Investment Planning

Question 1

Money market instruments/T-Bills/cash equivalents

Answer 1

Money market refers to the full range of low risk, high quality, liquid, short-term investments with maturities of less than one year.
include Treasury bills, commercial paper, and bankers’ acceptances.

Question 2

Yield of T-bill

Answer 2

Yield = (Par – Purchase Price)/Purchase Price x 365/Term x 100

Question 3

Mortgage-backed securities (MBS)

Answer 3

Certificates backed by a pool of home mortgages insured under the National Housing Act. Pay interest and a small amount of principal on monthly basis.

Question 4

coupon (or face rate)

Answer 4

stated interest rate that is used to calculate the periodic interest paid on each coupon date. Bonds pay interest semiannually, unless otherwise stated!

Question 5

Investor holds a Government of Canada 6% Bond due May 15, 2032 The Coupon payment will be

Answer 5

1/2 x 6% x 1,000 = $30

Question 6

Today is May 15. Assume current interest rates are 8%, calculate the price of a Government of Canada 6% Bond due in 5 years on May 15.

Answer 6

N = 5x2=10, I=8%/2=4%, PMT=$60/2=$30, FV=$1,000

Question 7

The offering price and redemption value of an open-end mutual fund

Answer 7

Offering Price = NAV / (1 – Load)
Redemption Value = NAV x (1 – Load)

Question 8

Labour-sponsored mutual funds (LSVCC or LSIF)

Answer 8

specific mandate to invest in small and medium-sized Canadian businesses as well as in new start up businesses
investors receive a 15% Federal tax credit and a possibly a provincial tax credit
The credits are applied up to a maximum purchase amount of $5,000
LSIFs are risky investments and thus are appropriate for investors who already hold a well diversified portfolio of securities.
investment in a LSIF must be held for a minimum of eight years.
When LSIFs are purchased within a spousal RRSP, either spouse is entitled to claim the LSIF tax credit.

Question 9

Registered Annuities

Answer 9

There are two types of registered annuities:
*Registered Fixed Term-To-age 90
*Life annuity (available through a Life Insurance company only)

Question 10

Non-Registered Fixed Term annuity

Answer 10

initially payments comprise more interest than principal
your taxable income is greater with your early payments
appeal to an investor who would prefer to have a lower taxable income in later years

Question 11

Prescribed annuity

Answer 11

income is treated as equal parts principal and interest. As a result, your taxable income is constant over the whole term of the annuity
appeal to an investor who would prefer to have a constant taxable income

Question 12

Adding real estate to a portfolio- exam tip

Answer 12

Adding Real Estate investments to a portfolio of stocks and bonds will provide lower overall risk due to diversification and offer the potential for enhanced returns.

Question 13

Indirect Ownership of the real estate

Answer 13

Investors can gain exposure to real estate through exchange-traded securities called real estate investment trusts or “REITs”
Mortgage-backed securities or “MBS” offer investors the opportunity to participate in the mortgage market without having the risk linked to an individual homeowner.

Question 14

Taxation of investments- General Rules

Answer 14

General Rules
*Interest income is taxed as regular income at an individual’s top marginal tax rate
*Dividend income is taxed subject to special gross up and tax credit rules.
*Capital gains are taxed favourably, since only 50% of the gain is taxable.

Question 15

Taxation of Dividends- paid by Canadian corporations
(eligible dividends)

Answer 15

Eligible for an enhanced gross-up and federal dividend tax credit (DTC)
shareholders will include 138% of the eligible dividend amount in income (that is, a 38% gross-up)
The federal DTC with respect to eligible dividends is 6/11th of the gross up. Which is approximately equal to 15.02% of the taxable amount.

Question 16

Heather owns 100 shares of the Bank of Nova Scotia (BNS). BNS paid a $1.50 per share dividend. Assuming Heather’s marginal tax rate is 29%, calculate the tax payable and after-tax income.

Answer 16

Cash dividend received $150.00
Gross up (38%) $57.00
Taxable amount $207.00 ← Reported on the tax return
Federal Tax (29%) $60.03
Federal DTC (15.02%) - $31.09
Net Tax Payable $28.94
After Tax Income $150 - $28.94 = $121.06

Question 17

Ineligible dividends

Answer 17

115% of ineligible dividend as taxable income.
Tax credit would be 9.03% of the taxable income

Question 18

Exam Tips!

Answer 18

Dividends paid by “non- Canadian” corporations Taxed as regular income
Interest on bonds is taxed annually even if it is not received.

Question 19

How is capital loses applied

Answer 19

Where investors experience a loss, the 50 per cent “allowable capital loss” amount must first be used to offset any capital gains they may have in the same year.
*Any unused allowable capital loss amount may be carried back up to three years or forward indefinitely to reduce taxable capital gains of other years

Question 20

Dividend discount model (DDM)

Answer 20

The value of any security is equal to the present value of the future cash flows.
Ps = D1/(r-g)
Where: D1 = Expected dividend
r= required return by investors
g= dividend growth rate

Question 21

Price-earnings

Answer 21

P/E = Dividend Payout/(r-g)
Where: Dividend Payout = Dividends/ Earnings

Question 22

Markowitz Portfolio Theory

Answer 22

Markowitz showed that the total risk of a portfolio of securities could be lowered by selecting investments that were not related to each other, that is had a low correlation of returns. Correlation (ρi,j) is a relative measure of association that ranges between, +1 and -1.

Question 23

What is Modern portfolio theory based on?

Answer 23

Modern portfolio theory is based upon the three components of expected return (Er), portfolio risk (Standard Deviation) and diversification (Correlation)

Question 24

Systematic vs. Non-systematic Risk

Answer 24

Systematic risk refers to system-wide risk (or simply market risk) that affects all investors and all investments. Examples are global macroeconomic conditions, such as inflation fears, interest rate changes, and health of the economy.

Non-systematic risk (or simply company specific risk) refers to the risks that are unique to a specific business or industry.

Question 25

Market Line Formula (SML)

Answer 25

Capital Asset Pricing Model (CAPM), a portfolio’s expected return (ER) over a given period is equal to the risk-free rate (Rf) over the measurement period plus the beta (β) over the measurement period times the market return over the measurement period minus the risk-free rate (Rm– Rf) over the measurement period.
ER = Rf+ β(Rm – Rf)

Question 26

Efficient Market Hypothesis (EMH)

Answer 26

The EMH states that it is impossible to “beat the market” because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.