CH.1 Investment and savings Flashcards
Concept of investing
• Investing: money used to make more money
• Investors invest sum (principal/capital) that is repaid + profit
○ Profit= return
Compound interest
earning interest on investment
○ Interest reinvested
○ Interest on interest= compound interest
○ Very effective over long period of time
Types of Investment returns (3-PNN)
○ 3 types of return:
§ Positive and reflect profit earned
§ Neutral- investor receives sum already invested
§ Negative- investor loses money
Rate of return
return expressed as % of amt invested
Scale of risk
tells investor how likely it is he will get all money back
§ Low risk investment: more certain will get back all money invested
§ Speculative risk: most risky, uncertain if will get money back, possibility of very high returns
returns classified as:
§ Nominal: stated/advertised rate
Real return: nominal return - rate of return
Asset classes
○ 3 main asset classes: § Stocks (equities) § Bonds (fixed income/debt § Cash (money market instruments) ○ Each class has own risk/return features
Diversification
manages risk
○ Combines asset classes–> lowers investment risk,. Higher returns
Liquidity
how easily investment can be converted to cash
○ Or how easily asset/investment can be sold w/o decrease in value
○ Illiquid= NOT liquid
§ i.e. real estate
Presnt value:
- definition
- when to calculate
- formula
goes backwards from future date ○ How much money needed NOW to reach savings goal ○ Calculated when: § FV known § Future date known § Rate between today and future known
PV= FV / (1 + interest rate)n
Future Value
value of current investment @ future date, given interest earned on investment
○ How much will sum of money TODAY be worth in future
○ Calculate when:
§ PV known
§ Future date known
§ Rate between today and future known
FV= PV X (1 + interest rate)n
Investment objectives
investors reasons for investing/saving
Investment objectives classified as:
○ Short term: less than 3 yrs.
○ Medium term: 3-10 years
○ Long term: 10 years or more
Tax advantaged Investing
• Interest taxed at same rate as income from working
• Dividends from stock of qualified cdn co.
○ Gets dividend tax credit
• Capital Gains: taxed at rate lower than interest
Types of Investments-11
- seg funds
- annuities
- stocks
- bonds
- savings account
- GIC’s
- mutual funds
- ETF’s
- real estate
- CPB’s/CSB’s
- group plans
Segreated funds
- where to buy
- risk
- protection
• Only sold through life ins agents and brokers
- money pooled in fund
- maturity and death benefit guarantee
low risk- max loss 25% (100-75)
protected by assuris up to limit
seg funds advantages/disadvanatges
Advantages • Maturity and DB guaranteed • Designate beneficiary + bypass probate • Tax benefit when CL incurred • Investors protection (Assuris)
Disadvantages
• Sales charges ongoin
Annuities
- reliable source of income
- annuitant that receives income pmts
- fixed rate
-pmt determined by Prevailing interest rate at time invested
* Primary risk-- interest rate risk-- b/c fixed * Inflation risk- if not indexed
protected by assuris
Annuity advantages/disadvantages
Advantages • Easy to understand • Steady income stream • 2 forms: • Variable • Indexed • Choose pmt frequency • Investor protection of ins annuity contract--> Assuris
Disadvantages
• NOT flexible
• Interest rate risk- b/c doesn’t rise/fall with rates
• Penalties if surrender/withdrawal
Stocks
- preferred
- common
buy on toronto stock exchg
returns in form of:
○ CG
○ Dividends
○ CL
risks: • Blue chip= least risk • Penny stocks= most risk • Market risk • Industry risk • Risk of loss of capital/principal (total loss)
Protected by CIPF
Stock advantages/disadvantages
Advantages
- High degree of transparency in stock market investing
- Dividends
- Favourable tax rates for CG/CL
Disadvantages
- Possibility of loss (even total loss)
- Possible absence of diversification= more risk
- Liquidity- if need to be sold, may be at lower price
- No beneficiary
- No creditor proofing
- No ability to rescind sale
bonds
• Bonds are debt investment (must be repaid)
○ Borrower (issuer
○ Lender (investor)
also called fixed inciome security
issuers:
- government
- corporations
• Issuer guarantees repayment of bond + regular interest pmt
buy through IIROC nad MFDA market dealers
types: cdn government bonds -gov of cda, provincial, municipal Foreign bonds eurobond
risks: • Interest rate risk • Reinvestment risk • Inflation risk • Credit risk • Liquidity risk • Currency risk
protected by CIPF
Bonds advantages/disadvanatges
Advantages
• Repayment of principal + interest pmts guaranteed
disadvantages??
Savings accounts general infor + adv/disadv
advantages:
• Immediately available cash that benefits from interest
• Money can be withdrawn
Disadv:
Low interest rates– inflation risk
• Exposed to inflation risk
Investor protection by
• CDIC- up to $100,000
• 2 basic types:
○ Traditional: low interest rate, lower fees + no restrictions on withdrawals
○ High interest savings accts: higher rates , withdrawals restricted
• 2 basic types:
○ Traditional: low interest rate, lower fees + no restrictions on withdrawals
○ High interest savings accts: higher rates , withdrawals restricted
GIC’s
= Term, deposit
- Issuer guarantees investor will receive principal + promised rate @ maturity
- Guaranteed return of principal + interest at stated
- Interest rate risk (b/c low)
- Inflation risk (b/c rises, may rise above interest rate)
Investor protection
• CDIC- up to $100,000, 5yrs or less maturity
• Assuris- for Insurance GIC’s
GIC adv/disadv
Advantages:
• Guaranteed return of principal + interest
• Variety of products
• Convenient., easy
Disadv:
• Low rates of return
Significant penalties if withdraw
Types of GIC’s
- Fixed Interest GIC
- Cashable/redeemable GIC
- Escalating GIC
- Variable Interest GIC
- Market linked GIC
- Insurance GIC’s
Fixed Interest GIC
○ Specific interest rate
§ Simple interest paid annually
§ Interest that compounds annually, paid at maturity
Cashable/Redeemable GIC
○ Allows early cashing out
“cost”= lower interest rate
Escalating GIC
○ Increases interest rates on anniversary
Can cash out all/some at anniversary
Variable Interest rate GIC
Rate increases over time
Market Linked GIC
○ Links portion of return to performance of specific equity market index
○ Not cashable before maturity
Insurance GIC
CHK BOOK
Mutual Funds: DEFINITION guarantees NAV + NAVPU Portectd by?
• Investors money pooled in to fund (like Seg funds)
either:
open ended or closed
- No guarantees on mutual funds
- Returns based on Net asset Value (NAV)= TOTAL NET ASSET VALUE OF FUND / # O/S UNITS
protected by
CIPF
MFDA
TO MAX $1 MILLION
Type of mutual funds adn risks
○ Cash- incl funds in money market ○ Fixed income ○ Equity ○ Commodity ○ Other
risks:
○ Cash based funds: interest rate and inflation risk
○ Equity Funds: Market Risk and industry risk
○ Fixed Income funds: Interest rate risk
Mutual Fund Distributions
earnings generated in fund + CG from buying/selling securities
Exchange Traded Funds (ETF’s)
definition
Guarantees
protection
- ETF’s- investors buy shares in fund
- Fund represents all components of a chosen index or multiple indexes
- Value of ETF based on index/indexes
○ Difference in return btwn actual index and ETF
Investor Protection
• CIPF
ETF adv/disadv
advantages: • Diversification • Convenience • Transparent • Lower MER • Professional mgmt • No penalties
Disadv:
??
Types of ETF’s
• Currency, industry, commodity, dividends, real estate
Seg funds specialized by
• Specialized by:
○ Asset class
○ Real estate and commodities
○ Geographically
- may combine asset classes– > balanced funds
- may invest in other Seg funds–> funds of funds
Seg fund returns
• Return based on fund performance, Stated as %
• Returns earned as interest, dividends, foreign income, CG
-registeed accts- returns not taxed
NON registered acct- returns taxed
Real estate Adv/Disadv
adv: • Diversification • Steady rental income • CG on sale can be used as collateral
Disadv:
• Need down pmt
Evidence of financial stability/strength
• Value subject to market
Real estate returns
- No guarantees
- Return in form of rental Income
- CG on sale
Real estate risks
- Liquidity risk
- Market risk
- Interest rate risk
NO INVESTOR PROTECTION
Canada premium bonds (CPBs) and Canada Savings Bonds (CSB’s)
- DEFINITION
- RETURNS
- RISKS
- 2 types of savings bonds from gov
- Represents debt
- Principal and interest guaranteed
- CPB’s pay higher rate, but CSB pays monthly
- Interest rate risk
- Inflation risk
cpb/csb ADV/DISADV
ADV:
• Least risk
• Can be cashed out anytime
Valuable employee benefit
DISADV:
Rate very low
where to buy CPB/CSB
• CPB: directly from Gov. or financial institution
○ 2 month starting in October
• CSB’s: through job payroll savings plan
○ oct-nov 1
Group Plans types
- Defined benefit Pension Plan (DBPP)
- Defined Contributions Pension Plan (DCPP)
- Group registered retirement savings plan (GRRSP)
- Deferred Profit sharing Plan (DPSP)
- Tax free savings acct (TFSA)
- Pooled Registered Pension plan (PRPP)
Group plan adv/disadv
??
Economic risk
possibility investment will be affected by macroeconomic factors
○ Cannot be managed by individual investor
Infaltion risk
- purchasing power risk
- if rate lower than inflation = LOSS
Interest rate risk
• When investment that pays interest is tied to specific interest rate- can’t take advantage of rate increase
-inheret in all investments
Market risk
• Risk total financial market will decline
Liquidity risk
• Risk investments can’t be easily/quickly converted to cash
Risk cannot be sold without affecting value of asset/investment
Foreign Exchange risk
currency risk”
• Risk in chg. in price from 1 currency against another
credit risk
- Aka “default risk”
* Risk borrower will fail to repay loan
Industry risk
- Aka “default risk”
* Risk borrower will fail to repay loan
what is meant by investment time horizon
refers to how long savings/investent period will be
What is currency risk
foreign exchange risk/currency risk: risk of incurring losses as result of unfavorable changes in exchg rates
advantages of group plan by employer
- help employer attract/retain good staff
- can be tailored to employer needs/wants
- employer is plan holder, can change plan frequently
- employer contributions tax deductible as business exp
can seg fund investor redeem investment prior to maturity?
yes, but with penalties
from what is the name “Individual Variable Insurance contract” derived
derived from fact that INDIVIDUAL is buying INSURANCE contract that has VARIABLE return
What is a protection fund?
?
what is interest rate risk
risk that rate will be too low, and wil not rise w/ inflation
what is a load fee
fee charged to investor for agent commissions
2 main types of equities: c/s and p/s- which one offers higher reward
Common shares
- unlimited potential for dividends
- share price increases
2 main types of equities: c/s and p/s- what are characteristics of P/S
- NO voting rights
- paid 1st before c/s (dividends)
- trade onpublic stock exchg
- FIXED annual dividend
- If liquidated- P/S get invested capital back before C/S
escalating GIC
- rate rises over time
- may allow investor to redeem all/part of deposit each anniversary w/ remaining amt invested, earning higher interest rate
investments categorized in 3 main categories- what are they
Main:
- money market
- fixed income
- equity
Secondary:
- real estate
- commodities
what losses does protection fund cover
protects investor in event financial institution in vested in becomes insolvent
can bank sell life annuity
NO
only life insurane company can
Various Protection funds, which industry is each following protection fund associated:
- Assuris
- CDIC
- CPIF
ASSURIS: insurance, incl insurance GIC’s
CDIC: Deposit taking insitutions (banks, trusts, etc)
CPIF: securities industry
2main risks of annuity
interest rate risk
inflation risk
How are Seg funds grouped?
- asset class
- subsets of asset class
- combinations of asset classes
- geographically
what types of financial institutions can sell life annuity?
life ins companies
which offers higher coupon rate?
- bond w/ shorter term?
- Bond w/ longer term?
bond with longer term
- /c investors expect to be compensated for loaning money to insurer for longer period of time.
Advantages of investing in bonds
- wide range of bond issuers (gov/corp) + domestic/foreign– can diversify
- purchased in varying terms- short term to long term
- repayment of principal + interest on government bonds virtually guaranteed
- barring default- investor receives regular interest payments + principal @ maturity
characteristics of C/S
- HAVE VOTING RIGHTS
- unlimited dividends
Define equity investment
equity can be defined as ownership
-own shares, own part of company
what is seg funds min guarantee @ death and @ 10 yr maturity?
75%
disadvantages of plan sponsor (employer) of group plan
- group RRSP contribution subject to payroll tax
- may place financial constriants on employer- i.e req to fund DBPP
2 main types of equities: C/S and P/S: which type carries less investment risk?
preferred shares- because get their dividends 1st
how to calculate real return on investments
real return=
nominal return - inflation
features of seg funds NOT offered with mutual funds
- maturity and death benefit guarantee
- bypass probate
- creditor proofing
liquidity risk
how fast asset can be converted to cash or how fast it can be converted to cash without decrease in value
why does canada premium bond pay higher rate than canada savings bond
b/c canada premiu bond id LESS liquid, + offers slightly higher interest rate (premium)
diversification
spreading/managing the risk across different asset classes (less risk = higher returns)
another name for foreign exchange risk
currency risk
where does name “segregated funds” come from
investments kept seperate by insurer
inflation risk
- purchasing power risk
- risk that rate will not rise with inflation, reduces the value
-if inflation exceeds rate of return, investor looses purchasing power
closed end mutual fund
fixed number shares issued
what is an annuity
series of payments
what is CDIC
- Canadian Deposit Insurance Co.
- protects investors depostis in deposit taking institutions (banks, trusts, etc…)
- max $100,000
- term of 5 years or less
What is investing
using money to make money
biggest risk bond investor faces
-credit risk/default risk
Least taxed to most taxed (C.D.I)
- CG
- DIVIDENDS
- INTEREST INCOME
How are bonds market value affected if rates fall?
-bond price increases b/c interest rates and market values of bonds move in opposit directions
does “no load: fund charge management fee?
YES
Insurance GIC
- Accumulation annuity
- pays fixed rate
- issued by insurance company
how soon must fund facts be given?
withing 2 days of purchase
how would it affect market value if interest rates rise
- bond price falls b/c interest rates and bond market values move in opposit directions
