CFA Level 1 Equity Investments Practice Flashcards

Comprehensive practice vocabulary flashcards covering Market Structure, Indices, Efficiency, Equity Securities, and Company/Industry Analysis based on the CFA Level 1 Equity Valuation lecture notes.

Financial System

Consists of markets and financial intermediaries that facilitate the transfer of financial assets, real assets, and financial risks from one entity to another.

Arbitrageurs

Traders who trade on mispricing based on the Law of One Price; they buy and sell the same security in two different markets to connect sellers with buyers and provide liquidity.

Money Markets

Markets that trade debt instruments maturing in one year or less.

Capital Markets

Markets that trade financial instruments with maturities longer than one year.

Call Market

A market where all transactions take place at a single price where the quantity offered for sale is close to the quantity demanded.

Alternative Trading Systems (ATSs)

Trading platforms that do not exercise regulatory authority and often do not display orders sent to them (also known as dark pools).

Seasoned Offering

An offering where additional units of a previously issued security are sold; also referred to as a secondary offering.

Best-efforts offering

A primary market offering where the investment bank merely acts as a broker rather than guaranteeing the sale of the issue.

Securitization

The process of buying assets, placing them in a pool, and issuing securities known as asset-backed securities that represent ownership in that pool.

Repurchase Agreement (Repo)

A short-term fixed-income security involving the sale of a security with an agreement to buy it back at a later date.

Brokers

Agents who fulfill orders for their clients in an order-driven market.

Dealers

Market participants who fulfill orders for clients by taking positions as counterparties, creating liquidity by selling from or buying into their own inventory.

Forward Contract

An agreement between two parties where the long position is obligated to buy and the short position is obligated to sell an underlying asset at a fixed price at a future date.

Short Position

A position taken by selling an asset not currently owned, usually involving borrowing the securities to deliver to the buyer and later repurchasing them to return to the lender.

Leverage Ratio

The ratio of the total value of a position to the value of the equity investment in it.

Initial Margin

The value of the equity investment required by the investor, calculated as $\frac{1}{\text{Leverage Ratio}}$.

Maintenance Margin

The minimum equity an investor must hold in a margin account after a purchase has been made to avoid a margin call.

Trigger Price

The price at which a margin call is issued, calculated as $\frac{P_0 \times (1 - \text{Initial Margin})}{1 - \text{Maintenance Margin}}$.

Marketable Limit Order

A limit buy order placed above the best offer that is likely to be at least partially executed immediately.

Iceberg Orders

Orders where the trader indicates a specific display size that is lower than the actual order size to signal willingness to trade without revealing the full quantity.

Price Precedence

The execution rule where buy orders at higher prices and sell orders at lower prices are ranked first.

Security Market Index

A collection of individual constituent securities that represent a given market, market segment, or asset class.

Price Return Index

An index that reflects only the percentage change in the prices of its constituent securities.

Total Return Index

An index that reflects price changes and assumes the reinvestment of all income (interest and dividends) received since inception.

Fundamental Weighting

An index weighting method using company size measures independent of stock price, such as book value, cash flow, revenues, or earnings.

Index Reconstitution

The process of changing the constituent securities in an index to reflect changes in the target market due to bankruptcies, de-listings, or mergers.

Informationally Efficient Market

A market where security prices adjust rapidly to reflect all past and present information.

Intrinsic Value

The fundamental value of an asset that accurately reflects all its investment characteristics based on all available information.

Weak-Form EMH

Market efficiency hypothesis stating that current stock prices reflect all historical market data, meaning technical analysis cannot earn abnormal returns.

Semi-Strong Form EMH

Market efficiency hypothesis stating that security prices rapidly adjust to reflect all publicly available information, including market and nonmarket data.

January Effect

A time-series anomaly where stock prices often increase in January, attributed to tax loss selling or window dressing.

Loss Aversion

A behavioral bias where investors dislike losses more than they like comparable gains, contributing to the overreaction anomaly.

Cumulative Voting

A voting system where total voting rights equal the number of shares owned multiplied by the number of board directors being elected, providing better representation for minority shareholders.

Depository Receipts

Securities that trade like ordinary shares on local exchanges but represent an economic interest in a foreign company.

Accounting Return on Equity (ROE)

A measure of efficiency calculated as $\frac{\text{Net Income}}{\text{Average Equity}}$, though it is sensitive to management's choice of accounting methods.

Bottom-up Analysis

A revenue analysis method where revenue is broken down into specific drivers like price, volume, business segments, or geography.

Economies of Scale

Occur when increasing output decreases unit costs because fixed costs are allocated over a greater volume of output.

Degree of Operating Leverage (DOL)

A measure of how sensitive operating profit is to changes in revenue, calculated as $\frac{\% \triangle \text{Operating Profit}}{\% \triangle \text{Revenue}}$.

Cash Conversion Cycle

$\text{Days of Inventory} + \text{Days of Receivables} - \text{Days of Payables}$; represents the external financing needed for operations.

Herfindahl-Hirschman Index (HHI)

A numerical expression of industry concentration calculated as the sum of the squares of the market shares of all participants.

PESTLE

A framework for examining external influences on an industry: Political, Economic, Social, Technological, Legal, and Environmental.

Cost Leadership Strategy

A competitive strategy where a firm seeks to have the lowest production costs in its industry to offer the lowest prices and gain market share.

Disruptive Innovation

Innovation that creates a new market or enters an existing one with a completely different value proposition, such as internet video streaming versus cable TV.