Chapter 1:

1.1:
What is the financial system?
- They transfer money from suppliers like individual households to users like companies.
- It includes the financial intermediaries, markets and instruments (securities: stocks and
bonds).
- Suppliers: they have savings that they want to invest in order to get a return.
- Users: they need money to fund their activities.

What are financial markets?

- They are the place that users and suppliers
transact.
- They often transact through intermediaries
and rarely transact directly with each other.
- The intermediaries include
commercial banks, investment banks, funds and
insurance companies.

Bonds:
- A debt instrument issued by governments and corporations with a maturity of more than
1 year. Coupon bonds pay periodic (annual or semi-annual) interest payments to the
holder (called coupons) and pay a final lump-sum (called the face value) at maturity.
What is the bond market?
- It is the market for coupon and zero coupon bonds with maturities ranging from 1 to 30
years and includes bonds issued by governments and corporations.
- The users(issuers) of the bond market include the government which accounts for 65%
for bond issuance. Corporations hold 14%.
- The suppliers (holders) are the domestic households which hold 35% of all the bonds.
Although they don't generally buy bonds directly. Households usually own mutual funds
through their retirement accounts.
What is the equity market?
- A place where stocks and company shares are traded.
- The largest issuer of equity markets is publicly traded companies.
1.2:
What is the difference between the capital market and the money market?
- Money market: is for securities that mature in 1 years or less.
- Capital market: is for securities that mature in more than 1 year.
What happens to securities in money markets?
- They are fixed income securities (like bonds)
- They are short term
- They are highly liquid (easy to sell)
 - They mature in less than 1 year from their issue date.
1.3
1.4
1.5
Chapter 3:

Chapter 4:
4.1
What is an annuity?
-
They are a series of equal payments made at equal intervals. They don't have to be
made annually despite their name.
- They can be made weekly, daily, monthly but the important thing is that the payments
are equal and the time intervals are the same.
What is an ordinary annuity?
- It is an annuity in which payments are made at the end of each period.
- These are more common than annuity due.
What is an annuity due?
- An annuity in which payments are made at the beginning of each period.
What are the Future values of an ordinary annuity?
- We use it to find the future balance of an interest bearing balance. This is the formula
that is used.
- PMT x FVIFA

What is FVIFA?
- It stands for future value interest factor for an annuity.
- It is the future value of an n-period ordinary annuity at rate i with payments of one dollar.

How do we solve payments when we know how much we want?

- The question will be how much you need to save each period to reach the goal. So we
need to solve for the payments.
- The formula that can be used is the following.
What is the formula for an annuity due future value?

4.2
What is the formula for the present value of streams of payments?

What is PVIFA?
- It stands for the present value interest factor for an annuity (PVIFA).

When do we use present value?

- Anytime we want to know how much we need today to create a future cash flow stream,
find the present value of the cash flow.
- So if we are planning to retire at 65 and will need 50,000 per year for the next 30 years
then we compute the PV of a 30 year $50,000 annuity.
4.3
What is an equation of value?
- It is an equality between cash inflows and outflows after they have been all accumulated
or discounted to a common point in time.
- This common point in time is called a focal date.
What is the focal date used for?
- The focal date is central to solving time value of money problems, since money is more
valuable the sooner it is received.
How do we solve a TVM problem?
1. Jot down what is known in the Q.
2. Draw a timeline
3. Select a focal data, there are only two directions that you can move money: forward or
backward.
- If you pick a focal date at the end of the timeline then you are moving cash
forward future value.
 - If you pick a focal date at the begging of a timeline, then you are moving cash
backward (discounting).
4. Determine whether the cash flows are lump sums or annuities.
- If you have single cash flow or if there are multiple with varying amounts then
you are dealing with a lump sum.
- If there are multiple cash flows with the same values then it is an annuity.
- If an annuity goes on forever then you have a perpetuity.
5. Determine the compounding frequency of the problem (e.g annual, monthly, or weekly)
and decide whether the cash flows are beginning of period or end of period.
What is an imbedded annuity?
- It is an annuity mixed with other irregular payments. Payments other than he series of
fixed payments.
What is a deferred annuity?
- It is a series of equal payments that does not begin immediately, but rather at some
future date.
4.4
What is a balloon loan?
- A loan where zero or low payments are due while the loan is outstanding and the
balance is due at maturity.
- It is when the principal and interest (sometimes just the principle) are paid at the end of
the loan term. The end of the term payment is referred to as the balloon payment.
- Examples like short term construction loans during the construction phase followed by a
long term amortized loan.
- The balloon payment is just the future values of the principal when compounded at the
loan rate (i) over the loan term (n). The equation would just be the basic future values

equation.

4.5
What is an amortized loan?
- A loan where the borrower repays the loan with level and regular periodic payments.
Each payment incorporates a blend of interest and principle. The payments are applied
first to interest and the remainder is applied to principle.
- Examples would be a car loan and mortgages.
- Amortization schedule: a complete table of periodic loan payments, showing the amount
of principle and the amount of interest that comprise each payment until the loan is paid
off at the end of its term.
What is the amortized loan equation?

The equation involves four variables: the principle, the payments, the interest rate and the
number of payments. We can also rearrange to solve for payments.

What are the two forms that interest come in for amortized loans?
1. Each payment contains interest
2. The lender receives the payments before the end of the term and so can earn interest by
investing the.
How does this connect to balloon payments?
- The future value of the amortized loan payments is only equal to the balloon payment if
the lender can reinvest intermediate payments at the loan rate.
What is the reinvestment rate assumption?
- The lenders can earn i% on amortized loans if they can reinvest at i%.
- It is also the assumption that as funds are received they will be reinvested at the interest
rate required by the investor.
What is the formula for a car loan?
- Car loans are also amortized loans

How does the loans amortization schedule work?

- Amortized loans are a blend of interest and principle
- The portions of each payment that is interest and principle changes.
- Each payment reduces the principal owing and so reduces the amount interest owing in
the next period. And we can calculate that using the amortization schedule.
What is the meaning of principle outstanding ?
- It is the amount that is owed to the lender after the first payment.
- There is a formula which is quicker than building a amortization schedule
What is a car lease?
- It is a variation of a car loans, the payments are structured like an amortized loan with
the addition of a lump sum payment at the end of the loan term.
- Lease payments occur in the beginning of each month.so they are structured as an
annuity due.
What does a lease payment include?
1. It includes a downpayment
2. The monthly lease payments
3. The buyout
What is the general formula of value for a loan?
- This formula states that the principle is equal to the present value of the loan payments
discounted at the loan rate.
- The buyout is present regardless if you will buyout or walk away since the left hand side
and right hand side need to be equal.

Chapter 7:
7.1
What is a zero coupon bond?
- It is a bond that does not pay coupons.
- With this bond the holder (lender) pays a price that is less than the face value, and then
receives a face value at maturity.
What is the difference between the price and the face value?
- The difference is the interest earned by the holder.
Where are the short maturity zero coupon bonds traded?
- These bonds with less or equal to 1 year are traded in the money market.
- These bonds include commercial paper, bankers acceptance and government T-bills.
What are money markets?
- It is the market for bonds with a maturity of less than or equal to 1 year.
- All of these bonds are zero coupon bonds and include bankers acceptances, commercial
paper, and government T-bills.
What are T-bills?
- These are bonds issued by the Canadian government that have maturities of 91 days,
182 days or 52 weeks.
- They are zero coupon based also known as treasury bills.
What are mutual funds?
- They are a professionally managed pool of money.
- The money comes from a disparate group of investors who exchange their money for
units (if the fund is organized as a trust) or shares in the fund.
- They can be invested in any type of security depending on the goals of the funds.
- Money market mutual funds are simply a portfolio of these securities.
Does the government of canada issue zero coupon bonds with maturities greater
than 1 year?
- No they dont.
- But many financial intermediaries strip the government of canada coupon bonds and sell
the stripped coupons and face value as zero coupon bonds.
- But strip bonds aren't part of the money market since their maturities exceed one year.
- There aren't much trading for strip bonds since the buyer holds them the security to
maturity.
7.2
What does a zero coupons bond promise?
- It promised the holder a fixed sum of money, face value of $FV, at a fixed date in the
future, (date T).
- The price of the bond is less than the face value if the interest rate is positive which it is.
- The dollar amount of interest earned on the bond is the difference between the face
value and the price.

What is the return on the bond?

- It is the rate that the price grows to equal the face value at maturity. If we think of the
price as a present value and the face as a future value, then we can use the future value
formula to solve for the return.

Solve for k to find return on the bond.

What is the yield to maturity?
- It is also the return of the bond. And estimate on the annual return an investor will earn if
they buy a bond and hold it to maturity.
What are treasury spot rates?
- The yield on a default-free-zero-coupon treasury where the yield is quoted for immediate
settlement.
- They are the building block for all yields because they are essentially default free, there
is almost no risk that the Canadian government will fail to pay its obligations,
What is the term structure of interest rates?
- They are the relationship between term (maturity date) and interest rates.
- Because they are the interest rates for different maturities (terms).
What is the yield curve?
- It is the graphical representation of the term structure. A graph of yields on the y axis
against time to maturity on the x axis.
What is the yield curve of the treasury spot known as?
- It is known as the treasury spot rate yield curve.
- Each point on the yield curve represents the return on a Canadian government zero
coupon bond with the indicated maturity.

If we know the yield..

- If the yield is known then the price of a zero
coupon bond is the present value of the face
discounted at the yield. We can solve for the price using this
formula.

What is the relationship between bond prices and yields?

- Bond prices and interest rates move inversely.
- If yield rises then bond prices fall.
- The yield is in the denominator of the right hand side of the equation, when the yield
increases the ratio declines.