Investing Chapter 3

What is Holding-Period Return (HPR)?

• HPR is the total return during the holding period

• including investment income and the change in the investment's value

What is the HPR formula?

HPR = (Income + Ending Value − Beginning Value) ÷ Beginning Value.

How do you calculate HPR if you buy for $50, sell for $54.80, and receive a $1.20 dividend?

HPR = ($1.20 + $54.80 − $50) ÷ $50 = $6 ÷ $50 = 12%.

If an investment rises from $50 to $54.80 and pays a $1.20 dividend, what is the price-only return?

($54.80 − $50) ÷ $50 = 9.6%.

What is the bid price?

The highest price a buyer is willing to pay.

What is the ask price?

The lowest price a seller is willing to accept.

When you buy a security, do you generally buy at the bid or ask?

The ask.

When you sell a security, do you generally sell at the bid or ask?

The bid.

What is the bid-ask spread?

The difference between the ask price and the bid price.

What is the bid-ask spread formula?

Spread = Ask − Bid.

If the bid is $24.95 and the ask is $25.05, what is the bid-ask spread?

$25.05 − $24.95 = $0.10.

What is a market order?

An order to buy or sell at the best available price.

What is the main advantage and disadvantage of a market order?

Advantage: high likelihood of execution and speed. Disadvantage: the execution price is not guaranteed.

What is a limit order?

An order that specifies the price you are willing to accept.

What is the main advantage and disadvantage of a limit order?

• Advantage: price control

• Disadvantage: execution is not guaranteed

What is a stop order?

An order that uses a stop price as a trigger to activate the order.

What is a stop-limit order?

An order that combines:

• a stop price that activates the order

And

• a limit price that controls the acceptable execution price.

If a sell stop-limit order has a stop price of $45 and a limit price of $44, what happens when the stock reaches $45?

• order becomes a limit order

• and the investor will accept $44 or higher

What happens if a stock drops immediately to $40 after a $45 stop and $44 limit are triggered?

• order may not execute

• because $40 is below the $44 minimum acceptable selling price

What is the DJIA and how is it weighted?

• Dow Jones Industrial Average contains 30 U.S. stocks

• price-weighted, meaning higher-priced stocks have greater influence

What is the S&P 500 and how is it weighted?

• broad U.S. stock-market index of large companies

• Uses market-capitalization weighting, so larger companies have greater influence

What is the S&P/TSX Composite and how is it weighted?

• A common benchmark for Canadian equities

• Uses float-adjusted market-capitalization weighting

How do you calculate percentage change in an index?

Percentage change = (Ending value − Beginning value) ÷ Beginning value × 100.

An index increases from 100 to 108. What is the percentage change?

(108 − 100) ÷ 100 × 100 = 8%.

What does T+1 mean?

• Trade date plus one business day.

• Most Canadian stock and bond trades normally settle one business day after the trade.

What does CIPF protect against, and what does it NOT protect against?

• Protects: Missing eligible cash/securities if the investment firm goes insolvent

• Does NOT protect: Market losses or bad investments/advice

What are the five things to check when evaluating investment information?

1. Source

2. date

3. evidence

4. incentive

5. value

What is a pump-and-dump scam?

1. Promoters create excitement about a stock, encourage investors to buy

2. drive up the price

3. then sell their own shares

4. leaving other investors with losses.

When does paying for investment research make economic sense?

When the expected benefit from the research is greater than the total cost, including the value of your time.

How do you calculate the net benefit of investment research?

Net benefit = Expected benefit − Cost of research − Value of time.

How do you calculate the value of research if a $175 research cost increases the expected return on a $10,000 investment from 6% to 9%?

• The increase is 3% × $10,000 = $300. Net benefit before time = $300 − $175 = $125.

• The research is worthwhile only if the value of the time spent is less than $125.

How do you calculate the value of a stock index when given stock prices and a divisor?

Add the stock prices together, then divide the total by the divisor.

If five stocks have closing prices of $120, $95, $80, $105, and $100 and the divisor is 0.775, what is the index value?

($120 + $95 + $80 + $105 + $100) ÷ 0.775 = $500 ÷ 0.775 = 645.16.

What happens to the price per share after a stock split?

• The number of shares increases while the price per share decreases proportionally

• so the overall value is not changed by the split itself

If a company has a three-for-one stock split and the stock price is $90 before the split, what is the price after the split?

$90 ÷ 3 = $30 per share.

What is Regulation FD, and what is a potential drawback?

• Regulation FD (Fair Disclosure) relates to the disclosure of company information

• Potential drawback: can restrict the flow of information to individual investors

Why might individual investors lose money by trading excessively on stray or complex financial data?

• Individual investors may lack the expertise to properly interpret complex financial information

• which can lead to excessive trading and poor decisions

What is a blue-chip stock?

A stock of a well-established company with a history of stable earnings.

What is a key risk of day trading?

Frequent trading can result in high transaction costs.

What is a cash account?

An account where securities are purchased using your own available money.

What is a margin account?

• allows you to borrow money from the brokerage firm

• to purchase securities

• using securities as collateral

What is execution?

Execution is when an order is actually filled.

What is settlement?

When the cash and securities officially change hands.

Why should you question the source of investment information?

• not all information is reliable

• verify the original source before relying on it

Why shouldn't you directly compare a technology firm with a banking company?

They are different industries with different risks and business factors.

What should you consider when deciding how to fund an investment account?

• where the money comes from

• whether you are using cash or margin

What four areas should you understand when executing an investment?

1. Price limits

2. trading costs

3. settlement

4. investor protection

What is the basic process for investing?

Research → Compare → Choose → Execute.

Can investment information guarantee an investment's future return?

No. It can help inform decisions, but future returns cannot be guaranteed.

What is a stock-screening tool?

• online tool that filters stocks

• using criteria such as dividend yield or P/E ratio

Why should investors be cautious about online message boards?

The qualifications and reliability of contributors may be unknown.

Where can investors find reliable Canadian economic information?

Bank of Canada publications.

What influences a market-cap-weighted index the most?

Companies with the largest market capitalization.

What does bond yield generally represent?

• return an investor would receive

• based on a bond's characteristics and holding it to maturity

What is a full-service broker?

A broker offering investment advice, research and personalized investment strategies.

What is a basic discount broker?

• lower-cost broker

• for self-directed investors

• who make their own investment decisions

What is one disadvantage of a basic discount broker?

Limited access to personalized financial advice.

What is a round lot?

100 shares or multiples of 100.

What is an odd lot?

A transaction involving fewer than 100 shares.

What is mediation in an investment dispute?

A mediator helps both parties negotiate a resolution.

How does arbitration differ from mediation?

An arbitrator or panel makes a decision on the dispute.

What information does a robo-advisor collect?

• Financial goals

• risk preferences

• current financial position

What is an investment club?

A group of investors who share knowledge and may pool money to invest together.

What is one educational benefit of an investment club?

Members learn investment research and portfolio management together.

What is descriptive investment information?

Factual information about past economic, market, industry or investment performance.

What is analytical investment information?

Current information used to make investment projections and recommendations.

What is one benefit of a financial advisor?

Personalized investment strategies based on an investor's goals.