Chapter 2


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Chapter 2

  1. 1. FINANCE IN A CANADIAN SETTING Sixth Canadian Edition Lusztig, Cleary, Schwab
  2. 2. <ul><li>CHAPTER TWO </li></ul><ul><li>The Canadian Financial Environment </li></ul>
  3. 3. Learning Objectives <ul><li>1. Describe the difference between surplus-spending units and deficit-spending units, and discuss how each contributes to the development of efficient financial markets. </li></ul><ul><li>2. Explain how financial intermediation operates in channelling funds between savers and users of funds. </li></ul>
  4. 4. Learning Objectives <ul><li>3. Describe the different functions of primary and secondary markets. </li></ul><ul><li>4. Discuss the difference between traditional stock exchanges and over-the-counter (OTC) markets using examples from Canada and the United States. </li></ul><ul><li>5. Identify some major stock indexes, and discuss their strengths and weaknesses. </li></ul>
  5. 5. The Role of Financial Assets <ul><li>Two types of assets: </li></ul><ul><li>Real assets – physical property such as land, buildings, inventories </li></ul><ul><li>Financial assets – paper claims entitling the holder to some future payment such as interest and principle on a debt certificate </li></ul>
  6. 6. Financial Assets <ul><li>Two categories of financial assets: </li></ul><ul><li>Debt – entails a contractual loan with the purchaser entitled to future interest and repayment of principle </li></ul><ul><li>Equity – the sale of ownership certificates in a firm </li></ul>
  7. 7. Financial Intermediaries <ul><li>Financial intermediaries create a system of indirect financing. </li></ul><ul><li>Sources of indirect capital </li></ul><ul><li>- Individuals </li></ul><ul><li>- Foreign investors </li></ul><ul><li>Governments have been net borrowers in recent years to fund their deficits </li></ul>
  8. 8. Financial Intermediaries <ul><li>The “four pillars” of Canada’s financial system include: </li></ul><ul><ul><li>Chartered banks </li></ul></ul><ul><ul><li>Trust companies </li></ul></ul><ul><ul><li>Insurance companies </li></ul></ul><ul><ul><li>Investment dealers </li></ul></ul>
  9. 9. Financial Markets <ul><li>Encompass the institutions and procedures involved in the buying and selling financial assets </li></ul><ul><li>Their main purpose is to efficiently match buyers and sellers </li></ul>
  10. 10. Primary Markets <ul><li>Primary market - where borrowers issue new securities in exchange for cash from investors </li></ul><ul><li>Selling of new securities is handled by investment dealers </li></ul><ul><li>Investment dealers act as intermediaries between buyers and sellers </li></ul>
  11. 11. Secondary Markets <ul><li>Secondary market - where existing securities trade </li></ul><ul><li>Secondary markets exist for: </li></ul><ul><li>T- Bills </li></ul><ul><li>Stocks </li></ul><ul><li>Bonds & debentures </li></ul><ul><li>Derivatives </li></ul>
  12. 12. Global Perspective <ul><li>Investment banks act as global coordinators linking separate underwriting syndicates globally in selling equity issues </li></ul><ul><li>Reasons for raising fund internationally include: </li></ul><ul><ul><li>The limited size of the Canadian market </li></ul></ul><ul><ul><li>Management of foreign exchange exposure </li></ul></ul><ul><ul><li>Interest rate differentials </li></ul></ul><ul><ul><li>Availability of private placements </li></ul></ul>
  13. 13. Money Market <ul><li>Dominated by financial institutions </li></ul><ul><li>Operates as a dealer or over-the-counter market (OTC) </li></ul><ul><li>Sold in denominations > $100,000 </li></ul><ul><li>Most recognized money market instrument are T-bills </li></ul><ul><li>T-bills are highly liquid and sold in 91, 182, 364 day maturities </li></ul><ul><li>Other money market instruments include commercial paper, Banker Acceptances, eurodollars </li></ul>
  14. 14. Debt Markets <ul><li>Bond markets represent the most important markets for intermediate and long-term debt </li></ul><ul><li>The bond market operates as OTC market </li></ul><ul><li>Other important debt markets include </li></ul><ul><li>Asset-backed Securities (ABS) </li></ul><ul><li>Mortgage-backed securities (MBS) </li></ul>
  15. 15. Equity Markets <ul><li>Common stocks, preferred stock and warrants trade in equity markets </li></ul><ul><li>Equity securities trade on stock exchanges </li></ul><ul><li>Stock exchanges operate as: </li></ul><ul><li>Auction markets (TSE, NYSE, CDNX, ME) </li></ul><ul><li>or </li></ul><ul><li>Over-the-counter (NASDAQ) </li></ul>
  16. 16. Other Markets <ul><li>Third market – an OTC market for trading securities listed on organized exchanges </li></ul><ul><li>Fourth Market – involves transactions made directly with large institutions by passing brokers and dealers </li></ul>
  17. 17. Derivatives Markets <ul><li>Derivative securities - derive the value from underlying assets such as common shares or bonds </li></ul><ul><li>Option - a contract that grants the holder the right to buy or sell a security at a given price on or before a given date </li></ul><ul><li>Future contracts - agreements to trade assets at a specific price and time in the future </li></ul><ul><li>Two types of futures: </li></ul><ul><li>Real commodities  commodity futures contract </li></ul><ul><li>Financial obligations  financial future contract </li></ul>
  18. 18. Derivative Markets <ul><li>Options trading occurs on: </li></ul><ul><li>Montreal exchange (ME) - Canada </li></ul><ul><li>Chicago Board Options Exchange (CBOT) - US </li></ul><ul><li>Option positions are issued and guaranteed by a clearing corporation: </li></ul><ul><li>Canadian Derivatives Clearing Corporation (CDCC) (Canada) </li></ul><ul><li>Options clearing corporation (OCC) (US) </li></ul>
  19. 19. Derivative Markets <ul><li>Canada’s only commodity exchange is the Winnipeg commodity exchange (WCE) </li></ul><ul><li>Major North American Commodity exchanges include: </li></ul><ul><li>Chicago Board of Trade (CBOT) </li></ul><ul><li>Chicago Mercantile Exchange (CME) </li></ul>
  20. 20. Stock Market Indicators <ul><li>Canadian indicators include: </li></ul><ul><li>TSE 300 </li></ul><ul><li>S & P TSE 60 </li></ul><ul><li>CDNX </li></ul><ul><li>International indicators include </li></ul><ul><li>Dow Jones Industrial Average (US) </li></ul><ul><li>S & P 500 Index (US) </li></ul><ul><li>Nasdaq Composite Index (US) </li></ul><ul><li>Nikkei 225 Average (Japan) </li></ul><ul><li>FTSE 100 Index (UK) </li></ul>
  21. 21. Summary <ul><li>1. Efficient financial markets are required to channel funds from surplus-spending units (savers) to deficit-spending units. Typically, such securities entitle the holder to a stream of periodic future cash payments. </li></ul><ul><li>2. Financial intermediaries allow economies of scale to be realized when matching surplus-spending units with deficit-spending units. Greater opportunities for portfolio diversification and money management can be gained. </li></ul>
  22. 22. Summary <ul><li>3. Financial markets encompass the institutions and procedures involved in the trading of financial assets. They include the money market (trading of short-term debt instruments) and the capital market (trading of long-term securities). The capital market can be subdivided further into the equity market and the bond market. </li></ul><ul><li>4. Equities are traded either on organized security exchanges, or on the over-the-counter market. </li></ul>
  23. 23. Summary <ul><li>5. The Toronto Stock Exchange (TSE) is the largest secondary market in Canada. The New York Stock Exchange (NYSE) is the world’s premier secondary market. </li></ul><ul><li>6. Canadian OTC trading takes place through the Canadian Venture Exchange (CDNX). Most OTC trading in the United States takes place on the Nasdaq Stock Market. </li></ul>
  24. 24. Summary <ul><li>7. The best-known market indicator in Canada is the TSE 300 Composite Index. The best-known stock market indicator in the United States is the Dow Jones Industrial Average (DJIA). </li></ul>