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Our new Accelerated CFA Level 1 Prep (Part 1: The Formula Practice Generator)

David Harper CFA FRM

David Harper CFA FRM
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Hello members and visitors! We blogged here https://www.bionicturtle.com/our-new-accelerated-cfa-level-1-prep/ about our new Accelerated CFA Level 1 Prep Program. In this thread, I want to share some highlights about this program. Richie Owens is the instructor, and he deserves his world-class reputation. As usual, my observations attempt to add value. I earned my own CFA mark back in 2003, but I am always keen to refresh my knowledge of the fundamentals. My personal interests include: Richie’s tips on better exam preparation (he is a bona fide expert on exam strategies); common and durable concepts between the CFA and the FRM (some ambitious learners seek both credentials); and time-saving features in CeriFi’s innovative learning platform (although we’ve invested in our own Study Planner, CeriFi’s learning management system will finally bring us into the future of EduTech).

There are so many things I want to talk about, but I can’t resist first sharing the Formula Practice Generator. For key quantitative concepts, this is an infinite question generator. That’s right, to infinity and beyond! I try to create this effect in some of my Learning Spreadsheets, but Excel file formats are not nearly as convenient as CeriFi’s platform innovation. I’ve always wanted this for our members. Do you feel like you need more practice in translating interest rates? Here you can just keep practicing with different number sets. Here is an example of a question that asks us to compute the weighted average cost of capital (WACC):



This question (i.e., compute WACC) is a neat example of a concept where it is possible to jump right in and try to solve the problem. Why do I say that? Because it is like so many quantitative concepts: you do need to read about the formula, but after you passively study the formula, it is difficult to talk about WACC if you can’t apply the formula. This happens a lot in the FRM: some candidates will try to textually understand a model by reading about it first. In some cases, however, it’s better to interpret the model AFTER you can solve a question (like the WACC question above). Why? Because words can distract you into the theoretical weeds prematurely. Before we get into theoretical weeds, it’s often better to master the application of the basic formula. Then we can, for example, ask, “Why exactly is (1-tax_rate) in the model?”

The advantage of CeriFi’s Formula Practice Generator is that you aren’t distracted by the possibility of making a mistake. This is cognitively liberating. You can make several attempts without hesitation, learn immediately from your mistake, and grab the next iteration. The primary function of practice questions is not to test your ability; their primary function is to reinforce your learning and develop your mastery of the material. Practice questions are not the end; they are the means to the end. After a few, you will not only increase your accuracy, you will increase the speed of your response. Speed is the underestimated variable in exam prep. You may know the material, but you’ve got to be able to answer questions in the time allotted, too). In the FRM, some candidates never get around to addressing their speed problem. They remain too long in the passive learning phase. I would imagine speed is also a factor in the modern CFA.

Reflections on WACC

Richie has a video explaining WACC. WACC has a long history in finance. As a consultant years ago, I helped companies calculate their WACC to evaluate/implement economic value add (EVA) type strategies. Here’s an EVA tutorial I wrote for Investopedia. Here’s the essential idea. While we can discount the present value of future free cash flows (or net earnings, for the matter), such approaches are distorted by leverage. One of the oldest games in town is to increase leverage to boost EPS. It is arguably better to discount an economic profit stream by the WACC so that the value of the enterprise is recognized. But you may be thinking, isn’t WACC an academic concept? I do not think so! My own equities portfolio includes eleven REITs, where my selection is informed by specialists (on SeekingAlpha) like Brad Thomas and Jussi Askola. WACC plays a significant role in the evaluation of REITs by full-time REIT investors.

In the FRM, WACC is interesting because the FRM studies risk as a sort of complement to its traditional performance-based perspective, which concerns the optimal capital structure. We start by learning why capital structure doesn’t matter in a theoretical vacuum, then quickly proceed to the many realistic violations of M&M assumptions. Rene Stulz, Chairman of GARP’s FRM Committee, has a book somewhat focused on the issue. From the risk perspective, the issues are: what are the costs of financial distress or the threat of bankruptcy? And what are the benefits of the tax shield and tax management? And how does debt overhang encourage existing shareholders to avoid some desirable new projects? In risk, these are the “imperfections” that enable the risk manager to add value.

It’s hard to grapple with these issues if we don’t have a good sense of the basic WACC model. The model is elegant and efficient. We sometimes need simple models to intelligently discuss the realistic factors that influence decision-making. Consultants sometimes get teased about calculating WACC to two decimal places: how can you be exact about something with subjective inputs like beta. I think it misses the point. WACC is more often used in relative terms (how is it trending? Why is it trending? How does it compare to capitalization rates?) and to provoke discussions about decision making.

I hope that’s interesting! Stay tuned, as there is much more that I want to share about our new CFA Level I Prep program.
 
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