficient of determination, and a confidence interval for a regression
coefficient.
7. LOS 9.g: Formulate a null and alternative hypothesis about a population
value of a regression coefficient and determine the appropriate test
statistic and whether the null hypothesis is rejected at a given level of
significance.
8. LOS 9.h: Calculate the predicted value for the dependent variable, given an
estimated regression model and a value for the independent variable.
9. LOS 9.i: Calculate and interpret a confidence interval for the predicted
value of the dependent variable.
10. LOS 9.j: Describe the use of analysis of variance (ANOVA) in regression
analysis, interpret ANOVA results, and calculate and interpret the F-


statistic.
11. LOS 9.k: Describe limitations of regression analysis.
12. Key Concepts
1. LOS 9.a
2. LOS 9.b
3. LOS 9.c
4. LOS 9.d
5. LOS 9.e
6. LOS 9.f
7. LOS 9.g
8. LOS 9.h
9. LOS 9.i
10. LOS 9.j
11. LOS 9.k
13. Concept Checkers
1. Answers – Concept Checkers

14. Challenge Problems
1. Answers – Challenge Problems
16. Multiple Regression and Issues in Regression Analysis
1. LOS 10.a: Formulate a multiple regression equation to describe the relation
between a dependent variable and several independent variables and
determine the statistical significance of each independent variable.
2. LOS 10.b: Interpret estimated regression coefficients and their p-values.
3. LOS 10.c: Formulate a null and an alternative hypothesis about the
population value of a regression coefficient, calculate the value of the test
statistic, and determine whether to reject the null hypothesis at a given
level of significance.
4. LOS 10.d: Interpret the results of hypothesis tests of regression
coefficients.
5. LOS 10.e: Calculate and interpret 1) a confidence interval for the
population value of a regression coefficient and 2) a predicted value for the
dependent variable, given an estimated regression model and assumed
values for the independent variables.
6. LOS 10.f: Explain the assumptions of a multiple regression model.
7. LOS 10.g: Calculate and interpret the F-statistic, and describe how it is used
in regression analysis.
8. LOS 10.h: Distinguish between and interpret the R2 and adjusted R2 in
multiple regression.
9. LOS 10.i: Evaluate how well a regression model explains the dependent
variable by analyzing the output of the regression equation and an ANOVA
table.
10. LOS 10.j: Formulate a multiple regression equation by using dummy
variables to represent qualitative factors and interpret the coefficients and
regression results.

11. LOS 10.k: Explain the types of heteroskedasticity and how
heteroskedasticity and serial correlation affect statistical inference.
12. LOS 10.l: Describe multicollinearity and explain its causes and effects in
regression analysis.
13. LOS 10.m: Describe how model misspecification affects the results of a
regression analysis and describe how to avoid common forms of
misspecification.
14. LOS 10.n: Describe models with qualitative dependent variables.
15. LOS 10.o: Evaluate and interpret a multiple regression model and its
results.
16. Key Concepts
1. LOS 10.a
2. LOS 10.b
3. LOS 10.c
4. LOS 10.d
5. LOS 10.e
6. LOS 10.f
7. LOS 10.g
8. LOS 10.h
9. LOS 10.i
10. LOS 10.j
11. LOS 10.k, l
12. LOS 10.m
13. LOS 10.n
14. LOS 10.o
17. Concept Checkers
1. Answers – Concept Checkers
18. Challenge Problems
1. Answers – Challenge Problems
17. Time-Series Analysis

1. LOS 11.a: Calculate and evaluate the predicted trend value for a time
series, modeled as either a linear trend or a log-linear trend, given the
estimated trend coefficients.
2. LOS 11.b: Describe factors that determine whether a linear or a log-linear
trend should be used with a particular time series and evaluate limitations
of trend models.
3. LOS 11.c: Explain the requirement for a time series to be covariance
stationary and describe the significance of a series that is not stationary.
4. LOS 11.d: Describe the structure of an autoregressive (AR) model of order p
and calculate one- and two-period-ahead forecasts given the estimated
coefficients.
5. LOS 11.e: Explain how autocorrelations of the residuals can be used to test
whether the autoregressive model fits the time series.
6. LOS 11.f: Explain mean reversion and calculate a mean-reverting level.


7. LOS 11.g: Contrast in-sample and out-of-sample forecasts and compare the
forecasting accuracy of different time-series models based on the root
mean squared error criterion.
8. LOS 11.h: Explain the instability of coefficients of time-series models.
9. LOS 11.i: Describe characteristics of random walk processes and contrast
them to covariance stationary processes.
10. LOS 11.j: Describe implications of unit roots for time-series analysis, explain
when unit roots are likely to occur and how to test for them, and
demonstrate how a time series with a unit root can be transformed so it
can be analyzed with an AR model.
11. LOS 11.k: Describe the steps of the unit root test for nonstationarity and
explain the relation of the test to autoregressive time-series models.
12. LOS 11.l: Explain how to test and correct for seasonality in a time-series
model and calculate and interpret a forecasted value using an AR model

with a seasonal lag.
13. LOS 11.m: Explain autoregressive conditional heteroskedasticity (ARCH)
and describe how ARCH models can be applied to predict the variance of a
time series.
14. LOS 11.n: Explain how time-series variables should be analyzed for
nonstationarity and/or cointegration before use in a linear regression.
15. LOS 11.o: Determine an appropriate time-series model to analyze a given
investment problem and justify that choice.
16. Key Concepts
1. LOS 11.a
2. LOS 11.b
3. LOS 11.c
4. LOS 11.d
5. LOS 11.e
6. LOS 11.f
7. LOS 11.g
8. LOS 11.h
9. LOS 11.i
10. LOS 11.j
11. LOS 11.k
12. LOS 11.l
13. LOS 11.m
14. LOS 11.n
15. LOS 11.o
17. Concept Checkers
1. Answers – Concept Checkers
18. Probabilistic Approaches: Scenario Analysis, Decision Trees, and Simulations
1. LOS 12.a: Describe steps in running a simulation.
2. LOS 12.b: Explain three ways to define the probability distributions for a
simulation’s variables.

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LOS 12.c: Describe how to treat correlation across variables in a simulation.
LOS 12.d: Describe advantages of using simulations in decision making.
LOS 12.e: Describe some common constraints introduced into simulations.
LOS 12.f: Describe issues in using simulations in risk assessment.
LOS 12.g: Compare scenario analysis, decision trees, and simulations.
Key Concepts
1. LOS 12.a
2. LOS 12.b
3. LOS 12.c
4. LOS 12.d
5. LOS 12.e
6. LOS 12.f
7. LOS 12.g
9. Concept Checkers
1. Answers – Concept Checkers
19. Self-Test: Quantitative Methods for Valuation
1. Self-Test Answers: Quantitative Methods for Valuation
20. Currency Exchange Rates: Understanding Equilibrium Value
1. LOS 13.a: Calculate and interpret the bid–offer spread on a spot or forward

currency quotation and describe the factors that affect the bid–offer
spread.
2. LOS 13.b: Identify a triangular arbitrage opportunity and calculate its profit,
given the bid–offer quotations for three currencies.
3. LOS 13.c: Distinguish between spot and forward rates and calculate the
forward premium/discount for a given currency.
4. LOS 13.d: Calculate the mark-to-market value of a forward contract.
5. LOS 13.e: Explain international parity conditions (covered and uncovered
interest rate parity, forward rate parity, purchasing power parity, and the
international Fisher effect).
6. LOS 13.f: Describe relations among the international parity conditions.
7. LOS 13.g: Evaluate the use of the current spot rate, the forward rate,
purchasing power parity, and uncovered interest parity to forecast future
spot exchange rates.
8. LOS 13.h: Explain approaches to assessing the long-run fair value of an
exchange rate.
9. LOS 13.i: Describe the carry trade and its relation to uncovered interest
rate parity and calculate the profit from a carry trade.
10. LOS 13.j: Explain how flows in the balance of payment accounts affect
currency exchange rates.
11. LOS 13.k: Explain the potential effects of monetary and fiscal policy on
exchange rates.
12. LOS 13.l: Describe objectives of central bank or government intervention
and capital controls and describe the effectiveness of intervention and
capital controls.


13. LOS 13.m: Describe warning signs of a currency crisis.
14. Key Concepts
1. LOS 13.a

2. LOS 13.b
3. LOS 13.c
4. LOS 13.d
5. LOS 13.e
6. LOS 13.f
7. LOS 13.g, h
8. LOS 13.i
9. LOS 13.j
10. LOS 13.k
11. LOS 13.l
12. LOS 13.m
15. Concept Checkers
1. Answers – Concept Checkers
16. Challenge Problems
1. Answers – Challenge Problems
21. Economic Growth and the Investment Decision
1. LOS 14.a: Compare factors favoring and limiting economic growth in
developed and developing economies.
2. LOS 14.b: Describe the relation between the long-run rate of stock market
appreciation and the sustainable growth rate of the economy.
3. LOS 14.c: Explain why potential GDP and its growth rate matter for equity
and fixed income investors.
4. LOS 14.d: Distinguish between capital deepening investment and
technological progress and explain how each affects economic growth and
labor productivity.
5. LOS 14.e: Forecast potential GDP based on growth accounting relations.
6. LOS 14.f: Explain how natural resources affect economic growth and
evaluate the argument that limited availability of natural resources
constrains economic growth.
7. LOS 14.g: Explain how demographics, immigration, and labor force

participation affect the rate and sustainability of economic growth.
8. LOS 14.h: Explain how investment in physical capital, human capital, and
technological development affects economic growth.
9. LOS 14.i: Compare classical growth theory, neoclassical growth theory, and
endogenous growth theory.
10. LOS 14.j: Explain and evaluate convergence hypotheses.
11. LOS 14.k: Describe the economic rationale for governments to provide
incentives to private investment in technology and knowledge.
12. LOS 14.l: Describe the expected impact of removing trade barriers on
capital investment and profits, employment and wages, and growth in the
economies involved.


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13. Key Concepts
1. LOS 14.a
2. LOS 14.b
3. LOS 14.c
4. LOS 14.d
5. LOS 14.e
6. LOS 14.f
7. LOS 14.g
8. LOS 14.h
9. LOS 14.i
10. LOS 14.j

11. LOS 14.k
12. LOS 14.l
14. Concept Checkers
1. Answers – Concept Checkers
Economics of Regulation
1. LOS 15.a: Describe classifications of regulations and regulators.
2. LOS 15.b: Describe uses of self-regulation in financial markets.
3. LOS 15.c: Describe the economic rationale for regulatory intervention.
4. LOS 15.d: Describe regulatory interdependencies and their effects.
5. LOS 15.e: Describe tools of regulatory intervention in markets.
6. LOS 15.f: Explain purposes in regulating commerce and financial markets.
7. LOS 15.g: Describe anticompetitive behaviors targeted by antitrust laws
globally and evaluate the antitrust risk associated with a given business
strategy.
8. LOS 15.h: Describe benefits and costs of regulation.
9. LOS 15.i: Evaluate how a specific regulation affects an industry, company,
or security.
10. Key Concepts
1. LOS 15.a
2. LOS 15.b
3. LOS 15.c
4. LOS 15.d
5. LOS 15.e
6. LOS 15.f
7. LOS 15.g
8. LOS 15.h
9. LOS 15.i
11. Concept Checkers
1. Answers – Concept Checkers
Self-Test: Economics for Valuation

1. Self-Test Answers: Economics for Valuation
Formulas
Appendix A: Student’s T-Distribution


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Appendix B: F-Table at 5 Percent (Upper Tail)
Appendix C: F-Table at 2.5 Percent (Upper Tail)
Appendix D: Chi-Squared Table
Appendix E: Critical Values for the Durbin-Watson Statistic
Copyright


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BOOK 1 – ETHICAL AND PROFESSIONAL STANDARDS,
QUANTITATIVE METHODS, AND ECONOMICS
Readings and Learning Outcome Statements
Study Session 1 – Ethical and Professional Standards
Study Session 2 – Ethical and Professional Standards: Application
Self-Test: Ethical and Professional Standards
Study Session 3 – Quantitative Methods for Valuation
Self-Test: Quantitative Methods for Valuation
Study Session 4 – Economics for Valuation
Self-Test: Economics for Valuation
Formulas
Appendices


WELCOME TO THE 2017 LEVEL II
SCHWESERNOTES™
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Dr. Bijesh Tolia, CFA, CA
VP of CFA Education and Level II Manager
Kaplan Schweser


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READINGS AND LEARNING OUTCOME STATEMENTS
READINGS
The following material is a review of the Ethical and Professional Standards,
Quantitative Methods, and Economics principles designed to address the learning
outcome statements set forth by CFA Institute.

STUDY SESSION 1
Reading Assignments
Ethical and Professional Standards, CFA Program Curriculum, Volume 1, Level II (CFA
Institute, 2017)
1. Code of Ethics and Standards of Professional Conduct (page 1)
2. Guidance for Standards I–VII (page 1)
3. CFA Institute Research Objectivity Standards (page 80)

STUDY SESSION 2
Reading Assignments
Ethical and Professional Standards, CFA Program Curriculum, Volume 1, Level II
(CFA Institute, 2017)
4. The Glenarm Company (page 90)

5. Preston Partners (page 92)
6. Super Selection (page 95)
7. Trade Allocation: Fair Dealing and Disclosure (page 98)
8. Changing Investment Objectives (page 100)

STUDY SESSION 3
Reading Assignments
Quantitative Methods for Valuation, CFA Program Curriculum, Volume 1, Level II (CFA
Institute, 2017)
9. Correlation and Regression (page 111)
10. Multiple Regression and Issues in Regression Analysis (page 146)
11. Time-Series Analysis (page 194)


X VY

12. Excerpt from “Probabilistic Approaches: Scenario Analysis, Decision Trees,
and Simulations” (page 231)

STUDY SESSION 4
Reading Assignments
Economics for Valuation, CFA Program Curriculum, Volume 1, Level II (CFA Institute,
2017)
13. Currency Exchange Rates: Understanding Equilibrium Value (page 246)
14. Economic Growth and the Investment Decision (page 284)
15. Economics of Regulation (page 305)

LEARNING OUTCOME STATEMENTS (LOS)
The CFA Institute Learning Outcome Statements are listed below. These are repeated in
each topic review; however, the order may have been changed in order to get a better

fit with the flow of the review.

STUDY SESSION 1
The topical coverage corresponds with the following CFA Institute assigned
reading:
1. CFA Institute Code of Ethics and Standards of Professional Conduct
The candidate should be able to:
a. describe the six components of the Code of Ethics and the seven Standards
of Professional Conduct. (page 1)
b. explain the ethical responsibilities required of CFA Institute members and
candidates in the CFA Program by the Code and Standards. (page 2)
The topical coverage corresponds with the following CFA Institute assigned
reading:
2. Guidance for Standards I–VII
The candidate should be able to:
a. demonstrate a thorough knowledge of the Code of Ethics and Standards of
Professional Conduct by applying the Code and Standards to specific
situations. (page 5)
b. recommend practices and procedures designed to prevent violations of the
Code of Ethics and Standards of Professional Conduct. (page 5)


The topical coverage corresponds with the following CFA Institute assigned
reading:
3. CFA Institute Research Objectivity Standards
The candidate should be able to:
a. explain the objectives of the Research Objectivity Standards. (page 80)
b. evaluate company policies and practices related to research objectivity,
and distinguish between changes required and changes recommended for
compliance with the Research Objectivity Standards. (page 81)

STUDY SESSION 2
The topical coverage corresponds with the following CFA Institute assigned
reading:
4. The Glenarm Company
The candidate should be able to:
a. evaluate the practices and policies presented. (page 90)
b. explain the appropriate action to take in response to conduct that violates
the CFA Institute Code of Ethics and Standards of Professional Conduct.
(page 90)
The topical coverage corresponds with the following CFA Institute assigned
reading:
5. Preston Partners
The candidate should be able to:
a. evaluate the practices and policies presented. (page 92)
b. explain the appropriate action to take in response to conduct that violates
the CFA Institute Code of Ethics and Standards of Professional Conduct
(page 92)
The topical coverage corresponds with the following CFA Institute assigned
reading:
6. Super Selection
The candidate should be able to:
a. evaluate the practices and policies presented. (page 95)
b. explain the appropriate action to take in response to conduct that violates
the CFA Institute Code of Ethics and Standards of Professional Conduct.
(page 95)