Chapter 1- The Capital Market

Institutional Investors

Organizations that trade large volumes of securities and typically have a steady flow of money to invest. Include pension fund or mutual fund companies.

Country Risk evaluation analyzes such things as:

Political Environment -Whether the country is involved or likely to be involved in internal or external conflict. Economic Trends -Growth in gross domestic product, inflation rate, levels of economic activity, etc. Fiscal Policy -Levels of taxes and government spending, and the degree to which the government encourages savings and investment. Monetary Policy -The sound management of the growth of the nation's money supply and the extent to which it promotes price and foreign policy exchange stability. Investment Opportunities -Opportunities for investment and satisfactory returns on investment when considering the risks to be accepted. Characteristics of the Labour Force -Whether it is skilled and productive

Alternative Trading Systems (ATS)

Privately owned computerized trading facilities that match buy and sell orders for securities traded outside of recognized exchanges. Compete with the exchanges because brokerage firms operating ATFs can match orders directly form its own inventory, or act as an agent in bringing buyers and sellers together. One less intermediary, so more of the commission charged to the client is kept by the dealer. Commonly used by institutional investors, who can reduce transaction costs considerably and avoid the market impact of trading on exchanges. ATSs have the potential to threaten market stability due to lessened market transparency, cross-border trading issues and technological glitches.

Derivatives

Products based on or derived from an underlying instrument, such as a stock or index- most common are options and forwards.

Direct Investments

Real assets, for example the purchase of a home or government stimulus spending.

Businesses

Require massive amounts of capital to finance day-to-day operations, invest in capX, and grow. Can be funded internally, by financial intermediaries, or through securities markets (short-term money market, medium/long term debt, preferred/common shares)

Dealer Markets*

Second type of market which consists of a network of dealers who trade with each other- only their bid and ask quotations are entered by those dealers acting as market makers in a particular security.

Individuals

May require financing for housing, consumer durables (cars) etc.- usually obtain it in the form of a personal loan, mortgages or charge accounts because they are not large enough to issue securities. Foreign individuals may also obtain capital from Canadian banks if they believe they can access the capital at a less expensive rate than their own currency.

The Unlisted Equity Market*

Much smaller than the volume of stock exchange transactions- many junior issues trade OTC, as well as a few conservative industrial companies. Many of the stocks sold on the unlisted market are more speculative, and offer lower liquidity

2) Provincial Governments

May issue bonds to the federal government or borrow funds from CPP assets (or the QPP for Quebec) Can also issue debt directly to financial institutions or retail investment through a syndicate of investment dealers- may offer their own t-bills or savings bonds.

Primary Market

New securities are sold by companies and government to investors for the first time- investors purchase securities directly from the issuer, e.g. IPO

CanDeal

Operated by the TMX group, is a joint venture between Canada's six largest investment dealers. Recognized as an ATS and investment dealer, offering institutional investors access to Government securities and money market instruments.

CBID

Operates distinct retail and institutional fixed income marketplaces Registered dealers act on behalf of retail clients

Liquidity is the Fundamental Operation of an Exchange- a liquid market has:

1) Frequent Sales 2) Narrow Spread 3) Small price fluctuations from sale to sale.

Capital has three important Characteristics

1) Mobile 2) Sensitive to its Environment 3) Scarce

Investment Funds

A company or trust that manages investments for clients. The most common is an open-end fund (mutual fund), which raises capital by selling shares or units to investors and then investing the capital. Mutual funds continuously issue shares or units to investors and redeem these shares or units at net asset value.

Changes to the global capital markets over the last several years include:

ATSs are taking market share away from traditional stock exchanges. Exchanges are merging and taking over the other exchanges to meet the challenge of globalization. In addition to mergers and takeovers, exchanges are forming alliances, partnerships and electronic links with exchanges in other countries to foster global trading. Driven by increased global trading, aggressive competition.

What is Capital?

Any kind of wealth- real (building, materials, etc.) and representational (money, stocks) Capital represents the invested savings of individuals, corporations, governments, etc.

1) Federal Government

Borrow to accomodate a deficit using treasury bills (T-bills), marketable bonds, Canada Savings Bonds (CSBs), and Canada Premium Bonds (CPBs)

Why Capital is Needed*

Capital output is necessary to expand output capability, improve productivity, increase competitiveness and develop innovative new products. Decreased capital investment will result in lower living standards. The securities industry and government work together to encourage more saving and investment of savings in productive plant and equipment.

Indirect Investments

Consists of investing in the representational items , and is the focus of the CSC. Such purchases are indirect because the investor buys the securities, and the government/corporation uses the money to purchase equipment, supplies, etc.

OTC Derivatives Market

Dominated by financial institutions- market stays open 24 hours a day, has no trading floor or regular hours. One of the attractive features is that they can be custom designed by the buyer and seller, and as a result the products tend to be more complex.

Quotation and Trade Reporting Systems (QTRS)

Entities (other than exchanges or registered dealers) that disseminate price quotations for the purchase and sale of securities and report completed transactions to the applicable securities commission. Must be recognized by a provincial securities regulatory authority.

Sources of Capital*

Government that are able to operate at a surplus are "savers" and able to invest their surpluses. Other governments are "dis-savers" and must borrow in capital markets to fund their deficits

Foreign Investors

Historically, Canada has depended upon large inflows of foreign investment for continued growth.

Auction Markets in Canada*

In an auction market, buyers enter bids and sellers enter offers for a stock- the price at which the a stock is traded represents the highest price the buyer is willing to pay and the lower price the seller is willing to accept.

Retail Investors

Individual investors who buy and sell securities for their own personal accounts, and not for another company or organization.

CanPX

Information processor for government and corporate debt securities that provides investors with real-time bid and offer prices and hourly trade data.

Early Stage Venture Capital

Investment in firms that are in the infancy stages of developing products or services in high growth industries (healthcare, tech, etc.).

Turnaround

Investments in under-performing or out of favour industries that are either in financial need or operating restructuring.

Secondary Market

Investors trade securities that have already been issued by companies and governments- the issuing company does not receive any of the proceeds from the transactions.

3) Municipal Governments

Issue Instalment Debentures (or serial debentures) because the investments last for longer and therefore they spread the cost over a longer period of time.

Toronto Stock Exchange (TSX)

Lists senior equities, some debt instruments that are convertible into a listed equity, income trusts, and ETFs.

Governments

Major issuers of securities in public markets, either directly or through guaranteeing the debt of their Crown corporations.

Other Financial Instruments

Structured products that have various combinations or characteristics of debt, equity, and investment funds- e.g., linked notes and ETFs.

Leveraged Buyout

The acquisition of companies financed with equity and debt, one of the most commonly used forms of private equity.

Spread

The difference between the bid and ask prices.

Growth Capital

The financing of expanding firms for their acquisitions or high growth rates.

Private Equity*

The financing of firms unwilling or unable to find capital using public means- for example, via the stock or bond markets. provides greater returns and greater risk. Private equity allows businesses to obtain financing when issuing equity in the public markets may prove difficult or impossible. Venture Capital is a good example- finances businesses at a time when they produce little or no cash flows, invest most or all revenue in more or less unproven technologies or production processes, and have little or no assets to offer as collateral.

Late Stage Venture Capital

The financing of firms which are more established but still not profitable enough to be self-sufficient, revenue growth is still very high.

Bid

The highest price a buyer is willing to pay for the security being quoted.

Equity Instruments

The investor owns a share of the company (ownership stake), gets a portion of earnings, provides potential for capital gain through price appreciation.

Debt Instruments

The issuer promises to repay the loan at maturity and in the interim makes interest payments to the investor. Ex- Bonds

Offer (ask)

The lowest price a seller will accept

Last Price

The price at which the late trade on that stock took place. -This price fluctuates as orders are filled, and is known as the market price.

Distressed Debt

The purchase of debt securities of private or public companies that are trading below par due to financial troubles at the firm.

Canadian National Stock Exchange (CNSX)

Trade securities of emerging companies- intent is to provide an alternative market to TSX Venture for emerging companies.

ICE Futures Canada

Trades agricultural futures and options.

Montreal Exchange (MX)

Trades all financial and equity futures and options.

TSX Venture

Trades junior securities and a few debenture issues.

Fixed Income Electronic Trading Systems*

With the exception of a few debentures listed on the TSX and TSX venture, all bond and money market securities are sold through the dealer markets.

Canadian Stock Exchanges

provide a marketplace for the buyers and sellers of securities to trade with each other. On Canadian exchanges, trading is carried on in common/preferred shares, rights and warrants, listed options and futures contracts, instalment receipts, ETFs, income trusts, and a few convertible debentures.