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Business Final Exam Notes.docx

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Wilfrid Laurier University
Roopa Reddy

1 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 intermediaries  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 Act  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 currency) 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) 2  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 bankers) 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 firm  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 interest o Bondholders have a claim on the company’s assets and earnings that comes before common and preferred stockholders 3  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 indebtedness  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 4  Other Investments o Mutual Funds: pool investments from individuals and other firms to purchase a portfolio of stocks, bonds and short-term securities (also called ethical funds) o Hedge Funds: private pools of money that try to give investors a positive return regardless of stock market performance  Often engage in risky practices like short-selling and leverage buying  Historically limited to wealthy people (accredited investors) but recently marketing to the average investor o Future contracts: agreements to purchase a specified amount of a commodity at a given price on a set date in the future (future trading is very risky)  Margin: the percentage of the total sales price that a buyer must put up to place an order for stock or a future contract o Stock Option: right to buy or sell a stock (call option: right to buy at a certain price up to a certain date; put option: right to sell)  Market order: requests the broker to buy or sell a certain security at the prevailing market price at the time  Limit order: authorized the purchase of a stock only if its price is less than or equal to a given limit Chapter 6  How Government Influence Business o Government as a Customer  Buys thousands of products and services from business firms (such as helicopters, office buildings, computers, etc.) o Government as a Competitor  Compete with businesses through Crown Corporations (ex. Canada Post)  Crown corporations exist at both provincial and federal levels o Government as Regulator  Regulate many aspects of business activity through administrative boards, tribunals and commissions (ex. CRTC)  Reasons for regulations: protecting consumers, protecting competition, achieving social goals, protecting environment o Government as Taxation Agent  Revenue Taxes (income taxes): levied by governments primarily to provide revenue to fund various services and programs  Progressive Revenue Taxes: levied at a higher rate on higher- income taxpayer and lower rate on lower-income taxpayers  Regressive Revenue Taxes: levied at the same rage regardless of a persons income  Restrictive Taxes: levied partially for the revenue the provide, but also because legislative bodies believe that the products in questions should be controlled (ex. tobacco, alcohol and gasoline) 5 o Government as a Provider of Incentive and Financial Assistance  Federal, provincial and municipal governments offer incentive programs that attempt to stimulate economic development o Government as Provider of Essential Services  Facilitates business activity through services they supply (ex. highways, postal services, statistical data, etc.)  How Businesses Influence Government o Lobbyist: a person hired by a company or industry to represent that company’s interests with government officials o Trade associations: employees and owners of small businesses that cannot afford lobbyists often join trade associations (may act as an industry lobby to influence legislation) o Advertising: influence legislation indirectly by influencing voters through advertising Chapter 7 – Forms of Business Ownership  Sole Proprietorship: o Business owned and operated by one person o Legally, the business is considered an extension of the owner, and not a separate legal entity o Majority of businesses in Canada are sole proprietorships, but account for small portion of total business revenues  Advantages of Sole Proprietorship o Freedom (owner answers to no one but themselves, since they don’t share ownership) o Easy to form o Tax benefits (losses can be deducted from income the proprietor earns through personal sources rather than from the business since the business and owner are legally one and the same)  Disadvantages of Sole Proprietorship o Unlimited liability (personally liable for all business debts) o Lack of continuity (business legally dissolves when owner dies) o Depends on resources of one person whose managerial and financial limitations may constrain the business  Often find it hard to borrow money to start up or expand  Partnership o Established when two or more individuals (partners) agree to combine their abilities for the purpose of operating a business for profit o Often used by professionals such as accountants, lawyers, etc. o Often extension of business that began as sole proprietorship  General Partners: actively involved in managing the firm and have unlimited liability  General partnership is most common (all partners jointly liable)  Limited Partners: don’t participate actively in the business, and their liability is limited to the amount the invested 6  Limited partnership consists of at least one general partner
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