FCFA common mistakes
FCFA · Understand the traps and how to avoid them.
Treating the three-step DuPont decomposition as a standalone calculation and reporting the product of net profit margin, asset turnover, and equity multiplier without reconciling it to reported ROE, or mixing average and ending balances across the ratios.
Candidates memorize the formula but not the balance-sheet consistency requirement; they plug ending equity into the multiplier while using average assets in turnover, so the decomposition does not tie to the reported ROE and the diagnostic conclusion is wrong.
What to do instead
Before computing, write down the balance-sheet dates used for every ratio in the chain. Use average balances consistently for turnover and leverage, and prove the identity by multiplying the three components and comparing to net income divided by average equity. If the check fails, fix the input before interpreting.
Choosing the wrong tail and the wrong test statistic when the question gives a sample standard deviation and a small sample: using z instead of t, or splitting alpha incorrectly for a one-tailed test.
Candidates default to the normal distribution and to a two-tailed alpha because those are the most practiced patterns; the question's wording about 'greater than' or 'less than' and the sample size are skimmed rather than parsed.
What to do instead
Build a two-line decision checklist before every hypothesis question: (1) is sigma known or is n large? If not, use t with n-1 degrees of freedom; (2) does the alternative contain > or <? If yes, one-tailed with full alpha in one tail. Write the rejection region before touching the data.
Confusing a change in quantity demanded with a shift in demand, and then applying the wrong curve shift when a price of a complement, income, or a substitute changes.
The terminology is deceptively similar in everyday language, and candidates map 'price changes' directly to 'demand changes' without distinguishing movement along the curve from a shift of the curve.
What to do instead
For every supply-and-demand item, label the event as either a determinant of demand (income, tastes, prices of related goods, expectations, number of buyers) or a determinant of supply (input costs, technology, taxes/subsidies, expectations, number of sellers). If the event is the good's own price, it is a movement along the curve, not a shift.
Computing NPV and IRR and then selecting the project with the highest IRR when the projects differ in scale or timing, or when the NPV profiles cross.
IRR is expressed as a percentage and feels comparable across projects; candidates forget that IRR is a relative measure and that the NPV decision rule dominates for value maximization.
What to do instead
State the decision rule explicitly: accept if NPV > 0 at the required rate of return; when projects are mutually exclusive, choose the highest positive NPV. Use IRR only as a secondary check, and if IRR and NPV conflict, identify the crossover rate and trust NPV. Also check for multiple IRRs when cash flow signs change more than once.
Applying the dividend discount model with a growth rate that exceeds the required return, or using the Gordon growth model for a firm in a high-growth transition without a two-stage structure.
Candidates force every valuation into the simplest formula because it is the one they can recall under time pressure, ignoring the model's assumption that g < r.
What to do instead
Before substituting, test g < r. If the company is in a high-growth phase, use a two-stage or H-model: forecast dividends explicitly for the high-growth period, compute a terminal value with a sustainable g below the required return and below nominal GDP growth, then discount all cash flows to today.
Quoting a bond's yield to maturity as if it were the investor's realized return without checking reinvestment assumptions, and mispricing a bond between coupon dates by ignoring accrued interest.
YTM is the most visible number on a bond quote, and candidates treat it as a guaranteed return; accrued interest is a small detail that is easy to skip when the question gives a settlement date.
What to do instead
Separate the three return components: coupon income, reinvestment income, and capital gain/loss. State that YTM equals realized return only if coupons are reinvested at the YTM and the bond is held to maturity. For between-coupon pricing, compute the full price from the fractional period, then subtract accrued interest to get the flat (clean) price.
Valuing a forward contract at initiation as if it had positive value, or forgetting to discount the forward payoff back to the present when marking to market.
Candidates conflate the forward price with the forward value; at initiation the price is set so that value is zero, but the price itself is generally not zero and not equal to the spot price.
What to do instead
Write the two formulas side by side: forward price F0 = S0 × (1+r)^T (adjusted for carry); value at time t = (Ft − F0) / (1+r)^(T−t) for a long position. At initiation, substitute Ft = F0 and confirm the value is zero. Always discount the terminal payoff.
Treating the Sharpe ratio as the correct performance measure for a portfolio that is not the investor's entire risky portfolio, or ranking portfolios by Sharpe when they have different levels of unsystematic risk.
Sharpe is the most familiar ratio, so candidates apply it universally; they forget that it assumes the portfolio is fully diversified and that it penalizes total risk, including diversifiable risk.
What to do instead
Match the measure to the context: Sharpe for a standalone portfolio that represents the investor's total risky holdings; Treynor or Jensen's alpha when the portfolio is one component of a larger diversified fund and only systematic risk matters; information ratio when evaluating active management against a benchmark. State the assumption before selecting.
Reading the Standards as general ethical aspirations and answering 'what would a reasonable person do' instead of applying the specific prohibitions, especially on gifts, additional compensation, and use of client brokerage.
The Ethics material is prose-heavy and candidates skim it, relying on personal intuition; the exam tests precise rule boundaries (for example, whether a gift requires written consent from the employer).
What to do instead
For each scenario, identify the exact Standard and sub-section, then ask three questions: is there a duty to disclose, a duty to obtain written consent, or an outright prohibition? Memorize the trigger words: 'written consent' for additional compensation and for gifts from clients to the employer; 'best execution' and 'client benefit' for soft dollars. Practice with short vignettes and justify each choice by citing the Standard number.
Treating the financial reporting quality spectrum as binary (fraud versus clean) and ignoring the middle ground of earnings management within GAAP, or missing conservative versus aggressive accounting choices in the same footnote.
Candidates look for an obvious red flag and stop; they do not systematically compare accounting policies across periods or peers, and they conflate aggressive accounting with fraud.
What to do instead
Use a three-layer framework: (1) GAAP compliance - is the policy allowed? (2) earnings quality - are accruals backed by cash flow? (3) sustainability - will the choice reverse? Compare accruals to operating cash flow, check the direction of changes in estimates (useful life, reserves), and read the accounting policy footnote for changes. Label each finding as conservative, neutral, aggressive, or fraudulent.