Textbook Notes (363,019)
Canada (158,147)
Finance (37)
MGFB10H3 (19)
Chapter 1

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University of Toronto Scarborough
Sultan Ahmed

Chapter 1: An Introduction to Finance  Finance: the study of how and under what terms savings (money) are allocated b/w lenders and borrowers  Financial securities: contracts that come into existence whenever funds are transferred 1.1 Real versus Financial Assets Canada’s Balance Sheet  4 major domestic groups in our economy o Individuals (AKA household sector) o Businesses o Government o Foreign (non-residents)  w/I Canada we had lots of debt but they were to other Canadians. When we add everything up, these debts to ourselves net out to zero b/c one person’s debt is another person’s asset Real Assets  Real assets: the tangible things that compose personal and business assets o Personal assets: value of houses, land houses are on, and consumer durables (e.g. cars and major appliances) o Business assets: office towers, factories, mines, the land the office is on  Finance is the management of an entity’s balance sheet o Asset acquisitions are generically referred to as capital expenditure (capex) decisions o On the liability side are ways to finance these expenditures which are referred to as corporate financing decisions Intangible Assets  E.g. patents and goodwill that are used by the firms to generate future cash flows Financial Assets  Financial assets: a claim that one individual or institution has on another o securities such as stocks and bonds  Firm finances its investments in real asset by issuing financial assets in the debt market for investors  Net assets/net worth= real assets + financial assets (AKA shareholder’s equity)  Households own real assets and own net financial assets issued by the govt, corporations and non- residents Households  Two major financial assets of the household sector: market value of investments in shares and the market value of investments in insurance and pensions  In the household sector, older people tend to lend whereas younger people tend to borrow o younger people borrow to buy houses and consumer durables whereas older individuals are paying down their mortgage and building up their financial assets  Real investment decisions of households are to buy consumer durables whereas business sector makes very different real investment decisions that increase our wealth overtime to increase our ability to produce goods and services in the future  A large part of household wealth consists of life insurance and pension claims with the latter being simply promises made by a government or private company to pay money to individuals after they retire. Promises made by private companies can severely compromised if its own future is in doubt 1.2 The Financial System  The basic financial flow is “intermediated” through the financial system which comprises of: 1. Financial intermediaries that transform the nature of securities they issue and invest in  Entities that invest funds on behalf of others and change the nature of the transactions 2. Market intermediaries that simply make the markets work better  Entities that facilitate the working of markets and help provide direct intermediation but do not change the nature of the transaction (AKA brokers)  Market intermediaries act as an “agent” and we call transactions that occur with market intermediaries “agency transactions”  Example: TSX. Market brings stockbrokers and clients together Channels of Intermediation  Intermediation: the transfer of funds from lenders to borrowers o Can occur directly and indirectly o Direct intermediation: borrow money from friends, relatives  Lender provides money directly to borrower w/o any help from a specialist  Non-market transaction b/c negotiation directly b/w borrower and lender o Indirectly: borrow money from financial institution like CIBC  First person deposits savings into institution which in turn is lent to ultimate borrowers  Borrower needs help to find suitable lender which is what market intermediaries do  Stock market has stockbrokers who facilitate the sale of financial securities, especially shares  Financial intermediation o Indirect claim b/w ultimate lender and borrower o Direct claim on financial institution  Market intermediaries help financial intermediaries as well as individuals in their dealings w/ the ultimate borrowers o Retail: when market intermediaries help individuals o Institutional: when market intermediaries help financial intermediaries  Credit crunch: a situation in which financial intermediaries have to raise the cost of their loans by a significant amount due to their own inability to raise financing on reasonable terms o this happens when individuals are unwilling to lend money Intermediaries  Life insurance is not really insurance b/c we are all going to die so we can’t insure against it so in many cases insurance is a form of savings. Term insurance is only insurance in the sense that it pays off only if you die during the life of the policy  Insurance companies are classified as contractual savers b/c the premiums on a policy are paid on a monthly basis so that the insurers receive a steady flow of money. You buy insurance and pay premiums. When you die, it pays off. o Insurer: A person or company that sells insurance and promises to compensate another in the event of lose or damage o Contractual savings institutions: obtain their funds through long-term contractual arrangements and invest these funds on capital markets  3 types of financial intermediaries: chartered banks, insurance companies and pension funds o Life insurance companies take in insurance premiums that people invested and pay off when an incident occurs  Mutual funds act as a “pass-through” for individuals, providing them with a convenient way to invest in the equity and debt markets o Mutual funds perform two major functions: 1. They pool small sums of money so that they can make investments that would not be possible for smaller investors 2. They offer professional expertise in the management of those funds The Major Borrowers  Government and businesses are the major borrowers (businesses are the most important)  Crown corporations: government-owned companies that provide goods and services needed by Canadians (e.g. Hydro-Québec and Ontario Power Generation)  Government of Canada debt is default free; people can invest and know that they will get their promised payments  Interest rates paid on different types of Government of Canada debt serve as benchmarks for the Canadian financial system 1.3 Financial Instruments and Markets Financial Instruments  Financial assets ar
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