Investment Planning Flashcards
What is the Investment Industry Regulatory Organization of Canada (IIROC)?
A self-regulatory organization (SROs) which is responsible for the regulation of its member firms, which include more than 200 investment dealers that are actively engaged in securities trading in Canada. Monitors activities of investment dealers (capital adequacy and business conduct) Registering qualified member firms
What is the Canadian Investor Protection Fund (CIPF) and what does it cover?
A trust fund established to protect investors’ assets in the event of the insolvency of an SRO member firm. Coverage is: 1. $1 million CAD for all general accounts combined (cash, margin, TFSAs), plus 2. $1 million CAD for all registered retirement accounts combined (RRSPs, RRIFs and LIFs), plus 3. $1 million CAD for all RESPs combined where the client is the subscriber of the plan
What is a money market instrument?
Refers to full range of low risk, high quality, liquid, short-term investments with maturities of less than a year. Treasury bills, commercial paper, bankers acceptances Issued at a discount and mature at par (usually $100,000 or $1,000,000)
What is the formula for yield of money market instruments?
Yield = [(Par - Purchase Price)/Purchase Price] x (365/Term) x 100
What are GICs/term deposits? What is the difference between the two?
GIC - debt security issued by a back or trust company for a fixed sum of money, maturing after a specific length of time and paying a fixed rate of interest. Redeemable only at maturity therefore not liquid. Term Deposits - similar to GICs, however pay slightly lower interest rate as they may be redeemed at any time and thus offer more liquidity.
What is a mortgage-backed security?
Certificates backed by a pool of mortgages insured under the National Housing Act. They pay interest and a small portion of principal on a monthly basis and offer a rate generally higher than treasury bonds (which offer similar liquidity and safety)
What is the difference of a corporate bond and a debenture?
Corporate bond is a certificate of debt secured by a physical asset. A debenture is essentially the same as a bon, except that the debentures are not secured by any specific assets and are backed only be the general credit quality of the issuer.
What is the relationships between the price of a bond, and the market interest rates?
If the current market interest rate rises (falls), bond prices fall (rise).
Describe the characteristics of a convertible security.
Usually convertible bond and convertible preferred shares. They represent a security in which the issuing company will, at the holder’s (or investor’s) option, convert for another security, most often a predetermined number of shares of common stock of the company. Investors usually buy these because of the potential upside of the common shares, and the downside protection associated with the bond or preferred share.
Describe the characteristics of preferred shares.
A class of share capital that entitles its owners a certain preferences over common stock, such as a fixed rate of dividend or the return of the stock’s par value in liquidation. Investors buy them with the objective of earning income. Prices are less volatile than common share prices, as they remain close the their stated par value. They react to market interest rates the same way as bonds, but in inverse fashion.
Why to people buy common shares?
To earn capital gains.
What is an open-end mutual fund?
Traditional mutual fund with an unlimited number of units (or shares), that are always issued in primary market. Always priced at the Net Asset Value (NAV). Redeemable anytime Exact prices not known until the the end of the trading day)
How to calculate the NAV of mutual funds
NAV = (Fund Assets - Fund Expenses)/Number of Units Issued
How does load change the offering price or redemption value of an open-end mutual fund?
Offering Price = NAV/(1 - Load) Redemption Value = NAV x (1 - Load)
What is a closed-end mutual fund?
Trade on secondary market (NYSE or TSX). They issue a limited number of units (or shares), and may trade at a premium or discount to their actual NAV due to investor perceptions of value. Can be bought at any time during the trading day and will know exactly the price they are paying or receiving.
Describe Unit Investment Trusts (UITs)
Pools of capital that invest in fixed income securities. Have a limited number of units and trade on the secondary market. They have a maturity date (associated with the maturity of bonds in pool), at that time the trust is collapsed.
Describe Labour-sponsored mutual funds (LSVCC or LSIF)
Investment fund that has a 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 depending on the province, maybe 15% provincially as well). Credits are applied to a maximum purchase of $5,000. Purchase of LSIFs should be primarily based on the investment potential - not tax credit. They are risky, therefore only appropriate for investors who already hold a well diversified portfolio of securities.
What is the difference between mutual funds and segregated funds?
Segregated funds have the following guarantees and protection: Maturity, Death, Creditor, Probate, and Insurance. Segregated funds are actually variable deferred annuity contracts with insurance protection in the vent of death - at death, proceeds can pass directly to a named beneficiary, and are not subject to probate, lawyers, or executors fees. Mutual funds do no have this protection as at death they become part of the deceased’s estate. Segregated funds have maturity guarantees designed to limit potential losses at maturity (ten years from date of purchase) or death. Often between 75% - 100% of original deposits, less any withdrawals. Non registered seg funds have a flow through of losses to the unit holders. Mutual funds do not have this, the only way to declare a loss with a mutual fund is to sell the units. Phantom Tax Problem - non registered mutual funds could have you paying capital gains for a whole year even if you bought at the end of the year.
Does the payment of distributions reduce the NAV of a Seg fund?
No - only with traditional mutual funds.
Describe the taxation of Seg funds.
Considered a trust for Canadian tax purposes (T3 slip). Investor owns an annuity contract (not units). Allocation of income retains it’s character - flows to the investor.
What are the 2 types of registered annuities?
Registered Fixed Term-To-Age 90 Life annuity (available through a life insurance company only)
What are the 2 types of non-registered annuities?
Non-Registered Fixed Term annuity Prescribed annuity
What is the taxation of a registered annuity?
The entire payments are taxable - annuity payments are fixed for the term of the plan and cannot be changed.
Describe a non-registered fixed term annuity
Investors may select any term - however cannot extend past your 90th birthday. Payments are fixed for the term of the plan and cannot be changed. Interest portion of the payment is taxable in the year of receipt. Initial payments have more interest than principal - taxable income is greater with your earlier payments.
What is the difference between a prescribed annuity and a fixed term annuity?
In a prescribed annuity - your income is treated as equal parts principal and interest. Appeals to an investor who would prefer to have constant taxable income.
What is the benefit of adding real estate to a portfolio?
Adding to a portfolio of stocks and bonds will provide lower overall risk due to diversification and offer the potential for enhanced returns.
What are the different ways to invest in real estate?
- Direct ownership - should be viewed as a long term investment as is illiquid. 2. Indirect ownership - through real estate investment trusts (REITs) of mortgage-backed securities.
Describe the parties rights in a call option.
The party who buys (or is long) in a call option, has the right, but not the obligation, to buy the underlying security at a specific price anytime up to and including the expiration date. The party who sells (or is short) a call option, has the obligation to SELL the underlying security at a specific price anytime up to and including the expiration date.
Describe the parties rights in a put option.
The party who buys (or is long) in a put option, has the right, but not the obligation, to SELL the underlying security at a specific price anytime up to and including the expiration date. The party who sells (or is short) a put option, has the obligation to BUY the underlying security at a specific price anytime up to and including the expiration date.
When would an investor buy a call option contract?
If they believe the price of the underlying security is going to go up.
When would an investor buy a put option contract?
if they believe the price of the underlying security is going to go down.
What is a futures contract?
When the buyer locks in a price to buy the underlying security, with delivery and settlement at a future date. If the underlying security goes up in value, the buyer gains and the seller loses that potential gain. If the underlying security goes down in value the buyer loses and the seller gains.
What is the gross up rate and dividend tax credit for eligible and non-eligible dividends?
Eligible - 38% Gross Up, credit = 6/11 of gross up. Non-eligible - 17% Gross Up, credit = 21/29 of gross up
Explain duration and the two primary factors that affect duration.
Duration measures how much the bond values will change due to changes in interest rates. Generally, the greater the duration, the greater the sensitivity or response to changes in interest rates. The lower the duration, the lower the sensitivity to changes in interest rates. 1. Time-To-Maturity - In general, holding coupon constant, the longer the time to maturity, the greater the duration, and the shorter the time to maturity, the lower the duration. 2. Coupon Rate - In general, holding time to maturity constant, the higher the coupon rate, the lower the duration, and the lower the coupon rate, the higher the duration.
What is BETA?
Market Risk, Systematic Risk - relates to the co-movement of the investment to the movement of the market. Cannot be diversified away. By definition, the market has a BETA equal to 1. Defensive (or lower risk) stocks have a BETA of less than 1, and risky stocks have BETAs greater than 1. Eg. If a stock has a BETA of 2 - you would expect the stock to outperform the market by 100% Change in value = Beta x (% change in market)
