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Economic Factors (BU111)

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Wilfrid Laurier University
Leanne Hagarty

Monday, October 22, 2012 Economic Factors Types of investments: BONDS  Represents debt for issuing corporation or government o For companies to borrow money o Not like equity, keep control of company  Bond holders means them borrowing money to companies  Characteristics o Legal, binding agreement o Fixed rate of return (often paid semi-annually)  What you get back investing in that bond, is certain. The return is certain o Fixed term – principal repaid at maturity  Principal: who ever owns the bond, collects the principal  Initial amount is the “Principal” o Priority over stockholders  If bond issued by corporation, bond holder are prioritize to who pays first. Since of legal obligation  contract; legal, binding agreement.  Types o Secured vs Unsecured (debentures)  Secure: Has legally obligation. Has the ability to pay back  Unsecure: structure on the promise of the issuer. Since it’s unsecured it shouldn’t be called a Bond, should be called “Debentures”  Usually government bonds are unsecure *** (not sure o Registered vs. Bearer  Registered: Until maturity, keep track of ownership of bonds, bond owner are registered on file, and will be paid back on maturity.  Bearer: it’s up to the bearer to redeem the principal. Whoever holds the bond must redeem the principal with their coupon.  Anyone can redeem that coupon.  Features o Callable  Can pay out the bondholder earlier  Less interest if pay back earlier  Reduce debt load  Strategy: Pay down the higher percent interest rate bonds, and reissue a lower rate bonds. o Serial  Series of maturity date.  Ex: 5 million in 5 years, 5 million in 10 years, … 5 million in 20 years, for a 20 million debt. o Convertible  Never on a government bond  Can be converted into a common share  Ownership of a company  Company set out this convertible condition  Bond holder chooses to convert o Ex: first few years, you get 30 shares, later only 20 shares, etc o Incentive to turn them into common shares  What impacts Bond Value? o Why different bond have different rates? o Prevailing interest rates  If prevailing interest rate higher than the fixed bond value, then the fixed bond value is less attractive o Credit rating of issuer  Assess the risk, and credit rate will be given to them  Eg: B-bonds are riskier  Riskier = Higher interest rate  Safe = Lower interest rate  Even if it’s legal binding agreement, why have a risk rating?  Companies can default  Still a high degree of risk o Inflation  Inflation rising, bond prices fall  Inflation makes principal, interest rate less attractive  Inflation decreasing, bond prices lower o Economic/Market Risk o Features Concept of Yield  Percentage return on any investment  Helps us to compare investments For a bond: Interest = coupon rate x face value Capital gain = face value – purchase price  In BU 111, always use a face value of $1000 for bonds Approximate Yield to Maturity Notes:  Assumes you will hold the bond until maturity  Need to calculate “what you made” on an annual basis Wednesday, October 24, 2012 Why do bond prices fluctuate?  Can’t change o Coupon rate o Face value o Time to maturity o Face value  Can Change o Price paid Bond Pricing  Pay less than face value (discount value) o Coupon is less than expected future yield  So price of bond is at discount, since we expect the higher yield later  Ex: 2008 bond with 3%, future expects 5% yield.  Then lower price paid, to get a higher capital gain, which gives us a greater yield  Pay more than face value (pay at a premium) o Coupon is more than expected future yield  So price has a premium, since we expect a lower yield later  Ex: 2004 bond with 7% coupon, expect future 5%  Then higher the price paid, by paying a premium, so that we have the same yield at the end, 5%.  Pay the face value (pay at par) o All good. Face value. Expect same constant yield in the future Bond prices vary inversely with interest rates Reading bond quotations  Issuer, Coupon, Maturity, Price, Yield, Change o Price : % of face value STOCKS  Represents equity/capital for issuing company o Not locking ourselves into a fixed interest o Giving up ownership  Characteristics o Voting rights  Votes on who sits on the BOD (ownership of company) o No fixed term  No way of knowing when we will sell those shares, don’t know the price in the future.  Don’t know, on-going return, don’t know capital gain  No set maturity date  You decide when to sell it o Variable return o Discretionary payment (dividends)  Usually paid annually,  No certainty of dividends  Usually relationships to profit  BOD can decide to not pay dividends  No legal obligation to pay dividends  It’s a discretion o Risk  More risk because of these variables, not a lot of fixed aspects Types of Stocks Paid to investors : Bonds > Preferred Stock > Common Stock Voting rights : Common Stock > 0 votes = Preferred Stock = Bonds Common stocks :  Lots of growth for company, capital gain. Usually for new companies o Might start giving out dividends when company matures  Extra dividends, sometimes given  More volatility o Riskier investment  Larger market, more shares o High volume  Right – more shares at set price o If company issued another block of shares,  Before they issue, they will ask share holders.  You could buy existing percentage of ownership, by buying more shares until same percentage Preferred stocks:  Dividends is written on the stock issue o Though not legally obligated o Looking for investors that likes regular income payments  Cumulative feature o Even if missed the dividend,  Keep tracks of it, and they’ll make it up  Participation feature o Might get extra amount of dividend than the listed dividend on the stock issues, like a bonus  Less volatile o Sensitive to interest rate  Thinner market o Less volume  Redemption – co, can buy back  Convertibility – to common What impacts stock price?  Demand and supply of stock due to negative or positive perceptions/facts  Primary factors o Earnings – above or below expectations, rumours  Contract deals got through and stuff.  Predicted earning reports o General market conditions – bull vs bear markets, economy, interest (especially preferred)  Though some companies to better in bear markets o Speculation – bought or sold on belief price will soon move  Price of a security is a collective expression of all opinions of those who are buying and selling  Undervalued issue – offers higher return than stocks of similar risk Reading Stock Quotations High Low Stock Dividend High Low Close Change Volume First one: Volatility high low -> 52 weeks Second one: Volatility high low -> Day Close: Last price of board lot Other investment Vehicles  Blue chip stocks o High capitalization o A lot of shares/volume  Small-cap stocks o Junior, younger company,  Higher risks  Penny stocks o More extremely, speculative, junior company o Usually for resource sector : Gold oil etc  Less than a dollar per share  High Volatility  Not very liquid, low volume  Canada Savings Bonds – CSBs o You get through the bank  Not traded part way through their life  Guaranteed by the government  Not able to provide fantastic return, because no risk  Hence low return  Guaranteed Investment Certificates – GICs o Not a loan to government or corporation o Safe low risk investment  Protected by the banking insurance system  Low risk low return  Treasury Bills – T – Bills o Like a bond  Issued, it’s a loan  All different government bodies,  Provinces,  Municipality o 90 day return, minimum 100 000$ for a T-Bill  Much more administratively simple  Mutual Funds o Diversification o Since hard enough for individual to have enough capital to diversify portfolio. Capitalization = share price X number of shares outstanding Monday, October 29, 2012 Leverage  Engaging in a transaction whose value is greater than the actual dollars you have available  Creates potential to make a larger return or loss than indicated by the investment you have made  Examples: o Buying on margin o Selling short Buying on Margin  Put up only party of purchase price  Broker lends remainder (with interest)  Min. requirements set and enforced by Securities Commission – crash of ’29 – 10% Comparison of long and margin buy Example: XYZ is trading @ $45. You have $6,300 to invest. The minimum margin requirement is 70%. Annual interest on the margin loan is 10%. In each scenario, you sell at $55 3 months later. A) What is your capital gain if you go long and purchase the stock Capital gain: $1,120 Yield 17.8% B) With margin Capital gain: $1,532.50 Yield 24.33% Margin buying rules:  Must qualify for margin account o Must have net worth, income, experience, and things to be able to liquidate.  Must sign “hypothecation” agreement (Margin Account Agreement Form) – pledging of securities as collateral for a loan o You are agreeing any stocks you purchased with the loan, you don’t have access to it, it uses as collateral for a loan.  Must pay interest on loan Investors % equity (margin) in the margined stock must always be >= the minimum margin requirement Wednesday, October 31, 2012 Time value of money  Is $1 one year from today worth the same as $1 today?  No! It’s worth less because of: o Risk: Maybe not there anymore, who says you’ll get paid back? o Inflation: Prices go up, dolla
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