lectures 1-10 bu111

What is Business?

Sum total of all activities involved in the creation and distribution of goods and services for private profit.

Business-

OPERATIONS FUNCTION

PRODUCTION FUNCTION

Creation of good/service○

MARKETING FUNCTION

Distribution function○

Primary activities of a business-

Accounting

Finance - generate funds, etc. (not primary purpose)

Human resources

IT

Facilitate the primary activities (support or make possible)○

Ancillary (Secondary) Activities-

Drives people to do business○

Profit Motive-

The BU111 Course Model

A representation of reality○

What is a model?-

A good model simplify our understanding of what would be very complex○

Good model structures or "frames" our thinking regarding a complex topic○

Good model provides a meaningful framework for analyzing and studying a complex phenomena○

Good model also shows up how the various aspects of reality (parts of a model) interact with or impact upon one another

○

What are the characteristics of a good model?-

Frame business and role that managers must plan in today's business environment-

MODEL (SEE SLIDE)Constantly monitor external environment, monitor changes and proactive approach (good) vs. reactive approach (fail)

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Controllable decisions - what type of machinery?○

Critical Success Factors

Make profit□

Achieving financial performance

Identify needs of customers, listen, solicit feedback, looking for new needs to fulfill.□

Meeting customer needs

Global = competing with the best□

Providing high quality products and services

Constantly reinventing□

Encourage innovation and creativity

Most important asset□

All success factors are people driven.

Gaining employee commitment

If you hope to achieve success...-

Internal Environment-

Lecture 1September-16-091:03 PM

Lectures

Lectures

STM 101,tueday 5PM SI

Business StakeholdersIndividuals or groups who depend on a company for the realization of their personal goals and on whom the company is dependent for the realization of its goals

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Employees, stockholders, owners, suppliers, distributors, consumers

Therefore the relationship between a business and its stakeholders is said to be one of " mutual dependency"- rely on each other.

-

Primary StakeholdersOwners (shareholders)-

Customers-

Employees-

Secondary StakeholdersSuppliers-

Creditors-

Communities-

Government-

Society as a whole-

Business - Stakeholder Relationship

Capital

Owners○

Sales

Customers○

Labour

Employees○

Stakeholders provide a business with the capacity to operate...-

Fair ROI

Owners○

Quality products

Customers○

Fair wages

Employees○

Stakeholders therefore have legitimate expectations of a business...-

Therefore business must recognize its responsibility to address stakeholder expectations-

Demotivated and uncommitted employees○

Low levels of creativity and innovation○

Low levels of quality and customer service○

Poor financial performance○

Failure to address stakeholder expectations will result in:-

Dissatisfied and disappearing customers-

Angry shareholders and falling stock prices-

Management's Primary Objective

To devise and implement strategies that will allow the organization to achieve the critical success factors in a manner that meets legitimate stakeholder expectations

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In attempting to achieve this primary objective all managers must be able to analyze two different sets of environmental factors

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Characteristics of the external business environment

Extremely dynamic and constantly changing - pace of change is accelerating-

Increasingly competitive-

Increasingly globalized-

Complex, interactive, two-way phenomena-

Largely uncontrollable from the perspective of the individual firm or manager-

Lecture 2September-21-09

12:55 PM

Lectures

PEST: A model for analyzing the external environmentBecause the external business environment is largely uncontrollable, it must be constantly monitored by management

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Goal is to be proactive vs. Reactive (anticipatory vs. waiting) -

The PEST model breaks the external environment down into four sub -environment: political, economic, social, technological

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A firm's internal environmentUnlike the external environment a firm's internal environment is largely controllable-

Marketing○

Finance and accounting○

Operations management (production)○

Human resources management and industrial relations○

Consists of four key functional areas-

The process of ManagementAll managers, irrespective of their level in the organization must master the process of management-

Planning○

Organizing○

Directing, motivating, and empowering○

Controlling○

Communicating○

The basic tasks performed by all levels of management in order to realize the firm's primary objective - achieving the critical success factors in a manner that meets legitimate stakeholder expectations

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Lectures

Factors of Production: Capital

Economic environment of a business explains how firms and government to raise capital (money) necessary to operate.

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Reference: Lab Manual p7-25 reading-

Internal

$ required○

Finance infrastructure□

Government -> taxation

Finance capital expansion□

Public Corporations -> reinvesting profit (retained earnings)

2 Primary Groups○

This is commonly refereed to as the Capital Formation Process-

Internal vs. External Financing

Two ways in which corporations and government can obtain capital-

When internal sources of capital are insufficient go to the capital markets..○

External financing-

External Financing: Canadian Capital Markets

Capital marketsPlaces where people or institutions with money to invest (lenders/savers) are brought together with those who require capital (borrower/spenders)

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The TSX, NYSE○

Capital markets may be actual places-

The bond market, the money market○

Capital markets may also be virtual markets with no real physical location-

Users of Capital p7-9 LM

Acquiring new productive capacity

For capital expansion projects○

To fund the start-up of a new business○

Large public corporations-

Fund infrastructure○

All levels of government-

Suppliers of Capital

Bank, trust companies, credit unions

Pension funds, insurance companies

Mutual funds

Institutions that invests the money of others in the capital markets in order to fund a future liability.

○

Financial intermediaries (institutional investors)-

Public Corporations-

Individual investors-

Foreign governments and investors-

SecuritiesThings that are bought and sold in the capital markets-

Preferred and common shares, bonds and debentures, options, futures contracts, treasury bills,

Securities represent proof or evidence that a transaction has occurred between a supplier of capital and a user of capital

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12:53 PM

Lectures

Preferred and common shares, bonds and debentures, options, futures contracts, treasury bills, commercial paper, rights, warrants, shares in mutual funds.

○

External Financing

Gov't○

Corporations○

Debt financing (borrowing)-

Corporations○

< 1 year□

Short term

>10 years□

Long term

Intermediate term

How long is the $ required-

Canadian Financial System

Funds Required |

Debt ///////////////

/////////////

/////// /////// /////////////// Equity / Stock

Short term

Long Term

Private PlacementInstitutional investors

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Public sale

Banks Money Markett-bills-

Commercial paper

-

Bankers acceptances

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Bonds & Debentures

OSC - Ontario Securities commission

Stock Exchanges -preferred & common shares, Options(derivatives)

Over the Counter Market (OTC) bonds/debentures, unlisted stock, mutual funds

Investment Dealers (investment bankers) - Agent vs. Principal(underwriting)IB takes principal status, and assumes risk.

Agent Status -investment dealer(best efforts) - take commission on each share (i.e. Real estate agent)

Selling a share of ownership (equity financing)-

Investments

Lectures

Investments

The sacrifice of certain present value for uncertain future value-

Lectures

Individual Investors: Why invest?

Risk of living too longa.Risk of not living long enoughb.

To protect oneself against the two primary risks in life1.

To serve as a hedge against inflation2.To earn money for future purchases3.To inv4.invest in Canada's future5.

Factors to consider before investing

Different people/different investment objectivesa.

Safety of principal (risk) Risk vs. Return tradeoffsi.Income producing capacity (annual cash returns: interest or dividends)ii.Growth potential (capital gains)iii.

All investments vary (sometimes dramatically) in three key respects b.

Define your investment objectives before you commit any funds1.

Recognize that there is no such thing as a "perfect" investment2.Evaluate your personal circumstances regarding the need for liquidity in your investments3.Diversify your investments (build a balanced portfolio)4.Consider the time and expertise that you have available to manage your investments5.Think about how your investment returns will be taxed6.

The Canadian Tax System

Pertains to the taxation of individuals

Pertains to the taxation of unincorporated businesses (sole proprietorships, partnership)

Personal tax law○

Pertains to the taxation of private and public corporations

Corporate tax law○

Two branches of Canadian tax law-

Personal Taxation

A graduated or progressive system based on an individual taxpayer's level of taxable income-

Taxable income = total income ( see p.41) - allowable deductions

The higher an individual's level of taxable income...the higher that individual's marginal tax rate-

The more you make...the more you pay-

Federal tax (Canada)○

Provincial tax (Ontario)○

Provincial surtax (Ontario)○

Three different levels of tax must be paid by individuals living in Ontario-

Taxation of Investment Returns

The tax rate paid by an investor on his or her last dollar of taxable income earned

Strict Definition:○

The tax rate applied to every dollar of taxable income earned within a given tax bracket

Our Definition:○

Determining Marginal Tax Rate

The combined federal/provincial marginal tax rate after surtax for an Ontario resident in 2009 is the sum of his or her:

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Marginal Tax Rate-


12:53 PM

Lectures

Federal tax rate + Ontario tax rate + Ontario surtax rate (p 45)

Lectures

Taxation of Investment Returns

Interest○

Dividends○

Capital gains○

Each is taxed differently○

Therefore investment returns should always be compared on an after tax basis○

There are three types of investment returns-

Interest - 100% taxable○

Dividends - %45 gross-up, %19 federal and 7.4% provincial tax credit○

Capital gains - 50% of net capital gains are taxable○

Net capital gains = (total capital gains - total capital looses)

Tax rules for various forms of investment income 2009-

Example: $5000 on $50000 investment at highest combined rate

Taxable interest = $5000

$1450 Fed. Tax (29%x5000)+ 558 Prov.Tax before surtax (11.16x 50000)+312 Prov.Surtax (56% x 558)

= 2320

OR $5000 x 46.41% = $2320.5

Effective Tax rate = Tax Payable / amount received$2320/5000= 46.40% rounding

Rates of Return before and After Tax

Before Tax Rate of Return = interest received /amount invested-

$5000 /$50000= %10

After tax rate of return-

Interest - taxes/ amount invested

($5000, 2320) / $50 000= 5.36%

Tax on Dividend Income

$5000

Tax on interest income


1:41 PM

Lectures

$5000$2250 (45% gross up)$7250 amount subject to tax/taxable amount

$2103 fed before credit (29% x $7250)-1378 fed tax credit (19%x 7250)$725

+ 809$ prov before credit (11.16x 7250)-537 (Ontario tax (7.4% x 7250)272 prov before surtax

+152 prove surtax (56% x 272)

= 1149

Effective Tax rate = tax payable/amount recorded= 22.98

Before tax rate of return= 10%= 5000/50000Dividend received/ amount invested

After tax rate of return= dividend - taxes/amount invested= $5000-1149) / $50000= 7.70

Tax on Capital Gain Income

$5000 Net capital gainX 50% Capital gains tax rate$2500 amount subjected to tax

$725 fed (29%x 2500)+279 prov+156 prov surtax

=$1160

Or $2500 x 46.41% = $1160.25

Effective tax rate =tax payable / amount received= 23.20%

After tax rate of return = 7.68%

Comparing Impact of Tax on Different Investment Returns

Dividends 22.98%-

Capital gains 23.20%-

Interest 46.41%-

Lectures

Lectures

Alternate types of investments

BondsA bond is a promise by the issuer or borrower (gov't or corporation) to repay an investor (lender) a set dollar amount (principal), at a set date (final date of maturity), and to pay the investor a fixed rate of interest (the coupon rate) each year

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Bell 8 of 18Issuing company, coupon rate (interest rate) (8%), of date of final maturity (2019)

Bell repay $1000

Annual interest = coupon rate * face (par value of bond)

|_____________________________________________________|Date of initial sale Oct 5 1999 =20 year run to maturity= Date of final maturity Oct 5, 2019

Characteristics of All Bonds

Most bonds are initially sold at a face value (par value) of $1000 per bond

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Face value-

Most bonds have a relatively long life from the time they are initially sold, until they mature

○

Referred to as the bond's "term" or "run to maturity" or "life expectancy" and is normally 20 years

○

However some bonds may have a longer run to maturity or shorter run○

Always assume that a bond will have life expectancy of 20 years○

Length of life/date of final maturity-

At the end of it's life, a bond is said to "mature" and the issuer will repay the principal to holder

○

Date of final maturity-

Fixed rate of interest○

Amount receiver annually:○

Annual interest = coupon rate * face (par value of bond)○

An investor will never receive anything more than this amount of interest, but will also never receive anything less than this amount

○

Coupon rate-

If the issuer of a bond fails to pay the required amount of interest to the investor, it is considered to be an act of bankruptcy

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The bond indenture (contract)○

The bond trustee(trust companies, third party, watch over contract, full power to ask for repayment)

○

The order of liquidation○

The bondholders can then take action to force the company to liquidate its assets and use the proceeds to pay their outstanding claims (all interest owed plus fill repayment of the principal loaned):

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Order of Liquidation

Secured creditors (banks, bondholders)-

Preferred creditors (government)-

Unsecured creditors (suppliers, employees, debenture holders)

You lend Bell $1000

Lecture 6October-05-091:01 PM

Lectures

Preferred creditors (government)Unsecured creditors (suppliers, employees, debenture holders)-

Preferred stockholders-

Common stockholders-

Bonds are very safe investments

If the issuer defaults on the terms of the bond indenture, company liquidates-

Type of bond Type of collateral

Mortgage bond Property (land, buildings)

Collateral trust bonds Stocks and bonds (securities)

Equipment trust bonds Machinery and equipment

Debentures No collateral. Bondholders are unsecured creditors

Reading bond quotations in the financial press

Issuer Coupon Maturity Bid

Canada 5.50 Jun 1/14 106.48

Bell 6.55 May /29 99.42

Actual selling price = bid price x 10Canada of Canada 5.5 of '14 = 1064.80Bell Canada 6.55 of'29 = 994.2

The rough bond yield formula***MIDTERM***

The rough bond yield formula assumes that the investor holds the bond until the date of final maturity-

= (annual interest + annual capital gain) / purchase price of bond x 100%

# years to maturity= (coupon rate x par value) + (par value - p.Price)

Purchase price of bond

Example 1Calculate the yield on a GM 10 of october 5' 19 purchased for $900 on October 5, 2009

Yield = annual interest/bond + annual capital gain (loss) / purchase price / bond

= 10% x 1000 + (1000+900) = 2000 10 year

$900

$110 = $110.00 12.2% = $12.2% 900

Calculate the yield on a GM 10 of october 5' 19 purchased for $1100 on October 5, 2009

= (10% x $1000) + (1000 - 1100) / 10 years = 1100

Summary Bond Yields

Yield is greater then the coupon rate○

If a bond sells at a discount (less than $1000)-

If a bond sells at a premium (greater than $1000)

Lectures

Yield is greater then the coupon rate

Yield less then coupon rate○

If a bond sells at a premium (greater than $1000)-

Yield equals to he coupon rate○

If a bond sells at par or face value ($1000)-

Characteristics of Bonds

When you purchase a bond you are a creditor-

Therefore, you have no voting rights or say in how the company will be run-

If interest rates increase...bond prices fall○

If interest rates fall...bond prices increases○

Bond prices vary inversely with interest rate movements in the economy-

Indifference Analysis

Bell 8 of 191)XYZ 10 of 29.2)

Why do bond prices vary inversely?

Once a bond has been sold, the coupon rate is fixed-

If new bonds of similar risk and sold bearing a higher coupon rate (interest rates have risen in the economy)

-

Then rational investors will prefer to purchase these new bonds rather then old ones-

Rational investors will only be willing to own the old bond if that bond's yield is equal to that of the new bonds

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Price of old bond falls-

Sample problem : interest rates rise

Solution:Yield of old bond = yield of new bond

Let the purchase price of bell 8 of '10 be x-

10% = 10% (8%x $1000) + (1000 - x) 10 yearsx = $800 + $1000 - xX = $900

Summary: interest rates in economy have risen from 8% to 10%, you would be indifferent if bond costs $900

Lectures

Other features possessed by SOME bonds

Allows the issuer to repurchase the bond for a predetermined fixed price at the issuer's discretion prior to the date of final maturity

○

This fixed price is determined by the call schedule printed on the bond certificate○

Bell 10 of 29

Years Call price

2009-2014 $1030

2015-2019 $1020

2020-2024 $1010

2005-2029 $1000

The call or redemption feature (callable or redeemable bonds)-

Allows the issuer to the flexibility to buy back the outstanding bonds if interest rates fall substantially in the future

○

Lose potential interest

Lost capital gain from low interest rates

Callables usually pay a higher coupon than non-callables

Disadvantageous to the investor○

Why is a call feature attached to a bond?-

Allows the investor the right to convert the bond into a prescribed number of common shares in the same company

○

Conversion rate1 Bond -> 20 sharesC/S = $40 x 20 sh= $800

$60 x 20 = $1,200.00

May allows the investor to realize a capital gain at some time in the future if the form's common stock appreciates substantially in value

○

Favourable to investor○

Convertibles sell at lower coupon rates than non-convertibles○

Conversion feature (convertible bonds)-

Allows the investor the option to extend the life of the bond beyond it's maturity date (extendible) or have the bond refunded before its date of final maturity (retractable)

○

Favourable to investor○

Can see which way interest rates have moved (likely to move) and make the decision to extend (if interest rates have fallen below the coupon rate of the bond) or to retract (if interest rates have risen above the coupon rate of the bond)

○

Preferred Shares

Hybrid financing-

Falls between bonds and common stock, characteristics of both-

Extendible/retractable feature-

Exams, lab manual1)% of Par Value

How is fixed rate determinedi.Fixed rate of dividend ->> stock (dividend) bond (fixed rate)1.

Characteristics of Preferred Shares-

Lecture 7October-07-09

1:00 PM

Lectures

Ex. BMO 10% -> $100 par, $50 par, $20 par

Dividend rate * par value = dollar amount of annual dividend

Newspaper, online2)

BMO.Pr BMO.D $2.25

(PREFERRED)

Option to not pay dividendsi.Discretionary dividends2.

Non-voting (similar to bonds)3.

Preference in liquidation vs. Common stocki.

Arrears - dividends from previous years1)Dividendsii.

Preference rights4.

Preferred stock price vary inversely with inversely with interest5.

PURCHASE PRICE /SHARE6

= 66.67$

STOCK YIELD = (DIVIDENDS/SHARE/YEAR)

Characteristics of Some Preferred

Cumulative feature1.Call feature (10% 5%)2.Conversion feature3.Voting feature4.

Can have more then one feature

Lectures

Features of some preferred shares (cont.)

Once common stock dividends reach a certain prescribed level, and there are still additional profits available to be distributed in the form of dividends, then the common stockholders and preferred stockholders will share equally in the distribution of these additional profits on a per share (pro rata) basis

○

Allows preferred stockholders to receive dividends in excess of the stated preferred stock dividend rate in years of exceptional company profitability

○

Example (slides)

Favourable to investors○

Participating feature-

Calculating Stock Yield

Applies equally to preferred and common

= dividends/share/year Price / share

Common Stock

Common stockholders are the true owners of any organization-

They bear the greatest levels of risk but also enjoy the greatest potential rewards with regard to both dividends and capital gains when compared to bondholders and preferred stockholders

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Characteristics of Common Stock

Elect people to sit on board of directors

Right to attend meeting and vote on any issues

Vote on major issues

Voting rights-

Discretionary

No fixed amount

Dependent upon company profitability

Right to receive dividends-

Liquidation rights-

Offer stock first to existing common stock holders

Must be offered in a way that allows them to maintain % share of ownership in business

How are common stock prices derived

Bonds and preferred stock prices are closely related to the prevailing rates of interest in the economy

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How are common stock prices derived?-

Strictly on the basis on the laws of supply and demand-

If investors fell that a company will be highly profitable in the future that pays high levels of high levels of demand and payout and appreciation in share values

-

This will mean high levels of demand for a limited supply of shares, high rice-

The reverse holds true if investors feel a company will not be profitable-

Low levels of demand and falling stock prices-

Stock market Transactions

Straight buys/straight sells

Pre-emptive right-

Lecture 8Wednesday, October 14, 2009

1:00 PM

Lectures

Market orders□

Straight buys/straight sells-

Short selling-

Buying stock on margin-

Stock options -- puts and calls-

Straight buys and sells

The most common-

Buy low/sell high strategy-

Buy shares..hold for a period of time-

Bid and Ask Prices

Stock markets work on the basis of a bid and ask price system-

Call up a stockbroker and ask for a quote on ABC-

Ask price is the lowest amount per share that anyone is currently willing to sell ABC□

Bid price is the highest amount per share that anyone is currently willing to pay for a share of ABC

□

Currently at bid of $9 and ask $10… no shares would be changing hands□

Broker replies ABS is currently trading at a bid price of $9 and an ASK price $10-

Market orders

Telling your broker to execute your order immediately at the best available price in the market

-

Market order to buy… pay current ASK price and vice versa-

Short Selling

Prices are generally increasing□

Buy low sell high□

Bull market-

Prices are generally falling□

Sell high buy low (short sale)□

Bear market-

Sell shares you don't own - borrow from broker-

Other investors who have left stock with broker for safe keeping□

Margin stock□

Brokers own holdings □

Example: ABC selling at $70/share

Where does broker get stock to lend?-

You expect a drop in price and sell short 100 shares-

Broker lends you 100 shares of AABC-

Sells @ $70 x 100 = $7,000.00 - left as collateral-

$7000 (proceeds of short sale)Deposit another 50% market value as collateral (short deposit)-

Short deposit = 150% of stock shorted-

= 7000 + 3500 = 10500

Market price drop to $55-

Decide to 'cover' short position-

Buy 100 shares of ABC @ $55 = $5500-

Shares go back to broker - investor gets back collateral-

cost of covering $5500Gross profit = $1500Less : 2% out $140 2% in 110

Profit: proceeds from sale $7000-

Lectures

2% in 110= $1250

Risks associated with Short Selling:

Agreement may be terminated by either party at any time.-

Dividends declared are the responsibility of the short seller-

No limit on amount how high price can go□

Theoretically no limit to the amount of money an investor can lose-

Short CallsShort selling rule: short deposit must be 150% CMV of stock shorted at all times-

If price of stock rises above level at which it was initially shorted - investor is subject to a short call (deposit with broker is less then 150% of current market value of stock)

-

Deposit more money into short deposit-

Price increased to $75 x 100 = $7,500.00 CMV

10500 now on deposit-

$750 short call

150%($7500) = 11.250

Price decrease to $65 x 100 sh = $6500150%(6500) = $975010 500 now on deposit-

$750 can withdraw

Buying on Margin

Put up only part of purchase price-

Broker lends remainder (with interest)-

Allows you to buy more shares then you could using just your own money-

You have $5000, XYZ @ $100/shMaintain margin requirement 50%

Go long - purchase $5000/$100 = $50.00 50 sharesA.Use full margin - you put up 50% = 50% $5000B.100% = 100% $10000 buy $10000/$100 = $$100 sharesC.

Therefore, allows you to realize greater profits-

Price of XYZ increases to $120

Full margin - 100sh x $20 = $2000 gross profitB.

But also realize greater losses!

$1 increase/decrease leads to profit/lossLEVERAGE - making money from borrowed money

Min requirement set and enforced by OSC currently %50-

Example:

XYZ selling @ $45Have $6300 to investMin margin req 70%, interest 10%3 months later, price increases to $55

Sell 140 shares @ $55 = $7700Go long - purchase $6300 / $45 = 140 sharesA.

A. Go long - 50sh x $20/sh = $1000 gross profit

Lectures

Sell 140 shares @ $55 = $7700

$1400Bought for $6300

Less 2% IN $126Etc. 2% OUTEtc. PROFIT

Go long - purchase $6300 / $45 = 140 sharesA.

Utilize full marginB.Let total amount invested be 'x'70%x = 6300X = 9000Broker advances 9000-6300 = 2700 (30%)-

Sell 200 @ 55 = 11000$

= 2000$Bought for 9000$

Less 2% IN + 2% OUT = 180 + 220Interest = 67.50$ ( 10% x $2700 x 1/4 year = $67.50 )

$1532.50 (412.50 more)

Simple interest

Principal x annual interest x adjustment factor

Adjustment factor = x / 12 where x = # of months loan outstandingOr y / 365 where y = # of days loan outstanding

Margin Buying Rules

Must sign 'hypothecation' agreement -- pledging of securities' as collateral for a loan-

Purchase 9000/45 = 200 shares-

Lectures

Short Selling

Prices are generally increasing□

Buy low sell high□

Bull market-

Prices are generally falling□

Sell high buy low (short sale)□

Bear market-

Sell shares you don't own - borrow from broker-

Other investors who have left stock with broker for safe keeping□

Margin stock□

Brokers own holdings □

Example: ABC selling at $70/share

Where does broker get stock to lend?-

You expect a drop in price and sell short 100 shares-

Broker lends you 100 shares of AABC-

Sells @ $70 x 100 = $7,000.00 - left as collateral-

$7000 (proceeds of short sale)Deposit another 50% market value as collateral (short deposit)-

Short deposit = 150% of stock shorted-

= 7000 + 3500 = 10500

Market price drop to $55-

Decide to 'cover' short position-

Buy 100 shares of ABC @ $55 = $5500-

Shares go back to broker - investor gets back collateral-

cost of covering $5500Gross profit = $1500Less : 2% out $140 2% in 110= $1250

Profit: proceeds from sale $7000-

Risks associated with Short Selling:

Agreement may be terminated by either party at any time.-

Dividends declared are the responsibility of the short seller-

No limit on amount how high price can go□

Theoretically no limit to the amount of money an investor can lose-

Short CallsShort selling rule: short deposit must be 150% CMV of stock shorted at all times-

If price of stock rises above level at which it was initially shorted - investor is subject to a short call (deposit with broker is less then 150% of current market value of stock)

-

Deposit more money into short deposit-

Price increased to $75 x 100 = $7,500.00 CMV

10500 now on deposit-

$750 short call

150%($7500) = 11.250

Lecture 9Wednesday, October 14, 2009

1:29 PM

Lectures

$750 short call

Price decrease to $65 x 100 sh = $6500150%(6500) = $975010 500 now on deposit-

$750 can withdraw

Buying on Margin

Put up only part of purchase price-

Broker lends remainder (with interest)-

Allows you to buy more shares then you could using just your own money-

You have $5000, XYZ @ $100/shMaintain margin requirement 50%

Go long - purchase $5000/$100 = $50.00 50 sharesA.Use full margin - you put up 50% = 50% $5000B.100% = 100% $10000 buy $10000/$100 = $$100 sharesC.

Therefore, allows you to realize greater profits-

Price of XYZ increases to $120 A. Go long - 50sh x $20/sh = $1000 gross profitFull margin - 100sh x $20 = $2000 gross profitD.

But also realize greater losses!

$1 increase/decrease leads to profit/lossLEVERAGE - making money from borrowed money

Min requirement set and enforced by OSC currently %50-

Example:

XYZ selling @ $45Have $6300 to investMin margin req 70%, interest 10%3 months later, price increases to $55

Sell 140 shares @ $55 = $7700

$1400Bought for $6300

Less 2% IN $126Etc. 2% OUTEtc. PROFIT

Go long - purchase $6300 / $45 = 140 sharesE.

Utilize full marginF.Let total amount invested be 'x'70%x = 6300X = 9000Broker advances 9000-6300 = 2700 (30%)-

Sell 200 @ 55 = 11000$

= 2000$Bought for 9000$

Less 2% IN + 2% OUT = 180 + 220Interest = 67.50$ ( 10% x $2700 x 1/4 year = $67.50 )

$1532.50 (412.50 more)

Purchase 9000/45 = 200 shares-

Lectures

$1532.50 (412.50 more)

Simple interest

Principal x annual interest x adjustment factor

Adjustment factor = x / 12 where x = # of months loan outstandingOr y / 365 where y = # of days loan outstanding

Margin Buying Rules

Must sign 'hypothecation' agreement -- pledging of securities' as collateral for a loan-

Margin Buying Rule - an investors %equity in the margined stock must be always be >/= the investor's minimum margin requirement

-

Value of stock - value of loan = equity

(CMV - Loan) / CMV >/= %margin req't

ExampleXYZ drops to $40

CMV = 40 x 200 shares = 8,000 $Equity = CMV $8000 - loan $2700 = $5300%equity = 5300/8000 = 66.25% < req't of 70%

Receive a margin call from broker for amount x that will bring % equity back up to minimum requirement

5300 + x/8000 = 70%

Solve for xX = 300

Lectures

Options

You are not buying and selling stock1)When you buy a option, you purchase a right to purchase/sell shares at some point in the future at a fixed price

2)

A prescribed a number of shares (1 contract = 100sh)○

For a prescribed price (exercise, striking price)○

For a prescribed time period (until expiry--life expectancy)○

For a market determined premium○

An option is a contract that allows the investor (option 'holder'/'buyer') the right to buy or sell-

Option Contact:

Writer Purchaser

Jim InvestorBu111C

BUY 100 SH OF RIMFor price of $72/share for next 3 months

Ok. Acceptance.

Ex. a) Price of RIM + to $85/SH in 2 monthsBuy @ $72 and resell at $85

Price of RIM - to $60/SHa)Lose $200 premium (maximum loss)

CALL = Option to buyPUT = Option to sell

EXAMPLE:

One LMN July/85 Call at 5

100 shares of underlying interest/security, expiry on July - 3rd Friday at 4:00PM (convention), at $85 strike price at $5 premium/sh

Call Option

WriterSells call option-

Receives premium-

Agrees to sell stock at striking price-

Hopes price of stock will fall or not rise above striking price-

PurchaserBuys call option-

Pays premium (up front = maximum loss)-

Can buy shares at striking price-

Hopes price will rise above striking price-

Call example

LMN selling @ $49/sh, you think price will rise-

Lecture 10Wednesday, October 21, 200912:59 PM

Lectures

Expect rise stock price-

Abc => CMP $50/sh-

You have $5000, margin requirement 50%-

100 shares

Go long, straight buy○

5000$ x 50% = 10000

= 200 shares

Buy on margin○

Premium $15/sh = 1 contract = $500

$5000/500 = 10 contracts

1000 shares

Purchase a call option○

Write a put option○

CALL EXAMPLE:

LMN selling @ $9/sh, you think price will rise-

Purchase 1 LMN dec/50 call at 5-

Price increases to $70/sh-

Buy 100 shares from writer @ 50 = 5000$

$2000Less premium = 500-

2% in = 100-

2% out = 140-

2% on premium = 10-

Sell 100 shares in market at $70 = $7000$

= $1250

Yield= $1250 / 510 = 245%

Annual Rate of return

245% = 3 months12/3 = 4 x 245% = 980%

Three months later: exercise option-

Strategies:-

Put Option

WriterSells put option-

Receives premium-

Agrees to buy stock at striking price-

Hopes price of stock will rise or not fall below striking price-

PurchaserBuys put option-

Pays premium-

Can sell shares at striking price-

Hopes price will fall below striking price-

Put example:

LMN selling @ $51 /sh, you think price will drop-

Purchase 1 LMN Dec/50 Put at 4.50-

Price decreases to $30/SH-

4 months later exercise option-

Buy 100 shares at $30 market price = $3000-

$2000Less premium 450-

2% in = 60-

2% out = 100

Sell 100 shares at $50 share price = $5000-

Lectures

2% in = 602% out = 100-

2% on premium = 9-

= 1381$-

Yield = $1381 / 459 = 301%

Expect falling stock pricesABC => CMP $50/sh$5000, margin requirement 50%150% of CMVStrategies:Straight sell, liquidate positiona)

Your 5000$ (50%), broker sell short $10000 (100%)a.= 200 shares you can shortb.

Sell shortb)

Purchase a put optionc)Write a call optiond)

Lectures

lectures 1-10 bu111

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