CSC Chapter 1

Ch.
1 The Capital Market
Investment Capital
- Capital: Wealth; anything with economic value (land, buildings, money,
stocks, bonds)
o The invested savings of individuals, corps, entities
o Requires direct or indirect investmentonly then you can extract the
value from the capital
- Direct inv Investing your savings into a home
- Indirect inv Purchasing stocks or bonds, or depositing money in a ban
3 characteristics of capital
- Mobile, Sensitive to its environment, Scarce
o Capital flows btwn countries depending on regulations, trade barriers,
taxes, etc
o Capital moves to users that offer the highest risk-adjusted returns.
- Where capital is found (which countries) depends on:
o Political env: is there internal/external conflict?
o Economic trends: GDP, inflation rate
o Fiscal policy: taxes & gov spending
o Monetary policy: Does the countrys money supply promote foreign
exchange?
o Investment opportunity: Risk vs reward
o Labour force: How skilled and productive it is
Sources and Users of Capital

- Source of capital is savings (when revenue >cost, that profit can be saved to
invest)
- Corps are not main providers of funds in the capital market b/c they retain
funds in the companyindividuals are the ones who invest (consume less
now and invest your surplus so you can consume more in the future)
- Canada relies on savings for direct plant/equipment investment and portfolio
investment
- 3 types of investors (sources)
o Retail: individuals who buy and sell securities for personal reasons
(usually smaller volume)
o Institutional: Orgs like mutual funds trade large volumes of securities
with steady flow of investment capital
o Foreign: FDI in Canada in manufacturing, energy, mining industries
- 3 types of users
o Individuals: Use capital to finance consumption, housing, car, etc.
Through debt such as personal loans, mortgages, etc
o Businesses: Need capital to finance daily operations, maintain
equipment, diversify activities. Can come from retained earnings,
borrowed form banks, or bond/stocks. Foreign users (bus or gov) will
want Can. Capital is they can get it at a lower rate than their own
currency.
o Governments: Issue securities in public markets
Federal: T-Bills, Canada Savings Bonds (CSBs), marketable
bonds, Canada Premium Bonds (CPBs)
Provincial: Can issue bonds to the fed gov or, borrow through
Canada Pension Plan (CPP). Can also issue debt through dealers.
Municipal: Need funds for infrastructure, transportation, welfare,
etc. Spread expenses over long-term through issuing
instalment debentures
How does capital investment affect Canadas growth?
When capital investment declines insufficient output, diminishing productivity,
rising unemployment and decreasing competitiveness in domestic and international
markets lower living standards. Sufficient capital ensures that Canada has
enough productive capacity to compete in the global economy.
Financial Instruments
- Securities are formal, legal docs - they set out the rights and obligations of
the buyers and sellers.
- Debt Instruments: Issuer promises to repay the loan at Maturity (M) and
makes interim interest pmts to the investor until then.
o Ie. Fixed-income securities bonds, T-bills, mortgages, debentures, etc
o Debentures are type of debt not secured by assets or collateraljust
backed by creditworthiness and reputation of issuer.
- Equities: Stocks or shares investor buys an ownership stake in the company.
o The owner shares in the losses and gains of the firm
o Could get dividends
o 2 types common and preferred stocks
- Investment funds: Company that manages investments for its clients
o Ex. Mutual fund (or open-end fund)
o Fund raises capital by selling shares, and then invests that capital. The
investors will get part of that money made.
o MFs issue shares on a continuous basis, and redeem them at net asset
value.
- Derivatives: For sophisticated investors
o Derived from a stock or index options/forwards
- Others: Financially engineered products with combinations of debt and equity
o Linked notes
o Exchange traded funds (ETFs)
Private Equity
- Higher risk but higher return
- Financing firms that cant raise capital or issue equity in public markets by
themselves
o Ex. Venture Capital Finances firms at their beginning stages when
they have little or no CFs, or no assets to offer as collateral.
o But then why do investors finance these firms, because although there
is great risk, they have big potential for profits.
- PE has grown over last 25 yrs
- PEs role is return enhancement (the reward for investing in less liquid
securities compared to common stock market) and portfolio diversification.
- Caters to high net-worth investors with lots of money, large portfolios
o Public/private pension plans
o Endowments & foundations
o Min. investment in PE is higher compared to regular retail market.
Types of PE financing
- Leveraged Buyout: Most common form acquisition of companies financed
with equity (some of your own money) and debt (outside borrowed capital).
- Growth Capital: Financing rapidly growing firms
- Turnaround: Investing in slow industries in financial need or in need of
restructuring.
- Early Stage Venture Capital: Investing in firms in their early stages of product
development or high growth industries (health, tech, etc)
- Late Stage Venture Capital: Financing firms which are established but not
profitable enoughrevenue growth is still high.
- Distressed Debt: Purchasing debt securities (bonds) of firms that are trading
below par due to financial troubles.
Financial Markets
- Provide fast transactions, low trans. costs, high liquidity, and effective
regulation
- Brings buyers and sellers together, but not directly
o Intermediaries Investment Advisors (IAs) or bond dealers act on
clients behalf
- All exchanges are electronic in Canada
- Capital market/securities markets is comprised of many individual markets
(ie. Stock, bond, money markets)
- Primary market: New securities sold to investors for first time by firms
(stocks/bonds) or gov (bonds)
o Investors purchase directly from issuers
o Initial Public Offering (IPO): When a firm issues stock for first time
- Secondary Market: Investors trade securities with each other that have
already been issued, at a mutually beneficial price.
o The original issuer does not get involved at allentire exchange is
btwn the 2 investors.
Auction Markets
- Buyers bid and sellers offer (ask)
- Stock price = highest price buyer is willing to pay (bid) and lowest price
seller is willing to accept (ask/offer).
o The trade only occurs when the bid and ask prices match.
o Difference btwn bid and ask is spread.
o Last price/market price: Price of the last trade on that stock
fluctuates btwn bid and ask price.
- Stock Exchange: Marketplace where buyers and sellers of secs meet to
trade
o Prices determined by S&D
o Canadian trading in common/preferred shares, options and futures,
rights and warrants ETFs, income trusts, convertible debentures.
o A liquid market has frequent sales, small bid/ask spread, minimal
fluctuations btwn sales.
o Canadas Stock Xchanges are auctions
o More than 100 xchanges around the world.
Dealer Markets/Over the counter (OTC)/Unlisted Mkts

- Network of dealers who trade with each other (thru phone or computer
network)
- Negotiated market only the dealers bids and asks are entered so they
become the market makers
o Whereas in an auction mkt, every individual investor can enter their
orders.
o Mkt makers: work for investment dealers; ensure proper execution of
trades, maintain a 2-sded mkt at an agreed upon max. bid/ask spread
for that day. They make a market fair, orderly, and liquid for everyone
else.
- All bonds and debentures are sold here
- Volume of trading ($$) for debts in the dealer mkt is much larger than the
equity mkt.
- OTC trading: Individ. Investors orders are not entered or displayed dealers
act as mkt makers and enter their bids and asks
o They have an inventory of securities they sell from, and then add new
ones into it.
o When the mkt makers post their bids and asks, that determines the
liquidity of the system
- OTC Derivatives Mkt: Mostly fin. Institutions (banks, brokerages) trading with
other corps or instits
o No trading floor or hoursall virtual, 24/7
o Derivatives can be custom designed by the buyer and seller more
complex options and forwards.
- Reporting unlisted trades: No requirement except for Ontariotrades of
unlisted secs must be listed on Canadian Unlisted Board (CUB), under the
Ontario Securities Act.
Equity Electronic Trading Systems

- Alternative Trading Systems (ATSs): electronic marketplaces provides
automated trade matching from multiple buyers and sellersthis is replacing
stock exchanges
- ATSs compete with other exchanges and must be registered as an invsmt
dealer and a member of and SRO (self-regulatory org.)
- ATSs dont have all the same functions as an exchangethey cannot list their
own securities like the TSXrather just trade securities that are listed on
other exchanges.
Fixed Income E-Trading Systems

- For the most part, bond and money mkt securities are sold on dealer mkts.
- CanDeal: Joint venture btwn Canadas 6 banks, operated by TMX
o It is a debt ATS and invstmnt dealer
o Gives instit. Investors access to Gov bonds and money mkt
- CBID: A debt ATS; operates retail and institutional mktplaces
- CanPX: Joint venture of IIAC/IIROC dealer member firms
o Is an info processor for gov and corporate debt secsprovides real-
time bid and ask prices and hourly trade data
o Entirely for gov bonds and few corp bonds
Trends in Financial Markets
- ATSs are competing with regular stock exchanges and taking over slowly
- Exchanges are undergoing M&A, forming alliances, partnerships to adapt to
globalization and for global trading.
- These changes due to:
o Increased global trading
o Competition
o Electronic communication
o Modern computer tech
o Increased mobility of capital

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How do individuals and businesses use capital?

What are the different types of financial instruments discussed in the text?

Ch.

1 The Capital Market

Sources and Users of Capital

Dealer Markets/Over the counter (OTC)/Unlisted Mkts

Equity Electronic Trading Systems

Fixed Income E-Trading Systems

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