Chapter 7 Flashcards
Loddered GIC
Evenly divided into multiple term lengths. As each portion matures it can be redeemed or re-invested. Reduced interest rate
Instalment GIC
Initial lump sum contribution is made with further minimum contributions made weekly, bi-weekly or monthly
Index-Linked GIC
Guarantee a return of the initial investment upon expiry and some exposure to equity markets. Insured by the CDIC
Interest-Rate-Linked GIC
Offer interest rates linked to the changes in other rates (like prime, bank’s non-redeemable GIC interest rate or money market rate)
Yield Curve
Represents the relationship between the interest rates and the time to maturity for a given borrower
Current Yield Calculation
Annual Cash Flow divided by Current Market Price times 100
Callable Preferred Shares
Shares thar can be bought back at the discretion of the issuing company prior to maturity
Cumulative Preferred Shares
Dividends not paid in one period will accumulate and be paid in a later period
Convertible Preferred Shares
Shares that can be exchanged for common shares of the issuing company
Participating Preferred Shares
Shares that pay a fixed dividend along with the common shares.
- Preferred dividend is paid
- Common shareholders receive a particular amount of common dividend
- Any remaining funds from the dividend payment are distributed on a share-by-share basis to both common and preferred share holders
Odd Lots
Transactions with less than the standard trading units (less than 100)
Common Shares
Are issued by corporations and are expected to earn either dividends or capital gain or both
Preferred Shares
Are issued by corporations to raise capital for investment projects and are generally issued at a fixed par value per preferred share
Gives an investor ownership stake in the company
Perpetual Preferred Share / Hybrid Securities
A preferred share without a maturity date. Sold in the primary market at a par value.
Identify the relationship between Bonds and Interest Rates
Bond yields and bond prices fluctuate daily
Short Selling
The sale of securities that the seller does not own
Margin Account
The investor can buy securities on credit and initially pay only part of the full price of purchase (no borrowing permitted)
Cash Account
Customer is required to make full payment for purchases on or before the required settlement date (2 business days after transaction)
Long Positions
Investor buys a security and holds it in hopes of selling later for a higher price
Treasury Bills (T-Bills)
Are issued through a competitive bidding process at a discount from par
Fixed Income Securites
Considered loans that investors make to governments and corporations
Coupons
Include promise to re-pay the maturity value/principal on maturity date. Represents the fixed income the bondholder receives from holding that bond. Also referred to as interest income, bond income or coupon income
5 Most common types of Fixed-Income Securities
- Government and corporation Bonds
- Guaranteed Investment Certificate (GIC)
- Treasury Bills
- Bankers’ Acceptances
- Commercial Paper
Government Bonds
Have virtually no default risk but are subject to interest rate risk. This is because governments can just raise taxes to pay the coupon payment or re-pay the value at maturity
Serial Bond
Who is it used by?
Part of the bond matures in each year during the bond term.
Also known as Instalment Debenture
Used by municipalities
Debentures
Who is it used by?
Simply promises to pay and their value depends on the issuers ability to pay interest and re-pay principal
Used provincially
Corporation Bonds
Issues by corporations to finance acquisition of equipment and other purposes. Used to raise capital as an alternative to issuing new shared (debt financing vs. Equity financing)
Convertible Bond
Can be converted/exchanged into a given number of common shares. Have features of both bonds and shares.
Bond quality can be determined by 2 factors…
1: Credit Quality of a Province - degree of certainty that interest will be paid and principal when due
2: Market Conditions
Escalated-Rate GIC
Interest rate increases over GIC term
Banker’s Acceptance (BA)
A commercial draft (written instruction to make a payment) drawn by borrower for payment on a specific date
- guaranteed at maturity by the bank
- sold at a discount and mature at face value
Commercial Paper
An unsecured promissory note issued by a corporation or an asset-backed security-backed by a pool or underlaying financial assets
- sold at a discount and mature at face value
- issued by large firms with established financial history and are ranked based on ability to meet short-term debt obligations
Interest Rate Risk
The tendency of bonds to change in value with changing interest rates
2 different types of return calculations of bonds…
1: the current yield - the coupon payment for one year divided by the market price of the bond
2: the yield to maturity - shows the return you would expect to earn over the life of a bond starting today, assuming you are able to reinvest the coupons you receive at the yield to maturity.
Yield to maturity calculation
Interest income +/- price per compound period / (purchase price + par value) / 2 X 100
Interest Rate Risk
Because they represent a claim on a stream of dividends, preferred shares are sensitive to the general level of interest rates. When interest rates rise, the prices of fixed-rate preferred shares tend to fall because the fixed dividend will be worth less to investors in a higher-rate environment.
Credit Risk
Because preferred shareholders rank below all creditors and bondholders in the even of bankruptcy, preferred share prices can be quite sensitive to changes in perceived creditworthiness, especially when that perception goes down
Call Risk
Because almost all preferred shares are callable at the option of the issuer, investors are subject to call risk. When investors are focused to give up their preferred shares when it is not in their best interest which usually happens when the shares are trading at a premium to their par value
Extension Risk
If a preferred share does not have a retraction feature, the issuer have the sole ability to determine when it will return the par value to investors
Liquidity Risk
The total market value of preferred shares in Canada is a fraction if the market value. As a result the value that changes hands each day through trading on Canadian exchanges is also small
Margin Account Calculation
Share Dollar x 100 x % difference of max loan value = Answer
Call Option
Gives the owner the option of buying shares at a fixed-exercise price prior to the call’s expiration date
