RSM230 Summer 2012
FINAL EXAM STUDY NOTES!
CH.8 - Stock Indices and Averages
Index a number that measures a number of stock prices so that a percentage change in this
index can be calculated over time. They serve as the underlying assets for options, futures,
Average used for the same purpose, but is determined by summing up the number of prices
and diving by the number of items (equally weighted).
S&P/TSX Composite Index determined by the total market capitalization of a portfolio of
the most actively traded Canadian stocks. Its a market/value-weighted index. The stocks
are reviewed every quarter, and stocks can be replaced. A base value of 1000 was set in
S&P/TSX 60 base is 100
MidCap index contains 60 stocks that rank below S&P/TSX 60 in market cap, while the SmallCap
index contains the remaining stocks.
Dow Jones Industrial Average (DJIA) most widely quoted measure of NYSE stock
performance, but only includes 30 stocks. Its a price-weighted average, which reflects the
highest quality blue chip stocks in the US. Due to its low risk, it tends to underperform
broader indices like the S&P 500.
S&P 500 Index broader based market-weighted index that measures US stocks. Its used to
measure the investment performance of institutional investments.
NASDAQ Composite Index contains over 4000 OTC stocks and is market valued.
Wilshire 5000 Equity Index measures almost everything, and is the broadest based US
NYSE maintains market valued indices which include listed equities for: composite, industrials,
transportation, finance and real estate, and utilities.
Others Include: Nikkei (price weighted), FTSE 100 (UK, market weighted), DAX (Germany,
value-weighted with 30 blue chips).
Financials is NOT a subsector index in the Canadian market.
Under the Canadian system, capital gains are taxed at a rate equal to 50% of regular
Pari Passu when different classes of preferred shares have the same rank in relation to
asset and dividend entitlement
CH.9 Equity Trading
Cash Accounts = not granted credit b the securities firm and have to make full payment o the
settlement date (same day for T-bills, 2 days for Govt direct and guarantees up to 3 years,
and 3 days for all other securities) RSM230 Summer 2012
Margin Accounts = enable them to buy or short sell securities by paying only part of the full
price, borrowing the remainder from the member (with interest charged). The term
margin means the amount the investor must contribute to the margin account.
Maximum Loan Values for securities other than bonds and debentures are:
70% for securities eligible for reduced margin
50% for prices of $2 and over that are not eligible for reduced margin
40% for prices of 1.75 to 1.99
20% for prices of to 1.74
No loan value for under 1.50
When a margin falls below a level, theres a margin call requiring the client to deposit more into
their margin account, or else shares will be sold.
E.g. Cost is $2 x 1000 = $2000. ID max Loan = 0.5x2x1000 - $1000. Min Margin
Requirement = $2000 - $1000 = $1000. If price decreases, max loan decreases and there
is a margin deficit. If the prise rose, the max loan increases and there is a margin surplus.
Short Sales investor sells securities they dont own. The investor must leave the proceeds of
the sale with the dealer, and deposit a certain portion of the market value in addition. Its
like the opposite of buying on margin, and the required balances are:
130% for securities eligible for reduced margin
150% for prices of $2 or over
$3/share for 1.50 to 1.99
200% of market value for 0.25 to 1.49
100% of market plus 0.25/share for prices under 0.25
E.g. Short sell 1000 shares of stock at $10. The min account balance is 1.3 x 10 x 1000 =
13,000. The proceeds from the sale is $10,000. The min margin requirement is $3000.
The min account balance changes depending on MARKET PRICE.
There is no time limit on a short position, but the client must buy the necessary shares if the
broker is unable to borrow sufficient shares to do so. Thus, the stocks that are short sold
are usually actively traded one. TSX reports short positions twice a month. Hazards of this
Difficulties in borrowing enough shares
Liability for any dividends paid
Possibility of volatile prices should a rush to cover happen
The unlited potential loss
Responsibility of having an adequate margin
Traditional equity transactions involve a buyer and a seller who are represented by an
investment dealer. The IAs report the current bid and ask for shares. After a transaction
occurs, both the buyer and seller receive a confirmation of the transaction, and are required
to settle in 3 business days. IAs can also be principals, where they fill a customers order
from their own inventory, and the trade is made at the market price.
Buy and Sell Orders
Market Orders best available price in the market
Limit Orders only if a specific price or better can be obtained
Day orders limit orders that are valid for one day RSM230 Summer 2012
Good Till Cancelled/Open Orders limit orders that remain until filled, for 30, 60, or 90
All or None Orders only filled if the total number of shares can be bought or sold
Any Part Order accept any amount of shares, in round or odd lots
Stop Loss it generates market orders to SELL if the price drops below a certain point;
used to limit losses on long positions
Stop Buy Orders a market buy order is generated if the price rises above a certain
level to limit losses on short positions
Pro Orders transactions involving partners, directors, shareholders, IAs, or employees
The preferential trading rule requires IAs to give priority to client orders over those of non-
clients, which include pro orders (labelled Pro, N-C, or Emp).
Market orders are made at the best available price, while day orders are made only if a specific
price or better can be obtained.
If an investment order doesnt specify the time in which the IA has to fill the order, then the
order remains open until the close of the business day or until filled, whichever is sooner.
CH. 11 Financing and Listing
Forms of Businesses:
Proprietorship not a separate legal entity, unlimited liability, capital generation restrictions,
income is taxes as personal income.
Partnership at least one general partner who is liable for all business debits. Limited partners
are not involved in daily business acitivty and liability is limited.
Corporation dominant form, separate legal entities, separation of ownership from
management, unlimited life, shareholders have limited liability and can transfer ownership,
greater access to capital.
A corp comes into existence when a charter is issued by the government, and may be: letters
patent, memos of association, or articles of incorporation.
Private corporations restrict the right of shareholders to transfer shares, limit the number of
holders to less than 50, and prohibit inviting the public to own it.
A corp is regulated by the government act which it was incorporated (provincial or federal), its
own charter, and its by-laws (whicha re passed by directors and approved by shareholders)
Significant events require the approval of shareholders: liquidation of businesses, changing
amendments, etc. All shareholders have the right to receive proxies and AFS.
Proxy the power of attorney that allows another party to vote on behalf of the shareholder.
If management obtains a sufficient number of proxies it can control the board of directors.
During restructuring, a corp may have a voting trust, which shareholders deposit their
shares with a trustee to transfer voting control to few individuals.
Corps are required to a have outside directors that are responsible for: appointing officers,
signing authorities, contracts, budgets, and declaration of dividends. They must act like a
reasonably prudent person. The board elects a chairman, who (or the president) can be the