Chartered Financial Analyst (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 Chartered Financial Analyst (CFA), not a summary of it.

1. 1

   Market Organization and Indexes

   3 topics

   • Market Organization and Structure
     • Functions of the financial system
     • Types of assets, intermediaries, and positions
     • Order types, leveraged positions, and margin
   • Security Market Indexes
     • Index construction and weighting methods
     • Rebalancing, reconstitution, and index uses
   • Market Efficiency
     • Forms of the efficient market hypothesis
     • Market anomalies and behavioral finance
2. 2

   Equity Securities and Industry Analysis

   3 topics

   • Overview of Equity Securities
     • Common vs. preferred shares and private vs. public equity
     • Investing in non-domestic equities
     • Risk and return characteristics
   • Industry and Company Analysis
     • Industry classification and life cycle
     • Porter's five forces and competitive analysis
     • Forecasting company performance
   • Company Analysis: Forecasting
     • Revenue and cost modeling
     • Scenario and sensitivity analysis
3. 3

   Equity Valuation Models

   4 topics

   • Equity Valuation Concepts and the DDM
     • Intrinsic value and the dividend discount model
     • Gordon growth and multistage models
     • Present value of growth opportunities (PVGO)
   • Free Cash Flow Valuation
     • FCFF and FCFE valuation models
     • Forecasting free cash flows
     • Single-stage and multistage FCF models
   • Market-Based and Residual Income Valuation
     • Price multiples: P/E, P/B, P/S, EV/EBITDA
     • Method of comparables vs. justified multiples
     • Residual income model and economic value added
   • Private Company Valuation
     • Asset-based, income, and market approaches
     • Discounts for lack of control and marketability

Equity Investments flashcards for Chartered Financial Analyst (CFA)

21 of 60 cards from the Equity Investments deck — real questions with worked answers.

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

   (1) Allow entities to save, borrow, issue equity, manage risks, exchange assets, and use information (achieve purposes); (2) determine equilibrium interest rates (rates of return that equate aggregate savings with aggregate borrowing); (3) allocate capital efficiently to its most productive uses.

2. Distinguish a call market from a continuous trading market.

   In a call market, a security trades only at specific times when buyers and sellers are gathered and a single clearing price is set. In a continuous trading market, trades can occur at any time the market is open at prices determined by the available orders.

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

   The bid is the highest price a dealer/buyer will pay; the ask (offer) is the lowest price a dealer/seller will accept. The bid-ask spread is the difference (ask minus bid); a narrower spread indicates greater liquidity. The best bid and best ask form the inside (market) quote.

4. What distinguishes a market order from a limit order?

   A market order executes immediately at the best available price (certainty of execution, uncertain price). A limit order executes only at a specified price or better (certainty of price/better, uncertain execution); it may not fill if the limit is not reached.

5. How does buying on margin magnify returns, and what is the formula for return on a margin purchase?

   Margin lets an investor borrow part of the purchase price, increasing leverage so gains and losses are amplified. $$\text{Return} = \frac{(P_{1}-P_{0}) + D - \text{Interest paid}}{\text{Initial equity (margin) invested}}$$ where $P_{0}$ is purchase price, $P_{1}$ is sale price, and $D$ is dividends received.

6. Give the formula for the leverage ratio and the margin call (trigger) price for a long position.

   Leverage ratio $= \frac{1}{\text{initial margin requirement}}$. The price at which a margin call occurs is $$P = P_{0}\,\frac{1 - \text{initial margin}}{1 - \text{maintenance margin}}$$

7. What is the difference between a quote-driven (dealer) market and an order-driven market?

   In a quote-driven (dealer) market, customers trade with dealers who post bid and ask quotes. In an order-driven market, orders from buyers and sellers are matched using order-matching and trade-pricing rules (no required dealer intermediary).

8. List the four orders along the spectrum of well-functioning financial systems' market characteristics (completeness, liquidity, etc.).

   A well-functioning financial system is operationally efficient (low trading costs and liquidity), informationally efficient (prices reflect fundamental value), and complete (markets exist for the full range of assets/contracts investors want). Allocational efficiency results: capital flows to its most productive uses.

9. What are the main classes of assets/securities traded in financial markets?

   Securities (fixed income/debt, equity, pooled investment vehicles), currencies, contracts (forwards, futures, options, swaps), commodities, and real assets (real estate, equipment). Securities can also be classified as public (registered) versus private.

10. Compare a primary market with a secondary market.

    The primary market is where issuers sell new securities to raise capital (e.g., IPOs, seasoned offerings, private placements). The secondary market is where investors trade already-issued securities among themselves; the issuer receives no proceeds but secondary liquidity supports primary issuance.

11. What is short selling, and what are the investor's obligations?

    Short selling is selling borrowed securities, hoping to buy them back later at a lower price. The short seller must repay any dividends/interest to the lender, post collateral, and eventually buy the shares to cover. Losses are theoretically unlimited because the price can rise without bound.

12. Name the four desirable properties of a security market index's underlying methodology a constituent index should address.

    An index is defined by (1) its target market/security selection, (2) the number of securities, (3) the weighting method, and (4) the rebalancing and reconstitution policy. These determine how well it represents the target market.

13. Give the formula for the value and the return of a price-weighted index.

    $$\text{Index value} = \frac{\sum_{i=1}^{N} P_{i}}{D}$$ where $D$ is a divisor adjusted for splits/composition changes. The return weights each stock by its price; a high-priced stock has the most influence (e.g., the Dow Jones Industrial Average).

14. How is a market-capitalization-weighted index constructed, and what is float adjustment?

    Each constituent's weight equals its market cap divided by total index market cap: $$w_{i} = \frac{P_{i}Q_{i}}{\sum_{j=1}^{N} P_{j}Q_{j}}$$ Float adjustment uses only shares available to public investors (excluding closely held/restricted shares). Cap-weighting is self-rebalancing but overweights overvalued stocks.

15. Compare price-weighted, equal-weighted, and market-cap-weighted indexes on rebalancing needs and biases.

    Price-weighted: biased toward high-priced shares; rebalances only for splits. Equal-weighted: biased toward small-cap stocks and requires frequent rebalancing to restore equal weights. Market-cap-weighted: biased toward large-cap (possibly overvalued) stocks but is self-rebalancing (no rebalancing needed for price moves).

16. Distinguish rebalancing from reconstitution of an index.

    Rebalancing adjusts the weights of existing constituents back to target weights on a schedule. Reconstitution changes the set of constituents (adds/removes securities) per the selection rules, which also triggers rebalancing of the new set.

17. What is the difference between a price return index and a total return index?

    A price return index measures only price appreciation of constituents. A total return index measures price appreciation plus reinvested income (dividends/interest). Over time the total return index value exceeds the price return value by the accumulated, reinvested income.

18. What are the main uses of security market indexes?

    They serve as (1) gauges of market sentiment, (2) proxies for measuring and modeling returns (e.g., market return in CAPM), (3) proxies for systematic risk, (4) benchmarks for active manager performance, and (5) the basis for index funds and ETFs.

19. State the three forms of the Efficient Market Hypothesis and the information each price reflects.

    Weak form: prices reflect all past market (price/volume) data — technical analysis cannot earn abnormal returns. Semi-strong form: prices reflect all public information — fundamental analysis on public data cannot earn abnormal returns. Strong form: prices reflect all public and private information — not even insiders can earn abnormal returns.

20. What is the relationship between market value, intrinsic value, and market efficiency?

    Intrinsic (fundamental) value is the value a rational investor with full information would assign; market value is the transaction price. In an efficient market the two are equal (or differ only randomly). Active managers profit only if their estimate of intrinsic value differs from market price and is correct.

21. Define a market anomaly and give three examples.

    An anomaly is a persistent pattern that appears to allow abnormal risk-adjusted returns, contradicting market efficiency. Examples: the calendar (January) effect, the size/small-firm effect, the value effect (low P/E, low P/B outperformance), and momentum and earnings-announcement (post-earnings-drift) effects.

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