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BU 111Introduction to

Management and Business Organization

´ I went to class (important for getting all the extraspeaking points), did the lab manual questions,and wrote out study notes come exam time. Istayed on top of the material during the year andpaid attention in class.´

Former BU 111 ³A´ SB

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Puzzles to ponder« My sister had her first meeting with a Financial Planner yesterday so that

she could begin setting up an investment portfolio. She said she was reallymad because the Planner immediately gave her advice on a specific stockto invest in. What¶s up with that? Wasn¶t she going there for advice?

My Uncle Rich makes $200,000 a year and always complains about payinghigher tax rates than his brother who makes $35,000 a year. My other Uncle says Uncle Rich is full of it because they both pay the same rate of tax. Which Uncle is right?

My friend Sally has the option of receiving $5,000 in interest income or $5,000 in dividend income. She wants to receive the investment income

from dividends but I don¶t get why she cares ± isn¶t it all the same amount of money? I thought if you invested in a bond, all you would get in return would be the

bond interest. But then I read something about capital gains earned fromselling bonds so what is that all about? And«I thought bonds were safeinvestments so how could there be a capital loss?

Why on earth would a person pay more than $1,000 for a bond when that¶s

all it is worth when you redeem it on it¶s maturity date?

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Topics of Discussion Reminders/Updates

 ± Midterm #2 will be on _ 4230________________ 

 ± Bring your calculator to class on Wednesday, Jan. 19th

Economic part of external environment ± Individual investing

why? how? taxation system & implication for investing

Alternative Types of Investments ± Debt

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1. Households, corporations, governments c a. Market for short term debt products

2. Canadian financial system e b. Investment dealer who takes ownership of stocksand resells them to earn a spread

3. Issuing Debt i c. Providers of capital and users of capital

4. Issuing Equity g d. Two options for corporations to issue equity

5. Money market a e. System made up of financial markets and financialintermediaries to efficiently bring together providers of capital with users of capital

6. Over the counter market j f. Initial Public Offering (1st time a company publiclysells stock)

7. Stock exchanges k g. Selling ownership of a company to raise capital

8. Agent h h. Investment dealer who sells shares on a best-efforts

basis and earns commission

9. Principal b i. Borrowing money to raise capital

10. Private placement and public sale d j. Market for long term debt products

11. IPO f k. Market for secondary (used) equities

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Portfolio Management

Protection

Protection

accumulation

accumulation

Hedge

Hedge(patriotism )

(patriotism )

(ethics)

(ethics)

Why invest?

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Building an Investment Portfolio

1. Evaluate your personal situation

2. establish your investment objectives3. determine your asset allocation

4. build your portfolio

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personal detailspersonal details financesfinancesinvestment

knowledge andtime restrictions

investmentknowledge andtime restrictions

tolerance for risk

tolerance for risk

time horizontime horizon

1. Evaluate your personal situation

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safety

income growth

factors to consider:

 ± risk vs. return ± income vs. growth

 ± tax

2. Establish your investment objectives

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cash/fixed income/equities

 ± diversification ± balanced portfolio

4. Build your portfolio diversification ± geographic allocation

diversification ± specific security selection

3. Determine your asset allocation

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Taxation of Investment Returns

Personal Tax System

based on taxableincome

progressive,graduated system

3 taxes

Taxation of Investment

Returns marginal tax rates

interest vs. dividendsvs. capital gains

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Table 1

2010 Federal Tax Rates

Personal Tax Rates - 2010

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Table 2

2010 Ontario Provincial Tax Rates before Surtax

Personal Tax Rates - 2010

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Table 3

2010 Ontario Provincial Surtax Rates

Personal Tax Rates - 2010

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Taxation of Investment ReturnsWhy did we care about tax?

To determine impact of tax treatment in investment income

How can we estimate after-tax investment return?

Isolate the investment income and determine what rate of tax

would be applied to it

What rate would apply to t

he investment income?

marginal rate

rate paid on last dollar or next dollar within a particular tax

bracket

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Taxation of Investment Returns marginal tax rates - Table 4

Federal Ontario Ontario

Taxable Income Fed. Tax Rat nt. Tax Rat nt. Surtax

$0 - $37,106 15% 5.05% 0%

>$37,106 - $40,970 15% 9.15% 0%

>$40,970 - $60,407 22% 9.15% 0%

>$60,407 - $72,658 22% 9.15% 20%

>$72,658 - $74,214 22% 9.15% 56%>$74,214 - $81,941 22% 11.16% 56%

>$81,941 - $127,021 26% 11.16% 56%

above $127,021 29% 11.16% 56%

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Combined Marginal Tax Rates

What is the combined 2010 federal/provincial

marginal tax rate after provincial surtax for anOntario resident with taxable income of 

$65,000?

= Federal rate of 22% + Ontario rate beforeOntario surtax of 9.15% + Ontario surtax rateof 9.15%20%1.83%

32.98%

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Taxation of Interest/Dividends/Capital Gains

$5,000 interest $5,000 dividends $5,000 cap. gains

Interest

Dividends 44% gross-up 18% federal + 6.4% provincial tax credit

Capital Gains 50% net gains are taxable NET = capital gains - capital losses

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Tax on Dividend Income

Example: ($5,000 of dividend income for taxpayer earning $65,000)

$5,000

+44%*5000

$ 7200Amount subject to tax / taxable amount

$ 1584 Fed. Tax before Credit ( 22 % x $ 7200 )

- 1296 ( 18% * 7200 )

Effective tax rate

=525.60/5000=10.51%

+ 658.80 P

rov.T

ax before Credit ( 9.15 % x $ 7200 )

+ 39.60 Prov. Surtax ( 20% * 198 )$ 525.60

- 460.80 ( 6.4% * 7200 )

$ 198 Prov. Tax before Surtax

288 Fed. Tax

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Comparing Impact of tax on Different

Types of Investment Income

Effective Tax Rates for $65,000 of income: ± Dividends 10.51%

 ± Capital Gains 16.49%

 ± Interest 32.98% ± therefore, investment income must be

considered on an AFTER-T AX BASIS!

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Types of Investments: BONDS

What are the characteristics of a bond?

debt for issuers indenture (,,)

fixed rate or return

fixed term

safety

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Type Features Benefit to:Secured Assets are pledged

as collateral i.e.mortgage bond

Investor 

Unsecured/Debenture

Only backed up bya ³promise to pay´by issuer i.e.government bond

Issuer 

Serial () Staggeredredemption ()

dates in a bondseries

Issuer 

Callable/

Redeemable

 Allows issuer toµcall¶ it or pay it backearlier than originalmaturity date

Issuer 

Types of Bonds

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Type Features Benefit to:Sinking Fund/

Purchase Fund

Money is set aside for repayment of bondsvia call, purchase onopen market or 

redemptionExtendible/

Retractable

Maturity date can bepushed back or forward

Convertible/

Exchangeable

Right to exchange

bond for commonshares of companystock

Floating Rate Coupon rate floats withprevailing interest ratesinstead of being fixed

for term

Types of Bonds

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How do I know if a bond is a goodinvestment for me?

In order to estimate yield, we must recognize andassume:  ± bonds are often traded through their life

 ± when they are traded, they may be bought/sold at a price

 ± at the end of a bond¶s life, the holder receives the

 ± capital gain or loss may occur  ± that you will hold it to maturity for purposes of estimating yield

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Calculating Bond YieldRough Bond Yield - RBY 

( must assume will hold until maturity )

=

= interest/bond/year + annual capital gainprice/bond

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Calculating Bond Yield

Example:

You are considering buying a 6% bond for $850

with 10 years to maturity.

What is the rough bond yield?

Yield =

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Bond Price affected by:

 Additional factors: credit rating, features, time to maturity