So you’ve reached the final CFA exam. This is not something to be sniffed at so you should be proud of your achievements. You are almost there and I am hoping that this article will help you in your studies and will guide you towards the right direction, so please keep reading.
IPS is King
If you have done some research on the exam format or you have attempted past questions, I am sure that you have noticed that for the first time you are not faced with multiple choice questions and instead you will have what they call ‘constructed responses’. Yes, you will have to write sentences using pencil and paper rather than marking an answer sheet. An IPS which stands for Individual Policy Statement is a type of constructed response question that you will see in the morning session, needless to say you need to be scoring high on IPSs if you want to pass. Please note that the afternoon format is multiple choice.
If I was explaining what an IPS is to my grandmother, I would tell her that it’s an assessment of her current finances and set of financial goals. You need to picture yourself as a financial advisor, helping your client come to grips with his or her financial situation; this entails being aware of any assets that are held, sources of income or any expenses. Given your client’s financial situation you need to assess the below points:
Time horizon: what is your client’s time horizon? 10, 15 years? If we talk about inheritance this could extend to a longer period. Multi-generational time horizon is a buzz word you might want to take note of.
·Taxes: should there be any aspect that would cause a high tax expense, note this down and remember to emphasise tax efficient investing.
·Liquidity: liquidity is very important. After having assessed your client’s outflows, is their source of income sufficient enough to cover them? If there are a lot of foreseeable expenses and your client’s wealth is concentrated in illiquid real estate then liquidity could be a problem.
·Legal: you don’t tend to see this come up but always acknowledge that local laws apply and should there be applicable laws from multiple jurisdictions, mention that.
·Unique: you will easily notice this. This tends to be some unique situation that your client is in. For example, the majority of their wealth might come from their company or it could be their aversion towards sin stocks.Then you will need to assess your client’s ability and willingness to take risk. Willingness is more related to cognitive aspects, so make sure to pay attention to any traits or biases that the person could exhibit. Ability is more of an objective assessment. Does your client have a sufficiently large portfolio and a long-term time horizon? Then chances are he/she will be able to afford having a more aggressive portfolio to aim for higher returns in the long run. If instead your client is retired and their portfolio is their only source of income and they have numerous upcoming expenses, then chances are high that you should be conservative. You should recommend your client to invest in safe instruments that provide a steady, reliable stream of income.
OK so how do I nail an IPS question you might ask?
(1) Write concise and clear bullet points. When I was first tackling the questions I was making the mistake of writing long, convoluted sentences making it hard for the marker. The marker will have an answer key and will be ticking boxes to ensure that you covered the relevant points.
(2) Practise, practise, practise. You just need to get used to answering IPSs. A good thing about CFA Level 3 (unlike levels 1 and 2) you will have access to past morning exam papers, so make sure to attempt them and see what recommended responses the CFA Institute provides. When doing past papers though, be careful NOT to go too far back into the past as some of the questions will not be as relevant.
(3) If you have a study partner, try to mark each other’s papers. It might be helpful to have another person read your responses and give you some honest feedback as to whether you covered the main points. Sometimes when marking our own mocks we might give ourselves the benefit of the doubt whilst examiners might not.
(4) Passion. OK you might think that this might sound strange but try and think of yourself as a consultant or a financial advisor. Try and think of the people who pop-up in the question as if they were real clients, friends or family. After months or years of gruelling studies, you are the financial expert – what genuine advice would you give them so that they can reach their financial goals? I found approaching questions in this manner to be entertaining and helped concepts to stick in my mind.
Is CFA Level 2 harder than CFA Level 3?
This is a debate that I find very interesting. Some people pass level 2 and will tell you that you have cleared the hardest exam, others will tell you that level 3 is a real nightmare. I personally think that if you are the technical and mechanical type, you will find level 2 a fair exam. You should not approach level 3 with the same mind-set that you had for level 2, I certainly did and got punished for it. This might sound abstract but for level 3 you need to see the big picture. Level 3 isn’t about how quickly you can value swaps or calculate free cash flows, it’s about being able to understand your client’s situation and applying sound judgement in addition to technical knowledge. Level 3 takes for granted that you have understood the core concepts and requires you to put them into practise in the field of portfolio management. For this reason if you have started preparing for level 3, I would personally recommend just skimming through the whole curriculum and getting a general idea, then going into the nitty gritty details.