1. BU 111 Review Qualitative Review (no numbers – just theory)

2. Bull Market Think the stock prices will increase Think the stock prices will increase –Go long in stock –But on Margin –Buy call options –Write put options

3. Bear Market Think the share prices will decrease Think the share prices will decrease –Short the stock –Buy Put options –Write Call options

4. Reasons for Investing Hedge against inflation Hedge against inflation Extra retirement money – protect against living forever Extra retirement money – protect against living forever Insure family against an early death Insure family against an early death Savings for future purchases Savings for future purchases Too lazy to work – like the free money Too lazy to work – like the free money

5. Short Sale Think the shares will decrease (bearish) Think the shares will decrease (bearish) You borrow shares from the broker You borrow shares from the broker Sell the shares in the market Sell the shares in the market Deposit the proceeds as well as a 50% deposit with the broker. Deposit the proceeds as well as a 50% deposit with the broker. If shares go up – you will receive a broker call. If shares go up – you will receive a broker call. Remember – you need to have 50% on deposit therefore the short call will be: Remember – you need to have 50% on deposit therefore the short call will be:

6. Short Call New deposit = Current market value (# of shares * share price) * 50% New deposit = Current market value (# of shares * share price) * 50% Short call = New Deposit – Old Deposit Short call = New Deposit – Old Deposit To cover a short you must go into the market and buy the shares. To cover a short you must go into the market and buy the shares.

7. Short Calls and Dividends When you short a stock, you are selling the shares that are borrowed from the broker. Therefore, you do not own the shares and do not have any of the rights associated with the shares. When you short a stock, you are selling the shares that are borrowed from the broker. Therefore, you do not own the shares and do not have any of the rights associated with the shares. Therefore, when a dividend is declared you will not receive it. In fact, since you sold someone else’s shares without their knowledge, you now owe them the dividend. Therefore, when a dividend is declared you will not receive it. In fact, since you sold someone else’s shares without their knowledge, you now owe them the dividend.

8. Short Call Risks Responsible for dividends if declared Responsible for dividends if declared Unlimited loss – price can go up forever Unlimited loss – price can go up forever Market conditions – bull vs. bear Market conditions – bull vs. bear Forced to cover at an inopportune time Forced to cover at an inopportune time

9. Margin Buy You think the stock price will increase (bullish) You think the stock price will increase (bullish) You borrow a set percentage from the broker and purchase X number of shares You borrow a set percentage from the broker and purchase X number of shares Amount usable (50% margin, $5000 to invest): Amount usable (50% margin, $5000 to invest): –50% * X = $5000 –X = $10,000

10. Margin Call When the stock price declines you will receive a margin call. When the stock price declines you will receive a margin call. The amount loaned by the broker is a certain percentage of the market value of the stock. The amount loaned by the broker is a certain percentage of the market value of the stock. To determine the margin call: To determine the margin call: –Compute the current market value –Multiply the margin percentage to determine what the broker will loan as of today

11. Margin Call Margin call = Amount of old loan – amount of new loan. Margin call = Amount of old loan – amount of new loan. When margin call is paid, the loan is deducted by that amount, and you only pay interest on the new loan amount. When margin call is paid, the loan is deducted by that amount, and you only pay interest on the new loan amount.

12. Margins and Dividends When you buy a stock on margin you own the stock (with all the rights) and owe the broker the amount of the loan. When you buy a stock on margin you own the stock (with all the rights) and owe the broker the amount of the loan. If the stock declares a dividend, then, since you own the stock you will receive the dividend in the entire amount. If the stock declares a dividend, then, since you own the stock you will receive the dividend in the entire amount.

13. Options Call Options – the right to buy shares (100 shares per contract) at a stated price (exercise price) Call Options – the right to buy shares (100 shares per contract) at a stated price (exercise price) Put Options – the right to sell shares at a stated price Put Options – the right to sell shares at a stated price Price of an option is a combination of the intrinsic value and time value. Price of an option is a combination of the intrinsic value and time value.

14. Factors affecting Option Prices Strike Price Strike Price Stock Price Stock Price Risk free interest rate Risk free interest rate Time to maturity Time to maturity Volatility Volatility Dividends Dividends

15. Intrinsic Value Intrinsic Value Intrinsic Value –Call = Stock Price – Exercise Price –Put = Exercise Price – Stock Price –Value of the option if exercised today, or 0. –The intrinsic value can never be negative

16. In the Money A call option is in the money when the price of the underlying shares has increased above the exercise price. A call option is in the money when the price of the underlying shares has increased above the exercise price. A put option is in the money when the price of the underlying shares has decreased below the exercised price. A put option is in the money when the price of the underlying shares has decreased below the exercised price. Options are at the money when the price of the underlying shares are equal to the exercise price of the option. Options are at the money when the price of the underlying shares are equal to the exercise price of the option.

17. Bonds Bonds are a fixed income investment Bonds are a fixed income investment Debenture – an unsecured bond (not guaranteed by mortgage) Debenture – an unsecured bond (not guaranteed by mortgage) Price of the bond is the present value of all future interest payments and the average capital gain/loss of the principle. Price of the bond is the present value of all future interest payments and the average capital gain/loss of the principle.

18. Bond Features Conversion – bond can be converted into a specific number of shares – option of the owner of the bond Conversion – bond can be converted into a specific number of shares – option of the owner of the bond Redemption – Company can redeem the bonds at their discretion Redemption – Company can redeem the bonds at their discretion Retractable – bondholder has the option to redeem the bond before maturity Retractable – bondholder has the option to redeem the bond before maturity Extendable – bondholder has the option to extend the maturity of the bond Extendable – bondholder has the option to extend the maturity of the bond Callable – firm recalls the bonds before maturity Callable – firm recalls the bonds before maturity

19. Bond Prices and Interest Rates Discount – bond price is below $1,000 Discount – bond price is below $1,000 –Interest rates have risen in the economy Premium – bond price is above $1,000 Premium – bond price is above $1,000 –Interest rates have dropped in the economy Par – bond price is equal to $1000 Par – bond price is equal to $1000 –Interest rates have not moved

20. Bond Prices vary inversely with Interest rates Because the price is made up of both a capital gain/loss and interest payments the bond prices will move with the prevailing interest rate. Because the price is made up of both a capital gain/loss and interest payments the bond prices will move with the prevailing interest rate. Since the interest rate is fixed, only the capital gain can move and therefore the price of the bond must change with the interest rates. Since the interest rate is fixed, only the capital gain can move and therefore the price of the bond must change with the interest rates.

21. Bond Prices and Interest Rates If the interest rates in the market go up, then the old bonds at the lower rate are less attractive and therefore need a discount in price in order to sell. If the interest rates in the market go up, then the old bonds at the lower rate are less attractive and therefore need a discount in price in order to sell. The capital gain achieved from this discount, helps to bring the yield of the bond to that of the going market rate. The capital gain achieved from this discount, helps to bring the yield of the bond to that of the going market rate.

22. Stocks Common stock Common stock –Usually have full voting rights –Not guaranteed dividend payments Preferred Stock Preferred Stock –Usually have no voting rights –Usually guaranteed dividends Dividends can accumulate (arrears) Dividends can accumulate (arrears) Participative – get extra dividends when more money is declared and a certain level of common dividends are done. Participative – get extra dividends when more money is declared and a certain level of common dividends are done.

23. Value of Stocks Overvalued – the stock is trading at a price that is greater then that of stocks of comparable risk. Overvalued – the stock is trading at a price that is greater then that of stocks of comparable risk. Undervalued – the stock is trading at a price that is less then that of stocks of similar risk. Undervalued – the stock is trading at a price that is less then that of stocks of similar risk.

24. Investor Preferences Different investors will require different mechanisms to invest: Different investors will require different mechanisms to invest: –Older people are generally on a fixed income and therefore cannot absorb a loss as readily as younger investors. Therefore, they would be more interested in fixed income securities such as bonds/GIC’s/preferred shares that have limited risk.

25. Investment Preferences cont… Younger people on the other hand are still working and therefore can make back potential losses and are willing to take more risk. They would then be more interested in high growth stocks and speculation. Younger people on the other hand are still working and therefore can make back potential losses and are willing to take more risk. They would then be more interested in high growth stocks and speculation. Remember it is best to have a well diversified portfolio no matter the age. Remember it is best to have a well diversified portfolio no matter the age.

26. Critical Success Factors Financial Performance Financial Performance Satisfied customers Satisfied customers Quality product and service Quality product and service Innovation and Creativity Innovation and Creativity Knowledgeable and dedicated staff Knowledgeable and dedicated staff

27. Relationship among CSF’s You will achieve financial performance when you have satisfied customers. You will achieve financial performance when you have satisfied customers. You will have satisfied customers when you have quality products/services. You will have satisfied customers when you have quality products/services. You will have quality products/services when you have innovation and creativity. You will have quality products/services when you have innovation and creativity. You will have innovation and creativity when you have a knowledgeable and dedicated staff. You will have innovation and creativity when you have a knowledgeable and dedicated staff.