Canadian Securities Course (CSC) Textbook Vol. 1

8/11/2019 Canadian Securities Course (CSC) Textbook Vol. 1

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Prepared and published by

CSI

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Canadian Securities CourseVolume 1

Credentials that matter.


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Every attempt has been made to update securities industry

practices and regulations to reflect conditions at the time

of publication. While information in this publication has

been obtained from sources we believe to be reliable, such

information cannot be guaranteed nor does it purport

to treat each subject exhaustively and should not be

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to update the content in this publication.

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ISBN: 978-1-927104-73-6

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CSI GLOBAL EDUCATION INC. (2013) i

Course Introduction

Welcome to the Canadian Securities Course (CSC)!

In beginning this course, you are taking an important first step toward a comprehensive

financial education. You will be able to apply the knowledge you acquire in this course

to an exciting career in the financial services industry, or you can use it simply to make

informed financial decisions and maximize your investment potential.

The CSC is recognized as an industry benchmark. It covers a diverse range of topics,including financial markets, financial instruments, and financial intermediaries. The course

content reflects the ever-changing nature of the securities industry. Ten years ago,

for example, exchange-traded funds, principal protected notes, and hedge funds were

barely covered in the CSC, because they were of little significance. Today, these types of

securities are treated in-depth in the CSC, because they have come to play a vital role in

the financial landscape.

The dynamic nature of the industry is a compelling reason to take the CSC course,

whether you aspire to a career, are already working in the financial services industry

or merely want to enhance your investing knowledge. Your challenge is to thoroughly

understand the material so you can apply it in the workplace, discuss key concepts with

your financial advisor, or use your knowledge to make your own investment decisions.Our challenge is to make the content easy to learn. We created various course

components for this purpose, and we highly recommend that you use them all. They

include the textbook, online learning activities, post-test questions, discussion boards,

Frequently Asked Questions(FAQs), and the CSC Checkproduct.


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COURSE INTRODUCTION iii

CSI G LOBAL EDUCATION INC. (2013)

Tell Us How Were Doing!

Although we make every effort to ensure that what you are learning is accurate, practical, andwell written, we recognize that there is always room for improvement. The course is updatedregularly, so please let us know what you think. You can submit comments, suggestions orcomplaints to [email protected].

This edition of the Canadian Securities Course (CSC) textbook was prepared in the Fall of 2012.The CSC textbook is updated and revised regularly to better reflect the rapidly changing financialservices industry. We thank those students and industry representatives who helped with therevision process, either through their suggestions or by providing or verifying information forthe book.

What Youll Learn

The CSC covers the three central elements of the Canadian securities industryfinancialproducts, financial markets, and the role of financial intermediaries. Intermediaries includeInvestment Advisors, financial planners, and financial advisors, among others. Our goal is to help

you understand the marketplace and introduce you to industry terminology and practices.Our journey begins with an introduction to the Canadian securities industry, the regulatorylandscape and the economy. From there, we move to the different types of markets, instrumentsand methods of analysis. The course ends with a look at the many types of structured orfinancially engineered products, taxation, ethics and, finally, the financial planning process.Volume 1 provides the tools and knowledge that you will need to apply to the material inVolume 2.

What Is the Big Picture?

Think of the capital market as the engine of the economy. By this we mean that the capital

market transforms savings into investments, and these investments drive a nations growth. Thisvital economic function is based on a simple processthe transfer of money from those who haveit (savers) to those who need it (users).

Capital transfer at its simplest occurs when you deposit money into a bank account. Once youmake a deposit, the bank can lend it to a business that needs funds. For example, the businessmay use borrowed funds to expand their operations or to become a publicly-traded company ona stock exchange. In return, the business pays interest on the borrowed funds, and you receive aportion of that interest for the use of your money.

Of course, the capital transfer process is more sophisticated in our financial markets, especially asthey become increasingly complex.

In essence, the financial markets have evolved to work like this:

Financial instruments, such as stocks and bonds, formalize the transfer of capital.

Financial markets provide a forum where capital is transferred in the form of financialinstruments.

Financial intermediaries, such as Investment Advisors, make the transfer process fasterand easier.


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CANADIAN SECURITIES COURSE VOLUME 1iv


These three componentsinstruments, markets, and intermediariesare the key elements of thesecurities industry. In combination, they facilitate the efficient allocation of capital.

For example, a company needs capital to expand its operations. The company raises capital byissuing financial instruments, such as stocks or bonds, into the market through an investmentdealer. Investors buy the securities through an intermediary such as a financial advisor. In the

process, the investors temporarily transfer their money to the company. In return, they receivesecurities representing claims on the companys real assets.

If the business does well, it earns a profit. Part of these earnings may be distributed to theinvestors in the form of dividends or interest, depending on the type of security that waspurchased. The price of the security also may rise, yielding a profit or capital gain for the investorwhen the security is sold in the marketplace.

Investors arent the only ones to profit, however. Part of the money earned by the company maybe reinvested in the business, spurring further economic development. Consequently, securitiesinvestments benefit not only the investor and the user of capital, but also the country as a whole.

Key Chapter FeaturesEach chapter includes the following learning features:

Chapter Outlines: The chapter outline lets you know what content will be covered in thechapter and will prepare you for the material you are about to read.

Learning Objectives: The learning objectives help to focus your studies on important topic areas.Be sure to read each objective before you begin a chapter; the objectives specify precisely whatyou are expected to know after reading the chapter and studying the material. To highlight theirimportance, we have linked each objective directly to the chapters major headings.

Chapter Openers: Each chapter begins with a short overview of the importance and relevance

of the material to be covered. The openers set the stage and help to increase your motivation bylinking the chapter content to the real world.

Key Terms: Understanding the terminology and jargon of the securities industry is an importantpart of your success in this course. We provide a list of key terms at the start of each chapter.Each key term is boldfaced in the chapter and appears in the glossary included at the end of thetextbook.

Chapter Summaries: Each chapter closes with a concise summary of the material, organized bylearning objective. The summaries will help to reinforce the relationship between the materialand the chapter learning objectives. They also help to suggest areas of weakness that requirefurther study.


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COURSE INTRODUCTION v


Your Journey Through the Course

Although each student will develop an individual technique for studying, some may find thefollowing suggestions helpful.

Your registration includes access to online modules that can be used as study guides. They aredesigned to help reinforce the textbook content and assess your knowledge.

Before you read a chapter, we recommend that you log onto the online course and use themodules along with your text. We suggest the following approach:

Read the Getting Startedsection and the learning objectivesfor the chapter.

Read the chapter in your textbook or the online PDF. Use this first reading to familiarizeyourself with the material. Take notes where necessary, especially if there is a concept youdont understand.

Complete the learning activitiesassociated with each chapter.

If you have any questions related to the course material, review the online Frequently Asked

Questionssection. You may find the answers there.

Read the chapter slowly a second time. Pay particular attention to those areas you foundchallenging during your first reading.

Pay attention to the tables, charts, and exhibits. These will help with the practical aspects ofthe material.

Work through allexamples and calculations, making sure that you understand how thecorrect answers were arrived at.

Complete thepost-testfor each chapter.

Read the chapter summaryand learning objectivesonce again to reinforce your learning.

Dont forget to review the Glossaryat the end of the textbook, where the Key Termsfrom eachchapter are defined. Understanding the terminology and jargon used within the industry is anessential part of this course. We particularly recommend a thorough reading of the Glossary forthose who are new to the material. In fact, the Glossary provides an excellent means to review thematerial and prepare for the exam. If you are still in doubt about any concept, use the Indextofind a full discussion of that concept in the textbook.


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CANADIAN SECURITIES COURSE VOLUME 1vi


The Canadian Securities Institute

The Canadian Securities Institute(CSI) has been setting the standard for world-class,life-long education for financial professionals for more than 40 years. Our experience trainingover 700,000 global professionals makes us the preferred partner for individual and corporatefinancial services education internationally. Our expertise extends from securities to mutual

funds, from banking and trust to insurance, from portfolio management to financial planningand wealth management.

CSI is a thought leaderwhose real world training sets professionals apart in their field, bydeveloping them into leaders who are able to excel in their chosen careers. Our focus onleading educational and ethical standards means that our graduates have met the highest levelof proficiency and certification. We develop course content based on industry trends andcontinuous involvement from our worldwide partners to ensure our graduates are the mostcurrent in every financial sector.

CSI is a partnerthat works collaboratively with practitioners and industry regulators. This leadsto a higher educational standard in an evolving financial services marketplace. By anticipatingindustry requirements, we are able to develop relevant curriculum and testing for real world

application.

CSI grants designationsthat have become a true measure of expertise. We focus on state ofthe art industry knowledge that is the recognized standard for regulatory authorities, financialorganizations and associations in Canada and around the globe. Our graduates come with highlyendorsed credentials that are respected throughout the financial services industry.

CSI is valued for its expertisein both course content and program delivery. CSI has establishedprofessional designations in growing specialties such as financial derivatives and wealthmanagement. These are in addition to our respected and established courses and seminars.Weve also pioneered the use of the Internet as a powerful tool for teaching and professionaldevelopment through online courses and study aids.

CSI leadsinnovative, lifelong education for career-minded financial professionals. CSI coursesare available on demand in a variety of formats that can be used anywhere and anytime. We arecontinually adapting to changing technology and to the changing needs of learners and theirorganizations.


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CSI GLOBAL EDUCATION INC. (2013) vii

Contents

SECTION I

THE CANADIAN INVESTMENT MARKETPLACE

1 The Capital Market ....................................................................11

What is Investment Capital? ........................................................................... 15

Characteristics of Capital ............................................................................................ 15

Why Capital Is Needed ............................................................................................... 16

Who are the Sources and Users of Capital? .................................................. 16

Sources of Capital ....................................................................................................... 17

Users of Capital .......................................................................................................... 17

What are the Financial Instruments? ............................................................. 19

Financial instruments ................................................................................................. 19

Private Equity ........................................................................................................... 110

What are the Financial Markets? ...................................................................111

Auction Markets in Canada ...................................................................................... 112

Dealer Markets ......................................................................................................... 114

Other Trading Systems .............................................................................................. 116

Fixed-Income Electronic Trading Systems ................................................................. 116

Trends in Financial Markets ...................................................................................... 117

Summary ...........................................................................................................119

VOLUME I


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CANADIAN SECURITIES COURSE VOLUME 1viii

2 The Canadian Securities Industry ...............................................21

Overview of the Canadian Securities Industry .............................................. 25

What Role do Financial Intermediaries Play? ................................................ 26

Types of Firms ............................................................................................................ 27

Organization within Firms .......................................................................................... 28

Investment Dealers and their Principal or Agency Functions .................................... 210

The Clearing System ................................................................................................. 211

What Roles do Banks Play as Financial Intermediaries? .............................212

Schedule I Chartered Banks ...................................................................................... 212

Schedule II and Schedule III Banks .......................................................................... 213

What are Trust Companies, Credit Unions and

Life Insurance Companies? .............................................................................214

Trust and Loan Companies ....................................................................................... 214

Credit Unions and Caisses Populaires ....................................................................... 214

Insurance Companies ............................................................................................... 214

What are Investment Funds, Savings Banks, Sales Finance and

Consumer Loan Companies, and Pension Plans? .........................................216

Summary ...........................................................................................................218

3 The Canadian Regulatory Environment ......................................31

Who are the Regulators?.................................................................................. 35

Federal Regulators ...................................................................................................... 35

The Provincial Regulators ........................................................................................... 36

The Self-Regulatory Organizations ............................................................................. 38

Investor Protection Funds ......................................................................................... 310

Role of Arbitration.................................................................................................... 313

Ombudsman for Banking Services and Investments .................................................. 313What are the Principles of Securities Legislation? ......................................314

Full, True and Plain Disclosure ................................................................................. 314

Registration .............................................................................................................. 314


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CONTENTS ix

The National Registration Database (NRD) ............................................................. 316

Know Your Client Rule ............................................................................................. 316

Client Relationship Model (CRM) ........................................................................... 316

What are the Ethics of Trading? .....................................................................318

Examples of Unethical Practices ................................................................................ 318

Prohibited Sales Practices .......................................................................................... 319

What are Public Company Disclosures and Investor Rights? .................... 320

Continuous Disclosure ............................................................................................. 320

Statutory Rights for Investors ................................................................................... 321Proxies and Proxy Solicitation ................................................................................... 322

What are Takeover Bids and Insider Trading? ............................................ 322

Takeover Bids ........................................................................................................... 323

Insider Trading ......................................................................................................... 324

Summary .......................................................................................................... 326

SECTION II

THE ECONOMY

4 Economic Principles ...................................................................41

What is Economics? .......................................................................................... 46

Microeconomics and Macroeconomics ....................................................................... 46

The Decision Makers .................................................................................................. 47

Demand and Supply ................................................................................................... 47

How is Economic Growth Measured? ............................................................. 49

Measuring Gross Domestic Product ............................................................................ 49

Productivity and Determinants of Economic Growth ............................................... 411

What are the Phases of the Business Cycle? ................................................413Phases of the Business Cycle ..................................................................................... 413

Using Economic Indicators ....................................................................................... 416

Identifying Recessions ............................................................................................... 418


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CANADIAN SECURITIES COURSE VOLUME 1x

What are the Key Labour Market Indicators? ............................................. 420

Labour Market Indicators ......................................................................................... 420

Types of Unemployment ........................................................................................... 422

What Role do Interest Rates Play? ................................................................ 423

Determinants of Interest Rates .................................................................................. 423

How Interest Rates Affect the Economy ................................................................... 424

Expectations and Interest Rates ................................................................................. 424

What is the Nature of Money and Inflation? ................................................ 425

The Nature of Money ............................................................................................... 425Inflation.................................................................................................................... 425

Disinflation .............................................................................................................. 429

Deflation .................................................................................................................. 430

How does International Economics Impact the Economy? ....................... 430

The Balance of Payments .......................................................................................... 430

The Exchange Rate ................................................................................................... 431

Summary .......................................................................................................... 436

5 Economic Policy .........................................................................51What are the Different Economic Theories? ................................................ 55

Rational Expectations Theory ..................................................................................... 55

Keynesian Theory ....................................................................................................... 55

Monetarist Theory ...................................................................................................... 56

Supply-Side Economics .............................................................................................. 56

What is Fiscal Policy? ........................................................................................ 57

The Federal Budget .................................................................................................... 57

How Fiscal Policy Affects the Economy ...................................................................... 58

What is the Role of the Bank of Canada? ......................................................510Role of the Bank of Canada ...................................................................................... 510

Functions of the Bank of Canada .............................................................................. 511


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CONTENTS xi

What is Monetary Policy? ................................................................................512

Implementing Monetary Policy ................................................................................ 513

Open Market Operations.......................................................................................... 514

Cash Management Operations .................................................................................. 516

What are the Challenges of Government Policy? ........................................517

The Consequences of Failed Fiscal Policy .................................................................. 518

Summary ...........................................................................................................519

SECTION III

INVESTMENT PRODUCTS

6 Fixed-Income Securities: Features and Types ...............................61

What is the Fixed-Income Marketplace? ....................................................... 66

The Rationale for Issuing Fixed-Income Securities ...................................................... 66

What are the Basic Features and Terminology of

Fixed-Income Securities? ................................................................................. 67

Basic Terminology ...................................................................................................... 67

Describing Bond Features .......................................................................................... 68Liquid Bonds, Negotiable Bonds and Marketable Bonds ............................................ 69

Strip Bonds ............................................................................................................... 610

Callable Bonds .......................................................................................................... 610

Extendible and Retractable Bonds............................................................................. 612

Convertible Bonds and Debentures .......................................................................... 613

Sinking Funds and Purchase Funds ........................................................................... 615

Protective Provisions of Corporate Bonds ................................................................. 616

What are Government of Canada Securities? ..............................................617

Marketable Bonds ..................................................................................................... 617

Treasury Bills ............................................................................................................ 618Canada Savings Bonds .............................................................................................. 618

Canada Premium Bonds ........................................................................................... 618

Real Return Bonds ................................................................................................... 619


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CANADIAN SECURITIES COURSE VOLUME 1xii

What are Provincial and Municipal Government Securities? .....................619

Guaranteed Bonds .................................................................................................... 620

Provincial Securities .................................................................................................. 620

Municipal Securities ................................................................................................. 620

What are Corporate Bonds? ...........................................................................621

Mortgage Bonds ....................................................................................................... 621

Collateral Trust Bonds .............................................................................................. 622

Equipment Trust Certificates .................................................................................... 622

Subordinated Debentures ......................................................................................... 622

Floating-Rate Securities ............................................................................................ 622

Corporate Notes ....................................................................................................... 622

Domestic, Foreign and Eurobonds ............................................................................ 622

Preferred Securities ................................................................................................... 623

High-Yield Bonds ..................................................................................................... 624

What are some Other Fixed-Income Securities in the Marketplace?...... 624

Bankers Acceptances ................................................................................................ 624

Commercial Paper .................................................................................................... 624

Term Deposits .......................................................................................................... 625

Guaranteed Investment Certificates .......................................................................... 625Fixed-Income Mutual Funds and ETFs..................................................................... 626

How to Read Bond Quotes and Ratings? ...................................................... 626

Summary .......................................................................................................... 629

7 Fixed Income Securities: Pricing and Trading ..............................71

How are Price and Yield of a Bond Calculated? ............................................ 75

Calculating the Fair Price of a Bond ............................................................................ 77

Calculating the Yield on a Treasury Bill .................................................................... 711

Calculating the Current Yield on a Bond .................................................................. 712Calculating the Yield to Maturity on a Bond ............................................................ 712


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CONTENTS xiii

What is the Term Structure of Interest Rates?............................................715

The Real Rate of Return ........................................................................................... 715

The Yield Curve ....................................................................................................... 716

What are the Fundamental Bond Pricing Properties? ................................719

The Relationship between Bond Prices and Interest Rates......................................... 719

The Impact of Maturity ............................................................................................ 720

The Impact of the Coupon ....................................................................................... 721

The Impact of Yield Changes .................................................................................... 722

Duration as a Measure of Bond Price Volatility ......................................................... 723

How does Bond Market Trading Work? ....................................................... 725

Clearing and Settlement ........................................................................................... 725

Calculating Accrued Interest ..................................................................................... 726

What are Bond Indexes? ................................................................................ 728

Canadian Bond Market Indexes ................................................................................ 728

Global Indexes .......................................................................................................... 728

Summary .......................................................................................................... 730

8 Equity Securities: Common and Preferred Shares ........................81What are Common Shares? ............................................................................ 85

Benefits of Common Share Ownership ....................................................................... 85

Capital Appreciation ................................................................................................... 86

Dividends ................................................................................................................... 86

Voting Privileges ......................................................................................................... 89

Tax Treatment ........................................................................................................... 810

Stock Splits and Consolidations ................................................................................ 812

Reading Stock Quotations ........................................................................................ 813

What are Preferred Shares? ...........................................................................814

The Preferreds Position ............................................................................................ 814

Why Companies Issue Preferred Shares ..................................................................... 815

Why Investors Buy Preferred Shares .......................................................................... 816

Preferred Share Features ............................................................................................ 816


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CANADIAN SECURITIES COURSE VOLUME 1xiv

Straight Preferreds ..................................................................................................... 817

Convertible Preferreds .............................................................................................. 818

Retractable Preferreds ............................................................................................... 821

Floating-Rate Preferreds ............................................................................................ 822

Foreign-Pay Preferreds .............................................................................................. 823

Other Types of Preferreds .......................................................................................... 823

What are Stock Indexes and Averages? ....................................................... 824

Canadian Market Indexes ......................................................................................... 825

U.S. Stock Market Indexes ........................................................................................ 828

International Market Indexes and Averages ............................................................... 829

Summary ...........................................................................................................831

9 Equity Securities: Equity Transactions .........................................91

What are Cash Accounts? ................................................................................ 95

Cash Account Rules .................................................................................................... 95

Free Credit Balances .................................................................................................. 96

What are Margin Accounts? ............................................................................ 96

Long Margin Accounts ............................................................................................... 96Margining Long Positions ........................................................................................... 97

What is Short Selling? ...................................................................................... 99

How Short Selling is Done ....................................................................................... 910

Dangers of Short Selling ........................................................................................... 914

How do Trading and Settlement Procedures Work? ..................................915

Trading Procedures ................................................................................................... 915

How are Securities Bought and Sold? ............................................................918

Types of Orders ........................................................................................................ 918

Summary .......................................................................................................... 923


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CONTENTS xv

10 Derivatives ................................................................................101

What is a Derivative? ...................................................................................... 106

Features Common to All Derivatives ........................................................................ 106

Derivative Markets.................................................................................................... 107

Exchange-Traded versus OTC Derivatives ................................................................ 107

What are the Types of Underlying Assets? .................................................1010

Commodities .......................................................................................................... 1010

Financials ................................................................................................................ 1010

Who are the Users of Derivatives? ..............................................................1011

Individual Investors ................................................................................................ 1011

Institutional Investors ............................................................................................. 1012

Corporations and Businesses ................................................................................... 1013

Derivative Dealers ................................................................................................... 1014

What are Options? .........................................................................................1015

Option Exchanges .................................................................................................. 1020

Option Strategies for Individual and Institutional Investors .................................... 1021

Option Strategies for Corporations ......................................................................... 1029

What are Forwards and Futures? ................................................................1031Key Terms and Definitions ..................................................................................... 1031

Futures Exchanges .................................................................................................. 1033

Futures Strategies for Investors ................................................................................ 1033

What are Rights and Warrants? .................................................................. 1036

Rights ..................................................................................................................... 1036

Warrants ................................................................................................................. 1039

Summary ........................................................................................................ 1041


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CANADIAN SECURITIES COURSE VOLUME 1xvi

SECTION IV

THE CORPORATION

11 Financing and Listing Securities ................................................111

What are the Different Types of Business Structures? ...............................116

What are Incorporated Businesses? ..............................................................116

Public and Private Corporations ............................................................................... 119

The Structure of the Organization .......................................................................... 1111How do Governments and Corporations Finance Themselves? .............. 1113

Investment Dealer Finance Department ................................................................. 1113

Canadian Government Issues .................................................................................. 1114

Provincial and Municipal Issues .............................................................................. 1115

Corporate Issues ..................................................................................................... 1116

How does the Corporate Financing Process Work? .................................. 1118

The Dealers Advisory Relationship with Corporations ........................................... 1119

The Method of Offering ......................................................................................... 1121

The Prospectus ....................................................................................................... 1122

After-Market Stabilization ...................................................................................... 1127

What are the Other Methods of Distributing Securities to the Public? ...1129

Junior Company Distributions ............................................................................... 1129

Options of Treasury Shares and Escrowed Shares .................................................... 1129

Capital Pool Company Program ............................................................................. 1129

NEX ....................................................................................................................... 1130

How does the Listing Process Work? ..........................................................1130

Advantages and Disadvantages of Listing ................................................................ 1131

Withdrawing Trading Privileges .............................................................................. 1132

Summary .........................................................................................................1134


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CONTENTS xvii

12 Corporations and their Financial Statements .............................121

What is the Statement of Financial Position? ..............................................125

Classification of Assets .............................................................................................. 126

Classification of Equity ........................................................................................... 1210

Classification of Liabilities ...................................................................................... 1211

What is the Statement of Comprehensive Income?..................................1212

Structure of the Statement of Comprehensive Income ............................................ 1212

What is the Statement of Changes In Equity? ............................................1215

What is the Statement of Cash Flows?........................................................ 1216

Operating Activities ................................................................................................ 1217

Financing Activities (items 38 to 41) ...................................................................... 1218

Investing Activities (items 42 to 44) ........................................................................ 1218

The Change in Cash Flow (items 45 to 46) ............................................................ 1218

What is included in the Annual Report? .....................................................1219

Notes to the Financial Statements ........................................................................... 1219

The Auditors Report .............................................................................................. 1219

Summary .........................................................................................................1221

Appendix A Sample Financial Statements ...............................................1223

Summary for Volume 1 ....................................................................S1

Glossary ..........................................................................................G1

Selected Web Sites .......................................................................Web1

Index............................................................................................ Ind1


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CANADIAN SECURITIES COURSE VOLUME 1xviii

SECTION V

INVESTMENT ANALYSIS

13 Fundamental and Technical Analysis .........................................131

What are the Methods of Analysis? .............................................................. 135

Fundamental Analysis ............................................................................................... 135

Technical Analysis ..................................................................................................... 135

Market Theories ....................................................................................................... 136

What is Fundamental Macroeconomic Analysis? ........................................137

The Fiscal Policy Impact ........................................................................................... 138

The Monetary Policy Impact .................................................................................... 139

The Flow of Funds Impact...................................................................................... 1310

The Inflation Impact .............................................................................................. 1310

What is Fundamental Industry Analysis? ....................................................1311

Classifying Industries by Product or Service ............................................................ 1311

Classifying Industries by Stage of Growth ............................................................... 1313

Classifying Industries by Competitive Forces .......................................................... 1314

Classifying Industries by Stock Characteristics ........................................................ 1314

What are Fundamental Valuation Models? .................................................1316

Dividend Discount Model ...................................................................................... 1316

Using the Price-Earnings Ratio ............................................................................... 1317

What is Technical Analysis? ..........................................................................1318

Comparing Technical Analysis to Fundamental Analysis ......................................... 1319

Commonly Used Tools in Technical Analysis .......................................................... 1319

Summary .........................................................................................................1327

VOLUME 2


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CONTENTS xix

14 Company Analysis ....................................................................141

What is Company Analysis? ........................................................................... 145

Statement of Comprehensive Income Analysis .......................................................... 145

Statement of Financial Position Analysis ................................................................... 146

Other Features of Company Analysis ........................................................................ 148

How are Financial Statements Interpreted? ............................................... 149

Trend Analysis ........................................................................................................ 1410

External Comparisons ............................................................................................. 1411

What is Financial Ratio Analysis? .................................................................1412

Liquidity Ratios ...................................................................................................... 1413

Risk Analysis Ratios ................................................................................................ 1414

Operating Performance Ratios ................................................................................ 1419

Value Ratios ............................................................................................................ 1421

How is Preferred Share Investment Quality Assessed? ............................1427

Investment Quality Assessment ............................................................................... 1427

Selecting Preferreds ................................................................................................. 1428

Summary .........................................................................................................1429

Appendix A Company Financial Statements ...........................................1431

SECTION VI

PORTFOLIO ANALYSIS

15 Introduction to the Portfolio Approach .....................................151

What is Risk and Return? ............................................................................... 155

Rate of Return .......................................................................................................... 156

Risk ........................................................................................................................ 1510

How are Portfolio Risk and Return Related? ..............................................1512

Calculating the Rate of Return on a Portfolio ......................................................... 1512

Measuring Risk in a Portfolio ................................................................................. 1513

Combining Securities in a Portfolio ........................................................................ 1514


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CANADIAN SECURITIES COURSE VOLUME 1xx

What is the Portfolio Management Process? .............................................1517

What are Investment Objectives and Constraints? ...................................1518

Return and Risk Objectives .................................................................................... 1518

Investment Objectives............................................................................................. 1520

Investment Constraints ........................................................................................... 1522

What is an Investment Policy Statement? ..................................................1523

Summary .........................................................................................................1524

16 The Portfolio Management Process ...........................................161

How is an Asset Mix Developed? ................................................................... 165

The Asset Mix .......................................................................................................... 165

Setting the Asset Mix ................................................................................................ 167

What are the Portfolio Manager Styles? .....................................................1611

Equity Manager Styles ............................................................................................ 1612

Fixed-Income Manager Styles ................................................................................. 1615

What is Asset Allocation? .............................................................................1616

Balancing the Asset Classes ..................................................................................... 1618

Strategic Asset Allocation ........................................................................................ 1619

Ongoing Asset Allocation ....................................................................................... 1620

What is Portfolio Monitoring? ......................................................................1622

Monitoring the Markets and the Client .................................................................. 1623

Monitoring the Economy ....................................................................................... 1623

How is Portfolio Performance Evaluated? ..................................................1624

Measuring Portfolio Returns ................................................................................... 1624

Calculating the Risk-Adjusted Rate of Return ......................................................... 1625

Other Factors in Performance Measurement ........................................................... 1626

Summary .........................................................................................................1627


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CONTENTS xxi

SECTION VII

ANALYSIS OF MANAGED PRODUCTS

17 Fundamentals of Managed and Structured Products .................171

What Factors are Driving the Growth of Managed and

Structured Products? .......................................................................................175

Recent Industry Developments - Meeting the Evolving Needs of Investors ............... 176

Regulatory Considerations ........................................................................................ 176

What Are Managed and Structured Products? ............................................176

Types of Managed and Structured Products .............................................................. 178

How do Managed and Structured Products Compare? ............................1710

Advantages of Managed Products ............................................................................ 1710

Advantages of Structured Products .......................................................................... 1711

Disadvantages of Managed Products ....................................................................... 1712

Disadvantages of Structured Products ..................................................................... 1713

Risks Involved With Managed and Structured Products .......................................... 1713

How is the Market Evolving for Managed and Structured Products? ......1714

Outcome Based Investment Solutions ..................................................................... 1714

Changing Compensation Models............................................................................ 1716

Summary .........................................................................................................1717

18 Mutual Funds: Structure and Regulation ..................................181

What is a Mutual Fund? .................................................................................. 185

Advantages of Mutual Funds..................................................................................... 186

Disadvantages of Mutual Funds ................................................................................ 187

What is the Structure of Mutual Funds? ...................................................... 188

Mutual Fund Trust Structure .................................................................................... 188

Mutual Fund Corporation Structure ......................................................................... 189


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CANADIAN SECURITIES COURSE VOLUME 1xxii

Organization of a Mutual Fund ................................................................................ 189

Pricing Mutual Fund Units or Shares ...................................................................... 1811

Charges Associated with Mutual Funds .................................................................. 1812

What are Labour-Sponsored Venture Capital Corporations? .................1817

Advantages of Labour-Sponsored Funds ................................................................. 1817

Disadvantages of Labour-Sponsored Funds ............................................................. 1818

How are Mutual Funds Regulated? ...............................................................1818

Mutual Fund Regulatory Organizations .................................................................. 1819

National Instruments 81-101 and 81-102 .............................................................. 1820General Mutual Fund Requirements ....................................................................... 1820

The Simplified Prospectus ...................................................................................... 1820

What Other Forms and Requirements are Necessary? ........................... 1822

Registration Requirements for the Mutual Fund Industry ....................................... 1822

Mutual Fund Restrictions ....................................................................................... 1824

What is the Know Your Client Rule? ...................................................... 1828

Suitability and Know Your Product ......................................................................... 1829

The Role of KYC Information in Opening an Account .......................................... 1830

What are the Requirements when Opening andUpdating an Account? ....................................................................................1831

Relationship Disclosure .......................................................................................... 1831

New Accounts ........................................................................................................ 1833

Updating Client Information .................................................................................. 1833

Distribution of Mutual Funds by Financial Institutions .......................................... 1834

Summary ........................................................................................................ 1836

19 Mutual Funds: Types and Features ............................................191

What are the Different Types of Mutual Funds? ......................................... 195Money Market Funds ............................................................................................... 195

Fixed-Income Funds ................................................................................................. 196

Balanced Funds......................................................................................................... 196

Equity Funds ............................................................................................................ 197


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CONTENTS xxiii

Specialty Funds ......................................................................................................... 199

Index Funds .............................................................................................................. 199

Target-date Funds ................................................................................................... 1910

Comparing Fund Types .......................................................................................... 1910

What are the Different Fund Management Styles? ...................................1912

Indexing and Closet Indexing ................................................................................. 1912

How are Mutual Fund Units or Shares Redeemed? ...................................1913

Tax Consequences................................................................................................... 1913

Reinvesting Distributions ....................................................................................... 1916Withdrawal Plans ................................................................................................... 1917

Suspension of Redemptions .................................................................................... 1920

How is Mutual Fund Performance Compared? ......................................... 1920

Reading Mutual Fund Quotes ................................................................................ 1921

Measuring Mutual Fund Performance..................................................................... 1922

Issues that Complicate Mutual Fund Performance .................................................. 1924

Summary .........................................................................................................1927

20 Segregated Funds and Other Insurance Products .......................201What are the Different Segregated Fund Features? .................................. 205

Maturity Guarantees ................................................................................................. 206

Death Benefits .......................................................................................................... 207

Creditor Protection ................................................................................................... 208

Bypassing Probate ..................................................................................................... 208

Cost of the Guarantees ............................................................................................. 209

Bankruptcy and Family Law ..................................................................................... 209

Comparison to Mutual Funds ................................................................................... 209

How are Segregated Funds Taxed? ..............................................................2011

Impact of Allocations on Net Asset Values .............................................................. 2011

Tax Treatment of Guarantees .................................................................................. 2012

Tax Treatment of Death Benefits ............................................................................. 2014


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CANADIAN SECURITIES COURSE VOLUME 1xxiv

How are Segregated Funds Regulated? ...................................................... 2014

Monitoring Solvency .............................................................................................. 2014

The Role Played by Assuris ..................................................................................... 2015

What are other Insurance Products? ......................................................... 2015

Guaranteed Minimum Withdrawal Benefit Plans ................................................... 2016

Portfolio Funds ....................................................................................................... 2017

Summary ........................................................................................................ 2018

21 Hedge Funds.............................................................................211How has the Market for Hedge Funds Evolved? ...........................................215

Comparisons to Mutual Funds ................................................................................. 215

Investing in Hedge Funds ......................................................................................... 216

Size of the Hedge Fund Market ................................................................................ 218

Tracking Hedge Fund Performance ........................................................................... 218

What are the Benefits and Risks of Hedge Funds? ......................................219

Benefits ..................................................................................................................... 219

Risks ......................................................................................................................... 219

Due Diligence......................................................................................................... 2112What are the Different Hedge Fund Strategies? .......................................2114

Relative Value Strategies .......................................................................................... 2115

Event-Driven Strategies........................................................................................... 2117

Directional Funds ................................................................................................... 2117

What are Funds of Hedge Funds? ................................................................2121

Advantages.............................................................................................................. 2121

Disadvantages ......................................................................................................... 2122

Summary .........................................................................................................2124


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CONTENTS xxv

22 Exchange-Listed Managed Products ..........................................221

What are Closed-End Funds? ........................................................................ 225

Advantages of Closed-End Funds .............................................................................. 225

Disadvantages of Closed-End Funds ......................................................................... 226

What are Income Trusts? ............................................................................... 226

Real Estate Investment Trusts (REITs) ...................................................................... 227

Business Trusts .......................................................................................................... 228

What are Exchange-Traded Funds? .............................................................. 229

Trading ETFs .......................................................................................................... 2210

Recent Trends in ETFs............................................................................................ 2211

Regulatory Issues .................................................................................................... 2214

What is Listed Private Equity? .....................................................................2215

Structure of Listed Private Equity Companies ......................................................... 2215

Advantages and Disadvantages of Listed Private Equity .......................................... 2217

Summary .........................................................................................................2218

23 Fee-Based Accounts ...................................................................231

What are the Different Fee-Based Accounts? ............................................. 234

Managed Accounts ................................................................................................... 235

Fee-Based Non-Managed Accounts ........................................................................... 236

Advantages and Disadvantages of Fee-Based Accounts .............................................. 237

Discretionary Accounts ............................................................................................. 237

What are the Different Types of Managed Accounts? ................................ 238

Single-Manager Accounts ......................................................................................... 238

Multi-Manager Accounts ........................................................................................ 2310

Private Family Office .............................................................................................. 2313

Summary .........................................................................................................2314


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CANADIAN SECURITIES COURSE VOLUME 1xxvi

24 Structured Products ..................................................................241

What are Principal-Protected Notes? .......................................................... 245

PPN Guarantors, Manufacturers and Distributors .................................................... 245

The Structure of PPNs.............................................................................................. 246

Risks Associated with PPNs ...................................................................................... 248

Tax Implications of PPNs ......................................................................................... 249

What are Linked Guaranteed Investment Certificates? .......................... 2410

Structure of Linked GICs ....................................................................................... 2410

How Returns are Determined ................................................................................. 2411Risk Associated with Linked GICs .......................................................................... 2412

Tax Implications ..................................................................................................... 2413

What are Split Shares? ..................................................................................2413

Risks Associated with Split Shares ........................................................................... 2414

Tax Implications ..................................................................................................... 2415

What are Asset-Backed Securities? .............................................................2416

The Securitization Process ...................................................................................... 2417

Asset-Backed Commercial Paper ............................................................................. 2418

What are Mortgage-Backed Securities? .................................................... 2420Structure and Benefits of MBS................................................................................ 2421

Summary ........................................................................................................ 2423

SECTION VIII

WORKING WITH THE CLIENT

25 Canadian Taxation ....................................................................251

How does the Canadian Taxation System Work? ....................................... 255

The Income Tax System in Canada ........................................................................... 255Types of Income ....................................................................................................... 256

Calculating Income Tax Payable ................................................................................ 257


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CONTENTS xxvii

Taxation of Investment Income ................................................................................ 257

Tax-Deductible Items Related to Investment Income ................................................ 259

How are Investment Gains and Losses Calculated? ...................................2511

Disposition of Shares .............................................................................................. 2512

Disposition of Debt Securities ................................................................................ 2514

Capital Losses ......................................................................................................... 2515

Tax Loss Selling ...................................................................................................... 2516

What are Tax Deferral Plans? ......................................................................2517

Registered Pension Plans (RPPs) ............................................................................. 2517Registered Retirement Savings Plans (RRSPs) ......................................................... 2518

Registered Retirement Income Funds (RRIFs) ........................................................ 2523

Deferred Annuities ................................................................................................. 2523

Tax-Free Savings Accounts (TFSA) ......................................................................... 2524

Registered Education Savings Plans (RESPs) ........................................................... 2525

Pooled Registered Pension Plans (PRPPs) ............................................................... 2526

What are Tax Planning Strategies? ............................................................. 2527

Summary ........................................................................................................ 2529

26 Working with the Retail Client .................................................261

What is the Financial Planning Approach? .................................................. 265

What are the Steps in Financial Planning Process? .................................... 265

Establishing the Client-Advisor Relationship ............................................................ 266

Collecting Data and Information .............................................................................. 266

Analyzing Data and Information .............................................................................. 268

Recommending Strategies to Meet Goals .................................................................. 269

Implementing Recommendations ............................................................................. 269

Conducting a Periodic Review or Follow-Up ............................................................ 269

What is the Life Cycle Hypothesis?..............................................................2610


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CANADIAN SECURITIES COURSE VOLUME 1xxviii

What are Ethics and the Advisors Standards of Conducts? ....................2612

The Code of Ethics ................................................................................................. 2612

Standards of Conduct ....................................................................................2613

Summary ........................................................................................................ 2622

Appendix A .................................................................................................... 2624

Appendix B Client Scenarios .................................................................... 2628

27 Working With the Institutional Client ......................................271Who are Institutional Clients? ...................................................................... 274

What are the Suitability Requirements for Institutional Clients? ............ 276

Suitability Standards for Institutional Clients............................................................ 277

What are the Roles and Responsibilities in the Institutional Market? ..... 278

The Role of the Institutional Salesperson .................................................................. 279

The Role of the Institutional Trader ........................................................................ 2712

Summary .........................................................................................................2714

Summary for Volume 2 ....................................................................S1

Glossary ..........................................................................................G1

Selected Web Sites .......................................................................Web1

Index............................................................................................ Ind1


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SECTIONI

The Canadian Investment

Marketplace


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CSI GLOBAL EDUCATION INC. (2013) 11

Chapter1

The Capital Market


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CSI GLOBAL EDUCATION INC. (2013) 13

LEARNING OBJECTIVES

By the end of this chapter, you should be able to:

1. Define investment capital and describe its role in the economy.

2. Describe how individuals, businesses, governments and foreign agencies supply and use capital in theeconomy.

3. Differentiate between the types of financial instruments used in capital transactions.

4. Explain the role of financial markets in the Canadian financial services industry, distinguish among thetypes of financial markets, and describe how auction markets and dealer markets work.

THE CAPITAL MARKET

The Canadian securities industry plays a significant role in sustaining and expanding the Canadian economy.

The industry grows and evolves to meet the ever-changing needs of Canadian investors, both from

domestic and international perspectives.

In some way, we are all affected by the securities industry. The vital economic function the industry plays

is based on a simple process: the transfer of money from those who have it (savers) to those who need it

(users). This capital transfer process is made possible through the use of a variety of financial instruments:money market, stocks, bonds, mutual funds and others. Financial intermediaries, such as banks, trust

companies and investment dealers, have evolved to make the transfer process efficient.

The first two chapters of this textbook focus on the three central elements of the securities industry:

investment markets, products and intermediaries. The emphasis throughout the course, however, is on

securities. The text examines the main types of investment products, how to analyze them, how they are

sold, and how they are used as part of a well-planned portfolio of investments.

For those new to this material, we offer a suggestion: stay informed about the markets and the industry

because it will help you better understand the material presented in this textbook. There are countless

sources of financial market information, including newspapers, the Internet, books and magazines. The

course material will be that much easier to grasp if you can relate it to the activity that unfolds each day in

the financial markets. Ultimately, this will help you achieve your goal of becoming an informed and effective

participant in the securities industry.


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ONE THE CAPITAL MARKET 15


WHAT IS INVESTMENT CAPITAL?

In general terms, capital is wealth both real, material things such as land and buildings, andrepresentational items such as money, stocks and bonds. All of these items have economic value.

Capital represents the invested savings of individuals, corporations, governments and many otherorganizations and associations. It is in short supply and is arguably the worlds most importantcommodity.

Capital savings are useless by themselves. Only when they are harnessed productively do they gaineconomic significance. Such utilization may take the form of either direct or indirect investment.

Capital savings can be used directly by, for example, a couple investing their savings in a home;a government investing in a new highway or hospital; or a domestic or foreign company payingstart-up costs for a plant to produce a new product.

Capital savings can also be harnessed indirectly through the purchase of such representationalitems as stocks or bonds or through the deposit of savings in a financial institution. The indirect

investment process is the principal focus of this course.

Indirect investment occurs when the saver buys the securities issued by governments andcorporations, who in turn use the funds for direct productive investment equipment, supplies,etc. Such investment is normally made with the assistance of the retail or institutional salesdepartment of the investment advisors firm.

Charac

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Canadian Securities Course (CSC) Textbook Vol. 1

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