Chapter 1: The Capital Market Flashcards

1
Q

what is the vital function of financial markets

A

to help facilitate transfer of capital (money) from those who have extra wealth to those who require capital

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2
Q

how do financial markets drive economic growth

A

by turning savings into investments

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3
Q

why would those who have extra wealth/capital transfer it to those who require it

A

because they expect to make a return on it

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4
Q

what are the 3 components of the wealth transfer process

A
  1. financial instruments
  2. financial markets
  3. financial intermediaries
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5
Q

what are financial instruments

A
  • what is actually being bought/sold
  • mechanisms wealth/capital is transferred
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6
Q

what are financial markets

A

a marketplace where the buying/selling of financial instruments are facilitated

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7
Q

what exactly is capital

A

it is savings of:
- individuals (you and me)
- corporations
- governments

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8
Q

what are financial intermediaries

A

People and companies that improve market efficiency by facilitating the flow of capital from buyers to sellers

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9
Q

what are some points to note about capital

A
  • it is scarce and valuable
  • only economically significant when properly used
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10
Q

what are the types of investment

A
  • direct investment
  • indirect investment
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11
Q

what is direct investment

A

assets that generate wealth directly (ex. land, real estate, equipment) - something physically tangible

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12
Q

what is indirect investment

A

financial assets such as stocks, bonds, and treasury bills

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13
Q

what are stocks/shares/equity

A

ownership of a company/asset

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14
Q

what are bonds/fixed income

A

debt of a company or government (liability for those who issue it)

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15
Q

what are treasury bills

A

debt of a government

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16
Q

how does indirect investments work

A
  • companies and governments issue (sell) financial assets and receive funds
  • they then take the funds and invest them directly
  • investors are the ones who are buying the financial assets to generate a return (ex. expecting to make more than originally invested)
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17
Q

what are the characteristics of capital

A
  • mobile
  • scarce
  • sensitive
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18
Q

what is the affect of efficient allocation of capital

A

efficient allocation promotes economic growth

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19
Q

what is the affect of inefficient allocation of capital

A

inefficient allocation constrains economic growth

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20
Q

Where does capital tend to flow

A

capital is selective & tends to flow towards attractive economic environments

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21
Q

when will those who have capital transfer/invest their wealth

A
  • only if it is easy, cheap, and generates a good return
  • if it isn’t investors won’t provide capital
  • and people who need it (ex. the government) won’t receive it
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22
Q

what does capital flows depend on

A
  • the political environment (whether it is a stable government or a banana republic)
  • economic trends
  • fiscal policy (government spending & taxation)
  • monetary policy (government by central banks)
  • investment opportunities
  • labour force (highly educated/laws governing rights of labour force)
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23
Q

who finds the availability of capital important and what do they do

A
  • availability of capital is important to any nation
  • all countries try to promote economic output, improve productivity, encourage innovations, & improve competitive position
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24
Q

what are the sources of capital (who are those that provide capital)

A
  • retail investors
  • institutional investors
  • foreign investors
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25
Q

who are retail investors

A
  • individuals like you and me
  • those that invest for their own personal account
  • represent a significant source of investment capital in Canada
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26
Q

who are institutional investors

A
  • those that invest on behalf of another entity
  • are set up to serve those people
  • pension funds (Canada Pension Plan Investment Board; Ontario Teachers’)
  • Mutual funds (Trimark, AGF)
27
Q

what is a pension fund

A

a financial vehicle established by employers, employees, or both, to contribute and invest funds over time, with the goal of providing retirement benefits to employees

28
Q

what is a mutual fund

A

an investment vehicle that pools money from multiple investors to collectively invest in a diversified portfolio of stocks, bonds, or other securities, managed by a professional fund manager

29
Q

who are foreign investors

A
  • those that are not Canadian but invest in the Canadian market
  • can include foreign retail, institutional, and government investors
  • investments are made directly in Canadian firms or through stocks/bonds for Canadian firms listed on foreign exchanges
30
Q

who are users of capital

A
  • companies/businesses
  • governments
31
Q

who is not a user of capital

A
  • individuals
  • they only used money for consumption purposes
  • that is why they invest their capital
  • if they need capital, they will go to the bank for a loan
32
Q

how do companies raise capital

A
  • internally through existing operations and reinvest it into the company to grow
  • by issuing stocks/bonds and/or bank loans
33
Q

what do companies invest their capital in

A

new products/markets/machinery that they hope will grow the company more capital and general additional returns

34
Q

how do governments raise capital

A
  • by issuing debt
  • they usually face deficits & need to borrow money to finance their expenses so they issue debt
35
Q

what are the types of debt governments issue

A
  • treasury bills (t-bills)
  • longer term debt
  • Canadian Savings Bonds (only the federal & provincial governments issue these ones)
36
Q

what are treasury bills

A
  • debt due in less than one year
  • can be bought by foreign investors
37
Q

what is longer term debt

A
  • debt due in longer than one year
  • can be bought by foreign investors
38
Q

who can buy Canada savings bonds

A

only Canadian residents

39
Q

what do governments spend their capital on

A
  • all forms of government spending that aren’t covered by tax and other revenues
  • health care, education, infrastructure spending (roads, sewers, water)
40
Q

why don’t governments issue equity

A
  • equity = ownership
  • people should not own the government, so they can’t give out ownership
41
Q

what are the different types of financial instruments

A
  • debt
  • equity
  • investment funds
  • derivatives
  • private equity
42
Q

what is debt

A
  • funds are borrowed
  • at a specific date (maturity date) funds (principal) are paid back
  • between the borrowing date & the maturity date, interest payments are paid
  • ex. bank loans, bonds, mortgages
43
Q

what is equity

A
  • typically represented by stock/shares in a company
  • As an equity investor, you own part of the company
  • money is given and not paid back
  • At annual meetings, you have voting privileges
  • You may also receive regular dividend payments (but not necessarily)
  • preferred shareholders comes before common shareholders when receiving dividends
44
Q

what are derivatives

A
  • These products derive their value from another asset (stock, bond, commodity, currency)
  • Often used for hedging (ie. Mitigate the effect of a strong C$ or higher oil prices)
45
Q

what are investment funds

A
  • a pooled financial vehicle that gets capital from multiple investors to collectively invest in a diversified portfolio of securities, aiming to achieve specific investment objectives
  • usually done through a mutual fund
46
Q

what is private equity

A
  • Invest in both debt and equity
  • Typically investments are made directly in companies (not through purchases of stock or bonds)
  • Funds are provided by pension funds, endowments, wealthy individuals
47
Q

Why might authorities restrict who can invest funds in derivatives and private equity

A

because both are very risky

48
Q

where are financial instruments sold

A

in the financial markets

49
Q

when do financial instruments work well

A

only work well if they are accompanied by efficient markets

50
Q

what does it mean to be “efficient”

A
  • Fast (can I buy / sell a stock with minimal delay)
  • Cheap (low fees to buy / sell)
  • Liquid (are there many buyers and sellers)
51
Q

what financial instruments would be considered inefficient and efficient

A
  • Buying or selling a house may not be efficient
  • Buying or selling a stock or a bond should be
52
Q

what are the different types of financial markets

A
  • primary markets
  • secondary markets
53
Q

Do all of financial intermediary companies operate for the purposes of “market efficiency”?

A
  • no
  • may work in their self-interest
54
Q

what is the difference between the primary and secondary market

A

who gets the money

54
Q

what are primary markets

A
  • Securities (ie. shares or bonds) are sold by issuers for the first time
  • The issuer receives the money from this sale
  • It may be an IPO or a subsequent equity offering
  • money goes between investors and the company
54
Q

what are secondary markets

A
  • Where securities previously issued (above in the primary markets) are bought and sold
  • Note: funds do not go to the issuer
  • Example: 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 Bank)
  • money goes between investors
55
Q

what is an IPO

A
  • Initial public offering
  • The first time a company sells its shares to the public and its shares are listed on a stock exchange (i.e. Toronto Stock Exchange)
  • prior to the IPO, the company was private
  • investors couldn’t buy shares on stock exchanges, only private investors could buy their shares
55
Q

what are examples of financial intermediaries

A
  • Banks; Bank of Canada
  • Insurance companies
  • Pension funds
  • Investment dealers
  • Private equity / venture capital firms
55
Q

what did the financial crises reveal in terms of self-interest and market efficiency

A

The financial crises exposed areas where firms were working in their self-interest and also working against market efficiency / a productive economy

55
Q

what is an auction market

A
  • Where all transactions converge in one location
  • Like any other market where items are bought and sold
  • A stock exchange is an auction market where stocks are bought and sold
55
Q

what do governments do to help create market efficiency

A

they set up regulations are meant to be structured such that market efficiency is a by-product of this self-interest

55
Q

what are some facts about auction markets

A
  • at the start of 1999, there were 5 stock exchanges in Canada
  • then there was a complete overhaul in 1999 & 2000, leaving only 3 stock exchanges
  • In Canada: the main exchange is the TSX
  • TSX is the official exchange for trading Canadian senior stocks (big companies with sold history of profits)
  • 80 exchanges in over 60 countries
  • TSX is the 8th largest in the world; New York Stock Exchange is the largest
55
Q

How does a stock exchange make money

A
  • Transaction fees (if you buy or sell a stock – you pay a fee)
  • Initial listing fees (if a company conducts an IPO – they pay a fee)
  • Fees from companies making capital structure changes
  • Sale of historic data
55
Q

what are some trends in stock exchanges

A
  • Stock exchanges have largely transferred from physical locations to trading systems.
  • As a result, speed and cost efficiency are crucial
  • Stock exchanges around the world have been joining together (through mergers & acquisitions) to become “bigger and better”