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Canada (158,317)
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FIN 502 (69)
Joan Lobo (33)
Chapter 15

CFIN502- Chapter 15- Types of Investments-1.docx

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Ryerson University
FIN 502
Joan Lobo

CFIN502- Chapter 15- Types of Investments CASH AND CASH EQUIVALENTS  Federal government and Canada securities o Government runs into a deficit—funds the deficit by borrowing money though the issuance of government securities o Considered virtually no default risk—federal government can always get money to pay its debt o Major type of securities sold by the federal government: T-bills, Canada saving bonds, and government of Canada bonds o Treasury bills (T-bills)- short term debt obligations issued normally in denominations ranging from $1000 to $1 million, and with 91-days, 182-days, and occasionally, one- year terms  Issued by auction once a week  No default risk—if you want to cash before maturity date you may suffer a capital loss or enjoy a capital gain  Very liquid; you can normally sell them though the same investment dealer you bought it from  Do not pay interest—they are bought at a discount from their face value  Face value- amount federal government will pay on maturity date  Discount- pay a lower price than the face value  Rate of return on T-bills is usually higher than the rate of inflation  Actually free of default risk only o Canada saving bonds- sold once a year with the actual issue date and maturity date falling on November 1  Offer a fixed rate of interest compounded annually and the interest rates are normally adjusted for later years  Two types  Regular interest bond- pays annual interest either by cheque or by direct deposit on Nov 1 each year o Available in denominations of $300, 500, 1000, 5000, 10000  Compounded interest bond- does not pay annual interest but reinvest the interest payable automatically until maturity or redemption o Available in denominations of $100, 300, 500, 1000, 5000, 10000  There is a maximum limit of any one series that an individual is allowed to hold  Ownership of a CSB cannot be transferred or assigned—not traded in the market like other bonds  Free of default  Perfectly liquid and vale of bond is always equal to face value  No downside risk—when the market interest rate rises, the CSB are still worth their face value  Prices of all other bonds rise when interest rates fall and vise versa  Government pays all the commissions for the buying and selling of the CSB through financial institutions  Yields of CSBs are usually slightly lower than that of treasury bills and other government bonds  Redeenability of CSBs justifies their lower return  Conservative investors who want perfect liquidity and zero default risk should find CSB to be suitable investments  Deposits with financial institutions o Safe, liquid, convenient, rate of return is low o Bank accounts  Basic types of accounts—chequing, chequing-savings, savings  Chequing accounts usually don’t pay interest  Savings accounts no not allow chequing buy pay interest to the account holder  Chequing-savings account has the attributes of the other two allows chequing but pays a lower interest rate than savings accounts 1 CFIN502- Chapter 15- Types of Investments  Safe and almost default risk free—terms of relative default risk they are next in line after treasury bills and CBS  Perfectly liquid  Always honored investors withdrawals even though legally they can ask you to wait several days on withdrawals from saving accounts  Some ways consumer is paying for the convenience and other services by accepting lower rate of return  Many intuitions calculate the interest on savings accounts on the minimum monthly balance and compounded it semi-annually  Most financial institutions now offer daily interest accounts—interest is calculated daily and compounded semi-annually o Term deposits  Guarantee a rate of interest  Typical terms range from 30-364 days—usually the longer the term the higher the rate of interest  Safe as saving accounts—less liquid than saving accounts  Capable of earning a higher rate of return than savings accounts o Guaranteed investment certificates (GIC)  Really long term accounts  Terms ranging from 1 to 5 years  As safe as savings accounts and term deposits  Less liquid—they have longer terms but you can normally expect a higher interest rate on GICs o Deposit insurance  Canada deposit insurance corporation- provide investors with insurance against any loss on their deposits would a member institution become insolvent or bankrupt  Members in the CDIC is restricted to banks, trust companies, and mortgage loan companies  Not all financial institutions are members of the CDIC  CDIC insures savings and chequing accounts, term deposits, guaranteed investment certificates, debentures, and other obligations issued by member intuitions  CDIC does not cover investments in stocks, bonds, mortgages, or mutual funds  Maximum coverage is $100000 for each person in each member intuition  Amount applies to the combined total of principal and interest  If you have more than 100000 to deposit, you should spread it around so that no more than $100000 is deposited with any one CDIC member institution  Credit unions and caisses poplaires are regulated provincially and do not participate in CDIC coverage  Likely that a really large failure, which would have to involve several credit unions at once would also attract support from the federal government—id credit unions centrals were unable to cover it  Limits by province are current as follow  Alberta, BC, Manitoba, and Saskatchewan—100% of all deposits  New Brunswick, Newfoundland and Labrador, and Nova Scotia-- $250000 per deposit  Ontario and Quebec-- $100000  PEI-- $125000 BONDS  Bonds- fixed income securities issued by various levels of government  Corporations and governments need long-term financing borrow money by selling bonds o When you buy their bonds—you become their creditor and receive a bond certificate by which issuer promises that the principal will be repaid  Important items of information o Face value- amount that the issuer has promised to pay on date of maturity o Maturity date- date on which the face value will be paid o Coupon rate- rate that forms the basis for calculating interest 2 CFIN502- Chapter 15- Types of Investments  Annual interest payable is the coupon rate times the face value  Interest normally paid semi annually on the stated dates interest coupons attached to the bond certificate o Coupon bonds- bonds with a series of interest coupons attached to the bond certificate itself  Investing in bonds o Bought and sold in the bond market though bond brokers o Bond market- not a physical place where brokers meet—communication system where brokers put orders to buy and order to sell together o Major security firms act as investment dealers in the bond market o Bond quotations- price list o Two prices for any given bond  Bid price- what the dealer will pay to buy the bond  Ask price- price at which the dealer will sell the bond o Spread- difference between the ask price and the bid price—represents the dealers gross profit margin  Basic bond pricing mathematics and yields o Accrued interest  Prices quoted for bonds are all calculated as of the previous interest date  When you buy a bond you have to pay the ask price plus all interest accrued from the previous interest date to the closing date of the transaction o Yield to maturity- average rate of return that will be earned on a bond if it is bought and held until maturity  Also called—return maturity or internal rate of return o Current yield VS yield to maturity  Current yield- bonds annual coupon payment divided by the bond price  Not the same as yield to maturity  Yield to maturity—widely accepted as measure for the average return on investment  Interpreted as the coupon rate of return of ones investment over the life of the bond  Under assumption that all interest coupons can be reinvested rate equal to the bonds yield to maturity  Investment risk of bonds o Market value of bonds can fluctuate o Issued by the federal government—free of default risk, bonds price is guaranteed only at maturity  Before then price can go up or down 1. Default risk- risk that the issuer may not be able to pay part or all of the interest and face value  Issued by the provincial and municipal government are not free of default risk although they are usually considered to be less risky than corporate bonds  Depends largely on quality of the assets and cash flow of the issuer  Al long as he issuer is not in financial difficulty—bond holders will get their interest and principal as promised  Canada—largest bond rating agencies are Canada Bond Rating Services and Dominion Bond Rating Services  Bond ratings- can be used as indicators of the probability of uninterrupted payment of interest and principal repayment  Ratings classify bonds from investment grade to speculative grade and relate one company’s ability to meet its obligations to those of other companies  Dominion bond rating services-- ratings AAA Highest quality Protection of principal and interest is highest order AA Superior quality Protection of principal and interest is high A Highest medium-grade Protection of principal and interest is substantial but less securities than AA BBB Medium-grade securities Protection of principal and interest is adequate but some areas of potential weakness exist BB Lower medium grade Mildly speculative securities the prot
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