CFA Program Curriculum 2017 Level 1 - Vol 5.pdf - Contents 1 Table of Contents 2 How to Use the CFA Program Curriculum 3 Equity a STUDY SESSION 13

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Unformatted text preview: Contents 1. Table of Contents 2. How to Use the CFA Program Curriculum 3. Equity a. STUDY SESSION 13 Equity: Market Organization, Market Indices, and Market Efficiency i. READING 45 Market Organization and Structure ii. READING 46 Security Market Indices iii. READING 47 Market Efficiency b. STUDY SESSION 14 Equity Analysis and Valuation i. READING 48 Overview of Equity Securities ii. READING 49 Introduction to Industry and Company Analysis iii. READING 50 Equity Valuation: Concepts and Basic Tools 4. Fixed Income a. STUDY SESSION 15 Fixed Income: Basic Concepts i. READING 51 Fixed-Income Securities: Defining Elements ii. READING 52 Fixed-Income Markets: Issuance, Trading, and Funding iii. READING 53 Introduction to Fixed-Income Valuation iv. READING 54 Introduction to Asset-Backed Securities b. STUDY SESSION 16 Fixed Income: Analysis of Risk i. READING 55 Understanding Fixed-Income Risk and Return ii. READING 56 Fundamentals of Credit Analysis 5. Glossary 6. Index 7. Pages List Book Version EQUITY AND FIXED INCOME CFA® Program Curriculum 2017 • LEVEL I • VOLUME 5 Photography courtesy of Hector Emanuel. © 201 6, 201 5, 201 4, 201 3, 201 2, 201 1 , 201 0, 2009, 2008, 2007 , 2006 by CFA Institute. All rights reserv ed. This copy right cov ers material written ex pressly for this v olume by the editor/s as well as the compilation itself. It does not cov er the indiv idual selections herein that first appeared elsewhere. Permission to reprint these has been obtained by CFA Institute for this edition only . Further reproductions by any means, electronic or mechanical, including photocopy ing and recording, or by any information storage or retriev al sy stems, must be arranged with the indiv idual copy right holders noted. CFA®, Chartered Financial Analy st®, AIMR-PPS®, and GIPS® are just a few of the trademarks owned by CFA Institute. To v iew a list of CFA Institute trademarks and the Guide for Use of CFA Institute Marks, please v isit our website at . This publication is designed to prov ide accurate and authoritativ e information in regard to the subject matter cov ered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional serv ice. If legal adv ice or other ex pert assistance is required, the serv ices of a competent professional should be sought. All trademarks, serv ice marks, registered trademarks, and registered serv ice marks are the property of their respectiv e owners and are used herein for identification purposes only . ISBN 97 8-1 -94247 1 -7 1 -4 (paper) ISBN 97 8-1 -94247 1 -92-9 (ebk) Please v isit our website at GlobalFinance.com. TABLE OF CONTENTS HOW TO USE THE CFA PROGRAM CURRICULUM CURRICULUM DEVELOPMENT PROCESS ORGANIZATION OF THE CURRICULUM FEATURES OF THE CURRICULUM DESIGNING YOUR PERSONAL STUDY PROGRAM FEEDBACK EQUITY STUDY SESSION 13 EQUITY MARKET ORGANIZATION, MARKET INDICES, AND MARKET EFFICIENCY READING 45 MARKET ORGANIZATION AND STRUCTURE 1 INTRODUCTION 2 THE FUNCTIONS OF THE FINANCIAL SYSTEM 3 ASSETS AND CONTRACTS 4 FINANCIAL INTERMEDIARIES 5 POSITIONS 6 ORDERS 7 PRIMARY SECURITY MARKETS 8 SECONDARY SECURITY MARKET AND CONTRACT MARKET STRUCTURES 9 WELL-FUNCTIONING FINANCIAL SYSTEMS 10 MARKET REGULATION SUMMARY PRACTICE PROBLEMS SOLUTIONS READING 46 SECURITY MARKET INDICES 1 INTRODUCTION 2 INDEX DEFINITION AND CALCULATIONS OF VALUE AND RETURNS 3 INDEX CONSTRUCTION AND MANAGEMENT 4 USES OF MARKET INDICES 5 EQUITY INDICES 6 FIXED-INCOME INDICES 7 INDICES FOR ALTERNATIVE INVESTMENTS SUMMARY PRACTICE PROBLEMS SOLUTIONS READING 47 MARKET EFFICIENCY 1 INTRODUCTION 2 THE CONCEPT OF MARKET EFFICIENCY 3 FORMS OF MARKET EFFICIENCY 4 MARKET PRICING ANOMALIES 5 BEHAVIORAL FINANCE SUMMARY REFERENCES PRACTICE PROBLEMS SOLUTIONS STUDY SESSION 14 EQUITY ANALYSIS AND VALUATION READING 48 OVERVIEW OF EQUITY SECURITIES 1 INTRODUCTION 2 EQUITY SECURITIES IN GLOBAL FINANCIAL MARKETS 3 TYPES AND CHARACTERISTICS OF EQUITY SECURITIES 4 PRIVATE VERSUS PUBLIC EQUITY SECURITIES 5 INVESTING IN NON-DOMESTIC EQUITY SECURITIES 6 RISK AND RETURN CHARACTERISTICS OF EQUITY SECURITIES 7 EQUITY SECURITIES AND COMPANY VALUE SUMMARY REFERENCES PRACTICE PROBLEMS SOLUTIONS READING 49 INTRODUCTION TO INDUSTRY AND COMPANY ANALYSIS 1 INTRODUCTION 2 USES OF INDUSTRY ANALYSIS 3 APPROACHES TO IDENTIFYING SIMILAR COMPANIES 4 INDUSTRY CLASSIFICATION SYSTEMS 5 DESCRIBING AND ANALYZING AN INDUSTRY 6 COMPANY ANALYSIS SUMMARY REFERENCES PRACTICE PROBLEMS SOLUTIONS READING 50 EQUITY VALUATION: CONCEPTS AND BASIC TOOLS 1 INTRODUCTION 2 ESTIMATED VALUE AND MARKET PRICE 3 MAJOR CATEGORIES OF EQUITY VALUATION MODELS 4 PRESENT VALUE MODELS: THE DIVIDEND DISCOUNT MODEL 5 MULTIPLIER MODELS 6 ASSET-BASED VALUATION SUMMARY REFERENCES PRACTICE PROBLEMS SOLUTIONS FIXED INCOME STUDY SESSION 15 FIXED INCOME BASIC CONCEPTS READING 51 FIXED-INCOME SECURITIES: DEFINING ELEMENTS 1 INTRODUCTION 2 OVERVIEW OF A FIXED-INCOME SECURITY 3 LEGAL, REGULATORY, AND TAX CONSIDERATIONS 4 STRUCTURE OF A BOND'S CASH FLOWS 5 BONDS WITH CONTINGENCY PROVISIONS SUMMARY PRACTICE PROBLEMS SOLUTIONS READING 52 FIXED-INCOME MARKETS: ISSUANCE, TRADING, AND FUNDING 1 INTRODUCTION 2 OVERVIEW OF GLOBAL FIXED-INCOME MARKETS 3 PRIMARY AND SECONDARY BOND MARKETS 4 SOVEREIGN BONDS 5 NON-SOVEREIGN GOVERNMENT, QUASI-GOVERNMENT, AND SUPRANATIONAL BONDS 6 CORPORATE DEBT 7 STRUCTURED FINANCIAL INSTRUMENTS 8 SHORT-TERM FUNDING ALTERNATIVES AVAILABLE TO BANKS SUMMARY PRACTICE PROBLEMS SOLUTIONS READING 53 INTRODUCTION TO FIXED-INCOME VALUATION 1 INTRODUCTION 2 BOND PRICES AND THE TIME VALUE OF MONEY 3 PRICES AND YIELDS: CONVENTIONS FOR QUOTES AND CALCULATIONS 4 THE MATURITY STRUCTURE OF INTEREST RATES 5 YIELD SPREADS SUMMARY PRACTICE PROBLEMS SOLUTIONS READING 54 INTRODUCTION TO ASSET-BACKED SECURITIES 1 INTRODUCTION 2 BENEFITS OF SECURITIZATION FOR ECONOMIES AND FINANCIAL MARKETS 3 HOW SECURITIZATION WORKS 4 RESIDENTIAL MORTGAGE LOANS 5 RESIDENTIAL MORTGAGE-BACKED SECURITIES 6 COMMERCIAL MORTGAGE-BACKED SECURITIES 7 NON-MORTGAGE ASSET-BACKED SECURITIES 8 COLLATERALIZED DEBT OBLIGATIONS SUMMARY REFERENCES PRACTICE PROBLEMS SOLUTIONS STUDY SESSION 16 FIXED INCOME ANALYSIS OF RISK READING 55 UNDERSTANDING FIXED-INCOME RISK AND RETURN 1 INTRODUCTION 2 SOURCES OF RETURN 3 INTEREST RATE RISK ON FIXED-RATE BONDS 4 INTEREST RATE RISK AND THE INVESTMENT HORIZON 5 CREDIT AND LIQUIDITY RISK SUMMARY PRACTICE PROBLEMS SOLUTIONS READING 56 FUNDAMENTALS OF CREDIT ANALYSIS 1 INTRODUCTION 2 CREDIT RISK 3 CAPITAL STRUCTURE, SENIORITY RANKING, AND RECOVERY RATES 4 RATINGS AGENCIES, CREDIT RATINGS, AND THEIR ROLE IN THE DEBT MARKETS 5 TRADITIONAL CREDIT ANALYSIS: CORPORATE DEBT SECURITIES 6 CREDIT RISK VS. RETURN: YIELDS AND SPREADS 7 SPECIAL CONSIDERATIONS OF HIGH-YIELD, SOVEREIGN, AND NONSOVEREIGN CREDIT ANALYSIS SUMMARY PRACTICE PROBLEMS SOLUTIONS GLOSSARY INDEX List of Illustrations READING 45 Exhibit 1 Option Positions and Their Associated Underlying Risk Exposures Exhibit 2 Terms Traders Use to Describe Standing Limit Orders READING 46 Exhibit 1 Example of a Price-Weighted Equity Index Exhibit 2 Impact of 2-for-1 Split in Security A Exhibit 3 Example of an Equal-Weighted Equity Index Exhibit 4 Example of a Market-Capitalization-Weighted Equity Index Exhibit 5 Example of Float-Adjusted Market-Capitalization-Weighted Equity Index Exhibit 6 Three-Month Performance of Uranium Energy Corporation and NASDAQ April through June 2009 Exhibit 7 MSCI International Equity Indices—Country and Market Coverage (as of June 2009) Exhibit 8 Comparison of Minimum Issue Size and Bond Holdings by Index Exhibit 9 Dimensions of Fixed-Income Indices Exhibit 10 Market Sector Breakdown of the Barclays Capital Global Aggregate Bond Index Exhibit 11 Credit Breakdown of the Barclays Capital Global Aggregate Bond Index Exhibit 12 The FTSE EPRA/NAREIT Global REIT Index Family READING 47 Exhibit 1 The Event Study Process Exhibit 2 Price of Intel: 16 December 2009 Exhibit 3 Sampling of Observed Pricing Anomalies Exhibit 4 Calendar-Based Anomalies READING 48 Exhibit 1 Country and Regional Contributions to Global GDP and Equity Market Capitalization (2007) Exhibit 2 Equity Markets Ranked by Total Market Capitalization at the End of 2008 (Billions of US Dollars) Exhibit 3 Real Returns on Global Equity Securities, Bonds, and Bills During 1900– 2011 Exhibit 4 Real Annualized Equity Returns (%) in Local Currency and US Dollars, 1900–2011 Exhibit 5 Returns and Risk of Major Asset Classes since 1900 Exhibit 6 International Comparisons of Stock Ownership in Selected Countries: 2000–20087 Exhibit 7 Share Class Arrangements at Viacom Corporation9 Exhibit 8 Share Class Arrangements at Ford Motor Company12 Exhibit 9 Callable Stock Arrangement from Genomic Solutions13 Exhibit 10 Putable Stock Arrangement for Dreyer's Grand Ice Cream14 Exhibit 11 Callable Stock Arrangement between Goldman Sachs and Berkshire Hathaway16 Exhibit 12 Examples of Preference Shares Issued by DBS Bank17 Exhibit 13 Example of a PIPE Transaction19 Exhibit 14 Example of Increased Globalization of Share Ownership24 Exhibit 15 Sponsored versus Unsponsored Depository Receipts27 Exhibit 16 Summary of the Main Features of American Depository Receipts Exhibit 17 Impact of Reinvested Dividends on Cumulative Real Returns in the US and UK Equity Market: 1900–2011 Exhibit 18 Net Income and Book Value of Equity for Pfizer, Novartis AG, and GlaxoSmithKline (in Thousands of US Dollars) Exhibit 19 Return on Equity for Pfizer, Novartis AG, and GlaxoSmithKline Exhibit 20 Market Information for Pfizer, Novartis AG, and GlaxoSmithKline (in Thousands of US Dollars except market price) Exhibit 21 Pfizer, Novartis AG, and GlaxoSmithKline Exhibit 22 Book Value versus Intrinsic Value30 READING 49 Exhibit 1 Ten Sectors Exhibit 2 A Framework for Industry Analysis Exhibit 3 Some Industries Create Value, Others Destroy It: Average Industry ROIC Minus WACC, 2006–2008 Exhibit 4 A Two-Factor Analysis of Industries Exhibit 5 Market Share Stability in Global Orthopedic Devices (Entries Are Market Share) Exhibit 6 An Industry Life-Cycle Model Exhibit 7 Elements of a Strategic Analysis for Three Industries Exhibit 8 A Checklist for Company Analysis READING 50 Exhibit 1 Selected Financial Information for Total S.A. Exhibit 2 Sensitivity Analysis of the Intrinsic-Value Estimate for Total S.A. Exhibit 3 Value Line Report on Brown-Forman Exhibit 4 Estimates for Nestlé's Justified Forward P/E (Required Rate of Return = 12 Percent) Exhibit 5 Data for EADS and Boeing Exhibit 6 Data for Telefónica and Deutsche Telekom Exhibit 7 Estimated Market Value Exhibit 8 Data for Nine Major Mining Companies Exhibit 9 Company DPS, EPS, Share Price, and P/E Data Exhibit 10 Balance Sheet as of End of Year 5 READING 51 Exhibit 1 Cash Flows for a Plain Vanilla Bond Exhibit 2 Domestic and International Debt Securities by Residence of Issuer at the End of December 2011 Exhibit 3 Exhibit 4 Example of Payment Schedules for Bullet, Fully Amortized, and Partially Amortized Bonds Exhibit 5 Exhibit 6 Inflation-Linked Bonds Outstanding by Market Value at the End of December 2011 Exhibit 7 Exhibit 8 Outstanding Bonds and Notes by Type of Interest Payment and Conversion Features at the End of March 2012 READING 52 Exhibit 1 Global Debt and Equity Outstanding by Sector at the End of December 2010 Exhibit 2 Global Debt and Equity Outstanding for Various Countries and Economic Areas at the End of December 2010 (US$ trillions) Exhibit 3 Amounts of International Bonds Outstanding by Currency Denomination at the End of December 2011 Exhibit 4 Amount of Bonds Outstanding by Residence of Issuer and Type of Issuer at the End of December 2011 (US$ billions) Exhibit 5 Amounts of Bonds Outstanding at the End of December 2011 and Amounts of Net Bond Issuances in 2011 by Residence of the Issuer (US$ billions) Exhibit 6 Results of a US Treasury Public Auction on 16 October 2012 Exhibit 7 Commercial Paper Ratings Exhibit 8 USCP vs. ECP Exhibit 9 READING 53 Exhibit 1 Relationships between Bond Prices and Bond Characteristics Exhibit 2 The Convex Relationship between the Market Discount Rate and the Price of a 10-Year, 10% Annual Coupon Payment Bond Exhibit 3 Constant-Yield Price Trajectories for 4% and 12% Annual Coupon Payment, 10-Year Bonds at a Market Discount Rate of 8% Exhibit 4 Matrix Pricing Example Exhibit 5 A Government Bond Spot Curve Exhibit 6 A Government Bond Yield Curve Exhibit 7 A Government Bond Spot Curve and Forward Curve Exhibit 8 Yield-to-Maturity Building Blocks Exhibit 9 Bloomberg FIRV Page for the 5.70% IBM Bond READING 54 Exhibit 1 Mediquip's Securitization Exhibit 2 Monthly Cash Flow to Bondholders for a US$800 Million Mortgage PassThrough Security with a WAC of 6.0%, a WAM of 357 Months, and a Pass-Through Rate of 5.5%, Assuming a Prepayment Rate of 165 PSA Exhibit 3 CMO-01: Sequential-Pay CMO Structure with Four Tranches Exhibit 4 Average Life of the Collateral and the Four Tranches of CMO-01 for Various Actual Prepayment Rates Exhibit 5 CMO-02: CMO Structure with One PAC Tranche and One Support Tranche Exhibit 6 Average Life of the PAC Tranche and the Support Tranche of CMO-02 for Various Actual Prepayment Rates and an Initial PAC Collar of 100–250 PSA Exhibit 7 CMO-03: CMO Structure with Sequential PAC Tranches and One Support Tranche READING 55 Exhibit 1 Constant-Yield Price Trajectory for a 10-Year, 8% Annual Payment Bond Exhibit 2 Macaulay Duration of a 10-Year, 8% Annual Payment Bond Exhibit 3 Macaulay Duration of an Eight-Year, 6% Semiannual Payment Bond Priced to Yield 6.00% Exhibit 4 Approximate Modified Duration Exhibit 5 Bloomberg YAS Page for the 0.625% US Treasury Note Exhibit 6 Macaulay Duration between Coupon Payments with a Constant Yield-toMaturity Exhibit 7 Properties of the Macaulay Yield Duration Exhibit 8 Interest Rate Risk Characteristics of a Callable Bond Exhibit 9 Interest Rate Risk Characteristics of a Putable Bond Exhibit 10 Convexity of a Traditional (Option-Free) Fixed-Rate Bond Exhibit 11 Bloomberg YAS Page for the Zero-Coupon US Treasury Bond Exhibit 12 The Positive Attributes of Greater Bond Convexity on a Traditional (Option-Free) Bond Exhibit 13 Interest Rate Risk, Macaulay Duration, and the Investment Horizon READING 56 Exhibit 1 Seniority Ranking Exhibit 2 Average Corporate Debt Recovery Rates Measured by Ultimate Recoveries Exhibit 3 Global Recovery Rates by Seniority Ranking, 1990–2010 Exhibit 4 Long-Term Ratings Matrix: Investment Grade vs. Non-Investment Grade Exhibit 5 URI's S&P Ratings Detail, 27 May 2011 Exhibit 6 Global Corporate Annual Default Rates by Rating Category (%) Exhibit 7 Average Three-Year Corporate Transition Rates, 1981–2010 (%) Exhibit 8 Ford Motor Company Senior Unsecured Debt: Price vs. Moody's Rating Since 2005 Exhibit 9 Industrial Comparative Ratio Analysis Exhibit 10A Watson Pharmaceuticals' Financial Statements Exhibit 10B Watson Pharmaceuticals' Financial Statements Exhibit 10C Watson Pharmaceuticals' Financial Statements Exhibit 11 Johnson & Johnson's Credit Ratios Exhibit 12 ArcelorMittal Credit Ratios Exhibit 13 Corporate Yields by Rating Category as of 30 June 2011 Exhibit 14 US Trailing 12-Month Returns by Rating Category, 31 December 1996– 30 June 2011 Exhibit 15 US Investment-Grade and High-Yield Corporate Spreads Exhibit 16 Impact of Duration on Price for a Given Change in Spread Exhibit 17 Default Rate by Rating Category (%) (Non-financials) Exhibit 18 AT&T Credit Curve vs. US Treasury Curve Exhibit 19 Freescale Semiconductor Debt and Leverage Structure as of Year-End 2010 Exhibit 20 URI's Capital Structure Exhibit 21 US Trailing 12-Month Returns by Asset Class, 31 December 1988–30 June 2011 Exhibit 22 Key Sovereign Statistics for Portugal Exhibit 23 Municipal Debt Comparison: California vs. Texas Exhibit 1 Adidas AG Excerpt from Consolidated Income Statement Year Ending 31 December 2010 (€ in millions) Exhibit 2 European Food, Beverage, and Tobacco Industry and Grupa Zywiec SA Selected Financial Ratios for 2010 Exhibit 3 European Food, Beverage, and Tobacco Industry; Associated British Foods plc; and Davide Campari-Milano S.p.A Selected Financial Ratios, 2010 Exhibit 4 Industrial Comparative Ratio Analysis, Year 20XX How to Use the CFA Program Curriculum Congratulations on your decision to enter the Chartered Financial Analyst (CFA®) Program. This exciting and rewarding program of study reflects your desire to become a serious investment professional. You are embarking on a program noted for its high ethical standards and the breadth of knowledge, skills, and abilities it develops. Your commitment to the CFA Program should be educationally and professionally rewarding. The credential you seek is respected around the world as a mark of accomplishment and dedication. Each level of the program represents a distinct achievement in professional development. Successful completion of the program is rewarded with membership in a prestigious global community of investment professionals. CFA charterholders are dedicated to life-long learning and maintaining currency with the ever-changing dynamics of a challenging profession. The CFA Program represents the first step toward a career-long commitment to professional education. The CFA examination measures your mastery of the core skills required to succeed as an investment professional. These core skills are the basis for the Candidate Body of Knowledge (CBOK™). The CBOK consists of four components: A broad outline that lists the major topic areas covered in the CFA Program ( ); Topic area weights that indicate the relative exam weightings of the top-level topic areas ( ); Learning outcome statements (LOS) that advise candidates about the specific knowledge, skills, and abilities they should acquire from readings covering a topic area (LOS are provided in candidate study sessions and at the beginning of each reading); and The CFA Program curriculum, which contains the readings and end-of-reading questions, that candidates receive upon exam registration. Therefore, the key to your success on the CFA examinations is studying and understanding the CBOK. The following sections provide background on the CBOK, the organization of the curriculum, and tips for developing an effective study program. CURRICULUM DEVELOPMENT PROCESS The CFA Program is grounded in the practice of the investment profession. Beginning with the Global Body of Investment Knowledge (GBIK), CFA Institute performs a continuous practice analysis with investment professionals around the world to determine the knowledge, skills, and abilities (competencies) that are relevant to the profession. Regional expert panels and targeted surveys are conducted annually to verify and reinforce the continuous feedback from the GBIK collaborative website. The practice analysis process ultimately defines the CBOK. The CBOK reflects the competencies that are generally accepted and applied by investment professionals. These competencies are used in practice in a generalist context and are expected to be demonstrated by a recently qualified CFA charterholder. The Education Advisory Committee, consisting of practicing charterholders, in conjunction with CFA Institute staff, designs the CFA Program curriculum in order to deliver the CBOK to candidates. The examinations, also written by charterholders, are designed to allow you to demonstrate your mastery of the CBOK as set forth in the CFA Program curriculum. As you structure your personal study program, you should emphasize mastery of the CBOK and the practical application of that knowledge. For more information on the practice analysis, CBOK, and development of the CFA Program curriculum, please visit . ORGANIZATION OF THE CURRICULUM The Level I CFA Program curriculum is organized into 10 topic areas. Each topic area begins with a brief statement of the material and the depth of knowledge expected. Each topic area is then divided into one or more study sessi...
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