RSM230 Intro To Financial Markets
CHAPTER 1 The Capital Market
Financial markets drive economic growth by transforming savings into investments. The three
components of wealth transfer are: financial instruments, financial markets, and financial
Suppliers and Users of Investment Capital
Capital can be used through:
1. Direct Investment (Land, buildings, human capital)
2. Indirect Investment (Financial Assets like stocks and bonds, wealth-generating assets)
Capital is mobile, scarce, and sensitive
It comes from retail and institutional investors and goes towards corporations and
government. Foreign investments play a large role, and there are two main kinds of
bonds: foreign bonds and Eurobonds denominated in some currency and sold in
One security cannot maximize two or more of these objectives, so they are mutually exclusive. If
you want to maximize safety, you must sacrifice income or growth. Short-term bonds to
preferred to common stocks range from safest to most risky, and from steady income with
limited growth to variable income with highest growth.
For governments, a lower yield signals a steadier economy. They offer T-bills, marketable bonds,
and Canada Savings Bonds.
Financial instruments are formal docs that set out rights and obligations of the parties
Debt instrument represent a legal obligation to repay borrowed funds at a specific time, such
as bank loans, commercial paper, T-bills, bonds, debenture, etc.
Equity instruments represent part-ownership of a company, such as common and preferred
Investment Funds are companies that manage investments for clients, like mutual funds.
Derivative Products derive their value from the price of another asset like a stock, stock index,
commodity price, etc. Theyre suited for hedging or speculative purposes.
Other Investment Products include income trusts, exchange-traded funds, etc.
Primary Markets involve the sale of securities to the market by the issuer (capital formation).
Secondary markets involve the sale of previously issued securities (no funds go to the issuer). Chapter 2 The Canadian Securities Industry
Financial INTERMEDIARIES facilitate the transfer of capital from suppliers to users. There are
different types, such as banks and trust companies that accept deposits from capital
suppliers and lend to capital users. Investment funds and insurance companies collect
money and invest in securities.
Primary Markets new issue market where investment dealers act as principals or agents.
Underwriting or financing the purchase of new securities from the issuer on a given date at a
specified price, which is then sold to others. IDs serve as principals, and their compensation
is the spread b/w the purchase and resale price. They assume the risk of the security not
selling, but often form underwriting syndicates to decrease risk and increase marketability
of the shares.
IDs can also be agents who market the new securities on a best efforts basis. They receive
commission, but it is the issuer that assumes the risk. This is typical for smaller speculative
companies or private placements for large companies with good credit ratings.
Secondary Markets facilitate the transfer of existing securities among investors. IDs can also
act as principals by trading securities from their own inventory and when they trade for their
own account. They assume the majority of the risk. IDs are brokers/agents when they
execute transactions for customers and charge them commissions. There is no min. for
commissions, so many discount brokerage firms with a do-it-yourself attitude has developed
over the years.
Agency Transaction clients instructing their IDs to get the best possible price (market order),
and once it goes through on the exchanges ticker, the details of the trade go to the buyer
and seller. The firms phone their clients to confirm the transaction and mail written info to
Afterwards, they must settle the transaction and hand over the money. They must provide funds
by the settlement date (usually 3 days after the trade).
Banks gather funds through savings deposits or certificates of deposit, and transfers them to
users in form of loans. They make the spread between what they charge for loans and what
they pay for deposits, as well as service fees.
Schedule I Banks: Widely held, with no investor holding more than 20% and foreign ownership
more than 25%. The Big Six banks in Canada account for over 83% of bank assets: RBC, CIBC,
BMO, Scotiabank, TD, and National.
Its important that they keep a large reserve of liquid assets, but its not a legal requirement.
Usually it is 13.5%.Schedule II Banks: incorporated and operate in Canada, but are subsidiaries of foreign banks.
They can accept deposits, and there was only 24 in 2007.
Schedule III Banks: Branches of foreign banks that can accept deposits and provide loans not
subsidiaries but branches.
Banks with equity over $5 billion must have maximum 20% control for any individual or group.
Medium banks with $1-5 billion can have a single owner hold up to 65%, if the remaining
are traded publicly. Small banks dont matter.
Recently, banks moved into the securities business and can offer trust, insurance, and
investment counselling/portfolio management services to clients.
Chinese Walls controls to restrict the flow of info b/w various bank business segments.
Trust and Mortgage Companies although they offer similar services of banks, they are
distinct because they are the only type of corporation in Canada permitted to act as trustees
in charge of corporate or individual financial assets.
Credit Unions and Caisses Populaires cooperative, member-owned businesses that provide
basic financial services to members. Has a prudent portfolio approach.
Life Insurance Companies May act as trustees for funds they get from policyholders. Since
most arelong-term, they invest in mortgage and long-term bonds. Also required to have a
prudent portfolio approach, and can own trust companies through subs. Demutualization
has occurred, meaning policyholders are being replaced by shareholders.