Standard V. Investment Analysis Flashcards
Standard V. Investment analysis, recommendation, or action:
Diligence and Reasonable Basis (V(A))
Diligence and Reasonable Basis (V(A))
What It Means:
* Always conduct thorough research and due diligence before making investment recommendations.
* Ensure there is a reasonable and adequate basis for all investment decisions, backed by solid analysis.
Why It’s Important:
* Prevents reckless or uninformed recommendations.
* Ensures that investment actions are based on objective and credible information.
Best Practices:
✅ Analyze financial data: Review company reports, earnings statements, and industry trends.
✅ Consider various sources: Look at market trends, economic conditions, and expert opinions.
✅ Remain independent: Avoid being influenced by personal biases or external pressures.
✅ Review assumptions: Ensure models and forecasts are reasonable.
Examples:
✅ Following the Rule:
A portfolio manager recommends a stock after reviewing financial statements, speaking with company management, and analyzing market trends.
❌ Breaking the Rule:
An analyst suggests investing in a startup solely because a social media influencer says it’s “the next big thing,” without verifying the claim.
Communication with Clients (V(B))
Communication with Clients (V(B))
What It Means:
- Be clear and transparent when communicating with clients about investments.
- Distinguish between facts (objective data) and opinions (forecasts, predictions).
- Disclose risks, fees, and changes in the investment process.
Why It’s Important:- Helps clients make informed decisions.
- Prevents misleading or exaggerated statements.
- Builds trust and credibility in client relationships.
Best Practices:
✅ Explain your investment strategy: Tell clients how you analyze investments and what factors you consider.
✅ Be upfront about costs: Clearly state any fees or commissions.
✅ Highlight risks: If an investment carries high volatility or liquidity risks, make it clear.
✅ Notify of changes: If your investment strategy shifts, inform clients right away.
✅ Separate fact from opinion: If making a projection, say, “This is a forecast based on historical data.”
Examples:
✅ Following the Rule:
An investment adviser informs a client that a structured product may be hard to sell in a downturn due to low liquidity.
❌ Breaking the Rule:
An analyst writes, “This stock will double in a year,” without clarifying that it is a prediction, not a certainty
Record Retention (V(C))
Record Retention (V(C))
What It Means:
- Maintain records of all research, analysis, and client communications related to investment decisions.
- Keep records for at least seven years or as required by law.
Why It’s Important:- Provides a paper trail to justify investment decisions.
- Protects against legal disputes or compliance issues.
- Ensures consistency in investment research and recommendations.
Best Practices:
✅ Document investment research: Save reports, meeting notes, and spreadsheets.
✅ Record client communications: Keep copies of emails, disclosures, and recommendations.
✅ Follow firm and regulatory policies: Maintain records as required by law and company policies.
Examples:
✅ Following the Rule:
A financial analyst keeps a digital record of research reports supporting a buy recommendation.
❌ Breaking the Rule:
An investment manager deletes old reports, making it impossible to verify why certain stocks were recommended.
Ahmed bases his recommendation on third-party research but fails to assess its credibility or assumptions.
A) V(A)
B) V(B)
C) V(C)
A
Liu updates her clients on portfolio changes but doesn’t explain the risks associated with a new strategy.
A) V(A)
B) V(B)
C) V(C)
B
Cheng uses outdated assumptions from 3 years ago in a new company valuation.
A) V(A)
B) V(B)
C) V(C)
A
Nelson gives a client an investment recommendation but doesn’t clarify which parts are facts and which are personal opinions.
A) V(A)
B) V(B)
C) V(C)
B
Rodriguez doesn’t keep records of model changes that materially affected his past recommendations.
A) V(A)
B) V(B)
C) V(C)
C
Singh prepares a portfolio recommendation based on historical return data, but makes no effort to assess current suitability.
A) V(A)
B) V(B)
C) V(C)
A
Miller uses a model to project returns but fails to disclose the assumptions or limitations of the model to clients.
A) V(A)
B) V(B)
C) V(C)
B
Petrov writes a research report but fails to disclose that he owns a significant personal stake in the company.
A) V(A)
B) V(B)
C) V(C)
B
Kim recommends a complex derivative strategy but doesn’t explain it clearly to the client.
A) V(A)
B) V(B)
C) V(C)
B
Evans downloads industry data and uses it to recommend several stocks without checking for accuracy or relevance.
A) V(A)
B) V(B)
C) V(C)
A
Clark distributes marketing material with investment performance but omits major risks related to the strategy.
A) V(A)
B) V(B)
C) V(C)
B
Thompson reuses templates for reports and accidentally copies outdated assumptions into a current client recommendation.
A) V(A)
B) V(B)
C) V(C)
A
Freeman summarizes an investment process in a client pitch but fails to update the description after a major change in methodology.
A) V(A)
B) V(B)
C) V(C)
B
De la Cruz doesn’t document the basis for recommendations she made to several institutional clients.
A) V(A)
B) V(B)
C) V(C)
C
Nguyen provides performance data to clients but doesn’t distinguish gross from net returns.
A) V(A)
B) V(B)
C) V(C)
B
Lopez fails to keep records of emails that contain key justifications for investment decisions.
A) V(A)
B) V(B)
C) V(C)
C
O’Donnell recommends an M&A deal based on internal insights but doesn’t support it with public data or valuation analysis.
A) V(A)
B) V(B)
C) V(C)
A
Diaz tells clients she selects mutual funds based on performance but omits that she excludes funds with less than 5 years of history.
A) V(A)
B) V(B)
C) V(C)
B
Kumar sends a generic investment newsletter but fails to disclose that past performance is not indicative of future results.
A) V(A)
B) V(B)
C) V(C)
B
Wong posts a research blog about a new company without checking if all financial data has been audited.
A) V(A)
B) V(B)
C) V(C)
A
Sato delivers a favorable recommendation on a new IPO but doesn’t inform clients that she didn’t conduct any due diligence.
A) V(A)
B) V(B)
C) V(C)
B
Baldwin sends a report on a sector rotation strategy but doesn’t update clients after a market shock changes assumptions.
A) V(A)
B) V(B)
C) V(C)
B
Zhang uses a data vendor’s screeners for research but fails to understand how the screen filters were designed.
A) V(A)
B) V(B)
C) V(C)
A
Choi fails to explain a major tax implication tied to a structured product she recommends.
A) V(A)
B) V(B)
C) V(C)
B
Foster tells clients that his firm evaluates companies using ESG metrics but omits to say ESG was not applied to 40% of the portfolio.
A) V(A)
B) V(B)
C) V(C)
B
Washington recommends a biotech stock based solely on media reports without reviewing financials or analyst opinions.
A) V(A)
B) V(B)
C) V(C)
A
Lee tells clients he uses a quantitative model for security selection but doesn’t disclose that the model was replaced recently.
A) V(A)
B) V(B)
C) V(C)
B
Adams provides a valuation of a private company using aggressive projections without disclosing the speculative nature of the inputs.
A) V(A)
B) V(B)
C) V(C)
B
Hawke, head of corporate finance at Sarkozi Securities, rushes to price IPOs using company size as a proxy due to time constraints, planning to justify the pricing later.
a. No violation because time constraints are valid in fast-moving markets
b. Violation because she bypassed full due diligence in pricing securities
c. No violation if her pricing turns out to be accurate
d. Violation only if investors complain about IPO performance
Correct Answer:
b. Violation because she bypassed full due diligence in pricing securities
Explanation:
Hawke violated Standard V(A) by not conducting a full analysis of all material factors. Estimating based on size alone does not meet the standard of diligence and a reasonable basis for investment recommendations.
Chandler recommends five U.S. equity managers to a UK pension client. After submitting the report, she learns that one of the firms lost key personnel but doesn’t revise her recommendations.
a. No violation because the report was already submitted
b. Violation because she failed to update her analysis with new material information
c. No violation since other firms in the report are unaffected
d. Violation only if the client selects the affected firm
b. Violation because she failed to update her analysis with new material information
Explanation:
Chandler violated Standard V(A) by not incorporating significant organizational changes that could impact the firm’s ability to deliver on the product being recommended.
Lindstrom manages an equity portfolio for a client whose investment policy included a 35% allocation to technology stocks. After three years of poor tech sector performance, the client complains about the allocation—despite agreeing to the benchmark originally.
What documentation would best help Lindstrom respond to the client’s concerns?
a. A performance summary comparing his fund to a different tech fund
b. A signed investment policy statement and records of past client discussions about the strategy
c. A market analysis showing technology was expected to decline
d. A detailed log of daily stock trades in the portfolio
b. A signed investment policy statement and records of past client discussions about the strategy
Explanation:
Maintaining the IPS and supporting documentation confirms the investment decisions were consistent with the agreed-upon strategy and communicated properly.
Cannon, a quantitative analyst, incorporates a new factor into CityCenter’s model based on ideas from a blog without testing how it affects investment recommendations.
a. No violation if the source is reputable
b. Violation because he failed to evaluate the impact of the changes before using them
c. No violation if the model improves performance
d. Violation only if client portfolios suffer
b. Violation because he failed to evaluate the impact of the changes before using them
Explanation:
Cannon violated Standard V(A) by failing to conduct adequate due diligence before applying the changes to the model. He must test any modifications to ensure they provide a sound basis for recommendations.
Stefansson recommends a new performance attribution system based on a conversation at a conference without evaluating the system’s methodology or reviewing alternatives.
a. No violation if the system appears technically advanced
b. Violation for failing to sufficiently compare and analyze available options
c. No violation if her firm uses it temporarily
d. Violation only if clients question the attribution results
b. Violation for failing to sufficiently compare and analyze available options
Explanation:
Standard V(A) requires thorough evaluation before making recommendations. Stefansson failed to compare the systems or confirm alignment with the firm’s investment practices.
Young prepares industry research on luxury retailers, incorporating interviews, surveys, site visits, and third-party analysis. He wants to ensure his work is properly backed up.
What action should he take to support the credibility and compliance of his reports?
a. Only save the published reports, since preliminary research is nonessential
b. Keep all original sources and supporting materials used to prepare each report
c. Record the conclusions but delete raw data to save space
d. Archive only the reports that result in public recommendations
b. Keep all original sources and supporting materials used to prepare each report
Explanation:
To support the integrity of his research, he must retain all data and third-party research used in forming his conclusions, even if it’s not published.
Maalouf’s firm changes its advisory fee methodology to use end-of-cycle market values and include cash in calculations but does not disclose the changes to clients.
a. No violation if fees are lower
b. Violation for not informing clients of a change in fee calculation
c. No violation if the standard valuation method was used
d. Violation only if clients complain
b. Violation for not informing clients of a change in fee calculation
Explanation:
Clients must be informed of changes in advisory fee methodologies. Even if the changes reduce fees, failing to disclose them violates Standard V(B).
Williamson plans to publish a newsletter for high-net-worth clients, listing only buy/sell recommendations without explaining the complex investment methodology behind them.
a. No violation because clients just need the final recommendations
b. Violation for failing to disclose the basis of investment decisions
c. No violation if clients are experienced investors
d. Violation only if clients misunderstand the recommendations
b. Violation for failing to disclose the basis of investment decisions
Explanation:
Standard V(B) requires disclosure of the basic principles behind recommendations so that clients can evaluate associated risks and limitations.
Dupont neglects to update his U.S. credit risk model and later introduces a flawed “quick fix.” Reichardt, who uses the model to manage client portfolios, does not fully understand how it works.
a. Only Dupont is in violation for neglecting model maintenance
b. Only Reichardt is in violation for using a model he doesn’t understand
c. Both are in violation: Dupont for lack of testing, Reichardt for lack of understanding
d. No violation since they corrected the issue quickly
c. Both are in violation: Dupont for lack of testing, Reichardt for lack of understanding
Explanation:
Dupont failed to validate the model changes adequately, violating Standard V(A). Reichardt also violated the standard by relying on a model he did not understand, even though he was making client investment decisions based on it.
Ramon tells clients that Brickell’s value at risk (VaR) methodology is highly reliable and has never failed, but he doesn’t explain the assumptions or potential weaknesses in the model.
a. No violation if the model has historically been accurate
b. Violation for not disclosing inputs, assumptions, and model limitations
c. No violation if clients don’t request further explanation
d. Violation only if future losses exceed the VaR
b. Violation for not disclosing inputs, assumptions, and model limitations
Explanation:
Standard V(B) requires that the limitations of analytical tools, like VaR models, be disclosed so clients can understand both their usefulness and their risks.
Thomas writes a report promoting a structured product that benefits from declining interest rates. The report highlights potential returns but omits details of how the product works, embedded leverage, and possible outcomes if interest rates rise.
a. No violation since the strategy is proprietary
b. Violation for failing to disclose the full risk profile and structure of the investment
c. No violation if high returns are achievable
d. Violation only if clients experience losses
b. Violation for failing to disclose the full risk profile and structure of the investment
Explanation:
Standard V(B) requires full communication of actual and implied risks, including how the strategy performs in both expected and adverse scenarios.
May & Associates changes its small-cap investment threshold from US$2 billion to US$8 billion and informs only prospective clients via new marketing materials.
a. No violation because the strategy is still growth-oriented
b. Violation for failing to notify existing clients of a material change in investment process
c. No violation if the change improves liquidity
d. Violation only if performance deteriorates
b. Violation for failing to notify existing clients of a material change in investment process
Explanation:
Standard V(B) requires that all clients—not just new ones—be informed of significant changes that could affect asset allocation or mandate expectations.
ABC Capital charges structuring fees to companies its fund invests in. It retains fees when investments increase in value and remits them when they decrease. This arrangement is not disclosed in the private placement memorandum, as the CEO considers it “common industry practice.”
a. No violation because clients benefit from the arrangement
b. No violation since the fees are internal to the portfolio companies
c. Violation for failing to disclose material compensation arrangements
d. Violation only if investors lose money due to the arrangement
c. Violation for failing to disclose material compensation arrangements
Explanation:
Standard V(B) requires full disclosure of all material fees and compensation structures. Even if the practice benefits clients, withholding disclosure is a violation.
May & Associates expands its small-cap universe to include non-U.S. companies. The firm does not notify current clients of this change.
a. No violation because the strategy still focuses on small-cap stocks
b. Violation for failing to disclose a shift in geographic investment criteria
c. No violation if international stocks improve performance
d. Violation only if currency risk increases
b. Violation for failing to disclose a shift in geographic investment criteria
Explanation:
Including non-U.S. equities represents a significant change in the investment process that must be disclosed to clients under Standard V(B).
Jones compares gross-of-fees performance across three fixed-income managers and provides each manager’s fee structure, estimated total costs, and explanations to her client before the final selection.
a. Violation for using gross-of-fees performance instead of net
b. No violation because she provided full, fair, and clear disclosure
c. Violation if fee structures differ by client
d. No violation only if final fees are lowest
b. No violation because she provided full, fair, and clear disclosure
Explanation:
Jones adhered to Standard V(B) by ensuring a uniform and transparent comparison of manager services and fees, allowing the client to make an informed decision.
RJZ Capital replaces its trailing P/E-based model with a new dividend discount model incorporating inflation and interest rate forecasts. The change is not communicated to clients.
a. No violation if the new model is more accurate
b. Violation for failing to disclose a material change in the investment process
c. No violation since the model is internal
d. Violation only if performance suffers
b. Violation for failing to disclose a material change in the investment process
Explanation:
Clients must be informed when a firm changes from a data-driven to a forecast-based model. This is a fundamental shift requiring disclosure.
Violation of V (B)
Fundamental Asset Management changes its stock selection from individual analysts to a committee but does not inform clients. Morales, a portfolio manager, sees no need to notify them.
a. No violation because the portfolio construction remains unchanged
b. Violation for failing to disclose a change in the decision-making process
c. No violation since analysts still provide research
d. Violation only if committee recommendations are inconsistent
b. Violation for failing to disclose a change in the decision-making process
Explanation:
Standard V(B) requires disclosure of changes to the investment process, including who is responsible for security selection.
Chinn informs a charity that Diversified Asset Management will begin using external fund managers for small- and mid-cap investments. He includes details about oversight and manager qualifications.
a. No violation because Chinn explained the process change and rationale
b. Violation for outsourcing part of the investment strategy
c. No violation only if external managers are selected promptly
d. Violation if fund performance changes dramatically
a. No violation because Chinn explained the process change and rationale
Explanation:
Chinn satisfied Standard V(B) by transparently communicating changes in how the portfolio will be managed, enabling the client to reassess the relationship if needed.
Yakovlev’s small-cap strategy has a capacity limit of US$3 billion. He informs the marketing team, but they leave it out of offering materials. Yakovlev does not object since the fund only has US$100 million in capital.
a. No violation because the capacity constraint has not yet been reached
b. Violation for failing to disclose a material limitation that could affect future performance
c. No violation if past returns are strong
d. Violation only if the fund grows past US$3 billion
b. Violation for failing to disclose a material limitation that could affect future performance
Explanation:
Standard V(B) requires disclosure of information that could materially affect investor expectations. Capacity constraints fall under this obligation.
Dox calculates that a mining firm likely holds 500,000 ounces of gold based on recent core samples and concludes his report by stating the firm has that amount of gold.
a. Violation for expressing personal judgment
b. No violation if based on quantitative analysis
c. Violation for failing to distinguish opinion from fact
d. No violation since the estimate is reasonable
c. Violation for failing to distinguish opinion from fact
Explanation:
Dox’s statement presents an opinion as fact. Standard V(B) requires analysts to clearly distinguish between factual representations and subjective assessments.
While working at Buku Investment Management, Blank designs a successful analytical model and documents all his assumptions and supporting calculations. After being hired by a competitor, he brings copies of his work to use at the new firm.
Which of the following best describes Blank’s situation?
a. He may use the files if they contain only his personal notes
b. He must obtain written permission before transferring those records
c. He can reuse the material if it was developed individually
d. He is allowed to bring the model since he was the creator
b. He must obtain written permission before transferring those records
Explanation:
The supporting materials created at Buku are the property of that firm. Taking them to a new employer without consent breaches professional obligations, even if he developed the content himself.
