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final study notes.docx

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Leanne Hagarty

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Economic Factors Four Pillar of Canadian Financial System • Financial institutions facilitate the flow of money from surpluses to deficits • Lines between the 4 financial pillars have been blurred since 1980 due to deregulation  changes were made to the Bank Act  more competition and less regulation in Canada o Chartered banks have been allowed to enter other businesses. They have bought trust companies and have (to a degree) become investment dealers. o In Canada, for a bank to operate, the bank must have a charter o Trust companies have declined in importance o Many trust companies have been bought by banks or insurance companies  Canada Trust (largest trust company) merged with Toronto-Dominion Bank  TD Canada Trust 1. Chartered Banks o businesses such as TD, world bank, Bank of Montreal o Privately owned (not government owned) firm that serves individuals, non- business organizations, and businesses as a financial intermediary o Largest and most important institution o You can buy stocks in these banks; allow people to borrow and save money o 5 largest Canadian banks account for 90% of total bank assets o Bank Act limits foreign-controlled banks to less than 8% of total domestic bank assets  Act allows foreign-controlled banks to increase competition; but still limit the extent to which the foreign competitors to come in, to prevent population investing money in foreign banks  Determines what banks can or cannot do o Major source of short-term loans for business (up to 5 years)  Secured loans: when you go to the bank and take out the loan, you give them the right to sell your personal belongings if you do not pay them back  lower interest than unsecured  Unsecured loans: backed only by the borrower’s promise to repay it. Only the most credit-worthy borrowers can get unsecured loans. o Expand money supply through deposit expansion  They do not make money, but by taking deposits and making loans, they expand money supply.  Reserve requirement: banks must keep a portion of chequable deposits in vault cash  You deposit into the bank. The bank pays you interest. The bank lends some of your money to someone else, and charges them more interest. The bank keeps the interest left over.  When the bank lends money to someone, the person buys something from a business, and the business deposits money to the bank -> bank holds onto some, and lends some of it -> cycle repeats  The more money circulates, the more people can buy, etc. 2. Alternate banks o Trust companies, such as Canada Trust, credit unions o The difference between trust companies and chartered banks  Trust companies are smaller versions of banks. Before, you could borrow/deposit money to them, but they weren’t trustworthy/popular because they did not offer the same range of services. Now, they do not really exist.  Credit unions: cooperative savings and lending associations formed by a group with common interests. They lend to business and consumers. When you do things with CUs, you’re a member of that union. So when the union generates profits, you get a dividend -> growing in appeal o A trust company safeguards property (funds and estates) entrusted to it. It may also serve as trustee, transfer agent, and registrar for corporations and provide other services. 3. Specialized lending/saving intermediaries o (Life) Insurance companies  You pay premiums to the insurance companies -> hence they share risk with policyholders for premium. They then invest and profits from the money by lending it -> your premiums grow.  Substantial investors in real estate mortgages and in corporate and government bonds.  Largest financial intermediaries in Canada next to chartered banks o Venture capital firms  Opportunity recognition: when there are small/medium firms that want to grow, banks are not willing to lend them money because it is still risky. But venture capitalist firms provide funds for new/expanding firms that seem to have significant potential.  Will exchange money for equity -> risky  May demand an ownership stake of 50% or more before they buy into a company  May insist at least one seat on the BOD to observe how their investment is faring  Obtain their funds from initial capital subscriptions, from loans from other financial intermediaries and from retained earnings. o Pension funds  Accumulates money that will be paid out to plan subscribers at some time in the future  The money collected is invested in corporate stocks and bonds, government bonds, or mortgages until it is to be paid out 4. Investment Dealers: stockbrokers, underwriters o Facilitates trade of securities -> primary/secondary distributors/traders of new stock& bond issues o They make the connection between investors and companies Changes in Banking Industry 1. Deregulation: allowed banks to alter role as intermediaries between depositors and borrowers. 2. Changes in consumer demands: banks try to be responsive to demands to remain deregulated; banks respond to new competition by selling a growing array of services in their branches 3. Competition from foreign banks Bank of Canada • The banks’ bank managed by the board of governors, and is crucial in managing economy • Whenever banks borrow money, they go to the Bank of Canada • Open market operations o If the Bank wants to increase $$ supply, it can buy government securities. The people who sell the bonds then deposit the proceeds in their banks, which increase banks’ reserves and willingness to loan. The Bank can also lower bank rate, causing increased demand for loans. o If the Bank wants to decrease money supply, it can sell government securities. People spend money to buy bonds, and these withdrawals bring down banks’ reserves and reduce their willingness to loan. The Bank can also raise bank rate, causing decreased demand for loans. • Bank/rediscount rate: the Bank of Canada sets the interest rate. This is the rate at which chartered banks can borrow from the Bank of Canada. This influences how the other banks are going to charge us when we borrow, or how much they are going to give us when we save International Banking and Finance • Governments and corporations frequently borrow in foreign markets o We choose to borrow from foreign markets is because they may offer us more money o Problem is that eventually, that foreign government now has influence over you • International Bank Structure: similar to the United Nations, countries maintain control of their own financial systems and want to maintain their own jurisdiction. o They want to create a body that can impose any kind of structure o Stability relies on a loose structure of agreements  we all agree to play nicely o Makes it difficult to create a body that can impose any kind of regulations o World Bank: provides limited services; typically funds national improvements through loans for roads (infrastructure) etc. o International monetary fund (IMF) promotes stability of exchange, short-term loans to members, encourages member cooperation on international monetary issues (how we are going to determine money supply…), encourage development of a system for international payments. Securities Markets • Where stocks, bonds, and other securities are sold stocks and bonds are securities because they represent a secured claim on the part of investors • Primary markets o Where initial public offering and subsequent offerings are sold -> whenever a firm first issues stock/bond, they sell it in the primary market o Handle the buying and selling of new securities by firms or governments o Investment bankers will do 3 important things 1. Advise them on the timing and financial terms for a new issue: what type of security to issue, terms, price, other features 2. Underwrite (buying) the new securities -> actually buy it from the corporation -> investment bankers bear some of the risk of issuing a new security 3. Create a distribution network that moves the new securities through the banks and brokers into the hands of the individual investors. • Secondary markets 1. Once the security leaves the investment bankers, they go to Secondary markets. 2. When you decide you don’t want those shares/bond anymore, you will go to Toronto Stock Exchange (or other exchanges) to sell them 3. You have to contact the Ontario Securities Commission in order to control what you do with your stock -> every stock exchange you want to trade on, you must go through a process 4. If you can’t afford to have stock on stock exchange, smaller market = over-the- counter: organization of securities dealers formed to trade stock outside the formal institutional setting of the organized stock exchanges  Disadvantage: lack of visibility -> potential investors cannot see you  Advantage: it does not cost you Bonds • Represents debt -> lending by investors, a written promise to pay the lender the sum + interest • When you buy a Canada savings bond, you are lending the government money. (owner = lender) When a company issues bonds, it agrees to repay the debt (principal) at some point at the maturity date. The value of principle to be repaid is the face/par value which is usually in $1000 denominations. • Characteristics 1. Fixed rate of return (often paid semi-annually) x number of years from now, they will pay you X amount back that you lent them. In the meantime, they will pay you an interest of xx %. (Coupon payment of the bond). The annual interest is the fixed rate of return, and this doesn’t change. 2. Fixed term: principal repaid at maturity. The maturity date is the date that the company is supposed to pay you back. The day that the interest payment stops. 3. Priority over stockholders: If the business goes bankrupt, people want their money back, and bondholders come first, ahead of the stockholders in terms of liquidation and repayment • Types 1. Secured vs. Unsecured(debenture) • secured are backed by mortgages or assets • debentures have higher interest rates 2. Registered ns. Bearer • Registered bond-whoever issued the bond know who the owner/lender of the bond is(they know who they’re sending the coupon payments to) -> holder names registered with company • Bearer bond-bearer of bond can cash it anonymously. The bondholders must
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