Tue, 22 Jan 2008

Thoughts on the Eve of CFA I Results

On 01 December 2007, I took the CFA Level I exam. The results for this exam will be made available tomorrow (23 January 2008), but before I find out how I did, I think it might be useful to you and a good exercise for me to describe my thoughts on the exam, the process, and my self-assessment of how I did.

First, a word of background. I am untrained in finance and economics in any formal sense. On the job as a venture capital analyst and associate for the past two years, I have learned modeling and DCF, and have also picked up a strong interest in reading macroeconomic blogs and news (e.g. The Economist, Calculated Risk). However, VC is not a "finance-heavy" branch of finance, as most of the risk we look to assess is more human and "soft" in nature, such as management and market risk. I never took economics, finance, or economics in school, although I did run bookkeeping for a couple of startup companies I ran (accrual accounting, double-entry bookkeeping). So the content of CFA I was largely new to me, though the generalities of finance were not.

In general, I am very smart and a good test-taker. For example, I aced the SATs (on my second try), several College Board and AP exams, and most of my International Baccalaureate exams. But I studied like a mofo for those, and those (roughly 11 years ago) were the last time I took any standardized tests. In college, my record was significantly less stellar (for too many reasons to list here).

However, CFA I claims you need 250 hours of prep. It boasts a 40% pass rate. Nearly all of the takers (so far as I can tell) come from the finance industry and/or economics or finance academic backgrounds. So I figured (then and now) that it's anyone's game: me, the solid test-taker, against CFA I, the exam whose pride depends upon trouncing 60% of comers despite their being specialists.

So, I set out in June / July 2007 to begin studying for CFA I. I bought both the "official" curriculum (several hundred $$), about 12" thick of books, and the "Schweser" third-party, "Cliff's Notes"-style curriculum, which was perhaps 7" or 8" thick. I started out powering through the CFA books, but quickly, upon advice of friends and upon realizing the difference in concision, switched to using the Schweser exclusively.

I got busy with a lot of work stuff and really didn't put much, if any, time into test prep in July-September 2007. Maybe 1 hour a week. Then, in October, I really picked things up, and started putting in 4-5 hours a week. Finally, in November, I rededicated myself to the effort, making flash cards, carrying books with me to lunch each day, and adopting a mantra of "study every day, test (practice tests) every weekend." I probably did an average of 15 hours per week during November 2007, starting at 10 hours and moving to 20 hours for the last couple weeks (2 hours a day for 6 days + 8 hours on Saturday).

All in all, I'd estimate time spent:

Nov 2007   4.3 weeks @ 15 hrs / week   = 64.5
Oct 2007   4.3 weeks @ 5 hrs / week    = 21.5
July-Sept 2007 13 weeks @ 1 hrs / week = 13
---
Total                                  = 99 hrs

In the last two weeks, I was scoring between 68% and 78% on the Schweser practice exams. (Two runs closer to 68%, the final "outlier" being closer to 78%.) Part of this may have been a discrepancy in the difficulty between the Schweser "sample" vs. "practice" exams; I think that the "practice" exams may be a bit harder to make the "sample" ones, and the real thing, seem easier.

On exam day, I showed up with a good amount of fresh fruits, complex carbos, caffeine and nicotine, and lots of fresh pencils and two TI BA-II+ calculators. I did not get a good night's sleep before; much of that was probably stress (both CFA I and exogenous, career- and personal-oriented stress).

On the morning half, I finished the exam once through with about an hour left to spare. I spent 35-40 minutes going over my answers and changed perhaps 10% of my answers from their prior values. (You're stuck in the room for the final 30 minutes if you haven't bailed before then; I napped at my desk.)

On the afternoon half, I finished with just over an hour left. I reviewed my answers and changed maybe 5% of the values, but realized that I was "bonking" -- getting somewhat tired and low-blood-sugar, I was in danger of making corrections worse than the originals. So I called it with 45 minutes left, and drove home to Seattle through an incipient snowstorm to party it up with some old friends (including a CFA II candidate).

Overall, I left the exam center confident that I did at least as well on the exams as I had on my practice / sample runs. Given what folks had been posting on Analyst Forum, I think high 60s would probably be a safe pass. Considering that my low-end practice runs were already there, and that I left feeling I did at least that well, I would wager, perhaps laying 4:1, that I passed.

The one area I have some serious apprehension about would be with respect to the particulars of filling in the bubbles. Perhaps it was my 11 year hiatus, but in the afternoon session I recalled filling in some bubbles or such (not answers, just pro forma stuff) that I didn't remember from the morning. I'm hoping that it was a false memory, a true difference in the AM / PM test forms, or something not tabulated for scoring. But given the anal nature of standardized tests, who knows. Also, there were some rocky sections in the vagaries of financial statement analysis (there are lots of traps and tricks with e.g lease capitalization and LIFO COGS) and ethics. Bad showings in those two areas could have really knocked me down a few notches, perhaps enough to fail.

So, there you have it: the story of one man's CFA I attempt. Will my superior test-taking history compensate for only having done 40% of the recommended hours of study? Will my senile old-man's mistake of filling in the wrong test center number or such disqualify my entire AM session? And will those whippersnappers with their recent finance degrees outfox me, leaving me in the dust? Stay tuned.

(I promised myself a new motorcycle if I passed, so if you do stay tuned, you may get to hear another "product review" in short order...)

Update: I passed.

Multiple Choice
Q#    Topic                   Max Pts <=50% 51%-70% >70%
- Alternative Assets              12  -       *       -
- Derivatives                     12  -       *       -
- Economics                       24  -       -       *
- Equity Analysis                 24  -       -       *
- Ethical & Professional Stnds.   36  -       -       *
- Financial Statement Analysis    68  -       -       *
- Fixed Income Analysis           24  -       -       *
- General Portfolio Management    12  -       -       *
- Quantitative Analysis           28  -       -       *

Thanks to the CFA Society of Seattle for a scholarship and to Voyager Capital for picking up expenses.

$Id: thoughts_on_cfa_i_results_eve.txt 1061 2008-01-23 18:26:44Z rlucas $

Thu, 30 Aug 2007

Bubble Factors: Real Change, Easy Credit, and Self-Interested Lies

Look at "Bubble 1.0" (as it's known in the relatively young tech industry: the 1997-2000 tech-media-telecom bubble and the general IPO / equity bubble that went along with it).

Wed, 16 May 2007

Just How F'ed Is The U.S. Dollar? I'll Tell You.

Here's how F'ed the U.S. Dollar is right now. If you go for a bit of shopping in Montreal over the weekend these days, you probably pay with your credit card to try and get the best exchange rate. When you next get online and look at your credit card statement, you will be shocked to find:

Tue, 08 May 2007

The Housing Bubble and General Financial Depravity

Yesterday the Seattle Times brought us this gem:

... the couple -- with no savings and about $20,000 in credit-card debt -- shopped for a mortgage to buy their 1,200-square-foot house in Tukwila last year, they heard the same thing from lenders and in a home-buying class they attended: Forget it. "You basically had to be Scot free, no massive credit debt, which we had, and to have money in the bank, which we didn't," said Swartz, 31. "How do people buy houses in America anymore?"

In a nutshell, the country is going to hell in a handbasket. When people are so poisoned with the mindset of entitlement that they literally can't comprehend why having no cash and a negative $20k net worth doesn't qualify one to incur a quarter million in debt, well, it's hard to believe that these are the attitudes and values that built the greatest economy in the world.

$Id: housing_bubble_and_general_financial_depravity.txt 862 2007-05-09 18:06:16Z rlucas $

Mon, 12 Mar 2007

The Washington State 529 Program (GET) Offers an Overlay

State-administered "529 plans" for education savings are another in the series of tax dodges doled out by the Bush administration (thereby further and regressively lowering the effective rate of taxation on the higher-income people most likely to avail themselves of such dodges). (Sticklers will observe that 529s predate Bush; true, but their extra tax favorability is a post-2001 invention.) On the bright side, they offer quite a good deal if you can find an investment that keeps pace with college tuition (and you don't need to worry about also beating the tax rake, since 529 gains are tax free when used for qualifying tuition etc.). You do have to nominate a beneficiary when you set one up, but you as the controlling owner can change the nominee at any time to any blood relation (and it can even be yourself).

There are two types of 529 plans: one is like a 401k plan and involves picking a retail investment or mix of assets; I'm sure someone, somewhere has done the analysis to pick out correlates of tuition costs, so if you can find that, maybe you should look at the first form. The second 529 plan is somewhat more interesting. In the second form, the 529 plan is actually selling you "prepaid tuition." This kind of thing is normally a terrible deal: fronting money for something way in the future is generally a sucker bet, one made against the collected wisdom of armies of actuaries by not-sophisticated-enough retail investors with both informational and scale disadvantages. But I have a few reasons for believing that the Washington State 529 plan (known as the GET: see their web site) offers an overlay in certain circumstances.

1. Each state may offer either or both types of 529 plans to its residents. As it happens, a couple of states that have offered guaranteed tuition programs have run into trouble with the plans being underfunded and unable to meet obligations, according to this article. Although this might raise an alarm in some folks' minds, to me it says that tuition costs have been rising faster than can be achieved by even the professional money managers hired by state 529 plans specifically to meet that hurdle rate. Therefore, I see it as a sign that tuition is in general an expensive thing to guarantee and that if you can get a reliable guarantee (see below), you are getting the best of it (until or unless a mean reversion on tuition growth rates vs. inflation occurs).

2. Washington's GET program is (ostensibly) backed by the full faith and credit of the State, unlike other states' 529 guarantees. In my mind, combined with the evidence of other states' underfunding difficulties, that means the WA GET is a good bet to get bailed out by the State at some point in the future. (In general, any time you see something other than a plain vanilla bond backed by the full faith and credit of an American government, someone in the government got snookered or corrupted, and the public purse is about to make its counterparties rich: see e.g. the PBGC, the S&Ls, the Federal Housing Enterprises, etc.)

3. The index for the GET tuition price is the most expensive state university in Washington, invariably the University of Washington, located in Seattle, a thriving and growing metropolis which is well positioned to weather many economic threats and therefore in which prices and incomes are likely to remain high enough to induce the University to charge steadily increasing sums for tuition. (Although I certainly don't think that the outlook for Seattle is monotonically ever rosier, it seems a much better bet than somewhere like e.g. Montana or Idaho, where relatively small disturbances to nondiversified industrial bases could result in stagnation at all state universities.) The University also has competition in town from a number of private schools charging full freight to their students, therefore establishing the viability of increased tuition at UW.

5. The WA GET program has a scam built into its marketing strategy: rich people can buy the tuition units at the "buy-in price" (see below), but they try to sign up poor people for a payment plan where they charge them 7.5% interest on top of the buy-in price. Whether this is morally appropriate or not is a separate issue; the fact that we can spot the fish (and we ain't it) is good for us.

6. The big catch to the WA GET is the difference between the buy-in price and the pay-out value (the bid-ask spread, if you will). For the past few years, that has looked like so:

Year	Purchase $	Purchase YOY %	Purchase CAGR
1999	$35.00	NA	NA
2000	$38.00	8.57%	8.57%
2001	$41.00	7.89%	8.23%
2002	$42.00	2.44%	6.27%
2003	$52.00	23.81%	10.40%
2004	$57.00	9.62%	10.25%
2005	$61.00	7.02%	9.70%
2006	$66.00	8.20%	9.48%
2007	$70.00	6.06%	9.05%

Year	Payout $	Payout YOY %	Payout CAGR
1999	$33.75	NA	NA
2000	$35.19	4.27%	4.27%
2001	$36.42	3.50%	3.88%
2002	$38.64	6.10%	4.61%
2003	$45.31	17.26%	7.64%
2004	$48.63	7.33%	7.58%
2005	$51.81	6.54%	7.40%
2006	$55.05	6.25%	7.24%
2007	$58.80	6.81%	7.19%

Year	Purchase $	Payout $	Payout Ratio
1999	$35.00	$33.75	96.43%
2000	$38.00	$35.19	92.61%
2001	$41.00	$36.42	88.83%
2002	$42.00	$38.64	92.00%
2003	$52.00	$45.31	87.13%
2004	$57.00	$48.63	85.32%
2005	$61.00	$51.81	84.93%
2006	$66.00	$55.05	83.41%
2007	$70.00	$58.80	84.00%

Observations on these numbers:

• 2003 saw a big bump in tuition and hence in both purchase price and payout values. This jibes with 2002 news reports of the same.
• The payout ratio (payout $ / purchase $) has been declining steadily, but has recently hovered around 84%.
• That said, WA GET is raising the price of purchase by 9% annually, while tuition has been increasing at 6-7% annually. If these two don't converge, the payout ratio will get worse.
• This supports a 6-7% tuition increase rate, especially because that makes the 7.5% interest on the payment plans accretive to GET's situation.

7. The time-lag spread between purchase and payout makes sense only if you assume that college costs rise faster than the rate of return you can make elsewhere, adjusted for tax treatment. Assuming a fairly conservative 5.25% risk free rate and a 28% tax rate, the line crosses with 7% annual rising educational costs after about 6 years:

Years Held	After-tax return risk free	GET Return	GET to risk-free %
0	$70.00	$58.88	84.11%
1	$72.65	$63.00	86.72%
2	$75.43	$67.41	89.37%
3	$78.36	$72.13	92.05%
4	$81.45	$77.18	94.76%
5	$84.69	$82.58	97.51%
6	$88.11	$88.36	100.29%
7	$91.71	$94.55	103.10%
8	$95.49	$101.17	105.94%
9	$99.48	$108.25	108.82%
10	$103.67	$115.83	111.72%
11	$108.09	$123.93	114.66%
12	$112.73	$132.61	117.63%
13	$117.62	$141.89	120.63%
14	$122.77	$151.82	123.67%
15	$128.18	$162.45	126.73%
16	$133.88	$173.82	129.83%

As you can see, given these numbers, it doesn't make any sense to buy units for a teenager. You're just going to get hammered down by the time-lag spread if you hold less than 6 years before redemption. Of course, it gets a lot worse if risk-free interest rates rise a lot compared to college tuitions, or if you're paying more than 28% in tax.

However, if you think that college tuitions will maintain their higher growth rate relative to the risk rate, and if you can hold for well over 6 years, then you should strongly consider buying tuition in the GET. Why do this if you can get a higher return in a normal 529 in, say, the stock market? Well, remember that you need to beat UW's tuition growth rate, and do so without a great deal of volatility. I'd be surprised if normal 529 plans let you use sophisticated tools like options to hedge against volatility.

I, like numerous others, believe that we're entering a period of increased market volatility, and that if you can offload the risk of matching investment returns that are linked to a tax-free, inflating expenditure requirement to a full-faith-and-credit backed State obligation, you should seriously consider it.

Serious risks in this strategy include the possibility that Washington state politics will result in tuition increases that do not track inflation. Also, general mean reversion in higher education could threaten this strategy. I don't think that there's a lot of risk from falling behind a big run-up in equity prices that sustains for 15 years without a concomitant rise in inflation and tuition, but if equity returns beat my expectation and whoop up on tuition increases, you could stand to lose relative to a more traditional asset allocation. Also, waiting is not advisable; the bigger the gap between the purchase price and payout value, the longer you have to spend invested to catch up to risk-free.

Of course, remember that WA GET isn't something you invest in for strict performance; it's a way to cover a known expenditure requirement with lower risk. As far as I can tell, for periods well over 6 years (and ideally ~ 18 years, since you can purchase GET units naming yourself as a beneficiary and then transfer them later to your as-yet-unborn children), WA GET makes good sense.

$Id: wa_get_529.txt 836 2007-03-14 17:13:10Z rlucas $

Wed, 17 Jan 2007

The Yen Carry Trade for Everyman, or, How You, Too, Can Unbalance Financial Markets

I was reminded by an Economist article recently about a conversation I overheard at an Asian noodle shop a few weeks back. Some guy was talking to his buddy. The conversation went, roughly:

Powered by Blosxom.