SF CH1

Question 1

What are investments?

Answer 1

These are commitments of funds to one or more financial assets that will be held over some future time period.

Question 2

What the is the field of investments?

Answer 2

This is the management of an investor’s wealth, which is the sum of the current income and the present value of all future income.

Question 3

What are financial assets?

Answer 3

These are paper claims on some issuer such as the federal or provincial government or corporations.

Question 4

What are real assets?

Answer 4

These are tangible physical assets such as precious metals, gems, art, and real estate.

Question 5

What are marketable securities?

Answer 5

These are financial assets that can be easily and cheaply traded on the public market.

Question 6

What is a portfolio?

Answer 6

A portfolio is the securities held by an investor taken as one whole unit. Basically a portfolio is all the financial assets of an investor.

Question 7

What are the three primary investment objectives?

Answer 7

1. Safety
2. Income
3. Growth of Capital

Question 8

What are the two secondary investment objectives?

Answer 8

1. Liquidity

2. Tax minimization

Question 9

What are some constraints to an investor?

Answer 9

1. Stability of income.
2. Level of liabilities and financial obligations.
3. Level of investment knowledge

Question 10

What is risk and return?

Answer 10

Return: this what investors receive in the future after investing.

Risk: the probability that the actual return on an investment is different from its expected return.

Question 11

What is expected return and realized return?

Answer 11

Expected return: the amount that the investor expects in the future.

Realized Return: what the investor actually receives.

Question 12

What are risk-averse investors?

Answer 12

A risk averse investor is an investor who prefers lower returns with known risks rather than higher returns with unknown risks.

Risk-averse investors assume the risk if they expect to be adequately compensated for it.

Question 13

What is the Expected Return formula?

Answer 13

Expected return = Risk-free rate (RF) + Expected risk premium

Question 14

What is the two-step investment decision process? Define them.

Answer 14

1. Security Analysis: involves the valuation and analysis of individual securities.
2. Portfolio Management: involves understanding which securities to include and what securities to get rid of in your portfolio.

Question 15

Why is security analysis hard?

Answer 15

1. You must understand the characteristics of different securities and the factors that affect them.
2. A valuation model must be applied to these securities to estimate their price or value.

Question 16

What is a active investor and a passive investor?

Answer 16

Active investor: an investor that purchases securities believe to be underpriced to create a portfolio that will try to beat the market.

Passive investor: an investor that purchases a portfolio that mirrors the performance of the market with the belief that most securities are fairly priced.

Question 17

What are the four key factors that affect the investment decision process?

Answer 17

1. Uncertainty in the market.
2. Global events.
3. Role played by institutional investors.
4. Efficiency of markets.

Question 18

What global events have significant impact on Canadian investors? Why?

Answer 18

1. The increase and decrease of foreign exchange rates. Canadian industries focus mainly on commodities such as oil, mining and forestry. The price for those commodities are determined by the global supply and demand. If the foreign exchange rates go down that could mean less Canadian dollars.
2. The rate of return in foreign securities are often high than securities in Canadian markets.
3. Investing in foreign securities increases risk reduction through foreign diversification. Since the markets are separate, if the Canadian stock market is underperforming, its losses can be offset by the performance of foreign stocks.

Question 19

What are the differences between new economy and old economy stocks?

Answer 19

1. Old Economy stocks refers to the traditional service, consumer and financial companies like Procter and Gamble, McDonalds. These companies are successful but are not considered exciting.
2. New Economy stocks have a heavy focus on technological companies. These companies are exciting because they had high rises and very dramatic declines.

Question 20

What is the Efficient market Hypothesis?

Answer 20

This is the idea that markets are efficient meaning that the prices of stocks accurately reflects their economic value.

Question 21

How can the efficient market hypothesis affect the decision of investors?

Answer 21

1. Investors that believe in the hypothesis will assume less risk and adopt a passive investment strategy, believing that they will not be able to find underpriced securities.
2. Investors that refer the hypothesis will adopt an active investment strategy, believing that they can find underpriced securities.

Question 22

A market security is said to be liquid if it can be easily and cheaply traded. Why is the liquidity of a marketable security an important thing for investors to consider?

Answer 22

Investors wants to be able to sell an investment in a timely and efficient manner. Having an illiquid security holds risk because you might be stuck with a declining priced stock without an option to get rid of it.

Question 23

List four categories of institutional investors. Give examples of Canadian corporations that fit in each category.

Answer 23

1. Banks
2. Pension Funds.
3. Investment Companies
4. Life Insurance Companies.
5. Trust Companies.

Question 24

Carefully describe the risk-return trade off faced by all investors.

Answer 24

For investors to earn a return in their investments above a risk free asset, they must assume a risk. The higher the returns, the higher the risks.

Question 25

Summarize the basic nature of the investment decision in one sentence.

Answer 25

The basic nature of the investment decision is the upward sloping trade off between expected return and risk that must be dealt with each time an investment decision is made.

Question 26

Are all rational investors risk averse? Do they all have the same degree of risk aversion?

Answer 26

All rational investors are risk averse because they will not assume risk unless they can be adequately compensated.

Not all rational investors have the same degree of risk aversion because some investors have a higher threshold to assume risk. (more money).

Question 27

Although a T-Bill is said to be risk free, what risks are actually associated with it?

Answer 27

There is a risk that the nominal return of the T-Bill will get outpaced by the increase in the nominal rate of inflation.

Unexpected increase in tax rates could lead to a lower after tax rate of return.

Question 28

What is meant by the terms ex ante and ex post?

Answer 28

1. Ex ante: refers to the investor’s expectation of higher returns before the investment has been made.
2. Ex post: the actual return realized for the risk taken.

Question 29

How has Internet technology influenced the nature of investing?

Answer 29

1. Revolutionized the flow of investment information.
2. Lowered commission rates for individual investors.
3. Allowed investors to trade with their computers.