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CHAPTER 1
THE INVESTMENT INDUSTRY:
A TOP- DOWN VIEW
by Ian Rossa O’Reilly, CFA

LEARNING OUTCOMES
After completing this chapter, you should be able to do the following:
a
Explain how an economy benefits from the existence of the investment
industry;
b Explain how an individual benefits from the existence of the investment
industry;
c
Describe types and functions of participants that collectively comprise
the structure of the investment industry;
d Describe forces that affect the evolution of the investment industry.

Introduction 3
INTRODUCTION
1
People work to sustain themselves and their dependents. Often, they earn money for
their labor and use that money to purchase goods and services. If they spend less than
they earn, they have savings. If they expect to earn a return on their savings, they
are investing. For example, an individual might lend her savings to a neighbor who is
starting a new business. If she realistically expects to get more money back than she
lent, she is making an investment.
One reason why the financial services industry exists is to provide a link between
savers (also called lenders or investors) that have funds to invest and spenders (also
called borrowers) that need funds. After all, not all savers have savvy neighbors who
are starting promising businesses. As a result, they have to look elsewhere for opportunities
to earn a return on their money.
Lenders invest their savings in a wide range of assets. Assets are items that have value
and include real assets and financial assets. Real assets are physical assets, such as
land, buildings, cattle, and gold. In contrast, financial assets are claims on real assets.
For example, a share of stock represents ownership in a company. This share gives its
owner, called a shareholder (or stockholder), rights to some of the company’s assets
and earnings.
Financial assets that can be traded are called securities. The two largest categories
of securities are debt and equity securities:
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■
Debt securities are loans that lenders make to borrowers. Lenders expect the
borrowers to repay these loans and to make interest payments until the loans
are repaid. Because interest payments on many loans are fixed, debt securities
are also called fixed- income securities. They are also known as bonds, and
investors in bonds are referred to as bondholders. More information about debt
securities is provided in Chapter 10.
Equity securities are also called stocks, shares of stock, or shares. As mentioned,
shareholders have ownership in the company. The company has no
obligation to either repay the money the shareholders contributed or to make
regular payments, called dividends. However, investors who buy stocks expect
to earn a return by being able to sell their shares at a higher price than they
bought them and, possibly, by receiving dividends. Equity securities are discussed
further in Chapter 9.
Places where buyers and sellers can trade securities are known as securities markets or
financial markets. A distinction is sometimes made within financial markets between
money markets, for securities that have a maturity shorter than a year, and capital
markets, for securities that have a maturity longer than a year. How securities are
issued, bought, and sold is explained in Chapters 13 and 15.
Copyright © 2012 CFA Institute

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Chapter 1 ■ The Investment Industry: A Top- Down View
The primary role of financial markets is to channel funds from savers to spenders.
Savers include individuals (households), companies (firms), and governments with
excess money to invest. Note that in this chapter and in the rest of the curriculum,
the terms money, cash, funds, and financial capital (or capital) may be used interchangeably.
Savers provide capital to spenders.
Spenders include individuals, companies, and governments. For example, individuals
borrow to pay for houses, tuition, and unforeseen expenses. Companies borrow to
invest in real assets, such as land, buildings, or machinery. These real assets represent
a company’s means (or factors) of production, and they are sometimes referred to as
physical capital. Governments borrow when their current tax receipts are insufficient
to fund their current spending plans.
Savers and spenders sometimes interact through financial markets. The movement
of funds from those who have funds to invest (the savers who become providers of
capital) to those who need funds (the spenders who become users of capital) through
financial markets is called direct finance. Savers and spenders often rely on individuals
in the investment industry to help them navigate financial markets. The investment
industry is a subset of the financial services industry. It comprises all the players that
are instrumental in helping savers invest their money and borrowers get the funds they
require. The major investment industry participants, such as exchanges, investment
brokers (brokers), investment dealers (dealers), financial advisers, and investment
analysts (analysts), are introduced in Section 4 of this chapter and discussed further
in Module 5.
Savers and borrowers often rely on financial intermediaries to find each other and to
channel funds between each other. This is indirect finance. Financial intermediaries
act as “middlemen” between those who have funds to invest and those who need funds.
Credit institutions, such as banks, are a typical example of financial intermediaries.
They collect savings from lenders and transform them into loans to borrowers. This
transformation process is known as financial intermediation, hence the reason why
banks are called financial intermediaries. Other types of financial intermediaries are
discussed in Chapter 13.
Financial intermediaries and the investment industry play important roles in the
financial services industry. Many savers do not have the time or the expertise to identify
and select individuals, companies, and governments to lend to or invest in. Once
savers have lent money, they have to monitor the borrower’s behavior and financial
health to ensure that they will get their money back—a task that is time- consuming
and costly. Matching savers and borrowers and monitoring borrowers are functions
that financial intermediaries can perform better and more cheaply than most investors
can do on their own. The investment industry helps investors evaluate the behavior
and financial health of the companies and governments they invest in.
Because savers are assigning responsibilities to financial intermediaries and participants
in the investment industry, trust is essential to the proper functioning of the financial
services industry. Savers should have confidence that they will earn a return on their
investments and that they will be treated fairly by borrowers, financial intermediaries,
and investment industry participants. If trust is lacking, savers will be reluctant to
invest, and the economy will suffer.

How Economies Benefit from the Existence of the Investment Industry 5
Exhibit 1 summarizes graphically how funds can be channeled between savers and
spenders, either directly through financial markets or indirectly through financial
intermediaries.
Exhibit 1
Overview of the Financial Services Industry
DIRECT FINANCE
Savers/
Lenders/
Providers of Capital
Funds
Financial Markets
Funds
Spenders/
Borrowers/
Users of Capital
Funds
Funds
Financial Intermediaries
INDIRECT FINANCE
Funds
Source: Based on data from the European Central Bank (http://www.ecb.int/mopo/eaec/structure/
html/index.en.html).
HOW ECONOMIES BENEFIT FROM THE EXISTENCE OF THE
INVESTMENT INDUSTRY
2
Economic systems can take many forms, from pure capitalism with free markets to
planned economies with centralized authority. The goal of all economic systems is the
efficient allocation of scarce resources to their most productive uses.
Resources, such as labor, real assets, and financial capital, are necessary to produce
goods and services. People have an unlimited desire for goods and services, but
resources are limited. To illustrate this concept of scarcity, assume that an individual
has a limited budget; his financial capital is scarce. Should he spend his money on
buying food, paying his mortgage, purchasing a new car, or going on an expensive
holiday? Similarly, should governments spend money on health care, education,
defense, or infrastructure?
Because resources are scarce, decisions must be made regarding the allocation of these
resources. All economic systems must address three questions: (1) Which goods and
services should be produced? (2) How should the goods and services be produced?

6
Chapter 1 ■ The Investment Industry: A Top- Down View
(3) Who should receive the goods and services that are produced? The allocation of
scarce resources is efficient if the scarce resources are used to produce goods and
services that best satisfy the needs of consumers.
2.1 Market Economies
Capitalism is an economic system that favors private ownership as the means of production
and markets as the means of allocating scarce resources. Markets are places
where buyers meet sellers to trade. Markets include goods and services markets as
well as financial markets.
In a pure, free market, capitalistic economy, there is no central authority, such as a
government, directing economic activity. Instead, individuals and companies make
their own decisions about what goods and services to manufacture and provide, and
they get to keep the profits from their activities. If everything goes according to plan,
scarce resources are deployed in the most efficient manner through the markets and
the economy grows at a healthy rate.
Pure free market capitalism is something that exists only in theory. In the real world,
governments play a role in all economies. In some capitalistic economies, such as in
Western economies, the government’s role in business is fairly minimal. In countries
largely based on extraction of natural resources, such as some former Soviet Republics,
some Middle Eastern countries, and some South American countries, the government
maintains significant control over key national industries. In transition economies,
which are moving from socialist planned economies to market economies, the government
plays a significant role in the economy and business. China’s economy is often
described as state capitalism because the Chinese central and local governments have
significant ownership of many businesses. In China, however, people can create and
invest in businesses and a great deal of market competition exists.
2.2 Benefits Provided by the Investment Industry
The investment industry brings several benefits to the economy. It facilitates lending
and borrowing. As mentioned above, the investment industry is instrumental in
channeling funds between savers who have money but no immediate use for it and
spenders who have projects to finance but insufficient capital to do so.
The investment industry contributes to the efficient allocation of resources in the
economy. Without the investment industry, suppliers and users of capital would have
to spend significant resources finding each other. These resources would be expended
on the search rather than on more productive uses, resulting in less efficiency.
The investment industry plays an important role in providing and processing information
about investment opportunities. Many investment industry participants help
investors collect and analyze macroeconomic data and information about individuals,
companies, and governments’ capital needs and asset values. Some of the tools and
inputs these participants use are described in Module 3.

How Individuals Benefit from the Existence of the Investment Industry 7
Investment industry participants package investment opportunities so that they satisfy
the needs of lenders and borrowers. The investment industry offers a wide range
of products and services that make it easier for savers to invest and for spenders to
access the funds they need. These investment products and services are discussed in
Modules 4 and 5.
The investment industry also provides liquidity. Liquidity refers to the ease of buying
or selling an asset without affecting its price. Some assets, such as real estate, are
inherently illiquid. For example, if you wish to sell a house, it will likely take some time
to sell even if it is priced fairly compared with other houses in the market. If you want
to sell a house quickly, you may have to sell it at a lower price than you think is fair.
Other assets are more liquid, such as shares that trade actively. However, an investor
may hold such a large position (i.e., so many shares) that the sale of her position may
alter the price in the market. For example, if an investor owns 100 shares in a company
with actively traded shares, she will likely be able to sell her shares quickly and
without affecting the stock price. However, if she owns 100,000 shares, she may not
be able to sell those shares quickly without affecting the price in the market. Liquidity
is a very important aspect of well- functioning financial markets because highly liquid
markets allow investors to complete a transaction quickly (and to reverse it quickly if
they change their minds) and to have confidence that they are getting the best price
at that particular moment.
All these benefits increase the willingness of suppliers of capital to provide funds
to those who need them. Capital put to better use fosters growth, which ultimately
benefits the economy.
HOW INDIVIDUALS BENEFIT FROM THE EXISTENCE OF THE
INVESTMENT INDUSTRY
3
In a well- functioning investment industry, investors are treated fairly and honestly.
As a result, they have confidence to commit their savings to investments. Investment
industry participants compete fairly for investors’ business, and they are competent
and trustworthy in managing investment products and portfolios, executing investment
transactions, and advising on investment matters.
3.1 Benefits Provided by the Investment Industry
Below are some of the most important features that define a well- functioning investment
industry and, in turn, benefit investors.
The first important feature that characterizes a well- functioning investment industry
is the availability of a broad range of investment products and services that meet
investors’ needs. Investment products are not limited to the debt and equity securities
already presented. Other investment instruments, such as derivatives and alternative
investments, are described in Chapters 11 and 12, respectively.

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Chapter 1 ■ The Investment Industry: A Top- Down View
Investment industry participants may also buy and sell various real and financial
assets and then package them to create new investment products (frequently referred
to as investment vehicles) and structures that suit the needs of investors better than
the original assets. Mortgage- backed securities provide an example. They represent
a claim on the cash flows that are expected to materialize not from a single mortgage
but from a large number of mortgages that have been grouped together in a process
called securitization. Other examples of investment vehicles and structures are provided
in Chapter 14.
In addition to being able to choose from a broad range of investment products, investors
benefit when they have access to a broad range of investment services that help
them make better decisions and implement those decisions. The investment industry
offers financial advisory, information, and trading services that are valuable to investors.
How investment industry participants assess and serve the needs of investors is
discussed further in Module 7.
Investors benefit when financial markets are competitive. Markets in general and
financial markets in particular are competitive if a large number of players compete
with one another without any one of them having an undue influence on supply or
demand. Supply refers to the quantity of a good or service sellers are willing and able
to sell, whereas demand refers to the quantity of a good or service buyers desire to buy.
More information about supply and demand and how the interaction of supply and
demand affects prices of goods and services is presented in Chapter 6. Competitive
markets promote higher production efficiency and help keep prices of goods and
services, including investment products and services, down.
Investors also benefit when financial markets are liquid and transaction costs are low.
As mentioned earlier, liquidity ensures that investors can quickly buy or sell an asset
without affecting its price. Transaction costs are the costs associated with trading.
Because transaction costs reduce the return savers make on their investments, the
lower the transaction costs, the better. The combination of liquidity and low transaction
costs ensures that investors can trade as much (or as little) as they wish under
the best possible conditions.
To make reasonable judgments about their investments, investors need information
about the companies and governments to which they provide or may provide capital.
Therefore, access to relevant and reliable financial information is important. By helping
collect and process financial information, investment industry participants provide
benefits to investors. Timely access to this information is also critical because securities
prices may change quickly in response to new, relevant information. For example, the
stock price of an oil company that announces it has discovered a large new oil field
will likely increase at the prospect of higher revenues and profit.
Another important feature that characterizes a well- functioning investment industry
is the ability to transform and transfer risk. Risk is defined as the effect of uncertain
future events on an organization or on the outcomes the organization achieves; risk
is discussed in greater detail in Chapter 17. Risk is an inherent element of investing,
and investors should always consider both return and risk when they make investment
decisions. For example, the individual who lent her savings to her neighbor faces the
risk that her neighbor’s business fails and she never gets her money back. Although
the prospect of investing in the next Apple, Google, or Microsoft may be appealing,
the investor may finally decide not to lend her money to her neighbor if losing her
entire savings would have a devastating effect on her lifestyle. The investment industry

How Individuals Benefit from the Existence of the Investment Industry 9
offers those who want to reduce risk the opportunity to do so. For example, products
that represent some form of insurance may be available for purchase. Those who are
willing to take on risk may sell insurance or offer investments that allow others to
reduce their risks.
3.2 Laws, Regulations, and Trust
Laws and regulations are necessary to ensure that investors are treated fairly and
honestly. Usually, laws are passed by a legislative body, such as Congress in the United
States, Parliament in the United Kingdom, or the Diet in Japan. Regulations are created
by agencies, such as the Canadian Securities Administrators in Canada, the Autorité
des Marchés Financiers in France, or the Securities & Futures Commission in Hong
Kong. Both laws and regulations are enforceable, and enforcement is critical for laws
and regulations to be effective.
The form and extent of laws and regulations vary between countries and change
over time, but there are some general principles that apply consistently. Laws and
regulations are designed to
■
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■
prevent fraud;
protect investment industry participants, in particular investors; and
promote and maintain the integrity, transparency, and fairness of financial
markets.
For example, trading based on nonpublic information that could affect a security’s
price, called insider trading, is generally forbidden across most jurisdictions. An analyst
who learns during a private meeting with a company’s management that the company
is about to acquire a competitor is not allowed to buy or sell shares in the company
or its competitor until the company has officially announced the acquisition. If the
analyst were to trade before this information is available to all market participants, he
could gain from his inside information and the integrity and fairness of the financial
market would be compromised.
Although the investment industry is subject to laws and regulations, these laws and
regulations cannot cover every situation and cannot prevent fraud or market abuse
from happening. This is why it is important that
■
■
individuals who work in the investment industry behave ethically, in accordance
with a set of moral principles, and act professionally; and
organizations that employ these individuals promote cultures of integrity.
Ethical behavior on the part of investment industry participants is paramount to
protecting the reputation of the industry and to maintaining trust in the industry.
Without trust, savers may be less likely to make investments, which would ultimately
be detrimental to the economy.
We return to the discussion of ethics and regulation in Chapters 2 and 3, respectively.
Chapter 17 also addresses the issue of compliance with laws and regulations.

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Chapter 1 ■ The Investment Industry: A Top- Down View
4
INVESTMENT INDUSTRY PARTICIPANTS
There are many investment industry participants who help savers invest their funds
and help lenders get the funds they require. Anybody working in the investment
industry or using services provided by the investment industry is bound to come in
contact with several of these players.
4.1 Major Players
To introduce some of the major players, consider the example of a Canadian company
that needs funds to support its growth. The company may generate funds from its
current operations, but if the funds are not enough to support its growth plans, it will
have to turn to providers of capital. The investment industry can help the company
raise the funds it needs and allow investors to participate in the company’s growth.
We first discuss investment industry participants that may help the Canadian company
to raise funds. Then we discuss investors and investment industry participants that
may help them to invest funds.
4.1.1 Raising Funds and Investment Industry Participants
The Canadian company wants to issue shares to raise additional equity capital. Until
now, it has been private; it has not raised funds by issuing shares publicly. It wants to
take the equity issuance opportunity to become a public company and have its stock
listed on the Toronto Stock Exchange. Stock exchanges are organized and regulated
financial markets that allow buyers and sellers to trade shares with each other.
The company contacts an investment bank. Investment banks have expertise in helping
companies and governments raise funds globally. The investment bank will organize
the company’s first equity issuance, called an initial public offering (IPO). Chapter 9
provides more details about IPOs and equity issuances in general.
The investment bank will help determine the price at which the new shares will be
issued. To do so, it not only has to assess the company’s value, but it also has to gauge
investor interest in purchasing shares of the company. The investment bank’s analysts—often
called sell- side analysts because they work for the organization selling
the securities—will collect and analyze information about the company and prepare
detailed reports that can be shared with potential investors.
Once the investment bank has determined the price of the new shares, the IPO will
take place in the primary market—that is, the market where new securities, IPOs,
and subsequent offerings are issued and sold to investors. In exchange for providing
money to the company, investors will receive shares in the company. Companies get
funds when they issue new securities in primary markets. After the IPO, the company’s
shares will be traded in the secondary market—that is, the market where investors buy
and sell securities to each other. The Canadian company will not receive any capital
from the trading of its shares in the secondary market.

Investment Industry Participants 11
Now that the Canadian company is a public company, it will have to comply with the
rules set forth by the Toronto Stock Exchange and with relevant Canadian laws and
regulations. One typical rule is related to financial reporting; the Canadian company
will have to file quarterly financial statements and audited annual financial statements.
Auditors, who evaluate a company’s accounting and internal controls, play
a very important role. They ensure that investors receive reliable information, a key
feature of a well- functioning investment industry. More information about financial
statements is provided in Chapter 4.
4.1.2 Investing Funds and Investment Industry Participants
The Canadian company may have sold its shares to many investors. When investors
want to buy (sell) shares in the secondary market, they need to find another investor
who is willing to sell (buy) shares. Brokers and dealers are very important investment
industry participants who facilitate trading between investors. Brokers act as agents.
They do not trade directly with market participants; they only help buyers and sellers
find one another and trade with each other. In contrast, dealers act as principals.
They use their own accounts and their own capital to trade with buyers and sellers in
what is known as proprietary trading. They “make markets” in securities by acting as
buyers when investors want to sell and as sellers when investors want to buy. Brokers
and dealers provide liquidity and help reduce transaction costs; as mentioned earlier,
liquidity and low transaction costs are beneficial to investors.
There are also investment industry participants that provide trading support. They
include clearing and settlement agents that confirm and settle trades after they
have been arranged. Custodians also provide trading support by holding money and
securities on behalf of their clients.
There are different categories of investors, which are discussed further in Chapters 13
and 19. Institutional investors are typically organizations that invest for themselves to
advance their mission or invest for others to meet the others’ needs. For example, pension
funds manage portfolios for the benefit of current and future retirees. Institutional
investors usually rely on their own analysts to review a potential investment. These
analysts are called buy- side analysts because they work for the organization buying
the securities. They rely on investment information service providers, such as data
vendors and investment research providers, to gather data about the company and
its environment.
Individual investors often do not have the time, the inclination, or the expertise to
perform their own analysis. Some of them, such as wealthy individuals called highnet-
worth investors, may seek the help of investment professionals, such as financial
advisers (also called investment advisers). Financial advisers help their clients understand
their future financial needs and the risks they face when investing as well as
provide advice about investments. High- net- worth investors very often give authority
to their advisers to manage the investments on their behalf. These advisers are called
investment managers or asset managers.
Many investors may be willing to invest but lack sufficient financial resources to
contract an asset manager to look after their investments. These investors, called
retail investors, very often buy investment products created and managed by banks,
insurance companies, or investment management firms. For example, an individual

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Chapter 1 ■ The Investment Industry: A Top- Down View
who wishes to plan for her retirement may need a convenient and inexpensive way
of investing money regularly. She may buy shares in a mutual fund, a professionally
managed vehicle that has investments in a range of securities.
Exhibit 2 summarizes the investment industry participants introduced in this section.
They are grouped into categories that are discussed further in Chapter 13. The rest
of the curriculum provides more information about how these participants operate
and how they interact with one another and with investors.
Exhibit 2
Investment Industry Participants
Investment
Information Service
Providers
Investment
research providers,
analysts
Financial Advisory
Service Providers
Financial advisers
Investment
Management
Service Providers
Asset managers
Savers/
Lenders/
Providers of Capital
Retail, high-networth,
and
institutional
investors
Trading Service
Providers
Funds
Exchanges,
brokers, dealers,
clearing and
settlement agents
Custodial Service
Providers
Custodians
Financial
Markets
Funds
Investment Banks
Spenders/
Borrowers/
Users of Capital
Individuals,
companies,
governments
All these players can affect trust in the investment industry through their relationships
with one another and with their clients. Trust in the investment industry is only as
strong as the trust in its weakest link; it is thus critical that all players act with integrity.

Investment Industry Participants 13
4.2 Duty of Care
As presented above, there are different types of investment professionals, such as
financial advisers and asset managers, who provide advice to investors. Investment
professionals are held to different duties of care to their clients. Duty of care refers to
the legal obligations that investment professionals have when acting for or on behalf of
their clients. The level of care depends not on the title of the investment professional
but on the laws and regulations where the investment professional is based and the
role the investment professional plays when advising his clients.
In the United States, there are two levels of care: a high standard of care, called the
fiduciary standard, and a lower standard of care, called the suitability standard. To
differentiate these two levels of care, consider the example of a financial adviser who
has to recommend an investment product to her client. Whether the adviser is held to
a fiduciary or suitability standard, she must understand her client’s objectives in terms
of risk and return and any constraints her client may have. The process of identifying
an investor’s needs and constraints is described in Chapter 19. If the investment adviser
is held to the fiduciary standard, she is required to recommend the best investment
product. In contrast, if the investment adviser is held to the suitability standard, she
has to recommend an investment product that meets her client’s objectives and constraints,
but it does not have to be the best investment product. It is sufficient for the
investment product to meet the client’s objectives and constraints even if there is a
better alternative available. The distinction between the fiduciary and the suitability
standard is particularly important if the adviser represents certain funds or products.
Laws and regulations across Asia vary greatly, but in some places, such as Singapore
and Hong Kong, the legal concept of fiduciary duty is based on the British legal system.
Duties of care, similar to the suitability standard described earlier, are usually defined
by laws and regulations that are country specific.
Duty of care in the European Union is governed by the Markets in Financial Instruments
Directive (MiFID). The options in the EU are either a suitability standard or an appropriateness
standard. The appropriateness standard only requires investment professionals
to assess a client’s level of understanding, not to review the client’s objectives
and constraints. The suitability standard is the higher standard and requires the
investment professional to review and consider the client’s objectives and constraints.
Investors seeking advice from investment professionals should understand the laws
and regulations that apply to these investment professionals and the duty of care these
investment professionals hold with regard to their clients. These issues may influence
investment professionals’ advice significantly. In particular, investors must assess when
the interests of investment professionals may not be aligned with their own interests,
which is known as a conflict of interest. For example, an investment manager might
have a monetary incentive to invest a client’s money in a particular investment product
or to buy and sell assets more actively than is justified for the client.

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Chapter 1 ■ The Investment Industry: A Top- Down View
5
KEY FORCES DRIVING THE INVESTMENT INDUSTRY
The four key forces that drive the investment industry are competition, computerization,
globalization, and regulation.
Competition in the investment industry is based on innovative investment product
offerings. It is also based on pricing, service, and performance.
Over the years, technological advancements have allowed investment industry participants
to reduce operating costs. Computerization, in particular, has dramatically
decreased trade processing costs and increased trade processing capacity. It has also
spurred the development and analysis of innovative types of investment products.
Globalization is another force driving the investment industry. Investors look outside
their domestic markets to diversify their investments and generate higher returns.
Emerging markets, in particular, hold the promise for higher rates of growth. For
example, China, Brazil, and India are emerging economies that are growing faster
than developed economies. Furthermore, such countries as China, Saudi Arabia, and
Russia, which have trade surpluses, use those surpluses to invest abroad in a variety
of opportunities. These foreign investments contribute to economic development as
well as to the overall profits of the investment industry.
Globally, there has been a growing trend toward greater regulation of the investment
industry. Regulation is needed to protect investors and safeguard their investments.
By promoting disclosure and transparency, it is hoped that regulation will prevent the
kinds of mistakes and frauds that have cost investors significant amounts of money over
the years. International cooperation among financial regulators has played and should
continue to play an important role in raising global standards of securities regulation.
SUMMARY
■
■
■
■
The financial services industry exists to provide a link between savers/lenders/
providers of capital that have funds to invest and spenders/borrowers/users of
capital that need funds.
Financial intermediaries help channel financial capital efficiently between savers
and spenders.
The investment industry comprises all the players that are instrumental in helping
savers invest their money and borrowers get the funds they require.
Capitalism takes different forms, but two important characteristics are that it
favors private ownership as the means of production and markets as the means
of allocating resources.

Summary 15
■
■
■
■
■
The investment industry provides several benefits to the economy, including
the efficient allocation of scarce resources, better information about investment
opportunities, products and services that are appropriate for suppliers and
users of capital, and liquidity.
The benefits for investors of a well- functioning investment industry include a
broad range of investment products and services that meet their needs, competitive
markets that provide liquidity and keep transaction costs low, timely
and efficient disclosure of information, and the ability to modify their risk
exposures.
Laws and regulations are necessary to protect clients and ensure the integrity,
transparency, and fairness of financial markets.
Ethical behavior is critical to protecting the reputation of and maintaining trust
in the investment industry.
Investment industry participants include the following:
Categories Participants Key Characteristics
Investors Retail investors Individual investors with the least
amount of assets
Financial advisory
service providers
Investment management
service
providers
Investment information
service providers
High- net- worth
investors
Institutional
investors
Financial advisers
Asset managers
Data vendors
Investment research
providers
Analysts
Individual investors with a higher
amount of assets
Organizations that invest to advance
their mission or to provide financial
services to their clients
Professionals that provide advice
about investments and help clients
understand their needs and the risks
they face
Professionals that manage investments
on behalf of their clients
Organizations that provide information
resources
Organizations that produce information
reports
Professionals who produce research
reports
(continued)

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Chapter 1 ■ The Investment Industry: A Top- Down View
Categories Participants Key Characteristics
Trading service
providers
Custodial service
providers
Exchanges
Brokers
Dealers
Clearing and settlement
agents
Custodians
Financial markets that allow investors
to trade
Professionals and their firms that
facilitate trading between investors,
acting as agents (do not trade with
their clients)
Professionals and their firms that
facilitate trading between investors,
acting as principals (trade with their
clients)
Organizations that confirm and settle
trades
Organizations that hold money and
securities on behalf of their clients
■
■
Investment professionals are held to varying standards of care based on regulatory
jurisdiction and the investment professional’s role. Some are held to a high
level of care (fiduciary standard), whereas others are held to a lower level of
care (suitability standard or appropriateness standard).
The four key forces that drive the investment industry are competition, computerization,
globalization, and regulation.

Chapter Review Questions 17
CHAPTER REVIEW QUESTIONS
Test your knowledge of this chapter at cfainstitute.org/claritasstudy.
1 The financial services industry benefits the economy by providing a link
between providers of capital and:
A
savers.
B lenders.
C
borrowers.
2 The investment industry benefits the economy by:
A
increasing risk.
B decreasing liquidity.
C
increasing efficiency.
3 Which of the following best describes a benefit of a well- functioning investment
industry from the perspective of an individual investor?
A
Risk transformation
B Scarce resource allocation
C Fewer financial intermediaries
4 A major benefit of competitive markets for the individual investor is:
A
risk transfer.
B lower prices.
C
greater integrity.
5 Which of the following would most likely assist high- net- worth individuals in
arranging their financial affairs?
A
Financial advisers
B Investment dealers
C
Investment bankers
Copyright © 2012 CFA Institute

18
Chapter 1 ■ The Investment Industry: A Top- Down View
6 Which of the following is least likely to facilitate trading and help reduce transaction
costs?
A
Stock exchanges
B Investment dealers
C
Investment analysts
7 Relative to the suitability standard of care for investment professionals, the
fiduciary standard of care is:
A
lower.
B higher.
C
equivalent.
8 Which of the following forces that drive the investment industry promotes
transparency of financial markets?
A
Competition
B Computerization
C
Regulation
9 Globally, regulation of the investment industry has:
A
increased.
B decreased.
C
remained stable.

Answers 19
ANSWERS
1 C is correct. The financial services industry exists to provide a link between
providers of capital (also called savers, lenders, or investors) that have funds to
invest and users of capital (also called spenders or borrowers) that need funds.
A and B are incorrect because savers and lenders are providers, not users, of
capital.
2 C is correct. The investment industry helps savers invest their money and helps
borrowers get the funds they require. In doing so, it reduces the resources that
would be expended on the search rather than on productive uses, thus increasing
efficiency. A is incorrect because the investment industry helps transform
and transfer risk, not increase it. B is incorrect because the investment industry
increases rather than decreases liquidity.
3 A is correct. In a well- functioning investment industry, risks can be transformed
and transferred. Individuals who want to reduce risk can do so—for
example, by buying insurance. B is incorrect because the efficient allocation
of scarce resources through a well- functioning investment industry is a primary
benefit for the economy, not the individual. C is incorrect because a
well- functioning investment industry is characterized by competitive markets.
Competitive markets are made up of a large number of financial intermediaries
(e.g., banks or insurance companies) that compete with one another.
Competitive markets keep prices of investment products and services down.
4 B is correct. Competitive markets promote higher production efficiency and
help keep prices of investment products and services down. A is incorrect
because risk transfer, although it is a benefit for the individual investor, deals
with transferring risk from those that want to reduce risk to those that are willing
to take on risk; risk transfer does not deal with competition. C is incorrect
because greater integrity is achieved by effective laws and regulations and not
through competition.
5 A is correct. Financial advisers typically provide high- net- worth individuals
with advice about how to manage their investments. B is incorrect because
investment dealers facilitate trading between investors. C is incorrect because
investment bankers help companies and governments raise funds globally.
6 C is correct. Investment analysts are primarily engaged in analyzing investment
opportunities and providing recommendations about the investments they
follow. A is incorrect because stock exchanges facilitate trading of new and
existing securities and, as such, help reduce transaction costs. B is incorrect
because investment dealers facilitate trading by acting as buyers when investors
want to sell and as sellers when investors want to buy. By doing so, they help
reduce transaction costs.
7 B is correct. Investment professionals who have a fiduciary responsibility to
their clients must act in their clients’ best interests. The fiduciary standard is
a higher standard of care than the suitability standard. A and C are incorrect

20
Chapter 1 ■ The Investment Industry: A Top- Down View
because investment professionals who have a fiduciary responsibility to their
clients have a higher, not lower or equivalent, standard of care than investment
professionals who must meet the suitability standard of care.
8 C is correct. Regulation promotes transparency. Increased transparency is
designed to prevent mistakes and fraud. A is incorrect because competition,
although one of the four forces, does not promote transparency. B is incorrect
because computerization, although it is one of the four forces, does not promote
transparency. Regulation is the only one of the four forces that promotes
transparency.
9 A is correct. Globally, there has been a growing trend toward greater regulation
of the investment industry. B and C are incorrect because globally, there has
been a growing trend toward increased regulation of the investment industry,
not a trend of decreased or stable regulation.

G-1
GLOSSARY
Analysts Analysts select, evaluate, and interpret information
to arrive at an opinion.
Asset managers
See investment managers.
Assets Resources that a company controls as a result of past
events and that are expected to provide future economic
benefits.
Auditors An external auditor is an independent accountant
that examines financial statements and provides a written
opinion on them. An internal auditor is employed by
the company and evaluates a company’s accounting and
internal controls.
Bond
A formal contract that represents a loan from an investor
(bondholder) to an issuer. The contract describes the key
terms of the debt obligation such as the interest rate and
the maturity.
Brokers Agents who execute orders to buy or sell securities
for their clients and provide trading services in exchange
for a commission.
Capital markets Financial markets for securities that have a
maturity longer than a year.
Capitalism An economic system that favors private ownership
as the means of production and markets as the means of
allocating scarce resources.
Clearing and settlement agents Investment industry participants
that confirm and settle trades after they have been
arranged.
Conflict of interest When either the employee’s personal interests
or the employer’s interests conflict with the interests
of the client (conflicts of interest can also arise when
employee’s and employer’s interests conflict).
Custodians Entities that hold money and securities on behalf
of their customers, help arrange trade settlements, and
collect interest and dividends for their customers.
Dealers Financial intermediaries that allow their clients to
trade when they want to trade by standing ready to buy
(sell) when their clients want to sell (buy) by acting as
principals in trades.
Demand The desire for a good or service coupled with the ability
and willingness to pay for the desired product.
Duty of care The legal and professional obligations that investment
professionals have when acting for or on behalf of
their clients.
Financial advisers Investment professionals who provide both
financial planning and investment advisory services to
their clients.
Financial assets Claims on other assets and on future cash
flows; for example, a share of common (ordinary) stock
represents ownership in a company or a claim on the
residual value of the company.
Financial capital Funds provided to corporations and governments
that allow them to purchase physical capital, to hire
labor, and to acquire other inputs necessary to produce
goods and services.
Financial intermediaries Financial institutions—such as banks,
securitizers, and insurance companies—that channel funds
from savers to spenders; they transform deposits made by
savers into loans to borrowers.
Financial intermediation Process of collecting savings from
lenders in one form, such as deposits, and transforming
them into another form, such as loans, for borrowers.
Financial markets Places where buyers and sellers can trade
securities; also called securities markets.
Fixed- income securities Loans that lenders make to borrowers;
also called debt securities and bonds.
High- net- worth investors Individual investors who have investable
assets over a certain amount (e.g., USD1 million or
CNY10 million) and who are often, but not always, more
sophisticated investors.
Initial public offering The first issuance of common shares to
the public by a formerly private corporation.
Insider trading Trading while in possession of material nonpublic
information.
Institutional investors Companies, trusts, and governments
that invest to advance their missions or to provide financial
services to their clients.
Investment banks Financial intermediaries that typically
provide capital raising and strategic advisory services,
brokerage and dealing services, and research services to
companies and governments.
Investment industry All the players that are instrumental
in helping savers invest their money and lenders get the
funds they require.
Laws Rules passed by a legislative body, such as Congress in
the United States, Parliament in the United Kingdom, or
the Diet in Japan.
Liquidity Measure of the ease of buying or selling an asset
without affecting its price.
Money markets Financial markets for securities that have a
maturity shorter than a year.

G-2 Glossary
Mutual fund Investment company that holds portfolios of
investment securities and assets.
Pension funds Institutional investors who hold investment
portfolios for the benefit of future and current retirees.
Physical capital The means of production; tangible goods such
as equipment, tools, and buildings.
Primary market The market where new securities, IPOs, and
subsequent offerings are issued and sold to investors.
Proprietary trading When dealers trade using their own
accounts and their own capital with buyers and sellers.
Real assets Physical assets such as land, buildings, cattle,
and gold.
Regulations Rules that set standards for conduct and that
carry the force of law.
Retail investors Individual investors who have the least amount
of investable assets and who are often, but not always, less
sophisticated investors than institutional investors.
Risk
The effect of uncertain future events on an organization
or on the outcomes the organization achieves.
Secondary market Market in which traders of a security trade
with each other but not with the original security issuer;
market in which investors buy and sell securities with
each other.
Securities
Financial assets that can be traded.
Stock exchanges Organized and regulated financial markets
that allow buyers and sellers to trade securities with each
other.
Stocks Ownership in a company; also called equity securities,
shares of stock, or shares.
Supply The quantity of a good or service sellers are willing and
able to sell at a given price.
Transaction costs Costs that accrue from brokerage commissions,
bid–ask spreads, and market impact; the costs
associated with trading.

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