Home › CFA® Level I › Equities
CFA® Level I · Equities · free lesson
Equity Issuance and Trading
Shares are created in the primary market and change hands in the secondary market, and the venue, liquidity and index membership of a stock affect how cheaply investors can trade it and who owns it. This module covers how companies issue equity, where and how shares trade, how to measure a stock's liquidity, how equity indexes are built, and how margin and short positions magnify gains and losses.
What you will learn
1. Describe how companies raise equity in primary markets and explain the functions of secondary markets.
- Primary market: the issuer sells new shares and receives the proceeds; secondary market: investors trade existing shares.
- IPOs use underwriters, book-building and often a greenshoe option of up to about 15% extra shares.
- Direct listings and SPAC mergers are alternative routes to a listing.
- Rights issues protect existing holders from dilution; the price adjusts toward TERP.
- Secondary markets supply liquidity and price discovery, which lower the cost of raising equity.
2. Compare trading on exchanges, off-exchange venues and over-the-counter markets, including the role of order types and transparency.
- Exchanges: central limit order books with pre- and post-trade transparency, plus opening and closing auctions.
- Market orders buy certainty of execution at the cost of the spread; limit orders control price but may not fill.
- Dark pools hide orders before execution, usually match at the midpoint and reduce market impact for large trades.
- Wholesalers internalize much US retail flow; payment for order flow raises conflict-of-interest questions.
- OTC markets are quote-driven dealer networks, usually for unlisted or smaller shares with wider spreads.
3. Describe and calculate liquidity measures for a listed share, including free float, average daily volume, spreads and days to trade a position.
- Free float = shares outstanding minus strategic, government, insider and locked-up holdings.
- Index weights usually use float-adjusted market capitalization.
- ADV measures typical trading activity; turnover relates it to float or shares outstanding.
- Relative spread = (ask - bid) / midpoint, the cost of a small round trip.
- Days to trade = position / (participation rate x ADV).
4. Describe the main types of equity indexes and compare price-weighted, market-capitalization-weighted, float-adjusted, equal-weighted and fundamental weighting.
- Indexes are classified by coverage (broad, size, sector, style, regional, thematic) and by weighting.
- Price-weighted: weight proportional to price; the divisor is adjusted for splits and membership changes.
- Float-adjusted market-cap weighting is the standard for broad benchmarks.
- Equal weighting tilts toward small companies and needs frequent rebalancing.
- Fundamental weighting uses accounting measures and tends to tilt toward value.
5. Calculate the leverage, return and margin-call price of a position bought on margin, and explain how short selling works.
- Leverage ratio at purchase = 1 / initial margin.
- Leveraged return = (price change + dividends - interest) / equity invested.
- Margin call price (long) = P0 x (1 - initial margin) / (1 - maintenance margin).
- Margin call price (short) = P0 x (1 + initial margin) / (1 + maintenance margin).
- Short sellers borrow and sell shares, pay dividends to the lender and face unlimited potential losses.
- Margin calls and short squeezes can force trades at the worst possible time.
Module at a glance
- Primary markets create shares for the issuer's benefit; secondary markets provide liquidity and price discovery.
- TERP = (old shares x old price + new shares x subscription price) / total shares.
- Exchanges offer transparent order books; dark pools hide pre-trade orders; OTC markets are dealer-driven.
- Free float excludes strategic, government, insider and locked-up shares; index weights depend on it.
- Days to trade = position / (participation rate x ADV).
- Index weighting (price, float-adjusted cap, equal, fundamental) can change returns for the same stocks.
- Margin: leverage = 1 / IM; call price = P0 x (1 - IM) / (1 - MM); leverage magnifies gains and losses.
This free module has 5 lessons, 13 practice questions with full explanations.