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BU 111 Final Exam > Economics > Flashcards

Economics Flashcards

1
Q

What are the different elements of the economic factor?

A
  1. Inflation/deflation (the rate at which prices are changing)
  2. Interest rates (the rate at which prices are changing can be a threat)
  3. Employment rates (unemployment: number of people who don’t have the money to buy your product)
  4. Exchange rates (from buying selling foreign products)
  5. Balance of trade
  6. Productivity
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2
Q

What is the significance of economic factor?

A

It affects economic stability, employment, economic growth (measures: aggregate output, GDP, GNP). It affects our ability to borrow money, how much customers are willing to spend, how much supplies will cost, and buyer power

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3
Q

What is the purpose of the Canadian Financial System?

A

It facilitates the flow of money

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4
Q

What are the four legal areas (“pillars”) of the Canadian Financial System?

A
  1. Chartered banks
  2. Alternate banks
  3. Life insurance companies
  4. Investment dealers
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5
Q

Describe what chartered banks are, what they do, and who their customers are

A
  • Publicly traded, profit seeking companies
  • Largest and most important institution
  • Serves individuals and businesses
  • Major source of short-term loans for businesses
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6
Q

How many banks account for the greatest percentage of bank assets?

A

The 5 largest banks account for 90% of total bank assets

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7
Q

What does the banking industry look like in terms of competition, regulation, and significance?

A

It is a highly concentrated and highly regulated industry, and the health of these institutions is vital the health of the country’s economy

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8
Q

What are some of the recent changes in banking?

A
  1. Deregulation
  2. Changes in consumer demands: more people are willing to put their money in banks
  3. Competition from foreign banks: more banks are willing to come into Canada and the US, and customers have more options
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9
Q

Describe what alternate banks are, what they do, and who their customers are

A
  • Trust companies and credit unions
  • More limited in services and more specialized
  • They issue bonds
  • Trust companies: set up trusts (a trust is a fund that you want to allocate towards different people)
  • Credit unions: not-for-profits. The money goes into a big pool of money that people borrow from and pay interest on: it is a facilitated direct exchange of money
  • Serves small businesses and individuals
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10
Q

Describe what specialized lending/saving intermediaries are, what they do, and who their customers are

A
  • Insurance companies: people who get in accidents often have to pay a higher premium (individuals, businesses)
  • Venture capital: people who are willing to invest in new companies once you show that your company is a good idea and has potential (small business that have gotten started)
  • Pension fund: a fund is created so that you get a pension when you retire (individuals)
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11
Q

Describe what investment dealers are, what they do, and who their customers are

A
  • They facilitate trade of stocks, bonds, and other products in securities markets
  • They help you know what to sell, how much to sell, and which bonds to invest in/sell
  • Primary market: investment bankers/dealers; they advise, underwrite, and distribute (rarely open to the public)
  • Secondary market: Toronto stock exchange (open to the public)
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12
Q

How do you know what pillar to go to?

A

The pillar that you go to will depend on the size/age of you/your business

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13
Q

What are the roles of pillars 1 and 2? Who do they serve?

A

Small or medium enterprises (primary lending source). Their customers make deposits and borrow money in the short term

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14
Q

What is the role of pillar 3? Who do they serve?

A

Medium to large enterprises. Their customers use private equity financing and borrowing (long term debt). In most cases, they are not ready to go public

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15
Q

What is the role of pillar 4? Who do they serve?

A

Large and established companies who are ready to go public through stocks and bonds

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16
Q

What do bonds represent?

A

Bonds are a form of debt for the issuing corporation or the government. They borrow money by selling bonds, and have to pay the money back with interest

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17
Q

What are the characteristics of bonds?

A
  1. Legal, binding agreement
  2. Fixed rate of return (often paid semi-annually)
  3. Fixed term: principle repaid at maturity
  4. Priority over stockholders
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18
Q

Explain how a bond is a legal, binding agreement

A

It has a set loan amount, interest rate, maturity date, and payment frequency. However, if those conditions are not met, the bank can take away your collateral, take you to court, and liquidate you assets to pay the difference

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19
Q

Explain how a bond has a fixed rate of return

A

The owner of the bond is paid a certain amount every 6 months

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20
Q

Explain how a bond has a fixed term

A

The principle that is repaid at the maturity date is the “face value” of the bond. After that date, the owner cannot no longer expect to be repaid for giving the loan

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21
Q

Explain how a bond owner priority over stockholders

A

Bonds under considered a long-term liability, and therefore they get paid first before shareholders are entitled to anything. This is in their semi-annual payments and in the case that the company’s assets are liquidated

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22
Q

Given the following bond, what are all the different pieces? What is the face value?
SunLife 5.3 of 2021 at 91.75

A

SunLife: the company borrowing money
5.3: the coupon rate (% of face value, paid semi-annually)
2021: maturity date, when the borrower pays back the face value
91.75: the price of the bond (% of face value)
Face value = $1000

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23
Q

How do you calculate yield on a bond?

A

What you made / what you paid

(interest + capital gain) / what you paid = x%

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24
Q

How do you calculate the interest on a bond?

A

coupon rate x face value

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25
Q

How do you calculate capital gain on a bond?

A

face value - purchase price

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26
Q

How do you calculate the approximate yield to maturity on a bond?

A

(coupon rate x face value) + ((face value - price paid) / years to maturity) / price paid

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27
Q

Why is the approximate yield to maturity calculation an approximation?

A

It doesn’t consider the time value of money

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28
Q

What impacts the coupon rate at bond issue?

A
  1. Prevailing interest rates
  2. Credit rating of issuer
  3. Features (that make the bond more attractive. Eg. can it be returned before the maturity date? Can the owner convert the bond from debt to equity?)
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29
Q

What impacts the bond price when traded?

A
  1. Coupon rate + prevailing rates of interest
  2. Changes in credit rating
  3. Economic/market risk
  4. Inflation (sudden spikes will affect bond prices, slow changes will affect interest rates: if you bought a bond during a recession, you can sell it for a lot during an economic boom)
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30
Q

How are interest rates and bond prices related?

A

They are inversely related: when interest rates go up, bond prices go down; when interest rates go down, bond prices down up

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31
Q

Why do interest rates go up when bond prices go down?

A

If the interest rate is higher than the coupon rate, it is more attractive to invest your money and earn more interest instead of buying bonds. The demand will go down and prices will fall, causing the bond to be sold at a discount

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32
Q

What are the characteristics of a stock (holder)?

A
  1. Voting rights
  2. No fixed term
  3. Variable return
  4. Discretionary payment (dividends)
  5. Risk
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33
Q

Explain how a stockholder has voting rights

A

A stockholder is an owner of the company, so they a have a say in its decisions. Because there are so many stockholders in large companies, they elect a board of directors to represent them

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34
Q

Explain how a stock does not have a fixed term

A

Stocks do not mature of expire, as long as the company continues to exist

35
Q

Explain how a stock has a variable return

A

Companies have to legal obligation to pay you back, and there is no legal obligation to pay stockholders anything while they own the stock

36
Q

Explain how a stock has discretionary payments (dividends)

A

Owners get a portion of the profits (if anything at all). However, they are not a legal requirement. The only way for owners to get their return is to sell the stock

37
Q

Explain how a stock has higher risk

A

A stock has a higher risk than a bond because bond holders get paid before stockholders: there is no promise that stockholders will be paid back if the company goes bankrupt

38
Q

What are the two types of stocks?

A
  1. Common stock

2. Preferred stock

39
Q

Describe the characteristics of a common stock

A
  • Voting rights
  • No fixed payments (dividends are discretionary): they will get paid if the company has enough money and only AFTER they have paid interest on debt and after paying bonds
40
Q

Describe the characteristics of a preferred stock

A
  • No voting rights
  • Promised fixed payments but not legally required: dividends are paid as a percent of the par value and are granted in exchange for silence
41
Q

How would a company decide what kind of stock to use?

A

They would look at the expected profits and decide whether or not they would have enough money to issue dividends after paying interest. If no, that company will use common stock; if yes, that company will use preferred stock

42
Q

What impacts a stock’s price?

A

The present value of expected future cash flows. Anything that affects this also affects the demand and supply of a stock

43
Q

What affects expected future returns?

A
  1. The general environment (is it a bull or a bear economy - bull is where prices are rising, bear is where prices are falling - economy, interest, and PEST)
  2. Industry conditions: competitor movements, changing dynamics within five forces
  3. Organization choices: strategies and changes in Diamond-E elements
44
Q

How do stocks and bonds compare in terms of repayment from the company’s perspective?

A

Stocks: companies do not need to repay stockholders
Bonds: there is a principal paid on the maturity date

45
Q

How do stocks and bonds compare in terms of claims on income from the company’s perspective?

A

Stocks: stockholders are only paid their residual claim (dividends)
Bonds: bond holders are paid regular, fixed amounts every six months

46
Q

How do stocks and bonds compare in terms of their affect on management control/ownership from the company’s perspective?

A

Stocks: dilutes ownership and control because it adds more owners to the business
Bonds: bond holders have no ownership or control over the company

47
Q

How do stocks and bonds compare in terms of their tax effects from the company’s perspective? Are their payments tax deductible?

A

Stocks: dividends are not tax deductive because they are given out after the company pays their taxes
Bonds: the interest paid to bondholders is tax deductible because they are paid before anything else

48
Q

What type of financing is more attractive, generally speaking? Why?

A

Debt financing (bonds) is typically more attractive because it is cheaper and the company does not have to give up any control

49
Q

Why would companies not use all debt-financing?

A

The more you borrow, the less likely it is that you will be able to pay it back. Companies can only carry so much debt, so they have to decide how much debt it makes sense to carry

50
Q

How do stocks and bonds compare in terms of repayment from the investor’s perspective?

A

Stocks: no repayment
Bonds: the principle is paid on the maturity date

51
Q

How do stocks and bonds compare in terms of income from the investor’s perspective?

A

Stocks: there are dividends but they are discretionary
Bonds: the coupon/interest payment is required

52
Q

How do stocks and bonds compare in terms of claims on assets in liquidation from the investor’s perspective?

A

Stocks: are paid after all other creditors are paid, with the preferred stocks being paid before common stocks
Bonds: bond holders are paid along with other creditors and before stockholders

53
Q

How do stocks and bonds compare in terms of their ownership/voting rights from the investor’s perspective?

A

Stocks: stockholders have ownership. The common stocks can vote, the preferred stocks cannot vote
Bonds: no ownership

54
Q

How do stocks and bonds compare in terms of their price volatility between instruments of same company from the investor’s perspective

A

Stocks: common stocks have the highest price volatility, preferred stocks have moderate price volatility
Bonds: lowest price volatility

55
Q

What does leverage allow a buyer to do as they are purchasing stocks? What are the results?

A

Given the dollars you have in hand, leverage allows you to make an investment that is bigger than those dollars. It creates a potentially higher return, but also a potential drop in returns

56
Q

What are some examples of leverage when purchasing stocks?

A

Selling short, buying on margin (the buyer pays/lends some of the value)

57
Q

What are the rules about buying on margin?

A
  1. Must qualify for margin account
  2. Must sign “hypothecation” agreement - pledging of securities as collateral for a loan (you have to leave the shares with the broker as collateral)
  3. Must pay interest on loan
  4. The investor’s percent of equity in the margined stocked must also be greater than or equal to the minimum marginal requirement
58
Q

What is the margin requirement equation?

A

((current market value - loan) / current market value)must be greater than or equal to (% of margin requirement)

59
Q

What do you do if you bought shares on margin and then the current market value drops?

A

You have to pay back some of your loan to brink the equation back into balance

60
Q

What is the maximum profit you can make when buying on margin?

A

Infinite (minus interest and commissions): the price of the stock can keep going up

61
Q

What is the maximum loss you can make when buying on margin?

A

You can lose up to whatever you paid to buy the stock (plus interest and commissions)

62
Q

What are the risks of buying on margin compared to going long?

A
  • You will have to pay interest on the loan, which you don’t have to do if you go long
  • You will get a margin call, which you won’t get if you go long
63
Q

What happens with the money that is paid on a margin call when you buy on margin?

A

The broker uses the money you pay for a margin call to reduce your loan

64
Q

What is selling short?

A

Buying stocks low, then selling them high

65
Q

How do you sell stocks that you don’t own when you sell short?

A

You borrow shares from your broker and sell them (only legal in finance)

66
Q

What are the rules about selling short?

A
  1. The deposit must be 150% of the current market value at the initial purchase
  2. The maintenance margin must be met (125-140%)
  3. Agreement may be terminated by either party at any time, and the buyer will be forced to cover their costs and buy back shares early (may not be a good price)
  4. Dividends declared are the responsibility of the seller (never sell short a stock that is close to its dividend declaration date)
67
Q

Why does the broker make a margin call?

A

The broker has given you a load: they want to make sure that they don’t lose their loan money. In a short sell, the broker wants to cover your short positions: if the stock price keeps going up, they want to make sure there is actually enough money from selling your stocks to cover the loan

68
Q

What is the maximum profit of selling short?

A

The price of the short sell

69
Q

What is the maximum loss of selling short?

A

Infinite: if the price of the stock keeps going up

70
Q

What are the risks of selling short?

A
  • Margin calls
  • You might be forced to cover your short position and buy back stocks even when it’s a bad price
  • Price of stocks may never go down, so there is potential for unlimited losses
  • You have to pay the dividends on the stocks
71
Q

What happens with the money that is paid on a margin call when you sell short?

A

The broker uses the money to increase the collateral of your deposit

72
Q

Why is $1 today worth less than $1 one year from today?

A
  1. Risk (putting something off instead of getting it right now)
  2. Real interest (investing it can increase the value of that money)
  3. Inflation (prices of goods may go up)
73
Q

In what scenarios is the concept of time value of money important?

A

Leases, mortgages, bonds, retirement contributions, stock valuation, project selection

74
Q

What is an annuity?

A

When there are multiple but equal payments over equal periods of time

75
Q

What is an ordinary annuity?

A

When the payments does not start today

76
Q

What is an annuity due?

A

When the payments start today

77
Q

What is a perpetuity?

A

An annuity that goes on forever (eg. a dividend on a preferred share)

78
Q

When do you use the effective rate formula?

A

When the payment frequency (p) and compounding periods (m) do not match

79
Q

How do you calculate the interest rate when you are given an APR value? What is the new n?

A

r = APR/payment frequency

the new n = n x payment frequency

80
Q

What is a bond? How are you paid?

A

A bond is a loan from you to the government/a corporation. You receive a series of coupon payments (these are your interest payments), which is an annuity. You also receive a lump sum (principle payment) upon the maturity of the bond, which is a single payment

81
Q

What is the process for getting a mortgage?

A
  1. Figure out mortgage amount
  2. Decide on amortization period
  3. Based on current interest rates, figure out payments over amortization period
  4. Sign mortgage agreement locking in payment terms for period up to 5 years
  5. When agreement expires, repeat process
82
Q

What are some characteristics of a mortgage?

A
  • There is no lump sum payment at the end: you make payments until the loan is paid off
  • You pay a series of identical payments at exactly the same intervals
  • Always an present value ordinary annuity
  • Long-term debt used to buy real estate
  • Maximum amortization period up to 25 years
83
Q

What are the characteristics of a vehicle lease?

A
  • Rental agreement for three or four years
  • At the end of the agreement you can either pay the remaining value of the car (residual value) and keep the car, or give it up with no penalties
  • Price of car = down payment + lease payments + residual
  • Lease payments = present value annuity due
  • Residual = present value single payment

BU 111 Final Exam (4 decks)

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