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BU111 Study Guide - Final Guide: Comparative Advantage, Double Taxation, Asia-Pacific

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Roopa Reddy
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Business Final Exam Notes
Chapter 5
Balance of Trade: value difference between a countries exports and imports
o Surplus: more exports than imports (favourable balance of trade)
o Deficit: more imports than exports (unfavorable balance of trade)
Financial Institutions:
o Provide services to individuals and businesses
o Main function is to facilitate flow of money from sectors with surpluses to
those with deficits by attracting funds into chequing and saving accounts
Four Financial Pillars
o 1) Chartered banks
Privately owned, profit-seeking financial intermediary
Largest and most important financial institution in Canada
Main source of short-term loans for business firms
o 2) Alternate banks
Trust companies & credit unions
o 3) Life insurance companies and other specialized lending and saving
Finance companies, venture capital firms, factors, mutual funds,
pension funds
o 4) Investment dealers
Primary distributors of new stock and bond issues
Crumbling of four financial pillars began in 1980 with changes made to the Bank
Services offered by banks: pension services, trust services, international
services, financial advice, electronic funds transfer
Banks Loans:
o Secured Loan: backed by collateral
o Unsecured Loan: backed by borrowers promise to repay it (only given to
the most credit-worthy borrowers)
Prime rate of interest: Lowest rate charged to borrowers
o By taking deposits and making loans banks expand the money supply
“Big Six”: Royal Bank, CIBC, Bank of Montreal, Bank of Nova Scotia, TD Canada
Trust, National Bank of Canada
Changes in Banking: deregulation, changes in customer demands (blurring
traditional boundary between banks and securities firms) and changes in
international banking (foreign banks now allowed to do business in Canada)
Overvalued Currency: exchange rate higher than warranted by economic
conditions; high costs make it less competitive (may devalue nation’s currency,
making it less expensive for other countries to buy the countries products)
Undervalued Currency: low costs and low prices (government may revalue the
o Law of One Price: the principal that identical products should sell for the
same price in all countries (a way to tell the value of a countries currency)

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World Bank & International Monetary Fund: help to finance international trade
Securities Market: the market in which stocks and bonds are sold
o Stocks and bonds are known as securities because they represent a
secured (asset-based) claim on the part of the investors
o Primary Securities Markets: handle the buying and selling of new stocks
and bonds by firms or governments (using the services of investment
o Secondary Securities Market: the market for existing stocks and bonds
(handled by organizations such as the Toronto Stock Exchange)
Common Stock
o Buy common stock hoping it will increase in value (capital gain) and/or
provide dividend income
o All corporations issue common stock
o Stock values are expressed in three ways:
Par Value: The face value of a share of stock (set by issuing
company’s board of directors)
Market Value: A stock’s real value - current price of a share in the
secondary securities market (stock market)
Can be influenced by: objective factors (company profits)
and subjective factors (rumours, investor relations and
stockbroker recommendations)
Book Value: Value of a common stock expressed as total
stockholder’s equity divided by the number of shares of stock
Preferred Stock
o Usually issued with a stated par value (dividends paid on preferred stock
are expressed as percentage of the par value, paid annually)
o Because of its preference on dividends, it’s less risky than common stock
(growth potential limited due to fixed dividend)
o Most preferred stock is cumulative
Cumulative preferred stock: any dividend payment the firm misses
must be paid later as soon as the firm is able
o Callable Preferred Stock: issuing firm can require the preferred
stockholders to surrender their shares in exchange for cash payment
(known as the call price)
Stockbroker: receives by and sell orders from those who are not members of a
stock exchange and executes the orders for commission
NASDAQ: worlds first electronic stock market (many newer firms are listed here
when their stocks first become available on the secondary market)
Blue-Chip Stock: one that has been issued by a well-established, financially sound
Bonds: a written promise that the borrower will pay the lender, at some stated
future date (maturity date), as sum of money (the principal) and a stated rate of
o Bondholders have a claim on the company’s assets and earnings that
comes before common and preferred stockholders

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Stockholders provide equity capital, while bondholders are lenders (though also
considered ‘investors’ in the securities market)
o Stock certificates represent ownership, while bond certificates represent
Bonds differ from each other in terms of maturity date and risk level
o Default risk: the chance that one or more promised payments will be
deferred or missed all together
Government Bonds:
o Among the safest investments available
o All federal bonds backed by Canadian government
o Municipal bonds: issued by local and provincial governments
Corporate Bonds
o Source of long-term financing for Canadian corporations
o Usually have maturity dates of 10, 20 or 30 years
o Corporate bonds may be categorized in two ways:
1) According to methods of interest payments
2) According to whether they are secured or unsecured
Nearly all secondary trading in bonds occurs in the over-the-counter market
rather than organized exchanges
Direction of bond prices moves opposite to interest rate changes (as interest
rates move up, bond prices tend to go down)
Bond Security:
o Secured Bonds: borrowers can reduce the risk of their bonds by pledging
assets to bondholders in the event of default; can be backed by mortgages
or other specific assets
o Unsecured Bonds: called debentures
No specific property pledged for security
Holders of unsecured bonds generally have claims against
property not otherwise pledged in the company’s other bonds
Financially strong corporations often use debentures
Maturity Dates (vary with callable, serial and convertible bonds):
o Callable Bonds: the issuer has the right at almost any time to call the
bonds in and pay them off at a price stipulated in the bond indenture
Call Price: price issuer must pay to call in the bond (usually gives a
premium to the bondholder)
Call price and the premium decrease annually as bond
nears maturity
o Sinking-Fund Provision: requires issuing company to put enough money
into special bank account each year to cover retirement of bone issue
(including interest) on schedule (generally regarded as safer investments
than bonds without this clause)
o Serial Bonds: firm retires portions of the bond issue at different
predetermined dates
o Convertible Bonds: can be converted to common stock at the option of the
bondholder (since it gives the bondholders a chance for capital gains,
companies can offer lower interest rates when issuing these bonds
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