Study Session 1: Purposes and Goals of Investing
Introduction: What to Expect
Lets begin by discussing the details you need to know about investment capital. As you
proceed through the chapter, you will see how an individual s investment objectives are
determined by his or her risk tolerance and the return on investment required.
This topic will comprise about 3% of the CSC Vol.1 examination; however, keep in mind
that additional questions will require cumulative knowledge. In these cases, although
you may not be directly tested on these topics, you will still need to understand the
concepts to answer the questions correctly.
Investment Capital
Capital is the most important commodity: you need it to purchase goods and services,
finance business operations, and so on. Individuals, governments, and businesses are
all users of capital, whether they use it to purchase durables or assets, to fund a deficit
budget, or to carry out operations.
The Three Characteristics of Capital
o Mobile
o Sensitive
o Scarce
Capital Creation
o Savings are the only source of capital
o Direct sources of capital are real assets such as land or buildings.
o Indirect sources of capital include items such as stocks, bonds, and savings
deposits in a bank.
As you read the next section, note that some exam questions will require you to
recognize the difference between capital sources and capital users.
Sources and Users of Capital:
In general, savings and investments are the main sources of capital. Individuals,
business, governments and foreigners make these contributions. These same entities
can also be classified as users of capital, as capital is required for purchases,
operations, and more.
As we progress through the upcoming study sessions, we will describe how various
economic events affect the net flow of capital.
In the meantime, to ensure you understand the differences between entities functioning
as sources of capital versus entities functioning as users of capital, the following tables
will illustrate the specific details you should know.
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Study Session 1: Purposes and Goals of Investing
Table 1-1
Sources of Capital in Canada
-Through saving and investment, individuals inject capital into the
economy.
Individuals - Savings are those funds placed into retirement plans, pension
plans, insurance, savings accounts, and other forms of
investment.
- Investment capital is generally created from retained earnings.
- Financing is also obtained from financial intermediaries or
Businesses
through financial markets by offering stocks or bonds to the
public.
- Governments obtain capital by issuing various financial
instruments.
- The federal government issues Canada Savings Bonds (CSB)
and Canada Premium Bonds (CPB).
Government
- Provincial governments obtain capital through the Canada
Pension Plan (CPP) or short-term debt instruments.
- Municipal governments borrow money based on credit rather
than an underlying security.
- Foreign investors inject capital into the economy through
investment in stocks, bonds, real estate, etc.
Foreign
- Some investors choose to invest in another country, as the rate
Investors*
of return for foreigners may be higher in another country than
what they can earn domestically.
*We will discuss the consequences of foreign investment in Study Session 2
Table 1-2
Users of Capital in Canada
- Require capital to purchase durables and other assets
Individuals - Use loans, mortgages, and other forms of financing to
facilitate consumption
- Require capital to carry out operations and increase output,
Businesses
efficiency, competitiveness and innovation
Government - Require capital to fund a deficit budget
- Require capital to fund projects in their home countries
Foreign
- Borrowing capital from another country can be a cheaper form
Investors
of financing.
Capital is transferred from its sources to users through these elements:
o Financial instruments such as stocks and bonds. We will discuss these
instruments in Study Sessions 4 and 5.
o Financial markets such as stock exchanges. These will be discussed within Study
Session 2.
o Financial intermediaries such as investment firms and banks. We will detail the
players in capital markets in Study Session 3.
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Study Session 1: Purposes and Goals of Investing
To determine where capital will flow, you need to analyze five factors:
o Political environment
o Economic trends
o Fiscal and monetary policies
o Labour force
o Return on investment (ROI)
Investment Objectives
Savers of capital have varying investment objectives and a number of different
investment methods to choose from. Often, the tradeoff between risk and return is a
key factor in determining a person s investment objectives and, thus, investment
vehicles.
The risk and return tradeoff is an important concept to know, as it is central to many
investment decisions and products. You can learn more about this topic in the
following Investopedia article:
Weblink 1.1
Article:  Determining Risk and the Risk Pyramid
http://www.investopedia.com/articles/basics/03/050203.asp
Primary Investment Objectives
The following three primary investment objectives are the most important to
consider when devising a financial plan for a client. These objectives, when coupled
with knowledge of a client s current financial situation and risk tolerance will
determine their appropriate asset mix. Note that a client s goals may also be a mix
of these objectives.
1) Safety
o Client s with this objective want to maintain their capital position. As a result
they are:
- Willing to accept a lower rate of return in exchange for reduced risk
- Willing to give up opportunities for capital growth
o Appropriate investments are low risk securities such as federal, provincial,
and municipal bonds, high grade corporate bonds, and Treasury bills.
2) Income
o Client s with this objective are willing to forego some safety in order to
maximize income return.
o Investments that provide income include corporate bonds and/or preferred
stocks that pay regular dividends.
3) Growth
o Client s in higher tax brackets often seek capital gains rather than income,
since only 50% of capital gains is added to an individual s taxable income.
o Companies with growth stock tend to be expanding companies and
innovative industries. These companies tend to reinvest retained earnings to
fuel growth rather than pay a dividend.
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Study Session 3: Players in the Financial Industry
Secondary Investment Objectives
In addition to the primary objectives described above, the following secondary
factors must also be considered when determining the appropriate asset mix for a
client.
1) Liquidity
o What is the likelihood that a client will need to withdraw a portion or all of
their investment on short notice? If there is a high likelihood of this
occurrence, investments with a high degree of liquidity are required.
o With the exception of some real-estate investments, most Canadian
securities are easy to liquidate.
2) Minimize Tax
o How you achieve this objective depends on the investor s chosen investment
and its details. For example, does it include dividends or interest?
You may be given a person s profile and be asked to identify his or her
investment objectives. Remember that safety, income, and growth are primary
objectives, while liquidity and tax minimization are secondary objectives.
Conclusion
Capital is required in order to purchase goods and services, expand business
operations, save for retirement, and more. Individuals, business , governments and
foreign investors serve as both sources and users of capital, which demonstrates how
net capital flows within the economy. For savers of capital, five investment objectives
must be considered before determining what combination of financial instruments is
most important for their investment portfolio.
Here is a brief summary of the topics we have just discussed:
Investment Capital
- Capital is used to purchase goods and services and run businesses, therefore
both sources and users of capital exist.
- Capital is mobile, sensitive, and scarce.
Primary Investment Objectives
- The three primary investment objectives are safety, income, and growth.
Secondary Investment Objectives
- The two secondary objectives are tax minimization and liquidity.
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Study Session 3: Players in the Financial Industry
Top 15 Terms to Know
1) Bonds
2) Canada Pension Plan (CPP)
3) Canada Premium Bonds (CPB)
4) Canada Savings Bonds (CSB)
5) Capital
6) Deficit
7) Dividends
8) Growth Stock
9) Liquidity
10) Loans
11) Mortgages
12) Preferred Stock
13) Real Assets
14) Return on Investment (ROI)
15) Treasury Bills
Notes:
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