Chapter 1: Capital Market Flashcards
3 Components of wealth transfer process
- Financial instruments (what is actually bought/sold)
- Financial markets (facilitate buying/selling of 1)
- Financial intermediaries (people/companies involved in 1 and 2)
Capital
savings of individuals, corporations, and governments
Direct Investment
assets that generate wealth (land, real estate, equipment, etc)
Indirect Investment
- Financial assets: stocks (ownership of company), bonds (debt of company or government), treasury bills (debt of government)
- Companies and governments issue these financial assets and receive funds. The funds are used to invest in the funds directly
- Investors buy these financial assets to generate a return
Efficient Allocation of Capital
Capital is mobile, scarce and sensitive (those who have capital will only transfer/invest if it is easy, cheap, and generates good return)
Capital Flow Depends on…
- Political environment
- Economic trends
- Fiscal policy (government spending and taxation)
- Monetary policy (government by central banks)
- Investment opportunities
- Labour force (highly educated/laws governing rights of labour force)
Sources of Capital
Retail, institutional and foreign investors provide capital
Retail Investors
Individuals
Institutional Investors
pension funds and mutual funds
Foreign Investors
- foreign retail, institutional and government investors
- Investments are made directly in Canadian firms or through stocks/bonds for Canadian firms listed on foreign exchanges
Financial Instruments
mechanisms by which wealth/capital is transferred (what is actually bought/sold)
Debt
- Funds are borrowed
- At specific date (“maturity date”) these funds are paid back
- Between the borrowing and maturity date, interest payments are paid
Equity
- Typically represented by stock/shares in a company
- As equity investor, you own part of the company
- At annual meetings, you have voting rights
- May receive regular dividend payments (not necessarily)
Investment Funds
buys and sells stocks/bonds (typically through mutual funds)
Derivatives
these products derive their value from another asset (stock, bond, commodity, currency) often used for hedging (ex. Mitigate the effect of a strong C$ or higher oil prices)
Private Equity
- invest in both debt and equity
- typically investments are made directly in companies (not through stock or bonds)
- Funds are provided by pension funds, endowments, and wealthy individuals
Efficient market properties
- Fast (can I buy / sell a stock with minimal delay)
- Cheap (low fees to buy / sell)
- Liquid (are there many buyers and sellers)
- Ex. Buying or selling a house may not be efficient, buying or selling a stock or a bond should be
Primary Markets
- Securities (shares or bonds) are sold by issuers for the first time
- Issuer receives the money from this sale
- May be an IPO or subsequent equity offering
Secondary Markets
- Where securities previously issued (above primary markets) are bought and sold (funds do not go to the issuer)
- Ex. If I buy 100 shares of TD bank on the TMX today - the funds go to the shareholder who sold me the shares (not TD)
IPO (Initial Public Offering)
first time a company sells its shares to the public and the shares are listed on the stock exchange
Auction Market
like any other market where items are bought and sold. A stock exchange is an auction market where stocks are bought and sold (all transactions converge in one location).
How does the stock exchange make money?
- Transaction fees (you pay a fee when buying or selling a stock)
- Initial listing fees (company conducts IPO they pay a fee)
- Fees from companies making capital structure changes
- Sale of historic data
Trends in stock exchanges
- Stock exchanges have largely transferred from physical locations to trading systems (speed and cost efficiency are crucial)
- Stock exchanges around the world have been joining together (through mergers & acquisitions) to become “bigger and better”
Financial Intermediaries
People and companies that improve market efficiency by facilitating the flow of capital from buyers to sellers
- May work in their self interest
- Regulations are meant to be structured such that marker efficiency is a by-product of this self interest
- The financial crises exposed areas where firms were working in their self interest and also working against market efficiency/product economy
Examples of Financial Intermediaries
Bank of Canada Banks Insurance companies Pension Funds Investment dealers Private equity/venture capital firms
Function of financial markets
Help facilitate transfer of capital
Users of Capital
Companies/businesses
- Earn money internally through existing operations and reinvest that money
- Raise funds by issuing stocks/bonds
more and generate additional returns
Governments (federal, provincial, municipal) issue debt
- Treasury bills (debt due in less than one year), longer term debt, Canada Savings Bond (federal/provincial governments only)
What do companies/businesses invest funds in?
New products/markets/machinery that they hope will grow the company more and generate additional returns
What does the government invest funds in?
All forms of government spending that aren’t covered by tax and other revenues
Healthcare, education, infrastructure spending (roads, sewers, water, etc)
