Chapter 1 Finance Module

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Department
Management and Organizational Studies
Course
Management and Organizational Studies 1023A/B
Professor
Maria Ferraro
Semester
Fall

Description
Chapter 1.1 Real versus Financial Assets • finance is the study of how and under what terms savings are allocated between lenders and borrowers finance is not just about how resources are allocated but also under what terms and through • what channels • whenever funds are transferred, a financial contract comes into existence, and these contracts are called financial securities Canada’s Balance Sheet • a balance sheet is a snapshot of what is owned (assets) and what is owed (liabilities) at a particular time • difference between the value of what is owned and what is owed is net worth or equity • can estimate balance sheets for individuals and for institutions (both businesses and governments) • three major domestic groups in our economy: (1) individuals, referred to as the household sector, (2) businesses and (3) government • Canadian assets and liabilities that are held by non-resident individuals, businesses and governments compose the balance sheet of the non-resident sector, which we generally “net” out to determine what the country owes to or is owed by non-residents • as of 2005, Canadians had total assets with a market value os $4 567 billion or $135 000 for every Canadian Real Assets • real assets representing the tangible things that compose personal and business assets personal assets are the value of houses, land, major appliances • • major appliances and cars are referred to as consumer durables • for businesses, the major assets are office towers, factories, mines, machinery and equipment • finance is essentially the management of an entity’s balance sheet build a new factory, make strategic asset acquisition decisions, such as buying another firm, • examples of asset acquisition • asset acquisitions, generically referred to as capital expenditure • liability- ways to finance these expenditures, which we will refer to as corporate financing decisions all entities have a balance sheet • Financial Assets • national balance sheet nets out all the debts we owe to ourselves, which is almost all of our debt National Balance SheetAccounts (NBSA) • • basic idea behind NBSAis to collect financial data on the major agents in the financial system • financial assets are simply what one individual has lent to another, one person’s position financial asset is another’s negative financial asset (or liability) • Canadian households owned net financial assets issued by government, corporations and non- residents • in 2005, all layers of Canadian governments had real assets worth $497 billion • government had net financial assets of -$634 billion, which is the market value of all government debt outstanding • when we add up the total net financial assets of these three sectors, we end up with financial assets owned by non-residents • government and business entities obtain most of their financing from the domestic household sector with the remaining small proportion of their financing coming from foreign investors • four major areas of finance: personal, government, corporate, international • primary source of savings is the household sector Households • offsetting these financial assets are $260 billion in consumer credit, $131 billion in mainly bank loans and $588 in mortgage debt • two major financial assets of the household sector: market value of investments in shares and market value of investments in insurance and pensions • net negative financial asset position vs. net positive financial asset position • the people taking out the mortgage debt and consumer credit are generally not the same people as those investing The Financial System • basic financial flow is “intermediated” through the financial system, which comprises (1) financial intermediaries that transform the nature of the securities they issue and invest in, and (2) market intermediaries that simply make the markets work better Channels of Intermediation • financial system transfers funds from lenders to borrowers, occurs through intermediation • borrowers obtain funds directly from individuals or they borrow indirectly from individuals who have first loaned their savings to a financial institution, which in turns lends to the ultimate borrowers • three basic channels • first is direct intermediation, where the lender provides money directly to the ultimate borrower, non-market transaction • second channel also represents direct intermediation between the lender and borrower, but in this case, some help is needed because no one individual can lend the full amount needed or because the borrower is not aware of the available lenders • market intermediary is simply an entity that facilitates the working of markets and helps provide direct intermediation • market intermediaries are called brokers i.e. real estate and mortgage brokers, insurance brokers, stockbrokers • their responsibilities are to assist with the transaction and bring borrowers and lenders together, but they do not change the nature of the transaction itself • most important financial market in Canada is the stock market, or the Toronto Stock Exchange (TSX), which supports a variety of market intermediaries • third channel, represents financial intermediation, where the financial institution or financial intermediary lends the money to the ultimate borrowers but raises the money itself by borrowing directly from other individuals ultimate lenders have only an indirect claim on the ultimate borrowers; their direct claim is on • the financial institution • financial intermediary changes the nature of the transaction, whereas the market intermediary does not • market intermediaries help financial intermediaries, as well as individuals, in their dealings with the ultimate borrowers • refer to these to these two market segments as the “retail” and “institutional” markets • when market intermediaries help individuals, this is retail; when they help financial intermediaries; it is institutional Intermediaries • financial institutions i.e. Canadian chartered banks • Canadian banks’core activity is acting as deposit takers and lenders • the banks are overwhelmingly the most important financial intermediaries, major insurance companies are also very large in most cases, insurance is a form of savings • • insurance companies are called contractual savers, because in most cases, the premiums are paid on a monthly basis so that the insurers receive a steady flow of money • the “pure” insurance companies, which do not have a significant savings component, are the companies that insure houses against fire or cars against collision these companies are much smaller than the life insurance companies • • funds in pension plans are held directly for their pensioners • major Canadian pension plans, pension plans are contractual savers • Caisse de depot et placement du Quebec is the largest pension fund manager in Canada three types of financial intermediaries discussed above the financial institutions that change the • nature of the financial contract • have traditionally been the three most important types of financial intermediaries • mutual funds act as a “pass-through” for individuals • many mutual funds receive their monies through monthly savings plans • mutual funds do not transform the nature of the underlying financial security • 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, and (2) they offer professional expertise in the management of those funds The Major Borrowers • governments are important in this process • Canada Pension Plan (CPP) and the Quebec Pension Plan (QPP) play large roles in channelling funds from lenders to borrowers • governments provide many services to Canadians • Government of Canada had total expenditures of $216 billion for the year ended March 31, 2006 • Crown corporations provide goods and services needed by Canadians • the government debt market plays a very important role in the financial system the federal government is a net debtor and a significant borrower • • provinces and territories are also net debtors, except forAlberta, Yukon and Northwest Territories • g
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