Course Content
MARKET ORGANIZATION AND STRUCTURE
This chapter is covered in Reading 36 of Study Session 12 of the institute. After reading this chapter, the candidate should be able to: a. explain the main functions of the financial system; b. describe classifications of assets and markets; c. describe the major types of securities, currencies, contracts, commodities, and real assets that trade in organized markets, including their distinguishing characteristics and major subtypes; d. describe types of financial intermediaries and services that they provide; e. compare positions an investor can take in an asset; f. calculate and interpret the leverage ratio, the rate of return on a margin transaction, and the security price at which the investor would receive a margin call; g. compare execution, validity, and clearing instructions; h. compare market orders with limit orders; i. define primary and secondary markets and explain how secondary markets support primary markets; j. describe how securities, contracts, and currencies are traded in quote-driven, order-driven, and brokered markets; k. describe characteristics of a well-functioning financial system; l. describe objectives of market regulation.
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LOS A: Main Functions of Financial System
LOS B: Classification of Assets and Markets
LOS C: Types of Assets
LOS D: Financial Intermediaries
LOS E: Positions of Investors
LOS F: Margin
LOS G and H: Order Types
LOS I: Primary and Secondary Markets
LOS J: Trading
LOS K: Well Functioning System
LOS L: Objectives of Market Regulations
SECURITY MARKET INDEXES
This chapter is covered in Reading 37, of Study Session 12 of the material provided by the institute. After reading this chapter, a student should be able to: a. describe a security market index; b. calculate and interpret the value, price return, and total return of an index; c. describe the choices and issues in index construction and management; d. compare the different weighting methods used in index construction; e. calculate and analyze the value and return of an index given its weighting method; f. describe rebalancing and reconstitution of an index; g. describe uses of security market indices; h. describe types of equity indices; i. describe types of fixed-income indices; j. describe indices representing alternative investments; k. compare types of security market indices.
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LOS A: Security Market Index
LOS B: Index Return
LOS C: Index Construction
LOS D and E: Index Weightings
LOS F: Rebalancing and Reconstitution of Indices
LOS G: Uses of Security Market Indices
LOS H: Types of Equity Indices
LOS I: Fixed Income Indices
LOS J and K: Alternative Investment’s Indices
MARKET EFFICIENCY
This chapter is covered in Reading 38, of Study Session 12 of the material provided by the institute. After reading this chapter, a student should be able to: a. describe market efficiency and related concepts, including their importance to investment practitioners; b. distinguish between market value and intrinsic value; c. explain factors that affect a market’s efficiency; d. contrast weak-form, semi-strong-form, and strong-form market efficiency; e. explain the implications of each form of market efficiency for fundamental analysis, technical analysis, and the choice between active and passive portfolio management; f. describe market anomalies; g. describe behavioral finance and its potential relevance to understanding market anomalies.
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LOS A: Market Efficiency
LOS B: Market Value Vs. Intrinsic Value
LOS C: Factors That Affects the Market Efficiency
LOS D and E: Weak, Semi-Strong, & Strong Form of Market Efficiency
LOS F: Market Anomalies
LOS G: Behavioral Finance
OVERVIEW OF EQUITY SECURITIES
This topic is covered in the reading 39 of study session 13 of the study material provided by the institute. After reading this chapter a student should be able to: a. describe characteristics of types of equity securities; b. describe differences in voting rights and other ownership characteristics among different equity classes; c. distinguish between public and private equity securities; d. describe methods for investing in non-domestic equity securities; e. compare the risk and return characteristics of different types of equity securities; f. explain the role of equity securities in the financing of a company’s assets; g. distinguish between the market value and book value of equity securities; h. compare a company’s cost of equity, its (accounting) return on equity, and investors’ required rates of return.
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LOS A and B: Equity Securities
LOS C: Public & Private Equity Securities
LOS D: Non-Domestic Equity
LOS E: Risk and Return Characteristics of Different Types of Equity Securities
LOS F: Role of Equity Securities in Financing of Company’s Assets
LOS G: Market Value Vs. Book Value
LOS H: Cost and Return on Equity
INTRODUCTION TO INDUSTRY AND COMPANY ANALYSIS
This topic is covered in reading 40 of study session 13 of the study material provided by the institute. After reading this chapter a student should be able to: a. explain uses of industry analysis and the relation of industry analysis to company analysis; b. compare methods by which companies can be grouped, current industry classification systems, and classify a company, given a description of its activities and the classification system; c. explain the factors that affect the sensitivity of a company to the business cycle and the uses and limitations of industry and company descriptors such as “growth,” “defensive,” and “cyclical”; d. explain how a company’s industry classification can be used to identify a potential “peer group” for equity valuation; e. describe the elements that need to be covered in a thorough industry analysis; f. describe the principles of strategic analysis of an industry; g. explain the effects of barriers to entry, industry concentration, industry capacity, and market share stability on pricing power and price competition; h. describe industry life cycle models, classify an industry as to life cycle stage, and describe limitations of the life-cycle concept in forecasting industry performance; i. compare characteristics of representative industries from the various economic sectors; j. describe macroeconomic, technological, demographic, governmental, and social influences on industry growth, profitability, and risk; k. describe the elements that should be covered in thorough company analysis.
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LOS A: Industry Analysis
LOS B and C: Grouping and Classification of Company
LOS D: Peer Group
LOS E: Components of Industrial Analysis
LOS F: Principles of Strategic Analysis of Industry
LOS G: Effects of Various Factors
LOS H: Life Cycle Models
LOS I and J: Industry Comparison
LOS K: Elements of Thorough Company Analysis
EQUITY VALUATION: CONCEPTS AND BASIC TOOLS
This topic is covered in reading 41 of study session 13 of the study material provided by the institute. After reading this chapter a student should be able to: a evaluate whether security, given its current market price and a value estimate, is overvalued, fairly valued, or undervalued by the market; b describe major categories of equity valuation models; c describe regular cash dividends, extra dividends, stock dividends, stock splits, reverse stock splits, and share repurchases; d describe dividend payment chronology; e explain the rationale for using present value models to value equity and describe the dividend discount and free-cash-flow-to-equity models; f calculate the intrinsic value of a non-callable, non-convertible preferred stock; g calculate and interpret the intrinsic value of equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate; h identify characteristics of companies for which the constant growth or a multistage dividend discount model is appropriate; i explain the rationale for using price multiples to value equity, how the price to earnings multiple relates to fundamentals, and the use of multiples based on comparables; j calculate and interpret the following multiples: price to earnings, price to an estimate of operating cash flow, price to sales, and price to book value; k describe enterprise value multiples and their use in estimating equity value; l describe asset-based valuation models and their use in estimating equity value; m explain the advantages and disadvantages of each category of the valuation model.
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LOS A : Intrinsic Value and Market value
LOS B: Categories of Equity Valuation Model
LOS C: Dividends, Stock Splits, and Share Repurchases
LOS D: Dividends Payment Chronology
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LOS E: Present Value Models
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LOS F: Intrinsic Value of Non-Callable Non-Convertible Preferred Stock
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LOS G: Gordon Growth Model
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LOS H: Multi-Stage Dividend Discount Models
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LOS I and J: Price Multiples
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LOS K: Enterprise Value Multiples
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LOS L: Asset Based Valuation
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LOS M: Advantage and Disadvantages of Each Model
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Equity Investments
About Lesson

a.  The companies can issue their shares in not just their country, but in the international markets as well, due to globalization and free trade. This helps the countries widen their base of shareholders and get the best cost (obviously lower cost) for the capital issued.

b.  Though the investors have a bias towards domestic investments due to the tax laws promoting the local investments, still they can gain access to the foreign investments, which may result in diversification of risk, away from the ‘domestic only’ investments.

c.  There are certain restrictions imposed by different countries that restrict the flow of capital away from the local territorial boundaries. Such restrictions:

     i.  Limit the amount of control foreign investors have over domestic companies,

    ii.  Give domestic investors an opportunity to own the shares of foreign companies conducting business in the domestic markets, and

   iii.  Reduce the volatility of capital inflows and outflows.

These restrictions promote the investment in and growth of the local companies and thus the economy.

d.  However, these restrictions do affect the performance of the equity market, which can be improved if these restrictions are reduced.

e.  Off lately, a large number of companies have listed their shares in the markets outside their home countries. This is called ‘dual-listing. The main benefits of foreign listing are:

     i.  This improves the awareness about the company’s products and services, not only in the foreign countries but also improves their reputation locally.

    ii.  Foreign listing improves the liquidity of the shares.

   iii.  Since the companies issuing the shares internationally, have to fulfill the filing requirements of different countries, their transparency also gets increased.

1.1.         Methods of Issuing Non-Domestic Equity

Following methods can be used to issue equity in a non-domestic region:

1.1.1.     Direct Investing

a.  As per this method, the securities are bought and sold directly in foreign markets.

b.  The purchases, sales, gains/losses on the sale, payment of dividends, etc. are all done in foreign countries by the issuing companies. This kind of issue is, thus, subject to the exchange rate risk.

c.  To make such an issue, the issuing company must be familiar with the trading, clearing, and settlement regulation of the foreign market.

Such issues may lead to either less transparency and more volatility, or more transparency and less volatility.

1.1.2.     Depository Receipts

a.  Depository receipt is the financial security issued by a local bank (acting as a custodian or transfer agent) that represents the foreign company’s traded securities.

b.  These instruments trade like an ordinary share on a local exchange but represent an economic interest in a foreign company.

The following diagram explains the mechanism of a depository receipt:

mechanism of a depository receipt Equity Investment CFA Level 1 Study Notes

c.  The depository receipts do not eliminate the foreign currency risk but eliminate the foreign currencies from the transaction for the local investors.

d.  The depository receipts may be of two types, i.e. sponsored or unsponsored.

e.  The sponsored depository receipts allow the foreign companies a direct involvement in the issuance of receipts; whereas the investors in the depository receipts have the same rights as the direct owners.

f.  The level 1 American Depository Receipts (ADRs) trade on the over-the-counter markets, whereas level 2 & 3 ADRs trade on the stock exchanges. Thus level 2 & 3 ADRs must be registered with SEC, and follow the regulatory guidelines. According to rule 144A, only qualified institutional buyers are allowed to trade in privately placed instruments.

g.  In the unsponsored depository receipts, the foreign issuing company does not have any direct involvement in the issuance of receipts. The right of ownership also lies with the depository and not the investor.

h.  The two most common types of depository receipts are American Depository Receipts (ADRs) and Global Depository Receipts.

i.  The American Depository Receipts (ADRs) are certificates that are issued by a bank of American origin and traded in the US as domestic shares.

j.  The Global Depository Receipts (GDRs) are issued by a depository in both banks outside the issuer’s home country and the US.

1.1.3.     Global Registered Shares

These are ordinary shares that are quoted and traded in different currencies on different markets.

1.1.4.     Basket of Listed Depository Receipts

It is nothing but the exchange-traded funds listed on the non-domestic territories.

 

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