CFA Equity Investments Syllabus

Equity Investments syllabus — full chapter and topic list

Expand any chapter to see its topics and sub-topics. This is the whole examinable outline for Equity Investments in CFA, not a summary of it.

1. 1

   Market Organization and Structure

   2 topics

   • Types of Markets
   • Market Indices
2. 2

   Security Markets

   2 topics

   • Primary and Secondary Markets
   • Market Efficiency
3. 3

   Equity Valuation

   2 topics

   • Dividend Discount Model
   • Price Multiples

Equity Investments flashcards for CFA

21 of 51 cards from the Equity Investments deck — real questions with worked answers.

1. What are the two main functions of the financial system?

   To allow entities to (1) save, borrow, issue equity, manage risks, exchange assets, and use information; and (2) determine the rates of return (interest rates) that equate aggregate savings with aggregate borrowing, thereby allocating capital efficiently.

2. Distinguish between a financial asset and a real asset.

   A real asset is a physical/tangible asset such as land, buildings, machinery, or commodities. A financial asset is a claim on the income or cash flows generated by real assets or by an entity, e.g., stocks, bonds, and derivatives.

3. In market classification, what is the difference between the spot market and the forward/futures market?

   In the spot (cash) market, assets are traded for immediate delivery and payment. In forward and futures markets, participants contract now to trade an asset at a specified price on a future delivery date.

4. Define the primary market versus the secondary market.

   The primary market is where issuers sell newly created securities to investors, raising capital for the issuer. The secondary market is where investors trade already-issued securities among themselves; the issuer receives no proceeds.

5. What is the distinction between a money market and a capital market?

   Money markets trade debt instruments with original maturities of one year or less (e.g., T-bills, commercial paper). Capital markets trade longer-term debt (maturity over one year) and equity securities.

6. Contrast a call market with a continuous market.

   In a call market, trades occur only at specific times when the market is 'called' and buy/sell orders are batched to set a single clearing price. In a continuous market, trades can occur at any time the market is open, at prices set by the latest matching orders.

7. What is the difference between a primary (public) equity offering and a seasoned (secondary) offering?

   An initial public offering (IPO) is the first sale of shares to the public by a previously private company. A seasoned (secondary/follow-on) offering is the sale of additional new shares by a company that is already publicly traded.

8. Name and briefly describe the three main mechanisms of a primary market equity issuance handled by an investment bank.

   (1) Underwritten offering: the bank guarantees the sale by buying the entire issue at a negotiated price, bearing the risk. (2) Best-efforts offering: the bank acts only as a broker and does not guarantee the sale. (3) Shelf registration / private placement: securities are sold gradually or to a small number of qualified investors.

9. What is a rights offering in the primary market?

   A rights offering gives existing shareholders the right to buy new shares in proportion to their current holdings, usually at a price below market, protecting them from dilution. Because the subscription price is below market, existing shares often fall in value.

10. List the four types of secondary-market order-execution systems.

    (1) Quote-driven (dealer) markets — trade with dealers who quote bid/ask prices; (2) Order-driven markets — orders matched by rules (order-matching + trade-pricing rules); (3) Brokered markets — brokers find counterparties for unique/illiquid assets; and combinations/hybrids of these.

11. In an order-driven market, what is the difference between a market order and a limit order?

    A market order executes immediately at the best available price, guaranteeing execution but not price. A limit order executes only at a specified price or better, guaranteeing price but not execution.

12. Define the bid price, ask price, and bid-ask spread.

    The bid price is the highest price a dealer/buyer will pay; the ask (offer) price is the lowest price a dealer/seller will accept. The bid-ask spread $= \text{Ask} - \text{Bid}$, a measure of transaction cost and liquidity.

13. What characterizes a well-functioning (operationally efficient) financial market?

    Complete markets (assets available for all needs), operational efficiency (low transaction costs, high liquidity), informational efficiency (prices reflect information), and allocational efficiency (capital flows to its most productive uses).

14. What is the purpose of a security market index?

    A security market index represents the value of a specified target market, market segment, or asset class using the values of a selected group of constituent securities, serving as a benchmark, gauge of sentiment, and basis for investment products.

15. Write the formula for the price return of a single-period index.

    $$PR_I = \frac{V_{PT1} - V_{PT0}}{V_{PT0}}$$ where $V_{PT1}$ and $V_{PT0}$ are the index portfolio values at the end and beginning of the period.

16. Write the formula for the total return of a security market index for a single period.

    $$TR_I = \frac{V_{PT1} - V_{PT0} + Inc_{PT}}{V_{PT0}}$$ where $Inc_{PT}$ is the total income (dividends/interest) from the constituent securities over the period.

17. What is a price-weighted index and how is its value calculated?

    A price-weighted index sums the constituent prices and divides by a divisor: $$\text{Index Value} = \frac{\sum_{i=1}^{N} P_i}{D}$$ Higher-priced stocks have more influence. The Dow Jones Industrial Average and Nikkei 225 are examples. The divisor is adjusted for stock splits.

18. How is the weight of a constituent computed in a price-weighted index?

    $$w_i^{P} = \frac{P_i}{\sum_{j=1}^{N} P_j}$$ The weight is the security's price divided by the sum of all constituent prices.

19. How is the weight of a constituent computed in a market-capitalization-weighted index?

    $$w_i^{M} = \frac{Q_i P_i}{\sum_{j=1}^{N} Q_j P_j}$$ where $Q_i$ is shares outstanding and $P_i$ is price; the weight equals the security's market cap divided by total market cap of the index.

20. What is float-adjusted market-capitalization weighting?

    It weights each constituent by the market value of only its shares available to the public (free float), excluding shares held by controlling shareholders, governments, or other strategic holders that are not available for trading.

21. How is the weight of a constituent computed in an equal-weighted index?

    $$w_i^{E} = \frac{1}{N}$$ Each of the $N$ constituents receives the same weight, regardless of price or market cap. This requires periodic rebalancing and effectively overweights small-cap securities.

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