RSM230 Summer 2012

FINAL EXAM STUDY NOTES!

CH.8 - Stock Indices and Averages
Index a number that measures a number of stock prices so that a percentage change in this
index can be calculated over time. They serve as the underlying assets for options, futures,
and ETFs.
Average used for the same purpose, but is determined by summing up the number of prices
and diving by the number of items (equally weighted).
S&P/TSX Composite Index determined by the total market capitalization of a portfolio of
the most actively traded Canadian stocks. Its a market/value-weighted index. The stocks
are reviewed every quarter, and stocks can be replaced. A base value of 1000 was set in
1975.
S&P/TSX 60 base is 100
MidCap index contains 60 stocks that rank below S&P/TSX 60 in market cap, while the SmallCap
index contains the remaining stocks.
Dow Jones Industrial Average (DJIA) most widely quoted measure of NYSE stock
performance, but only includes 30 stocks. Its a price-weighted average, which reflects the
highest quality blue chip stocks in the US. Due to its low risk, it tends to underperform
broader indices like the S&P 500.
S&P 500 Index broader based market-weighted index that measures US stocks. Its used to
measure the investment performance of institutional investments.
NASDAQ Composite Index contains over 4000 OTC stocks and is market valued.
Wilshire 5000 Equity Index measures almost everything, and is the broadest based US
Index.
NYSE maintains market valued indices which include listed equities for: composite, industrials,
transportation, finance and real estate, and utilities.
Others Include: Nikkei (price weighted), FTSE 100 (UK, market weighted), DAX (Germany,
value-weighted with 30 blue chips).

Financials is NOT a subsector index in the Canadian market.

Under the Canadian system, capital gains are taxed at a rate equal to 50% of regular
income.
Pari Passu when different classes of preferred shares have the same rank in relation to
asset and dividend entitlement

CH.9 Equity Trading

Cash Accounts = not granted credit b the securities firm and have to make full payment o the
settlement date (same day for T-bills, 2 days for Govt direct and guarantees up to 3 years,
and 3 days for all other securities)

RSM230 Summer 2012

Margin Accounts = enable them to buy or short sell securities by paying only part of the full
price, borrowing the remainder from the member (with interest charged). The term
margin means the amount the investor must contribute to the margin account.
Maximum Loan Values for securities other than bonds and debentures are:
70% for securities eligible for reduced margin
50% for prices of $2 and over that are not eligible for reduced margin
40% for prices of 1.75 to 1.99
20% for prices of to 1.74
No loan value for under 1.50
When a margin falls below a level, theres a margin call requiring the client to deposit more into
their margin account, or else shares will be sold.
E.g. Cost is $2 x 1000 = $2000. ID max Loan = 0.5x2x1000 - $1000. Min Margin
Requirement = $2000 - $1000 = $1000. If price decreases, max loan decreases and there
is a margin deficit. If the prise rose, the max loan increases and there is a margin surplus.
Short Sales investor sells securities they dont own. The investor must leave the proceeds of
the sale with the dealer, and deposit a certain portion of the market value in addition. Its
like the opposite of buying on margin, and the required balances are:
130% for securities eligible for reduced margin
150% for prices of $2 or over
$3/share for 1.50 to 1.99
200% of market value for 0.25 to 1.49
100% of market plus 0.25/share for prices under 0.25
E.g. Short sell 1000 shares of stock at $10. The min account balance is 1.3 x 10 x 1000 =
13,000. The proceeds from the sale is $10,000. The min margin requirement is $3000.
The min account balance changes depending on MARKET PRICE.
There is no time limit on a short position, but the client must buy the necessary shares if the
broker is unable to borrow sufficient shares to do so. Thus, the stocks that are short sold
are usually actively traded one. TSX reports short positions twice a month. Hazards of this
include:
Difficulties in borrowing enough shares
Liability for any dividends paid
Possibility of volatile prices should a rush to cover happen
The unlited potential loss
Responsibility of having an adequate margin
Equity Transactions
Traditional equity transactions involve a buyer and a seller who are represented by an
investment dealer. The IAs report the current bid and ask for shares. After a transaction
occurs, both the buyer and seller receive a confirmation of the transaction, and are required
to settle in 3 business days. IAs can also be principals, where they fill a customers order
from their own inventory, and the trade is made at the market price.
Buy and Sell Orders
Market Orders best available price in the market
Limit Orders only if a specific price or better can be obtained
Day orders limit orders that are valid for one day

RSM230 Summer 2012

Good Till Cancelled/Open Orders limit orders that remain until filled, for 30, 60, or 90
days
All or None Orders only filled if the total number of shares can be bought or sold
Any Part Order accept any amount of shares, in round or odd lots
Stop Loss it generates market orders to SELL if the price drops below a certain point;
used to limit losses on long positions
Stop Buy Orders a market buy order is generated if the price rises above a certain
level to limit losses on short positions
Pro Orders transactions involving partners, directors, shareholders, IAs, or employees
The preferential trading rule requires IAs to give priority to client orders over those of nonclients, which include pro orders (labelled Pro, N-C, or Emp).
Market orders are made at the best available price, while day orders are made only if a specific
price or better can be obtained.
If an investment order doesnt specify the time in which the IA has to fill the order, then the
order remains open until the close of the business day or until filled, whichever is sooner.
CH. 11 Financing and Listing
Forms of Businesses:
Proprietorship not a separate legal entity, unlimited liability, capital generation restrictions,
income is taxes as personal income.
Partnership at least one general partner who is liable for all business debits. Limited partners
are not involved in daily business acitivty and liability is limited.
Corporation dominant form, separate legal entities, separation of ownership from
management, unlimited life, shareholders have limited liability and can transfer ownership,
greater access to capital.
A corp comes into existence when a charter is issued by the government, and may be: letters
patent, memos of association, or articles of incorporation.
Private corporations restrict the right of shareholders to transfer shares, limit the number of
holders to less than 50, and prohibit inviting the public to own it.
A corp is regulated by the government act which it was incorporated (provincial or federal), its
own charter, and its by-laws (whicha re passed by directors and approved by shareholders)
Significant events require the approval of shareholders: liquidation of businesses, changing
amendments, etc. All shareholders have the right to receive proxies and AFS.
Proxy the power of attorney that allows another party to vote on behalf of the shareholder.
If management obtains a sufficient number of proxies it can control the board of directors.
During restructuring, a corp may have a voting trust, which shareholders deposit their
shares with a trustee to transfer voting control to few individuals.
Structure
Corps are required to a have outside directors that are responsible for: appointing officers,
signing authorities, contracts, budgets, and declaration of dividends. They must act like a
reasonably prudent person. The board elects a chairman, who (or the president) can be the
CEO.

RSM230 Summer 2012

The max number of shares a corp may issue is the numberof authorized shares. Issued shares
refer to the number issued, while outstanding shares are those that are held by investors.
Par Value Shares no relationship to market value or enetitlement to corporate assets.
Advantages of Corporations:
Separate legal entity that can sue and be sued
Limited liability
Continuity of existence
Ease of ownership transfer
Professional management
Tex benefits
General enhanced capital accessing
Growth potential
Disadvantages:
A loss of flexibility
Possibility of double taxation
Additional admin costs
Complications involving withdrawal of capital
The Financing Procedure
The investment dealer advises the issuer regarding the amount, timing, pricing, and attributes
of the issue. Sometimes the dealer or broker may become the broker of record, which
gives them the right of first refusal on new financing.
- A private placement is an arrangement with private investors that doesnt need a ful
prospectus, just a offering memorandum.
- Public offerings are regulated by the Canadian Business Corporations Act and provincial
securities regulations. It must include full, true, and plain disclosure of all material facts
and material facts are those that affects/impacts the market price.
- The dealer will consider the financing structure, stability of earnings, prospects for the
future, as well as current market conditions before recommending an option

Debt Financing:
- Interest payments are tax deductible
- Not a permanent commitment
- Doesnt dilute ownership
- Some of the issuing discount may be tax deductible
- Lowest cost financing alternative
Equity Financing:
- No obligation to pay any portion of earnings as dividends
- Repayment of capital not required
- Managements actions are not restricted
- Greater cushion against insolvency and can improve the credit rating
A prelim prospectus is given to the securities commission and investors, which includes most
information except the price. A red statement means its not final, and a greensheet

RSM230 Summer 2012

(information circular) highlights the important features of the issue and can be used by the
sales department to generate interest.
There is a 75 day waiting period between the issuance of red herrings and final prospectuses.
After it is approved, the issue is blue skied and distributed to the public. Must be mailed to all
purchasers of securities on the second business day after the trade.
Short Form Prospective Distribution System saves time and focus on price, distribution
spread, use of proceeds, and security attributes. Allows senior reporting issuers who have
made public distributions already (already lots of info). They are common in BOUGHT
DEALS, where the underwriter buys all of it and resells it, bearing all risk.
Lead underwriters generally provide after-market stabilization of the issuers market price,
which must be disclosed on the first page of the prospectus. This may mean selling more
securities than the original amount, and buying it back if the price drops.
New share issues are usually traded OTC before listing on an exchange. Advantages of listing:
1. Prestige and goodwill
2. Established value in mergers
3. Market visibility, more information
4. Valuation for tax purposes, increased marketability
Disadvantages include:
1. Additional controls on management
2. Additional costs to the company
3. Market indifference (if trading volumes are low)
4. Additional disclosures required, the need to keep market participants informed
Listing requires the disclosure of info like:
1. The companys charter and current prospectus
2. The financial statements for the last 3-5 years
3. An opinion from the legal counsel
4. Sample share certificates
5. Annual reports
Listing Requirements Include:
1. The submission of annual and interim financial statements
2. Notification to the exchange about dividends
3. Proposed stock options for employees, underwritings, sale of treasury shares
4. Material changes In business of a listed non-exempt company
A listed security can be cancelled because: it no longer exists, has no assets or bankrupt,
public distribution is no longer sufficient, or it no longer complies with the terms of its listing
agreement.
CH. 13 Fundamental and Technical Analysis

Expected profitability and interest rates are the two most important factors affecting the value
of a security.

Fundamental Analysis looks at the economy, industry, and company, where the most
important factor is the future profitability of the issuer.

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Technical Analysis looks at stock prices, trading volumes, and market data to find recurring
patterns. Both may use quantitative analysis to find patterns of interest rates, economic
variables, and stock valuations to measure the factors influencing investment decisions.
Efficient Markets Hypothesis asset prices fully reflect available information
Random Walk Theory in efficient markets, prices will change randomly (no patterns)
Rational Expectations Hypothesis people make decisions consistent with all available info
same for everyone and wisely serve their own interests
Fundamental Macroeconomic Analysis: Factors
External effects like wars and elections
Fiscal Policies, such as taxes, govt spending
Monetary Policy, which affects interest rates and corporate profitability. The US
affects Canada strongly, and also monetary policy affects inflation, which affects bond
yieds. When inflation happens, the central bank raises interest rates, which leads to less
economic growth
o Tilting of the yield curve when short term interest rises and long term falls.
This relieves inflation, while the decline in long term rates makes equities more
attractive than bonds. Gains increase as the degree of tilt increases.
Flow of Funds capital flows from one asset class to another are determined by
changes in demand for bonds and stocks. A mutual fund purchase is an important factor
influencing the S&P/TSX index. Equity fund purchases rise as interest rates fall.
Inflation inflation causes uncertainty about the future, which higher interest rates,
lowers profitability and price-earnings. The growth on ROE is highly correlated with
changes in GDP and inflation.
Industry Analysis
S&P/TSX Composite Index is classified into 10 major sectors, and industry growth is compared
to GDP and inflation. IN order to be competitive, companies strive to become:
Either a low cost producer, or a producer of a differentiated product
All industries have a life cycle:
1. Emerging or initial growth new goods, may have negative cash flow, low yields, and
risky in nature
2. Rapid growth sales are growing, growth finance by reinvesting earnings and have high
P/E ratios with above average risk
3. Mature industries slowing of growth, more competition, slower sales but greater
financial resources. Dividends tend to be higher
4. Declining growth declines, profit magins fall
5 Competitive Forces determine the industry attractiveness:
1. Ease of entry or exit
2. Degree of competition
3. Availability of substitutes
4. Ability to exert pressure over selling price of products
5. Ability to exert pressure over the purchase price of inputs
ROE calculates profitability relative to the quity investment in a business.
ROE = net earnings before extraordinary items / total equity

RSM230 Summer 2012

Cyclical Industries earnings are affected to a larger than average amount by downturns in
the business cycle. ROE would vary by at least 100% over a complete cycle, while its 1/3
for defensive industries and 55% for the entire index. Usually commodity based, or
automobiles.
Defensive stocks sales are less affected by swings in the cycle, such as blue chip stocks.
Usually financial and utility companies are strong, but their earnings vary due to interest
rate changes.
Speculative industries great deal of risk, such as penny stocks or tech stocks.
Dividend Discount Model = Div/ r g
The model predicts that the value of commons shares will increase as a result of:
- Increases in expected dividends are related to profitability
- Increases in the growth rate of these dividends
- Decreases in the discount rate
Price-Earnings Ratio
Tend to increase during rising stock markets, rising earnings, falling interest rates, and overall
the level of investor confidence. Decline in the riskiness of cash flows and falling inflation
will also increase the P/E Ratio.
Technical Analysis
Three main assumptions:
1. All market actions are automatically accounted for in price activity, therefore
fundamental is not right
2. Prices move in a series of trends and patterns
3. The past repeats itself in the future
Some tools include chart, quantitative, cycle analyses, and sentiment indicators.
Moving Averages: adding the closing prices for a stock over a given period of time. If the
overall trend has been down, the MA line will be above the current prices, and if the price
breaks through the moving average line from below, its a buy signal. If price passes the
MA line from above, it generates a SELL signal.
Elliot Wave Theory the market moves in waves
Sentiment when CONSENSUS finds that more than 75% of those surveyed are bullish, then
the market is overbought, while when its below 25%, then it is oversold.
MC Questions
The rationale for technical analysis is inconsistent with the random walk theory and efficient
markets hypothesis.
Technicaly analysis involves looking at trading prices and volumes.
Rising inflation causes P/E ratios to decrease due to the upward pressure it exerts on interest
rates.
An investor who cares about income should buy shares of a company in a mature life cycle.
If the P/E ratio is higher, the price believes that it has greater growth potential because prices
are higher.
Inflation leads to more uncertainty, lower profits, and higher interest rates. It also results in
lower P/E multiples. P/E ratio are higher when it is in a growth or speculative industry, and
investor confidence is high.

RSM230 Summer 2012

Blue chip companies do not have growth in sales and earnings.
A resistance level is when supply exceed demand and prices beings to fall
CH.14 Company Analysis
Earnings statement analysis examines trends, and reasons, by using:
-sales
-operating ocsts and profitability
-profit margin, ROE, cash flow, EPS, and dividend record
Balance Sheet analysis gives a picture of overall financial position and examines:
-the effect of leverage on earnings
-the companys capital structure
-what types of securities have been issued
Qualitative analysis can also be taken to measure management effectiveness.
Common warning signs to look for in financial statements are:
1) Changes in accounting practices
2) Long term commitments
3) A series of mergers and takeovers
Four areas of firm operations that are often analyzed by ratios are:
1. Liquidity (ability to generate cash in a hurry to meet short-term obligations)
2. Risk analysis (ability to repay and assume more debt)
3. Operating performance (make use of assets to generate profits)
4. Value (relates the market value and returns with the companys shares to tis accounting
values)
Liquidity:
Working Capital: current assets current liability
Current Ratio: assets/liabilities
Quick Ratio: current assets inventory / current liabilities
Operating cash flow ratio: cash flow / current liabilities
Risk Analysis:
-Asset Coverage
-Debt percentage of total capital
-Debt/equity ratio (total debt outstanding/book value of shareholders equity)
Cash flow/total debt (operating cash flow / total debt)
Interest coverage (EBIT / interest) most important quantitative test. Higher ratio is better
Preferred dividend coverage (
Analyzing VALUE:
Dividend Payout Ratio: Total dividends/net earnings
Price Earnings Ratio: current market share price/EPS [net earnings pref div / # of common
shares]
CH. 17 Mutual Funds

RSM230 Summer 2012

Advantages of mutual funds include:

-professional management
-diversification
-variety of types of funds, purchase and redemption plans, special options
-liquidity and transferability
-loan collateral
-eligibiltiy for margin
Disadvantages:
-costs/sales fees
-unsuitable for short-term investment or emergency reserve
-management can make mistakes too
Tax complications may arise
The Structure of Mutual Funds
Investment funds are companies or trusts that sell their shares to the public and invest the
proceeds in a diverse portfolio. The funds earn income by interest, dividends, or capital
gains.
Usually open-end trust, which is redeemable and sometimes provide voting rights. The trust
itself isnt taxable, and the fund is established in a trust deed, which describes:
The investment objectives and policy
Investment restrictions and details about fund managers
Specifies which class of units will be sold to the public
Fund distributors parties that sell shares or units
Custodians collect and distribute cash for the fund as required (usually trust companies)
Load funds charge a commission on the purchase or sale of fund units or shares.
Front-end Load sales commissions when units are purchased
Back-end Load redemption fee when units are sold
No-Load funds dont charge direct selling charges, but have admin/management fees
Trailer Fees???
Switching fee for switching funds in the same company
Management fees 1% to money market and index funds to 3% to equity funds.
Management Expense Ratio = Aggregate Fees Payable in the Year/Average Net Asset Value
for the Year x 100%
This is charged directly to the fund, such that if a fund earned 20% and MER was 2%, the
investor gets 18%. F-class funds charge lower MERs.
Mutual Fund Dealers Association is a new SRO that regulates the distribution of mutual funds.
Fund buyers must receive copies of the simplified prospectuses no later than two business
days after an agreement of purchase. It should include:
- Significant holdings in other issuers
- Tax status and contracts outstanding

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-

Directors, officers, trustees

Financial statements including investment portfolio, changes in net assets, etc.

Unacceptable Sales Practices:

- Quoting a future price
- Offering to repurchase securities
- Advertising the fact that they are registered
CH. 18 Mutual Funds: Types and Features
Objectives generally cover the degree of safety or risk, whether income or capital gain is the
prime objective, and main securities in the portfolio. They vary significantly between funds.
1. Cash and Money Markets focus on income and liquidity (low risk and high liquidity,
although interest is fully taxable)
2. Fixed Income Funds steady stream of income, not capital appreciation. Bonds, income
trusts, mortgage funds. Mortgages are risker due to longer term interest rate risk
3. Balanced Funds provide a mix of safety, income, and capital appreciation, which must
adhere to min percentages in each asset class. Asset allocation funds are similar without
the requirements
4. Equity or Common Stock Funds objective is capital gains
5. Index Funds mirror the performance of a market index, and the fees are much lower
The order from low-risk low-return to high-risk and high-return are:
1. Money market
2. Mortgage
3. Bond
4. Balanced
5. Dividend
6. Equity
7. Real estate
8. Speciality
Risk of funds should be measured comparatively by:
-standard deviation of returns (total volatility)
-beta: the volatility of the funds returns relative to those in the market portfolio (risk)
-number of years it lost money
Avoid:
-funds history
-performance of peer group averages because they are survivorship biased
-short term comparisons (min 3years)
CH. 19 Segregated Funds
Unlike investment funds, they are exempt from securities laws. The holders dont own the
assets but are protected by provisions in the contract. They must guarantee that a min of
75% of the payments will be returned at the end of 10 years. There are no probate fees,
provide business owners with protection, but contract holders pay more for these benefits.

RSM230 Summer 2012

Maturity guarantees alter the normal risk return relationship because it allows market gains and
principal protection. There are three forms:
1. Deposit-based guarantees for each deposit made
2. Yearly policy based guarantees grouping all contributions made within a 12 month
period, and giveng them the same maturity date.
3. Policy based guarantees that base guarantees on the original policy issue date
Since the index has never been negative over a 10 year spread, there is debate as to whether
seg funds are worth it. Those with RRSPs must be terminated before 69, life income fund
holders must be below 90, and the start age is 16.
The proportion of seg funds they should hold is:
-risk tolerance
-proportion of funds alrdy held in cash and fixed income
-time horizonshorter = less need for seg funds
Since seg funds are insurance products, they provide protection from creditors, unlike mutual
funds. In order for this to apply, the fund must:
- For plans with revocable beneficiary status, the B must be a spouse, child, or parent of
the contract holder in Quebec
- The B must be a spouse, child, or parent of the annuitant in other countries
- Non registered plans with irrevocable Bs have no B restrictions (can be loan collateral)
Similar to mutual funds, seg funds have these fees:
-legal, admin, registration, mailing, and taxes (higher than MFs)
-Trailer and switching fees may also apply
Feature
Seg Funds
Legal Status
Insurance contract
Asset Ownership
Insurance company
Regulation Body
Provincial insurance
regulators
Maturity Guarantees
Min. 75% after 10 years
Death Benefits
Yes (some restrictions)
Creditor Protection
Yes (with conditions)
Probate Bypass
Yes

Mutual Funds
Security
The Fund
Ontario Securities
Commission
None
None
None
None

CH. 20 Hedge Funds

Hedge funds facer lighter regulation, and more flexibility in asset management. They are similar
to mutual funds because they both pool investments with sales charges, are sold by IDs,
and charge management fees. However, they can short, use derivatives for hedging or
speculation, may have liquidity restrictions, and sold thru memo offers to accredited
investors. They have higher returns (and risk) than MFs.
Eligible hedge fund investors include:
- High net worth and institutional investors issued through offering memos which
disclose less info than prospectuses. Three reasons for being exempt from prospectus:

RSM230 Summer 2012

Min. investment exemption - $150,000
Accredited investor exemption institutions with net assets of $5million or more
Offering memo exeption
Investors
Commodity Pools (MFs that use short selling through derivatives)
Closed-end funds (less restrictions)
PPNs provide exposure to returns of one or more hedge funds and have a
principal return guarantee by a bank or issuer
Although there are hedge fund indexes, none of them is exhaustive because the reporting of
information is optional.
o
o
o
Retail
o
o
o

BENEFITS:
- Offer diversification benefits and lower overall portfolio risk
- Risk minimization
- Higher absolute returns
- Potentially lower volatility with higher returns
RISKS:
- Light regulation
- Manager and market risk
- Complex investment strategies
- Liquidity constraints (not liquidlockupsmay charge early redemption fees and/or
require advanced notice)
- Incentive fees
- Tax
- Short-selling and leverage
- Business risk because hedge funds are small businesses
IAs must do due diligence before recommending any to the investor, such as:
1. Managers investment process and strategy
2. Fund details (AFS availability, historical returns, redemption policy)
3. Investors legal and taxation issues
4. Business issues (profitability, stability, financial backing)
Hedge Fund Strategies
(Lowest risk to Highest)
1. Relative Value exploit market inefficiencies or arbitrage opportunities, such as
a. Equity Market-Neutral: simultaneously creating long and short portfolios
b. Convertible Arbitrage exploit mispricings in convertible bonds or pref shares
relative to the common stock.
c. Fixed Income Arbitrage price discrepancies b/w interest rate securities and
other securities based on rates.
2. Event Driven exploit events such as m&a, stock splits, and buybacks.
a. Merger or Risk Arbitrage
b. Distressed Securities
c. High-Yield Bonds invest in junk debt securities that may be due for an
upgrade, be a takeover target, or undervalued
3. Directional Strategy take positions based on beliefs about future movements in
equity, debt, and FX markets. The highest risk.

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a. Long/Short Equity most popular hedge fund. Net exposure is long short
exposure / capital.
b. Global Macro
c. Emerging Markets
d. Dedicated Short-Bias
e. Managed Futures Funds commodity and currency markets, many are set up as
commodity pools
PPNs Principal Protected Notes
No min investment requirements, and involve three roles which may be the same person 1.
Guarantor or issuer, 2) the hedge fund manager, and 3) distributor. They are lightly
regulated, and include many costs, which include: marketing, trailer, broker, financing,
leverage, and set-up fees.
Exchange Traded Funds
Trusts that hold shares of companies in market indices in proportion to their weights in the
index. Trade in secondary markets. They differ from mutual funds by:
- They trade throughout the day on exchanges
- Lower management fees
- Lower portfolio turnover, reducing capital gains income and taxes payable
- They permit short selling
- May be purchased on margin
Popular types are i60s, which is 1/10 of the S&P/TSX 60 Index. Dividends are paid quarterly.
CH. 15 Portfolio Management
Investment Management Process: Security selection, asset mix, market timing, and portfolio
management.
Returns consist of two components: cash flow yield and price change.
Return % = cash flow + (ending value beginning value) x 100
Beginning value
Ex-post returns = past returns. Projected returns = ex-ante returns. The real rate of return
depends on nominal and inflation rates.
Real Return = Nominal Rate Inflation Rate.
There are many risks involved (see written notes), but the variability in a securitys total returns
is unavoidable, called systematic market risk.
It is estimated that asset allocation accounts for 80-90% of investment returns.
Portfolio Management:
1. Determine investment objectives and constraints (risk, return, time horizon, liquidity,
taxation) or constraints like ethical, tolerance for risk, legal, etc.
a. Three main investment objectives are income, capital gains (growth), and
preservation of capital(safety), with secondary objectives of liquidity and tax
minimization
2. Formulate asset allocation strategy

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3. Design investment policy statement formal written doc that says the guidelines agreed
upon by the manager and investor.
4. Implement asset mix
5. Monitor the economy, markets, portfolio, and client
6. Adjust the portfolio and measure performance
Beta = market risk, or volatility. If its less than 1, then it moves x% of the market movements
CH. 16 Portfolio Management Process
The Asset Mix
-Cash includes money markets, GICS, bonds of one year or less makes up 5% of a portfolio
-Fixed Income include medium to long term bonds, and non convertible preferred shares.
-Equity Assets commons hares, derivatives, options, etc.
Equity Cycle
Expansion maintain or increase stocks, since they are growing
Peak stop buying stock and invest in s/t instruments since interests will rise
Contraction lengthen terms of bond holdings and avoid stocks
Trough sell long term bonds (capital gains due to falling interest rates), start buying equity
P = Div(1) / r g
This dividend discount model can be used to interpret changes in equity prices:
a. If r is rising and g is falling, prices will fall
Young Investor with long time horizon = 5% cash, 20% fiex income, 75% equities
Middle-aged with kids = 10% cash, 30% fixed income, 60% equities
Retirement = 10%, 60% fixed income, 30% equities
The desired long term asset mix is called strategic asset allocation. Some techniques:
1. Tactical asset allocation (moderately active approach that allows managers shortterm deviations from long term asset mixes to take adv of market timing)
2. Dynamic AA (adjusts the asset mix as market conditions change)
3. Integrated AA (incorporate all of the above approaches)
Passively managed funds follow a market benchmark and reduce costs (buy and hold
strategies, indexing, or ETFs)
It requires a systematic monitoring of changes in investor circumstances and market conditions.
CH. 10 Derivatives
They derive their value from another underlying asset. They are either options or forwards, and
can trade on exchanges or OTC. However, OTCs termination is more difficult with no thirdparty guarantee. Instead of gains marked to market daily, they are settled at the end, and
delivery happens often. Trading costs are less visible and they are used by corps/institutional.
The Canadian Derivatives Clearing Corporation is the only one that issues and guarantees
all equity, bond, and stock option positions.

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Buying a call option can leverage a short position, so if the prices go up at least you can buy
the share back at a reasonable price/loss.
Naked call writers dont own the securities and must have margin accounts, whereas covered
call writers own the stock and dont have to maintain margins.
New option contracts are created in the primary market, and must be issued with the option
prospectus. Option sales settle the next business day, and exercise of options ettle in 3 days.
They are said to be in-the-money when they make a profit. The intrinsic value is the amount it
is in the money, or 0. Time value of money = Option Price Intrinsic Value
Futures and Forwards
Both buyers and sellers of futures must deposit and maintain margins on their accounts. The
accounts are marked to market daily.
Swaps are OTC contracts that are forward contracts that involve an agreement to exchange a
series of future cash flows.
Hedgers are participants who deal in the underlying commodity or financial asset and manage
risk by
1. Selling futures to pre sell inventories (gold)
2. Buying futures to lock in a future purchase price for the asset
Marketing to market refers to the daily settlement of gains and losses between those long and
those short futures contracts.