Chapter 1: Intro Flashcards
What is Finance
the study of how and under what terms savings (money) are allocated between lenders and borrowers
How is finance different than economics?
it addresses 1. how resources are allocated (same as economics) 2. under what terms and through what channels resources are allocated
When do financial contracts or securities happen
whenever funds are transferred form issuer to buyer
What does the study of finance require a basic understanding of?
- securities 2. corporate law 3. financial instituions and markets
what are real assets? Definition
they are tangible items owned by persons and businesses
Give some examples of real assets: Personal
- value of residential structures (houses) 2. Land 3. Major appliances (televisions, washing machines etc) 4. cars
Give some examples of real assets: business
- NOn-residential structures (office buildings, factories, mines) 2. Machinery and Equipment 3. Land 4. Stock Inventories (items waiting to be sold)
What are financial assets: Definition
are what one individual has lent to another
Give some examples of financial assets
- consumer credit 2. Loans 3. Mortgages
a household with no financial assets often has what?
financial problems - because real assets cannot be easily used to pay off or service debt (ie make loan payments) - real assets as not as LIQUID as most financial assets
who is the primary provider of funds to business and government?
hosueholds
Why do households have to accumulate financial resources?
so they have enough (pension) to live during their retirement
Who are financial intermediaries
transform the nature of the securities they issue and invest in (eg. banks, trust companies, credit unions, insurance firms, mutual funds)
who are market intermediaries
such as investment dealers and brokers (investment advisors) - help make markets work by adding liquidity
What are the 3 channels of intermediation
- direct transfer - from lender to borrower in a non-market transaction 2. direct intermediation - through a market intermediary such as a broker in a market-based transaction 3. indirect claims through financial intermediary (such as a bank offers deposit0taking services and ultimately lends the deposited funds out a mortgages or loans
what is an example of a direct transfer
people borrow from friends, relatives, acquaintance - non-market transaction
What is an indirect claim through a financial intermediary??????
borrow form financial institution (people have loaned their money (savings) to financial institutions - still direct intermediation between the lender and borrower except some help is needed (no one has enough money to lend all the amount, usually)
What is an indirect claim?
when an individual or the lender deposits money in the bank and the business or borrower borrows the money. the borrower pays interest of say 10% - the bank receives 5% and the individual receives 5%
what are the 4 major areas of fianance
- personal finance 2. government finance 3. corporate finance 4. international finance
Describe life insurance and Pension claims
- make up a large part of household wealth - if the promises are made by a private co, this ability to fulfil them can be severely compromised if its own future is in doubt -therefore, pensions can be a major issue in salary and benefit negotiations
Describe the mortgage market
- shock to a financial system like a recession and job loss or collapse in house prices - can have a huge impact on the mortgage market and therefore the financial system as a whole
What are the key questions to ask regarding finance
- How does money flow from those who have it to those who want it 2. Who are the agents in the financial system 3. what types of securities are isused
Who is the primary contributor in Canada financial system to government and business
- household
what are financial intermediaries
transforms the nature of the securities they issue and invest in - facilitate exchange - balance the demands on its resources (match borrowers to lenders) - conduit
what does household include
personal and unincorporated businesses?
What are market intermediaries
- make the markets work better
What are the 4 main financial intermediaries in Canada
- Banks and other deposit taking institutions 2. insurance companies 3. pension funds 4. mutual funds
Which asset usually the most liquid asset?
Financial assets
Intermediaries: Canadian Chartered Banks, what do they do?
- Deposits from numerous depositors from across canada are “pooled” into banks
- pooled funds are lent to households and businesses in the fomr of mortgages and loans
- the bank transforms the original nature of the savers’ (depositros’) money:
1) Individual depositors save in small amount and want to face little or no risk, but expect to be able to withdrawl their deposit at any time
2) loans and mortgages are usually large in amount, borrowed for long periods fo time and for risky purpsoes, and may not always be repaid in full
Why can banks be th eintermediaries
banks can perorm this transformation function because they become experts at risk assessment, finanical contracting (pricing the risk) and monitoring hte acitivities of borrowers
Intermediaries: Insurance companies who are they and what do they do
- insurers sell policies and collect premiums from cusotmers based on the pricing of those policies given
1. the probability of a claim
2. size of the policy and
3. administrative fees - premiums are invested so that the accumualted value in the future will grow to meet the anticipated claims of hte policyholders
- allows househlds and businesses to take on more riks (in case something happens, we are insured)
What are Pension Plans
- individuals and employees make payments over thier entire working lives to pension plans, which invest those funds to grow over time
- the accumulated value of the pension can be used to fund retirement
- starts out small but accumulates
- individuals deposit funds into pension -> they funds pooled together and invested for the long term therefore can take on more risk, -> payout , possilby with restrictions(ie how much per year you can take out)
What are the funds in a pension plan often used for?
- they are a major source of capital, fuelling investment in
- research and development
- capital equipment
- resource exploration
ultimately contributes to the growth of the ecomony
What are Canadian Mutual Funds Assets
- give small investors access to diversified, professionally-managed portfolios of securities
- small investors often do not have the funds necessary to invest directly into makret-traded financial instruments (eg. stocks and bonds)
What is the process called for mutual funds
- the process is called denomination intermediation because the mutual fund divides investments denominated in larger amounts of fund into smaller more affordable amounts (eg. a $1 million treasury bill could be purchased in $10 units in a money- market fund)
- canadian indirect investmnt in the markets through managed products such as mutual funds and segregated funds has gorwn exponentially in recent years
who are the major borrowers
- public debt
- private debt
what is public debt
- government of canada (the federal government)
- provincial and territorial governments
- muicipaliies
- crown corporations
what is private debt?
- households
- non-finanical corporations
There are two major categories of finaical securities, what are they?
1. Debt Instruments
2. Equity instruments
What are debt instruments
- commerical paper
- bankers’ acceptances
- T-bills
- mortgage loans
- bonds
- debentures
What are equity instruments
- common shares
- preferred shares
What are non-marketable assets
- cannot be traded between or among investors
- may be redeemable (a reverse transaction between the borrower and the lender)
what are some examples of Non-makretable assets
- savings accounts
- term deposits
- guaranteed invstment certificates (GICS)
- Canada Savings Bonds
what is a term investment
set amount that you will receive at the end of the term (preset)
- you know what your return will be as you investment
- less risky for the investor
How are marketable securities categorized
according to their time to maturity
what are money market securities
- short-term debt securities that are pure discount notes and usually have maturities less than one year
ex.
1. bankers’ acceptances
2. commerical paper
3. t-bills
what are capital market securities
- long-term debt or equity securities with maturities gerater than one year
ex.
1. bonds
2. debentures
3. common and preferred shares
what are the two types of financial markets?
- Primary Market
2 Secondary Market
what is a primary market
- markets that involve the issue of new securiities by a company in exhance for cash from investors
What are secondary markets
- markets that involve buyers and sellers of exisiting securities
- funds flow form the buyer to the seller fo the seucities, and the buyer becomes the new owner of the security
- no new capital is formed
- it is only the exchange of already exisiting seucrities representing already formed capital
What are the types of secondary markets?
- Exchange or aution markets
- dealer or over the coungter (OTC) markets
what are exchange or auction markets
invovle a bidding process that takes place in a specific locaiton
- ex. TSX, NYSE
what are dealer or over-the-counter (OTC) markets
- do not have a physical location and consist of a network of dealers who trade directly with each other
- ex. bond market
what is market capitalization
- the total makret value of a company
- calcualted by multiplying the number of shares outstanding by the market price of each share:
market capitalization = #of shares x share price
What is the 3rd market
the trading of securities that are listed on organzied exhcanges in the over-the-counter (OTC) market
what is the fourth market
the trading of securities directly between investors (usually between two large instituitions) without the involvement of brokers or dealers
- opeartes through the use of privately owned automated systems sucha s instinet
How is the global financial community important
- represents an improtant source of funds for borrowers
- provides investors with improtant alternatives as they seek to build wealth through diversified portfolios
- money markets and bond markets are global
- doemstic equity makrets ar eincreasingly linked because of golbalizaiton and consolidaiton
- the correlation between markets is high, especially during a systemic downturn
What are financial assets
a claim that one individual or isnituition has on another
what are financial intermediaries
entities tha tinvest funds on behalf of others and change the nature of hte transactions
there are 2:
- market intermediaries (brokers)
- Financial intermediaries (banks)
what do financial intermediaries do
they transform the nature of the securities they issue and invest in
what do market intermediaries do
simply make the markets work better
what is intermediation
the transfer of fund from lenders to borrowers
what is a credit crunch
a situation in which financial intermediaries have to raise the cost of their loans by a significant amount due to their own inability to raise fianciang on reasonable terms.
what are crown corporations
grovernment -owned companies that provide goods and services needed by Canadians
what are debt instruments
legal obligations to repay borrowed funds at a specified maturity date and to provide interim interst payments
what are examples of debt instruments
- bank loans
- T-bills
- mortgage loans
- bonds
- debentures
what are equity instruments
ownership stakes in a company
what are some examples of equity instruments
- common shares
- preferred shares
what are common shares
equity instruments that represents part ownership in a company and usually gives voting rights on major decisions affecting the company
what are preferred shares
equity instruments tha tusually entitle the onwer to fixed dividend paymetns that must be made before any dividneds are paid to common shareholders
what are non-marketable finaincal assets
invested funds that are avaialable on demand in instruments tha are not tradable
ex. savings accounts
you can’t sell these funds to someone else without first withdrawling the funds and then transfer the cash
also Canada savings bonds
what are marketable financial assets
those assets that can be tradded amojng market particpants
ex. typically categorized by debt or equity but also by their temr to maturity
two types
- money makret seucurities (short term, less than one year)T-bills, commerical papers, BAs
- Cpaital market seucrities - (longer term debt greater than one yaer)
bonds, debentures, etc
what are primary markets
markets tha tinvovle the issue of new seucrities by the borrower in return for cash form investors (or lenders)
ex. when gov sells new issues of T-bills or bonds or when a comapny sells new common shares to the public
- new securities are created
primary markets are key to wealth creation process, because they enable money to be transferred to hose who can make best use of it in terms of develping new real assets such as factories and houses
they need secondary markets in order to function properly
what are secondary markets
provide trading (or market) enviorments tha tpermit investors to buy and sell existing securities
- critical to the funcitoning of primary markets because gov. and companies would not be able to raise financiang if investors were unable to sell their investments when necessary
what are exhanges or auction markets
secondary markets that involve a biddng process tha ttake splace in a specific locaiton
- investors (both buyers and sellsers) can be represented at these markets by brokers
what are Over-the-Counter (OTC) markets
secondary markets tha tdo not have a physical location and consist of a network of dealers who trade directly withh one another
- increasinlgy automated, reducing the amoutn of direct haggling between dealers
who are brokers
market intermediaries who facilitate the sale of financial securities and help to make the market work
What is the Toronto Stock Exchange
the major stock exchange in Canada, where most equity seucrities transactions take place, it is the official excahnge for trading canadaian senior securities
what is TSX Venture exchange
thje stock exchange for trading securities of emerging companies not listed on the TSX
what is the TSX markets
the group that performs trading operations for the TSX and the TSX Ventrue exchange
what is TMX Group Inc.
the company tha towns the TSX, the TSX Ventrue excahnge and the ME
what is bourse de montreal
the exchange that acts as the canadian national derivatives market and carries on all trading in finacial futures and options
what is OSC Ontario securities Commission
an agency created by the ontario govenrment to protect investors in securities transactions
wa tis Canadian Trading and Quation system in (CNQ)
an alternative market form small emerging comapnies
what is the third market
the trading of seucrities that are listed on organized exchagnes in the OTC market
- particularly important for “block trades” which are extermely large transactions invovling at least 10,000 shares or $100,000.
what is the fourth market
the trading of securities directly between investors wihtout the involvement of brokers or dealers
- trades are made directly between investors (usually large instutions)
- use privately owned auotmated systems
two most widely known systmes:
- instanet (insiutional network)owned by Reuters
- Alpha (owned by some of canada’s largest financial instiutions)
which stock exchange market is the largest in the world
New york stock exchanged (NYSE)
what are investments
decisions made by the invesotrs in financail seucriites
