Example Question

Jane Smart wishes to partially finance her son's university education. She will contribute $2,000 per year into investments returning 6% per annum for the next 12 years. How much in total will Jane be contributing to her son's education?

Example Solution

Show your work as in either (i) or (ii).

i. $2,000 x 16.870 (FV Annuity 6%, 12 yrs) = $33,740

or

ii. Calculator (TI BA II +): 12 N, 6 I/Y, -$2,000 PMT, FV = $33,740 (rounded)

Required:

a.Kristen deposits $1,000 into a GIC paying 4% per annum. What is the future value of the GIC if it is left untouched for 5 years?

b.Stacey and Steven will need $20,000 to pay for their wedding in 3 years' time. They can earn a return of 3% per annum. How much will they need to deposit in a lump sum amount today (present value) so that they will have the funds needed to pay for the wedding?

c.Every year end, Triton invests $3,000 in Canadian growth stocks via his mutual fund for retirement savings. If Triton averages a 10% annual return and plans to retire 30 years from now, how much will he have in his mutual fund at retirement? (Solve for future value of an annuity.)

d.Tim is 25 years old and plans to retire at age 65. He wishes to have a $500,000 lump sum available at retirement to cover annual living expenses beyond his pension income. If Tim invests in the stock markets and receives an average return of 9% per annum, how much would he have to deposit each year to save up the desired $500,000?

Part 2: Fundamentals of Investing (36 marks total)

1. In one to two paragraphs, respond to the following comment made by Frank:
3. "I work as a department store greeter and earn only enough to pay my monthly bills. With such a small income, there is no value in starting an investment program."
5. (2 marks)
6. Consider the many factors that can affect investment choices. Then,
7. discuss safety and risk as factors affecting investment choice. (2 marks)
8. explain the difference between investing and speculating. (2 marks)
9. explain the concept of "investor risk tolerance." What are the three drivers of risk tolerance? (2 marks)
10. describe five types of risks that investors face when considering investment alternatives. (5 marks)
11. using a single paragraph, explain the difference between assets that focus on investment income and assets that focus on investment growth. In your answer, provide three examples of assets that are primarily income oriented, and three examples of assets that are growth oriented. (2 marks)
12. describe the reward/risk trade-off:

Level of Risk:

1.Financial security 2.Safety and income 3.Growth 4.Speculation

1. For each of these four levels of risk, list at least three types of investments that would be appropriate (three per level). (4 marks)
2. Of these four levels of risk, which level would you expect to provide the highest reward (investment return) and which level would you expect to provide the lowest reward? (1 mark)
3. define investment liquidity, and explain why having too little or too much liquidity may be detrimental to the investor. (2 marks)
4. explain the process of diversification and why it is important to investors.
5. (1 mark)
8. Investment alternatives
9. Discuss the main difference between equity financing and bond financing from the issuer's perspective. (4 marks)
10. Provide three reasons investors might choose segregated funds over mutual funds. (3 marks)
11. Provide two reasons investing in real estate can be risky. (2 marks)
12. What is the main reason investors are attracted to trusts as a type of investment, such as a real estate investment trust (REIT)? (1 mark)
13. Interest income, dividend income, and capital gains income
14. The textbook refers to interest income being taxed as ordinary income. Explain what is meant by ordinary income and what this means for tax purposes. (1 mark)
15. Explain why dividend income may have a preferred tax treatment. (1 mark)
16. Explain the difference between a capital gain and a taxable capital gain by defining the percentage of capital gains (often referred to as the inclusion rate) an investor is taxed on. (1 mark)

Part 3: Investing in Stocks (25 marks total)

1. Common stocks
2. What types of stocks might an investor seeking an income stream choose to invest in? (1 mark)
3. If an investor is not looking for an income stream from investing in stocks, then what would be the most likely motive for buying the stock? (1 mark)
4. Why do corporations split their stocks? (1 mark)
5. How does the pre-emptive right potentially benefit the investor? (1 mark)
6. Preferred stocks
7. What are the most important features of preferred shares? (1 mark)
8. What are callable preferred shares? (1 mark)
9. How do cumulative preferred shares differ from non-cumulative preferred shares? (1 mark)
10. Describe the conversion feature of preferred shares. (1 mark)
11. Stock market exchanges
13. Calculate the percentage returns generated over the past five years by the following three indices: TSX Composite, Dow Jones Industrial Average (DJIA), and S&P 500. Use the Globe Investor website to chart and estimate the returns. Choose an index, then view the five-year chart by clicking on the 5Y link above the chart. Hover your cursor on the beginning and ending of the graph line to see the price (this feature may not work in Internet Explorer). Once you have the beginning and ending values, use the formula
15. (End Price - Beginning Price)/Beginning Price
17. to calculate the total percentage return over the five-year period. Show your calculations, contrast the results, and discuss possible reasons for the differences between indices.
19. (6 marks)
21. Primary and secondary markets
22. What is the main difference between primary and secondary markets?
23. (1 mark)
24. Would an IPO (initial public offering) be traded in a primary or a secondary market? (1 mark)
25. Identify the market in which securities are traded between investors.
26. (1 mark)
27. Describe four long-term investment techniques that may be applied to developing a retirement savings plan for someone who may recently have graduated from university. (8 marks)

Part 4: Investing in Bonds (25 marks total)

1. From an investor's perspective, holding shares (equity) issued by a corporation represents ownership. As such, is it reasonable to suggest that when an investor purchases a bond issued by government or a corporation that the investor has essentially loaned money to the bond issuer? Discuss briefly. (4 marks)
2. What is the primary reason that corporations and governments issue bonds? Explain in one paragraph. (3 marks)
3. Explain the two sources of future cash inflow an investor will receive from holding a bond to maturity. (2 marks)
4. Is it possible to have a capital gain or capital loss if a corporate bond or Government of Canada bond is sold before maturity? If so, describe the economic factor that leads to the capital gain or capital loss. (2 marks)
5. The long-term average return for stocks typically exceeds that of bonds, so what is the attraction of holding bonds in an investment portfolio? (2 marks)
6. Answer the following questions about types of bonds and features:
7. How does a bond differ from a debenture? (1 mark)
8. Describe the type of security that may be provided for a mortgage bond.
9. (1 mark)
10. Horatio purchased a subordinated bond, which means his interests are secondary to other bondholders with respect to interest and principal repayment. What factor likely motivated Horatio to purchase the subordinated bond? (1 mark)
11. Why might a bondholder not be motivated to exchange his or her convertible bonds into shares of the corporation's common stock even if the market price of the stock exceeds the conversion price? (1 mark)
12. What motivated many bond issuers to exercise their call feature during the 1990s? (1 mark)
13. Considering strip bonds do not have coupon payments, how does the investor earn a return? (1 mark)
14. Canada Savings Bonds (CSBs)
15. CSBs are different from marketable bonds in that they are not transferable. If CSBs are not transferable, is a capital gain or capital loss for the investor possible? (1 mark)
16. Describe how an investor in CSBs earns a return for holding these assets.
17. (1 mark)

1. Bond ratings

On the Issuers section of the DBRS website, choose a sector and click "Search." On the results page, select the Research tab, and select a rating report of your choice.

Provide the issuer's name and sector, and the DBRS rating provided in the report summary (e.g., AAA, BB). Discuss(one to two paragraphs) how risky that investment may be from the investor's perspective.

Note: No registration at DBRS is required to answer this question-while the full reports are only available to subscribers, most reports have a brief description that includes the rating. If the report you select does not include the rating in a summary, select a different report. You may want to filter the search to only include rating reports.