unit 1 | the capital market

Question 1

what is the capital market?

Answer 1

help facilitate transfer of capital

Question 2

what is capital?

Answer 2

money that is bought & sold

Question 3

3 components of wealth transfer process:

Answer 3

1. financial instruments (what is actually bought & sold)
2. financial markets (facilitate buying/selling of #1)
3. financial intermediaries (people & companies involved with #1 & #2)

Question 4

who are the suppliers of investment capital?

Answer 4

savings of individuals, corporations & government

Question 5

how is capital utilized/transferred/invested?

Answer 5

direct and indirect investment

Question 6

define direct investment

Answer 6

investing in asset that generates wealth (land, real estate, equipment)

Question 7

financial assets involved with indirect investment:

Answer 7

• stocks/shares/equity (ownership of a company)
• bonds/fixed income (debt of a company)
• treasury bills (debt of a government)

Question 8

define indirect investment

Answer 8

companies & governments issue financial assets & receive funds, which are invested directly

investors buy these financial assets to generate a return

Question 9

describe the concept of efficient allocation of capital

Answer 9

capital is mobile, scarce, and sensitive, so people will only transfer/invest if it is easy, cheap, and generates a good return

Question 10

what factors can capital flow depend on?

Answer 10

• political environment (stable government or 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)

Question 11

sources of capital

Answer 11

1. retail investors (individuals)
2. institutional investors (pension funds - canada pension plan investment board, ontario teachers | mutual funds - trimark, AGF)
3. foreign investors (foreign retail, institutional, and government investors)

Question 12

how does foreign investors transfer capital?

Answer 12

investments are made directly in canadian firms or through stocks/bonds for canadian firms listed on foreign exchanges

Question 13

who are the users of capital?

Answer 13

1. individuals don’t (if needed will go to bank for loan)
2. companies/businesses
   — earn money internally through existing operations & reinvest the money
   — raise money by issuing stocks/bonds (to generate high return to invest back into operations)
3. Governments (federal, provincial, municipal) issue debt
   — Treasury bill (debt due in less than 1 year)
   — Longer term debt
   — Canada Savings Bonds (federal/provincial only)

Question 14

what are funds that companies receive invested in?

Answer 14

new products/markets/machinery that they hope will grow the company more & generate additional returns

Question 15

define bonds

Answer 15

company getting loaned money to invest in operations (need to pay back)

Question 16

define fixed income

Answer 16

investment with fixed interest/dividend payment until maturity date (ex. pension) company to investors

Question 17

what are funds that governments receive invested in?

Answer 17

• All forms of government spending that aren’t covered by tax & other revenues
• Healthcare, education, infrastructure spending (roads, sewers, water)

Question 18

define debt as a financial instrument

Answer 18

• Funds are borrowed
• At a specific date (maturity date) these funds are paid back
• Between the borrowing date & the maturity date, interest payments are made

Question 19

define equity as a financial instrument

Answer 19

• Typically represented by stock/shares in a company
• Claims partial ownership of company
• Voting privileges
• Receive regular dividend payments (but not necessarily)

Question 20

Investment Funds

Answer 20

Buys & sells stocks/bonds → typically through a mutual fund

Question 21

Derivatives

Answer 21

These products derive their value from another asset (stock, bond, commodity, currency)
- The option price to buy TD Bank stock will fluctuate up & down
Often used for hedging (ie. mitigate the effect of a strong C$ or higher oil prices)

Question 22

Private Equity

Answer 22

• Invest in both debt & equity
• Investments made directly in companies (not through purchases of stock/bonds)
• Funds are provided by pension funds, endowments, wealthy individuals

Question 23

why are financial markets necessary?

Answer 23

Financial instruments only work well if accompanied by efficient markets

Question 24

define “efficient”

Answer 24

• Fast (can a stock be sold/bought with minimal delay)
• Cheap (low fees to buy/sell)
• Liquid (are there many buyers & sellers)

Question 25

Primary markets

Answer 25

- Securities (shares or bonds) are sold by issuers for the first time - The issuer receives money from this sale - May be IPO or subsequent equity offering

Question 26

Secondary markets

Answer 26

(most financial instruments are sold and bought here) - Securities previously issued (in primary markets) are bought & sold - Note: fund does not go to issuer Ex: 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)

Question 27

Financial Intermediaries

Answer 27

People & companies that improve market efficiency by facilitating the flow of capital from buyers to sellers - Financial intermediaries may work in self interest - Regulations are structured such that market efficiency is a by-product of this self-interest

Question 27

examples of Financial Intermediaries

Answer 27

Bank of Canada Banks Insurance companies Pension funds Investment dealers Private equity/Venture capital firms (Not all of these companies operate for the purpose of “market efficiency”)

Question 27

Initial Public Offering

Answer 27

First time a company sells its shares to the public & its shares are listed on a stock exchange (TSX)

Question 28

why do financial crisis occur?

Answer 28

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

Question 28

Auction Markets

Answer 28

- Where items are bought & sold (Ex. stock exchange) - Where all transactions converge in one location (80 exchanges in 60+ countries)

Question 29

How does a stock exchange make money

Answer 29

- 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

Question 30

Stock exchange trends

Answer 30

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

Question 31

what does being efficient mean to corporations stating their future?

Answer 31

cutting cost to generate profit