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 All CFA Institute members and candidates are
required to comply with the Code and Standards
Structure of the CFA
Institute Professional
Conduct Program
a.
1. Code Of Ethics And
Standards Of
Professional Conduct
Process for the enforcement
of the Code and Standards
Six components of
the Code of Ethics
b,c.
Seven Standards of
Professional Conduct
1. Code Of Ethics And Standards Of Professional Conduct - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS
The CFA Institute Bylaws
Basic structure for enforcing
Based on two Fair process to member and candidate
the Code and Standards
primary principles
Rules of Procedure Confidentiality of proceedings
Maintains oversight and responsibility
The CFA Institute Is responsible for the
Board of Governors enforcement of the
Through the Disciplinary
Professional Conduct Review Committee (DRC) Code and Standards
program (PCP)
The CFA Designated Conducts professional
Officer Directs professional conduct staff conduct inquiries
Selfdisclosure
Written complaints
An inquiry can be prompted
Evidence of misconduct
by several circumstances
Report by a CFA exam proctor
Analysis of exam materials and monitoring
of social media by CFA Insitute
Requesting a written explanation
The Professional from the member or candidate
Conduct staff conducts
The member or candidate
an investigation that
may include Interviewing Complaining parties
Third parties
Collecting documents and records in support of its investigation
Conclude the inquiry with no disciplinary sanction
Issue a cautionary letter
When an
inquiry is If finding that a violation of
Upon reviewing the the Code and Standards
initiated
material obtained during occurred, the Designated Accepted by member
the investigation, the Officer proposes a
Designated Officer may The matter is referred to a
disciplinary sanction hearing by a panel of CFA
Continue proceedings Institute members
Rejected by member
to discipline the
member or candidate
condemnation by the member's peers
If sanction is imposed suspension of candidate's continued
participant in the CFA program
Act with integrity, competence, diligence,
respect and in an ethical manner
Integrity of investment profession &
interest of clients above personal interest
Care & judgment
Practice ethics & encourage others to practice
Integrity & viability of the global capital markets
Professional competence
Professionalism
Integrity of Capital markets
Duties of Clients
Duties to Employers
Investment analysis, Recommendations & Actions
Conflict of interest
Responsibilities as a CFA Institute
member or CFA Candidate
 Understand and comply with
applicable laws and regulations

Code and Standards vs. Local law Follow stricter law and regulation

Responsible for violations in which they

knowingly participate or assist
Dissociate from illegal,
unethical activities Leave employers (in extreme case)

Attempt to stop the behavior by bringing it to the attention of

Guidance employer through a supervisor or compliance department
Participation or association
May consider directly confronting
with violations by others
the involved individuals
Intermediate steps
If not successful,--> step away and Removing their name from written reports
dissociate from the activity by
Asking for a different assignment

A. Knowledge Inaction with continued association may be construed as knowing participation

of the law Not required reporting violations to government, CFAI,
but advisable in some cases or required by laws in others

Stay informed
Review procedures
Members and Maintain current files
candidates
When in doubt, seek advice of
compliance personnel or legal counsel
When dissociating from violations, --> Document
Recommended any violations and urge firms to stop them
procedures for
compliance (RPC) Develop and/or adopt a code of ethics
Make available to employees info that
Firms highlights applicable laws and regulations
Establish written procedures for reporting suspected
violation of laws, regulations or company policies
Application

Maintain independence and

objectivity in professional activities
Gifts, Invitations to lavish
functions, Tickets, Favors, Job referrals,
By benefits Allocation of shares in oversubscribed IPOs...
External
pressures
From public companies To issue favorable reports

From Buyside clients May try to pressure sellside analysts

From their e.g. to issue favorable research reports/

own firms recommendations for certain companies

Internal
pressures to issue favorable research on current or
Investmentbanking prospective investmentbanking clients
How to cope with external and
relationships
internal pressures Conflicts of interest

Modest gifts and entertainment are

acceptable but special care must be taken must disclose to employers

Best practice: reject any offer of gifts,

threatening independence and objectivity
Guidance
convey true opinions
--> free of bias from pressures
Recommendations must
be stated in clear
B. Independence and unambiguous language
and objectivity Portfolio managers must respect and
foster honesty of sellside research

Is fraught with conflicts

2.1 Standard I Must engage in thorough,
PROFESSIONALISM independent, and unbiased analysis
Must fully disclose potential conflicts,
including the nature of compensation
Issuerpaid research Must strictly limit the type of compensation
Analysts they accept for conducting research
Accept only flat fee for their
work prior to writing the report
Best practice Without regard to conclusions
or recommendations

Protect integrity of opinions

Create a restricted list
Restrict special cost arrangements
Limit gifts

RPC Equity IPOs

Restrict employee investments
Private placements
Review procedures
Written policies on independence
and objectivity of research

Definition of any untrue statement or omission of a fact

"Misrepresentation"
or any false or misleading statement

Must not knowingly make

oral representations, advertising
misrepresentation or give
false impression in electronic communications
written materials

qualifications or credentials, services

performance record
Must not misrepresent Without regard to conclusions or
Guidance any aspect of practice, including recommendations
characteristics of an investment
any misrepresentation relating to
C. Misrepresentation member's professional activities
Must not guarantee clients specific return
on investments that are inherently volatile
Standard I(C) prohibits plagiarism in preparation
of material for distribution to employers, associates,
clients, prospects, general publish

Written list of available services, description of firm's qualification

Designate employees to speak on behalf of firm
Prepare summary of qualifications and experience,
list of services capable of performing
RPC
Maintain copies
To avoid plagiarism Attribute quotations
Attribute summaries

Address conduct related to professional life

Any act involving lying, cheating, stealing, other dishonest conduct that
reflects adversely on member's professional activities would be violation
Conduct damaging trustworthiness or competence (include behaviour may
not be illegal but negatively affect a member to perform responsibility such
Guidance as abusing alcohol during lunch hours)
Violations
D. Misconduct Abuse of the CFA Institute Professional Conduct Program
Involved in personal bankruptcy is not automatically assumed to be in violation but
bankruptcy involve fraudulent or deceitful business conduct may be a violation

Develop and/or adopt a code of ethics

Disseminate to all employee a list of potential violations
RPC
Check references of potential employees

2.1 Standard I PROFESSIONALISM - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS
 The financial markets and
investment management industry
are becoming increasingly global
a1. Why were the GIPS Standards created?
Only investment management firms
that actually manage assets
a2. Who can claim compliance?
Note: GIPS standards are printed in their Prospect clients and investment
entirety in the readings, but the Level I management firms
candidate is required only to know the a3. Who benefit from Compliance?
Fundamentals and Compliance material through the end of Section II.0
Consistency of input data is critical to "Fundamental of Compliance." A composite is an aggregation of discretionary
effective compliance with GIPS and portfolios into a single group that represents a
establish a foundation for full, fair and particular investment objectives or strategy
comparable performance presentations
Input data A composite must include all actual, fee-paying
discretionary portfolios managed in accordance
Uniformity in methods used to with the same investment objective or strategy
calculate returns to achieve
comparability among firms Introduction to Global Composites must include new portfolios on a
Calculation methodology Investment Performance timely and consistent basis after the portfolio
b. Construction & purpose of Composites comes under management
composite return is the Standards (GIPS)
asset-weighted average of all the Firms may set minimum asset levels for inclusion in
portfolios' performance results a portfolio, but changes to a composite-specific
Composite construction minimum asset level are not permitted retroactively.
allow firms to elaborate on the raw Terminated portfolios must be included in the
numbers and give the end user the historical returns of appropriate composites
proper context to understand
No "negative assurance" is needed Increase the level of confidence that a firm claiming
Disclosures Major sections of
for non-applicable disclosures GIPS compliance did adhere to GIPS
Presentation and reporting
GIPS standards Improve a firm's internal policies and procedures with
Real estate regard to all aspects of complying with the GIPS standards.

Refers to investments in non-public Firms are encouraged but not required

companies that are in various stages of
development and venture investing,
buyout investing and mezzanie financing
Wrap fees are a type of bundle fee and are
specific to a particular investment product
is charged by a wrap fee sponsor for investment
management services and included trading
expenses that cannot be separately identified
can be all-inclusive, asset-based fees and may include
a combination of investment management fees, trading
expenses, custody fees and/or administration fees
A wrap fee portfolio is sometimes
referred to as a "separately managed
account (SMA) or "managed account"
Comply with local law or
regulation conflicts with GIPS
Make full disclosure of the conflict
Note: this differs from Standards of If local/country specific law or
Professional Conduct in which the
regulation conflicts with GIPS
stricter of local laws or Standards of
Professional Conduct prevails
Firms from any country may come into compliance with GIPS
GIPS must be applied on the firm-wide basis. Firm must be defined as an investment
firm, subsidiary, or division held out to clients as a distinct business entity
Total firm assets must be the aggregate of the market value of
all discretionary and non-discretionary assets under management.
This includes both fee-paying and non-fee-paying assets
Firms must initially show GIPS compliant history for a minimum of 5 years, or
since inception if the firm has been in existence for less than 5 years.
After 5-year compliant history has been achieved, firms must
add an additional year of performance each year until
10-year performance record is established, at a minimum
only GIPS compliant performance is
presented for periods after 1 Jan. 2000;
A firm may link non-GIPS
and
compliant performance to its
Firm discloses non-compliance period
compliant history as long as
and explain how it is not in compliance
with GIPS
to undertake the verification process
c. Verification
A single verification report is issued for the entire firm.
Private equity Verification cannot be carried out for a single composite
Firms that have been verified are encouraged to add a disclosure to composite presentations or
advertisements stating they have been verified: "[name of firm] has been verified for the periods
[insert dates] by [name of verifier]. A copy of the verification report is available upon request."
To obtain global acceptance of calculation and presentation
standards in a fair, comparable format with full disclosure
Wrap Fee/ Separately Managed
To ensure consistence, accurate investment performance data
Account (SMA) portfolios.
3+4 GIPS GIPS Objectives To promote fair competition among investment management firms
To promote global "self regulation"
To claim GIPS, investment management
firms must define its "firm"
Require Firms to include all actual fee paying,
discretionary portfolios in composites defined
How are GIPS standards according to similar strategy/investment objectives
implemented in countries
Rely on integrity of input data
with existing standards Key characteristics
If an investment firm applies GIPS in a performance situation that is
for performance reporting not addressed specifically by GIPS/ is open to interpretation,
disclosures other than those required by GIPS may be necessary
GIPS do not address every aspect of performance
measurement, valuation, attribution or cover all asset classes
Compliance cannot be achieved on a
single product, portfolio, or composite
Firms must meet full
Investment firm definition compliance to claim GIPS
Key features of the The effective date of the revised Standards is 1 Jan 2011.
GIPS standards & Presentations that include performance results for periods after 31
fundamentals of Dec. 2005 must meet all the requirements of the revised GIPS.
Performance presentations that include results through 31 Dec. 2005
compliance maybe prepared in compliance with the 1999 version of GIPS.
Effective date
The scope of the GIPS
Firms must document, in writing, their polices and
procedures used in establishing and maintaining
compliance with all requirements of GIPS
Documents policies and procedures
Historical performance record
Once a firm has meet all the required requirements of GIPS , use this
statement to declare: "[Insert name of firm] has prepared and presented this
report in compliance with the Global Investment Performance Standards (GIPS)."

Firms previously claiming compliance with an Investment Performance If not meet all the requirements, cannot state:"...in compliance with GIPS except for..."
Council-endorsed Country Version of GIPS are granted reciprocity to Statements referring to the calculation methodology used in a composite
claim compliance with GIPS for historical periods prior to 1 Jan. 2006 presentation as being "in accordance [or compliance] with the Global
Claims of compliance Investment Performance Standards" are prohibited .
Statements referring to the performance of a single, existing client as being "calculated in
accordance with the Global Investment Performance Standards" are prohibited except when a
GIPS complaint firm reports the performance of an individual account to the existing client

provide a compliant presentation to all prospect clients, cannot

choose to whom they want to present compliant performance
Firm fundamental
provide a complete list and description of all of the firms'
responsibilities composites to any client that makes such a request
must list discontinued composites on
the firms' list of composites for at
least 5 years after discontinuation

3+4 GIPS - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS
 to solve many types of time
value of money problems
Find PMT
Find N
Loan payment
Find I/Y and Amortization
Amortization table
Rate of compound growth
Number of periods for specific growth
Other applications
Funding a future obligation
the sum of the present values of the cash Rows is the present value of the
series. The sum of the future values (at some future time = n) of a series of
cash flows is the future value of that series of cash flows.
The cash flow additivity principle refers to the fact that present value of any Connection between
stream of cash flows equals the sum of the present values of the cash flows PV, FV & series of CF
equilibrium interest rate for a
particular investment
Required rate of return
a. Interest rate,
for calculating the present value of
considered as future cash flows
Discount rate
f1. Use time line Opportunity cost
real risk-free rate is a theoretical
rate on a single-period loan when
there is no expectation of inflation.
Nominal risk-free rate = real risk-free rate
+ expected inflation rate
a borrower will not make the promised
default risk payments in timely manner

b. Interest rate
receiving less than fair value if an
5. TIME VALUE liquidity risk investment must be sold for cash quickly
Future value Several risks of securities
OF MONEY
Longer-term bonds have more risk
Present value maturity risk than shorter-term bonds

FV of Annuity Due = FV of Ordinary
Annuity x (1+ I/Y)
PV of Annuity Due = PV of Ordinary
Annuity x (1+ I/Y)
a series of equal cash flows that occurs
at evenly spaced intervals over time.
occur at the end of each time period. Ordinary Annuity
occur at the beginning of each time period. Annuity Due
PV of a Perpetuity
Discount each individual cash flows
Use CF function in Calculator
-->The required rate of return on a security = real risk-free rate + expected inflation rate
+ default risk premium + liquidity premium + maturity risk premium
represents the annual rate of return actually being earned after
adjustments have been made for different compounding periods
Annuity e. CF calculations
Where:
Periodic rate = stated annual rate/m
m = the number of compounding periods per year
c,d. EAR
divide the stated annual interest rate by the number of compounding
periods per year, m, and multiply the number of years by the number
of compounding periods per year
Non-annual time value of
money problems
Uneven CF

5. TIME VALUE OF MONEY - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS
 the PV of the cash flows less the initial (time = 0) outlay
where:
CFt = the expected net cash flow at time t
N = the estimated life of the investment
r = the discount rare (opportunity cosr of capital)

NPV
Acce pt projects with a posi tive NPV

Convert among these yields Reject projects with a negative NPV

Decision rules
Two mutually exclusive projects:
accept higher positive NPV

is the discount rate that make the

NPV of a project equal to zero

1. Based on face value, not price Different project size: the smaller projects may have
Calculate,
2. Use 360-day higher IRR but their contribution to the firm value
Not much meaningful Interpret, Conflict with may be smaller compared to the larger projects
3. Use simple interest, ignore Decision rule NPV due to
reinvestment of interest Differen timing of cash flows

Multiple IRR or No IRR When CFA pattern is unconventional

Problems
IRR IRR method: project cash flows are
Bank discount yield
Where: assumed to reinvest at IRR while with NPV
r BD = the annualized yield on a bank discount basis it is assumed to reinvest at market rate
D = the dollar discount, which is equal to the difference
6. DISCOUNTED Unrealistic assumptions
--> at the bottom lines: use NPV
between the face value of the bill and the purchase price CASH FLOW
Accept projects with an IRR > the firm's
F = the face value (par value) of the bill APPLICATIONS
t = number of days remaining until maturity (investor's) required rate of return.
360 = bank convention of number of days in a year Decision rules Reject projects with an IRR < the firm's
(investor's) required rate of return.
Yields of T-bills For single project, IRR and NPV
lead to exactly the same decision
Where:
Po = initial price of the the instrument Holding period yield is the percentage change in an
P1 = price received for instrument at maturity HPR investment over the period of holding
D1 = interest payment (distribution)

defined as the IRR

More appropriate if manager has
Effective annual yield Money Weighted
complete control over cash in/out

rMM = HPY x (360/t) measures compound growth

Money market yield
Portfolio Not affected by cash in/out
BEY = 2 x semi annual discount rate rate of return Preferred method
Bond equivalent yield
Time weighted Value the investment immediately after
(chain-link) any withdrawals or deposits, divide the
overall investment horizon into subperiods
3 steps Calculate HPR for each subpediod
Compute the geometric mean

6. DISCOUNTED CASH FLOW APPLICATIONS - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS
 Financial Statement
Element Additional disclosures required by regulatory
Any commentary by management

FR Financial position
Useful to a wide range of users in
Roles of FR & FSA Role of FR Firm's performance making economic decisions

Changes in financial position

> To evaluate past, current, and prospective

Use info in a company's Fin Statements performance & fin position
Roles of FSA Use other relevant info > To make economic decisions

Revenues
Expenses
Income Statement
Gains and Losses

Assets
Liabilities
Role of key FS Balance Sheet (A=L+OE)
Owners' equity

CFO
CFI
CF statement
CFF
Statement of changes in Owners' equity

disclose the basis of preparation for FS

(e.g: accounting methods, assumptions,...)
acquisitions or disposals
legal actions
employee benefit plans
Additional items: contingencies and commitments
FS notes (footnotes)
significant customers
sales to related parties
segments of firm
are audited

not audited
operating income or sales by region
or business segments
Supplementary schedules reserves for an oil and gas company
info about hedging activities and
financial instruments
Importance of
assessment of financial performance and condition of a
company from the perspective of its management
22. FSA
Results from operations, with trends
Introduction in sales and expenses
Publicly held companies in US Capital resources and liquidity, with trends in CF
General business overview
discuss accounting policies that require
significant judgements by management
discuss significant effects of trends, events, uncertainties
MD&A
liquidity and capital resource issues, transactions
or events with liquidity implications
Discontinued operations, extraordinary
items, unusual or infrequent events
Extensive disclosures in interim financial statements
disclosure of a segment's need for CF
or its contribution to revenues or profit

= independent review of an entity's FS

objective: auditor's opinion on fairness
and reliability of FS, "no material errors"
Independent review though FS prepared by mgmt and are its responsibility
3 parts Reasonable assurance of no material errors (follow generally accepted auditing standards)
FS prepared in accordance with accepted accounting principles, reasonable accounting principles and estimates, consistency
Explanatory paragraph: when a material loss is probable but
Audits of FS
amount cannot be reasonably estimated. Uncertainties
may relate to the going concern assumption --> signal serious
Standard auditor's opinion problems and need close examination by analyst
(under US GAAP): Opinion on internal controls
Unqualified opinion: auditor believes statements are free from material omissions and errors
3 types of Opinions Qualified opinion: if statements make any exceptions to accounting principles --> explain these exceptions
Adverse opinion: if statements are not presented fairly or are materially nonconforming with accounting standards

Interim reports Quarterly or semi- reports (NOT audited)

About election of board members, compensation, management and qualifications

Other info sources and issuance of stock options
Proxy statements Filed with SEC

Corporate reports and press releases Viewed as PR or sales materials

1. Articulate the Purpose & Context of analysis

2. Collect data
3. Process data
FSA framework
4. Analyze/interpret data
5. Report the conclusions or recommendations
6. Update the analysis

22. FSA Introduction - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS
 Operating activity: activities that are part of the day-to-day business function of an entity
Classification Investing activity: activities associated with acquisition & disposal of long-term asset
Financing activity: activities related to obtaining or repaying capital from shareholders or creditors

Assets
Liabilities
Elements Equity
Revenue
FS elements
& accounts Expense

Chart of accounts : set forth the actual accounts used in a company's accounting system
Account & financial Accounts
statement Contra account: offset or deducted from other accounts

Liabilities
Assets Contributed capital
Accounting equation Owners' equity
Retained earning

Expanding: A = L + Contributed capital + BGN Retained earnings + Rev - Exp - Dividend

23. Financial reporting Unearned (Deffered) revenue

Cash movement prior to Acct. recognition
mechanics Prepaid expense
Accruals & Valuation
Accruals Unbilled (Accrued) revenue (when billing, Un.Rev decrease & Receivables increase)
adjustment Cash movement after Acct. recognition
Accrued expense
Valuation adjustment: made to company's A or L so that account records current market value (not Historical cost)

Relationships among IS, BS: show a company's financial position at a point in time
BS and statement of CFs, Changes in BS accounts during an accounting period are
and of owners' equity reflected in IS, statement of CFs and owners' equity

1. Journal entries & Adjusting entries (record=time)

2. General ledger & T-accounts (record=order)
Accounting system Flow of information 3. Trial balance (list account balances at a particular point in time)
4. Fin. statement
Debit & Credit

Using fin. statement Analyst uses FS to judge the fin. health of the company
in security analysis Analyst can use his understanding to detect misrepresentation

23. Financial reporting mechanics - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS
 Objective of FR: provide fin. info about the reporting entity
Overview FRS
Importance of reporting standards in security analysis and valuation

IASB (International Accounting Standards Board)

Standard-setting bodies
(establishing standards) US FASB (Financial Accounting Standards Board)

IOSCO (international): not a regulatory, but its members regulate significant portion
Standard setting &
Regulatory bodies FSA (in UK)
Regulatory authorities 1. Protect investors
(enforcing standards) SEC (in USA) 2. Ensure: market is fair, efficient, transparent
3. Reduce systematic risk

Status of global convergence of accounting standards

standard setting bodies
c. disagree
regulatory authorities
Barriers to developing one universally accepted set of financial reporting standards
political pressures from business groups and others

Understandability
Verifiability
Relevance
Enhancing Comparability (consistent among firms and time periods)
Qualitative Faithful presentation
characteristics (complete, neutral, free from error) Timeliness

Trade off across Enhancing characteristics (reliability and relevance: timely)

Cost
Constraints
Non-quantifiable info: omitted

of Financial position: A, L, E
Measurements
of performance: Income, Expense
IFRS framework
Accrual basis
Assumptions
Going concern

Cost can be reliable measured

Recognition principal
Probably future economic benefit will flow to entity
Elements of FS
Historical cost : amount originally paid for the asset
Current cost : would have to pay today for the same asset
Measurement bases Realizable value: amount for which firm could sell the asset
Present value : discounted future cash flows
Fair value : 2 parties in an arm's length transaction would exchange the asset

BS, IS, CFS, OE, Explanatory notes (inclu. accounting policies)

Required financial statements

Fair presentation
24. Financial Going concern basis
Reporting Standards Accrual basis
General requirements Aggregation
for FS under IFRS
No offsetting
Principles for PREPARING
Consistency
Materiality
Comparative information
Frequency of reporting

IASB requires mgmt to consider the

framework if no explicit standard exists
Purpose of framework
IASB same objective
Objectives of financial statements FASB different objectives for biz and non-biz

IASB emphasizes going concern

Assumptions
FASB: relevance, reliability
Primary characteristics
Qualitative characteristics IASB: comparability, understandability also

IFRS (by IASB) #

IASB: income+expenses
US GAAP (by FASB)
Performance FASB: Revenues, Expenses, Gains,
Losses, comprehensive income

IASB: resource from which future

economic benefit is expected
Asset definition
FASB: future economic benefit
Financial statement elements
IASB: define criteria for recognition
"Probable"
FASB: define assets and liabilities

Values of assets to be IASB: allow

adjusted upward
FASB: not allow

Transparency
Characteristics of a coherent Comprehensiveness
financial reporting framework Consistency

Valuation
IFRS
Principles-based
Effective FR relies on broad framework

FASB in the past

Barriers to creating a coherent Standard setting Rules-based
financial reporting framework specific guidance how to classify trx

FASB moving now

Objectives oriented
blend the other two
Measurement

24. Financial Reporting Standards - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS
 Saving
Borrowing
Issuing equity
Allow entities to Risk management
Main functions
Exchanging assets
of financial system
Utilizing information

Equilibrium interest rate

Determine the returns that equate D &S
Allocate capital to most efficient uses

F.A: securities, currencies...

Protect unsophisticated investors Financial A vs. Real A R.A: commodities, real estate...

Establish minimum standard of competency Public sec: trade on exchanges

Help investors evaluate performance
Prevent insider
Promote commom FR requirements
Require minimum level of capital
Objectives of Public vs. Private securities Private sec: not trade on exchange
market regulation
Debt
Classification: Assets & Market Equity
Debt vs. Equity vs. Derivative
Der contract: values depend on the values of other assets

Complete market (Availability) Primary: for newly issued sec

Operational efficiency (Low cost) Characteristics of Primary vs. Secondary market Secondary: subsequents sales of sec

Informational efficiency (P reflects fundamental info) well-functioning fin. system Money: for debt securities < 1y
Allocational efficiency (at the best efficiency) Money vs. Capital market Capital: for equity+debt securities> 1y

Trades occur at specific times Common stock

All bids+asks are declared, and then one negotiated price is set for the stock Equity Preferred stock
in smaller markets Call market
Warrants
to set opening prices and prices after used
Mutual funds
trading halts on major exchanges
Distinguish
Trade occur any time the market is open Securities sometimes refer as Depositories
Pooled investment vehicles ETFs and ETNs
auction process Continuous market Classification ABS
Price is set by of markets
dealer bid-ask quote 45. Market Organization Asset classes Hedge funds
Quote-driven markets (trade with dealers) & Structure Fixed income Convertible debt=F.I+Equity
1. Price
2. Display precedence Matching rules
Currencies
Order-driven markets
3. Time precedence Distinguish Forward, Futures, Swap, Option

Contracts Insurance Credit default swap

Brokered markets
Commodities
IPO vs. Secondary issues Real assets
Public offerings vs. Private placements Primary market Primary vs.
Brokers
Securities trade after initial offerings Secondary markets
Block brokers help large trades
Importance: provide Liquidity+Price info Secondary market
Investment banks
M.O: execute at the best P Brokers,Dealers & Exchanges Exchanges
L.O Market vs. Limit order Alternative trading systems (ATS)

Dealers earn profit fr. bid-ask spread

Good-til-cancelled Financial
Immediate-or-cancel intermediaries Securitizers
Order
Good-on-close Depository institutions
Good-on-open Validity Insurance companies
Stop-sell refer who buy A in 1 market & resell in another market
Stop order Arbitrageurs
Stop-buy
Clearinghouses: intermediaries between buyers & sellers
Clearinghouses & Custodians Custodians

Long =Buy
Long vs. Short Short =Sell

borrow securities & sell

Short sales
Positions borrow funds to buy A

1 Initial margin
Leveraged positions Margin call P=P0
1 Maintenance margin

45. Market Organization & Structure - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS
 Security used to present the performance of an asset
class, security market or segment of a market
market index

Price index: calculate price only

Calculate an index
Return index: include P+Income

Which target market?

Which securities?
Index construction
How weight?
& management
Re-balancing frequency?
Re-examining when?

= Sum of stock prices / Number of stocks adjusted for splits

Adjust for stock split
Price-weighted index Adv: simple
Adv & Disad Disad: % change in a high-priced stock will have a greater
effect on the index

Equivalent to a portfolio that has equal dollar

amounts invested in each index stock
Equal-weighted index

Weighting methods NOT adjust

Weights based on the market-cap of each index stock

. Market-cap weighted index
Criticism: large company has greater impact
Float-adjusted market cap- weighted index

46. Security Market float : (-) shares from Controlling shareholders

Market Indices Free float: Market float - Not available to foreign investors

Fundamental weighting
(earnings, dividends, cash flow)

Rebalancing & Rebalance: adjust the weights of securities uses for Equal-weighted index
Reconstitution
Reconstitution: add & delete securities that make up an index

Reflect market sentiment

Proxy for measuring of market return & risk
Uses of securities
Proxy of beta & risk-adjusted return
market indices
Benchmark of management performance
Model portfolio for index fund

Broad market equity

Multi-market vs. Multi-market with fundamental weghting
Types of equity indices Sector index
Market-cap
Style index Value/Growth

Illiquidity, transactions costs, high turnover of

Large universe constituent securities => Difficult & expensive
Types of Fixed Income indices to replicate F.I index
Dealer market & infrequent trading

based on future contract

Commodities index
Alternative investment indices may have upward-bias
Hedge fund index
Real estate index
46. Security Market Indices - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS
 Its return is based on another
instrument (underlying assets)
Physical
Definition
Finance The biggest trading volume
Underlying assets
Event

Organized market -> liquid

Buy an asset at one price Standard terms
Concurrently sell it at higher price Exchange No default risk
Arbitrage
-> Riskless profit without investment Arbitrage & the law of one price Daily settlement
Where derivatives are traded?
NO arbitrage opportunities exist private between 2 parties -> illiquid
The law of one price Customized terms
OTC default risk & legal risk
Difficult to understand
Complex at the end of the contract: settlement
Criticism
Zero-sum game 57. Derivative
Legal gambling Firm and binding agreement -> obligation
Markets and
Forward commitment No premium paid up front
Instruments Characteristics
Information about underlying price
The long has the flexibility -> options
Price discovery
Contingent claims Premium is paid up front by the long
Control risk
Risk management
Purposes of derivatives market Exchange, OTC, Forward commitment
Mispriced -> adjust quickly -> Forwards
market efficiency
Market efficiency Exchange, Forward commitment
Futures
Low tnx cost
Trading efficiency Exchange, OTC, Contingent Claims
Options
Types of derivatives OTC, Forward commitments
Swaps
a contract that provides a bondholder
(lender) with protection against a
downgrade or a default by the borrower
Credit default swap (CDS) -> most common
Credit derivatives Types
Credit spread option

57. Overview of derivatives - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS
 = Long stock + short call
= S - C
Covered call = call is covered by a long stock

Covered call

Payoff diagram
Payoff (covered call) = Payoff (Long stock) + Payoff (short call)
= ST - Max(0, S T - X)
Profit (Covered call) = Payoff (Covered call) - So + C
Max loss when payoff is min -> S T = 0 -> Max loss = So - C
Max profit when payoff is max -> ST > X
59. Risk Management Payoff diagram (Covered call): similar to payoff diagram of short put
Applications of
Option Strategies = Long stock + Long put
= S + P
Protective put = Long put protects potential loss of a stock

Protective put

Payoff diagram
Payoff (Protective put) = payoff (Long stock) + Payoff (long put)
= ST + Max(0, X - S T)
Profit = Payoff - So - P
Max loss when payoff is min -> S T = 0 -> Max loss = So + P - X
Max profit when payoff is max -> ST > X -> Max profit is indefinite
Payoff diagram (protective put) is similar to that of long call
59. Risk management Appications of Option Strategies - CFA Mind Maps Level 1 - 2016 - Copyright by WAY TO FINANCE SUCCESS