Author: michaelmcduff_xq2i47

1. GOVERNMENT AND CORPORATE FINANCE

INVESTMENT DEALER FINANCE DEPARTMENT

-GOVERNMENT FINANCE

• The size (or dollar value), coupon (interest rate offered), and currency of denomination of the issue

• The timing of the issue

• Whether the issue should be domestic or foreign

• What effect the issue may have on the market

• Whether the issue should be a new maturity, or whether a previous issue should be reopened

-CORPORATE FINANCE

• Types of securities

• Timing to market

• Private or public offering

• Proportion directed to institutional and retail investors

• Pricing

• Coupon rate or valuation multiple (such as price-to-earnings ratio)

• Underwriting fee (charged to the corporation)

CANADIAN GOVERNMENT ISSUES

competitive tender system

government securities distributors

PROVINCIAL AND MUNICIPAL ISSUES

direct bonds and guaranteed bonds

CORPORATE FINANCING

-EQUITY FINANCING

-SHARE CAPITAL

DEBT FINANCING AND OTHER ALTERNATIVES

mortgage bonds and debentures

2. THE CORPORATE FINANCING PROCESS

THE DEALER’S ADVISORY RELATIONSHIP WITH CORPORATIONS

-ADVICE ON THE SECURITY TO BE ISSUED

Bonds

+• Bonds have a lower interest rate than comparable debentures. • They are marketable to institutions that require debt issues secured by assets.

-• They are less flexible because the assets are pledged to a trustee. • They can be problematic in mergers and amalgamations because of pledges against specific assets. • They require regular interest payments, the omission of which can lead to default.

Debentures

+• Debentures are flexible because there are no specific pledges or liens. • The cost at issue is lower because there is no registration of assets.

-• The coupon rate can be higher than that of a comparable bond because of the lack of pledge on specific assets. • They require regular interest payments, the omission of which can lead to default.

Preferred Shares

+• Technically, preferred shares are considered equity. Therefore, the company can increase debt outstanding and still maintain a stable debt-to-equity ratio, if the issue is successful. • Omission of a dividend payment does not trigger default, as non-payment of interest on the bond or debenture would. • They provide greater flexibility in financing because of the lack of pledge of assets. • They have a limited lifespan because they can be redeemed through the open market, lottery, or purchase fund.

-• The cost of issuing preferred shares is high because the dividends are paid with after-tax income. The high cost can increase risk to the corporation. • Occasionally, non-payment of dividends on preferred issues can trigger the implementation of voting privileges for preferred shareholders. • A purchase fund can be a drain on company

Common Shares

+• There is no obligation to pay dividends. • No repayment of capital is required. • The larger equity base can support more debt. • The market value of the company can be established for estate purposes, mergers, or takeovers.

-• Equity is diluted for existing shareholders upon the issuance of additional shares. • Dividends, if paid, are more expensive than interest because they are paid with after-tax dollars. • A higher underwriting discount than on a debt issue is charged.

ADVICE ON PROTECTIVE PROVISIONS

trust deed restrictions, or covenants

THE METHOD OF OFFERING

private placement, a primary offering, or a secondary offering

• The banking group consists of additional dealers with liability for their participation, as noted above.

• The selling group consists of other dealers who are not members of the banking group.

• Casual dealers are non-members of the banking or selling group. They may include broker dealers, foreign dealers, or banks.

• Special group orders may occur under various circumstances. For example, the issuer may demand special consideration for a dealer or its banker, or for its parent’s banker, if it is a subsidiary of a foreign parent.

• A portion may be allotted for sale to the exempt list. This list usually includes only large professional buyers, mostly financial institutions, that are exempt from prospectus requirements.

3. BRINGING SECURITIES TO THE MARKET

WHEN A PROSPECTUS IS REQUIRED

• Trades by or on behalf of an issuer (e.g., a new issue from treasury)

• Except in Quebec, trades from a control position, unless the trade is made under a prospectus exemption

• Trades in securities previously acquired by way of a prospectus exemption, unless the subsequent trade is made under a further prospectus exemption

NEW ISSUES

PRELIMINARY PROSPECTUS

red herring prospectus

PASSPORT SYSTEM

PERMITTED ACTIVITIES DURING THE WAITING PERIOD

FINAL PROSPECTUS

blue skyed

DETAILS OF AN OFFERING

• Cover page disclosure

• Summary

• Information relating to the issuer

• Information relating to the securities

• Information relating to the officers and shareholders

• Information relating to the parties involved

MARKET OUT CLAUSES

THE SHORT FORM PROSPECTUS SYSTEM

AFTER-MARKET STABILIZATION

• Greenshoe option (or over-allotment option)

• Penalty bid

• Stabilizing bid

SECURITIES DISTRIBUTIONS THROUGH THE EXCHANGES

• The issuer has filed an AIF, is a reporting issuer, and is a SEDAR filer.

• The securities are listed securities or units of securities and warrants.

• The issuer has filed with the TSX Venture Exchange an exchange offering document, which incorporates by reference the AIF, the most recent financial statements, and material change reports. (This document must be delivered to purchasers.)

• The number of securities offered does not exceed the number previously outstanding.

• The gross proceeds do not exceed $2 million.

• No more than 20% of the offering goes to one purchaser.

4. OTHER METHODS OF DISTRIBUTING SECURITIES TO THE PUBLIC

• As junior company distributions

• As options of treasury shares and escrowed shares

• Through a Capital Pool Company (CPC)

• The NEX board

• Through Crowdfunding

5. THE LISTING PROCESS

• Submit annual and interim financial reports, as well as other corporate reports, to the exchange.

• Promptly notify the exchange about dividends or other distributions, proposed employee stock options, and sale or issue of treasury shares.

• Notify the exchange of other proposed material changes in the company’s business or affairs.

Advantages

• Prestige and goodwill Company prestige is enhanced through increased public visibility. Shareholder goodwill increases as buying and selling become easier and market performance becomes more visible. • Established and visible market value The market value of a listed company is readily visible. Financial analysts are more likely to follow a listed company. In turn, this can attract new shareholders, enhance overall marketability in the secondary market, and increase the market for new issues by the company.

• Excellent market visibility The daily financial press carries full details of listed trading on a daily and weekly basis.

• More information available Because of strict exchange disclosure regulations, investors have access to more information on a regular basis.

• Simplified valuation for tax purposes The valuation of securities for estate tax purposes and estate tax planning is easier

Disadvantages

• Additional controls on management After listing, certain restrictions are put in place regarding stock options (those issued for internal use only), reporting of dividends, issue of shares for assets, and other matters.

• Need to keep market participants informed A listed company’s management must devote considerable time to meet with security analysts and institutional investors and to communicate with the press to explain company developments.

• Market indifference Low trading volume and poor market performance of a listed company become a matter of public record.

• Additional disclosure Listing imposes additional disclosure requirements on the company that consume management time. Specifically, management is required to make continuous and prompt disclosure of material changes related to the company.

• Additional costs to the company Various fees, including a listing fee and subsequent annual sustaining fee, must be paid to the exchange when a class of shares is listed.

TEMPORARY INTERRUPTION OF TRADING

• Delayed opening

• Halt in trading

• Suspension in trading

CANCELLING A LISTING (DELISTING)

• The delisted security no longer exists because it was called for redemption (in the case of a preferred share) or was substituted for another security as a result of a merger.

• The company is without assets or has gone bankrupt.

• The public distribution of the security has dwindled to an unacceptably low level.

• The company has failed to comply with the terms of its listing agreement.

1. CORPORATIONS AND THEIR STRUCTURE

Sole proprietorships Or partnerships:

ADVANTAGES OF INCORPORATION

• Limited shareholder liability

• Continuity of existence

• Transfer of ownership

• Ability to finance

• Growth

• Professional management

DISADVANTAGES OF INCORPORATION

• Inflexibility

• Taxation

• Expense

• Capital withdrawal

PRIVATE AND PUBLIC CORPORATIONS

• Private corporations have charters that restrict the right of shareholders to transfer shares, limit the number of shareholders to no more than 50, and prohibit members from inviting the public to subscribe for their securities.

• Public corporations are companies whose shares are listed on a stock exchange or traded over the counter.

CORPORATE BY-LAWS

VOTING RIGHTS

SHAREHOLDERS’ MEETINGS

VOTING BY PROXY

VOTING TRUSTS

THE CORPORATE STRUCTURE

• Directors

• Chairman of the board

• President

• Vice-Presidents

• Officers

2. FINANCIAL STATEMENTS OF A CORPORATION

International Financial Reporting Standards (IFRS)

STATEMENT OF FINANCIAL POSITION

• Assets consist of what the company owns and what is owed to it.

• Equity represents the shareholders’ interest in the company.

• Liabilities are what the company owes.

CLASSIFICATION OF ASSETS

ITEMS 1–3: NONCURRENT ASSETS

-Noncurrent assets include property, plant, and equipment (PP&E); goodwill and other intangible assets; and investments in associates.

-Two commonly used methods of calculating depreciation are the straight-line method and the declining-balance method.

ITEMS 5–8: CURRENT ASSETS

-Inventory, prepaid expenses, and trade receivables

• The weighted average method uses the average of the total cost of the goods purchased over the period on a per unit basis.

• The first-in-first-out (FIFO) method implies that items acquired earliest are assumed to be used or sold first.

CLASSIFICATION OF EQUITY

ITEM 11: SHARE CAPITAL

ITEM 12: RETAINED EARNINGS

ITEM 13: NON-CONTROLLING INTEREST

CLASSIFICATION OF LIABILITIES

ITEMS 15 AND 16: NON-CURRENT LIABILITIES

ITEMS 18–21: CURRENT LIABILITIES

• Current portion of long-term debt due in one year

• Taxes payable to the government in the near term

• Trade payables (unpaid bills for items such as raw materials and supplies)

• Short-term borrowings from financial institutions

STATEMENT OF COMPREHENSIVE INCOME

• Where earnings come from

• Where earnings go

• The adequacy of earnings, both to assure the successful operation of the company and to provide income for the holders of its securities

STRUCTURE OF THE STATEMENT OF COMPREHENSIVE INCOME

ITEMS 24–26: REVENUE, COST OF SALES, AND GROSS PROFIT

ITEM 27: OTHER INCOME

ITEMS 28 TO 31: GENERAL EXPENSES

• Distribution costs, including such expenses as advertising costs and salaries and commissions to sales personnel

• Administrative expenses, including office salaries, accounting staff salaries, and office supplies

• Other expenses not directly related to the company’s normal operating activities, including expenses associated with the sale of PP&E

• Finance costs in the form of interest payments on debtholders’ securities or loans to the company

ITEM 32: SHARE OF PROFIT OF ASSOCIATES

ITEM 33: INCOME TAX EXPENSE

ITEM 34: PROFIT

• Actuarial gains and losses on defined benefit plans

• Gains and losses from currency translations relating to the financial statements of a foreign operation

STATEMENT OF CHANGES IN EQUITY

RETAINED EARNINGS

TOTAL COMPREHENSIVE INCOME

STATEMENT OF CASH FLOWS

STRUCTURE OF THE STATEMENT OF CASH FLOWS

• Operating Activities • Financing Activities • Investing Activities

ITEMS 34 TO 37: OPERATING ACTIVITIES

• Trade receivables • Inventories • Trade payables • Interest payable • Taxes payable

ITEMS 38 TO 41: FINANCING ACTIVITIES

• If the company has issued new share capital (item 38) or debt (item 40), cash flows into the company. • If the company repays debt (item 39) or pays dividends to the shareholders (item 41), cash flows out of the company.

ITEMS 42 TO 44: INVESTING ACTIVITIES

ITEMS 45 AND 46: THE CHANGE IN CASH FLOW

3.THE ANNUAL REPORT

NOTES TO THE FINANCIAL STATEMENTS

THE AUDITOR’S REPORT

5. PUBLIC COMPANY DISCLOSURES AND INVESTOR RIGHTS

CONTINUOUS DISCLOSURE

STATUTORY RIGHTS OF INVESTORS

-RIGHT OF WITHDRAWAL

-RIGHT OF RESCISSION

-RIGHT OF ACTION FOR DAMAGES

5.TAKEOVER BIDS AND INSIDER TRADING

TAKEOVER BIDS

EARLY WARNING DISCLOSURE

INSIDER TRADING

INSIDER REPORTING

Derivatives

1. THE ROLE OF DERIVATIVES

Underlying asset

Two basic types: options and forwards. Both types are contracts between two parties: a buyer and a seller.

• The buyer in an option contract has the right, but not the obligation, to buy or sell a specified quantity of the underlying asset in the future at a price agreed upon today. The seller of the option is obliged to complete the transaction if called upon to do so. An option that gives its owner the right to buy the underlying asset is a call option; one that gives the right to sell the underlying asset is a put option.

• With forward contracts both parties oblige themselves to trade the underlying asset in the future at a price agreed upon today. Neither party has given the other any right; they are both obliged to participate in the future trade.

FEATURES COMMON TO ALL DERIVATIVES

• They are contractual agreements between two parties (often called counterparties): a buyer and a seller. The agreements spell out the rights (if any) and the obligations of each party.

• They have a price upon which the buyer and seller must agree; buyers try to buy them for as little as possible, whereas sellers try to sell them for as much as possible.

• They have an expiration date. Both parties must fulfill their obligations or exercise their rights under the contract on or before the expiration date. After that date, the contract is automatically terminated.

When a derivative contract is drawn up, it includes a price, or formula for determining the price, of an asset to be bought and sold in the future, either on or before the expiration date.

• With forwards, no up-front payment is required. Sometimes one or both parties make a performance bond or good-faith deposit, which gives the party on the other side of the transaction a higher level of assurance that the terms of the forward will be honoured.

• With options, the buyer makes a payment to the seller when the contract is drawn up. This payment, known as a premium, gives the buyer the right to buy or sell the underlying asset at a preset price on or before the expiration date.

DERIVATIVE MARKETS

• OTC derivatives : contracts can be custom designed to meet specific needs

EXCHANGE-TRADED DERIVATIVES

Derivative exchanges evolved in response to OTC issues, including concerns around standardization, liquidity, and default risk.

The Montréal Exchange (or Bourse de Montréal) lists options on stocks, indexes, and U.S. currency, as well as exchange-traded forwards (futures) on bonds, bankers’ acceptances, and indexes.

DEFAULT RISK

Canadian Derivatives Clearing Corporation (CDCC)

Exchange-Traded

• Traded on an exchange

• Standardized contract

• Transparent (public)

• Easy termination prior to contract expiry

• Clearinghouse acts as third-party guarantor ensuring contract’s performance to both trading parties

• Performance bond required, depending on the type of derivative

• Gains and losses accrue on a day-to-day basis (marking to market)

• Heavily regulated

• Delivery rarely takes place

• Commission visible

• Used by retail investors, corporations and institutional investors

Over-the-Counter

• Traded largely through computer and/or phone lines

• Terms of the contract agreed to between buyer and seller

• Private • Early termination more difficult

• No third-party guarantor

• Performance bond not required in most cases

• Gains and losses generally settled at the end of the contract, rather than marking to market

• Much less regulated

• Delivery or final cash settlement usually occurring

• Fee usually built into price

• Used by corporations and financial institutions

2. TYPES OF UNDERLYING ASSETS

Commodity futures and options are commonly used by producers, merchandisers, and processors of commodities to protect themselves against fluctuating commodity prices.

Financial derivatives

-Equity is the underlying asset of a large category of financial derivatives.

-Exchange-traded interest rate derivatives

-currency derivatives

3. THE USERS OF DERIVATIVES

• Individual investors

• Institutional investors

• Businesses and corporations

• Derivative dealers

INDIVIDUAL INVESTORS

exchange-traded derivatives only

INSTITUTIONAL INVESTORS

• Market entry and exit

• Arbitrage

• Yield enhancement

4. OPTIONS

Call Option

Holder (Long Position)

• PAYS premium to the writer

• Has the RIGHT to BUY the underlying asset at the predetermined price

• Expects the price of the underlying asset to RISE

Put Option

Holder (Long Position)

• PAYS premium to the writer

• Has the RIGHT to SELL the underlying asset at the predetermined price

• Expects the price of the underlying asset to FALL

Call Option

Writer (Short Position)

• RECEIVES premium from the buyer

• Has the OBLIGATION to SELL the underlying asset at the predetermined price, if called upon to do so

• Expects the price of the underlying asset to REMAIN THE SAME OR FALL

Put Option

Writer (Short Position)

• RECEIVES premium from the buyer

• Has the OBLIGATION to BUY the underlying asset at the predetermined price, if called upon to do so

• Expects the price of the underlying asset to REMAIN THE SAME OR RISE

OPTIONS TERMINOLOGY

• Strike price

• Option premium

• Expiration date

• Trading unit

• Americanstyle and Europeanstyle options

• Long-Term Equity AnticiPation Securities

• Opening transaction

• In-the-money

• Out-of-themoney and Atthe-money

• Intrinsic value

• Time value

BUYING CALL OPTIONS

Investors buy call options with either of two investment strategies in mind: to speculate in the hope of earning a profit or to manage risk.

WRITING CALL OPTIONS

Investors write call options primarily for the income they provide in the form of the premium.

BUYING PUT OPTIONS

A popular reason for buying put options is to profit from an expected decline in the price of the stock.

WRITING PUT OPTIONS

Investors write put options primarily for the income they provide in the form of the premium.

5. FORWARDS AND FUTURES

• Financial futures are contracts with a financial asset as the underlying asset. Common underlying assets include: Stocks Bonds Currencies Interest rates Stock Indexes

• Commodity futures are contracts with a physical asset as the underlying asset. Common underlying assets include: Precious and base metals Crude oil and natural gas Grains and oilseeds Meats and dairy Lumber

CASH-SETTLED FUTURES

Many financial futures are based on underlying assets that are difficult or even impossible to deliver. For these types of futures, delivery involves an exchange of cash from one party to the other.

MARGIN REQUIREMENTS AND MARKING TO MARKET

The Montréal Exchange lists financial futures.

BUYING FUTURES TO SPECULATE

BUYING FUTURES TO MANAGE RISK

6. RIGHTS AND WARRANTS

RIGHTS

A right is a privilege granted to an existing shareholder to acquire additional shares directly from the issuing company. There is no cost for shareholders to acquire these rights.

• subscription price or offering price

• record date

• ex-rights

• cum rights

Intrinsic Value of Rights

(S-X)/n

S = The market price of the stock X = The exercise or subscription price of the rights n = The number of rights needed to buy one share

WARRANTS

A warrant is a security that gives its holder the right to buy shares in a company from the issuer at a set price for a set period of time. In this sense, warrants are similar to call options. The primary difference between the two is that warrants are issued by the company itself, whereas call options are issued (i.e., written) by other investors.

Sweetener

1. THE ROLE OF DERIVATIVES

Underlying asset

Two basic types: options and forwards. Both types are contracts between two parties: a buyer and a seller.

• The buyer in an option contract has the right, but not the obligation, to buy or sell a specified quantity of the underlying asset in the future at a price agreed upon today. The seller of the option is obliged to complete the transaction if called upon to do so. An option that gives its owner the right to buy the underlying asset is a call option; one that gives the right to sell the underlying asset is a put option.

• With forward contracts both parties oblige themselves to trade the underlying asset in the future at a price agreed upon today. Neither party has given the other any right; they are both obliged to participate in the future trade.

FEATURES COMMON TO ALL DERIVATIVES

• They are contractual agreements between two parties (often called counterparties): a buyer and a seller. The agreements spell out the rights (if any) and the obligations of each party.

• They have a price upon which the buyer and seller must agree; buyers try to buy them for as little as possible, whereas sellers try to sell them for as much as possible.

• They have an expiration date. Both parties must fulfill their obligations or exercise their rights under the contract on or before the expiration date. After that date, the contract is automatically terminated.

When a derivative contract is drawn up, it includes a price, or formula for determining the price, of an asset to be bought and sold in the future, either on or before the expiration date.

• With forwards, no up-front payment is required. Sometimes one or both parties make a performance bond or good-faith deposit, which gives the party on the other side of the transaction a higher level of assurance that the terms of the forward will be honoured.

• With options, the buyer makes a payment to the seller when the contract is drawn up. This payment, known as a premium, gives the buyer the right to buy or sell the underlying asset at a preset price on or before the expiration date.

DERIVATIVE MARKETS

• OTC derivatives : contracts can be custom designed to meet specific needs

EXCHANGE-TRADED DERIVATIVES

Derivative exchanges evolved in response to OTC issues, including concerns around standardization, liquidity, and default risk.

The Montréal Exchange (or Bourse de Montréal) lists options on stocks, indexes, and U.S. currency, as well as exchange-traded forwards (futures) on bonds, bankers’ acceptances, and indexes.

DEFAULT RISK

Canadian Derivatives Clearing Corporation (CDCC)

Exchange-Traded

• Traded on an exchange

• Standardized contract

• Transparent (public)

• Easy termination prior to contract expiry

• Clearinghouse acts as third-party guarantor ensuring contract’s performance to both trading parties

• Performance bond required, depending on the type of derivative

• Gains and losses accrue on a day-to-day basis (marking to market)

• Heavily regulated

• Delivery rarely takes place

• Commission visible

• Used by retail investors, corporations and institutional investors

Over-the-Counter

• Traded largely through computer and/or phone lines

• Terms of the contract agreed to between buyer and seller

• Private • Early termination more difficult

• No third-party guarantor

• Performance bond not required in most cases

• Gains and losses generally settled at the end of the contract, rather than marking to market

• Much less regulated

• Delivery or final cash settlement usually occurring

• Fee usually built into price

• Used by corporations and financial institutions

2. TYPES OF UNDERLYING ASSETS

Commodity futures and options are commonly used by producers, merchandisers, and processors of commodities to protect themselves against fluctuating commodity prices.

Financial derivatives

-Equity is the underlying asset of a large category of financial derivatives.

-Exchange-traded interest rate derivatives

-currency derivatives

3. THE USERS OF DERIVATIVES

• Individual investors

• Institutional investors

• Businesses and corporations

• Derivative dealers

INDIVIDUAL INVESTORS

exchange-traded derivatives only

INSTITUTIONAL INVESTORS

• Market entry and exit

• Arbitrage

• Yield enhancement

4. OPTIONS

Call Option

Holder (Long Position)

• PAYS premium to the writer

• Has the RIGHT to BUY the underlying asset at the predetermined price

• Expects the price of the underlying asset to RISE

Put Option

Holder (Long Position)

• PAYS premium to the writer

• Has the RIGHT to SELL the underlying asset at the predetermined price

• Expects the price of the underlying asset to FALL

Call Option

Writer (Short Position)

• RECEIVES premium from the buyer

• Has the OBLIGATION to SELL the underlying asset at the predetermined price, if called upon to do so

• Expects the price of the underlying asset to REMAIN THE SAME OR FALL

Put Option

Writer (Short Position)

• RECEIVES premium from the buyer

• Has the OBLIGATION to BUY the underlying asset at the predetermined price, if called upon to do so

• Expects the price of the underlying asset to REMAIN THE SAME OR RISE

OPTIONS TERMINOLOGY

• Strike price

• Option premium

• Expiration date

• Trading unit

• Americanstyle and Europeanstyle options

• Long-Term Equity AnticiPation Securities

• Opening transaction

• In-the-money

• Out-of-themoney and Atthe-money

• Intrinsic value

• Time value

BUYING CALL OPTIONS

Investors buy call options with either of two investment strategies in mind: to speculate in the hope of earning a profit or to manage risk.

WRITING CALL OPTIONS

Investors write call options primarily for the income they provide in the form of the premium.

BUYING PUT OPTIONS

A popular reason for buying put options is to profit from an expected decline in the price of the stock.

WRITING PUT OPTIONS

Investors write put options primarily for the income they provide in the form of the premium.

5. FORWARDS AND FUTURES

• Financial futures are contracts with a financial asset as the underlying asset. Common underlying assets include: Stocks Bonds Currencies Interest rates Stock Indexes

• Commodity futures are contracts with a physical asset as the underlying asset. Common underlying assets include: Precious and base metals Crude oil and natural gas Grains and oilseeds Meats and dairy Lumber

CASH-SETTLED FUTURES

Many financial futures are based on underlying assets that are difficult or even impossible to deliver. For these types of futures, delivery involves an exchange of cash from one party to the other.

MARGIN REQUIREMENTS AND MARKING TO MARKET

The Montréal Exchange lists financial futures.

BUYING FUTURES TO SPECULATE

BUYING FUTURES TO MANAGE RISK

6. RIGHTS AND WARRANTS

RIGHTS

A right is a privilege granted to an existing shareholder to acquire additional shares directly from the issuing company. There is no cost for shareholders to acquire these rights.

• subscription price or offering price

• record date

• ex-rights

• cum rights

Intrinsic Value of Rights

(S-X)/n

S = The market price of the stock X = The exercise or subscription price of the rights n = The number of rights needed to buy one share

WARRANTS

A warrant is a security that gives its holder the right to buy shares in a company from the issuer at a set price for a set period of time. In this sense, warrants are similar to call options. The primary difference between the two is that warrants are issued by the company itself, whereas call options are issued (i.e., written) by other investors.

Sweetener

1. CASH ACCOUNTS AND MARGIN ACCOUNTS

• Clients with regular cash accounts are expected to make full payment for purchases or full delivery for sales on or before the settlement date. The settlement date is specified in the contract, generally according to the following industry rules: Government of Canada Treasury bills—on the day that the transaction takes place All other securities—two business days after the transaction takes place

• In contrast, margin accounts are used by clients who wish to buy or sell securities on partial credit. In such cases, the client pays only a portion of the purchase price and the investment dealer lends the balance to the client, charging interest on the loan.

2. MARGIN ACCOUNT TRANSACTIONS

• A long margin position allows investors to partially finance the purchase of securities by borrowing money from the dealer. Investors buy on margin with the expectation that the price of the security will rise.

• A short margin position allows investors to sell borrowed securities in the expectation that the price will fall, allowing the investor to buy back the shares at a lower price for a profit.

This requirement to deposit additional money is known as a margin call.

MARGIN RISKS

• Margin increases market risk

• Loan and interest must be repaid

• Margin calls must be paid without delay

SHORT MARGIN ACCOUNTS

Short selling

There is no limit on the amount of time that a short sale position

COVERING A SHORT POSITION

DECLARING A SHORT SALE

sell-order ticket Short (or S)

RISKS OF SHORT SELLING

• Borrowing shares

• Adequate margin

• Liability

• Buy-in requirements

• Insufficient information

• Price action

• Unlimited risk

• Regulatory risk

TRADING AND SETTLEMENT PROCEDURES

bid-ask spread

HOW SECURITIES ARE BOUGHT AND SOLD

TYPES OF ORDERS

• market order

• limit order

• day order

• good through order

• stop loss order

• stop buy order

• professional (PRO) order

1. COMMON SHARES

BENEFITS

• Potential for capital appreciation

• The right to receive any common share dividends paid by the company

• Voting privileges, including the right to elect directors, approve financial statements and auditor’s reports, and vote on important issues

• Favourable tax treatment in Canada of dividend income and capital gains

• Marketability—the shareholdings of most public companies can easily be increased, decreased, or sold

• The right to receive copies of the annual and quarterly reports, as well as other mandatory information pertaining to the company’s affairs

• The right to examine certain company documents, including its by-laws and its register of shareholders, at specified times

• The right to question management at shareholders’ meetings

• Limited liability

RISK

• The issuer has no obligation to pay dividends.

• Common shareholders generally have very little influence over the day-to-day operations of the company.

• Common share prices can be volatile, and price changes can lead to investors losing money.

• In terms of claims to assets, common shareholders fall behind creditors, bondholders, and preferred shareholders in the case of bankruptcy or dissolution.

CAPITAL APPRECIATION

retained earnings

REGULAR AND EXTRA DIVIDENDS

EX-DIVIDEND AND CUM DIVIDEND

Without dividend or with dividend

DIVIDEND REINVESTMENT PLANS

Dollar cost averaging

VOTING PRIVILEGES

Voting rights

RESTRICTED SHARES

• Non-voting shares carry no right to vote, except in certain limited circumstances.

• Subordinate voting shares carry a right to vote, if another class of shares is outstanding and those shares carry a greater voting right on a per share basis.

• Restricted voting shares carry a right to vote, subject to a limit or restriction on the number or percentage of shares that may be voted by a person, company, or group.

STOCK EXCHANGE REGULATIONS OF RESTRICTED SHARES

• Restricted shares must be identified by the appropriate restricted share term.

• Disclosure documents—including information circulars, annual reports, and financial statements sent to voting shareholders—must also be sent to holders of restricted shares, and the documents must describe the restrictions on their voting rights.

• Restricted shares must be identified in the financial press with a code.

• Dealer and advisor literature must properly describe restricted shares.

• Trade confirmations must identify restricted shares.

• Holders of restricted shares must be given notice of shareholders’ meetings. They must also be invited to attend and be permitted to speak at the meetings.

• Minority approval is required for any corporate action that would result in the creation of new restricted shares.

STOCK SPLITS AND CONSOLIDATIONS

Stock split or reverse stock split (or consolidation)

2. PREFERRED SHARES

THE PREFERRED SHAREHOLDER’S CLAIM TO ASSETS

Pari passu

PREFERRED ISSUE VERSUS DEBT ISSUE

• It is not feasible for the company to market a new debt issue because existing assets are already heavily mortgaged.

• Market conditions are temporarily unreceptive to new debt issues.

• The company has enough short- and long-term debt outstanding (i.e., its debt-to-equity ratio is high). Preferreds would increase the equity component

• The directors are reluctant to assume the legal obligations to pay interest and principal.

• The directors decide that paying preferred dividends will not be onerously expensive.

PREFERRED SHARE FEATURES

• Cumulative feature – Non-cumulative feature

• Callable feature – Non-callable feature

• Voting privileges

• Purchase fund

• Sinking fund

STRAIGHT PREFERRED SHARES

• They provide greater safety than common shares through preference to dividend and asset entitlements

• For individuals, they provide a tax advantage through the dividend tax credit.

• For corporations, they provide a tax advantage through preferred dividends received from taxable Canadian companies on a tax-exempt basis.

• They provide less safety than a debt investment because dividends are not a legal obligation. • They do not provide voting privileges (unless a stated number of dividend payments is in arrears).

• They have no maturity date.

• They are less marketable than common shares because there are usually fewer preferreds than common outstanding.

• They have limited potential for price appreciation compared to common shares. The price at which the preferreds could be redeemed by the issuer places a limit on any appreciation that might occur as a result of a decline in interest rates.

CONVERTIBLE PREFERRED SHARES

• They provide a two-way security because the holder is in a more secure position than the common shareholder, and yet the holder can realize a capital gain if the market price of the common shares rise sufficiently.

• They usually provide a higher yield than the underlying common shares.

• They provide the right to obtain common shares through conversion without paying a commission.

• They usually provide a lower yield than a comparable straight preferred.

• They sometimes convert into less (or more) than a standard trading unit of common shares, which in turn may be more difficult to sell than a standard trading unit.

• They revert to straight preferreds when the conversion period expires, if conversion has not taken place.

RETRACTABLE PREFERRED SHARES

• They provide a predetermined date and price at which to tender shares for retraction. The shorter the time interval to the retraction date, the less vulnerable the stock’s market price is to increases in interest rates. A straight preferred declines in price as interest rates rise, whereas a retractable preferred will not fall significantly below its retraction price as the retraction date approaches.

• They provide a capital gain if purchased at a discount from the retraction price and subsequently tendered at the retraction price.

• They sell above the retraction price and at least as high as the call price when interest rates decline sufficiently.

• They do not retract automatically; the retraction privilege expires if no action is taken by the holder during the election period.

• They become straight preferred shares if they are not retracted when the election period expires. If this occurs in a period of high or rising interest rates, the stock’s market value declines. The shares sell on a straight yield basis after the retraction privilege expires.

FLOATING-RATE PREFERRED SHARES

variable-rate preferred

• They are issued during periods in the market when a straight preferred is hard to sell and the issuer does not want to make the issue convertible or retractable. (Making the issue convertible could potentially dilute shareholder equity, whereas making it retractable allows holders to potentially force redemption at an inopportune time.)

• They are also issued when the issuer believes that interest rates will not go much higher than the rate on the new issue date. (The company is prepared to pay a higher dividend if interest rates rise, but if interest rates decline, of course, the issuer will pay a smaller dividend—subject, in most cases, to a guaranteed minimum rate.)

• They provide higher income if interest rates rise, but lower income if interest rates fall.

• They provide a variable amount of annual income that is difficult to predict accurately, but which reflect prevailing interest rate levels.

• As an investment, their market price is less sensitive to changes in interest rates compared to the market prices of straight preferred shares. The dividend payout of variable-rate preferreds is tied to changes in interest rates on a predetermined basis.

FOREIGN-PAY PREFERRED SHARES

3. STOCK INDEXES AND AVERAGES

• Gauge the overall performance and directional moves in the stock market.

• Enable portfolio managers and other investors to measure their portfolio’s performance against a commonly used yardstick within the stock market.

• Create index mutual funds.

• Serve as underlying interests for options, futures, and exchange-traded funds.

• S&P/TSX Composite Index

• S&P/TSX 60 Index

• S&P/TSX Venture Composite Index

• DJIA – THE DOW JONES INDUSTRIAL AVERAGE

• THE S&P 500

1. CALCULATING PRICE AND YIELD OF A BOND

PV=Cn+FV/(1+r)n

THE DISCOUNT RATE

The discount rate is the rate at which you would discount a future value to determine the present value.

CALCULATING THE FAIR PRICE OF A BOND

The fair price of a bond is the present value of the bond’s principal and the present value of all coupon payments to be received over the life of the bond.

Yield to maturity (YTM)

REINVESTMENT RISK

Because interest rates fluctuate, the interest rate prevailing at the time of purchase is unlikely to be the same as the interest rate prevailing at the time the investor reinvests cash flows from each coupon payment.

2. TERM STRUCTURE OF INTEREST RATES

• The general level of interest rates at any particular time

• The level of interest rates at different terms to maturity

Fisher Effect:

• The real rate of return

• The inflation rate

Because inflation reduces the value of a dollar, the return that is received, called the nominal rate, must be reduced by the inflation rate to arrive at the real rate of return.

Nominal Rate = Real Rate + Inflation Rate

THE YIELD CURVE

Yield curve is a curve showing several yields to maturity or interest rates across different contract lengths for a similar debt contract.

-Expectations theory : The expectations theory says that current long-term interest rates foreshadow future short-term rates.

-Liquidity preference theory : Investors prefer short-term bonds because they are more liquid and less volatile in price.

-Market segmentation theory : Yield curve represents the supply of and demand for bonds of various terms, which are primarily influenced by the bigger players in each sector.

3. FUNDAMENTAL BOND PRICING PROPERTIES

THE RELATIONSHIP BETWEEN BOND PRICES AND INTEREST RATES

When interest rates rise, bond yields also rise but bond prices fall; when interest rates fall, bond yields also fall but bond prices rise.

THE IMPACT OF MATURITY

The next important relationship to recognize is that longer-term bonds are more volatile in price than shorter-term bonds.

THE IMPACT OF THE COUPON

Lower-coupon bonds are more volatile in price percentage change than high-coupon bonds.

THE IMPACT OF YIELD CHANGES

The relative yield change is more important than the absolute yield change.

DURATION AS A MEASURE OF BOND PRICE VOLATILITY

• The value of a bond changes in the opposite direction to a change in interest rates: as interest rates rise, bond prices fall; as interest rates fall, bond prices rise.

• Given two bonds with the same term to maturity and the same yield, the bond with the higher coupon is usually less volatile in price than the bond with the lower coupon.

• Given two bonds with the same coupon rate and same yield, the bond with the longer term to maturity is usually more volatile in price than the bond with the shorter term to maturity.

4. BOND MARKET TRADING

THE SELL SIDE

• Investment banker

• Trader

• Sales representative

THE BUY SIDE

• Portfolio manager

• Trader

ROLE OF INTER-DEALER BROKERS

These brokers act solely as agents, bringing together institutional buyers and sellers in matching trades.

THE TRADE TICKET

• Specific details of the counterparties to the trade

• Full identification of the bond

• The bond’s Committee on Uniform Security Identification Procedure (CUSIP)

• The nominal

• The price

• The settlement date

• The name of the custodian

• The total settlement amount

CLEARING AND SETTLEMENT

Bearer bonds

Registered bonds

Bonds registered in book-based format

CALCULATING ACCRUED INTEREST

Accrued Interest = par amount X (coupon rate/100) X (Time Period/365)

5. BOND INDEXES

• As a guide to the performance of the overall bond market or a segment of that market

• As a performance measurement tool, to assess the performance of bond portfolio managers

• To construct bond index funds

CANADIAN BOND MARKET INDEXES

FTSE Global Debt Capital Markets offers a comprehensive set of Canadian bond indexes.

GLOBAL INDEXES

• Global bond indexes

• U.S. bonds

• Government bonds

• Emerging market bonds

• High-yield bonds