The Capital Market Flashcards
Investment Capital:
Define capital, the difference between real and representational capital, and its relevance to indirect investments:
- Capital is synonymous with wealth, both real (i.e., land, buildings, and other material goods) and representational (i.e., money, stocks, and bonds). All of these items have economic value that represents the invested savings of individuals, corporations, governments, and other organizations. Representational capital becomes more significant when it is harnessed productively, through either direct or indirect investment.
- The indirect investment process, where investors purchase representational items such as stocks or bonds, is the principal focus of this course. Indirect investment occurs when a person or entity with accumulated savings buys the securities issued by a government or corporation, which in turn invests the funds it receives directly for a productive purpose.
Capital has three important characteristics: mobility, sensitivity to environment, and scarcity. Explain:
- Capital has three important characteristics: mobility, sensitivity to its environment, and scarcity. These characteristics allow capital to be selective about where it settles, which is usually countries or locations where favourable conditions exist.
- Because capital is limited in quantity and considered scarce, it is in great demand everywhere in the world. And because it is mobile and sensitive, it moves in or out of countries or localities in anticipation of changes to taxation, exchange rates, trade barriers, regulations, and government attitudes.
The suppliers and users of capital:
Summarize the table that shows the 3 sources of capital and 3 users of capital, along with the role they serve.
Sources of Capital:
Retail Investors: Retail investors are individual clients who buy and sell securities for their personal accounts.
Institutional investors: Institutional investors are organizations, such as pension and mutual fund companies, that trade in large-share quantities or dollar amounts. They typically have a steady flow of money to invest.
Foreign investors: Foreign direct investment in Canada tends to concentrate in manufacturing, petroleum, natural gas, mining, and smelting. Some industries have restrictions on foreign investment.
Users of Capital:
Individuals: Individuals need capital to finance large purchases such as houses, cars, and major appliances. They usually obtain it in the form of personal loans, mortgage loans, and charge accounts
Businesses: Businesses require massive sums of capital to finance day-to-day operations, renew and maintain plants and equipment, and expand and diversify their activities. They generate much of that capital internally, in the form of profits retained in the business. They borrow from financial intermediaries for other needs, and they raise the remainder in securities markets
Governments: Governments are major issuers of securities in public markets, either directly or through guaranteeing the debt of their Crown corporations. When revenues fail to meet expenditures, or when they undertake large capital projects, governments must borrow
Financial Instruments:
What are financial instruments in the form of securities and what advantages do they offer?
- Financial instruments in the form of securities are formal, legal documents that set out the rights and obligations of the buyers (capital suppliers) and sellers (capital users) of the securities. As such, these instruments have many advantages as a means of distributing capital in a sophisticated economy. They tend to have standard features, which facilitates their trading. Both suppliers and users of capital can also choose from many types of securities to meet their particular needs.
Summarize the table with 5 financial instruments, provide a definition, and an example:
Fixed-income securities Fixed-income securities (also called debt securities) formalize a relationship in which the issuer promises to repay the loan at maturity and, in the interim, makes interest payments to the investor. The term of the loan varies depending on the type of instrument. * Treasury bills
* Bonds
Equity services Equity securities (commonly called stocks, equities, or shares) represent some form of ownership stake in the company that issued them. For example, if the value of a company increases, the owner of stock in that company receives a capital gain upon selling it. * Common Stock
* Preferred shares
Derivatives A derivative is a product whose value is derived from the value of an underlying instrument, such as a stock or an index. Unlike stocks and bonds, derivatives are more suited to sophisticated investors. * Options
* Forwards
Managed products Managed products (also called investment funds) are typically pools of capital gathered from investors to buy securities according to a specific investment mandate. * Mutual funds
* Exchange-traded funds
* Private equity funds
Structured products A structured product is a financially engineered product with the characteristics of debt, equity, and an investment fund. * Principal-protected notes
* Index-linked guaranteed investment certificates
Financial Markets:
We now focus our discussion on the financial markets where people come together to complete their financial transactions. A financial market provides a forum in which buyers and sellers meet. Markets can also be categorized as primary markets and secondary markets, and further as auction markets and dealer markets. We will now discuss all of these different types of markets
Primary versus secondary markets?
- Primary markets: This is where new securities (such as stocks or bonds) are issued for the first time. The key here is that new shares or bonds are created and sold to investors. The advice and pricing in the primary market are influenced by current conditions in the secondary market, meaning that the prices and features of new issues reflect what is happening in the market where previously issued securities are traded.
- Secondary markets: Once securities have been issued in the primary market, they are traded in the secondary market. This is where investors buy and sell securities that are already in circulation. The liquidity in the secondary market is important because it ensures that investors can sell their holdings if they choose to. This liquidity also supports the primary market by making investors more confident in buying new securities, knowing they can sell them later without difficulty.
Define auction markets and provide the example of an exchange of being a type of auction market:
- Auction markets are platforms where individual investors submit orders (bids from buyers and offers from sellers) into a single, centralized marketplace. Buyers’ bids and sellers’ offers are matched.
o Bid-Ask Spread: Between trades, the best bid (highest price offered by buyers) is lower than the best ask (lowest price offered by sellers); the difference is called the bid-ask spread. - A stock exchange is a specific type of auction market where the matching of bids and offers determines prices, reflecting supply and demand. In Canada: Common and preferred shares, rights and warrants, exchange-traded funds, income trusts, and some convertible debentures are traded on Canadian stock exchanges (such as the Toronto Stock Exchange). In Other Jurisdictions (e.g., U.S. and Europe): In addition to equities, bonds and debentures may also be traded.
Define and explain dealer markets (or over the counter markets) and how trading works in this market:
- Dealer markets are less centralized than auction markets. Instead of a central platform, trading occurs through a network of banks and investment dealers.
- Market Makers: Dealers in these markets, known as market makers, post their own bid and ask quotations electronically using various computer networks.
- They typically trade from their own inventories (acting as principals), rather than merely matching orders for clients.
- Securities Traded: Almost all bonds and debentures are traded through dealer markets. Despite the lesser visibility of these markets compared to equity exchanges, the trading volume (in dollars) is significantly larger for debt securities.
