CFA Level 1 Equity Investments Notes
Here are detailed, exam-focused CFA Level I notes for:
📘 READING 39: Market Organization and Structure
LOS 39.a: Explain the main functions of the financial system
The three core functions of the financial system are:
1. Facilitating Saving and Borrowing: Helps individuals and organizations allocate surplus funds
or raise capital.
2. Determining Market Returns: Sets the equilibrium interest rates and return expectations.
3. Capital Allocation: Channels resources to their most productive use.
✅ Takeaway: The system improves economic efficiency by allowing capital movement across time and
space.
LOS 39.b: Describe classifications of assets and markets
Assets:
Financial: Stocks, bonds, derivatives.
Real: Property, equipment.
Markets:
Capital vs. Money: Long-term vs. short-term funding.
Primary vs. Secondary: New issues vs. resale.
Public vs. Private: Traded vs. not publicly available.
Spot vs. Futures: Immediate vs. future delivery.
Traditional vs. Alternative: Equities/bonds vs. real estate/hedge funds.
📌 Exam Tip: Know the distinction between primary (issuance) and secondary (trading) markets.
LOS 39.c: Describe major types of securities, currencies, contracts, commodities, and real assets
Securities: Bonds (fixed income), stocks (equity), pooled vehicles (ETFs, mutual funds).
Currencies: Spot and forward traded.
Contracts: Derivatives (forwards, swaps, options).
Commodities: Traded in spot and futures markets.
Real Assets: Tangible investments like real estate.
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LOS 39.d: Describe types of financial intermediaries and services they provide
Brokers & Exchanges: Match buyers/sellers.
Dealers: Hold inventory, provide liquidity.
Arbitrageurs: Exploit pricing inefficiencies.
Securitizers: Bundle loans into investable assets.
Depositories: Accept deposits, issue liabilities.
Insurance Companies: Pool and manage risks.
🎯 Common Trap: Don't confuse brokers (facilitate) with dealers (inventory).
LOS 39.e: Compare positions an investor can take in an asset
Long Position: Buy low, sell high. Owns or will own the asset.
Short Position: Sell high, buy low. Sells borrowed asset, profits when price drops.
LOS 39.f: Calculate and interpret leverage ratio, margin return, margin call price
Leverage Ratio = Asset Value / Equity
Return on Margin = (Ending Value - Beginning Equity - Interest - Commissions) / Initial Equity
Margin Call Price formula:
Loan
P =
1 − M aintenance M argin
🧠 Remember: More leverage = Higher risk = Higher potential return or loss.
LOS 39.g: Compare execution, validity, and clearing instructions
Execution Instructions: How to trade (e.g., market, limit).
Validity Instructions: Order duration (e.g., day, GTC).
Clearing Instructions: Settlement and ownership transfer.
LOS 39.h: Compare market orders with limit orders
Order Type Features Pros Cons
Market Order Immediate execution at best price Fast execution No price control
Limit Order Execute at specified price or better Price certainty May not get executed
📌 Exam Phrase: “Most likely to execute” = Market order. “Best for price control” = Limit order.
LOS 39.i: Define primary and secondary markets; explain how secondary markets support primary
markets
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Primary Market: New securities issued. Includes IPOs.
Secondary Market: Trading of already-issued securities.
💡 Insight: Liquid secondary markets reduce the cost of raising capital in primary markets.
LOS 39.j: Describe quote-driven, order-driven, and brokered markets
Market Type Description Example
Quote-Driven Dealers post bid/ask prices OTC markets
Order-Driven Trades matched by price/time rules Stock exchanges
Brokered Brokers find counterparties Real estate, art
LOS 39.k: Describe characteristics of a well-functioning financial system
Complete Markets: All assets and liabilities can be traded.
Operational Efficiency: Low transaction costs.
Informational Efficiency: Prices reflect all known info.
Allocational Efficiency: Capital flows to highest return use.
LOS 39.l: Describe objectives of market regulation
🎯 Key Goals:
Protect unsophisticated investors.
Promote fair disclosure and transparency.
Reduce systemic risk.
Ensure proper conduct and prevent fraud.
Support financial system integrity.
🧠 Misconception: Regulation is not meant to control prices—it’s to ensure fairness and stability.
✅ Summary Takeaways
Concept Most Likely Asked As…
Primary vs. Secondary Markets Definition and role in raising capital
Types of Orders Execution logic, risk preference
Long vs. Short Positions Impact on profits and risk
Leverage Calculation, risk implications
Market Structure Comparison between quote/order/brokered
Regulation Objectives Least/most likely exam trap
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Let me know when you're ready for Reading 40: Security Market Indexes.
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