CFA Level 1 Study Notes – Equity Investments

CFA Level 1 Study Notes – Equity Investments

Study Session 12

Reading 36 – Market Organization and Structure

LOS 36a: explain the main functions of the financial system
LOS 36b: describe classifications of assets and markets
LOS 36c: describe the major types of securities, currencies, contracts, commodities, and real assets that trade in organized markets, including their distinguishing characteristics and major subtypes
LOS 36d: describe types of financial intermediaries and services that they provide
LOS 36e: compare positions an investor can take in an asset
LOS 36f: 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
LOS 36g: compare execution, validity, and clearing instructions
LOS 36h: compare market orders with limit orders
LOS 36i: define primary and secondary markets and explain how secondary markets support primary markets
LOS 36j: describe how securities, contracts, and currencies are traded in quote-driven, order-driven, and brokered markets
LOS 36k: describe characteristics of a well-functioning financial system
LOS 36l: describe objectives of market regulation

Reading 37 – Security Market Indices

LOS 37a: describe a security market index
LOS 37b: calculate and interpret the value, price return, and total return of an index
LOS 37c: describe the choices and issues in index construction and management
LOS 37d: compare the different weighting methods used in index construction
LOS 37e: calculate and analyze the value and return of an index given its weighting method
LOS 37f: describe rebalancing and reconstitution of an index
LOS 37g: describe uses of security market indices
LOS 37h: describe types of equity indices
LOS 37i: describe types of fixed-income indices
LOS 37j: describe indices representing alternative investments
LOS 37k: compare types of security market indices

Reading 38 – Market Efficiency

LOS 38a: describe market efficiency and related concepts, including their importance to investment practitioners
LOS 38b: distinguish between market value and intrinsic value
LOS 38c: explain factors that affect a market’s efficiency
LOS 38d: contrast weak-form, semi-strong-form, and strong-form market efficiency
LOS 38e: explain the implications of each form of market efficiency for fundamental analysis, technical analysis, and the choice between active and passive portfolio management
LOS 38f: describe market anomalies
LOS 38g: describe behavioral finance and its potential relevance to understanding market anomalies

Reading 39 – Overview of Equity Securities

LOS 39a: describe characteristics of types of equity securities
LOS 39b: describe differences in voting rights and other ownership characteristics among different equity classes
LOS 39c: distinguish between public and private equity securities
LOS 39d: describe methods for investing in non-domestic equity securities
LOS 39e: compare the risk and return characteristics of different types of equity securities
LOS 39f: explain the role of equity securities in the financing of a company’s assets
LOS 39g: distinguish between the market value and book value of equity securities
LOS 39h: compare a company’s cost of equity, its (accounting) return on equity, and investors’ required rates of return

Reading 40 – Introduction to Industry and Company Analysis

LOS 40a: explain uses of industry analysis and the relation of industry analysis to company analysis
LOS 40b: compare methods by which companies can be grouped
LOS 40c: 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”
LOS 40d: 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
LOS 40e: explain how a company’s industry classification can be used to identify a potential “peer group” for equity valuation
LOS 40f: describe the elements that need to be covered in a thorough industry analysis
LOS 40g: describe the principles of strategic analysis of an industry
LOS 40h: explain the effects of barriers to entry, industry concentration, industry capacity, and market share stability on pricing power and price competition
LOS 40i: 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
LOS 40j: compare characteristics of representative industries from the various economic sectors
LOS 40k: describe macroeconomic, technological, demographic, governmental, and social influences on industry growth, profitability, and risk
LOS 40l: describe the elements that should be covered in a thorough company analysis

Reading 41 – Equity Valuation: Concepts and Basic Tools

LOS 41a: evaluate whether security, given its current market price and a value estimate, is overvalued, fairly valued, or undervalued by the market
LOS 41b: describe major categories of equity valuation models
LOS 41c: describe regular cash dividends, extra dividends, stock dividends, stock splits, reverse stock splits, and share repurchases
LOS 41d: describe dividend payment chronology
LOS 41e: explain the rationale for using present value models to value equity and describe the dividend discount and free-cash-flow-to-equity models
LOS 41f: calculate the intrinsic value of a non-callable, non-convertible preferred stock
LOS 41g: calculate and interpret the intrinsic value of an equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate
LOS 41h: identify characteristics of companies for which the constant growth or a multistage dividend discount model is appropriate
LOS 41i: 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
LOS 41j: 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
LOS 41k: describe enterprise value multiples and their use in estimating equity value
LOS 41l: describe asset-based valuation models and their use in estimating equity value
LOS 41m: explain the advantages and disadvantages of each category of the valuation model

2024 Curriculum

Learning Module 1 – Market Organization and Structure

LOS 36a: explain the main functions of the financial system
LOS 36b: describe classifications of assets and markets
LOS 36c: describe the major types of securities, currencies, contracts, commodities, and real assets that trade in organized markets, including their distinguishing characteristics and major subtypes
LOS 36d: describe types of financial intermediaries and services that they provide
LOS 36e: compare positions an investor can take in an asset
LOS 36f: 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
LOS 36g: compare execution, validity, and clearing instructions
LOS 36h: compare market orders with limit orders
LOS 36i: define primary and secondary markets and explain how secondary markets support primary markets
LOS 36j: describe how securities, contracts, and currencies are traded in quote-driven, order-driven, and brokered markets
LOS 36k: describe characteristics of a well-functioning financial system
LOS 36l: describe objectives of market regulation

Learning Module 2 – Security Market Indices

LOS 37a: describe a security market index
LOS 37b: calculate and interpret the value, price return, and total return of an index
LOS 37c: describe the choices and issues in index construction and management
LOS 37d: compare the different weighting methods used in index construction
LOS 37e: calculate and analyze the value and return of an index given its weighting method
LOS 37f: describe rebalancing and reconstitution of an index
LOS 37g: describe uses of security market indices
LOS 37h: describe types of equity indices
LOS 37i: describe types of fixed-income indices
LOS 37j: describe indices representing alternative investments
LOS 37k: compare types of security market indices

Learning Module 3 – Market Efficiency

LOS 38a: describe market efficiency and related concepts, including their importance to investment practitioners
LOS 38b: distinguish between market value and intrinsic value
LOS 38c: explain factors that affect a market’s efficiency
LOS 38d: contrast weak-form, semi-strong-form, and strong-form market efficiency
LOS 38e: explain the implications of each form of market efficiency for fundamental analysis, technical analysis, and the choice between active and passive portfolio management
LOS 38f: describe market anomalies
LOS 38g: describe behavioral finance and its potential relevance to understanding market anomalies

Learning Module 4 – Overview of Equity Securities

LOS 39a: describe characteristics of types of equity securities
LOS 39b: describe differences in voting rights and other ownership characteristics among different equity classes
LOS 39c: distinguish between public and private equity securities
LOS 39d: describe methods for investing in non-domestic equity securities
LOS 39e: compare the risk and return characteristics of different types of equity securities
LOS 39f: explain the role of equity securities in the financing of a company’s assets
LOS 39g: distinguish between the market value and book value of equity securities
LOS 39h: compare a company’s cost of equity, its (accounting) return on equity, and investors’ required rates of return

Learning Module 5 – Company Analysis: Past and Present

LOS a: describe the elements that should be covered in a thorough company research report

LOS b: determine a company’s business model

LOS c: evaluate a company’s revenue and revenue drivers, including pricing power

LOS d: evaluate a company’s operating profitability and working capital using key measures

LOS e: evaluate a company’s capital investments and capital structure

Learning Module 6 – Industry and Competitive Analysis

LOS a: describe the purposes of, and steps involved in, industry and competitive analysis

LOS b: describe industry classification methods and compare methods by which companies can be grouped

LOS c: determine an industry’s size, growth characteristics, profitability, and market share trends

LOS d: analyze an industry’s structure and external influences using Porter’s Five Forces and PESTLE frameworks

LOS e: evaluate the competitive strategy and position of a company

Learning Module 7 – Company Analysis: Forecasting

LOS a: explain principles and approaches to forecasting a company’s financial results and position

LOS b: explain approaches to forecasting a company’s revenues

LOS c: explain approaches to forecasting a company’s operating expenses and working capital

LOS d: explain approaches to forecasting a company’s capital investments and capital structure

LOS e: describe the use of scenario analysis in forecasting

Learning Module 8 – Equity Valuation: Concepts and Basic Tools

LOS 41a: evaluate whether security, given its current market price and a value estimate, is overvalued, fairly valued, or undervalued by the market
LOS 41b: describe major categories of equity valuation models
LOS 41c: describe regular cash dividends, extra dividends, stock dividends, stock splits, reverse stock splits, and share repurchases
LOS 41d: describe dividend payment chronology
LOS 41e: explain the rationale for using present value models to value equity and describe the dividend discount and free-cash-flow-to-equity models
LOS 41f: calculate the intrinsic value of a non-callable, non-convertible preferred stock
LOS 41g: calculate and interpret the intrinsic value of an equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate
LOS 41h: identify characteristics of companies for which the constant growth or a multistage dividend discount model is appropriate
LOS 41i: 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
LOS 41j: 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
LOS 41k: describe enterprise value multiples and their use in estimating equity value
LOS 41l: describe asset-based valuation models and their use in estimating equity value
LOS 41m: explain the advantages and disadvantages of each category of the valuation model

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