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Equity
Investments
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Topic Weightings in CFA Level I
Session NO. ContentWeightings
Study Session 1Ethics & Professional Standards 15
Study Session 2-3Quantitative Analysis 12
Study Session 4-5Economics 10
Study Session 6-9Financial Reporting and Analysis 20
Study Session 10-11Corporate Finance 7
Study Session 12Portfolio Management and Wealth Planning 7
Study Session 13-14Equity Investment 10
Study Session 15-16Fixed Income 10
Study Session 17Derivatives 5
Study Session 18Alternative Investments 4
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Framework
Equity Investments
Structure
Company Analysis
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Market
Organization
and Structure
Equity Investments
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Characteristics of a Financial System
zAchievement of the purposes for which people use the financial system
9Save and borrow money, raise equity capital, manage risks, trade
assets currently or in the future, and trade based on their estimates
of asset values.
zDiscovery of the rates of return that equate aggregate savings with
aggregate borrowings
9Determine the returns (i.e., interest rates) that equate the total
supply of savings with the total demand for borrowing.
zAllocation of capital to the best uses
9The financial system allows the transfer of assets and risks from one
entity to another as well as across time.
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Characteristics of a Financial Market
zSaving: To move money from the present to the future. Stocks, bonds,
certificates of deposit, real assets, and other assets are tools for saving.
zBorrowing: Lenders aggregate from savers the funds that borrowers
require. Borrowers must convince lenders that they can repay their loans,
and that, in the event they cannot, lenders can recover most of the
funds lent. Borrow money from lenders who require collateral, take an
equity position, or investigate the credit risk of the borrower to protect
themselves in case of borrower defaults.
zRaising Equity Capital: Liquid markets help companies raise capital.
Companies often raise money for projects by selling (issuing) ownership
interests. The capital providers will share in any future profits.
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Characteristics of a Financial Market
zRisk management: Many people, companies, and governments face
financial risks that concern them. These risks include default risk and the
risk of changes in interest rates, exchange rates, raw material prices, and
sale prices, among many other risks. These risks are often managed by
trading contracts that serve as hedges for the risks.
zExchanging Assets for Immediate Delivery: People and companies
often trade one asset for another that they rate more highly or,
equivalently, that is more useful to them.
zUtilizing information: Investors with correctly analyzed information
expect to earn an additional return by identifying assets that are
currently undervalued or overvalued.
9Information-motivated traders: trade to profit from information
that they believe allows them to predict future prices.
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Characteristics of a Financial Market
zThe aggregate amount of money that savers will move from the present
to the future is related to the expected rate of return on their
investments. Interest rates are justified according to the total supply of
savings and the total demand of borrowings.
zEquilibrium interest rate: is the price for moving money through time.
9when the interest rate at which the entities are willing to borrow is
equal to the amount that entities are willing to lend, we say that the
supply and demand are balanced, and such balanced interest rate is
called the equilibrium interest rate.
9Equilibrium rates for different types of borrowing and lending will
differ due to differences in risk, liquidity, and maturity.
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Characteristics of a Financial Market
zOne of the most important functions of the financial system is to ensure
that only the best projects obtain scarce capital funds; the funds
available from savers should be allocated to the most productive uses.
zCompanies may raise funds by borrowing money or by issuing equity.
Governments may raise funds by borrowing money. Investors have to
weigh the expected risks and returns of different investments to
determine their most preferred investments due to limited availability of
capital.
zThis would result in an allocation to capital to its most valuable uses.
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Characteristics of a Financial Market
zBrokers, Dealers and Exchange
zSecuritizers
zDepository Institutions
zInsurance Companies
zArbitrageurs
zClearinghouses and Custodians
zHedgers
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Well functioned financial market
zallows entities to achieve their purposes.
zComplete markets: Savers receive a return, borrowers can obtain
capital. hedgers can manage risks, and traders can acquire needed
assets.
zOperational efficiency: Trading costs are low.
zInformational efficiency: Prices reflect fundamental information
quickly.
zAllocational efficiency: Capital is allocated to its most productive use.
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Classification of assets and markets
zPractitioners often classify assets and the markets in which they trade by
various common characteristics to facilitate communications with their
clients, with each other, and with regulators.
zFinancial Assets
9Security
9Currency
9Contracts
zReal Assets
9Commodity
9Real Estate
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Classification of assets and markets
zSecurity (Fixed income vs. Equity Securities )
9Fixed income securities: make sure the borrowed funds can be
repaid
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Classification of assets and markets
zSecurity (Fixed income vs. Equity Securities )
9Equity securities: represent ownership in a firm
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Classification of assets and markets
zSecurity (Fixed income vs. Equity Securities )
9Pooled investment vehicles:
vehicles.
units, depository receipts, or limited partnership interests.
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