Chapter 2: Overview of the Canadian Financial Marketplace
Auction Market
- market in which securities are bought and sold by brokers acting as agents for their clients, in contrast to a dealer market where trades are conducted over-the-counter - for example, the Toronto Stock Exchange/major stock markets in Canada - listing requirements to trade on this market
Financial Markets
- mechanism through which suppliers and users of capital are matched - financial institutions are federally regulated, while the security industry is provincially regulated
Debt Instruments
- money borrowed from lenders for a variety of purposes - borrower typically pays interest for the use of the money and is obligated to repay it at a set date
Ask Price
lowest price at which a seller will accept for the financial instrument being quoted
Administrator
used to describe the securities regulatory authority of a province, whether it is a commission, registrar or other government official
Equities
usually referred to as stocks or shares because the investor actually buys a "share" of the company, thus gaining ownership in the company
Capital
wealth - both real, material things such as land and buildings, and representational items such as money, stocks and bonds
Secondary Market
- market for securities that have previously been sold by the issuer - when an investor purchases a security through a broker, this is said to be a secondary market transaction
Dealer Market
- market in which securities are bought and sold OTC in which dealers act as principals when buying and selling securities for clients (a.k.a unlisted market) - no listing requirements for companies trading on this market - higher volume of trading - less regulation for companies traded on this market
Investment Industry Regulatory Organization of Canada (IIROC)
- Canadian investment industry's national self-regulatory organization - IIROC carries out its regulatory responsibilities through setting and enforcing rules regarding the proficiency, business and financial conduct of dealer firms and their registered employees and through setting and enforcing market integrity rules regarding trading activity on Canadian equity marketplaces
Initial Public Offering
- an issuing by a company that has never issued shares before - requires an estimate of an appropriate offering price for the shares - when a company issues stocks for the very first time in the primary market
Mutual Fund
- an unlimited number of units are issued by the fund and they are bought and sold directly by the fund itself - value of a unit is not determined by market demand but by the net asset value of the securities in the fund's portfolio
Self-Regulatory Organizations
- associations that regulate the companies and the employees within a specific industry - protect investors, maintain fair, equitable and ethical practices in the industry and ensure conformity with securities legislations - for example, the Mutual Fund Dealers Association (MFDA) is the mutual fund industry's SRO for the distribution side of the MF industry - IIROC - none of the securities commissions are SRO's. Securities commissions are the securities administrators. In fact, it's the securities commissions that recognize various institutions (e.g., IIROC) as SRO's and grant them the authority to act as such
Financial services sector consists of the following:
- banks (fed regulated) - credit unions (prov regulated) - finance companies - financial planning firms - insurance companies (either) - investment dealers - mutual fund dealers (prov regulated) - trust and loan companies (either)
Describe and differentiate among the types of financial instruments used in financial market transactions.
- debt (bonds or debentures): issuer promises to repay loan at maturity, and makes payments of interest or interest and principal at predetermined times - equity (stocks): investor buys a share that represents a stake in the company - investment funds (mutual funds): company or trust that manages investments for its clients - derivatives (options, futures, rights): products derived from an underlying instrument such as a stock, other financial instrument, commodity, or index - other financial instruments (linked-notes, ETFs): these relatively new products have been financially engineered and have various combos of characteristics of debt, equity and investment funds
What are the broad classes or categories of financial instruments?
- debt, equity, investment funds, derivatives and other financial instruments - they are traded among suppliers and users of capital on the financial markets
Describe the roles of the financial intermediaries in the Canadian financial services industry.
- financial intermediary is an organization that facilitates the movement of capital between suppliers and users - they can be divided into two broad categories: deposit-taking and non-deposit-taking institutions - deposit-taking institutions: banks and trust companies - non-deposit-taking institutions: life insurance companies and investment dealers, among others
Describe the roles and distinguish among the different types of financial markets and define primary and secondary markets.
- financial markets facilitate the transfer of capital between investors/users through the exchange of securities - exchanges do not deal in physical movement of securities; they are simply the venue for agreeing to transfer ownership - primary market is the initial sale of securities to an investor (MF are bought and sold in this market) - secondary market is the transfer of already issued securities among investors - in an auction market, clients' bid and ask quotations for a stock are channelled to a single central market (stock exchange) and compete against each other - dealer markets are a network of dealers that trade directly between each other (most bonds/debentures trade on these markets)
Over-the-Counter (OTC) Market
- has no physical location - it is really a large computer network through which investment dealers negotiate transactions among themselves - most bonds trade OTC but the shares of some small/large companies can also be traded OTC
Retail Investors
- individual investors who buy and sell securities for their own personal accounts, and not for another company or orgz - generally buy in smaller quantities than larger, institutional investors
Define investment capital and describe the role played by suppliers and users of capital in the economy.
- investment capital is available and investable wealth (real estate, stocks, bonds, and money) that is used to enhance the economic growth prospects of an econ - in direct investment, an individual or company invests directly in an item (house, new plant, or new road); indirect investment occurs when an individual buys a security and the issuer invests the proceeds - capital has three characteristics: it is mobile, it is sensitive, and it is scarce - only source of capital is savings and it comes from retail, institutional, and foreign investors - users of capital are individuals, businesses and gov (Canadian & foreign users)
List the industry regulators and their main functions and requirements affecting mutual fund sales representatives.
- most of the legislation regarding the trading and distribution of securities is a provincial matter, dealt with in each province's securities act and is the resp of each province's securities administrator - regulation of the financial system and financial transactions in Canada involves both fed and prov regulators - collectively, the prov regulators work together to harmonize/coordinate the regulation of the Canadian capital markets through the Canadian Securities Administrators (CSA) - Self-Regulatory Organizations (SROs) are private industry organizations that have been granted the privilege of regulating their own members by the prov regulatory bodies - Mutual Fund Dealers Association (MFDA) is the MF industry's SRO for the distribution side of the MF industry (does not regulate the funds themselves because that responsibility remains with the securities commissions) - Investment Industry Regulatory Organization of Canada (IIROC) is the self-regulatory organization that oversees investment dealers and trading activity in Canada
Underwriting
- occurs when a new issue is purchased by an investment dealer and the dealer bears the risk that the issue will be sold at the desired price - the assumed risk - in the securities industry, underwriting means to agree to buy, for example, stock from an issuer that has not yet been sold to the public (i.e., to take on the risk of buying and then reselling the shares to the public) - in the insurance industry, underwriting means to insure someone against losses (i.e., you take on the risk of collecting premiums in exchange for making payment if the insured suffers a loss)
Source of Capital
- only source of capital is savings - capital comes from retail, institutional, and foreign investors
Fixed-income Securities
- securities that generate predetermined periodic interest or dividend income - they include government and corporate bonds, mortgages, and preferred shares
Foreign Investors
- significant source of investment capital - historically, Canada has depended upon large inflows of foreign investment for continued growth - FDI in Canada has tended to concentrate in particular industries: manufacturing, petroleum and natural gas, and mining and smelting - some industries also have restrictions with respect to foreign investment
Financial Intermediaries
- suppliers and users of capital access the markets through the chartered banks, trust companies, life insurance companies, and investment dealers - intermediaries can be either deposit-taking or non-deposit-taking institutions
What is the difference between an agent and a dealer?
An agent acts as a go-between and receives a commission for their services. The traditional role of the stock broker who brings buyers and sellers together and receives a commission is a good example of an agent. A dealer acts on behalf of their firm rather than acting as a go-between. So rather than matching up buyers and sellers, the dealer acts as a principal and is buying or selling stock for the dealer's own inventory. So when you buy a bond from your dealer, it's likely that the dealer is selling you bonds that the dealer owns. The dealer makes money by selling securities for a higher price than they paid.
What's the difference between corporate debt and corporate commercial paper?
Corporate debt refers to corporate bonds and debentures. Commercial paper: an unsecured obligation issued by a corporation or bank to finance its short-term credit needs, such as accounts receivable and inventory. Maturities typically range from 2 to 270 days. Commercial paper is available in a wide range of denominations, can be either discounted or interest bearing, and usually have a limited or nonexistent secondary market. Commercial paper is usually issued by companies with high credit ratings, meaning that the investment is almost always relatively low risk.
How do corporations rate as sources of capital?
Corporations tend to retain their earnings and issue securities to finance their own operations and growth. Thus, corporations are not an important source of capital—they are seen as users of capital.
Do non-residents of Canada consider Canada a good place to invest?
Generally, yes. Non-residents tend to invest in Canadian industries, particularly manufacturing, petroleum and natural gas, and mining and smelting. Controls on some industries, such as the financial industry, could be eased to encourage more foreign investment.
Ontario Securities Commission (OSC)
responsible for creating and enforcing securities legislation
What is the difference between a provincial securities commission and a self-regulatory organization?
Provincial regulatory bodies create their own laws to regulate the securities industry in their province. SROs are private industry organizations that have been granted the privilege of regulating their own members by the provincial regulatory bodies. SROs are responsible for enforcement of their members' conformity with securities legislation and have the power to prescribe their own rules of conduct and financial requirements for their members.
Mutual Fund Dealers Association (MFDA)
Self-Regulatory Organization (SRO) that regulates the distribution (dealer) side of the mutual fund industry in Canada
Chambre de la sécurité financière
The Chambre is responsible for setting/monitoring continuing education requirements and for enforcing a code of ethics in QC
Why are bonds issued with different terms to maturity?
The decision on term to maturity will depend on the financial markets and on the company's financial structure. The dealer will analyze what term will make the bond most in demand and will be the most cost-effective for the company. They will also work to "fit" the term into the overall debt structure of the company. For example, if a company has a large amount of bonds maturing in 15 years, the dealer will take into consideration whether or not the company needs to time the maturity of the new bonds to occur before or after other bonds issued by the same company mature.
With respect to derivatives, what is an underlying instrument?
The instrument on which the derivative is based. So the underlying instrument is the instrument from which the derivative was derived. For example, a Manulife stock option is a derivative and Manulife common stock is the underlying instrument.
What is capital used for and where does it come from?/How does capital investment affect Canada's growth?
When capital investment declines, the result is insufficient output, diminishing productivity, rising unemployment and decreasing competitiveness in domestic and international markets, all of which lead to lower living standards. Sufficient capital ensures that Canada has enough productive capacity in place to compete in the global economy.
How are debentures different from bonds?
When the corporation borrows money and issues bonds in exchange, the bond is secured by specific and identifiable assets of the company. If the company defaults on their payment, the lenders may claim the pledged assets to recoup their money. When the corporation borrows money and issues debentures, the debenture is not secured by specific identifiable assets. If the company defaults on payments, the debenture holder must first wait until all bondholders recoup their money, and then money from any assets left over that are sold will go toward the debenture holders recouping their investment.
What is the difference between equity and a security?
a security refers to an investment issued by a corporation, government or other organization. Some typical securities include equity (e.g., common stock) and debt (e.g., bonds)
Equity Instruments
an investment instrument that provides an ownership stake in a company
Chartered Bank
banks that are regulated by the Bank Act
Autorité des marchés financiers (AMF)
body that administers the regulatory framework surrounding Québec's financial sector: securities sector, the distribution of financial products and services sector, the financial institutions sector and the compensation sector (everything but banks)
Investment Fund
company or trust that manages investments for its clients
Securities
formal, legal documents that set out the rights and obligations of the buyers and sellers (securities industry is prov regulated)
Bid Price
highest price at which a buyer will pay for the financial instrument being quoted
Users of Capital
individuals, businesses and governments
Primary Market
market for newly issued and underwritten securities that have never been offered to the public
Stock Exchange
marketplace where buyers and sellers of securities meet to trade and where prices are established according to supply and demand
Open-end Fund
most common form of an investment fund (a.k.a mutual fund)
Institutional Investors
organizations, such as a pension fund or MF company, banks, that trade large volumes of securities and typically have a steady flow of money to invest
Liquidity
refers to the readiness with which an asset can be sold without requiring the seller to make a large price concession
Derivatives
security whose value is determined by the value of some other security or asset (option or future)