CSC Chapter 2 - The Capital Market

Types of Financial Markets Pt.2

Stock Exchange - Is an auction market where buyers and sellers of securities meet to trade with each other and where prices are established according to the laws of supply and demand. Liquidity Market - Consists of frequent trades, narrow price spread between bid and asks prices, small price fluctuation from trade to trade. Dealer Markets or Over-the-Counter (OTC) Markets - Is a negotiated market where Market Makers post bid-and-ask quotations via electronic platforms and computer networks. In the OTC market, investment dealers typically act as principals. Almost all bonds and debentures are sold through dealer markets. The volume of trading in dollars for debt securities is significantly larger than that of the equity market. May also be referred to as Unlisted Markets because securities that trade on them are not listed on an organized exchange, as they are on auction markets. Over-the-Counter Derivatives Market - Dominated by large international financial institutions, such as banks and investment dealers that trade with corporate clients and other financial institutions. The market is open 24hrs a day. The OTC derivative products can be custom designed with special features making them somewhat complex. Canadian Unlisted Board Inc. - In Ontario, the Ontario Securities Act requires that trades of unlisted securities and unquoted equity securities be reported through this web-base system. Alternative Trading Systems (ATS) - Electronic marketplaces that provide automated matching and execution of trades in both the equity and fixed-income markets. On the equity markets, the ATS perform similar features to traditional exchanges however they cannot themselves list securities.

Users of Capital

Capital flows out of the country through mainly through foreign business and governments. They do so by borrowing from Canadian banks or by making securities available to the Canadian market.

Direct vs Indirect Investments

Direct Investment - A couple invests their savings in a home - A government invests in a new highway - A company pays start-up costs for a new plant Indirect Investment: - An investor buys stocks or bonds - A parent invests in an education savings plan - A couple deposits their savings at a bank

Different Financial Instruments

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). Fixed-Income Securities - Also called Debt Securities, may formalize a relationship in which the issuer promises to repay the loan at maturity end, in the interim, makes interest payments to the investor. The term of the loan depends on the instrument. Examples include Treasury Bills or Bonds. Equity Securities - Commonly referred to as stocks, equities, or shares. Represent some form of ownership stake in the company that issues them. Examples include Common Stock (Common Shares) and Preferred Shares. Derivatives - A product whose value is derived from the value of an underlying instrument, such as a stock or an index. Examples include Options and Forwards. Managed Products - Also called Investment Funds, are typically pools of capital gathered from investors to by securities according to a specific investment mandate. Examples include Mutual Funds, Exchange Traded Funds, and Private Equity Funds. Structured Products - Is a financially engineered product with the characteristics of debt, equity, and an investment fund. Examples include Principal-Protected Notes and Index-Linked Guaranteed Investment Certificates.

Types of Financial Markets Pt.1

Financial Market - Provides speedy transactions and low transaction costs, along with a high degree of liquidity and effective regulation. It often has no physical location. In Canada, the trading of securities such as stocks, bonds, and derivatives, takes place via electronic platform. Capital Market - Is made up of many individual financial markets, including stock markets, bond markets, and Money Markets, only short-term fixed-income securities with a term of one year or less trade in the money market. Primary Markets - Consist of newly issued securities that are sold by companies and governments to investors. Investors purchase securities directly from the issuing company or government. Companies may issue shares in the company while governments only issue bonds. Secondary Markets - Investors trade securities that have already been issued by companies and governments. Buyers and sellers trade amongst each other at a price that is mutually beneficial to both parties. Auction Markets - Buyers enter bids and sellers enter offers. These orders are channeled to a single market where they compete against each other. A trade is executed only when there is a match in the bid and ask price. The difference between the two prices is the Bid-Ask Spread.

Capital

Is synonymous with wealth, both real (i.e, land, buildings, and other material goods) and representational (i.e, money, stock, and bonds). It 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 favorable conditions exist. Favorable conditions include stable government, economic activity that is not heavily regulated, hospital investment climate, profitable investment opportunities. Flow of capital is guided by country risk evaluation and moves to locations that offer the highest risk-adjusted returns.

Fixed Income Electronic Trading Systems

i) CanDeal - Is operated by the TMX Group Limited and is recognized as both a debt ATS and an investment dealer. It offers institutional investors access to government securities and money market instruments. ii) CBID & CBID Institutional - An ATS that operates two distinct fixed-income marketplaces: retail and institutional. The retail-fixed income marketplace is accessible to registered dealers on behalf of retail clients. The institutional fixed-income marketplace is accessible by registered dealer, institutional investors, governments, and pension funds. iii) MarketAxess - Provides market data and a trading platform with access to multi-dealer competitive pricing for a wide range of corporate bonds and other types of fixed-income instruments. Is a member of IIROC and operates in Ontario and Québec. iv) CanPX - Joint venture between several Canadian investment dealers and Inter-Dealer Brokers (firms that facilitate trades between investment dealers). The system combines digital feeds from participating dealers to provide a display of real time bid and offer quotations, in price and yield terms and with volume information. The service covers Government of Canada bonds and Treasury bills.

Users of Investment Capital

i) 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. ii) 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 borrow from financial intermediaries for certain needs, and they raise the remainder in the securities market. iii) Governments - Governments are major issuers of securities in public markets, either directly or through guaranteeing the debt to their Crown corporations. When revenues fail to meet expenditures, or when they undertake large projects, governments must borrow.

Suppliers of Capital

i) Individuals - Tend to postpone consumption until they become more inclined to spend when incentives, such as tax breaks are provided. ii) Non-Fiscal Domestic Corporations - Generate large savings in the form of corporate earnings. However, the company usually retains these funds. Therefor, corporations are not significant providers of permanent funds to others in capital markets. iii) Governments - Some governments are able to operate at a surplus and invest their profits, thus becoming suppliers of capital. Others borrow thus becoming users. iv) Foreign Investors - Both corporate and individual foreign investors have seen Canada as a good place to invest. Canada, in turn, has relied on foreign savings for both direct investment in Canadian industries and securities.

Sources of Investment Capital

i) Retail Investors - Individual clients who buy and sell securities for their personal accounts. ii) Institutional Investors - 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. iii) 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.

Evaluating Country Risk

i) The Political Environment - Is the country involved, or likely to be involved in internal or external conflict? ii) Economic Trends - How strong is growth in key areas such as GDP, inflation rate, and economic activity? iii) Fiscal Policy - How high are taxes and government spending, and to what degree does the government encourage savings and investment? iv) Monetary Policy - How sound is the nations money supply management, and to what extent does it promote price and foreign exchange stability? v) Investment Opportunities - What opportunities exist for investment, and how satisfactory are the returns on investment in comparison to risk? vi) The Labor Force - What percentage of the labor force is skilled and productive?

Exchanges in Canada

i) Toronto Stock Exchange (TSX) - lists equities, some debt instruments that are convertible into a listed equity, income trusts, and exchange-traded funds. ii) TSX Venture Exchange - Lists equities and few debenture issues. iii) TSX Alpha Exchange - Offers trading in securities listed on the TSX and TSX Venture Exchange. iv) Montreal Exchange (Bourse de Montreal) - Trades all financial and equity futures and options listed for trading in Canada. v) ICE NGX Canada - Provides electronic trading, central counterparty clearing, and data services to the North America natural gas and electricity markets. vi) Canadian Securities Exchange - Lists equities and emerging companies. vii) NEO Exchange - An exchange that provides listing services and facilitates trading I securities listed on the NEO Exchange, TSX, and TSX Venture Exchange.