8 economics

Topics for Discussion
• Mid-Semester Feedback
• Individual Writing Assignment & Presentation
– revised instructions for submitting to Pearson
– only ﬁnal copy should be submitted to turnitin
– presentations are coming up quickly!
• Peer evaluations should be complete
• Demographics
• Midterm
– SI Virtual Study Session Oct. 20th
– Individual appointments with Learning Strategists
• Economic Factors
– Bring calculator on Oct. 20th & use paper notes

Inspiring Lives of Leadership and Purpose

Midterm
Midterm administrative details
– Saturday, October 22nd
– 9:00 a.m. to 11:30 a.m.
– locations are posted on course website (you must write in the
location posted for your lab)
– bring student ID and multiple writing instruments
– coats, bags, phones, IPods (TURNED OFF) must all be left at front
of room
– use the washroom before the exam starts
– read instructions carefully and read questions carefully
– show all your work and all your thinking – don’t second guess
marking key and don’t make it hard for your TA to mark!
– adhere to academic integrity guidelines!!!

Review Study Skills slides for additional tips i.e.
cue cards,
Inspiring Lives ofcomplete M/C questions, acronyms, sleep,
how to Leadership and Purpose
etc.

Economic Factors

• Canadian ﬁnancial system
• Investment instruments
• Time value of money


General economic factors

• Recall:
– Effect of trade balance on domestic
economy
– Effect of exchange rates on competitive
advantage
– Effect of GDP on standard of living


Canadian Financial System



• Financial institutions facilitate ﬂow of
money



money
• Four distinct legal areas /”pillars”:
– Chartered banks
– Alternate banks
– Life insurance companies
– Investment dealers



money
• Four distinct legal areas /”pillars”:
– Chartered banks
– Alternate banks
– Life insurance companies
– Investment dealers
• Lines between pillars have been
blurred due to deregulation

Pillar #1 – Chartered Banks

• Privately owned
• Serve individuals, business, and others
• Largest and most important institution
• Five largest account for 90% of total
bank assets
• Bank Act limits foreign-controlled
banks to <8% of total domestic bank
assets

Banks (continued)


Banks (continued)

• Major source of short loans for business
– Secured vs. unsecured loans


Banks (continued)

• Expand money supply through deposit
expansion


Banks (continued)

expansion
• Changes in banking


Banks (continued)

expansion
• Changes in banking

• Bank of Canada
– Open market operations
– Bank rate

• Pillar #2 – Alternate banks

• Pillar #3 – Specialized lending/saving
interm.

• Pillar #4 – Investment Dealers


International Banking & Finance


• Governments and corporations
frequently borrow in foreign markets


• International Bank Structure


– Stability relies on a loose structure of
agreements


agreements
– World Bank -


agreements
– World Bank -
– International Monetary Fund –


Securities Markets


Securities Markets

• Where stocks, bonds, and other
securities are sold


Securities Markets

securities are sold
• Primary markets
– Investment bankers


Securities Markets

securities are sold
• Primary markets
– Investment bankers
• Secondary markets
– Toronto Stock Exchange and other
exchanges


Bonds


Bonds
• Represents debt –


Bonds
• Characteristics of a Bond
– Fixed rate of return
– Fixed term
– Priority over stockholders


Bonds
• Characteristics of a Bond
– Fixed rate of return
– Fixed term
– Priority over stockholders
• Types
– Secured vs. Unsecured (debentures)
– Registered vs. Bearer
– Callable

- Serial, convertible

Bond value determined by:

• Prevailing interest rate
• Coupon rate
• Credit rating of issuer
• Features
• Time to maturity


Concept of Yield

• Percentage return on any investment


Calculating Approximate Yield to
Maturity
(assumes will hold until maturity)


Calculating Approximate Yield to
Maturity
(assumes will hold until maturity)

Example:


How are bond prices
determined?

• Facts: Example
– bond A has risk premium of 2%; issued in 2002,
coupon = 5%
– 2002 – interest = 3%,
– 2003 – interest = 4%
– 2004 – interest = 2%

Yield = coupon + capital gain/loss

2002
5% = 5% + ?

2003
6% = 5% + ?

Bond Price Calculation

• Example: What would you pay for a
GM 9.5 of 2021, if similar risk bonds
issued today have coupon rates of
10.5%?
1991 2011 2021



10.5%?
1991 2011 2021

GM 9.5s of 2021
issued at par



10.5%?
1991 2011 2021

GM 9.5s of 2021 prevailing interest rate 10.5%
issued at par pay $1,000 for GM 9.5 of ‘21?


Reading bond quotations

Bonds issued at $1,000 face value and
redeemed at $1,000 face value at maturity

Issuer Coupon Maturity Price Yield Change


Types of Investments: STOCKS

• What is a stock?
• Characteristics of stock
– equity
– voting rights
– no ﬁxed term
– variable return
– discretionary payment (dividends)
– risk


Types of Stocks


Factors that affect stock price

• demand and supply of stock due to negative or
positive perceptions/facts
• Primary factors

• PRICE OF A SECURITY IS A COLLECTIVE EXPRESSION
OF ALL OPINIONS OF THOSE WHO ARE BUYING AND
SELLING
• Undervalued issue -


Reading Stock Quotations

High Low Stock Dividend High Low Close
Change Volume

last price of board lot marketability
volatility
from yesterday’s close

•prices <$5 move in 1 cent increments
• prices >$5 move in 5 cent increments
• if not traded on a particular day…

BID
ASK

Other Investment Vehicles

• blue chip stocks
• small-cap stocks
• penny stocks
• Canada Savings Bonds - CSBs
• Guaranteed Investment Certiﬁcates -
GICs
• Treasury Bills - T-Bills
• mutual funds

Leverage
• Engaging in a transaction whose value is
greater than the actual dollars you have
available

• selling short –
• buying on margin -


Buying on Margin


Buying on Margin
• put up only part of purchase price


Buying on Margin
• broker lends remainder (with interest)


Buying on Margin
• broker lends remainder (with interest)
• allows you to buy more than you could
using just your own money...


Comparison of long and margin
Example:
XYZ trading @ $45; have $6,300 to
invest; minimum margin requirement is
70%; sell at $55


Example:
70%; sell at $55
A. go long -


Example:
70%; sell at $55
A. go long -

Sell
Bought for

Less: 2% IN
2% OUT
Capital gain

Utilize full margin


Utilize full margin
– let total amount invested be ‘x’


Utilize full margin

70% x =

x=


Utilize full margin

70% x =

x=
– broker advances


Utilize full margin

70% x =

x=
– broker advances
– Purchase


Utilize full margin

70% x =

x=
– broker advances
– Purchase
Sell

Bought for

Less: 2% IN
2% OUT
Capital gain $

Margin Buying Rules:


• Must sign ‘hypothecation’ agreement
(Margin Account Agreement Form) --
pledging of securities as collateral for a loan


• the investor’s % equity (margin) in the
margined stock must always be > the
minimum margin requirement


• the investor’s % equity (margin) in the
margined stock must always be > the
minimum margin requirement

CMV - loan > % margin
req’t
CMV

Selling Short


Selling Short

• sell shares you don’t own - borrow from
broker


Selling Short

broker
Rules


Selling Short

broker
Rules
• agreement may be terminated by either
party at any time - forced to cover /
“buy-in”


Selling Short

broker
Rules
“buy-in”
• short sale price governed by ‘last sale’
rule


Selling Short

broker
Rules
“buy-in”
rule
• dividends declared are the responsibility
of the seller


Selling Short

broker
Rules
“buy-in”
rule
• dividends declared are the responsibility
of the seller
• short deposit must be 150% CMV at all
times

Short selling

Current market Required Short accounts
value (CMV) of total balance
investment 150% = 50% 100%
(100 shares) (1.5xCMV)
Short @
$10/sh. $1000 $1500 = $500 $1000

Proceeds from sale Your investment


Example:


Example:
• ABC selling at $70/share; expect drop
in price, short 100 shares


Example:
• Broker


Example:
• Broker
$7, 000
Sell @ $70x100
(left as collateral)
$3 500
Deposit 50% of CMV as
collateral
as collateral deposit
Total short $10 500


Cover short at $55


Cover short at $55
• buy 100 shares of ABC @ $55 = $5,500


Cover short at $55
• buy 100 shares of ABC @ $55 = $5,500
• shares go back to broker - short seller gets
back additional collateral


Cover short at $55
• buy 100 shares of ABC @ $55 = $5,500
• shares go back to broker - short seller gets
back additional collateral
Proceeds from sale CA$7,000
Cost of covering - CA$5,500
Gross proﬁt = CA$1,500
110
Less: 2% IN
2% OUT + 140
Capital Gain = CA$1,250


Short Sales


Short Sales

• What is maximum proﬁt you can make?


Short Sales


• What is maximum loss?


Short Sales


• What is maximum loss?

• Risks


Options

‘call’ -option to buy at a set price
‘put’- option to sell at a set price


Options
• An option is a contract that allows the
investor (option ‘holder’/‘buyer’) the
right to buy or sell at a speciﬁc price
in the future regardless of market
price. ‘call’ -option to buy at a set price


Options

• Why?


Options

• Why?

• Buy Call - leverage, guarantee cover price


Options

• Why?

• Sell Call - income


Options

• Why?

• Buy Put - leverage, protect proﬁt


Options

• Why?

• Buy Put - leverage, protect proﬁt
• Sell Put - income

Example:
Speciﬁcally… purchase option to buy/sell


Example:
- prescribed # of shares of ‘underlying interest’ (100)


Example:
- at prescribed price (‘strike’ price/’exercise’ price)


Example:
- over a period of time (until expiry)


Example:
- for a ‘premium’


Example:

• One LMN July/85 Call at 5


Example:

100 shares


Example:

100 shares

underlying interest/security


Example:

expiry - 3rd Friday
100 shares of each month



Example:

expiry - 3rd Friday
100 shares strike price
of each month



Example:

• One LMN July/85 Call at 5premium/sh
expiry - 3rd Friday
of each month



Example:

buy
Opti on to

• One LMN July/85 Call at 5premium/sh
expiry - 3rd Friday
of each month



Derivative – Premium depends on…
volatility of stock optioned
direction of market
length of time contract ;time value
difference between strike price and market price -;intrinsic
value)


direction of market
value)

Example:


direction of market
value)

Example:
• market price of LMN is $40


direction of market
value)

Example:
• buy One LMN Nov/35 Call at 7


direction of market
value)

Example:
• premium =$5intrinsic value + $2
time value

direction of market
value)
Strike price on call $20:

Example:
time value

direction of market
value)
mkt $20 “at the money”

Example:
time value

direction of market
value)
mkt.$24 “in the money”
Example:
time value

direction of market
value)
mkt.$24 “in the money”
Example: mkt.$16 “out of the money”

time value

Exercise a call option


• LMN selling @ $50/sh, you think price will rise


• purchase 1 LMN Dec/50 Call at 5


• price increases to $70/share


buy 100 shares at 500 strike price CA$5,000
Sell 100 shares at $70 mkt. price CA$7,000

CA$2,000
equals=
500
Less: Premium
100
2% IN
140
2% OUT
10
2% on premium
Capital gain = CA$1,250

buy 100 shares at 500 strike price CA$5,000
Sell 100 shares at $70 mkt. price CA$7,000

CA$2,000
equals=
500
Less: Premium
100
2% IN Yield =
140
2% OUT $1250
2% on premium 10 $500
=250 %

PUT Example:


PUT Example:
• LMN selling @ $50/sh, you think price will drop


PUT Example:
• purchase 1 LMN Dec/50 Put at 4.50


PUT Example:
• price decreases to $30/sh


PUT Example:
CA$3,000
Buy
CA$5,000
Sell

450
Less: Premium
2% IN(buy commision) 60
2% OUT(sell commision 100
9
2% on premium

PUT Example:
CA$3,000
Buy
CA$5,000
Sell

450
Less: Premium
2% IN(buy commision) 60
Yield =$1,381
2% OUT(sell commision 100
9
$450
2% on premium =307%

Time value of money


Time value of money
• Is $1 one year from today worth the same as $1
today?


Time value of money
today?
• we want money today because is depreciates over time


Time value of money
today?
• risk - do we trust you


Time value of money
today?
• things can attack the value of it, we might need it for something today


Time value of money
today?
• things can attack the value of it, we might need it for something today

• Concept important to leases, mortgages, bonds,
retirement contributions, stock valuation, project
selection


Single amount – FV Single period
• What will you have in one year if you deposit
$100 into an account today that earns 4%
interest compounded annually? r=0.04 (int. or
discount rate
PMT= $100
(payment
100 ?
amount
x 1.04 (because we still have our hundred) n=1 number of
periods in years


Today
discount rate
PMT= $100
(payment
100 ?
amount
periods in years


Today 1 discount rate
PMT= $100
(payment
100 ?
amount
periods in years


Single amount – FV Multiple periods
• What will you have in three years if you
deposit a $100 gift into an account today
that earns 4% interest compounded
annually? r=.04
Today 1 PMT=$100
3 N=3
100 ?
x 1.04=$140 x 1.04=$108.16 x 1.04= $112.49
FVsingle amount =$100 x (1+.04^3)= $112.49


Sample problem
• How much money will you have in ﬁve
years if you deposit $200 into an
account that earns 3% compounded
annually?
• PMT=200
• r= 0.03
• n= 5

• FVsingle=PMTx(1+r)^n
=231.85 :Dwoo!

Single amount – PV Single period
• How much do you have to deposit today to have
$100 after one year (assuming 4% interest
compounded annually?) OR what is the present
value of $100 to be received in one year (assume a
4% discount rate).

? 100

100
(1+0.04)
= $96.15


4% discount rate).
Today

? 100

100
(1+0.04)
= $96.15


4% discount rate).
Today 1

? 100

100
(1+0.04)
= $96.15


Single amount – PV Multiple periods
$100 after three years (assuming 4% interest
value of $100 to be received in three years (assume
a 4% discount rate).


Today


Today 1


Today 1 2


Today 1 2 3


Sample problem:

• How much do you have to deposit
today to have $3,000 four years from
now (assume a 5% discount rate)?
PMT=3000
r=0.05
n=4

PV= 3000/(1.05)^4
=$2468.11


FV - Multiple payments & periods
• What will you have after three years if you deposit
$100 each year for three years (beginning at the
end of this year) into an account that earns 4%
interest compounded annually?
Today 1 2 3
PMT= 100
r=0.04
100 100 100 n=3
FVordinaryannuity=100[(1+0.04)^3-1
0.04]


FV - Multiple payments & periods
• What will you have after three years if you deposit
$100 each year for three years STARTING TODAY
into an account today that earns 4% interest
compounded annually?
Today 1 2 3

$100(1.04)^3 $100 (1.04)^2 $100 (1.04) =
$104
$108.16
FV Annuity Due: $112.4868+108.16+104= $112.4864


Sample problem:
• How much will you have in your
retirement account in 10 years if you
deposit $500 per year starting at the
end of this year (assume 3%
r=0.03
compounded annually). PMT=500
PMT [(1+r)^n-1 n=10
r]
=500[(1+0.03)^10-1
0.03]
0 1 2 3 ... 10
5731.94 500 500 500 ..?


Sample problem:
• What if we began saving immediately?
if we start saving today (use
the annuity due INSTEAD of
x 1+r for annuity ordinary annuity so
=500[(1+0.03)^10-1 annuity due you multiply final answer
0.03] (1+r)
(from previously slide) and
5731.94 x 1.03 multiply it by 0.03
=5,903.90

-on our timeline we start at
TODAY not 0!


Sample problem:
• How much must we put in an account
each year earning 4% if we want to
have $20,000 at the end of 10 years?
r=0.04 use FV formula but solve for PMT
PMT=? not FV
n=10 FV = PMT [(1+
r)^n-1
FV= 20,000 r]
20,000= PMT [(1+0.04)^10-1
0.04]
=166582
(solve for PMT)


PV - Multiple payments & periods
How big must your trust fund be today if you want to
receive a payment of $500 each year for the next
three years? Assume an interest/discount rate of
4%.
Today 1 2 3
*Today!*
=present value
? 500/1.04 500/1,04^2 500/1.04^3
NOT future
r=.04
PMT=$500 value
n=3

=500 [1 - 1
.04 .04(1+0.04)^3] =


PV - Multiple payments & periods
How big must your trust fund be today if you want to
receive a payment of $500 each year for the next
three years starting today? Assume an interest/
discount rate of 4%.
Today 1 2 3 r=0.04
PMT=500
n=3
use present value annuity due formula

=$1,443.05


Sample Problem:
You borrowed $20,000 to fund your education. How big will
your educational loan payments be if you want to have the
loan paid off in four years, you make the ﬁrst payment at the
end of this year, and the discount rate is 3%? r=.03
Today 1 2 3 4 PMT=?
n=4
PV=20, 000
PVord. annuity=P
MT[1 - 1
r r(1+r)^n ordinary annuity and discount rate
...discount rate= present value
annuity!
5,380.54
so ordinary present value formula


Sample Problem:
How much would you pay for an investment that will given you
$1,000 after four years and a payment of $50 each year as
well. Assume 3% interest compounded annually.
Today 1 2 3 4
r=.03
n=4
? 50 50 50 1000

this must be a bond because we know there is a set
maturity date

use PVordinary annuity + PVsingle amount = FV
(1+r)^n
price we pay for this investment TODAY=$1,074.34 (selling at premium)


Perpetuity

r=0.03
PMT=.
PV perpetuity= .05x12 05(12)=60
.03 =20


Perpetuity
• Annuity that goes on forever, e.g.
dividend on a preferred share

r=0.03
PMT=.
.03 =20


Perpetuity
r=rate
PMT=amount received

r=0.03
PMT=.
.03 =20


Perpetuity
r=rate
PMT=amount received

• What is the value of an investment in a 5%
preferred with a par value of $12 if interest
rates are 3%? r=0.03
PMT=.
.03 =20


Payment & compounding periods

• Payment and interest periods must be
the same
• Adjust compounding rate to match
payment frequency (this is your new
“r”)
• Always multiply “n” by number of
payments per year


Interest and payment periods same but more
than once per year (or single payment but
compounding >once per year)
-multiply “n” by number of payments per year
-divide “r” by number of payments per year

• What is the present value of four years
of $50 payments received every six
months and compounded semi-
annually at 3%?
r= .03/2 =0.015 since it does not start today it is
PMT= $50
n=4x2=8 an ordinary annuity! use
PVord.annuity

Interest & payment periods don’t match

this means r
rnom = rate given
m = # of compounding periods per year
P=

• What is the FV of $100 received monthly for
three years and compounded at 5% semi-
annually?
we are describing an ordinary annuity
effective monthly rate = (1 + 0.5/2) ^2*1/12 -1 = 0.0041

plug r into FV ordinary annuity formula = 3,870.72



rnom = .05 (rate given
m = 2 (# of compounding periods per year)
p= 1 (payment period measured in fractions of a year

effective annual rate = (1+.05/2)^2/1 - 1 = 0.0506


• What is the effective rate if you are calculating the
PV of a three year annuity of $1,000 compounded
at 5% semi-annually?
rnom = .05 (rate given
m = 2 (# of compounding periods per year)
p= 1 (payment period measured in fractions of a year

effective annual rate = (1+.05/2)^2/1 - 1 = 0.0506


Summary
Interest > Payments Matchin r & n adjustments
one per > once per g
year year schedul
es
Yes Yes yes New r=r÷payment frequency
New n=n x payment frequency

Yes or No Yes No r=Effective rate for payment
period
New n=n x payment
frequency
Interest Yes r=APR÷payment frequency
stated as New n=n x payment
APR frequency


Bond
What would you pay for a GM 9.5 of 2021, if the yield
(prevailing rate) on similar risk bonds issued today
is 10.5%?
1. Draw timeline.
--------------------------------------------------
today 1 2 10
47.50 47.50 47.50 47.50 47.50
2. What are we calculating? $1,000
the present value of ten years of semi- annual annuity payments $47.50. Add to this the present value of
a single amount of $1000 to be received in ten years. the discount rate is 10.5%

3.
What is my “r” and “n”?
-interest and payments happen at the same frequency (2 times per year)
r=.105/2=.0525 n=10x2=20


Bond example
4. Plug numbers into formulas

PV ordinary annuity= $579.61
PVsingle amount =
$359.3833

price of bond= 359.3833+579.61= $938.99 (discount rate!)


Bond example
4. Plug numbers into formulas
PMT (annuity) =$95-2
PMT(single)=1,000
r=.0525
n=20

PV ordinary annuity= $579.61
PVsingle amount =
$359.3833

price of bond= 359.3833+579.61= $938.99 (discount rate!)


Mortgage question


Mortgage question
• Calculate your mortgage payments if
you buy a house for $300,000, make a
down payment of $50,000, pay 6%
interest compounded semi-annually,
and make monthly payments.


Mortgage question
• Calculate your mortgage payments if
you buy a house for $300,000, make a
down payment of $50,000, pay 6%
interest compounded semi-annually,
and make monthly payments.
• Note:
– Mortgages are calculated over 25 years
but we actually only sign for 5 years or
less
– At end of ﬁve years we redo calculation
Inspiringon remaining Purpose
Lives of Leadership and balance for remainder of
years

Mortgage
Amount owing today = $300,000-$50,000=
$250,000
1. What are we calculating?
2. What is the “r” and “n”?
• Uneven payment & compounding
periods – calculate new “r”
effective monthly rate = (1+.06/2)^2/1/12 -1
=.0049
New n=25 years x
12 payments per
year =300


Mortgage
3. Plug numbers into formula

r=0.0049
n=300
PVordinary annuity=$250,000

$250,000=PMT [ 1 - 1 ]
.0049 .0049(1.0049)^300 PMT=$1,592.47


How much do you still owe when the mortgage is
renewed the end of five years?

PVordinary annuity=224,441.56

250,000-224,441.56=25,558.44

1,592.47x5x12-25,558.44= 69,989.76




Principal repaid = 250,000-224,441.56=25,558.44
1,592.47x5x12-25,558.44= 69,989.76




Principal repaid = 250,000-224,441.56=25,558.44

Interest paid = 1,592.47x5x12-25,558.44= 69,989.76


Lease

0 1 2 3 4

? ???? ? ? $7000
PV=23,000


Lease
Leased a $25,000 car at 4% APR with
$2,000 down payment and residual of
$7,000. What are the monthly lease
payments?

0 1 2 3 4

? ???? ? ? $7000
PV=23,000


Lease
payments?
Amount owing today:25,000-2,000=23,000
0 1 2 3 4

? ???? ? ? $7000
PV=23,000


Lease
payments?
Amount owing today:25,000-2,000=23,000
0 1 2 3 4

? ???? ? ? $7000
PV=23,000

1. What are we calculating? The
payments that will allow us to pay off
our lease/loan

Lease

a single payment of 7,000 and monthly payments over 4
years starting today

PVlease= PVsingle amount+PVannuity due

using APR therefore r=APR/12 (monthly payments)=. 04/12=0.0033
-new n=4 years x 12 payments per yr = 48


Lease
1a.
How are we paying this loan off?




Lease
1a.
How are we paying this loan off?


2. What is our “r” and “n”?


Lease

=5,976.1165

PMT=382.82


Lease
3.
Plug numbers into formulas.

=5,976.1165

PMT=382.82


Lease
Single amount =7,000
3.
Plug numbers into formulas.
Annuity payment =?
r=.0033
n=48

=5,976.1165

PMT=382.82


Tackling TVM problems


1. Draw timeline and note other variables


2. Figure out which formula(s) to use
 Are you calculating PV or FV?
 Hint: Look for the question mark or where your ﬁnal
total falls on your time line!
 Is it an annuity, a single payment, or both?
 Hint: Count the number of payments on your time line!


3. Calculate the “r” and “n” you will use
 Calculate “r” to match payment frequency (# of
payments per year)
 Multiply “n” by number of payments per year


3. Calculate the “r” and “n” you will use
 Calculate “r” to match payment frequency (# of
payments per year)
 Multiply “n” by number of payments per year
4. Plug new “r” and “n” into formulas

Requirements

• Must show formula and calculation
steps on ﬁnal exam
• Take number to four decimals while
executing calculation steps
• Round ﬁnal answer to nearest penny
• Formulas will be provided on exam 


8 economics

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