Equity Investments

CFA® Level I, published weight 11–14%. Market organisation, indexes, industry analysis, dividend models.

What the outline covers

Equity Instrument Features
Equity Jurisdictions, Classes, and the Voting Process
Equity Issuance and Trading
Sources of Equity Returns
Introduction to Equity Valuation
Discounted Cash Flow (DCF) and Growth Models
Relative Value Equity Valuation Approaches
Financial Statement Forecasting in Equity Valuation
Industry and Competitive Analysis
Company Analysis: Past, Present, and Future
Equity Analyst Research Reports
The CAPM, Market Model, and Other Factor-Based Equity Models

Sample questions

These 5 questions are free in the app too. Try each one before opening the answer.

Question 1

A stock just paid an annual dividend of $2.00. Dividends are expected to grow at 4% indefinitely and the required return is 9%. The value of the stock is closest to:

D₀ = $2.00 · g = 4% · r = 9%

A. $40.00
B. $41.60
C. $50.00
D. $52.00

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B. D₁ = 2.00 × 1.04 = $2.08. V₀ = 2.08 / (0.09 − 0.04) = $41.60. Using D₀ directly gives $40.00, the planted distractor.

Reading: Equity Investments — Discounted Cash Flow and Growth Models, LOS 6.b

Question 2

A two-for-one stock split of a constituent affects a price-weighted index by:

A. Reducing the index level permanently
B. Requiring an adjustment to the divisor
C. Increasing the constituent’s weight
D. Having no effect on any index type

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B. The divisor is adjusted so the index level is unchanged by the split. In a market-cap weighted index no adjustment is required at all.

Reading: Equity Investments — Sources of Equity Returns, LOS 4.c

Question 3

A firm has a retention ratio of 40% and a return on equity of 15%. Its sustainable growth rate is:

b = 40% · ROE = 15%

A. 4.0%
B. 6.0%
C. 9.0%
D. 15.0%

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B. g = b × ROE = 0.40 × 0.15 = 6.0%. This is the rate at which the firm can grow without issuing new equity.

Reading: Equity Investments — Discounted Cash Flow and Growth Models, LOS 6.d

Question 4

The justified leading P/E for a firm with a payout ratio of 60%, a required return of 10% and a growth rate of 5% is closest to:

(1 − b) = 0.60 · r = 10% · g = 5%

A. 6.0×
B. 10.0×
C. 12.0×
D. 20.0×

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C. P/E = (1 − b)/(r − g) = 0.60/(0.10 − 0.05) = 12.0×. The same inputs that drive a dividend model drive the justified multiple.

Reading: Equity Investments — Relative Value Equity Valuation Approaches, LOS 7.b

Question 5

Which characteristic most strongly indicates that an industry has high pricing power?

A. Low industry concentration
B. Minimal barriers to entry
C. High switching costs for customers
D. Rapid technological change

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C. High switching costs lock customers in and reduce buyer power, which supports pricing power. The other three erode it.

Reading: Equity Investments — Industry and Competitive Analysis, LOS 9.c

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