Financial Markets

Question 1

Characteristics of Money (5)

Answer 1

Divisible: Money can be broken down into smaller parts (e.g., a dollar can be divided into 100 cents).

Portable: It’s easy to carry around (bills and coins)

Durable: It’s made to last (so you can use the same dollar for years)

Difficult to Counterfeit: It’s hard to make fake money, which helps keep the system fair

Stable Value: Money should keep its value, so it’s worth the same tomorrow as it is today.

Question 2

Functions of Money (3)

Answer 2

Medium of Exchange: We use money to buy and sell things without having to trade goods directly (like trading apples for shoes)

Measure of Value: Money helps us understand the value of items (e.g., $1 buys one candy, but $20 buys a pizza)

Store of Value: Money can be saved to use in the future.

Question 3

How Interest Rates Are Set

Answer 3

The central bank (like the Bank of Canada) decides the overnight rate eight times a year

This is the base rate that affects all other rates

Question 4

Prime Rate

Answer 4

The prime rate is the interest rate banks give to their best customers (people or businesses with excellent credit)

Question 5

How does the prime rate work?

Answer 5

The prime rate is based on the central bank’s key rate. Banks add a bit to this rate and offer it to trusted customers. If you have good credit, you might get a loan at the prime rate or a little higher.

Example: Let’s say the prime rate is 4%. A customer with great credit might get a loan at 4%, while someone with fair credit might get “prime plus one,” meaning they pay 5%.

Question 6

Role of Households In the financial system (explain why, 3 points)

Answer 6

households are the primary source of funds for businesses and the government.

Households save money in various ways through savings accounts, investments, pension plans, or other financial products.

Must accumulate financial resources throughout their working
life times to have enough savings (pension) to live on in their
retirement years

Question 7

Financial intermediaries definition and examples (4)

Answer 7

Definition: they transform household savings into useful investments. They pool together the funds from many households and use it to fund businesses, government projects, or other loans

Examples: Banks and credit unions, insurance firms, mutual funds

Question 8

Market intermediaries and give and example

Answer 8

Market intermediaries are people or organizations that help make financial markets function smoothly. They don’t directly lend or borrow money but help buyers and sellers of financial products (like stocks, bonds, or real estate) connect with each other.

Example: Brokers

Question 9

Brokers

Answer 9

Brokers are a specific type of market intermediary. They act as the “middleman” between buyers and sellers of financial products. Their job is to help people buy or sell stocks, bonds, or other financial assets.

When you want to buy or sell stocks, you go to a broker. The broker doesn’t own the stocks but helps you find someone willing to sell them or buy them from you.

Question 10

Two main reasons of regulation

Answer 10

1- increase Information to Investors
Regulations require companies and financial institutions to provide accurate and clear information to the public. This ensures that investors know the risks and rewards involved.

2- Ensuring the Soundness of Financial Intermediaries
Keeps financial institutions (like banks, credit unions, and insurance companies) stable and secure. By setting rules for these institutions, regulators reduce the risk of financial crises or panics.

If banks or other financial intermediaries take too many risks, they could fail. When that happens, people could lose their money or trust in the financial system, leading to larger economic problems.

Question 11

Canadian Chartered Banks

Answer 11

These are Canada’s big, well-established banks that follow strict government rules.

Question 12

What established the first national bank and what is it?

Answer 12

The Bank Act of 1935: a key piece of Canadian legislation that laid the foundation for Canada’s national banking system. It established rules and standards for how banks in Canada operate.

Question 13

Canada Deposit Insurance Corporation (CDIC)

Answer 13

This insurance protects people’s deposits in Canadian banks up to a certain limit

If a bank fails, the CDIC makes sure people don’t lose their money up to this insured amount

This protection helps build public confidence in the banking system.

Question 14

What is the insurance that protects people’s deposits in Canadian banks up to a certain limit

Answer 14

Canada Deposit Insurance Corporation (CDIC)

Question 15

The Big Six national banks

Answer 15

Royal Bank of Canada (RBC)
Toronto-Dominion Bank (TD)
Scotiabank
Bank of Montreal (BMO)
Canadian Imperial Bank of Commerce (CIBC)
National Bank of Canada

Question 16

What do insurance companies do?

Answer 16

Insurance companies help people and businesses manage big, unpredictable risks (like accidents, health issues, or property damage) by pooling money from many customers.

Question 17

Explain Policies and Premiums

Answer 17

Policies: An insurance policy is a contract you buy from an insurance company. It promises that, if certain events happen (like a car accident), the insurance company will help cover the costs

Premiums: The premium is the regular payment (usually monthly or annually) you make to keep the insurance policy active.

Question 18

How Premiums Are Determined (2)

Answer 18

The probability of a claim (how likely it is that the event will happen) and the size of the policy (how much coverage it provides)

Administrative Fees are also included to cover the cost of running the insurance company.

Question 19

Investing Premiums for Future Claims

Answer 19

Insurance companies don’t just keep the premiums in a vault. They invest this money to make it grow over time. By investing in things like stocks, bonds, and other financial assets, they build up a large fund

Purpose of Investments: The goal is to ensure that there’s enough money in the future to cover all the claims they might receive

Question 20

Insurance companies enable risky activities

Answer 20

Insurance allows households, businesses, and even the government to take on activities that might be risky, knowing that they have financial protection if something goes wrong.

Question 21

What are pension plans

Answer 21

Pension plans are a way for people to save for retirement. They gather money over time, which grows so people have enough to live on when they’re older

Individuals and employers make payments over the entire working
life of a person with those funds invested to grow over time.

Question 22

Investment of Pension Funds

Answer 22

Pension plans don’t just let the money sit idly. Instead, pension managers invest these funds to help them grow

Question 23

ETF (Exchange-Traded Fund) characteristics (4)

Answer 23

a big basket that holds many different investments, like stocks or bonds (when you buy a share of an ETF, you’re buying a tiny piece of all the investments in that basket)

ETFs are bought and sold on the stock market, just like a regular stock. You can buy or sell them any time the stock market is open, and the price changes throughout the day.

Many ETFs are passive, which means they don’t try to pick winning stocks or time the market. Instead, they simply follow a specific index, like the S&P 500, and try to match its performance.

Since ETFs are passively managed and don’t need a team to pick stocks, they usually have low fees.

Question 24

Common Stock

Answer 24

Common stock is the most basic form of ownership in a company. When you buy common stock, you’re essentially buying a small piece of that company

Question 25

Key features of common stock (5)

Answer 25

• Voting Rights: As a common stockholder, you have the right to vote on major company decisions, like choosing members of the board of directors.
• Right to Dividends: dividends are payments made to shareholders when the company makes a profit.
• Capital Gains: capital gains happen when you sell your stock for more than you paid for it. You make a profit if the stock’s value has gone up, but you can also experience capital losses if the stock price goes down.
• Pre-Emptive Rights: if the company decides to issue new shares, stockholders will be notified before the public so they’ll get the first opportunity to buy them
• Residual Claim on Assets: If a company goes bankrupt and sells all its assets to pay off debts, common stockholders are entitled to any remaining funds, but only after all other debts

Question 26

Preferred Stock

Answer 26

Preferred stockholders have certain advantages, especially when it comes to dividends and claims on assets, but they don’t have voting rights.

Question 27

Preferred stock key characteristics (4)

Answer 27

Higher Dividends: Preferred stockholders typically receive higher dividend payments than common stockholders.

Better Claim on Assets: If a company goes bankrupt, preferred stockholders get paid before common stockholders. However, they still get paid after creditors (like banks or bondholders).

Cumulative Preferred Stock: Some preferred stocks are “cumulative,” meaning that if the company misses a dividend payment, it still owes that payment to preferred stockholders and must make up for it before paying common stockholders.

No Voting Rights: Unlike common stockholders, preferred stockholders generally don’t have the right to vote on company matters.

Question 28

Key terms of bonds (4)

Answer 28

Maturity Date: This is the date when the bond’s term ends, and the issuer must pay back the face value (also called par value) to the bondholder.

Par Value: Par value is the amount the bond issuer agrees to pay back when the bond reaches its maturity date.

Coupon rate: The coupon rate is the interest rate on the bond. It’s expressed as a percentage of the par value.

Current Yield: The current yield shows how much income you’re making on the bond, based on its current market price.

Question 29

Bond ratings

Answer 29

Bond ratings are scores assigned by rating agencies that evaluate the financial stability of the bond issuer

Question 30

Bond risks

Answer 30

If a bond issuer (like a company) is riskier and there’s a chance they might struggle to pay you back, they offer a higher interest rate to make up for the risk. This higher rate is like an “extra reward” for taking the chance that you might not get paid back in full.

Question 31

Treasury bills (T-Bills)

Answer 31

Treasury bills, or T-bills, are short-term loans that you give to the government. In return, the government promises to pay you back the full amount after a short period (less than a year), along with some profit.

You buy the T-bill at a discounted price, which means you pay less than its full value. Then, when the T-bill “matures” (or ends), the government pays you back the full value (face value)

Question 32

Security market

Answer 32

The securities market is where people buy and sell “securities

Question 33

Types of Markets in the Securities Market (2)

Answer 33

Primary Market: This is where new shares of a company are first sold to the public. When a company goes public (often through an Initial Public Offering, or IPO), it’s selling shares for the very first time in the primary market

Secondary Market: this is where shares are bought and sold among investors after they’ve been initially sold in the primary market. The secondary market includes major stock exchanges like the Toronto Stock Exchange (TSX) in Canada and the New York Stock Exchange (NYSE) in the U.S

Question 34

The largest securities exchange

Answer 34

Toronto Stock Exchange (TSX)

Question 35

Market Capitalization

Answer 35

Market capitalization, or “market cap,” is the total value of all a company’s shares combined. It’s calculated by multiplying the number of shares by the current share price.

Question 36

Types of Brokers in the Securities Market (2)

Answer 36

Brokers are experts who help people buy and sell securities

Full-Service Broker: These brokers offer a lot of services beyond just buying and selling, including financial advice, investment planning, and research.

Discount Broker: Discount brokers only handle transactions and don’t offer much advice or planning. They’re typically cheaper than full-service brokers.

Question 37

Types of Orders in the Securities Market (5)

Answer 37

When you tell a broker to buy or sell a stock, you give them an order. There are different types of orders based on your instructions.

Market Order: Tells the broker to buy or sell at the best price available right now.

Limit Order: Specifies the highest price you’re willing to pay (when buying) or the lowest price at which you’re willing to sell.

Stop Order: Instructs the broker to sell if the stock’s price falls to a certain point. This helps prevent further losses.

Open Order: This type of order remains open until you cancel it, meaning it stays active for a long period.

Day Order: This order is only valid on the day it’s placed and expires if it’s not executed by the end of the day.

Question 38

Margin Trading

Answer 38

When you borrow money from your broker to buy more stock than you could afford with just your own cash

Question 39

Short Selling

Answer 39

Short selling is a strategy where you borrow stock from a broker and sell it, hoping the price will fall so you can buy it back later at a lower price. After buying it back, you return the borrowed stock to the broker, keeping the price difference as profit.

Question 40

Fundamental Finance View (2 factors)

Answer 40

This approach is based on the idea that a stock’s price reflects the actual financial health and performance of a company. If a company is doing well financially, its stock price should go up. If it’s struggling, the stock price might go down.

Key Factors in Fundamental Analysis:
Profits: Companies that make a lot of money (profits) are likely to have higher stock prices.
Market Power: If a company has a strong position in its market (like Apple in tech), it can often set higher prices, leading to more profits and a higher stock price.
.

Question 41

Behavioral Finance Perspective (4 factors)

Answer 41

This approach focuses on investor psychology and emotions, which can drive stock prices up or down regardless of a company’s actual financial health.

Key Concepts in Behavioral Finance:
Irrational Exuberance: Sometimes, investors get overly excited about certain stocks or markets, driving prices up without any solid financial reason. This can create a “bubble,” where stock prices are much higher than they should be.

Pessimism: The opposite can happen when investors become too negative. If everyone believes the market will drop, stock prices might fall as people sell off their shares out of fear.

“Beauty Contest” Effect: This idea comes from a concept where investors guess which stocks others find attractive rather than focusing on the stock’s real value. It leads people to buy what others are buying, even if it doesn’t make sense financially.

Following the Herd: When people buy stocks just because others are buying them, it creates a “herd mentality.” This can push prices up or down based on trends or fads rather than actual performance.

Question 42

Technical analysis

Answer 42

Technical analysis is based on analyzing stock price patterns and trading volume to predict future price movements. It doesn’t focus on the company’s financial health but rather on trends in the stock’s trading data.

Question 43

The Great Recession

Answer 43

The Great Recession was caused by risky decisions made by banks and financial firms, focusing on short-term profits instead of long-term stability. Many investment banks, which traditionally just helped clients buy stocks and bonds, started investing their own money in risky assets. To make quick profits, they took on high levels of debt (leverage), sometimes borrowing up to 30 times their own money. This meant even small losses could be devastating. At the same time, banks were lending to people with poor credit, giving them subprime mortgages (home loans), which were risky because many of these borrowers struggled to pay back their loans. Banks then bundled these risky loans into complex investments called mortgage-backed securities and sold them as if they were safe, even though they weren’t. When people started defaulting on their mortgages, these securities lost their value, causing massive losses for banks and investors. Since there was little government oversight and regulation to prevent such risky practices, the financial system spiraled into a crisis, leading to widespread economic hardship.