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Investment Basics Clench Fraud Trust Investment Workshop October 24, 2011 Jeff Frketich, CFA.

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Presentation on theme: "Investment Basics Clench Fraud Trust Investment Workshop October 24, 2011 Jeff Frketich, CFA."— Presentation transcript:

1 Investment Basics Clench Fraud Trust Investment Workshop October 24, 2011 Jeff Frketich, CFA

2 2 Topics Risk and Return Fixed income (bonds) Equities (stocks) Asset Mix (how you combine stocks and bonds) Diversification

3 3 Risk and Return

4 4 Risk And Return In financial markets you get paid a Return for taking a Risk, and every investment contains some risk The two most common definitions or risk are the potential of permanent loss risk of borrower not paying back interest or principal risk of company not paying dividends or the value of company’s shares declining the volatility of day to day changes in the market value of investments how much and how often does the value of our investment change, for better or worse Fixed income (bonds and short-term money market investments) are typically less risky than equities

5 5 As An Investor, You Have 2 Options Make a loan to someone Cash deposit, GICs, bankers acceptances, commercial paper, money market, bonds Buy ownership in a company Purchase stocks All investments have Risk, it is only a matter of how much

6 6 Risk And Return Always a Tradeoff!! Risk Return Low Risk Low Return Higher Risk High Potential Return Cash Money Market Government Bonds Corporate Bonds Equities Canadian, U.S. & International Alternative Investments i.e. Private Equity, Hedge Funds

7 7 Fixed Income Securities (Bonds)

8 8 What Are Fixed Income Securities? They pay a fixed amount of income to the owner produce a steady income stream that you can use to budget Fixed income securities have a limited life at some point the security matures and the borrower pays back your principal Stocks do not ‘mature’ they exist as long as the company exists

9 9 Short Term Fixed Income Securities Examples of short-term (usually less than one year) fixed income include: GICs short-term borrowing by banks Treasury Bills short-term borrowing by Federal and Provincial Governments Bankers Acceptances and Commercial Paper short-term borrowing by corporations

10 10 Short Term Fixed Income Securities Examples of short-term (usually less than one year) fixed income include: Money Market a pool of treasury bills, bankers acceptances, commercial paper, short term bonds, all with a very short term to maturity

11 11 Long-Term Fixed Income Securities Examples of long-term fixed income include: Bonds long-term borrowing by governments (federal, provincial and municipal) and corporations Mortgage and Asset Backed Securities pools of mortgages that are packaged together and sold just like bonds

12 12 Bonds When talking about fixed income securities, we are usually talking about bonds Bonds are a contract that entitle the owner to regular interest payments and the return of their principal (original amount of the loan) when the bond matures Bonds are bought and sold in the open market, like stocks

13 13 Bond Example You receive the following interest payment each year 1 2 3 4 5 6 7 8 9 10 $40k $40k $40k $40k $40k $40k $40k $40k $40k $40k Total payments over 10 years is $400,000 ($40k per year for 10 years) Receive your principal of $1,000,000 back from the Government of Canada after 10 years, when bond matures Total money received over 10 years is $1,400,000 Suppose you buy a new 10 Year $1,000,000 Government of Canada bond with a 4% coupon:

14 14 Bonds: Changing Interest Rates Interest rates affect the price of most fixed income securities, especially bonds Interest rates (yields) go up and down, depending on what is happening in the economy; generally the better the economy, the higher the interest rate

15 15 Bonds: Changing Interest Rates Interest rates and the price of bonds move in opposite directions, i.e. when interest rates go up, bond prices go down; when interest rates go down, bond prices go up Interest rates Bonds prices

16 16 Bonds: Time to Maturity Can Have A Large Impact on Bond Prices The longer the time to maturity, the more volatile the bond price for a given change in interest rates a change in interest rates of 1% will not affect the price of a bond that matures tomorrow. however, a 1% change in interest rates will have a much larger effect on a bond that matures in 10 years

17 17 Bonds: Time to Maturity Can Have A Large Impact on Bond Prices

18 18 Credit Rating Agencies How do you know which bonds to buy and which to avoid? Your investment counsellor starts the process by reviewing what independent credit rating agencies say about the bond Two examples of credit rating agencies are Dominion Bond Rating Service and Standard & Poors

19 19 Credit Rating Agencies DBRS and S&P look at things like cash flows, earnings growth, the firm’s competitive position and future capital expenditures. The agencies come up with a grade representing the credit quality of the borrower. The better the credit quality, the higher the credit rating; the higher the rating, the lower the interest rate the borrower must pay on the debt.

20 20 Fixed Income – Credit Qualities Quality Counts Bond Rating Interest Rate Investment GradeAAA3% Best Quality (lowest risk, pays lowest rate of interest) AA4% A6% BBB8% Non-Investment Grade (Junk Bonds) BB10% B15% CCC??? Worst Quality (highest risk, pays higher rate of interest)

21 21 Equities (Stocks) (Shares of Companies)

22 22 Stocks What They Are Called equities or common shares Ownership of a piece of the company Create earnings (sales – expenses) Provide a return Capital gains (stock price goes up) Dividends Listed on a stock exchange Can be traded Can be risky

23 23 Stocks Why a Company Issues Shares Raise Money Start up the company Provide extra cash to run the business Buy property, plants, equipment Acquire other companies Alternative to borrowing money Spread the Risk of Ownership

24 24 Stocks What A Company Does With Earnings (profits) Reinvest in the Company (retained earnings) Buy back their own Shares Acquire another Company Pay Dividends to Shareholders

25 25 Stocks Why Investors Buy Them Investors – First Nations Provide long term Growth to a Portfolio Typically buy to hold for longer periods than traders/speculators For Total Return Capital gains Dividend income Traders/Speculators – NOT First Nations Make quick profits from an increase in price Capital Gains

26 26 ABC Company Stocks can provide two types of returns: 1. Dividends – Provides Income 2. Capital Gains – Provides Growth Stock Price = $100 Dividend = $4 ($1.00 paid each quarter) Dividend Yield = 4% Every year ABC stock pays $4/per share. So if you own 1,000 shares, you receive $4,000 in dividends each year for as long as you hold the stock Stock Returns

27 27 If ABC stock price rises you enjoy a Capital Gain Buy Price = $100 per share Price rises = $125 per share Capital Gain = $25 per share So if you bought 1,000 shares of ABC stock at $100 and the price goes to $125, you have a capital gain of $25,000 ($25 x 1000 shares) Stock Returns

28 28 Stocks What Makes Them Change In Price Earnings or Expected Earnings Company Business model Competitive position Revenues and Expenses Industry Anything affecting the particular industry or business of the company Economy Affects people’s ability to by Company’s products Consumer and Business spending Employment / Unemployment Interest Rates

29 29 Stocks What Makes Them Change In Price Demand for a Company’s Stock Information What is know or factual about the Company Company reports and results Past performance, Earnings, etc. Speculation What is assumed about the Company and its prospects Anticipation of changes to business and potential earnings Rumours about the Company Takeovers New business opportunities

30 30 Asset Mix: Combining Stocks and Bonds

31 31 Asset Mix Asset mix is another way of saying how much do you have in stocks and how much do you have in bonds Each Trust has its own unique return requirements and risk tolerance Asset mix will determine the risk/return levels in your trust portfolio generally, the more stocks you have the more risk you take

32 32 Asset Mix How do you decide on asset mix? Assessment of First Nation’s financial needs & long term goals ability to tolerate short-term loss in value ability to tolerate permanent loss of capital Professional help is recommended do it right the first time (very costly to fix later) avoid actual losses or lost opportunities

33 33 Asset Mix Example of asset mix choices: Under three years: fixed income only Three to five years balanced account with more fixed income than equities, i.e. 70% fixed income and 30% equities More than five years balanced account with more equities than fixed income, i.e. 40% fixed income and 60% equities EACH FIRST NATION/TRUST HAS IT’S OWN UNIQUE FINANCIAL OBJECTIVES AND CONSTRAINTS.

34 34 Diversification Balanced Portfolio Time Return Stocks Bonds Cash

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