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BU111

Exam Aid Slides

• http://vimeo.com/18129837

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Agenda

• Canadian Financial System

• Stocks

– Margin buying

– Short Selling

– Options

• Time Value of Money

• Bonds

• Technology

• Political Factors

– Sole Proprietorship

– Partnership

– Corporation

Canadian Financial System

• There are four “pillars”

1. Chartered Banks – the most important part of

the Canadian financial system, they expand

money supply through deposits

2. Alternate Banks – smaller, independent banks

3. Life Insurance Companies

4. Investment Dealers – facilitate trading

The lines between them have blurred. Example: Toronto-Dominion (TD) bank bought out Canada Trust (a trust company [alternate bank]) and became TD Canada Trust. They also run TD Waterhouse, and investment dealer 1. Big five own 90% of total Canadian Bank assets Bank of Canada loans money to the big banks and controls money supply through open market transactions and bank rate 2. Trust companies and credit unions 3. Insurance companies and venture capitalists

Investment Vehicles

• The main types of investment vehicles are stocks, bonds

and options

– They are trades on securities markets, first primary

then secondary

• Other investment vehicles are blue chip stocks, small-cap

stocks, penny stocks, Canada Savings Bonds – CSBs,

Guaranteed Investment Certificates – GICs, Treasury Bills -

T-Bills, mutual funds

Primary markets are where securities are sold for the first time, to investment bankers Secondary markets are where any other investor can buy and sell them, such as the TSX or the Dow Jones

Market Order

• An order that an investor makes through a broker or brokerage service to buy or sell an investment immediately at the best available current price. A market order is the default option and is likely to be executed because it does not contain restrictions on the buy/sell price or the timeframe in which the order can be executed.

• In order to get this transaction to go through, you pay your broker a commission (in this course we assume 2%)

• DON’T FORGET to account for commission when you make a market transaction

Capital Gains

• You want to capitalize on a stock RISING

• Share Appreciation

• Buy at a price and sell at a higher price

• Capital Gain -> How much did you gain on your transactions

– Capital Gain = (Sale Price – Buy Price – Commissions)

– Yield = What you make / What you paid

= Capital Gain / Purchase Price

Going Long

• Going long is simply buying a stock and selling it later

• Example: Buy a 150 ABC shares at $10/share and selling

those shares a month later at $13/share. What is your

capital gain and yield?

Sell 150 shares at $13 $1950

Less: 2% IN 30Yield: 381

1500

= 25.4%

Bought at $10 $1500

450

2% OUT 39

Capital Gain $ 381

Therefore your capital gain is $381 dollars and your yield is 25.4%

Margin Buying

• Leverage is the concept of engaging in a transaction that

has a greater value than the amount that you have

available

– Offers the potential for higher reward at the cost of the

potential for higher risks

• Margin buying is when you borrow money from your broker

to complete a transaction, so you only put up part of the

cost

• Your margin in the stock must always be greater than the

minimum margin requirement.

– If the prices of the stock goes down, you will be subjected to a

‘margin call’

-a margin call is when you must pay more money to the broker to increase the amount of your equity in the stock, as the market value of the stock went down, but the brokers loan stayed the same, so the margin is greater than the percent they originally agreed to loan you. *for the purpose of this course, you do not have to worry about paying interest on the loan from the broker

Problem

Say you have $1500 to invest. Your broker is willing to offer

you an additional 25%, so your margin requirement is 75%. If

you then buy ABC shares for $10 and sell them a month later

for $13, how much is your capital gain?

Margin Buy

Step #1: Calculate the broker loan

0.75x = $1500

x= $2000

So your broker loan = $2000 - $1500 = $500

Step #2: Calculate capital gain/loss

Buy 200 shares at $10/share

Sold 200 shares for $13 $2600

Bought for $10 2000

600

Less: 2% in 40

2% out 52

Capital Gain $508

Yield = 508/1500

= 33.9%

Therefore, the

capital gain for

this margin buy

is $508 and its

yield is 33.9%

As you can see, the yield is higher than in the going long example, even though the numbers were the same

Margin Call

Step #1: Calculate the adjusted broker loan

CMV = 200 x $8/share = $1600

Broker Loan = 1600 x 0.25 = $400

Step #2: Calculate the margin call

Margin call = $500* - $400 = $100*Previous broker loan

Therefore, in order to meet the margin call the investor will

need to add $100 to their margin account.

What if the stock went from $10 down to $8 during the

month, instead of up to $13? What is the amount on your

margin call?

Selling Short

• You want to capitalize on a stock FALLING

• You borrow the shares from a broker and sell them right away. Keep the funds in your “short account”

• When the stock falls, you use your funds to buy the stocks on the market at a lesser price

• Return the stock to the broker, and keep the profit you made from the transaction

• Your account must maintain a 150% credit balance (your account must always have 150% of the stock value at any given time!)

• If the stock goes up, its called a short call

-Don’t forget you incur commission on all transactions -If dividends are declared, whoever sold the stock short is liable for the extra dividends

Selling Short

Stock Price

• $35 on May 1st

• $40 on June 1st

• $33 on July 1st

– Let’s analyze the transaction details for 100 shares that occur on our each of these dates (assuming we sell short on May 1st buy back on July 1st)

Answer

Step 1: Determine the amount in your short account.Proceeds from sale of shares: 100 shares at $35 = $3500

2% commission = $70

Short account is 150% of CMV: 1.5($3500) = $5250

You must invest the difference: $5250 - $3500 = $1750

Step 2: Determine the amount of your short CallCMV of the stock is 100 shares at $40 = $4000

Broker expects you to have 150% of this in your short account: 1.5($4000) = $6000

You currently have $5250 in your short account, so your short call will be the

difference: $6000 - $5250 = $750

Your total current invest is the sum of your two payments: $1750 + $750 = $2500

Step 3: Determine your capital gainCost to buy back shares: 100 shares at $33 = $3300

Commission = 0.02($3300) = $66What you get back is the difference between the short account and the cost to

buy back: $6000 - $3300 = $2700Capital Gain is the amount you got back less the amount you paid and commission

Capital gain = $2700 - $2500 - $70 - $66 = $64

Options

• An option is a contract giving its owner the right to buy or

sell an share at a fixed price before a given date. There

are 100 shares per contract.

• Exercising the option is the act of buying or selling the

underlying asset.

• The fixed buy or sell price for the underlying asset is the

option's strike or exercise price.

• The maturity date of the option is when the option

expires.

Options

Types:

- PUT option: the option to SELL a security at a specified

price

- CALL option: the option to BUY a security at a specified

price

Option Premium = Intrinsic Value + Time Value

• Intrinsic Value: difference between the market price and

strike price

- Call’s Intrinsic Value = (Selling Price – Strike Price)

- Put’s Intrinsic Value = (Strike Price – Selling Price)

• Time Value: An extra amount added to the intrinsic value

to compensate for the writer’s opinion on future

movement of the asset (usually a missing variable)

Put: if the price of a stock goes down, you can buy the stock at that price, and the writer of the stock will buy it from you at the exercise price Call: if the price of a stock goes down, the writer of the stock will sell it to you at the strike price, and then you can sell it on the open market for the current market price -Usually how it works though is that the writer of the stock will pay you whatever you would have made, instead of doing through the market Intrinsic value can’t be negative, so if it is, the intrinsic value on the option is just 0 I

Options

MEGA Brands is currently undergoing litigation regarding the

safety of some of their products. Thus, you decide to

purchase a put option on their common stock in hopes that

the litigation will lower the price of the stock. The put

option expires in four months and has a strike price of

$29.14. The put option is currently trading for $5, while the

common stock is currently trading for $37.89. At maturity,

what is your profit if the stock price is $24.61? (Calculate to

2 decimal places). Would you exercise?

Step 1: Pull out the important information- Option premium is $5

- Strike price of $29.14

- Market price at maturity is $24.61

Answer

Step 2: Calculate the cost of the option premium Premium is $5/share and there are 100 shares per option: 100($5) = $500

Step 3: Determine your capital gain when exercised at maturity

Sell 100 shares for $29.14 $2914

Buy shares for $24.61 $2461

453

Less: Premium 5002% IN 49.22

2% out 58.28

2% on premium 10

Capital Gain $ -165.50

Therefore you would have a capital loss of $165.50 if the option was exercised at

maturity. However, I would still exercise the option at this time because my loss would

only be $165.50, as opposed to not exercising, where my loss would be the full $500

I paid for the option.

In general, you exercise a put option if the market price is lower than the strike price, to minimize your losses or make money, and you exercise a call option if the market price is higher than the strike price, again to minimize your losses or make money.

Options

Shares of Wayne Enterprises are currently trading for $21.92.

Put options on Wayne Enterprises shares, which expire in six

months and have a strike price of $28.37, are trading for

$10.45. At maturity, what is the profit to a put option writer

if the stock price is $29.39? (Calculate to 2 decimal places).

Also determine the intrinsic value and time value of the

option premium.

Answer

• In this example, the selling price is $28.37, which is less

than current market price of $29.39, so whoever bought

the stock will not exercise the contract.

• The writer of the stock will make what the contract was

sold for, less the commission.

Step #1: Gather important information

For the first question: 100 shares, $10.45/share

For the second question: $28.37 strike price, $21.97 MPV

Step #2: Calculate profit

100 shares at $10.45/share $1045

Less: 2% out 20.90

Profit $1024.10

Step #3: Calculate intrinsic and time value

Intrinsic value = strike price – market price

= $28.37 – $21.97 = $6.40

Time value = option price – intrinsic value

= $10.45 - $6.40 = $4.05

Therefore, the profit that the option writer receives is

$1024.10, the intrinsic value is $6.40 and the time value is

$4.05.

Time Value of Money

Time Value is the tool for valuing anything that yields cash

flows over time.

• What is the current value of my future cash flows?

• Is money earned today, equal to money earned

tomorrow?

0.50 0.50 0.50 0.50

2.00

Why are these seemingly equivalent cash flow streams actually different?

These $0.50 payments can be RE-

INVESTED

Time Value of a Single Amount

FV = Future Value

AMT = Single Amount

r = the interest rate

n = the number of periods

PV = Present Value

AMT = Single Amount



0.50

These $0.50 payments can be RE-INVESTED at the prevailing interest rate over this n-year period

0.50(1+r)^n

PV =AMT

(1+ r)nFV = AMT × (1+ r)n

Time Value of a Single Amount

FV = Future Value

AMT = Single Amount



PV = Present Value

AMT = Single Amount



0.50/(1+r)^-n

These payments can be RE-INVESTED at the prevailing interest rate over this n-year period to be worth $0.50

at the end of the n years

0.50

PV =AMT

(1+ r)nFV = AMT × (1+ r)n

Future Value of Single Amount

Annual Compounding (Uses the effective annual rate)

0 1 2

0 1 2

Semi-Annual (Uses the effective semi-annual rate)

Quarterly (Uses the effective quarterly rate)

0 1 2

Daily (Uses the effective daily rate)

0 1 2

IMPORTANT: These “r”s depend on the length of the compounding period

FV = AMT × (1+ r)730

FV = AMT × (1+ r)8

FV = AMT × (1+ r)4

FV = AMT × (1+ r)2

Present Value of Single Amount

Annual Compounding (Uses the effective annual rate)

0 1 2

0 1 2

Semi-Annual (Uses the effective semi-annual rate)

Quarterly (Uses the effective quarterly rate)

0 1 2

Daily (Uses the effective daily rate)

0 1 2

IMPORTANT: These “r”s depend on the length of the compounding period

PV =AMT

(1+ r)2

PV =AMT

(1+ r)4

PV =AMT

(1+ r)8

PV =AMT

(1+ r)730

Problem

Step #1: Draw a timeline

Step #2: Determine important information

Step #3: Plug values into the equation

1000

X 1.12= $1120 1254.4X 1.04= X 1.12 =$1404.928

r=.12 PMT = $1000 n=35

Therefore,

the future

value of this

amount

would be

$52,799.

62.52799$

12.01100035

Amount Single

FV

Today 1 2 35

?

What is the future value of $1,000 in 35 years at 12%?

Problem

If you are offered an investment that pays $100 in one year’s time, how much will you pay for it? Your alternative is to put your money in the bank at 10%.

$100?

PV =AMT

(1+ r)n

Step 1: Draw out the timeline

Step 2: Write out the formula

Step 3: Determine the numbers to plug into the formula

AMT = $100 r = 10% = 0.1 n = 1

Step 4: Plug numbers into the formula PV =$100

(1+ 0.1)1

Step 5: Compute the answer

Step 6: Write out a therefore statement

PV = $90.91

Therefore, I would not pay more than $90.91 for this investment, because that is

the amount I could put in the bank for an equal amount in 1 years time.

Since the alternative is to put the money in the bank for 10%, you will not be willing to buy an investment with an interest rate lower than 10%. You will accept 10% or higher. With this in mind, use ten percent in the present value of a single amount as the highest you will be willing to pay.

Nominal Interest Rate

• Also known as APR – it is just a simple interest rate that is

annualized

• For single amounts, you can just find the effective interest

rate by dividing the APR by the number of compounding

periods.

1. If you are looking for semi annual rate -> APR / 2

2. If you are looking for the quarterly rate -> APR / 4

3. If you are looking for a “m” period rate -> APR / m

• You must also remember to multiply the number of

periods, n, by the number of compounding periods, m.


Effective Rate for Payment Period= 1+rnom

m

æ

èç

ö

ø÷

m*p

-1

rnom = rate given

m = # of compounding periods per year

p = payment period measured in fractions of a year

• For multiple payments, if the interest periods and payment

periods are the same, you can find the interest rate the

same way as for a single amount

• If the interest periods and payment periods are not the

same, you use the following formula


• You would also use this formula to determine when an

interest rate for two different compounding periods makes

them equal.

For to be true, then:

Effective Rate for Payment Period= 1+rnom

m

æ

èç

ö

ø÷

m*p

-1

rnom = rate given

m = # of compounding periods per year originally

p = payment period measured in fractions of a year

rsemi =rnom

2AMT ×(1+ rsemi )

2 = AMT × (1+ rquarter )4

rquarter = (1+ rsemi )2

4 -1= (1+rnom

2)

1

2 -1

In this case:

Problem

You wish to deposit $7,000 in an account at the Shylock

Bank. The bank pays interest of APR 10% compounded

quarterly for 3 years, and then switches to semi annual

compounding for 4 years at an equivalent effective semi

annual rate. What is the future value in the account after

seven years?

Answer

Step 2: Determine the interest rates for the first 3 years and

for the last 4 yearsAPR/# of compounding periods = 10%/4 = 2.5% for the first three years


$7000

3 years 7 years

10% APR

compounded

quarterly

10% APR compounded

semi-annually

equivalent to quarterly

?

AMT ×(1+ rsemi )2 = AMT × (1+ rsemi )

4

Divide by AMT

Take the square root of both sides

Subtract 1

(1+ rsemi )2 = (1+ rquarter )

4

1+ rsemi = ((1+ rquarter )4 )

12

rsemi = (1+ rquarter )2 -1

For the last four years, we want

= (1.025)2 -1

The interest rate is given as APR, but the compounding periods are in quarters, so 4 times per year. Since this is just a single amount, to determine the quarterly interest rate, we just divide APR by the number of compounding periods. The square root is the equivalent to taking the power of 1/2

Answer

Step 3: Determine the amount of the $7000 after 3 years

Formula: FV = AMT × (1+ r)n

Numbers to plug into formula: AMT = $7000 r = 2.5% = 0.025 n = 3(4) = 12

Plug numbers into formula: FV = $7000 × (1+0.025)12

Compute (to 4 decimal places): $9414.2218

Step 4: Determine the total amount after 7 years

Formula: FV = AMT × (1+ r)n

Numbers to plug into formula: AMT = $9414.2218 n = 4(2) = 8

r =1.0252 -1Plug numbers into formula: FV = 9414.2218×(1+ (1.0252 -1))8

Compute (to 2 decimal places): $13975.47


Therefore, the $7000 dollars will grow to $13975.47 after four years if the

bank uses this interest method.

Follow the same format for any other TVM question. You already have the timeline, then go formula, numbers, plug in, compute and write out a concluding statement

Multiple Constant Payments

• Called an annuity

Today 1 2 3

PVordinary annuity = PMT1

r-

1

r(1+ r)né

ëê

ù

ûú

Today 1 2 3

PVannuity due = PMT1

r-

1

r(1+ r)né

ëê

ù

ûú× (1+ r)

xx

x

x

x x

?

?

Multiple Constant Payments

• Called an annuity

Today 1 2 3

FVordinary annuity = PMT(1+ r)n -1

r

é

ëê

ù

ûú

Today 1 2 3

FVannuity due = PMT(1+ r)n -1

r

é

ëê

ù

ûú× (1+ r)

xx

x

x

x x

?

?

Problem

Uriah Heep celebrated his 18th birthday by opening a savings

account at the Thames River Bank and depositing $3300. He

continued to deposit the same amount on every subsequent

birthday until he was 24 years old. After depositing $3300 on his

24th birthday Uriah decided to abandon his savings plan. He

never saved again, but he left the accumulated savings in the

bank account. The bank paid an interest rate of 7%. When Uriah

turned 65, he withdrew the money from the bank. What was the

amount of his withdrawal?

Answer

• This is a future value of annuity due for the first seven

years and then a single amount for the next 40 years.

Step #1: Draw a timeline:

$3300

Today 7 65

?

Step #2: Calculate the future value of the annuity due for

the first seven years

PMT = $3300

r = 7%

n = 7

Step #3: Calculate the future value a single amount for the

remaining 40 years

AMT= $30557.3485

r = 7%

n = 40

)1(1)1(

dueannuity rr

rPMTFV

n

)07.01(07.0

1)07.01(3300

7

dueannuity

FV

3485.30557dueannuity FV

40

amount single )07.01(3485.30557 FV

nrPMTxFV )1(amount single

73.457579amount single FVTherefore, the amount of

Uriah’s withdrawal was

$457579.73.

Problem

You are 40 years old and want to retire at age 55. Each year,

starting one year from now, you will deposit an equal amount

into a savings account that pays 6.8% interest. The last deposit

will be on your 55th birthday. On your 55th birthday you will

switch the accumulated savings into a safer bank account that

pays only 3.5% interest. You will withdraw your annual income

of $150000 at the end of that year (on your 56th birthday) and

each subsequent year until your 85th birthday (you expect to

pass away later that year). When you die you want to leave a

bequest of $350000 to your children. How much do you have to

save each year to make this retirement plan happen?

The easiest way to do this question is to split it into two parts, first

determine the present value of an ordinary annuity with $150000 payments

and the present value of a lump sum of $350000. Second, determine the

payments of an ordinary annuity with a future value of the amount you

determined in the first part.

Answer (for the first part)

Step 1: Draw the timeline

0 1 2 30

?$15000

$35000

$15000 $15000 . . . . . . . . . . . . . . . . . . . . . .


PV = PVordinaryannuity +PVsingle amount

Step 3: Determine numbers to plug into the formulas

PMT = $150000 AMT = $350000

r = 3.5% = 0.035 n = 30

PV = PMT1

r-

1

r(1+ r)né

ëê

ù

ûú+AMT

(1+ r)n

Step 4: Plug the numbers into the formula

Step 5: Compute (remember that this is an intermediate step

to the full problem, so round to 4 decimal places0

PV = $1500001

0.035-

1

0.035(1+ 0.035)30

é

ëê

ù

ûú+

$350000

(1+ 0.035)30

PV = $2883504.255

A regular calculator will only go to three decimal places for this question. You won’t be penalized.

Problem

You are 40 years old and want to retire at age 55. Each year,

starting one year from now, you will deposit an equal amount

into a savings account that pays 6.8% interest. The last deposit

will be on your 55th birthday. On your 55th birthday you will

switch the accumulated savings into a safer bank account that

pays only 3.5% interest. You will withdraw your annual income

of $150000 at the end of that year (on your 56th birthday) and

each subsequent year until your 85th birthday (you expect to

pass away later that year). When you die you want to leave a

bequest of $350000 to your children. How much do you have to

save each year to make this retirement plan happen?

Answer(for second part)

Step 1: Draw the timeline0 1 2 15

$0 ? ? ?$2883504.255


FVordinary annuity = PMT(1+ r)n -1

r

é

ëê

ù

ûú


FV = $2883504.255 r = 6.8% = 0.068 n = 15


$2883504.255 = PMT(1+ 0.068)15 -1

0.068

é

ëê

ù

ûú

The answer to this part will also be your final answer

Step 5: Rearrange and solve for PMT

PMT =$2883504.255

(1+ 0.068)15 -1

0.068

é

ëê

ù

ûú

PMT = $116527.41


Therefore I have to save $116527.41 per year to make this retirement plan

happen.

Bonds

What is a Bond?

Just as people need money, so do companies and

governments. A company needs funds to expand into new

markets, while governments need money for everything from

infrastructure to social programs.

Bonds

What are the components of a bond?

1. Maturity Date:

2. Face Value/Par Value: The value you loan. You get this

back on the maturity date

3. Principal/Bond Price: The price you pay for the bond, ie.

The amount you pay to the issuer in order to receive a loan

at maturity

4. Coupon Payment: Face Value * Coupon Rate% / 2

5. Yield To Maturity: Annual rate of return if you hold your

bond to maturity (the interest you earn)

2. Typically, a single bond will have a $1000 face value 3. The price of bonds is determined using the time value of money information found earlier (PV of an ordinary annuity plus PV of a single amount [$1000]) 4. The coupon rate is the stated percentage of interest that the seller of the bond will pay to bondholders Bonds sellers pay out interest payments (coupon payments) twice a year

Bonds

• If interest rates RISE, prices of old bonds will FALL

If interest rates FALL, prices of old bonds will RISE

Why do these bond prices vary with the interest rate?

How do you derive the yield to maturity formula?

Yeild =

coupon rate x face value + face value - price paid

time to maturity

price paid

Bonds vary inversely with market interest rates. This is because as interest rates go down, old bonds with higher rates become more attractive to investors, so the demand goes up, and thus drives the price up. The opposite happens if interest rates go up, they become less attractive and demand goes down.

Problem

To raise funds for software development for the gun registry,

the Federal Government of Canada has issued bonds on

behalf of the Department of Justice. The bonds, called “Gun

Bonds” have a face value of $1,000, two years to maturity

and a 6% coupon rate (annual coupons with the first coupon

due in one year). The bonds are priced at $1,018.86. What is

the yield to maturity on the Gun Bonds?

Bond Yield to Maturity

• Simply plug the required variables into the bond yield

formula

Coupon rate:6%

Face value: $1000

Price paid:1018.86

Time to maturity: 2 years

Therefore, the yield if held until maturity is 5%.

paidprice

maturitytotime

paidpricevaluefacevaluefaceratecoupon

Yield

86.10182

86.10181000)100006.0(

Yield

Yield =7%

Problem



What would you pay for the following bond structure?

- 3% coupon, maturing in 15 years, FV = 1000, 4% APR

compounded semi annually

0 1 2 15

? $15 $15 $15$15$15 . . . . . . . . . . . . . . . . .

$1000

PV = PVordinaryannuity +PVsingle amount

PV = PMT1

r-

1

r(1+ r)né

ëê

ù

ûú+AMT

(1+ r)n

Answer


PMT = $15

AMT = $1000

r = APR/2 = 4%/2 = 2% =0.02

n = 15(2) = 30


PV = $151

0.02-

1

0.02(1+ 0.02)30

é

ëê

ù

ûú+

$1000

(1+ 0.02)30

Step 5: Compute (to 2 decimal places)

PV = $888.02


Therefore, I would pay $888.02 for this bond today

Break Time!

We’re going to take a quick break now. Feel

free to get up and stretch your legs. We’ll

start going again in 5 minutes.

Technology

• What is TECHNOLOGY? (from a business perspective)

– Anything tangible that affects what produced how it is

produced and sold, and how the organization is

managed.

– Is always changing, demands constant adaptation

– NOT limited to computers, internet and information

tech.

Technology – Positives

• Speeds up production

– Reduces cost

– Enables larger quantities

– Increases efficiency

• Better products

– Quality – innovation

• Communication gaps are bridged

• Affects Porter’s forces

Technology - Negatives

• Easy to recreate (imitate)

• Excessive Information

• Unfamiliarity to organizations

• Constant change can be a hassle

• Differences in standards through evolution

IT – Information technology

• The various devices for creating, storing, exchanging, and

using information

• ATM, email, inventory software

• Makes collection and access easy and efficient

– Distance work possible

– Instant access

Concepts - Technology

• Installed base

– More customers means more influence

• Sunk investment (lock-in

– Larger = greater resistance to switch

• Switching costs

• Complementary goods – needed for value; creates vicious

or virtuous cycle

• Network effects

– value depends on users – if no one uses, its pointless

Disruptive Innovations

• Represent

innovation

that

creates a

new

market or

new way of

doing

things

compared

to old

Why do they cause large firm

failure?• Serving existing customer base and sure-fire revenues and

not seeing validity of a different opportunity leads to a

strategy that results in disaster!

• Organizational processes weed out ideas that don’t

address current customer needs

- Avoid small, uncertain, unfamiliar markets – these

technologies start out in small niches, that seem

financially unattractive

Types of Innovations

Knowledge/capabilities

challenged:

Knowledge/capabilities

unchallenged:

Architecture/

Organization

structure

challenged:

RADICAL

INNOVATION

(e.g. calculator compared to

slide rule)

ARCHITECTURAL

INNOVATION

(e.g. desktop computers

compared to IBM

mainframes)

Architecture/

Organization

structure

unchallenged:

MODULAR

INNOVATION

(e.g. digital camera

compared to film camera)

INCREMENTAL

INNOVATION

(e.g. image stabilizing

feature added to digital

cameras)

Political Factors

Elements:

• Laws, regulations

• Taxes

• Trade agreements or conditions

• Political system

• Political stability

Government

• Influences business in a number of ways

– As a customer, competition, regulator and taxation

agent

– Also provide financial assistance and essential services

(police, hospitals, education

• Businesses also effect government in a number of ways

– Lobby, trade associations, advertise

Forms of Ownership

• Sole Proprietorship

• Partnership

• Corporations

– Public

– Private

• Other forms

– Franchises

– Co-operatives

– Joint Ventures

Sole Proprietorship

• Single owner and legal entity

• Advantages

– Easiest form to set up.

• Less regulations

• Government support

– Owner solely controls the business.

• Disadvantages

– Unlimited liability.

– Can be hard to raise capital.

• Limited capital

– Lack of perpetuity

– TAX!!!!!!!!!!!!!!!!!

Partnership

• Two or more people, with same legal entity

• Advantages

– Shared risk.

– Shared management.

• Disadvantages

– Risk of conflict between partners.

– Shared decision making.

– Lack of continuity

– TAX!!!!!!!!!!!!!

Partnerships

• General

– Joint and several liability

• Joint – everyone shares liability

• Several – one partner may be liable for all

• Limited

– Limited by the investment, due to inactivity

Corporations

• Separate legal entity

• Finances raised by issuing shares and bonds.

• Governed by a BOD (board of directors)

– Internal

– External

• Types

– Public

– Private

– Crown

Corporation

• Advantages

– Limited liability.

– Easier to raise capital.

– TAX!!!!!

– Perpetual existence

– Financing and ownership transfer

• Disadvantages

– Most expensive form of business to set up.

– Involves a lot of ongoing paperwork.

– Double Tax!!!!!

– Complexity (regulation and cost of formation)

Large vs. Small Corporations

• Small Private

• borrow owner’s collateral

(not unlimited liability)

• small business tax rebate

• afford fewer experts

• owners directly involved

• max. 50 shareholders

• little govt. regulation

• secrecy possible

Large Public

• shares traded publicly

• taxed at higher rate

• double taxation

• afford more experts

• Board of Directors govern the

company

• unlimited shareholders

• excessive govt. regulation

• transparency

International Trade

• What is it?

– Trading outside the

nation’s borders.

– US, Europe, China,

India, Middle East

• Barriers

– Social and cultural

barriers

• Economic

- Exchange rates

• Legal

- Tariffs and subsidies

- Policies, and

business practice

laws

• GATT

• WTO

• EU

• NAFTA

Exam Tips

• No penalties for wrong answers on multiple choice – take a

guess if you don’t know

• Don’t spend too much time on any one question, go back

to it later if you have time

• Show all your work on problems, you may get part marks

• Don’t cram!!!!

GOOD LUCK!

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