unit 1 | the capital market Flashcards
what is the capital market?
help facilitate transfer of capital
what is capital?
money that is bought & sold
3 components of wealth transfer process:
- financial instruments (what is actually bought & sold)
- financial markets (facilitate buying/selling of #1)
- financial intermediaries (people & companies involved with #1 & #2)
who are the suppliers of investment capital?
savings of individuals, corporations & government
how is capital utilized/transferred/invested?
direct and indirect investment
define direct investment
investing in asset that generates wealth (land, real estate, equipment)
financial assets involved with indirect investment:
- stocks/shares/equity (ownership of a company)
- bonds/fixed income (debt of a company)
- treasury bills (debt of a government)
define indirect investment
companies & governments issue financial assets & receive funds, which are invested directly
investors buy these financial assets to generate a return
describe the concept of efficient allocation of capital
capital is mobile, scarce, and sensitive, so people will only transfer/invest if it is easy, cheap, and generates a good return
what factors can capital flow depend on?
- 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)
sources of capital
- retail investors (individuals)
- institutional investors (pension funds - canada pension plan investment board, ontario teachers | mutual funds - trimark, AGF)
- foreign investors (foreign retail, institutional, and government investors)
how does foreign investors transfer capital?
investments are made directly in canadian firms or through stocks/bonds for canadian firms listed on foreign exchanges
who are the users of capital?
- individuals don’t (if needed will go to bank for loan)
- 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) - Governments (federal, provincial, municipal) issue debt
— Treasury bill (debt due in less than 1 year)
— Longer term debt
— Canada Savings Bonds (federal/provincial only)
what are funds that companies receive invested in?
new products/markets/machinery that they hope will grow the company more & generate additional returns
define bonds
company getting loaned money to invest in operations (need to pay back)
define fixed income
investment with fixed interest/dividend payment until maturity date (ex. pension) company to investors
what are funds that governments receive invested in?
- All forms of government spending that aren’t covered by tax & other revenues
- Healthcare, education, infrastructure spending (roads, sewers, water)
define debt as a financial instrument
- 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
define equity as a financial instrument
- Typically represented by stock/shares in a company
- Claims partial ownership of company
- Voting privileges
- Receive regular dividend payments (but not necessarily)
Investment Funds
Buys & sells stocks/bonds → typically through a mutual fund
Derivatives
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)
Private Equity
- 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
why are financial markets necessary?
Financial instruments only work well if accompanied by efficient markets
define “efficient”
- Fast (can a stock be sold/bought with minimal delay)
- Cheap (low fees to buy/sell)
- Liquid (are there many buyers & sellers)
Primary markets
- 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
Secondary markets
(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)
Financial Intermediaries
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
examples of Financial Intermediaries
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”)
Initial Public Offering
First time a company sells its shares to the public & its shares are listed on a stock exchange (TSX)
why do financial crisis occur?
The financial crises exposed areas where firms were working in self-interest & also working against market efficiency/a productive economy
Auction Markets
- Where items are bought & sold (Ex. stock exchange)
- Where all transactions converge in one location (80 exchanges in 60+ countries)
How does a stock exchange make money
- 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
Stock exchange trends
- 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”
what does being efficient mean to corporations stating their future?
cutting cost to generate profit
