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.  There are basically two types of orders, i.e. bid order and ask order.

b.  The bid rate is the rate at which the dealers and traders are ready to buy, and an ask rate is a rate at which they are ready to sell.

c.  The bid-ask spread is the simple difference between the selling price and the buying price of the asset. In the foreign exchange market, the bid-ask spread is the dominant source of dealer’s income.

1.1.         Execution Instructions

Order Execution Instructions Equity Investment CFA Level 1 Study Notes

Execution instructions are the instructions as to how the market orders should be filled. They could be in the form of ordering instruction, exposure instruction, or validity instruction, etc.

1.1.1.     Order Instructions

 Some of the ordering instructions are:

a.  Market Order. It is the order to buy or sell the assets at the best current market price. Market orders provide immediate liquidity to the market. The investors who want to buy/sell the stocks instruct the broker to make the trade at the lowest/highest price available in the market. The investors may be unaware of the prices at which the stocks would be traded.
In the market orders, the execution of the trade is guaranteed, but the price at which it would be executed is not guaranteed.

b.  Limit Orders. In the limit order, the investor specifies the limit at which he would like his stock to be traded. The buyer would specify the maximum limit at which the stock would be bought by the broker. Thus the broker has the choice to buy the stock at the specified limit or lower than that. Similarly, the seller can also specify the maximum limit, below which the stock cannot be sold.
In the limit orders, the price guarantee is there, but the guarantee of execution of the order is not there.
So, if an investor is buying the securities, he could place the limit order in the following ways:

     i.  If the limit is put above the ask rate it is considered as a marketable limit order and can be filled at least partially.

    ii.  If the limit is put between the bid and ask rate, it creates a new market, as it is still below the current market rate.

   iii.  If the limit is put at the current bid rate, it makes the market. The chances of the order being executed depending upon the size of the order and all the buy orders placed at this price would be executed before the latter one is executed.

   iv.  If the limit is put below the current bid rate, it is behind the market and will be executed only if the price drops.

1.1.2.     Exposure Instruction

a.  Here the instructions are given by the investors, whether to display or hide the order on the exchange.

b.  The orders could be fully hidden; in this case, only the brokers and exchanges can see your order.

c.  The orders can also be partially hidden, where the display size of the order is lower than the actual order size. These are also called the iceberg orders.

d.  The orders are mainly hidden from the market, just so that, after knowing the large size of the order, the price is not pulled up.

1.1.3.     Validity Instructions

These are the instructions as to when an order may be filled. Some of the major validity instructions are:

a.  Day Orders. Day orders remain valid only during the specified day on which the order is placed. Generally, all the market orders are placed as day orders only. The underlying assumption behind such an order is that the market, economic and industry conditions may change; thus investment should be specified for a particular day only.

b.  Good-Till-Cancelled (GTC) Order. This order remains in the system until it is canceled by the trading member. It will therefore be able to span trading days if it does not get matched. The maximum number of days a GTC order can remain in the system is notified by the Exchange from time to time; but it remains for a maximum period of 6 months, typically.

c.  Fill-or-Kill (FOK) Order. This order allows the trading member to buy or sell security as soon as the order is released into the market, failing which the order will be removed from the market. A partial match is possible for the order, and the unmatched portion of the order gets canceled immediately.

d.  Good-on-Close Order. It is also called the market-on-close order. It is executed at the price prevailing at the close of trading on the day it was placed. The main motive behind placing a good on close order is that the trader might not want to close the books on a particular day at a loss. There may also be situations, where the market is pushed on high at the closing; in such situations, a good-on-close order is a more ideal option.

e.  Stop orders. It allows the trading members to place an order which gets activated only when the market price of the relevant security reaches or crosses a certain threshold price. Until then the order does not enter the market.
A sell order in the stop loss gets triggered only when the last traded price in the normal market reaches or falls below the trigger price of the order.
A buy order in the stop-loss book gets triggered only when the last traded price in the normal market reaches or exceeds the trigger price of the order.

1.1.4.     Clearing Instructions

The clearing instructions specify how the final settlement is arranged. When there is a single broker, there is not much need for the clearing instructions. However, when there is more than one broker, for executing both buy and clearing orders; then there is a need for the clearing instructions. The clearing instructions should indicate whether a sale is a long sale or a short sale.

 

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