The Cheat Sheet articles are a series of articles, each focusing on one specific topic area of the CFA exam for one specific CFA level. In each Cheat Sheet article, we will cover the basics of what you need to know before diving into the material – what it’s about in a nutshell, how significant is it in the CFA exams, real-life applications, and tips for the CFA exams. You should aim to read each relevant Cheat Sheet article before you start studying the topic area to get you to a flying start.
For this article, we will look at Quantitative Methods for CFA Level I, one of the most useful topic areas that’s used throughout CFA Level I.
- The Time Value of Money – the valuation of assets and securities in different points in time
- Discounted Cash Flow Applications – using discount rates to value investment opportunities
- Statistical Concepts and Market Returns – measuring central tendencies and dispersion
- Probability Concepts – using probabilities to predict outcomes when faced with uncertainty
- Common Probability Distributions – a discussion of normal and non-normal distributions
- Sampling and Estimation – using a sample to estimate characteristics of a population
- Hypothesis Testing – determining the level of confidence you can have in your conclusions
- Technical Analysis – how quantitative analysis is used to predict future stock price movements
In the context of financial analysis, quantitative methods are used to predict outcomes and measure results. Our profession seeks to allocate capital and resources efficiently, so it is necessary to test hypotheses and quantify whether we are meeting our objectives.
The Quantitative Methods readings, in a nutshell, teach you:
- How to predict the most likely outcomes, or range of outcomes, for future events
- How confident you can be in those predictions
- How to calculate the impact of events once they have occurred
This is not to say that everything covered in these readings is used every day in the real world. For example, the majority of candidates learn Bayes’ formula well enough to get through exam day and happily forget it within 5 seconds of exiting the testing facility. However, it’s strongly advisable to be not just competent, but fluent in this material because it is directly relevant to the day-to-day activities of a financial analyst.
Should I start my studies with Quantitative Methods?
One simple approach to studying for any exam is to start on page 1 and read through to the end. However, it is not uncommon for candidates to question whether to study the Ethical and Professional Standards readings first – because they don’t neatly fit in with the rest of the curriculum. As a result, many recommend saving the Ethics material for last.
It’s a good idea to start with Quantitative Methods first, or at least early in your preparation. These readings introduce essential topics that must be mastered in order to be successful on exam day because they are, in the words of Rob Thakur from Fitch Learning, “the absolute foundation of the Level 1 syllabus.” Moreover, this material will show up repeatedly throughout the curriculum at every level as you progress towards your CFA charter.
There aren’t many multiple-choice CFAI Practice Problems.
Save for Technical Analysis, only a small number of Practice Problems at the end of the Quantitative Methods readings are structured as multiple choice questions. This is a concern because, on exam day, you will not encounter a question such as:
“Explain the relationship among arithmetic mean return, geometric mean return, and variability of returns.”
Understand the concepts – don’t just memorise formulae.
For example, the knowledge that a dataset’s harmonic mean is always less than its geometric mean, which is always less than its arithmetic mean, is just as important as memorizing the formulas used to calculate these measures. Similarly, you don’t need to use your calculator to know that a security’s bank discount yield is less than its effective annual yield.
You will see Quantitative Methods in other topic areas.
As mentioned, the topics covered in the Study Sessions on Quantitative Methods are foundational knowledge with which you must become very familiar because it will show up repeatedly as you progress through the curriculum.
For example, developing a solid understanding of the yield measures presented in these readings can only benefit you when you get to the readings on fixed-income and corporate finance.
In yet another example, the concept of value-at-risk, which is covered in the Study Session on portfolio management, is first introduced in the reading on probability distributions. Indeed, it can be helpful to refer back to these readings if for no other reason than to remind yourself that you have covered these topics already and you probably understand them better than you give yourself credit for.
Beware of shifting terms.
More Cheat Sheet articles will be published over the coming weeks. Get ahead of other CFA candidates by: