chapter 2 3fb3

Question 1

Q: How are financial markets traditionally segmented?

Answer 1

A: Financial markets are segmented into money markets (short-term, marketable, liquid, low-risk debt securities) and capital markets (longer-term, riskier securities like bonds, equities, and derivatives).

Question 2

Q: What types of securities are included in money and capital markets?

Answer 2

A:Money Markets: Short-term debt instruments like Treasury bills and commercial paper.
Capital Markets: Longer-term instruments such as bonds, stocks, options, and futures.

Question 3

Q: What are the key steps in building an investment portfolio?

Answer 3

A:Asset Allocation: Deciding the proportion of investments across asset classes (e.g., stocks, bonds).
2: Security Selection: Choosing specific securities within each asset class.

Question 4

Q: What is the money market, and what are its key features?

Answer 4

A: The money market is a sub-sector of the fixed-income market, dealing with short-term, highly liquid, and low-risk debt securities such as Certificates of Deposit (CDs) and Treasury bills.

Question 5

Q: What are Treasury bills and Certificates of Deposit (CDs)?

Answer 5

A:Treasury Bills: Simplest form of government borrowing with short maturities and high liquidity.
CDs: Short-term, low-risk investments like Guaranteed Investment Certificates (GICs), offering higher liquidity.

Question 6

Q: What is the bid-ask spread, and why is it significant?

Answer 6

A: The bid-ask spread is the difference between the ask price (what you pay to buy) and the bid price (what you receive when selling). It represents the dealer’s profit margin

Question 7

Q: What is the T-bill yield using the bank-discount method?

Answer 7

A: The bank-discount method calculates T-bill yield based on its face value (par value) and assumes a 360-day year

Question 8

Q: What is the T-bill yield using the bond-equivalent yield (BEY) method?

Answer 8

A: The bond-equivalent yield method calculates yield based on the current purchase price and assumes a 365-day year:

Question 9

Q: What are the key differences between the bank-discount method and the bond-equivalent yield method?

Answer 9

A:Bank-Discount Method: Based on par value and assumes 360 days/year.
Bond-Equivalent Yield Method: Based on purchase price and assumes 365 days/year, providing a more precise comparison for bond investments.

Question 10

Q: What is commercial paper?

Answer 10

A: Commercial paper refers to short-term unsecured debt notes issued by well-known companies to meet short-term financing needs, typically with low default risk.

Question 11

Q: What are Bankers’ Acceptances and Eurodollars?

Answer 11

Bankers’ Acceptances: Short-term debt instruments guaranteed by a bank, second only to T-bills in terms of default security.
Eurodollars: U.S. dollar-denominated deposits held in foreign banks or international branches of U.S. banks.

Question 12

Q: What are repos, reverse repos, and key benchmark rates?

Answer 12

Repos: Agreements to sell securities and repurchase them later at a higher price.
Reverse Repos: Agreements to buy securities and sell them back later.
Key Rates: Bank of Canada overnight rate and U.S. Federal Funds rate influence repo agreements and short-term borrowing costs.

Question 13

Q: What are the 3 features of Government of Canada Bonds?

Answer 13

Maturities range from 3 to 40 years.
Par value is $1,000 with interest paid semi-annually.
Quotes are expressed as a percentage of par value.

Question 14

Q: What are Inflation-Protected and Provincial Bonds?

Answer 14

Inflation-Protected Bonds: Protect against inflation; called TIPS in the U.S. and Real Return Bonds in Canada.

Provincial Bonds: Issued by provincial governments or Crown corporations, typically to fund infrastructure or public services.

Question 15

Q: What are Corporate Bonds and their 4 unique features?

Answer 15

Issued by private firms with semi-annual interest payments.
Can include options:
Callable: Issuer can redeem before maturity.
Retractable: Investor can force early redemption.
Convertible: Can be converted into equity (shares).

Question 16

Q: What are International Bonds, and what are some examples?

Answer 16

A: International bonds are debt instruments issued in global markets, including:

Eurobonds: Bonds issued outside the home country in a different currency.
Maple Bonds: Foreign bonds issued in Canada, denominated in CAD.
Yankee Bonds: Foreign bonds issued in the U.S., denominated in USD.

Question 17

Q: What are Municipal Bonds, and what types are available?

Answer 17

A: Municipal bonds are issued by cities, municipalities, or counties and generally offer higher yields. Types include:
General Obligation Bonds: Backed by the issuing entity’s credit and taxing power.

Revenue Bonds: Secured by revenues from specific projects or sources, such as toll roads or utilities.

Question 18

Q: What are Mortgage-Backed Securities (MBS), and how are they guaranteed?

Answer 18

A: MBS provide proportional ownership in a mortgage pool and typically carry federal government guarantees:

Canada: Guaranteed under the National Housing Act.
U.S.: Backed by entities like Fannie Mae and Freddie Mac.

Question 19

Q: What do equity securities (common stocks) represent?

Answer 19

A: Common stocks represent ownership shares in a corporation, giving shareholders voting rights (typically one share, one vote) and the ability to elect the Board of Directors.

Question 20

Q: What is the concept of residual claim in common stock?

Answer 20

A: Residual claim means stockholders are last in line to claim the corporation’s assets and income, receiving payouts only after debts and other obligations are settled.

Question 21

Q: What does limited liability mean for stockholders?

Answer 21

A: Limited liability ensures that stockholders can lose no more than their original investment in the corporation, even in the event of corporate failure.

Question 22

Q: What are the key metrics used in stock market listings?

Answer 22

A: Dividend Yield: Annual dividend payment as a percentage of the stock price.
Capital Gains: Profit calculated as the sale price minus the purchase price.
Price-Earnings (P/E) Ratio: Stock price divided by earnings per share, indicating valuation.

Question 23

Q: What is preferred stock, and how does it differ from common stock?

Answer 23

A: Preferred stock:
Pays fixed dividends, like a perpetuity.
Has priority over common stock in dividend payments and claims.
Can be redeemable (bought back by the issuer) or convertible into common stock.

Question 24

Q: Why is the Price-Earnings (P/E) Ratio important in stock analysis?

Answer 24

A: The P/E ratio helps assess how much investors are willing to pay for each dollar of earnings, offering insights into a stock’s valuation and growth potential.

Question 25

Q: What are Income Trusts, and how are they taxed in Canada?

Answer 25

A: Income Trusts are pass-through entities designed to distribute income directly to investors. Initially benefiting from favorable tax treatment, their payouts have been taxed by the Canadian government since 2011.

Question 26

Q: What are American Depository Receipts (ADRs)?

Answer 26

A: ADRs are certificates traded on U.S. markets that represent ownership in shares of a foreign company, allowing U.S. investors to invest in international equities without trading on foreign exchanges.

Question 27

: What is a market value-weighted index, and what is an example?

Answer 27

A: A market value-weighted index assigns weight based on the market capitalization of each stock. Larger companies have a greater impact. Example: S&P 500.

Question 28

Q: What is a price-weighted index, and what is an example?

Answer 28

A: A price-weighted index assigns weight based on the stock price, so higher-priced stocks have a larger influence. Example: Dow Jones Industrial Average (DJIA).

Question 29

Q: What is an equally weighted index?

Answer 29

A: An equally weighted index gives all stocks the same weight, regardless of their price or market capitalization, emphasizing equal contribution to the index.

Question 30

Q: What are some examples of bond market indexes?

Answer 30

A: Examples of bond market indexes include:

FTSE TMX Canada Universe Bond Index (Canada)
Barclays Capital Aggregate Bond Index (U.S.)

Question 31

Q: What is a major issue with bond market indexes?

Answer 31

A: A major issue is that true rates of return on many non-government bonds are difficult to compute due to the infrequency of trading, which can impact accuracy.

Question 32

Q: What is a derivative, and how is its value determined?

Answer 32

A: A derivative is a financial instrument whose value depends on or is contingent upon the value of an underlying asset, such as stocks, bonds, or commodities

Question 33

Q: What are the two main types of derivatives?

Answer 33

Options: Contracts that give the right, but not the obligation, to buy or sell an underlying asset at a set price.
Futures: Agreements to buy or sell an asset at a predetermined price on a future date.

Question 34

Q: What is an option in financial terms?

Answer 34

A: An option gives the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined strike price before the option expires.

Question 35

Q: What is a call option, and how does its value change with the strike price?

Answer 35

A: A call option gives the holder the right to buy an underlying asset at the strike price. The value of a call option decreases as the strike price increases.

Question 36

Q: What is a put option, and how does its value change with the strike price?

Answer 36

A: A put option gives the holder the right to sell an underlying asset at the strike price. The value of a put option increases as the strike price increases.

Question 37

Q: How does time affect the value of options?

Answer 37

A: The value of both call and put options generally increases as the time to expiration increases, due to the higher probability of favorable market movements.

Question 38

Q: What is a futures contract, and what does it entail?

Answer 38

A: A futures contract is a derivative that obligates the buyer to purchase, or the seller to deliver, the underlying asset at a specified price on a future date.

Question 39

Q: What is a long position in the context of futures?

Answer 39

A: A long position in futures means the buyer commits to purchasing the underlying asset at the contract’s maturity date.

Question 40

Q: What is a short position in the context of futures?

Answer 40

A: A short position in futures means the seller commits to delivering the underlying asset at the contract’s maturity date.