CSC - Exam #1 Terms

Retail firms

Retail firms

full service and discount brokerage firms for individuals.

Institutional firms

includes pension funds, mutual funds, and insurance companies.

Integrated firms

contains all aspects of retail and institutional firms.

Front office

in charge of portfolio management, marketing, sales, and trading.

Middle office

in charge of compliance, accounting, audits, and legal.

Back office

in charge of settlements and clearing.

Schedule I banks

large domestic banks. There are ownership restrictions on shares - must be widely held.

Schedule II banks

large foreign banks. Can do same activities as domestic banks.

Schedule III banks

foreign branches of banks. They are limited, with a more institutional focus.

Trust company

acts as a trustee.

Auction market

market in which securities are bought and sold by brokers acting as agents for their clients (stock exchanges).

Dealer market

a network of marketplaces. Here, trades are conducted OTC and consist of bonds and debentures.

Equity electronic trading system

competes with existing exchanges. They can only trade stocks that are on an existing exchange. They may have benefits such as different hours, better commission, etc.

Fixed-income electronic trading system

where almost all bonds are traded (such as CanDeal).

Structured product

has the characteristics of debt, equity, and the investment fund (can be in the form of principal-protected notes or index-linked guarantees).

IIROC (Investment Industry Regulatory Organization of Canada)

the Canadian investment industry's SRO. It carries out its responsibilities through setting and enforcing rules regarding the proficiency, business, and financial conduct of dealer firms and their registered employees.

MFDA (Mutual Fund Dealers Association)

the SRO that regulates the distribution (dealer) side of the mutual fund industry in Canada.

OSFI (Office of the Superintendent of Financial Institutions)

the federal regulatory agency whose main responsibilities regarding insurance companies and segregated funds are to ensure that the companies issuing the funds are financially solvent.

CDIC (Canadian Deposit Insurance Corporation)

a federal Crown Corporation providing deposit insurance against loss (up to $100,000 per depositor) when a member institution fails.

CIPF (Canadian Investor Protection Fund)

a fund that protects eligible customers in the event of the insolvency of an IIROC dealer member.

General acct. = $1M total

Separate acct. = $1M each

MFDA IPC (Mutual Fund Dealers Association Investor Protection Corporation)

provides protection for eligible customers of insolvent MFDA member firms.

General acct. = $1M total

Separate acct. = $1M each

Gatekeeper

protects markets from potentially illegal client activity by collecting information, monitoring activity, and reporting suspicious behaviour.

"Know your client" rule

salespersons must use diligence to learn essential facts about the client (including every account and order) before entering into the relationship, in order to make appropriate decisions for the client.

Ombudsman for Banking Services and Investments (OBSI)

an independent organization that investigates customer complaints against financial services providers (non binding, but may hurt the company's reputation if it does not comply).

Front running

when a broker puts his own account's order in front of a customer's order, knowing the customer's order will move prices so the broker can make a profit.

National "Do not call" List (DNCL)

prohibits telemarketers from calling any number on the list that has been registered for 31+ days.

Expansion

characterized by stable inflation, adequate inventory, start-ups exceed bankruptcies, strong stock market, rising market activity (leading indicator), and falling unemployment.

Peak

when demand outstrips capacity, wages rise, interest rates fall, sales decline, and inventory rises. Stock prices decline, and market activity declines.

Contraction

when economic activity declines, profits decline, spending declines, and saving increases.

Trough

when the bond market rallies (prices rise as rates fall), and consumers start spending again.

Recovery

when GDP returns to its previous peak, investment rises, and inflation is set to fall further.

Current account

includes the exchange of goods between Canadians and foreigners, earnings from individual income, dividends, and transfers for foreign aid.

Capital and financial account

includes the financial flows between Canadians and foreigners (selling assets or borrowing funds to deal with surplus/deficit).

Leading indicators

peak and trough before the overall economy (such as housing starts or stock market indexes).

Coincident indicators

change at the same time as the market - GDP.

Lagging indicators

change after the economy, such as unemployment.

Natural unemployment rate

the unemployment rate when the economy is at full employment.

Higher interest rates

• Increase cost of capital = leading to lower investment

• Discourages consumer spending

• May lead to economic slowdown

Exchange rates

increased by rising interest rates or sale of commodities.

Fiscal policy

In charge of: Govt. spending, taxation, borrowing, and Federal Budget

Monetary policy

In charge of: Canadian financial system (regulation, clearing, and settlement), Issuing bank notes, Act as Govt. fiscal agent (banker)

Overnight market

when the BOC changes the target overnight rate, other short-term and long-term rates tend to follow. It is based on a 50 basis point (0.5%) operating range.

Bank rate

the upper limit of the overnight operating interest rate band.

Sale and Repurchase Agreements (SRAs)

an open-market operation by the Bank of Canada used to offset undesired downward pressure on overnight financing costs. Used when the Govt. wants to slow down the economy a bit.

Special Purchase and Resale Agreements (SPRAs)

an open-market operation by the Bank of Canada used to relieve undesired upward pressure on overnight financing rates. Used to stimulate the economy.

Drawdown

a transfer from banks to the BOC to lower the money supply.

Redeposit

a transfer from the BOC to the banks to raise the money supply.

Liquid bonds

bonds with good trading volumes, where large trades are quick and prices are not affected (have a ready market).

Marketable bonds

have a ready market, but not liquid - such as private-placements (cannot be sold on the secondary market).

Negotiable bonds

bonds that are in "good delivery form" (easy to transfer ownership). In some ways, this is an antiquated concept (where bonds were physical). All bonds that trade on the market today are considered to be in "good delivery form".

Convertible bond

a bond with an option allowing the bondholder to exchange the bond for a specified number of shares of common stock in the firm.

• If the stock price < conversion price = acts like bond.

• If the stock price > conversion price = acts like stock.

Sinking fund

sums of money set aside out of earnings each year to provide for the repayment of all or part of a debt issue at maturity (mandatory).

Purchase fund

set up to retire a specific amount of bonds through purchases in the market, if they can be made at or below a stipulated price.

Negative pledge provision

a protective provision written into the trust indenture of a company's debenture issue providing that no subsequent mortgage bond issue may be secured by all or part of the company's assets, unless at the same time the company's debentures are similarly secured.

T-bills

Government of Canada bonds that mature in 3-month, 6-month, or 12-month maturities. They do not pay interest, but are instead sold at a discount and mature at par. The return is taxable as income, and not a capital gain.

Canada Savings Bonds (CSBs)

a type of savings product that pays a competitive rate of interest and that is guaranteed for one or more years. They may be cashed at any time and, after the first three months, pay interest up to the end of the month prior to being cashed.

Banker's Acceptance

a short-term commercial draft sold at a discount (similar to a T-bill).

Commercial Paper

a short-term corporate money market security.

Escalating GIC

the interest rate for these GICs increases over the term.

Laddered GIC

the investment for these GICs is evenly divided into multiple-term lengths. As each portion matures, it can be reinvested or redeemed (this diversification reduces interest rate risk).

Instalment GIC

an initial lump sum contribution is made for these GICs, with further minimum contributions made weekly, bi-weekly, or monthly.

Index-linked GIC

these GICs guarantee a return of the initial investment at expiry and some exposure to equity markets.

Interest-rate linked GIC

these GICs offer interest rates linked to the change in other rates such as the prime rate, the bank's non-redeemable GIC interest rate, or money market rates.

T-bill yield

[(100-Price)/Price] x (365/term) x 100

Current yield

Annual dollar amount of interest/Current market price

Bond selling at a discount

If bond price is less than $1000.

Bond selling at a premium

If bond price is greater than $1000.

Expectations theory

says that current LT interest rates foreshadow future short-term rates. According to this theory, investors buying a single LT bond should expect to earn the same amount of interest as they would buying two ST bonds of equal combined duration.

Liquidity preference theory

says that investors prefer ST bonds because they are more liquid and less volatile in price.

Market segmentation theory

says that the yield curve represents the supply and demand for bonds of various terms, which are primarily influenced by the bigger players in each sector.

Reinvestment risk

the risk that the coupons cannot be reinvested at the same interest rate that prevailed at the time of purchase.

Duration

a measure of the sensitivity of a bond's price to changes in interest rates (takes both maturity and coupon rate into account). The longer it is, the more a bond's price will change for a given change in interest rates.

Accrued interest

Interest that has built up but has not yet been paid. Pay both the stated asking price for the bond + Interest from the previous period.

Stated asking price x [Coupon rate x (term/365)]

Common share advantages

• Potential for capital appreciation

• Dividends

• Favourable tax rate

• Voting rights

• Limited liability

• Marketability

Dividend record date

date which recorded shareholders receive the dividend.

Cum dividend

up to the 2nd business day before record date.

Ex dividend

1 day before record date.

Dividend Reinvestment Plan (DRIP)

an investment plan that allows the investor to automatically reinvest stock dividends in the same company's stock without paying any brokerage fees

Subordinated voting

where shares are given preferential treatment (e.g. Class A shares = 1 vote/share; Class B shares = 10 votes/share)

Preferred share advantages

• No obligation to pay dividends

• No maturity date

• Greater flexibility

• No dilution of earnings

• No dilution of control

• Only entitled to a "fixed" return

Cumulative dividends

preferred dividends that accumulate from year to year until paid (in arrears).

Delayed floater preferred

entitles the holder to a fixed dividend for a predetermined amount of time after it becomes variable.

Convertible preferreds

preferred shares that can be converted into common stock at the bondholder's option. They provide a higher dividend yield than common shares, but lower than a straight preferred.

Retractable preferreds

preferred shares that the holder can force the company to buy back. As market rates rise, it becomes more desirable.

Floating preferreds

protects against interest rate increases. The downside is that dividends can decrease if interest rates call - it works both ways.

Foreign-pay preferreds

If the currency is strong, there is an opportunity for gain on foreign exchange. The downside is the risk of declining foreign exchange rates.

Deferred preferred shares

pays no dividend until a future maturity date. Dividends compound without having to pay annual taxes. At maturity, the dividends are taxed at interest income.

Buy-in

the obligation to buy back the stock after selling it short. Becomes effective if adequate margin cannot be maintained.

Confirmation

the document that a dealer sends to the client when a transaction is made (at the latest, by the next day).

Two main types of derivatives

options and forwards.

Exchange-traded derivative characteristics

• Standardization

• Clearinghouse acts as 3rd party guarantor

• Gains and losses accrue (marking to market)

• Heavily regulated

• Performance bond required

• Prices public immediately

• Delivery rarely takes place (usually want to profit or hedge - not typical to want the underlying asset)

OTC-traded derivative characteristics

• Customizable

• No 3rd party guarantor

• Gains and losses settled at the end of contract

• Less regulated

• Delivery usually takes place

Bourse de Montreal (Montreal Exchange)

where all options and futures in Canada are traded.

ICE Exchange

where agricultural options and futures in Canada are traded.

Intrinsic value

the "in-the-money" option of an option's price (either positive or zero, cannot be negative).