1) What does the Bank of Canada do?

The Bank of Canada (the Bank) is Canada's central bank. It is the banker's bank. The Bank of Canada does not receive deposits from consumers. According to the Bank of Canada act the Bank has four primary functions:

1) Monetary policy - Monetary policy is concerned with the Canadian standard of living. The Bank's mandate is to keep the economy on a slow, stable, steady expansion.

2) Currency in circulation - The Bank of Canada is responsible for the currency notes which are circulating in the Canadian economy. The Bank deals with crimes of counterfeiting because part of its job is to maintain the integrity of our currency.

3) Central banking services - The Bank of Canada is the banker for the federal government and other financial institutions. The Bank operates in the Canadian money markets every day. Monetary policy is implemented through these open market operations.

4) Debt management - The Bank of Canada acts as the government's fiscal agent. As their fiscal agent they are the advisor to the federal government on debt matters.

2) What is the money market?

The money market is where short term borrowers and lenders come together. Some examples of investments traded in the money market are Treasury Bills, Commercial Paper and Bankers Acceptances.

3) What are the different types of business cycle indicators?

Business cycle indicators include leading, lagging and coincident. A leading indicator anticipates economic changes and moves before the economy changes. A lagging indicator moves after the economy. A coincident indicator changes at the same time and directly with the economy.

4) What is the most profitable strategy for an investor holding a portfolio of cash and fixed income investments, if interest rates are expected to rise or fall?

An investor would adjust the duration of the portfolio. If interest rates are expected to rise, an investor would shift to short term bonds and money market instruments in order to minimize capital losses and to profit from the rise in interest rates. If interest rates are expected to drop, which would raise bond prices, an investor would maximize portfolio returns by purchasing long term bonds which is known as lengthening the duration of the portfolio.

1) What is the difference between bond types and bond features?

Features are contained in the bond indentures e.g. a call provision or sinking funds. Conversely, types of bonds include collateral trust bonds, mortgage bonds and equipment trust certificates. The type of bond determines what is collateralized, how it is secured and what rights the bondholders have. For example, a mortgage bond collateralized by a building would require a legal proceeding in the event of default. An equipment trust certificate, on the other hand, is collateralized by rolling stock. Title to the rolling stock remains with the certificate holder until the debt is repaid. In the event of default, the process of collection is streamlined, since title to the assets already rests with the certificate holders. No lien is required.

2) Are there any restrictions on the ownership of Canada Savings Bonds?

Yes. According to Canada Investment and Savings a buyer must have a permanent residence in Canada and been in residence for six months. CSB's may be held by estates, charitable organizations, sole proprietorships, personal trusts, RRSP's, RRIF's and DPSP's. Corporations and mutual funds do not normally purchase these investment. Additionally, there are restrictions on the dollar limits of CSB's, as well as when these bonds can be purchased. Canada premium bonds (CPB's) which replaced Canada RRSP bonds are less liquid than CSB's.

3) Who buys junk bonds?

Due to the nature of this investment, buyers should be prepared for volatility and the higher risk potential of this type of bond or debenture investment. The junk bond purchaser should expect the same type of volatility as with an equity investment. The incentive to participating in this type of investment is the very attractive yields. For the average investor, a junk bond mutual fund offers diversification as well as management expertise.

4) What is a tranche?

A tranche occurs when a bond has a series of maturity dates. Each maturity date is called a tranche.

5) What is meant by a bond yield?

Bond yield can be calculated in two ways. Current yield is calculated as the annual interest payments expressed as a percentage of current market price. The yield to maturity takes into account both the annualized interest payment and also the capital gains or losses that will be experienced by the bond, if held until maturity.

6) How does an investor calculate cash flow?

Cash flow can be approximated from the Income Statement. It can be calculated by taking net income before extraordinary items plus depreciation or amortization or depletion, plus the increase in deferred income taxes, plus minority interest, minus equity income.

7) How can an investor judge the quality of a bond?

Analyses of the financial statements provide a simple method of judging the quality of most investments. Financial statement analysis looks at relationships between Balance Sheet and Income Statement accounts. Some classic ratios for analyzing bond investments are: the debt to equity ratio, the times interest-earned ratio and the asset coverage ratio.

8) What sweeteners can an issuer offer to both bond or preferred stock investors?

Convertibility, retractability, floating rate, or warrants.

9) What is "tilting of the yield curve"?

The yield curve tilts when long term interest rates fall and short term interest rates rise.

10) How is accrued interest, that has not been received by an investor, treated for income tax purposes?

Revenue Canada requires that accrued interest be taxed in the year it is accrued, which may not necessarily be when it was received.

11) What are the main factors that affect bond prices?

The main factors which affect a bond's price are the credit rating of the issuer, the coupon interest rate, the term to maturity and the level of interest rates in the economy.

12) Why are federal government securities considered to be risk free?

Federal government debt obligations consist of marketable bonds, non marketable CSBs and Treasury Bills. Additionally, the federal government guarantees certain Crown Corporation debt. These debt instruments are backed by the full taxing authority of the Canadian federal government which means that there is virtually no chance of default. In addition to guaranteeing the principal, the federal government also guarantees the interest rate.

13) Why would an investor choose a Mortgage Backed Security over a term deposit or a GIC?

Although all of these investments pay approximately the same interest rate, there is a secondary market in MBS which translates into greater liquidity for the investor.

1) Why should real estate be part of my portfolio?

Research studies show that real estate offers a long term, attractive real rate of return and act as a hedge to inflation. Commercial real estate has a lower standard deviation of returns (risk) than stocks or bonds. Most importantly the returns on real estate investments are not highly correlated with the other asset classes, which results in improved diversification in a portfolio.

2) Does real estate always increase in value?

Various studies show that real estate, like inflation, tends to follow long term trends. Factors which affect the value of real estate include supply, demand, and the nature of the property itself. Investors can lose money in real estate because they do inadequate research or are overly optimistic.

1) How do I know if my fund manager is doing a good job?

Research indicates that only about one third of U.S. mutual fund managers outperform the benchmark portfolio after factoring in expenses and risk. This same research also concludes that mutual fund performance is inconsistent, which means that a top performing fund in one year isn't necessarily the top performer in the following year. Studies indicate that although professional money managers can outperform the index, the costs to find these opportunities can most often be greater than the additional returns.

2) What is a stock index?

An index has a number of different purposes . It can be used to measure the average performance of a group of stocks. An index is also used to perform analysis on the whole asset class of equities because the index serves as a market portfolio. The market portfolio is a tool to measure beta and systematic risk. There are two common types of indexes:

i) Price Weighted Average - This average is calculated using a simple average. Prices of stocks are added together and divided by the number of stocks comprising the average. The most famous price weighted average is the Dow Jones Industrial Average (DJIA). Another example is the Nikkei-Dow Jones Average in Japan.

ii) Market Capitalization Weighted Index - This index measures the daily percentage change in total market capitalization of each stock. The price changes of the companies with the highest market capitalizations dominate the performance of the index. Examples of this type of index include the TSE 300, the S&P 500, the Financial Times Actuary, and the FTSE 100 (London).

3) What is the difference between a stock and a bond?

Bonds represent a liability of a company while each share of stock represents ownership. Bonds always trade over-the-counter while stocks may be traded over-the-counter or on an organized stock exchange.

Stocks earn dividends and capital gains, while bonds earn interest and have the possibility of earning capital gains.

A bond is generally considered to be a safer investment than a stock.

4) What is cyclical stock?

A cyclical stock is a stock that is sensitive to changes in economic conditions.

5) When is a bond negotiable?

When it is in a form that can be transferred between two investors.

6) What types of mutual funds can an investor purchase?

Money market, mortgage, bond, real estate, dividend, balanced, growth, international, global and specialty funds. Specialty funds can include asset allocation funds, ethical funds, segregated funds, LSVCC's and speculative or hedging funds.

7) How would an investor calculate the purchase price of a front end loaded mutual fund?

The purchase price equals (net asset value) divided by (1 - % load).

A fund selling for $12.00 with a three % load has a purchase price of ($12.00) divided by (1-.03) = 12/.97 = $12.37.

8) What is meant by a cyclical or a defensive stock?

Defensive stocks operate in industries that are not affected as dramatically by economic changes. Defensive stocks are companies which have stable earnings and continuous dividend history. Conversely, cyclical stocks are very sensitive to the underlying economic conditions and they usually have highly volatile earnings.

9) How should an investor go about building their investment portfolio?

An investor should first decide on their goals which are used to help establish written investment objectives, including a risk tolerance assessment. The next step is to set the asset allocation amongst the various asset classes which maximizes the portfolio return while minimizing the investor's risk. Once the portfolio is built, it must be regularly reviewed and monitored to ensure that the portfolio continues to meet the investor's changing needs.

10) What techniques are available to an investor for allocating funds amongst asset classes?

One can use strategic asset allocation, a passive portfolio management technique, which sets the long term mix for a particular investor. Tactical asset allocation is an active management technique which allows for discretionary, opportunistic deviations from the long term strategic allocation. Dynamic allocation, an active investment management technique, permits a great deal of discretion and allows the investor to pursue the most profitable opportunities. An integrated asset allocation approach can include all of the above methods.

1) What is the difference between speculation and hedging?

Hedgers either own a commodity or will need to purchase a commodity for business purposes at some point in the future. Hedgers therefore have positions or needs in the cash markets and they use derivatives to pass these price risks along to speculators. Speculators are willing to bear large risks in exchange for the potential to earn significant returns. It is common for speculators to use margin accounts and leverage in order to magnify their gains. Speculators use naked positions which means that they do not own or have a need for the physical commodity.

2) What is portfolio insurance?

Portfolio insurance is known as a protective put strategy. The strategy involves buying a stock and buying a put. What this strategy does is to put a minimum floor under the portfolio with unlimited upside potential. The tradeoff is that the investor has to pay a premium for the put. This can be considered as the premium on the insurance.

3) What is a covered writer?

A covered writer is the seller of an option who owns the underlying stock.

4) What type of investor would be interested in LEAPs?

LEAPs would appeal to an investor interested in options but who desires a longer term investment horizon. LEAPs can go out up to three years.

1) How do I make a market in baseball cards?

Have a garage sale! Many collectibles are not going to have an active secondary market in which the collectibles can be bought and sold. In order to liquidate a collection, which has no formal market, the investor might have to become a market maker. This can be achieved by having a garage sale which meets the technical definition of a call market!

1) What are benefits of international diversification?

Investing globally means that an investor has more investment options available to choose from.

Another benefit of international investment is the potential for higher returns. The correlation between domestic and foreign investments is low. Diversification is best achieved by combining assets with negative or low correlations. Combining assets that are highly correlated does not reduce risk. Warning! The research suggests that global diversification must be done carefully, considering regional factors. For example, the Canadian stock markets are highly correlated to the U.S. markets which means that combining U.S. stocks and Canadian stocks results in a minimal reduction of risk, unless a very careful analysis is performed.