STUDY SESSION

Code of ethics
o Acting with integrity, competence, diligence, respect, and in
an ethical manner with the public, clients, prospective clients,
employers, employees, colleagues, in the investment
professional, and other participants in the global capital
markets.
o Placing the integrity of the investment profession and the
interests of clients above their own personal interests.
o Using reasonable care and exercise independent professional
judgment when conducting investment analysis, making
investment recommendations, taking investment actions, and
engaging in other professional activities.
o Practicing and encouraging others to practice in a professional
and ethical manner which reflects credit on themselves and
their profession.
o Promoting the integrity of, and upholding the rules governing,
capital markets.
o Maintaining and improving their professional competence and
strive to maintain and improve the competence of other
investment professionals

1. The Standards of Professional Conduct
a) Professionalism
Knowledge of the Law: Members and Candidates
must understand and comply with all applicable laws,
rules, and regulations of any government, regulatory
organization, licensing agency etc. Members and
Candidates must not knowingly participate or assist in
any violation of laws, rules, or regulations and must
disassociate themselves from any such violation.
Independence and Objectivity: Members and
Candidates must use reasonable care and judgment to
achieve and maintain independence and objectivity in
their professional activities.
Misrepresentation: Members and Candidates must not
knowingly make any misrepresentation relating to
investment analysis, recommendations, actions, or
other professional activities.
Misconduct: Members and Candidates must not
engage in any professional conduct involving
dishonesty, fraud, or deceit or commit any act that
reflects adversely on their professional reputation,
integrity, or competence.

b) Integrity of Capital Markets
Members and Candidates having nonpublic information should
not reveal the information to others. Also they should not
artificially inflate trading volume with the intent to mislead
market participations.
Material Non-public Information
Market Manipulation

c) Duties to Clients
Members and Candidates must act for the benefit of their
clients and place their clients interests before their
employers or their own interests. When they are managing a
portfolio to a specific mandate the recommendations should
be consistent with the stated objectives and constraints of the
portfolio.
Loyalty, Prudence, and Care
Fair Dealing
Suitability
Performance Presentation
Preservation of Confidentiality

d) Duties to employers
Members and Candidates must act for the benefit of their
employers and not deprive their employer of the advantage of
their skills and abilities. They must not accept gifts, benefits,
compensation that competes with, or might reasonably be
expected to create a conflict of interest with their employers
interest unless they obtain written consent from all parties
involved.
Loyalty
Additional Compensation Arrangements
Responsibilities of Supervisors

e) Investment analysis, recommendations, and actions
Members and Candidates must have a reasonable and
adequate basis, supported by appropriate research and
investigations, making investment recommendations, and
taking investment actions. They must also develop and
maintain appropriate records to support their investment
analysis, recommendations, actions, and other investment-
related communications with clients and prospective clients.
Diligence and Reasonable Basis
Communication with Clients and Prospective Clients
Record Retention

f) Conflict of interest
Members and Candidates must disclose to their employer,
clients, and prospective clients, as appropriate, any
compensation, consideration, or benefit received from, or paid
to, others for the recommendations of products or services.
Disclosure of Conflicts
Priority of Transactions
Referral Fees

g) Responsibilities as a CFA institute member of a CFA
candidate
Members and Candidates must not engage in any conduct
that compromise the reputation of integrity of CFA Institute or
the CFA designation or the integrity, validity, or security of
the CFA examinations.
Conduct as Members and Candidates in the CFA
Program
Reference to CFA Institute

2. Introduction To The Global Investment Performance
Standards (GIPS)
GIPS are a set of ethical principles based on a standardized,
industry-wide approach. GIPS apply to investment management
firms and are intended to serve prospective and existing clients of
investment firms. GIPS allow clients to more easily compare
investment performance among investment firms and more
confidence in reported performance.

1. GIPS Objectives:
To obtain global acceptance of calculation and presentation
standards in a fair, comparable format with full disclosure
To ensure consistent, accurate investment performance data
in areas of reporting, records marketing, and presentations,
To promote fair competition among investment management
firms in all markets without unnecessary entry barriers for
new firms
To promote global self-regulation

2. Key Characteristics of GIPS
To claim compliance, an investment management firm must
define its firm. This definition should reflect the distinct
business entity that is held out to clients and prospects as
the investment firm.
GIPS are ethical standards for performance presentation
which ensure fair representation of results and full disclosure.
Firms are required to use certain calculation and presentation
standards and make specific disclosures.
Input data must be accurate.
GIPS contain both required and recommended provisions
firms are encouraged to adopt the recommended provisions.
Firms are encouraged to present all pertinent additional and
supplemental information.
There will be no partial compliance and only full compliance
can be claimed
Follow the local laws for cases in which a local or country
specific law or regulation conflict with GIPS, but disclose the
conflict.
Certain recommendations may become requirement in the
future.



3. Definitions:
a. Firm: Include the broadest definition of the firm, including all
geographical offices marketed under the same brand name.
b. Document policies and procedure: Document, in writing,
policies and procedures the firm uses to comply with GIPS.

4. Major Sections of GIPS Standards:

5. Fundamentals of compliance:
Fundamental issues involved in complying with GIPS are
Definition of firm
Documentation of firm policies and procedures with respect
to GIPS compliance
Complying with GIPS update
Claiming compliance

Input Data
Input data should be consistent in order to establish full, fair, and
comparable investment performance presentations.

Calculating Methodology
Uniformity in methods across firms is required so that their results are
comparable.

Composite Construction
Composite performance is based on the performance of one or more
portfolios that have the same investment strategy or investment
objective. Composite returns are the asset-weighted average of the
returns on the portfolios that are included in each composite
Disclosures
The firm must disclose information about the presentation and the policies
adopted by the firm so that the raw numbers presented in the report are
understandable to the user.

Presentation And Reporting
Investment performance must be presented according to GIPS
requirements.

Real Estate
Certain provisions apply to all real estate investments regardless of the
level of control the firm has over management of the investment.

Private Equity
Private equity investments must be valued according to the GIPS Private
Equity Valuation Principles unless the investment is an open-end or
evergreen fund.









Time Value of Money
When an investment is subjected to compound interest, the growth in the value
of investment is not only because of the interest on principal, but also the
interest on interest.
Future Value is the result of compound interest at the end of a certain period.
Present value is an investment back to the beginning of an investment life.
Cash flows associated with an income flow is very well represented on a
Time line. It should be noted that cash flow represented is taken to be
that at the end of the year.
The real risk free rate of interest is the theoretical rate over the entire
period of a loan that has no expectation of inflation on it.
Securities may have one or more types of risk.
Future Value of a single sum: Future value is the amount to which a
current deposit will grow over time when it is placed in an account paying
compound interest.
Present Value of a single sum: is the amount invested today at a given
rate over a certain period of time in order to end up with a specified FV.
Annuities: are stream of equal cash flows that occur at equal intervals
over a given period.
Future Value of an Annuity Due: an annuity where the annuity payments
occur at the beginning of each compounding period.
Perpetuity: pays a fixed amount of money over an infinite period. It is
perpetual annuity.
Loan amortization: is the process of paying off a loan with a series of
periodic loan payments, whereby a portion of the outstanding loan
amount is paid off with each payment.
Cash flow additivity principle states that present value of any stream of
cash flows is equal to the sum of present cash flows.
Connection between present values , future values and series of cash
flows: Present values of a series of cash flows is how much money should
be put in the bank today to make future withdrawals such that the last
withdrawal exhausts the account.

Discounted cash flow applications
Net Present Value: of an investment project is the present value of expected
cash inflows associated with the project less the projected value of the projects
expected cash outflows , discounted at the appropriate cost of capital. The
higher the NPV for a company, the better.
Internal rate of return
It equates PV of the investments expected benefits with the PV of its costs. If
the Discount rate > IRR, then the investment should not be made.
If for a single method, the IRR and the NPV rules lead to exactly same
accept/reject decision. If the IRR > Discount rate, the NPV is +ve and vice
versa.
Problems associated with IRR method
When the acceptance/rejection of one project has no bearing on that of
the other project, the projects are said to be independent.
NPV method assumes the reinvestment of funds at the opportunity cost of
capital, while the IRR method assumes that the investment rate is the
IRR. The discount rate denotes the market-based opportunity cost of
capital and is the required rate of return for the shareholders of the firm
Higher NPV should be chosen over more favourable IRR.
Holding period return
Is simply the %age change in the value of an investment over the period it is
held.
Money Weighted Return
This concept applied IRR to investment portfolios. It is defined as the internal
rate of return on portfolio, taking into account all cash outflows and inflows.
Time Weighted Rate of return :
Measures compound growth. It is the rate at which 1$ compounds over a
specified performance horizon.
Statistical concepts and market returns
Two key concepts to be focused on are measures of central tendency and
measures of dispersion
Measures of central tendency:
1. Arithmetic Mean
2. Geometric mean
3. Weighted mean
4. Median
5. Mode
Measures of dispersion:
1. Range
2. Variance
3. Mean absolute deviation
Descriptive statistics: summarizes important characteristics of huge sets of data.
Inferential Statistics: it pertains to the procedures used in making forecasts,
estimates, or judgements about a large set of data.
A Population is defined as the sum of all possible members of a stated group.
Types of Measurement Scale
Nominal Scale
Ordinal Scale
Interval scale
Ratio scales
A measure used to describe the characteristics of a population is referred to as a
parameter
A measure used to describe the characteristics of a sample is referred to as a
sample characteristic


Frequency Distribution
frequency distribution describes large data sets by doing the following:
(1) Establish series of intervals, as categories,
(2) Assign every data point in the population to one of the categories,
(3) Counting the number of observations within each category and
(4) Present the data with assigned category, also the frequency of observations
in every category.

Frequency distribution is indeed one of the simplest methods employed in
describing populations of data and is used for all four measurement scales -,
it is often the best way to describe data measured on a nominal, interval or
ordinal scale.
Measures of central Tendency
Identifies center, or average, of a data set. This central point can then be
used to express the expected value of the data point.
To calculate the population mean, all the values are added and divided by the
number of observations. ()
Sample mean is the all the values are added and divided by the number of
observations in a sample of a population.
Median
Median is the middle value in a series which is sorted in either descending or
ascending order.
Mode
Mode is the particular value which is most frequently observed. In some
applications, the mode is often the most meaningful description.
Weighted Mean
Weighted mean is often seen in portfolio problems wherein various assets
classes are to be weighted within the portfolio.

Harmonic mean is computed by the following steps:

1. Take the reciprocal of each observation

2. Add these terms together,

3. Average the sum by dividing by n( #of observations)

4. Take the reciprocal of this

Quartiles, Quintiles, Deciles, Percentiles.
By the same process, quartiles are the result of a distribution being divided into
four parts; quintiles refer to five parts; deciles, 10 parts; and percentiles, 100
parts.
Quantiles and measures of central tendency are known as measures of
location.
Dispersion is defined as the variability around the central tendency.
Range= Maximum Value-minimum value
Mean absolute deviation

Variance is defined as the mean of the squared deviations from the
arithmetic mean of the expected value of a distribution

Population Variance

Sample Variance

Standard deviation is the positive square root of variance is often used
as a quantitative measure of risk

Chebyshevs inequality: States that the proportion of population
within K standard deviations of the mean is atleast 1-1/K
2

The coefficient of variation of sample data is the ratio of standard
deviation of the sample to its mean
The Sharpe ratio measures excess return per unit of risk
Skewness describes a degree to which a distribution is not symmetric
about its mean. A right skewed distribution has a positive skewness. A
left skewed distribution has negative skewness.
For a positively skewed, unimodal distribution, the mean is greater
than the median, which is greater than the mode.
For a negatively skewed unimodal distribution, the mean is less than
the median, which is greater than the mode
Kurtosis measures peakness of a distribution and probability of
extreme outcomes :
o Excess Kurtosis is measured relative to the normal
distribution, which has a K of 3
o +vevalues of K indicate a distribution which is leptokurtic so
that the probability of extreme outcomes is greater than a
normal distribution
o vevalues of excess kurtosis indicate a platykurtic distribution
o Excess kurtosis with an absolute value greater than 1 is
significant
The Arithmenticmean return is appropriate for forecasting single
period returns in the future periods, while the GM is appropriate for
forecasting future compound returns over multiple periods.


Probability Concepts
Definitions:
Random Variable: RV is an uncertain number and an outcome is an
observed value of a random variable.

MutualExclusive: Events that cant both happen at the same time.

ExhaustiveEvents: Those events that include all possible outcomes.

Odds: If an event has a probability of occurring as p, the odds of the
event occurring are p/(1-p)

Unconditional Probability: P(A) or P(B) is the probability of an
event happening regardless of the occurrence of other events.
Unconditional probability is also called marginal probability

Conditional Probability: P(A/B) or P(B/A) is one where occurrence
of one event affects the probability of occurrence of other events.

Joint Probability: P(AB) of two events is the probability that they
will occur both. The relationship between these: P(A/B) = P(AB) / P(B)

Independent Event: The events whose probability is unaffected by
the occurrence of other events.

Expected Values: It is the probability weighed average of the
conditional expected values:

E(X) =

)(

)
a. Expected Value of a random variable: E(X) = [P
i
(x
i
)X
i

b. Variance of a random variable: Var(X) = [P
i
(x
i
) [X
i

E(X)]
2


Correlation: It is a standardized measure of association between two
random variables. The value of correlation ranges from -1 to 1 and is
equal to Cov(A,B)/

Theories:
Properties of probability:
a. The sum probabilities of all the possible mutually exclusive
events is 1.
b. Probability ranges from 0 P 1

Multiplication Rule of Probability:
P (AB) = P(A|B) x P(B)
Additional Rule of Probability: This gives the probability that at
least one of two events will occur:
P(A or B) = P(A) + P(B) P(AB)
Total probability rule is often used to determine the unconditional
probability of an event, given conditional probabilities:
P(A) = P(A |B
1
) P(B
1
) + P(A | B
2
) P(B
2
) ++P(A|B
N
)P(B
N
)
Where B
1
, B
2
,B
N
is mutually exclusive and exhaustive set of
outcomes.
The probability of an independent event is unaffected by the
occurrence of other events, but the probability of a dependent event is
changed by the occurrence of another event.
Events A and B are independent if and only if:
P(A|B) = P(A), or equivalently, P(B | A) = P(B)
According to the total probability rule, the unconditional probability of
A is the probability weighted sum of the conditional probabilities:
P(A) = (

)) (|

Where B
i
is a set of mutually exclusive and exhaustive events.
Conditional expected values depend on the outcome of some other
event. Hence, for forecasts of expected values of a stock return or
earning, conditional expected values are used.
Covariance measures the extent to which two random variables tend
to be above and below their respective means for each joint
realization.
Cov(A,B) = (

)(

Correlation is a standardized measure of association between two random
variables; it ranges from -1 to 1.
The variance of a random variable, Var(X) equals (

)(

()

and Standard deviation is

Bayes formula for updating probabilities based on the occurrence of
an event O is:

(|)
(|)
()
()
P (A|C) =
()
()()

The number of ways to order n objects in n factorial, n! = n x (n-1) x
(n-2) x x 1
There are

ways to assign k different labels to n items, where
n
i
is the number of items with the labeli.

Common Probability Distributions
Probability distributions describe the probability of all possible outcomes for a
random variable.
A discrete random variable Is one for which the possible outcomes are finite
and measurable
Probability function, denoted by p(x), specifies the probability that a RV is
equal to a specific value.
The set of specific outcomes of specific discreet RV are a finite set of
values
The cumulative distribution function gives the probability that a RV will
be less than or equal to a specified value.
Given the CDF of a RV, the probability that an outcome will be less
than or equal to a specific value is represented by the area under the
probability distribution to the left of that value
A discrete uniform distribution is one where there are n discreet,
equally likely outcomes.
The binomial distribution is a probability distribution for a binomial RV
that has two possible outcomes
For a discreet uniform distribution with n possible outcomes, the
probability of each outcome equals 1/n
For a binomial distribution, if the probability of success is p, the
probability of x successes in n trials is:

A binomial tree illustrates the probabilities of all possible values that a
variable can take on, given a couple of ( up move and magnitude of up
move) probabilities.
Tracking Error is calculated as the total return on a portfolio minus
the total return on a benchmark or index portfolio
A continous uniform Distribution is one where the probability of X
occuring in a possible range is the length of the range relative to the
total of all possible values. If a and b are the lower and uppier limit of
the distribution:
The normal probability distribution and the normal curve :
o Is symmetrical, bell shaped, with a single peak at the exact
centre of distribution
o Mean=median=mode
o A normal Distribution can be completely defined by its mean and
standard deviation because skewness is always 0 and kurtosis=3
Multivariate distributions describe the probabilities for more than 1 RV
A confidence level is the range within which we have a given level of
confidence of finding a point estimate
A normally distributed RV X can be standardized by Z=(X-)/
A standard normal distribution has a mean of 0 and a standard
deviation of 1
Shortfall Risk is the probability that a portfolios value will fall below a
specific value over a certain given period of time.
If x is normally distributed, e^xfollows a lognormal distribution. A
lognormal distribtution is often used to model asset prices.
As we decrease the length of discreet compounding periods, the
effective annual rate increases.
For a holding period return ( HPR ), over any period, the
equivalent continuously compounded rate over the period is ln(1+HPR)
Monte Carlo Simulation uses randomly generated values for risk
factors, based on their assumed distributions, to produce a distribution
of possible security values.
Historical simulation uses randomly selected past changes in risk
factors to generate a distribution of possible security values.


Sampling and Estimation
Some basic definitions:
Parameter: A parameter is a quantity used to describe a population
Statistic: Statistic is a quantity computed from a sample and is used to
estimate a population:
We typically use statistics to estimate parameters because
1. It isnt possible to examine the entire population.
2. It will be too expensive to go through every individual.
Random Sample: A simple random sample is a subset of the population
drawn in such a way that each element of the population has an equal
probability of being selected.
- Finite and limited populations can be sampled by assigning random
numbers to all of the elements in the population, and then selecting
the sample elements by using a random number generator and
matching the generated numbers to the assigned numbers.
Sampling Error: The difference between the observed value of a statistic
and the value of the parameter is known as the sampling error.
- Random sampling should reflect the characteristics of the underlying
population in such a way that the sample statistics computed from the
sample are valid estimates of the population parameter.
Sampling Distribution: Sample statistics, calculated from multiple
samples from the same population, will then have a distribution of
differing values that is known as the sampling distribution.
We generally refer to a sampling distribution by indicating the statistic to
which the distribution applies:the sampling distribution of the sample
mean.

Stratified random sampling: A set of simple random samples drawn
from an overall population in such a way that subpopulations are
accurately represented in the overall sample.
- In a large population, we may have subpopulations, known as strata,
for which we want to ensure inclusion in a representative way in the
sample.
- To do so, we can use stratified sampling, wherein we draw simple
random samples from each strata and then combine those samples to
form the overall sample on which we perform our analysis.

Time-Series and Cross-sectional data
Time Series Data: Time-series samples are constructed by
collecting the data of interest at regularly spaced intervals of time
and are known as time-series data.
Cross-Sectional Data: Cross-sectional samples are constructed by
collecting the data of interest across observational units (firms,
people, precincts) at a single point in time and are known as cross-
sectional data
The combination of the two is known as panel data

Central limit theorem
The central limit theorem (CLT) allows us to make precise probability
statements about the population mean using the sample mean, regardless
of the underlying distribution.



The standard error of the sample mean
The standard deviation of the distribution of the sample mean is
known as the standard error of the sample mean.
When the sample size is large (generally n > 30 or so), the
distribution of the sample mean will be approximately normal when
the sample is randomly generated (collected).
The standard error of the mean can then be shown to take the
value of
Point estimates & confidence intervals
Estimators are the generalized mathematical expressions for the
calculation of sample statistics, and an estimate is a specific outcome of
one estimation.
Estimates take on a single numerical value and are, therefore, referred to
as point estimates.
It is a fixed number specific to that sample.
It has no sampling distribution.
In contrast, a confidence interval(CI) specifies a range that contains the
parameter in which we are interested (1 a)% at the time.
The (1 a)% is known as the degree of confidence.
Confidence intervals are generally expressed as lower confidence
limit or upper confidence limit.
Estimator Properties:
Unbiasedness
o Occurs when the estimator expected value is equal to the
value of the parameter being estimated.
Efficiency
o Occurs when no other estimator has a smaller variance.
Consistency
o Asymptotic in nature, thereby requiring a large number of
observations.
o Occurs when the probability of obtaining estimates close to
the value of the population parameter increases as sample
size increases.
Confidence intervals
Constructing Confidence Intervals = Point estimate Reliability factor
Standard error
1. Point estimate: A point estimate of the parameter (a value of a
sample statistic), such as the sample mean.
2. Reliability factor: A number based on the assumed distribution of
the point estimate and the degree of confidence (1 ) for the
confidence interval.
3. Standard error: The standard error of the sample statistic providing
the point estimate.

Students t-distribution
When the population variance is unknown and the sample is random, the
distribution that correctly describes the sample mean is known as the t-
distribution.
The t-distribution has larger reliability (cutoff) values for a given level of
alpha than the normal distribution, but as the sample size increases, the
cutoff values approach those of the normal distribution.
The t-distribution is a symmetrical distribution whose probability density
function is defined by a single parameter known as the degrees of
freedom (df).
Degrees of freedom
The degrees of freedom for a given t-distribution are equal to the sample
size minus 1.
For a sample size of 45, the degrees of freedom are 44.
Consider that our calculation of the sample standard deviation isand
that the sample mean is measured with error because it is not the true
population mean, m.
Data-mining bias
Data-mining bias results from the overuse and/or repeated use of the
same data to repeatedly search for patterns in the data.
If we were to test 1,000 different variables, 50 of them would be
significant at the 5% level even though the significance is just an
artefact of the testing error rate.
This approach is sometimes called a kitchen sink problem.
Look-ahead bias and time-period bias
Look-ahead bias occurs when researchers use data not available at
the test date to test a model and use it for predictions.
Time-period bias ( TPB ) occurs when the model uses data from a
time period when the data is not representative of all possible
values of the data across all times.