CSC Summary

CH 1 CAPITAL MARKET Capital is mobile, sensitive to environment and scarce. Focus on indirect investment, savers buy securities issued by govies and corpries, who use these funds for direct Investments such as buildings, equipment, machinery, etc. Factors influencing capital flow: Political environment, economic trends, GDP, fiscal policy, monetary policy, ROI expected, risks, labour Source of capital: ONLY SAVINGS (can be from individuals, governments, corporations retained earnings) Retail Canadian investors had over $500b in personal savings at end of 2007 at chartered banks alone Other wealth sources include investments at trusts, credit unions, dealers (home equity, cash, insurance, etc.) Foreign investment in Canada concentrated in manufacturing, petroleum, natgas, mining, etc.) Government Annually, Minister of Finance presents govt budget to Parliament Provincial and municipal govies issue debt themselves and through Crown Corporations Municipalities responsible for streets, sewers, water supplies, police, protection, transportation, electricity Instalment debentures might be issued by municipalities to spread cost over several years Bonds backed by specific assets, debentures only backed by general credit of issuer and no specific pledge Investment Fund company that manages investments for clients Open end (mutual) fund: sells shares or units to investors, and invests this capital into securities FINANCIAL MARKETS Securities are needed as means of transferring capital. Well-organized market has low transaction costs, high efficiency, high liquidity and effective regulation. Investment advisors facilitate meeting of buyers & sellers. Auction markets are single central markets through which buyer and seller orders are channeled and matched. They compete against each other.Stock exchange is this market place to trade shares, rights, warrants, futures, options, installlment receipts, ETFs, income trusts and convertible debentures. 1) 2) 3) 4) 5) Toronto Stock Exchange: senior equities, debt instrments, income trusts, ETFs TSX Venture Exchange: junior equities, few debentures Canada National Stock Exchange (CNSX): securities of emerging companies ICE Futures Exchange: agricultural futures and options Montreal Exchange (Bourse de Montreal): derivatives, financial equity futures and options

Liquidity means frequent sales, narrow bid-ask spreads and small price fluctuations from sale to sale Dealer markets consist of dealer networks trading with each other, buy and sell to end consumers. Bonds and debentures trade through these OTC / unlisted markets 1) Dealers enter bid ask quotations, have inventory of securities to trade 2) Charges commissions for this service 3) Derivatives are also traded, this market dominated by large financial institutions 4) No regular market hours, no trading floor, open 24 hours a day, complex products 5) No requirement to report unlisted trades (Exception: Ontario) 6) Ontario Securities Commission (OSC) requires reporting through Canada Unlisted Board Inc. 7) CUB is automated system after reorganization of equity markets, Internet-based system for dealers to report compled trades in unlisted securities

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Quotation and Trade Reporting Systems (QTRS) are recognized stock markets operating similar to exchanges and provide facilities to userts to post quotations and report trades (bid and ask postings). Market does NOT match orders, they are negotiated and trades are reported Traditional model for NASDAQ Alternative Trading Systems (ATS) are privately owned computer networks, also referred to as PETS that match orders for securities outside exchanges. Profits made through commissions. Much slower than in the US Examples locally: Bloomberg Tradebook Canada, OMEGA ATS, Chi-X, Alpha Trading System Could threaten stability due to less transparency, technological glitches, cross-border trading, regulated CanDeal member of IIROC, joint venture between CDNs 6 largest dealers ATS and INVESTMENT DEALER It allows investors access to federal bond bid offer prices and yields from 6 bank-owned dealers CBID member of IIROC and ATS, operates RETAIL and INSTITUTIONAL markets: accessible by registered dealers, investors, govies, pension funds (Debt Instruments mostly 1st electronic fixedincome dealer) CanPX joint venture of IIROC and IIAC (association Canada) providing real-time bid offer prices (bonds, T-bills, provincial and corporate bonds) Private Equity can be stocks, bonds, debentures. Good example is venture or risk capital. Leveraged Buyout, Growth Capital, Turnaround, Early & Late Stage Ventures and Distressed Debt

Stock

exchange ownerships: are divided into not-for-profit and for-profit membership ALL CDN EXCHANGES set up as FOR-PROFIT memberships Members are known as participating organizations or approved participants Admin and policy setting are responsibilities of each exchanges BOD: 1 permanent exchange official, experienced senior executives from member firms, 2-6 highly qualified governors, Provincial securities acts allow exchanges to exercise considerable self-regulation Define acceptable standards of behaviour, trading rules, listing and reporting requirements for companies

Financing of Exchanges: Transaction fees, listing fees, sustaining fees (corporations to keep listing in good standing) Sale of historical trading, market information Largest Stock Exchanges in the World: NYSE, Tokyo SE Group, NASDAQ, NYSE Euronext, London SE, Shanghai SE, Hong Kong Exchange, TMX Group, BME Spanish Exchanges, BM&F BOVESPA (Brazil) CDN Stock Exchanges: 1) Securities trading started in Canada in 1832 2) 1999 Canadas 4 major exchanges did some restructuring to ensure strong global market competitiveness 3) TSX became Canadas senior-equities market, gave up derivatives trading and juniors 4) Alberta, Winnipeg and Vancouver stock exchanges merged to the CDN Venture Exchange (CDNX) 5) Montreal Exchange exclusive for financial futures and options 6) CDNX became subsidiary of the TSX, which abbreviated from TSE to TSX 7) CDNX renamed the TSX Venture Exchange, purpose 8) TSX Markets Inc. is the arm of TSX that sells market information and trading services 9) Investment Industry Regulatory Organization (IIROC) regulates trading, dealers must be member

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CSC Summary
CH 2 THE CANADIAN SECURITIES INDUSTRY Provinces have power to create & enforce their own laws Self-Regulatory Organizations (SROs) establish and enforce industry regulations to protect investors Trades are settled through organizations like Clearing & Depository Services Inc. Canadian Investor Protection Fund (CIPF) provide insurance against insolvency of dealer members INVESTORS BROKERS & DEALERS USERS OF CAPITAL SROs CSI Education MARKETS CIPF CLEARING & SETTLEMENT PROVINCIAL REGULATOR

In 2009, 200 members of the IIROC RBC employed over 70,000 people, assets = $654 billion Intermediaries: organizations that facilitates trading between financial instruments (transfer of capital) Most banks own a number of subsidiaries (dealers, trust companies, insurance subsidiaries) Investment Dealers (brokerage firms or securities houses): 1) Transfer capital from savers to users (underwriting and distribution of new securities) 2) Maintain secondary markets in which outstanding securities can be traded Why have chartered banks grown in number and size? Higher international activity, creation of more banks, foreign-owned Schedule II and III banks Purchase of trust companies by banks Changes in Bank Act permitting banks to compete A) Integrated Firms B) Institutional Firms C) Retail Firms

Generate about 70% of industry revenues Most underwrite debt and corporate equity issues Research, portfolio management , M&A advice, tax counselling, loans, safekeeping securities Operational structure: market share, number and location of employees, business mix, specialization Smaller dealers (investment boutiques): stock & bonds trading, reserach, insitutional trading, unlisted stock trading, arbitrage, portfolio management, underwriting of junior companies, mutual funds, tax-shelter Wealth Management: focuses on retail and institutional clients Global Capital Markets: trading, investment banking, institutional sales Management: chairman, president, vp, directors, etc. The following departments exist inside a securities firm A) Sales Department: very geographically dispersed i) Institutional deal with major traders at large financial institutions ii) Works with trading department to create trading volume iii) Located at head and major branch offices iv) Retail sales is smaller (investment advisors) v) IAs must be of legal age, passed CSC, Conduct Practices Handbook, 90-day training program vi) IAs must have passed the Wealth Management Essentials Course (30 months after registration) vii)Have to advise clients on financial goals, processing orders, investment decisions follow guidelines

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B) Underwriting / Financing Department: individual companies, governments interested in raising capital i) Type of security, price, interest, dividend rates, protective provisions C) Trading Department: works with underwriting and sales i) Divided into bonds, stocks, specialized products ii) Bonds typically traded out of inventories (govies, provies, municipals, corporate) iii) Stocks (common and preferred) typically trade on exchanges (buy/sell orders, phone calls) iv) Specialized instruments mutual funds, commodities, futures, contracts, etc. D) Research Department: economist, fundamental, technical analysts i) Study industries, economic & markettrends, research coverage ii) Institutional and retail (IAs make personal proposals) iii) Help underwriting and corporate finance in special studies (institutional) E) Administration Department: i) Operations: recording and accounting of all trades ii) Credit & Compliance: focus on clients accounts (transactions) iii) Financial: payroll, budgeting, financial statements, controls) How are securities firms financed? Originally by founders capital, retained earnings and loans. Very highly leveraged, usually most of their revenues from commissions. Returns for financial shigh during bull markets. Firms are typically vulnerable to business swings, bond and stock market fluctuations, securities price and interest rates. Dealer, Principal & Agency Functions Principal securities firm owns securities as part of its inventory (transaction with investors) Agent facilitate active and liquid secondary markets for transfer of securities (commissions) Underwriting purchase from government body / company NEW ISSUE of securities, anticipate making a profit when selling securities to investors. Risk that prices may fall. Dealer advises issuer on market conditions Principal Trading secondary markets market making. Routinely conducted on OTC markets. Dealers knowledge of secondary market conditions help them advise clients of how to issue new offerings. Adds to liquidity and efficiency (investors dont have to find buyers / sellers and wait) Broker agent or intermediary (earns a cut through commissions) CDS Clearing & Depository Services Banks, investment dealers, trust companies have access to this institution. Daily settlement process between members greatly shortens transaction costs and enhances effficiency. CDS founding member of Cdn Capital Markets Association. Trends in Securities Industry a) Mergers, alliances between CDN and global brokerage houses b) Harmonization of securities laws, creation of national securitie regulator c) Trend towards FEE-based accounts instead of COMMISSIONS-based. Switch from individual ownership to managed products like mutual funds d) Creation of innovative financial products BANKS (FINANCIAL INTERMEDIARIES) Bank Act: sets out specifically what banks may do, operating regulations; Banking Industry:

CSC Summary
2009: 77 banks (22 domestic, 26 foreign subs, 29 foreign branches) Largest six banks control 90% and $2.9 trillion in assets, employs 249k people Regulations designed to protect Canadian banks from foreign competition Schedules I, II, and III (most Canadian-owned banks Schedule I, and foreign are Schedules II and III) Voting shares of Schedule I must be widely held (less than 20% per shareholder) Banks less than $5 billion in Shareholders Equity can be owned by single shareholder (65% voting shares) Remaining shares have to be publicly traded Small bank (SE of < $1 billion) can be owned by individuals or organizations Banks can now hold other corporations: IT, E-Commerce, Real Estate, etc.

Schedule I Banks: 22 banks (RBC, CIBC, BMO, TD, SCOTIA, NATIONAL included) More than 9,000 retail branches, over 50,000 ABMs (business) Consumer, commercial banking products & services, mortgages, loans, accounts, investments, asset management, some through subs, mutual funds, financial planning, etc. Inv estment dealer activ ities, discount brokerag, and insurance must be handled by subsidiaries. CHINESE WALL sets controls about how different subsidiaries of banks can share information Schedule II Banks: Schedule II INCORPORATED in CANADA, operate as federally regulated foreign bank subsidiaries Accepting deposits eligible for protection from CDIC (AMEX, Citibank, BNP Paribas) May engage in all types of business of Schedule I (RETAIL and ELECTRONIC SERVICES mainly) Schedule III Banks: Federally regulated foreign bank branches of foreign institutions authorized by Bank Act HSBC, Comerica Bank & Bank of NY Mellon are examples Tend to focus on CORPORATE and INSTITUTIONAL FINANCE, IBANKING Trust and Loan Companies Many services overlap with chartered banks. Issue deposits, accept savings, personal and mortgage loans, sell RRSPs, other tax-deferred plans. Regulated under Trust and Loan Companies Act and by the OSFI Credit Unions (Caisses Populaires) Many investors felt banks too profit-oriented. Offer various services like deposit taking and lending, mortgages, mutual funds, insurance, trust services, debit and credit cards, etc. Governed by the federal regulation Cooperative Credit Associations Act. Limits activities to providing financial services to their members, which they have substantial investment. Requires adherance to prudent portfolio approach Insurance Companies Employs 200k people, $400 b assets. 2 main businesses, life insurance and property & casualty insurance. Source of funds mainly premiums on health, disability, term, whole life and pension plans. Largest premiums created by auto industry. Life insurance companies act as TRUSTEES, must be extremely cautious about investment selection. Underwriting in this case means assessing business risks and evaluating premiums. Governed by the Insurance Companies Act of 1992. Permits life insurance to own trust and loan companies through subsidiaries, and also could own Schedule I banks. However, it restricts in-house trust services and deposit-taking. Prudent portfolio approach which replaces legal for life brules (prohibited in acquiring substantial investments in unauthorizeed financial & quasi-financial entities) Trends in Insurance

CSC Summary
Demutualization process by which insurance companies reorganize into being owned by shareholders rather than policy holders. Gives them access to capital markets and make acquisitions. Likely leads to consolidation, emergence of larger, fewer companies. Banks can own insurance companies but are restricted in distriubtion of insurance products. Companies have access to the Payments System. Can offer chequing accounts, debit cards Investment Funds sell shares to the public and invest them in diverse portfolio 1) Closed-End Funds only issue shares at startup. 2) Open-End (MUTUAL) Funds continually issue shares to investors. Range in term of risk-preferences Savings Banks Alberta Treasury Branches formed in 1938. Funds on deposit guaranteed by province (100%) Sales Finance make direct cash loans to consumers (purchase at discount sales contracts)

CH 3 CANADIAN REGULATORY ENVIRONMENT Office of the Superintendent of Financial Institutions (OSFI) established in 1987 to REGULATE and SUPERVISE 153 deposite taking institutions (banks, trusts, credit unions, life insurance companies, etc). It does NOT regulate the Canadian securities industry. Also provides advice to Govt of Canada. Canadian Deposit Insurance Corporation (CDIC) is a fed crown corporation, 1967 to provide DEPOSIT INSURANCE and stabilize financial system. Insures $100,000 per eligible depositor in eaach member institution (banks, trusts, loan companies, etc.) Products include savings, chequing accounts, GICs (less than 5 years), money orders, certifed cheques, bank drafts, etc. It does NOT insure mutual funds, stocks, GICs more than 5 years, bonds, T-bills, debentures, etc. Note: Could have > $100,000 in deposits eligible, but must be held in more than one of CDICs 6 Deposit Insurance Categories in 1 name, jointly >1 name, trust acccount, RRSP, RRIF, mortgage tax acct Credit Union Deposit Insurance Corporation (CUDIC) established in BC 1958 to protect credit unions, unlimited deposit insurance protection on all deposit and money invested in non-equity shares with a BC credit union. Accrued interest & unpaid dividends are included. In Ontario, each client of a credit union or caisse populaire is insured up until $100,000 for combination of principal, interest, dividends. Canadian Securities Administrators (CSA) is the group of 13 provincial Canadian securities regulators, a forum to coordinate and harmonize regulation of capital markets. Self-Regulatory Organizations (SROs) are private organizations that have been granted the privilege of regulating their own members.The provincial securities commissions monitor the conduct of SROs. If an SRO rule differs from a provincial rule, the more strict of the two applies. Investment Industry Regulatory Organization of Canada (IIROC) and Mutual Fund Dealers Association IIROC was the consolidation of Investment Dealers Association of Canada and Market Regulation Services Financial Compliance (ensure dealer members have enough capital to carry out operations) Business Conduct Compliance (ensure policies and procedures are being properly placed) Registration responsibility for overseeing professional standards and educational programs

CSC Summary
Enforcement includes making sure rules and regulations are being followed Market surveillance by regulating securities trading and market activities in marketplaces Enforcing timely disclosure of information by publicly traded companies

IDA has two missions: protecting investors and creating professional association for members April 1, 2006, the professional association was separated into Investment Industry Association of Canada IIAC provides support and services, represents investment industrys views and interest to provies and govies. MFDA regulates distribution and sales of mutual funds. The CIPF primary role is INVESTOR PROTECTION and OVERSEEING SROs. No compensation from changing market values of investments, mutual funds or non-members of IIROC. Dec 2009 $559M to pay claims. Covers customers losses of securities and cash balances from insolvency of an IIROC member. Certain persons excluded, such as those who deal with CIFP members through accounts for financing purposes, securities lending are NOT eligible. Limited to $1MM for losses with regards to cash and securities. If the CIPF is insolvent, quarterly assessments wihin prescribed limits will be charged against dealer members, proceeds will be distributed until the Fund has been discharged. Works with financial examiners and senior regulatory officials to provide regulatory oversight. Under supervision of the CSA, CIPF and SRO reviews national standards for capital adequacy, etc.

MFDA Investor Protection Corporation (MFDA IPC) protects eligible customers from insolvence of MFDA member firms, limited up to $1 MM per customer account. Covered as part of a GENERAL or SEPARATE account, similar to a CIPF. Separate include RRSP, RRIF, etc. Note: Clients who feel they have been treated unfairly by SROs can go through arbitration. SROs can only DISCIPLINE member firms, but CANNOT order restitution. Clients must receive arbitration brochure when opening an account. Going through arbitration forfeits chance to go through courts. Before arbitration, 1) Attempts must have to solve problem with dealer member 2) Claim CANNOT exceed $100k 3) Events must have originated after 1992 in BC, after 1996 in Quebec, after 1998 in Ontario Note: Alternative is the Ombudsman for Banking Services and Investments (OBSI) independent organization investigating complaints against financial service providers, give prompt and impartial solutions. Ombudsmans decision is non-binding, but those failing to comply till be publicly reported (none so far) Principles of Securities Legislation A dministrator usually implies regulatory authority, commission, registrar or other govt official. General principle is full, true, plain disclosure of all important facts when selling securities to the public. 3 basic methods exist to protect investors: registration of securities dealers, disclosure of facts and enforcement. Registration: Every firm and IA must be registered 1) Investment Advisors (IAs): CSC, Conduct and Practices Handbook (CPH). Each new IA must complete 90-day training program, also Wealth Management Essentials (WME) within 30 months. 2) Investment Representatives (IRs): may not give advice to clients. Their training is only 30 days, no 30 month requirement for completing the WME. 3) Sales Manager: Branch Managers Course (BMC), within 18 months the Effective Management Seminar Note: Employees not engaged in sales may accept orders form public: Non-Trading Employees National Instrument (NI) 31-103, Registration Requirements, lists 9 registration categories: 1) Investment Rep: to take unsolicited orders

CSC Summary
2) Registered Rep: give investment advice 3) Trader: enter orders into trading systems of exchanges 4) Supervisor: supervise other apporved persons 5) Exeuctive: participate in management of investment dealer 6) Director: sit on BoD or occupy similar position 7) Ultimate Designated Person: CEO or similar position, responsible for statutory compliance 8) CFO: compliance with financial adequacy requirements of IIROC rules 9) Chief Compliance Officer: systems and controls reasonably designed to ensure compliance National Registration Database (NRD) is a web-based system used by employees, dealers to file registration forms electronically for APPORVAL by CSA, IIROC, single submission for all of CDN. Know Your Client Rule: Acceptance of any order bound by good business practices, recommendations for accounts should be appropriate with investment objectives (suitability principle). First step in comlying is a completion of New Account Application Form (NAAF) PRIOR to ACCEPTANCE of any order. Fiduciary Obligation: not reveal inside info, not release info before public disclosure, prevent conflicts of interest, providing investment advice, advising fully, honestly and in good faith. National Do Not Call List: using the telephone in soliciting clients is telemarketing. The Canadian RadioTelev ision and Telecommunications Commission (CRTC) has established certain rules, cannot call clients on the list. SROs have developed extensive rules and regulations, infractions punished by fines, suspension and expulsion. Criminal charges can be laid. Omission, conduct, manner of business are examples. Examples of Unethical Practices: Any conduct deceiving the public, purchaser or vendor of any security. False appearance of active public trading, sales and repurchase schemes to manipulate the market Sell and repurchase scheme to manipulate the market Deliberately causing last sale price of security to be higher than warranted (window dressing). Attempt to mislead board of governors or committee Confirming a transaction where no trade has been executed (bucketing), making fictitious trades Pressuring clients to trade securities, improper solicitation, making clients believe there is no risk in trading Selling or attempting to sell prospective dividend Trading a security prior to effectingg a trade for a client (front running) Public Company Disclosures Companies need to file financial statements, insider trading reports, information circulars, annual information form, press releases, material change reports Continuous public disclore requirement of the acts (primary: preses release, material change report) Material Change means any change in company that can dramatically effect market price of securities Examples: change in BoD, affairs, disposition / acquisition, contracts, takeovers, sale of shares foreigners Companies MUST FILE with administrators annual and interim reports No selective disclosure of confidential materials occur to 3rd parties during meetings with analysts Financial disclosure provisions requre these materials to be sent to shareholders: financial statements, comparative audited FS including all 4 statements within 120 days of year-ends in Venture Exchange, 90 days for TSX listed stocks, quarterly intereims 60 days for Venture, 45 days for TSX Statutory Investors Rights 1) Right of Withdrawal: right to withdraw from purchase 2 business days after receipt of prospectus or any amendment by giving notice to agene. If done without a prospectus, purchasers can revoke with time limits

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2) Right of Rescission: cancelling contract for purchase if the prospectus/amended prospectus contains a misrepresentation (omission of material fact or untrue statement). Must be brought within 180 days. Remedy can be eiteher RESCISSION or DAMAGES. 3) Right of Action for Damages: issuer, director, sellers, underwriters may be liable for damages if the prospectus contains a misrepresentation. This right applies to any EXPERT (auditor, lawyer, geologist, appraiser) who reports an opinion and the misrepresentation happens with his / her consent. They are not liable if the misrepresentation did not appear in their report or opinion. If company can prove purchaser knows of the misrepresentation, claim may be invalid. Acts also provide certain limitations with respect to maximum liability. Misrep may also be a criminal offence. Proxies and Proxy Solicitation: power of attorney given by shareholder, MUST be in WRITING and signed by the shareholder. Inactive shareholders who leave the proxy unmarked or unvoted is cast AUTOMATICALLY with managements viewpoint. Most provinces require solicitation of proxies by management Street form: registering shares in name of someone other than true beneficial owner, referred as nominee (bank, dealer, etc.) Nominees are required to mail out all materials related to meetings and shareholder information. Takeover bid is an offer to acquire shares of company totalling in excess of 20% voting outstanding

securities. Offers, if successful will obtain enough shares to control company.

1) Bid must be sent to all shareholders of securities class, including convertibles. 2) Offeror will distribute takeover bid circular (bids, holdings in target, management relations) 3) Directors circular must be sent within 15 days to security holders to provide certain info and

include a RECO to ACCEPT/DECLINE the bid.

4) Any securities taken up by offeror MUST BE PAID WITHIN 3 DAYS. Exemptions from takeover bid regulations: 1) Made through facilitates of exchange in accordance with by-lwas, regulations, policies 2) Acquisitions do not aggregate more than 5% of securities of a class within 12 months, price paid for the securities does NOT exceed price on date of acquisition 3) Offer by way of private agreement with five or less security holders at price <115% of market price 4) Purchasing shares in a private company 5) ONTARIO: number of holders <50 and securities held less than 2% of outstanding securities of the class. Investor has rights of rescission, action for damages, withdrawal, same thing as for stocks. This is against all related officials, professionals, directors, issuers, etc. Early Warning Disclosure: each person accumulating 10% or more of the outstanding securities MUST issue a PRESS RELEASE immediately with administrator and also FILE a REPORT within 2 business days. Must contain purpose o facquisition. After formal bids, persons acquiring >5% needs to issue press release no later than opening of trading next business day. Most provinces require insiders or reporting issuers to FILE REPORTS on trading of its securities. Insiders who make USE of undisclosed information must surrender their profits and may be liable for damages. Insiders are: 1) Director or senior officer 2) Person beneficially owning, directly or indirectly, but controlling >10% fo voting shares 3) Director or senior officer of the parent company 4) Reporting issuer which has redeemed, purchased or acquired any of its securities Insiders MUST REPORT to adminstrators any change from the previous report WITHIN 10 DAYS or any trade.

CHAPTER 4 ECONOMIC PRINCIPLES

CSC Summary
Microeconomics analyzes behaviour of individual firms and consumers, price determination, production, distribution, use of goods and services. Macroeconomics is the evaluation of the economys performance as a whole, such as price levels, natural resources, technological impacts, unemployment, recession, spending, etc. Consumers, firms, governments interact with the economy (DECISION MAKERS). Resources used by them are called factors of production. It includes labour, capital, entrepreneurship, services, etc. Market is any arrangement that allows buyers & sellers to conduct business. Gross Domestic Product (GDP) market value of all final goods and services PRODUCED in a country 1) EXPENDITURE: total spending on final goods and services (who spends: consumers, govies, investment) 2) INCOME: total income earned (wages, rent for land, interest for capital goods, profits for entrepreneurs) Nominal GDP reflects change in prices as well as volume, Real GDP only reflects volume Canadian GDP is around $1.5 trillion in 2009 Economic growth comes from increases in output per worker, capital, liquidity to support investments. a) Capital accumulation alone cannot sustain growth.Higher savings cannot result in sustained growth rate. b) Sustained growth requires technological progress with complex pattern of basic, applied research and product development in a supportive entrepreneurial context. Growth Accounting: technique to differentiate real GDP growth due to CAPITAL or TECH PROGRESS Canadian Stats: On average, Canadian GDP has grown by about 3.35% since 1960s Growth is highest in 1960s and slowest in 1980s. Fluctuations in output and employment are called the business cycle Expansions happen during times of normal growth, stable inflation, profits rising, inventories have been adjusted (rising) to meet excess consumer demand. Overall, GDP is rising. As we reach a Peak, demand begins to outstrip capacity, labour gets expensive, inflation, interest rates rise, bond prices fall. This dampens business investment and reduce sales of houses and durables. Contractions follow, economic activities decline, unwanted inventories, declining profits, business conditions worsen, formation of a trough nears, falling demand and excess capacity disbales firms from raising prices.

Inflation falls, interest rates fall, business investment increases, bonds rally. Recoveries usually help GDP return to its peak. People buy interest-rate sensitive items like houses, cars, furniture, etc. Expansion happens when economy surpasses its previous high. Economic indicators are statistics, data series we use to analyze business conditions and economic activity. Classified as LEADING, COINCIDENT and LAGGING: LEADING INDICATORS Designed to anticipate emerging trends (housing starts, manufacturers new orders, spot commodity prices), average hours worked, stock prices and money supply (available liquidity) Composite Leading Indicator (10 leading indicators combined by StatCan into single index): S&P/TSX Composite, real money supply, US Composite Leading Index, US Composite Leading Index, new orders durables, Shipments-to-Inventory Ratio (FG), average work week, employment, furniture & appliance sales, durable goods, sales of other retail durables, Housing Index, etc. Note: Trends in published statistics is only observable after economy has already moved into the trend. Sometimes false signals may be given.

CSC Summary COINCIDENT INDICATORS Change at approximately same time as direction of whole economy. Examples: Personal income, GDP, industrial production, retail sales LAGGING INDICATORS
Changes after the economy as a whole changes Examples: UNEMPLOYMENT, private sector plant and equipment spending, business loans, interest rates, labour costs, inventory levels and inflation rate.

Note: Popular definition of recession involves 2 consecutive quarters of declining growth. StatCan, however judges recessions by depth, duration and diffusion of decline of business activity. Soft landing refers to business cycle phase in which economic growth slows sharply but does NOT turn negative, while inflation falls or remains low. Considered Holy Grail of policy makers Labour Force is defined as sum of working-age population who are EMPLOYED or UNEMPLOYED In 2010, 27.6M Canadians were working-age, 18.6M were labour force, 17.1M were employed Participation rate is going up over last 50 years, from 54% in 1960s to 67% in 2010 Unemployment highest during recessions of 1980-1983 (11.9%) 1) Participation Rate is the % of working-age population that is in the labour force (willingness to enter) 2) Unemployment Rate is the % of labour force who are unemployed and actively looking for work 3) Discouraged workers are available and willing to work but feel they cannot find jobs A) Cyclical unemployment: closely tied to fluctuations of business cycle B) Fricitional unemployment: normal turnover, switching jobs, creation or destruction of jobs C) Structural unemployment: unable to find work, live in different places, lack skills, wage too low. Very closely tied to changes in technology, intl competition, govt policy, etc. Rising Unemployment in Canada: Labour market regulations discourage hiring (minimum wage) Rigidities such as labour unions, payroll taxes, indirect labour costs Welfare and unemployment insurance benefits, generosity of social assistance programs Severity of current recessions, obsolescence of certain types of jobs, changing tech environment Natural unemployment rate, full employment unemployment rate, non-accelerating inflation rate of unemployment (NAIRU) is the minimal level of unemployment that does NOT ca. use other negative effects. This rate is estimated by BoC at 6.5% - 7%. Divergences between actual unemployment rate and NAIRU can help us gauge where the economy is at. NAIRU is often viewed as the rate that corresponds to STABLE INFLATION. Interest rates important to link between current & future economic activity. These factors might be determinants: Supply and Demand (preferred habitat) Default Risk, Inflation, Central Bank Credibility Central bank operations (has much more of a long-term impact esp on bond yields) Foreign interest rates and exchange rates Interest rates affect the economy in the following ways: Affect cost of capital for business investments Discourages consumer spending, increasing household portion of income spent on financing homes, etc.

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Money and Inflation Functions as store of value, unit of account and medium of exchange. M1: currency, personal chequing, demand deposits (chartered banks) held by individuals & businesses M2: personal savings at chartered banks, non-personal notice deposits (chartered banks) M2+: deposits at trusts, loan, mortgage, credit unions, life insurance annuities, money market mutual funds M2++: CSBs (saving bonds), non money-market mutual funds M3: non-personal term deposits at chartered banks, foreign-currency deposits at chartered banks Consumer Price Index (CPI) shopping basket of 600 different goods and services, weighted to reflect spending Impacts of Inflation: Erodes standard of living on fixed income and those who lack bargaining power. Rewards those who can increase income through wages, investment strategy, magnifies social inequities Reduces real value of investments, mortgages, debt, etc. Distorts price signals (price is critical in balancing supply & demand) Usually brings about rising interest rates and recession (if accelerating so much) Causes of Inflation: Neutrality of money (changes in money growth fully reflected in inflation rates) Higher money growth, lower interest rates, boost spending and investment, cause inflation Phillips Curve relationship between inflation and unemployment (short-run inverse relationship) Output Gap (Actual GDP Potential GDP) Potential means max level of real GDP without inflation Demand-Pull Inflation scenario when strong demand allows corporation to charge higher prices, pushing inflation higher. Cost-push inflation caused by shocks from supply side of economy increase prices Disinflation is a decrease in the inflation rate. Phillips curve explains relationship with unemployment Sacrifice Ratio: how much should GDP be reduced to lower inflation by 1%. Could be as high as 5% Deflation is a sustained fall in prices, leading to decline in corporate prices, businesses have to lower prices, cut back on production costs and wages, layoffs, unemployment rises, growth slows, no investments International Economics Balance of payments is a detailed statement of countrys ECONOMIC transactions over a period of time. The two components are current account (exchanges of goods and services between Canada & foreigners, earnings from investment income, net transfers like foreign aid) and the capital account (financial flows of investmentts and capital between Canada and foreigners). It can be thought of as a SUPPLY or DEMAND of Canadian currency. Current account deficits DEPRECIATE the CDN$ because there is a demand for foreign goods. CDN$ has to be exchanged for foreign $. In theory, the current account has to EQUAL capital account balances. Think about spending and financing!! Current Account Components Merchandise trade most important of current account (Export $437b, imported $464b in 2009) 73% of CDN exports are to the US, import 63% from the US. Current account deficit of $43.5b in 2009 Investment Income is also important (paying interest or rents on capital goods) Canada usually runs a DEFICIT on services trade (freight charges, engineering & accounting, tourism) Transfers refer to assistance or unilateral transfers (immigrants, aids, donations, etc.) Capital Account Components Direct Investment: owning more than 10% of companies overseas Portfolio Investment: debt and equity securities (newly issued or T-Bills, etc.) International Reserve Transactions: Bank of Canada buying / selling CDN$ in curency markets Exchange rates most important with the US. CDN manufacturers may elect to keep US$ price constant

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Inflation differentials: countries with low inflation rates appreciate in currency Interest rate differentials: higher rates temporarily can appreciate currencies, attracts capital Current Account deficits mean spending more than earning. Depreciate currencies, demand more foreign Economic Performance Public debts and deficits: sometimes incentive to let inflation grow to reduce debt, running deficits if domestic savings are insufficient, may cast doubts about credibility to pay back Terms of trade: ratio of changes in export prices to import prices. Political stability: investors seldom like unstable or disreputable govies Can be STABILIZED by moving interest rates CH5 ECONOMIC POLICY Rational Expectations Theory suggests that firms and workers alike are rational thinkers, can undo

consequences of government policy.

Keynesian Economics advocates use of DIRECT GOVT INTERVENTION (1930 worldwide depression at that time John Maynard Keynes) to achieve growth and stability by lowering taxes or increasing spending

Monetarist Theory suggests economy is INHERENTLY stable, will automatically lead to a stable path of growth. Milton Friedman proposes that instability in MI is the major cause of fluctuations of real GDP & inflation. Central banks should raise MI by 2%-3%, economys long-term growth
Supply-Side Economics proposes that markets should be left on its own. However, contrary to the monetarist view, supply-siders suggest interventions should only occur through TAX RATES which stimulates invest Fiscal Policy is the use of govt spending & taxation powers to pursue goals like employment, sustained growth, etc Federal government responsible for EI, defence, old age security. Provies healthcare, education, welfare. Federal Budget is submitted by Minister of Finance to the House of Comons every year. National debt is the sum of past deficits and surpluses. Important because it tells the public and foreign investors how much they will be refinancing or borrowing in future years. Alternative is to tap on civil service pension fund Government Revenues: Personal, corporate, non-resident income taxes, goods & services tax, energy taxes, custom import duties, others, EI premium revenues Government Expenses: transfers to persons, other levels of government, direct program expenses, debt charges Fiscal policy affects economy in SPENDING, TAXES and DEFICIT. Taxes discourage activities being taxed. Deficits lead to borrowing, national debt, interest payments. Highest in 96-97 $563b, fell $100b until 2009 A utomatic Stabiliz ers are built in measures to stabilize GDP without real intervention. Makes business cycles less severe. Tax system hits individuals more if the economy is good. EI increases during bad times. BANK OF CANADA (founded in 1934: BoD, Governor, Senior Deputy Governer, 12 Directors) Regulate credit & currency in the best interests of economic life of nation Control and protect external value of national monetary unit Mitigate by its influence on general levels of production, trade, prices and employment Promote financial and economic welfare of the Dominion Act does NOT specify methods in which BoC may achieve these objectives, but grants powers

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Functions of the BoC: Issuance and removal of bank notes, fiscal agent of Government (debt management, advisory, forex, monetary) and to conduct Monetary Policy Fiscal Agent: manages accounts & deposits (BoC & chartered banks) and the Exchange Fund Account (forex reserves). Act empowers BoC to buy or sell gold, silver and forex, maintain deposits with other banks inside and outside Canada, act as agent and depositary for central banks & intl institutions. Monetary Policy sets to improve economys performance, regulates growth in money supply & credit. Curerntly, TARGET INFLATION RATE is between 1%-3% per year. Overnight Rate: interest rate set in the overnight market (financial institutions borrowing & lending). Operating band is 50 basis points, target is in the MIDDLE. Bank Rate is the MINIMUM rate (upper limit of the band) at which BofC lend money to chartered banks, members of the Cdn Payments Association (CPA). Open M arket Operations Special Purchase & Resale Agreements (SPRAs): combats upward pressure on overnight rates (WANT LOWER INTEREST RATES). Prevents dampening of business acitivity, BoC offers to LEND at the UPPER LIMIT (BANK RATE). They purchase bonds from chartered banks and resell them the next day. Sale and Repurchase Agreements (SRAs): relieve undesired downward pressure. BoC proposes to borrow from members at LOWER LIMIT if the overnight money is trading below that rate. Prevents inflationary pressures. Sell government securities to members and repurchase them the next day. Note: Changes in overnight band accompanied by press releases to reduce confusion and increase transparency. Large Value Transfer System (LVTS) created in 1991 for participating financial institutions to conduct large trades with each other through electronic wire system. Tracks receipts and payments throughout the day. Members send payments back and forth to each other. Does NOT make sense for institutions to lend or borrow money outside the operating band Drawdowns refer to the TRANSFER of deposits FROM chartered banks TO BoC (raise interest rates) Redeposits TRANSFER of deposits FROM BoC TO chartered banks (lower interest rates) Notes: Monetary policy may be effective in the SR but NOT in the LR. In late 1970s and early 80s, government did not try hard enough to reduce national debt, remained really high until most of 1990s. Interest burden made it hard to reduce deficit. Budget surpluses in 2000 helped. Often, fiscal policy is unsynchronized with monetary policy. For instance, late 1980s, inflationary pressures and growing economy was not coupled by large deficits (increase pressures and raise interest rates more, cost of debt servicing increased. Large national debt PREVENTS govies from running counter-cyclical fiscal policy. Investors sell bonds, driving up interest rates. CH6 FIXED INCOME TYPES & FEATURES Fixed income market is $6.1 trillion in 2009 (secondary debt market), approximately 5 imes total equity trading of $1.2 trillion and over 4.5 times of Canadas GDP of nearly $1.34 trillion. Bond issues are accompanied by a trust deed, outlining details of the issue and written into a bond contract. Trust deed provisions enable physical assets to be sold if bankruptcy occurs. Most pay interest 2X a year. Debentures are the same as bonds but are not secured by physical assets (general claim on residual assets or by issuers general credit rating). Some fixed income are floating-rate securities, index-linked notes.

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Denominations are usually $1,000s or $10,000s. Larger ones may be issued to suit preferences of big institutions. Money market funds have maturities <1 year, short-term between 1-5, medium between 5-10 and long-term. Liquid bonds trade in significant volumes, low bid-ask spreads, no sacrifice on prices. Negotiable bonds can be TRANSFERRED because they are in deliverable form (power of attorney, certificate in good standing). Most bonds now are book-based and certificates are NOT issued. Callable / redeemable bonds: issuer has to give 10-30 days notice. Call price usually set higher than par value. Provincial bonds callable at 100 plus accrued interest. Call protection period is the period of time before any calling can be made. Most corporate bonds issued with Canada yield call allowing issuer to call the bond at a price based on GREATER of PAR or Equivalent Term GoC bond with yield spread. Sinking funds are sums of money set aside OUT OF EARNINGS set aside each year to provide repayment of all or part of debt issue. They are as binding as a mortgage provision. Purchase funds on the other hand is a separate fund of money set aside to retire specific amount of outstanding debt through purchases in the market. Extendible bonds usually issued with short-term maturity (5 yrs) allows investor to exchange debt for an identical amount of longer-term debt at the SAME or SLIGHTLY HIGHER interest rate. Retractable bonds normally issued with long-term maturity but give investors the right to return the bond by the retraction date. With both these types of bonds, the DECISION to exercise the MATURITY OPTION must be made during the ELECTION PERIOD. Holders must notify appropriate trustee / agent to exercise those options. Convertible bonds (conversion price) can be exchanged for common shares, right is called conversion privilege. Appeals to investors unwilling to buy common shares with low yields. Conversion prices usually increased over time to DISCOURAGE early conversion. Protection against dilution when common shares are split, conversion privileges adjusted accordingly. Some trust deeds have a clause saying No adjustment for interest or dividends. No accrued interest paid if conversion happens in between two coupon dates. Convertibles usually CALLBLE, at a small premium and after reasonable notice. Forced conversion innovation built into certain convertible debt issues. Once market price increases to a certian level and trades at or above this level for specific level for number of consecutive days, company can call back at the stipulated price. Advantage to issuer rather than holder. Protective Provisions or Covenants for Bondholders: Security: details of assets that support the debt Negative Pledge: borrower will NOT pledge any assets if resulting in lesser security for bondholder Limitation on Sale and Leaseback transactions: protects debtholders from firms selling / leasing assets Sale of assets or merger: if mergers happen, the debt may be forced into retirement Dividend Test: rules for payment of dividends (interest payments have precedence) Debt Test: maximum debt that company can issue Sinking Fund / Purchase Funds and Call Provisions: specific dates and times bonds are callable. GOVERNMENT OF CANADA SECURITIES: T-Bill Short-term obligations (3mth, 6mth, 1yr) $1,000 to $1000,000 denominations Generally applied to banks, insurance companies, rust and loan companies Do not pay interest, sold at discount, taxable as income and not capital gain

Canada Savings Bonds (CSBs)

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Can only be purchased between October and April each year Not transferrable, not sold in bearer form, no secondary market Prices dont fluctuate, may always be cashed at FULL PAR VALUE plus INTEREST ACCRUED Must be registered in individual, estate or trusts name May be given as collateral for loans from chartered banks Sold to PAYROLL SAVINGS PLAN by Bank of Canada

Regular Interest CSBs Pays annual interest either by cheque or direct deposit (November 1st each year) $300, $500, $1000, $5000, $10,000 Maximum of five $300 and $500 bonds each for each registered owner Cashing in first 3 months after issue date: Only receive face value Interest payments taxable at regular income tax rate Compound Interest CSBs Allows borrower to forgo interest, minimum denomination of $100 Compound interest calculated each November 1st, accrued in equal payments for next 12 months Redemption: Whole face value plus total interest Should be redeemed early in the month if not lose interest for the month not ended Report accrued compound interest as taxable income Canada Premium Bonds Very similar to CSBs, higher interest rate, only redeemable once a year without penalty Redemption: Anniversary date and 30 days thereafter Real Return Bonds Pays interest throught life of bond, principal at the end Coupon payments and principal repayment are adjusted for inflation Fixed REAL COUPON RATE, principal also adjusted for inflation Bonds inflation compensation PROVINCIAL AND MUNICIPAL SECURITIES: For program spending, social welfare Same like Govies, Provies are actually debentures (promises to pay, no assets pledged) Provincial bonds have lower credit rating than govies, taxation powers 2nd to government Bond quality determined by credit and market conditions Credit depends on amount of debt, federal transfer transfer payments, stability of provincial government and wealth (natural resources, industrials, agriculture, etc.) Guaranteed Bonds Crown corporations (provinces guarantee their bonds) Provinces also borrow from international markets, or lend Issues sold abroad underwritten by syndicate of dealers and banks Global Bond Offerings distributed simultaneously in local and foreign markets, settle in different clearing agencies (EuroClear or Cedel) Provincial Savings Bonds: only residents, only certain time of year, 6 mths redemptions Instalment Debenture (Serial Bond) Used by most municipalities, part of the bond matures during the term (amortization) Only Montreal, Toronto and Vancouver issue term debentures with bullet maturities Usually non-callable, rank below provies and govies

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Credit rating depends on taxation power and resource, transportation facilities, good payment records, industrial growth, debt per capita, etc.

CORPORATE BONDS: More options for financing, sell assets, issue equity, borrow funds from investors, higher yield Most common types are listed below: Mortgage Bond Legal agreement to pledge land, buildigns or equipment (protective covenant) Created when capital requirement of firms became too large to be covered by individuals Deposited with trustee, usually split into $1,000 multiples First Mortgage Bonds: senior securities (1st charge on assets); best security companies can issue, especially if it applies to all fixed assets hereafter acquired After acquired clause means that all assets can secure the loan, even those purchased afterwards Collateral Trust Bond Secured by pledge of securities (own securities of subsidiaries) Equipment Trust Certificates a variation: pledge equipment as securities instead of real property Floating Rate Securities (Variable Rate) Offer protection when interest rates are volatile When interest rates fall, however, payments are adjusted every six months Minimum rate protection sometimes Corporate Notes Unsecured promise to pay interest and repay funds Secured note or a collateral trust note (finance companies often pledge notes as security) Sold to financial institutions or investors with diversified portfolio Secured Term Note backed by a written promise to pay (auto loans, appliances)

Strip Bonds Group of high-quality bonds, separates individual coupons from the principal payments and the rest of the bond, bond residue These bonds have no interest payments (income is considered interest) Should be held in a tax-deferred plan RRSP Foreign-pay bonds offer increased opportunity for portfolio diversification, choice of interest payments in two or more currencies Eurobonds are issued in foreigncurrency. For example, canadian issuer in France issuing US$ bonds Yankee bonds for US$ bonds Preferred Securities Very long-term instruments (25-99 years) Subordinated to all other debentures, but rank above preferred shares Interest can often be deferred Often traded on an exchange, better yields, lower priority than other debentures More secured than preferred shares, may be taxed on accrued unpaid interest Bankers Acceptance

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Written instruction to make payment (commercial draft) Guaranteed at maturity by borrowers bank Sold at a discount like T-bills, mature at face value Minimum initial investment of $25,000, generally between 30 to 90 days maturity

Commercial Paper Unsecured promoissory note (asset-backed by financial assets) <3 months to 1 year, minimum initial investment of $25,000 Sold at a discount like BAs and T-bills (used by corporations with good credit history) Term Deposits: offer guaranteed rate but penalties for withdrawing early GICs: fixed rates of interest, longer than deposit, both principal and interest guaranteed Redeemable and Non-Redeemable types, CDICs do not cover GICs more than 5 years Can be used as collateral for loans, automatically renew at maturity Escalating-rate GICs: interest rate increases over GICs term Laderred GICs: principal divided into multiple segments, each portion maturing can be reinvested Instalment GICs: Lump sum initially, further contributions made Indexed-linked GICs: some exposure to equity markets, insured by CDICs Interest-rate-linked GICs: offer interest rates linked to other prime rates Dominion Bond Rating Service S&P Moodys Credit analysis, independent and objective assessment Risk profile, likelihood that interest payments will continue S&P Bond Rating Service AAA AA A BBB BB B CCC CC C D S highest degree of protection, large national / multinational corporations, creditable history similar to AAA, considered superior in quality, margin of asset or earnings protection not as high good quality, favourable characteristics: more susceptible to adverse trade or economic conditions medium quality: more susceptible than A to economic turmoil, interest and principal protected lower-medium-grade: earnings may be modest / unstable, interest & principal protection may fall lack qualities of favourable investment: volatile operating conditions, doubtful protection (poor) speculative, dependent on favourable business and economic conditions, not likely for payments very vulnerable subordinated debt maybe bankruptcy petition has been filed, but payments are continued default, liquidiation process Suspended in operating or financial problems, may or may not be in default, large uncertainty

CH7 FIXED INCOME PRICING & TRADING APV = present value of coupon payments (they use the annuity formula) Discount rate = comparable yields on similar securities, risk-adjusted Yield on T-Bill = (100 Price) / Price X 365 / Term X 100 (simple formula, not effective interest rate)

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Current Yield on Bond = Annual Cash Flow / Current Market Price X 100 (doesnt consider purchase) Yield to Maturity = total return expected to earn over life of the bond (assume no defaut) YTM includes investors return from coupons and also the capital gain or loss from purchasing the bond at a price different from par vaue. Approximate YTM Formula: [(Interest +/- Annual Price change)] / [(Purchase + 100)/2] X 100 Reinvestment Risk: risk that coupons cannot be reinvested at the same rate Only a zero-coupon bond has no reinvestment risk Term Yield 1) 2) 3) Structure of Interest Rate: Graph is called a Yield Curve. Why interest rates vary? Real Rate of Return and Inflation Rate Determined by supply and demand for funds Real rate rises 1) through business cycles, lower during recessions and higher during booms and 2) Unexpected changes in inflation rate (satisfactory real rate) Curve depicts relationship between long and short-term bonds Expectation Theory: what investors expect future interest rates to be, consensus Liquidity Preference: short-term bonds will have lower yields because of more demand Market Segmentation Theory: where big players concentrate their investments (pension funds)

Inverse Relationship between Interest Rates and Bond Prices Long-term bonds are more volatile than short-term bonds: Interest Rate Risk Lower-coupon bonds are much more volatile than high-coupon bonds Relative Yield changes are much more important than absolute yield changes Duration used to compare bonds with different coupons and different terms to maturity Measure of the sensitivity of a bonds price to changes in interest rates The higher the duration of the bond, the more it will react to changes in interest rates If Duration = 10, price will change 10% for every increase of 1% in interest rates Bond Switches involve replacing a bond with another to capture possible benefits: Net Yield Improvement improve after-tax yield without adversely affecting quality High-tax bracket will be better off in deep discount bonds (capital gains taxes) Low-tax bracket would be safer in a high-coupon bond Time Reduction or Extension change in the maturity terms of the bonds Credit Improvement can improve yields for corporate bonds Portfolio Diversification Cash Take-Outs possible when proceeds from sale is greater than reinvestment (discount) Settlement Period: period of time until the securities have to be delivered GoC Treasury Bills GoC < 3 years GoC > 3 years & all others Same day Second clearing day after transaction Third clearing day after transaction

Bearer Bonds: risk of losin gcertificates Registered Bonds: non-transferrable (only when owner signed back of certificate) coupons mailed Book-Based format: issuance only with depository, trade clearing and settlement services provided by participating providers, CDS (Clearing and Depository Services Inc.)

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Accured Interest: calculated from principal amount, coupon rate, time period **Amount is based on par values, NOT on market values could have been purchased at discount or premium. Also the interest rate is the coupon rate instead of its yield ** Do not include the date of last coupon payment, but include the day of settlement! ** But ONLY the lesser of the accrued interest and a full coupon payment is paid Bond Indexes are used: Performance of the overall bond market Performance of bond managers Bond index funds

PC Bond, business unit of TMX Group: offers set of Cdn bond indices DEX Universe Bond Index tracks the overall Canadian bond market, best known Represented govies and corpories About $1 trillion in market cap as of September 2010 Measures TOTAL RETURN including realized and unrealized capital gains and also reinvestment of coupons Capitalization weighted index Merrill Lynch also maintains set of bond indexes for the US RBC Dominion Securities, CIBC Wood Gundy, S&P, Salomon Smith Barney and JPM (US)

CH8 EQUITY SECURITIES COMMON & PREFERRED Common Shares Provide initial equity capital to start business Sometimes referred to as venture / risk capital (risk profile) Dividends payable at discretion of BoD, less certainty for cyclical companies Street certificates registered in name of securities firm (readily transferrable to new owner) CDS offers computer-based systems to replace certificates (no need to handle physically) Standard Trading Unit (100 shares), otherwise odd lot Viewpoint of the company: Effect of a sale is that a new name appears on its list of shareholders Benefits of common shares: potential for appreciation, dividends, voting rights, favourable tax treatment, liquidity, right to receive annual reports, limited liability, right to question management in meetings Regular dividend: indicates payments investors can expect to be maintained Extra dividend: usually at end of FY, extra bonus if favourable economic conditions Street certificates: dividends are mailed to the securities firm Ex-dividend: The date after which purchase will not receive dividends Cum-dividend: opposite of ex-dividend Dividend Record date: two to four weeks in advance of the payment date (second business day after exdividend) Payment date **Trade settle on the third business day after a trade Open orders: limit orders to buy/sell security can more likely be executed when stock goes ex-dividend Dividend Reinvestment Plan: reinvested in common stock, taxable as ordinary cash dividends Made on the open market (repurchases) under trustee Commission savings for companies to repurchase shares in bulk Dollar Cost Average (reduce average cost per unit paid), fractions of shares cannot be purchased individually

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Stock Dividends: cash is conserved for expansion purposes, additional shareholders receive shares Treatment on Retained Earnings would be the same as cash dividends (tax purposes also) Restricted Shares Unlimited participation in the earnings of a company (no full voting rights) Non-voting: no right to vote at all, except in limited circumstances Subordinate voting: class of shares with higher voting power Restricted voting: carry right to vote, limited to % shares that may be voted by an individual Must be identified by the appropriate restricted share term (Stock exchange regulations) Disclosure documents, info circulars, annual reports, statements must be sent to holders, invited to meeting Must be identified in financial press with a code, must be confirmed when making trade Tax Treatment Current taxation 50% of capital gains taxed Dividend tax credit, Stock savings plans (deduct annual amounts from cost of some stocks in provinces) Pre-tax yield lower than debt investments (tax treatments of interest vs. dividends) Debt is paid from companys pre-tax dollars, dividends after-tax dollars Foreign dividends dont have the same privilege (non-taxable Canadian corporations) Example: $100 dividend, $45 (45% is the grossed-up amount), $145 (taxable amount of dividend) Then claim a 19% credit of $27.55 (reduces income tax paid) Stock Split directors pass a by-law for approval by voting common shareholders Usually a dividend increase anounced at the same time can have a bullish impact after split Main reason for splits: investor aversion to purchasing odd lots of high-priced securities, commissions Reverse Splits: company shares fell to unattractive levels for large capital investors, can put company in a better position to raise new capital Preferred Shares: each class has to be separately identified, pari passu means preferred share issues which rank the same to asset an dividend entitlements, preferreds have no maturity date No voting privileges as long as dividends are paid as schedule (unless certain number of dividends omitted) Voting available on matters affecting the quality of their security (new issuance) Preferrence as to assets clause ahead of common shares is not unusual Dividends are paid from earnings: current or past (not obligatory, but have to be paid if enough earnings) Dividend Rate is very important, no upside potential like common Investors may buy preferred to seek income, good tax treatment Cumulative Feature unpaid dividends pile up, favourable for purchaser, no payments to preferred shareholders who sold their shares, Non-cumulative only entitled to payment in a specific year, when declared Why issue preferred but not debt? Not feasible to issue debt (market conditions unfavourablle) Debt/equity issue already high, financial conditions not stellar enough to support interest & principal Low tax rate, not too much of a burden paying preferred dividends Avoids dilution of equity Before issuance of preferred, rights of bondholders in trust deeds or indentures have to be considered Callable Preferreds provide for a small premium above par value as compensation (open market or tender offer) Non-callable Preferreds cannot be called unless company is liquidated or delisted: freezes capital structure Rarely built into the security

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Straight Preferreds pay fixed dividend rate, trade on a yield basis (normal preferences to assets & dividends) Tax advantage dividend tax credit, less safe than debt however Fixed dividend rate which will NOT be increased No voting privileges, no maturity date, poorer marketability, limited appreciation potential Convertible Preferreds similar to convertible debt-like instruments at a predetermined conversion price Specify the number of common shares the preferred is convertible Preferred price is set at a modest premium (10-15%) to discourage early conversion Expire after a stated period of time, usually 5-12 years after the issue Dividends usually less than straight preferreds, provide higher yield than common No need to pay commission to obtain common shares, vulnerable to decline if common is going down Revert back to straight preferred if conversion expires Conversion Cost Premium Illustration: P = $62.50, C = $18.50 can convert 1P for 3C, 3 X 18.50 = 55.50, $7 premium $7 / $55.50 = 12.61% premium see below: 12.61% / 1.70% = 7 years to repay premium Div (P) = $2, Yield = 3.2%; Div (C) = $0.2775, Yield = 1.5%, Difference = 1.70% Retractible Preferreds shareholders can force company to buy back preferreds for cash at specific date & price Soft retractable preferreds may be paid, when redeemed in CASH or COMMON SHARES (choice) Shorter time to retraction date causes more stable stock price when interest rates move Will provide capital gain if bought at a discount, sell above retraction price if interest rates fall Privilege will expire after a certain time if no action taken by holder during election period Become straight preferreds if not retracted Floating-Rate Preferreds: Are issued in markets where straight preferreds hard to sell, or when issuer believes interest rates peaked Delayed floaters, fixed-reset or fixed floaters: entitle holder to fixed dividend after rates become variable High income if interest rates high, low if they fall (less responsive to changes in interest rates) Foreign-Pay Preferreds: Desirability of receiving dividends in funds other than Canadian, foreign currency risk DIVIDEND IS ELIGIBLE FOR TAX CREDIT: issued by CANADIAN COMPANY TAXABLE Participating preferreds share in earnings power of common above their specified dividend rate Deferred preferreds do NOT pay regular dividend, return based on purchase price (discount) & redemption value Dividend premium is the difference between purchase price and redemption value Not eligible for dividend tax credit, taxed as ordinary interest income If sold before maturity date, then taxable as CAPITAL GAINS Allow deferral of payment of income taxes until a later date Stock Index indicators (value-weighted) used to measure overall performance of stock market, create index mutual funds, enable fund managers to measure performance, underlying for options, futures, ETFs Stock Average indicator that is arithmetic average of current prices (price-weighted) DOW JONES INDUSTRIAL AVERAGE is PRICE-WEIGHTED 30 blue-chip stocks that trade on the NYSE (sum of the prices, divided by divisor which adjusts sum of stock prices to accurately reflect changes in value from mergers or stock splits) Canadian Market Indexes

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Toronto Stock Exchange and TSX Venture Exchange publish stock prices for different industries Indexes, dividend yields, P/E ratios can be found in TSX Monthly Review, Bank of Canada review S&P/TSX Composite Index began first index in 1934, measures changes in total market cap of stocks Composite Index: weight changes if price and number of shares change

How can a stock be included in the S&P/TSX Composite Index? Must be listed on the TSX for at least 12 full calendar months Minimum trade-weighted price of $1.00 over the past quarter Closing price greater than or equal to $1.00 at previous month-end Must represent a minimu weight of 0.05% Trading volume, value, transactions for the 12 months preceeding must be at least 0.025% of the sum of all eligible companies, trading volume, value and number of transactions No more than 25 non-trading days bover the past 12 full calendar months Stocks are reviewed quarterly Stocks classified into 10 sectors based on Global Industry Classification Standard (GICS), developed by Morgan Stanley Capital Intl (MSCI): Financials, Energy, Materials, Industrials, Consumer Discretionary, Utilities, Health Care, Consumer Staples, Telecommunications, IT Three subsector indices specific to CDN market: Diversified Mining, Real Estate, Gold Total Return Indexes measure change in value of portfolio by stock price fluctuations AND reinvestment of dividends and other distributions (total compoudn return): recalculated daily The base was set equal to 1,000 in December 1976, closed 31,019 Dec 2009, S&P TSX closed 11,746 % chnges are more accurate barometer for market performance rather than point changes S&P/TSX 60 Index: Dec 1998 new partnership S&P and TSX (60 largest companies by market cap), divided into 10 sectors that cover all the subgroup (everything on this index must be included in S&P/TSX Composite S&P/TSX Venture Composite Index: Managed by S&P, market cap based index, companies eligible to be listed if they are incorporated in Canada and represent at least 0.05% of the index capitalization; revised quarterly; stocks eligible must be listed on the TSX Venture Exchange for at least 12 full calendar months Dow Jones Industrial Average 2,300 issues trade on NYSE, 30 make up the DJIA, only few companies included in average Price-weighted, higher priced stock distorts average, greater day-to-day fluctuations Divisor continuously adjusted (if there is a 2 for 1 stock split, divisor decreases by 1) Composed of blue-chip stocks with lower-risk profile, tend to underperform broader market New York Stock Exchange five indexes: composite, industrials, transportation, utilities, finance & real estate American Market Value Index AMEX market-weighted 800 stocks includes reinvestments, Total Return NASDAQ Composite Index: market-weighted 4,000 stocks, dominated by smaller market-cap companies Value Line Composite Index: 1,700 stocks average daily % change in eah stock (equally weighted), created by Wiltshire Associates and is the broadest available barometer of US indexes Nikkei Stock Average (225 Price Index): price-weighted, first released in Tokyo Stock Exchange in 1950 (DJIA)

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FTSE 100 Index: 100 largest listed companies, market-cap weighted, calculated by the minute German DAX Index: 30 blue-chip market-cap weighted stocks (Total Return, reinvestment of dividends) Set to 1,000 in 1987 CAC 40 Share Price Index: 1988 based on 40 of the largest 100 companies in France Set to base of 1,000 on Dec 31, 1987 Swiss Market Index (SMI): Swisss blue-chip index maximum of 30 largest and most liquid stocks Set to 1,500 in June 30, 1988 CH9 EQUITY SECURITIES TRANSACTIONS Cash Account: make full payment for purchases or full delivery for sales before settlement date Margin Account: buy/sell securities on credit (pay part of full price, interest charged daily on debit balance) Free Credit Balances: uninvested funds held in accounts, dealer member may use as financing, payable on deand Margin: amount of funds investors must personally provide Long margin position: partially finance the purchase of securities Short margin position: arranging for dealer to borrow securities to cover short position Margin Account Agreement Form: need to be obtained before client opens an account Long Margin Accounts: Maximum Equity Value Loans (strictly enforced and regulated by IIROC) At $2.00 and over 50% of market value At $1.75 to $1.99 40% of market value At $1.50 to $1.74 20% of market value Under $1.50 No Loan Value Securities Eligible for Margin Reduction 70% of market value IIROC produces a quarterly list of securities eligible for reduced margin (high liquidity, low volatility) Exchange prohibits one dealer member from accepting another dealer member transfers of any under-margined account unless the member holds sufficient funds or collateral to the credit of the account Increased market risk (magnifies outcome) Loan and interest must eventually be repaid Margin calls must be paid without delay Dealer can sell securities or vcover a short position (cut loss) No limit on how long a short-sale can be maintained as long as no de-listing or liquidation Dealers loan securities to clients of other firms because the short seller must put up margin, can be used in the investment dealers business free of interest Short sales best done on large-capitalization companies on which trading is liquid IAs entering orders for short sales must clearly mark the sell-order ticket with a Short or S Difficulty in borrowing sufficent shares for shorting, responsible for maintaining adequate margin Liable for dividends or other benefits paid when the account is short Difficult to obtain info on total short sales on a security Prices very volatile when shorts are scrambling to cover Short Margin Accounts: Minimum Credit Balance (strictly enforced and regulated by IIROC) At $2.00 and over 150% of market value At $1.50 to $1.99 $3.00 per share

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At $0.25 to $1.49 200% of market value Under $0.25 100% of market value plus $0.25 per share Securities Eligible for Margin Reduction 130% of market value Trading Procedures: Buyer and seller consults IAs and decide to trade after confirming the bid and ask prices Instruction given to IAs to give best possible price (orders above 2,000 handled electronically + personally) Exchanges data transmission system reports trade over exchanges ticker, details relayed to IAs IAs originate transaction, confirm transactions to clients Settlement Procedures: Confirmation provided, settle transaction, commissions, provide additional margins, etc. Entries made in the security firms book of records TRADITIONAL AGENCY TRANSACTION Traditional Agency Transaction Model: 2 different parties buying and selling through 2 different firms Single Investment Dealer: transaction price is determined from that on the exchange CROSS Client vs. Investment Dealer: From firms inventory, price is market value on the exchange (regulated) Market Order, Limit Order, Day Order GTC Order (30 days), All or None (AON), Any Part Order Good Through Order specified period, automatically cancelled Stop Loss Order becomes Market Order when stop price is reached: for long positions Stop Buy Order protect a short position Professional (Pro) Order protect public interest; clients order given priority (partner, director, officer, shareholder, IA, holder of confidential information); labelled Pro or N-C (non-client) or Emp (Employee)

CH10 DERIVATIVES Derivative financial K between two parties dependent on underlying asset: stock, bond, currency, interest rate... Options and forwards: with forwards, both parties obligate themselves to trade at the specified price Forwards: one or both parties make a performance bond or good-faith deposit which gives other party higher assurance that terms will be honoured. Options: payment is made to seller from buyer (premium) Derivatives are a zero-sum game, unlike stocks and bonds

The difference between exchange-traded and OTC stocks or bonds is simply trading mechanics The difference between exchange-traded and OTC derivatives is much more pronounced!! OTC Derivatives: active market with loosely connected and lightly regulated brokers and dealers
Negotiate deals directly with one another over telephone ./ computer terminals Dominated by financial institutions, brokerage houses, trading firms (no regular hours) Contracts that can be tailor-made to meet specific needs

Exchange-Traded Derivatives Legal entity for the purpose of trading derivatives, standardization, liquidity and credit risk Exchange provides floor for trading, regular hours, regulations, order and transparency Montreal Exchange (Bourse de Montreal) and ICE Futures Canada Montreal Exchange lists options on stocks, bonds, indexes and futures on bonds and indexes ICE Futures Canada lists futures and futures options on agricultural goods

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Why have the two markets existed harmoniously: differences? OTC Markets are flexible (contract terms), but NOT Exchange-Traded Markets, Unregulated! Neither the public nor competitors know the transaction in an OTC market. OTC contracts cannot be transferred through a secondary market, standardized derivatives in exchanges Default risk major concern for OTC (have to establish creditworthiness) restricted to large players Clearinghouses, set up by exchanges, guarantee financial obligation of each party. These clearinghouses become seller for each buyer and buyer for each seller. Once transaction is made, the counterparty is the clearinghouse Canadian Derivatives Clearing Corporation (CDCC) is responsible for Montreal Exchange ICE Clear Canada is responsible for clearing ICE Futures Canada trades Unrestricted growth and financial innovation and engineering in OTC markets Efficiency, transparency and fairness is brought about by the exchange-traded markets Fees are built into prices for private OTC transactions Underlying Assets: generally commodities and financial assets Commodity Futures and Options (most are exchange-traded, except energy): Commonly used by producers, purchasers, processors to protect themselves (hedging) Soyeans, crude oil, copper, cattle (consumption) or gold, silver (speculation) Depends on supply, demand, political & economic conditions, agricultural production, weather, etc. Grains & oilseeds: wheat, corn, soybean, canola Livestock and meat: pork bellies, hogs, live cattle, feeder cattle Forest, fibre and food: timber, cocoa, sugar, cotton, orange juice and coffee Precious and industrial metals: gold, silver, platinum, copper, aluminum Energy products: crude oil, heating oil, gasoline, natural gas, propane (mostly OTC derivatives) Derivatives growth for past two decades fuelled by interest rates, exchange rates, financial deregulation, globalization of trade, information technology advancement, innovation in financial engineering Equity Options mostly traded in Montreal Exchange, Chicago Board Options Exchange (CBOE), Intl Securities Exchange (ISE), Boston Options Exchange (BOX), American Stock Exchange (AMEX) Interest Rate Futures in Canada all trade at the Montreal Exchange (Bourse de montreal) Mostly based on well-defined floating interest rates like LIBOR Currency Futures most commonly in US$, Pounds, Yen, Francs and Euros (exchanges) Currency Forw ards and Sw aps traded in the OTC market, NO DERIVATIVES ON CDN EXCHANGES 1) Individual Investors 2) Institutional Investors 3) Business & Corporations 4) Derivative Dealers

First three groups are end users of derivatives (speculation or protection, risk management) Last group of derivative users (dealers): try to trade derivatives with end users (earn profits from volume) Adverse effects (bid-ask spreads), transaction costs, commissions, admin fees can be hefty in thinly-traded markets Derivative Dealers in Canada: big six banks and subsidiaries, Canadian subsidiaries of large foreign banks. OPTIONS Strike / Exercise Price, Option Premium (always on a per-unit basis, NOT per contract) Writers of Exchange-Traded Options are required to maintain sufficient margin Trading Unit: one option contract consists of 100 shares LEAPS: Long-Term Equity AnticiPation Securities (long-term option contracts with same risks and rewards) Equity and Long-Term Options: Volume rose from 10M to 15M from 2005 to 2009 in Canada

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Volume came mostly from Montreal Exchange, ICE Futures Canada and futures options not so heavily traded Opening Transaction (buy to open or sell to open) 1. Offsetting transaction: cancels the original position (sell to close or buy to close) 2. Long position exercises the option, Short position assigned the option 3. Left to be expired Underlying Asset + Expiration Month + Strike Price + Option Type 10 PVG December 2011 9 calls Exchange-traded option prices reported in business press the next day, just like stocks Option volume: sum of trading days volume in all series of XYZ options Open interest: contracts that are outstanding and has not been executed Buy call options: challenge is to select appropriate strike price and expiration date Can limit potential losses in short position, profit by exercising or offseting Offsetting allows investor to recover time value built into the option premium Risk Management: fund manager wants to purchase a stock but funds are not available yet CDN company could buy call option on US$ to hedge against exchange rate risk, OTC derivative Writing call options: primarily for income, speculative but can be risk-management Covered call or naked call All exchange-traded stock options are American-Style! Buying put options: can be used to lock in minimum selling price (floor price) for stocks Speculation or risk-management (married put / put hedge) Oil company CDN wants to sell 1 million barrels in the next six months Could buy put options at $68 a barrel to protect company against lower oil prices Writing put options: provides income, speculative or risk-management Covered put (not as common as covered call) or naked put Cash-secured put write: writing a put and setting aside cash equal to strike price If possible, cash should be invested in short-term liquid money-market instrument Corporations use put options to hedge against interest rates, exchange rates or commodity prices Forward: buyer and seller agree to a price today (OTC markets) FUTURES: standardized forward contract financial futures and commodity futures No cash inflow or outflow during transaction date for futures, if NOT offset, then delivery will occur Longs will have to acccept delivery and shorts have to deliver (if NOT offset or cash-settled) S&P/TSX 60 Futures expire third Friday of each month Ten-year Govies expire third business day before last business day of the month Equity index futures are cash-settled (payment based on price differential) Futures margins represent a good-faith deposit or perforamnce bond Marking-to-market cash settling of gains and losses daily Initial (original) margin required when the contract is entered into Maintenance margin account balance that has to be maintained while contract is open 3-Month Bankers Acceptances is the underlying interest rate for futures Month refers to the delivery month Change (1) is the difference between the price that day and closing price previous day Change (2) is the change in the number of futures contracts open on underlying interests Est Sales is the estimated volume for trading that day Previous Sales estimated volume the previous day Open Interest (1) the open interest on that specific futures contract

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Open Interest (2) the total number of futures contracts open on the underlying interest Only two basic positions with futures: LONG or SHORT Buy and Sell Futures to Speculate or Risk management Firms in the commodity business might want to offset their hedges instead of continuing with delivery: 1) Save on delivery expenses 2) Quality differential 3) Standardized date in futures may differ RIGHTS AND WARRANTS Issued by companies to raise capital Rights are usually very short term (4-6 weeks), Warrants are long term (3 to 5 years) Right: privilege to acquire additional shares from issuing company (direct proportion to shares they own) Exercise, Subscription or Offering Price almost always lower than market price Record Date, Ex-Rights Date, Cum-Rights Date Usually, one right is granted for each number of outstanding common shares Should pay the subscription price, no commissions, fractional shares may or may not be issued Rights have very little time value, mostly intrinsic value Rights are listed on an exchange automatically if the stock is listed on the same exchange Regular delivery: rights have to be settledd by the third business day TSX Venture: since three days before expiry, buyer and seller have to transact in cash (same day) TSX: 3 days before expiry (settle 1 day before); 2 days and 1 day (settle next day); Expiry date (same day) Rights to trade terminated at noon on the expiry date

Intrinsic Value of Rights during Ex-Rights Period = (S X) / N Intrinsic Value of Rights during Cum-Rights Period = (S X) / (N+1) During the Cum-Rights period, the rights are embedded in the common stock.A portion of the stock price represents the value of the rights. Warrant: security that gives holder right to buy shares at a set price for a specified period of time Warrants are issued by companies themselves, unlike call options (by other investors / traders) Often issued as a sweeterner when raising capital through debt or preferred stock Warrants have lots of time value, but may have no intrinsic value if market price below exercise price Leverage potential is attractive, magnifies positive and downside risk

CH11 FINANCING AND LISTING SECURITIES Sole Proprietorship: fully liable debts, losses and obligations (one person), not regulated, free to make decisions Partnership: involves two or more persons (contributing capital, expertise), legistlated under Partnership Act General Partnership: involved in day-to-day operations, personally liable for all debts Limited Partnership: cannot participate in daily activities, liability limited to investment made in the business In these forms of business organizations, there is unlimited personal risk Corporation: unique distinct legal entity separate from its shareholders, can be sued or sue in court of law Properties acquired do not belong to individuals, pays own taxes, liable for its own obligations Able to raise funds through debt or equity, suitable for large business units Basic procedure: file documents with appropriate department of federal and provincial govt, pay fees Government: issue charter, the formal document (name, date, location, authorized max capital, restrictions) Limited, corporation, incorporated

CSC Summary
Chartered Banks must be incorporated under the Bank Act (companies formed by a specific act might not have the word limited or equivalent included in its name Advantages: Limited liability, growth, ability to handle large amounts of capital Continuity of existence: not affected by death of shareholders (bankruptcy or termination only) Transfer of ownership between shareholders is relatively easy (liquidity) Ability to finance by raising capital, shares of class, debt instruments, etc. Taxation benefits: tax deferrals and legitimate tax avoidance Disadvantages: Loss of flexibility (adhere to many rules and laws) Partnerships and sole proprietorships free of statutory regulations Earnings have to be transferred through dividends, changes in charters and by-laws require approval Taxation can be complex, possibility of double taxation (corporate and individual levels) Annual cost for tax returns, audits, shareholders meetings, compliance Withdrawal of funds can be cumbersome The jurisdiction of incorporation must be selected usually pick the province where the corporations chief place of business will take place (or incorporate under Canada Business Corporation Act: CBCA) Decision-making depend on method of incorporation, tax rates, corporate names available, director residences, Provincially incorporated firm might have to obtain permit to conduct business in other provinces Federally incorporated firm may not be discriminated by provincial laws Private Corporation: right of shareholder transfer shares, limit to 50 shareholder names, prohibition to invite m members of the public to subscribe for their securities BY-LAWS OF A CORPORATION Corporation is regulated by the federal or provincial act, its own charter, and its by-laws General by-law prepared at time of incorporation: contains rules that governs conduct of corporation: 1) Shareholders meetings: time, place and method of notifying shareholders, votes, quorum, proxy votes 2) Directors meetings: time, place and methods 3) Qualification, election and removal of directors, appointments, duties renumerations 4) Declaration and payment of dividends 5) Signing authority for documents; date of fiscal year end Right to vote allows shareholders to control direction of corporation Unusual and non-recurring events like merger, liquidation, amendment of charter must receive approval To vote, individual must have shares registered in his/her own name Regular meeting: eligible shareholders notified of the meeting, elect directors, appoint auditors, receive FS Proxy power of attorney given by shareholder to designated person to vote (only for one meeting) Proxies are always revocable, they can also be for all meetings within a stated period. Information circular to notify shareholders meeting (must contain details about directors, renumeration) Voting trust for companies undergoing financial difficulties, restructuring (for example, new investments) Transfer voting control: shareholders asked to deposit shares with trustee (trust company, certificate)

Directors Age of majority, set company policies, supervise work of officers Appointment and supervision of officers, signing authority of banking, approval of budgets, decision to issue shares, declaration of dividends, contracts

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Personally liable for illegal acts done with their knowledge and consent Employee wages, govt remittances Act honestly and in good faith, care diligence, reasonable prudent person test

Officers appointed by directors, responsible for day-to-day operations Chairman of Board: Elected by board, duties of president or other officer of corporation, may be the CEP Greatly exerts influence on management, may be president, present in meetingst President: appointed by and responsible to board of directors Exercises authority through heads of departments and devisions Executive Vice President: second in command, may be the Chief Operating Officer Vice-Presidents: appointed for specific areas of corporations operations GOVERNMENT FINANCINGS Fiscal agency oten helps govies accomplish financing or underwriting, private or secondary offering 1) Government Financing 2) Corporate Financing Government Finance Department sells debt instruments, advises clients and issuing governments on debt Size, coupon, currency, timing, domestic/foreign, effect on market, new or restructing of old maturities Competitive Tender System: Regularly schedules issues of debt; Auction system, bids are submitted Only government securities distributors can submit bids to Bank of Canada Schedule I and II banks, investment dealers, foreign dealers Primary dealers are government securities distributors that maintain a certain threshold of activity Non-Competitive Tender system: Accepted in full by Bank of Canada (awarded at auction average) Bids are submitted, usually by 12:30 pm on the auction date Competitive tenders may consist of up to 7 bids in multiples of $1,000; minimum size of $100,000 Bids state the yield that each bidder hopes to earn Primary dealers CANNOT exceed 40% of total amount of bonds being offered, NO COLLUSION Each non-competitive bid has a ceiling of $3M for each participant Non-competitive tenders are allotted by the Bank of Canada at the average price of the accepted competitive tenders, non-competitive tenders are always accepted in full Submitted bids are accepted in rising order of yield until full amount of auction has been allocated Direct Bonds & Guaranteed Bonds usually sold through fiscal agenet Provincial govt appoints syndicate of dealersto underwrite issues an dmanage prices and distribution Direct refers to the obligation being issued in provincial governments name Guaranteed refers to the issuance of debt in the name of a crown corporation, but is guaranteed by provy Municipal bond and debenture issues more likely to be bought by institutions and pension funds

CORPORATE FINANCINGS Purpose: repay debt, increase working capital, purchase fixed assets, repurchase shares Caveats: price, timing, underwriting fee, coupon rate, yield, private/public

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Negotiated Offering is a negotiation between firms management with dealer (security, price, interest) Competitive tender sometimes works or corporate issues Capital Stock or Equity capital consist of BOTH Common and Preferred Authorized Shares is the maximum number of common or preferred shares that corporations may issue Charter can be amended to increase / decrease number of authorized ahres (possible to provide unlimited) Issued Shares is portion of authorized shares issued (interchangeable with outstanding) Outstanding shares is part of issued shares which remain held by shareholders of the company Public Float is part of issued shares outstanding and available for trading by the public It excludes shares owned by directors, issuers, mutual funds, pension funds, etc. The bigger the public float, the less volatile the stock because a lot is held by individual or retail investors Par value is a stated face value (no relationship between par value and market value) In some jurisdictions, shares with a par value CANNOT be issued at a discount from their par value

Debt Financing: may take the form of mortgage bonds, debentures, bank loans, termnotes, callable & convertibles CORPORATE FINANCING PROCESS When deciding ones lead dealer, corporation considers reputation, timing, pricing of issue, distribution, after-issue market and informational support. Reputation helps improve market acceptance of the issue and a cheaper financing. Corporate finance team of dealers provide advisory services on reorganization, privatization, mergers, takeovers, share buybacks, etc. Dealers begin by providing thorough research on corporation and industry, including future prospects, financial structure, risk factors (due diligence report). Most of this information is given in return for a fee. Consultation with appropriate experts in the field (engineering, geology, accountancy, legal) may be required DEALERS ADVISORY RELATIONSHIP WITH CORPORATIONS Dealers, when guiding corporations in security designs, issue price, and attributes are often represented on the board of directors. Corporations value continuous access to dealers advice. Dealer may become the broker of record and may have the right of first refusal on new financings planned by corporation. Corporation wants to be sure that new securities have restricitive covenants in place or provisions that do not limit decision-making capability in the future. TYPE Bonds Debentures Preferreds Common ADVANTAGES Lower interest rate, marketable to institutions (secured by assets) No specific pledges or liens, reduce issue costs, no registration of assets Technically equity, good on restrictive covenants, flexibility, omission of dividend, limited lifespan No obligations, larger equity base DISADVANTAGES Less flexible, pledge of assets to trustees, difficult in mergers & amalgations Higher coupon rate to compensate lender High issue costs, dividends paid with after-tax $, increase risks & costs, purchase fund could be drained Dilution potential, expensive dividends, larger underwriting discount

Dealers may also advise clients on setting up trust deeds (protective provisions, trust deed restrictions, covenants), namely Deed of Trust and Mortgage for bonds and Trust Indenture for debentures. Dealer helps determine how the issue is to be distributed or sold. Private placements happen when one or several insitutional investors are solicited and the entire issue is sold to one or more of them. Since clients are sophisticated investors, no formal prospectus is necessary (dramatically reduces cost to issuing company). Many cases, they are announced after they happen.

CSC Summary
Public Offerings: corporation and dealer come to a preliminary agreement on whether dealer is to act as agent (earning a spread) or is to underwrite securities as principal. For public offerings, dealers have to act as principal. Prospectuses must be prepared and approv ed separately in each province.

Primary offerings require great deal of finesse in terms of pricing and marketing. Secondary offerings usually handled by investment dealer or syndicate, they earn spread afterwards Repurchasing treasury shares is another option for companies (these shares have no voting rights or dividend entitlements). However, the company could sell them back later in secondary offering Prospectus provides detailed description on securities, company, history, operations, risks, audited FS. Full, true and plain disclosure of all material facts (significant effect on market price). Most acts in provinces require mailing of prospectuses (no later than midnight on 2nd business day after trade). Important items include price, distribution, companys plan in managing funds raised, business and affairs of issuer, officials, capital structure, etc. Preliminary prospectus issued when underwriters have agreed to basic terms and methods of issuance, submitted to provincial securities commissions for review. After securities commission issues a receipt, issuing company has 90 days, the waiting period, to submit the final prospectus. Preliminary prospectus MUST be written in red ink on the front (red herring prospectus). Greensheet information circular for in-house use only to highlight pros and cons. Used sales reps. 1) Disclosure document required by securities laws in province 2) Soliciting interest from buyers of securities During the waiting period, only limited communication between dealers and potential investors is permitted. Sales staff can record names or addresses, but purchase and sale or distribution of research, commentary, reports, projections, may not be distributed at this time. Final prospectus must contain all information that may have been omitted in preliminary prospectus. Must contain consent of experts such as appraisers, engineers, auditors, lawyers, etc. After review by regulators, the issue is said to be blue skyed and ready to be distributed. Short form prospectus may only be used by senior reporting issuers who have made public distributions and subject to continuous disclosure requirements. Works on the theory that much of the info is already available and widely known because of continuous disclosure. Shortens time period to access capital markets through prospectus offerings.Conditions required: Files electronically using SEDAR (system for electronic document analysis & retrieval) Reporting issuer in at least one CDN jurisdiction Up to date with all filings in every jurisdiction, filed current annual FS Is not an issuer whose principal asset is cash (capital pool companies) Has securities listed / posted for trading, or quoted short form eligible exchange

Bought Deal underwriter makes best efforts to sell securities, commits to buy specified number at specified price, resell then to the public. If issues not sold, company cannot return to issuer the securities. Dealer acts as principal. Not as common, only one dealer as opposed to many OTHER DOCUMENTS & SALE OF ISSUE

CSC Summary 1) 2) 3) 4) Trust Deed, Trust Indenture (debt issue) Underwriting agreement or agency agreement between dealer and corporation Banking Group Agreement: lead dealer shared ownership, liability and profits on the issue Selling Group Agreement: extensive group of additional dealers, offered to purchase new issue and resell to clients (all members of IIROC and other CDn stock exchanges)

Unsuccessful issue: corporation does not raise funds required, overpricing, underpricing Step 1: Issuing Company sells bond at 98 of face value to A & B - Financing Group (managing underwriters / syndicate of dealers) for public resale. Banking Group consists of Financing Group and Dealers C to T, all of whom have agreed to participate on set terms and accept certain liability. Government may reserve certain portion to Canadian dealers. Issuers might request that % should be reserved for CDN dealers. Step 2: Financing Group sells securities to Banking Group (A to T) at 98.5 ace value. A&B also obtains an override, an additional payment above original entitlement for advisory and syndicate services. Dealers A to T are dealers whose name appears in tombstone advertisements in the press. Step 3: 60% of the issue may be sold directly by the Banking Group. 30% may be designated for sale to the exempt list. This list may include professional buyers, mostly financial institutions. If sales are less than 30%, the rest can be returned to the Banking Group. 10% may be provided to the i) Selling Group ii) Casual dealers or iii) Special gropus i) Selling Group: other dealers, members of the IIROC (liable for their orders, cannot return issue) ii) Casual Dealers: non-members of Banking / Selling Groups: broker, dealers, foreign dealers, etc. Not offered bonds directly or indirectly, but may receive orders from clients, no liability iii) Special Group: various circumstances, issuing company may demand special consideration for dealer or its banker, or parent banker if it is subsidiary to foreign parent AFTER MARKET STABILIZATION Dealer is required to support the offer price and trading of this stock in the after-market. Three types: 1) Dealer sells securities in excess of original amount offered by the issuer for sale to the public. This establishes a short position prior to the close of the offering. 2 possible scenarios share price falls below IPO price, or rises above IPO price on strong demand. When market price falls, the covering activity will bring liquidity and hopefully raise the market price. Overallotment / Green Shoe option: 10M shares issued, 11M sold to public, get more from issuer 2) Penalty Bid lead underwriter will penalize selling group if customer flips shares shortly after offer closes, in the form of commissions or reduction in future IPOs granted to the Selling Group. 3) Stabilizing Bid to purchase shares at a price not exceeding offer price if distribution of shares is not complete. Maintains demand while attempting to complete distribution of shares. Exchange offering prospectus / statement of material facts is a different form of prospectus when shares are distributed through facilities of CDN stock exchanges JUNIOR COMPANY DISTRIBUTIONS

CSC Summary Must find member firm to act as underwriter for offering or as agent when distributing treasury shares, which are priced below market price (disount an be NO GREATER than 10%-25% depending on price). The minimum amount of capital raised ranges from $100k to $350k. Example: junior oil & mining They normally have no record of earnings, few assets, risk capital. Junior companies often grant underwriter specified number of treasury share options. Involves use of escrowed shares which serve as payment for properties, goods , services. These escrowed shares are held by an independent trustee that CANNOT be sold or transferred without approval. This method ties value of shares to what happens to property used to obtain shares. Prevents owners from selling shares before a proper market develops, ensures stability in the secondary markets, or before an O&G company completes its exploration drilling. CAPITAL POOL COMPANY PROGRAM TSX Venture Exchange developed CPC program so that emerging private companies can obtain financing through an IPO to be conducted without company having assets or cash or business operations. CPC identifies an devaluates assets which qualify CPC for listing as Tier 1 or Tier 2 issuer on Venture Exchange (Qualifying Transaction) 1) Filing & clearing CPC prospectus, completion of IPO and listing of CPCs common shares 2) Identifying business assets that can be acquired in a Qualifying Transaction (QT), preparation and filing, shareholders meeting to get approval to close QT 3) CPCs diretors and senior issuers from listing until completion MUST be CDN residents, or has demonstrated positive associations with Canadian or US public companies. $100,000 min seed capital must be contributed by these officials 4) Issuer MUST raise between $200k to $1.9M in IPO, offering price can range from $0.15 to $0.30 NEX is a new and separate board of TSX Venture Exchange providing trading forum for companies that have fallen below TSX listing standards. Fail to meet Maintenance Requirements, failed to complete QT, inactive issuers. LISTING PROCESS: Before new share issue brought to market, grey market (OTC). Copies of the company charter Current prospectus Financial statements, annual reports (five years) Sample share certificates Advantages of Listing: 1) Prestige and goodwill increased public visibility (easier trading) 2) Established and visible market value (acquisitions, new financing, new shareholders) 3) More information available (financial reporting, disclosure regulations) 4) Valuation for tax purposes (estate tax and planning purposes) 5) Increased market visibility and investors following (analyst coverage, new issues, goodwill) Disadvantages of Listing: 1) Disclosure requirements: need to keep market participants informed 2) Meetings with security analysts an dinstitutional investors 3) Market indifference (low trading volume, poor market performance, badwill) 4) Additional costs and disclosres: listing fee, annual sustaining fee, etc. Listing Agreement: after application and supporting documents are completed, agreement specifies regulations and reporting requirements that company must follow, such as: 1) Submission of annual and interim financial reports

CSC Summary 2) Prompt notification to exchanges about dividends, ESOPs, distributions, sale/issue treasury shares 3) Notification of other material changes in business affairs of listed company 4) Listing standards increase when company wants to increase its prestige Withdrawing Trading Privileges Exchanges empowered to withdraw trading privileges temporarily / permanently. Serious actions like delisting occurs rarely. Three types of temporary withdrawals of trading privileges: 1) Delayed Opening prevents heavy influx of buy/sell orders (gives extra time for exchanges to sort out orders). This allows fair and orderly trading when resumed. 2) Halt in Trading allow significant news to be reported and widely disseminated (pending merger) 3) Suspension for more than one trading session, happens when financial condition does not meet exchange requirements, failure to comply with terms of listing agreement, etc. Members can execute orders for suspended security in unlisted market (OTC) except if suspend from Venture. Delisting can occur because: 1) Security has been called for redemption 2) No assets left or bankruptcy, or public distribution of security to an unacceptably low level. 3) Failed to comply with terms of listing agreement

CH12 CORPORATIONS FINANCIAL STATEMENTS Trust companies traditionally end FY on October 31 Advertising / Media companies traditionally end FY on August 31 The value of liabilities, unlike assets almost never shrink Balance Sheet Miscellaneous Assets can be cash surrender value of life insurance, amount due from directors, officers and employees, investments of a long-term nature and investments in or advances to subsidiaries. PPE value lies in ability of these assets to generate income stream (goods and services). Shown at B/S at original cost including installation and other acquisition expenses. Expressed as net carrying amount. When sold, original cost and amortization removed. Depletion common to mining, O&G, timber, natural resrources. Wasting assets refer to those assets sold and depletion is the annual decrease in value the company records. Must recover not only the cost of extraction but also exploration and development expenses before profits can be recognized. Deferred Charges represent payments made by company for which benefit will extend over several years (deferred taxes). From accounting perspective, cost is spread out annual write-offs. Intangibles represent valuable legal rights essential to operations. Shown as nominal value. Goodwill often defined as probability that regular customers will return. Excess amount paid for shares over net asset value. Bank advances consist of short-term loans from financial institutions Future Income Taxes result in temporary differences between BV of assets and liabilities as reported on the balance sheet vs amount attributed for tax purposes

CSC Summary Non-Controlling Interest in subsidiaries: consolidated method of accounting is used; noncontrolling, or minority interest is regarded as a quasi-liabilitiy, which MUST be deducted in arriving at the consolidated shareholders equity of the parent company Contingent liabilities are more suitably reported as a note to the financial statements. Share Capital is amount received by company during issuance of shars. Contributed Surplus sometimes appear in retained earnings, belongs to shareholders but originates from other sources than earnings. May result when companies sell shares more than par value. Foreign Currency Translation Adjustment adjusts for fluctuating exchange rates that make foreign subsidiaries worth more. INCOME STATEMENT Operating section, Non-Operating Section, Creditors section, Owners section (4 sections) The first two show sources of income, whereas the following two show distribution of income 1) Operating Section operating inome received by source, expenses incurred and net income. Net sales consist of gross sales less excise taxes, returns & allowances and discounts After arriving at gross profit, SG&A expenses, depreciation / amortization is deducted. Pension Expense, renumeration, legal fees are also deducted in this section Net Operating Profit is what we come up with after deducting all expenses from revenues 2) Non-Operating Section consists of income from royalty trusts, interests, dividends, rents from properties acquired for investments, finance charges earned, etc. It must be excluded form sales. 3) Creditors Section Less Intereest income, Net Income Before Taxes (NIBT) 4) Owners Section shareholders entitlements of net earnings produced by company Minority interest has to be subtracted for portion of subsidiary it does not own Equity Income is derived using equity accounting method (significant influence 20%-50%) Cost Method primarily used for ownership holdings that do not result in significant influence Extraordinary Gains or Losses represents windfall-type capital gains, losses or expenses after all other revenues and expenses have been accounted for. Net Earnings / Income is the amount of profit STATEMENT OF RETAINED EARNINGS From time to time, amounts may be set aside as reserves (ex. Decline inventory value). The use of a reserve does not mean that fund of cash has been set aside. Merely says that portion of RE has been earmarked as unavailable for distribution. CASH FLOW STATEMENT Begins with income before extraordinary items, followed by change in working capital items Dividends from an investment will also show up on the Investing Section of the CFS ANNUAL REPORT Footnotes to the financial statements: disclosure in detail of information in shareholders interest. These include accounting policies, share capital, long-term debt, commitments, contingent liabilities, hedging, etc. Also disclose variou ssegments of companys operations by industry and geographical area.

CSC Summary Canadian law requires every company to appoint an auditor to represent shareholders and report to them annually their opinions in writing as to fairness of the accounting system. Private corporations are not required to conduct an audit. Auditors report conventionally has 3 paragraphs: 1) Introductory paragraph (FS covered and distinguishes responsibilities of management and auditor) 2) Scope Paragraph (states how audit was conducted: planned and executed according to GAAP) 3) Auditors opinions on FS of the company (present fairly the financial position of company) GAAP allowed some flexibility for companies in different in dustries to choose standards IFRS is a globally accepted high-quality accounting that enhances transparency Canadian Public Accountability Board (CPAB) strengthen public confidence SEC demands CEOs and CFOs to vouch and swear for financial statements to improve public confidence Sarbanes-Oxley Act of 2002 created the Public Company Accounting Oversight Board