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BU111 Final Exam Review.docx

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Roopa Reddy

1 Exam Review – BU111 Economic Factors Four pillars of the Canadian Financial System Note: - Financial institutions facilitate flow of money Pillars = financial institutions Pillar 1: Chartered Banks - Privately owned, publicly traded, profit seeking, largest and most important institution - Ex. TD, RBC, Scotia Bank, CIBC, BMO o Account for 90% of total bank assets - Serve individuals, businesses, and others Services Offered Schedule I – Canadian owned banks, no more than 10% voting shares Schedule II – May be domestically or foreign owned, usually 8% voting shares - Pension services - Trust services - Major source of short-term loans for businesses - International services - Financial advice Secured Loan – Putting an asset against your loan, Ex. Against your house - Electronic funds transfer Unsecured Loan – Don’t put an asset against your loan, higher interest rate - Expand money supply through deposit expansion o Money in bank collects interest o We pay them higher interest rate Pillar 2: Alternate Banks Trust Company – Safeguards funds and estates entrusted to - Trust companies and credit unions it, may also serve as trustee, o Smaller than chartered banks, decreasing importance, transfer agent, and registrar for being bought out corporations. o Becoming more popular Credit Unions – Co-operative savings and lending association Pillar 3: Specialized Lending and Intermediaries formed by a group with common interests. - Insurance companies, venture capital firms, pension funds o One of the biggest financial intermediaries o Insurance companies are being paid into to be insured, if something happens they cover the cost, larger risk o Large potential for growth, making money off your money Pillar 4: Investment Dealers - Facilitate trade of stocks, bonds, and other products in securities markets - Primary markets (go through Provincials Security Commission) o Investment bankers/dealers – i.e. stockbrokers 2  Advise – tell you when you should enter the market, length of time  Underwrite – take on risk/ownership of the stock or bond  Distribute – Through secondary markets (Toronto Stock Exchange/other exchanges) Changes in Banking Industry - Deregulation – Allowing banks to expand beyond checkings and savings, offering more to consumers, Ex. TD buying out Canada Trust = TD Canada Trust - Changes in consumer demands – expecting more from banks - Competition from foreign banks – banks can’t merge to compete with foreign banks Bank of Canada (1935) - Canada’s central bank, manages Canadian economy, regulates aspects of chartered bank operations, manages money supply - Other banks borrow from this bank (bank rate) o Establishes chartered banks’ prime interest rates Money supply – Manages money supply in Canada - If bank of Canada wants to increase the money supply, they are able to buy government securities o People who sell these bonds then deposit the proceeds in their banks o Deposits increase banks’ reserves and their willingness to make loans - Can also lower bank rate; causes increase in demand of loans from businesses and households because customers borrow more money when interest rates drop - If bank wants to decrease money supply, they are able to sell government securities o People spend money to buy bonds, these withdrawals bring down banks’ reserves, reducing willingness to make loans - Can also raise bank rate; cause decrease in demand for loans from businesses and households because customers borrow les money when interest rates rise Investment Instruments Coupon = Interest rate Bonds – Represents debt Principle = Bond’s face Characteristics value (1000) - Fixed rate of return – Coupons often paid semi-annually - Fixed term – Principle repaid at maturity - Priority over stockholder – Related to bankruptcy, bondholders paid first Types - Secured vs. unsecured (debentures) 3 o Applied to bonds as well backed by some sort of asset (word that it will be paid back), or no assets backing them - Registered vs. bearer o Name of bond holder is registered with issuer, they don’t keep any of your information at the time/doesn’t have to stay with one person o Require bondholders to clip coupons from certificates and send them to the issuer to receive interest payments Features - Callable Bond – The issuer being able to pay off a bond before the maturity date - Serial Bond – Parts of the bond maturing at different times, firm able to pay off portions - Convertible Bond – Option to convert investment to fixed number of shares (this is good because investment has potential to increase depending on the share value) Factors affecting price 1. What impacts the coupon rate at bond issue? - Prevailing interest rates – Presents how much you get back, not the same as a coupon rate - Credit rating of issuer – Risk rating - Features – If there are more features it will be more attractive 2. What impacts bond price when traded? - Coupon rate and prevailing rate of interest - Changes in credit rating – Credit rating may change of company , less security, willing to pay less for bond - Economic/market risk – Can impact the risk level of the bond - Inflation – As prices rise, the bond price will be lower Concept of Yield - Percentage return on any investment For a bond: Interest = coupon rate x face value - Helps us to compare investments - Face value always $1000 Capital gain = face value – purchase price Approximate Yield to Maturity facevalue-pricepaid couponrate x facevalue  time tomaturity pricepaid 4 Example: Approximate Yield to Maturity You buy a 6% bond for $850 with 10 years to maturity. Calculate the Approximate Yield to Maturity on this bond. Step 1: Identify key information Coupon rate = 6%, Purchase price = $850, Years to maturity = 10 years Step 2: Calculate components Why do bond prices fluctuate? Annual bond interest = coupon rate x face value = 0.06 x 1000 - Most investors are concerned with yield - Can’t change coupon rate, face value, time to = $60 maturity, price paid Annual capital gain = 1000 – 850 10 = $15 Step 3: Plug components into formula = 60 + 15 Bond Pricing (Three scenarios) 850 1) You pay less than face value for the bond (Priced “At a Discount) = 0.09 2) You pay more than face value for the bond (Priced “At a Premium”) 3) You pay face value for the bond (Priced “At Par”) Scenario 1: Pay at a “Discount” Notice: With a Yield expectation that is greater than the coupon rate, you would need a capital gain to attain the Yield, which means you pay less than face value for the bond. Scenario 2: Pay at “a Premium” Notice: With a Yield expectation that is less than the coupon rate, you would be willing to pay more than face value (a premium) for the bond; in other words you would take a capital loss. Scenario 3: Pay “at Par” Notice: Since your Yield expectation is met by the coupon rate, you would have no capital gain, which means you pay face value for the bond. 5 Relationship between prevailing interest rates and bond prices Reading Bond Quotations Issuer – Company name Coupon – Annual rate of interest at face value Maturity – receive face value Price – of bond Yield – Diving the annual interest paid by the current market price Stocks – Represents equity/capital for issuing company (Claim of ownership, changing control structure) Types of Stocks - Common shareholders are true owners of the company Characteristics - Voting rights – Idea of being a part owner, right to have your voice heard - No fixed terms – No time period of investment - Variable return – - Discretionary payment (dividends) – If company is doing will, they can choose to pay dividends to shareholders - Risk – More risk inherent into investing in stocks than bonds, stocks behind bonds in pecking orders - Priority in bankruptcy situations – bondholders paid first Features 6 What impacts stock price? - Demand and supply of stock due to negative or positive perceptions/facts - Primary factors o Earnings – above or below expectations o General market conditions  Bull Market – A period of rising stock prices; in which investors act on a belief that stock prices will raise.  Bear Market – A period of falling stock prices; in which investors act on a belief that stock prices will fall. o Speculation – bought or sold on belief prices 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 Investing Strategies Reading Stock Quotation Stock – Name of company Volume – Total number of shares traded on certain date High and Low – Highest and lowest price during trading day Close – At the close of trading on this date, the last price paid per share Net Change – Different between today’s closing price and the previous day’s closing price 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. Ex. Buying on margin, selling short Rewards and Risks Margin Buying Going Long: The investor has - The investor is purchasing security and will make a profit only when the security increases in price and is sold, the purchased a security, when in a long position he/she is expecting to profit difference between going long and buying on margin is that when the price of the security when the investor buys on margin he/she is borrowing part increases and the investor sells it. of the investment’s purchase price from the broker - Benefit is that you are able to increase your buying power i.e., buy more with the same amount of personal investment, and therefore increase your potential profits - Cost is that you must pay interest on the amount that you borrow from your broker, this magnifies losses if the stock price falls. If the price falls before you sell the stock, the amount 7 that you have deposited with the broker will no longer be enough to meet the minimum margin requirement. Rules - Must qualify for margin account - Must sign hypothecation agreement (Margin Account Agreement Form) – pledging security as collateral for a loan - Must pay interest on loan Selling Short - Buy low, sell high = sell high, buy low - Sell shares you don’t own – borrow form broker Rules - Short deposit must be 150% CMV at all times - Agreement may be determined by either party at any time – forced to cover / ‘buy-in” - Short sale price governed by ‘last sale’ rule - Dividends declared are the responsibility of the seller Time Value of Money - $1 value not the same in a year o Risk – volatility, no certainty money will be there o Inflation - Concept important to leases, mortgages etc. (Refer to formulas and practice questions) Technological Factors Opportunities - Products – innovation, uniqueness, value - Management process – instant access to information, better service through coordination, leaner organization, improved operations efficiency, greater independence of company and workplace (flexibility in where you are working, saves time and money, more efficient) - Competitiveness – barriers to entry, technology helps maintain them, cooperation with other firms and able to partner with them for mutual benefit - Communication and collaboration – with firm and customer, faster access, better decisions makes it easier, track product information 8 - Customization – school bag or cars, machines more flexible, able to communicate directly to machine without human interaction, wider range of suppliers, more variety to offer Threats - Imitation – information costly to develop but cheap to share, Ex. Music, expensive to create new album/track, producing/recording, hoping people will pay, cheap to share, legal or not - New technologies in unfamiliar areas – disruptive technologies challenge the value of organizational capabilities and resources, Ex. Phone manufacturers, disrupted technologies, if you don’t keep up it’s a threat, rivalry with smart phones - Unpredictable evolution – not always best quality product or idea that wins, about execution with technology and standards, convincing that yours is better, standards war ex Blu-ray and DVDs - Constant learni
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