Chapter 1 - The Capital Market Flashcards
What is the vital function of financial markets?
to facilitate the transfer of capital
what is the transfer of capital?
Those who have extra wealth (SAVED money) –> those who require capital (want to INVEST money)
Why would those who have extra wealth/capital transfer it to those who require it?
People want a RETURN on their investment
3 Components of the transfer process
- Financial institutions (what is actually bought/sold)
- Financial markets (facilitate buying/selling of #1)
- Financial intermediaries (people/companies involved with #1 & #2)
what is capital?
capital = money
bought and sold
Savings of:
Individuals (you and me)
Corporations
Governments
How is capital utilized/transferred/invested?
Direct Investment – assets that generate wealth (land, real estate, equipment)
Indirect Investment -
Financial assets
>Stocks (ownership of a company)
>Bonds (debt of a company or government)
>Treasury bills (debt of a government)
How does investments benefit companies / governments and investors
Companies and governments ISSUE these financial assets and receive funds
They then take the funds and invest the funds directly
Investors buy these financial assets to generate a return (make more money than originally invested)
what does capital flows depend on?
> Political environment (stable government or banana republic?)
Economic trends
Fiscal policy (government spending and taxation)
Monetary policy (government by central banks)
Investment opportunities
Labor force (highly educated / laws governing rights of labor force)
what are the sources of capital?
Retail investors – individuals like you and me
Institution investors:
>Pension funds (Canada Pension Plan Investment Board; Ontario Teachers’)
>Mutual Funds (Trimark, AGF)
Foreign Investors
>Can include foreign retail, institutional, and government investors
>Investments are made directly in Canadian firms or though stocks/bonds for Canadian firms listed on foreign exchanges
who are the users of capital?
Companies / businesses:
>Earn internally through existing operations and reinvest that money
Ex. Apple with its huge piles of cash can reinvest to create new innovative products
> Raise money by issuing stocks / bonds
Ex. Facebook selling stocks
What do they invest these funds in?
New products / markets / machinery that they hope will grow the company more and generate additional returns
Governments (federal, provincial, municipal) issue debt:
How does the government earn capital?
>Treasury bills (debt due in less than one year) Matures in less than one year Paid back in 1 year
>Longer term debt
>Canada Savings Bonds (federal / provincial governments only)
What do they spend these funds on?
>All forms of government spending that aren’t covered by tax and other revenues
>Health care, education, infrastructure spending (roads, sewers, water)
why don’t governments issue equity
Equity is basically buying a portion of a company
You cannot buy a portion of the government
Thus they only issue bonds
Debt vs Equity
Debt
>Funds are borrowed
>At a specific date (“maturity date”) these funds are paid back
>Between the borrowing date and the maturity date, interest payments are paid
Equity
>Typically represented by stock / shares in a company
>As an equity investor, you own part of the company
>At annual meetings, you have voting privileges
>You may also receive regular dividend payments (but not necessarily)
What are the other roles of financial institutions?
investment funds - buys and sells stocks / bonds (typically through mutual fund)
mutual fund - let you pool your money with other investors to “mutually” buy stocks, bonds, and other investments
Derivatives - products that derive their value from another asset
private equity - investments directly made to companies (pension funds, endowments, wealthy individuals)
why might authorities restrict who can invest funds in derivatives and private equity?
Derivatives and private equity are generally more riskier
Thus restrictions are needed to prevent significant destruction
what does EFFICIENT mean in a financial market?
Fast (can I buy / sell a stock with minimal delay)
Cheap (low fees to buy / sell)
Liquid (are there many buyers and sellers)
