Investment Products

Question 1

Money Market

Answer 1

Low risk, high quality, liquid, short-term investments with maturities of less than one year

They include T-bills, commercial paper, and bankers’ acceptances

Question 2

Yield formula

Answer 2

Yield = (((Par - Purchase Price)/Purchase Price) X (365/Term))) X 100

Question 3

GIC

Answer 3

A debt security issued by a bank for a fixed sum of money, maturing after a fixed time and paying a fixed rate of interest (usually higher than that paid on a savings account)

Generally not considered since GICs are redeemable only at maturity and thus are not liquid

Question 4

Term Deposits

Answer 4

Generally pay lower interest rate as they may be redeemed at any time and thus offer more liquidity

Question 5

Mortgage-backed securities

Answer 5

Certificates backed by a pool of home mortgages (Agencies by mortgages from lending institutions and repackage them as securities which are then sold to investors)

Question 6

Corproate Bond

Answer 6

Debt secured by a physical asset, which the issuer (corp.) promises to pay the holder a specific rate of interest over the life of the bond (known as a coupon). At maturity, principal (face value) is paid in full to the bondholder

Question 7

Debenture

Answer 7

A bond that is not secured by any specific assets and are backed only by the general credit quality of the issuer (higher level of risk = higher return than bonds)

Question 8

Bond Basics

Answer 8

All bonds have:
1) Issue date
2) Maturity value
3) Face value (par value or maturity value)

Face value of most bonds =
$ 1,000.00

Priced in 100’s as a percentage of the par value (Ex. Bond trading at 98 means the bond is trading at 98% of its par value or $ 980.00)

Coupon (face rate) is the stated interest rate that is used to calculate periodic interest paid on each coupon date (usually semiannually)

Question 9

Bond/Yield Relationship

Answer 9

A bond’s yield is related to the prevailing market interest rates and its price is derived by discounting the future coupon payments and par value at the current market interest rate

Note:

If current market interest rate rises (falls), bond prices fall (rise)

Bonds priced below par ($1,000) are said to be trading at a discount

Bonds priced above par ($1,000) are said to be trading at a premium

Bonds priced at par ($1,000) are said to be trading at a par

Question 10

Convertible Securities

Answer 10

A security in which the issuing company will, at the holder’s option, convert for another security (predetermined number of shares of common stock of the company)

Upside:
1) Growth associated with common shares
2) Protects against downside associated with the bond or preferred shares

Question 11

Preferred Shares

Answer 11

A class of shares that entitles its owners to certain preferences over common stock holders, such as fixed rate dividend or return of stock’s par value at liquidation

Downside:
1) They have not voting rights
2) React to changes in interest rates (when interest rates rise, preferred share prices fall and vice-versa)

Upside:
1) Less volatile than common shares
2) Remain close to their stated par value
3) Objective of earning income
4) React to changes in interest rates (when interest rates rise, preferred share prices fall and vice-versa)

Question 12

Common Shares

Answer 12

Securities which represent ownership in corporation and usually have voting privileges

Downside:
1) Volatile price changes (long-term time horizon)
2) Have a residual claim on assets of the company after all other creditors

Upside:
1) Objective of earning capital gains
2) Have voting privileges

Question 13

Open-End investment (mutual funds)

Answer 13

Traditional mutual fund

Issue a unlimited number of shares

Issued on the primary market

Priced at NAV and redeemable at any time

Question 14

Net Asset Value

Answer 14

(Fund Assets - Fund Expenses)/(Number of units issued)

Question 15

Load

Answer 15

Commission charged

1) No load
2) Front load
3) Back-end load

Question 16

Offering Price

Answer 16

(NAV) / (1-Load)

Question 17

Redemption Value

Answer 17

NAV X (1-Load)

Question 18

MER

Answer 18

Fees charged by the fund and expressed as a percentage of the total assets

Question 19

Closed-End investment (mutual funds)

Answer 19

Trade on the secondary market (TSX or NYSE)

Issue a limited number of shares

Trade at a premium or discount to the actual NAV

Investors can buy/sell funds at any time during the trading day

Question 20

Mutual Funds

Answer 20

Capital from a large number of investors is pooled together and invested into specific stocks, bonds, mortgages, etc.

1) Maturity guarantee - no
No guarantees exist and possible to have little to nothing at death or plan maturity
2) Death guarantee - no
3) Creditor proofing - no
4) Probate protection - no
5) Insurance protection - no
Not covered under CDIC

Upon death, mutual funds become part of the deceased’s estate

Phantom Tax - Non-registered mutual funds purchased at the end of the year, could realize taxes for a year’s worth of capital gains even though units were not owned for a whole year (distributions paid based on the number of units owned)

Mutual funds do not have the ability to allocate and distribute gains and losses. The only way to declare a loss with a mutual fund is to sell the units held.

Question 21

Segregated Funds

Answer 21

The insurance companies’ version of mutual funds

1) Maturity guarantee - yes
Designed to limit potential losses at maturity (75% - 100% of original deposits, less withdrawals)
2) Death guarantee - yes
3) Creditor proofing - yes
4) Probate protection - yes
5) Insurance protection - yes
Amounts covered to a specific dollar limit by Assuris

At death, segregated funds pass directly to beneficiary (if named) and pass creditor’s claims, probate etc.

Creditor protection exists during policy holders lifetime even if bankruptcy occurs

Phantom Tax - Income is allocated monthly and taxes to be paid on gains that arose before units were owned does not exist (distributions paid based on the length of time held, and investor owns the units and number of units owned)

Segregated fund capital loses in a given year, the unit holders can claim the capital loss on their taxes and offset any capital gains made on other investments (taxation rules allow for the allocation of capital gains or losses without cashing in the units held).

Taxation:
1) Considered a trust for taxation purposes (T3)
2) Investor owns a annuity contract, not units
3) Allocation of income to investors retains its character (ie. dividends, interest income, capital gains/losses) and flows through to the investor who enjoys the various tax advantages.
4) Disposing of Segregated Funds is considered to occur when the policy holder takes cash out, transfers to another fund or upon the death of the annuitant. All of these actions result in the realization a capital gain or loss (Capital Gain/Loss = Proceeds of Disposition - ACB).
5) Investors can carry losses back 3 years or forward forever.
6) The ACB will increase when allocations of income are made and reduced with the allocation of capital losses

NOTE: The payment of distributions do not reduce the NAV of a Segregated fund the way distributions reduce the NAV of a traditional mutual fund

NOTE: Seg fund distributions are based on the number of units owned and the period of ownership, thus Seg funds remove the “phantom tax” liability associated with purchasing traditional mutual funds at the end of the year.

Question 22

Annuities

Answer 22

A contract purchased with a lump sum that provides a constant and guaranteed stream of payments over a chosen term

Question 23

Registered Annuities

Answer 23

1) Registered Fixed Term-to-ag 90 (term lasts until individuals 90th birthday)

2) Life annuity (only available through life insurance company)

NOTE:

Annuity payments are fixed for the term of the plan and cannot be changed.

The payment amount is determined by the amount, the term chosen and the interest rate for the term.

Each payment is a mixture of principal and interest.

The entire payment amount is fully taxable for the year of receipt.

Question 24

Non-Registered Annuities

Answer 24

1) Non-Registered Fixed Term Annuity
- initially, payments comprise more interest than principal, but as you receive more payments this is reversed.
-As a result, taxable income is greater with earlier payments. This will appeal to an investor who would prefer to have a lower taxable income in later years.

2) Prescribed Annuity (cannot extend beyond individuals 90th birthday)
- income is treated as equal parts principal and interest.
- As a result, taxable income is constant over the whole term of the annuity. This will appeal to an investor who would prefer to have a constant taxable income. If taxpayer is in a lower tax bracket in the later years of the annuity term, they may realize a tax savings.

NOTE:

Annuity payments are fixed for the term of the plan and cannot be changed.

The payment amount is determined by the amount, the term chosen and the interest rate for the term.

Each payment is a mixture of principal and interest.

With Non-Registered annuities, the interest portion of the payment is taxable for the year of receipt

Question 25

Derivatives

Answer 25

Investment products such as option products, futures contracts, forward contracts, interest agreements and swaps

Offers investors the opportunity to use leverage to magnify potential investment returns (With small of amount of money, investor can own a large amount of an underlying security)

Two parties to every derivative:
1) buyer/party going long
2) seller/party going short

Considered very risky investments (if used for speculative purposes)

Question 26

Derivative Securities

Answer 26

Contingent contracts that payoff to an investor dependent or contingent upon some other action occurring (change in stock price or interest rates)

Question 27

Types of Derivatives

Answer 27

1) Call Options
- The party that buys (or is long) on a Call Option, has the right, but not the obligation, to BUY the underlying security at a specific price (the exercise price) anytime up to and including the expiration date.

• The party that sells (or is short) a Call Option, has the obligation to SELL the underlying security at a specific price (the exercise price) anytime up to and including the expiration date.

NOTE:

a) An investor would buy call option contract if he/she believes the price of the underlying security is going to go up.
b) The investor would exercise his/her call option contract only if it were “in the money”, that is if the underlying security’s price were higher than the exercise price.
c) The opposite of being long on a call option is….being on the short side in that same contract.

2) Put Options
- The party that buys (or is long) a Put Option, has the right, but not the obligation, to SELL the underlying security at a specific price (the exercise price) anytime up to and including the expiration date.

• The party that sells (or is short) a Put Option, has the obligation to BUY the underlying security at a specific price (the exercise price) anytime up to and including the expiration date

NOTE:
a) An investor would buy a put option contract if he/she believes the price of the underlying security is going to go down.
b) The investor would exercise his/her put option contract only if it were “in the money”, that is if the underlying security’s price were lower than the exercise price.
c) The opposite of being long a put option is….being the short side in that same contract.

Question 28

Futures/Forward Contracts

Answer 28

The buyer and the seller are committed to follow through according to the contract details (contracts of commitment)

Note:

a) In a futures contract, today, the contract buyer locks in a price to buy the underlying security, with delivery and settlement at a future date.
b) If the underlying security goes up in value, the buyer gains and the seller, loses that potential gain.
c) If the underlying security goes down in value, the buyer loses and the seller gains

Question 29

Spot Market

Answer 29

Transactions that occur in the stock market today (settlement in two business days)

Question 30

Futures Market

Answer 30

Transactions that occur in the stock market today (settlement might be 3 months, 6 months, one year etc.)

Question 31

Swaps

Answer 31

Corporations and institutional investors, such as pension funds may “swap” the cash flows (interest income or payments) associated with floating rate assets or liabilities for fixed rate cash flows to better handle interest rate changes and minimize cash flow volatility.

They are interest risk hedging vehicles

Can be created based on two different currencies where multinational corporations may have some foreign currency need and may be able to find a counterparty to swap currencies and interest payments. In this case the agreement would be referred to as a “Currency Swap