Download Sell government securities: Market

Chapter 15
Money, Banking, and
Securities Markets
Copyright © 2006 Pearson Education Canada Inc.
15-1
Learning Objectives
Define money and identify the different
forms it takes in Canada’s money supply.
Describe the different kinds of financial
institutions that make up the Canadian
financial system and explain the services
they offer.
Explain the functions of the Bank of Canada
and describe the tools it uses to control the
money supply.
Copyright © 2006 Pearson Education Canada Inc.
15-2
Learning Objectives
Discuss the value of common stock and
preferred stock to shareholders and
describe the secondary market for each
type of security.
Describe the investment opportunities
offered by mutual funds and commodities.
Explain the process by which securities are
bought and sold.
Copyright © 2006 Pearson Education Canada Inc.
15-3
Money
Any object generally accepted by people as
payment for goods and services
Characteristics:




Portable: lightweight and easy to handle
Divisible: easily broken down to match the value
of goods
Durable: must not spoil or easily wear out
Stable: must be stable enough to hold its value
over time, apart from minor fluctuations
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Functions of Money
Medium of exchange

A single medium of exchange for goods
and services instead of barter
Store of value

Can be used for future purchases
Unit of account

Allows measurement of the relative value
of goods and services
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The Money Supply
Buyers and sellers must agree on the
value of money
The value of money is dependent on its
supply


As supply increases, value decreases
As supply decreases, value increases
Consists of both M-1 and M-2 forms of
money
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M-1 Money Supply
The most liquid forms of money


Currency: paper money and coins issued
by the Canadian government
Demand deposits: money in chequing
accounts, which can be transferred to
others by cheque
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M-2 Money Supply
Everything in the M-1 money supply plus



Savings deposits: savings account holdings
Time deposits: deposit requiring prior notice
before withdrawal of funds
Money market mutual fund investments
Measures the store of monetary value that is
available for making financial transactions
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Credit Cards
Not included in M-1 or M-2 money
supplies
Major source of consumer spending
Are a substitute for money, but they are
not money
Are privately issued and very profitable
due to annual fees, merchants fees &
interest
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Financial Institutions
Traditionally consisted of four financial pillars




Chartered banks
Alternate banks (trust companies, credit unions,
caisses populaires)
Life insurance companies and specialized lending
and saving intermediaries
Investment dealers
Changes due to deregulation of the banking
industry
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Pillar #1:
Chartered Banks
Privately owned, profit-oriented, financial
intermediary


Largest and most important of financial institutions
Each bank has many branches
Schedule A banks

Must be Canadian-owned with no more than 10% of
voting shares controlled by a single interest (90% of all
bank assets)
Schedule B banks

May be foreign-owned and need not meet the 10%
limit (foreign-owned bank deposits cannot exceed 8% of
the total domestic assets of all banks)
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15-11
Services Offered by Banks
Pension services
Trust services
International
services
Financial advice
Buy/sell securities
Electronic Fund
Transfer (EFT)
Debit Card
Bank deposits
Bank loans
Bank accounts
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15-12
Electronic Fund Transfers
(EFT)
Debit cards

Plastic money that immediately adjusts the
consumers account balance and pays the
merchant
Smart cards

A credit card sized computer that can be
programmed with “electronic money”
Ecash

Money that moves among consumers and
businesses via digital electronic transmission
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Bank Deposits
Accept deposits from some customers
to obtain money to lend to others


Chequing accounts
Term deposits (money that remains with
the bank for a period of time with interest
paid to the depositor)
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15-14
Bank Loans
Major source of
short-term financing
for business
Banks prefer to
finance inventories
or accounts
receivable rather
than provide longterm loans to many
businesses
Secured loan

Backed by collateral
(e.g.: Inventory)
Unsecured loan

Not backed by
property
Prime rate of
interest

Lowest rate charged
to best customers
Copyright © 2006 Pearson Education Canada Inc.
15-15
Banks As Creators of Money
Bank
1
2
3
4
5
6
7
8
9
Totals for
the first
nine banks
Expansion
limit for
entire
banking
system
New Deposit
Reserve
Requirement
New Loan
$100.00
$90.00
$81.00
$72.90
$65.61
$59.05
$53.14
$47.83
$43.05
$10.00
$9.00
$8.10
$7.29
$6.56
$5.91
$5.31
$4.78
$4.31
$90.00
$81.00
$72.90
$65.61
$59.05
$53.14
$47.83
$43.05
$38.74
$612.58
$61.26
$551.32
$1,000.00
$100.00
$900.00
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Other Changes in Banking
Changes in customer preferences


Deregulation is causing banks to shift from their
historical role as intermediaries between
borrowers and depositors
ING direct, president’s choice financial
Deregulation

Diversification into other financial products
 Investment banking
 Commercial paper
International banking
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15-17
The Bank of Canada
The central bank of Canada
Managed by a Board of Governors
Regulates operations of the chartered
banks
Manages the economy by manipulating
the money supply to expand or restrict
the economy
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15-18
Monetary Policy Actions of the
Bank of Canada
Expansionary Policy
Restrictive Policy
Tools
(stimulate business
activity and increase the
money supply)
(slow down business activity
and decrease the money
supply)
Open
Market
Operations
Buy government securities:
Sell government securities:
(increases bank reserves
(decreases bank reserves
enabling banks to make loans
to businesses and
consumers)
limiting the banks' abilities
to make loans to businesses
and consumers)
Lower the bank rate:
Raise the bank rate:
(increase the willingness of
(decrease the willingness of
Bank Rate
banks to borrow, more loans can
be made to businesses and
consumers)
Copyright © 2006 Pearson Education Canada Inc.
banks to borrow, fewer loans can
be made to businesses and
consumers)
15-19
Pillar #2: Alternate Banks
Trust companies


Safeguard funds and estates entrusted to it
Serves as a trustee, transfer agent, & registrar for
corporations
Credit unions (Caisses Populaires)



Cooperative savings and lending institution formed
by a group of individuals with common interests
Offer savings accounts, loans, mortgages to
members
Invest its own funds in corporate & government
securities
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Pillar #3: Specialized Lending
and Savings Intermediaries
Life insurance firms
Factoring companies
Financial corporations
Venture capital or development firms
Pension funds
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Life Insurance Firms
Life insurance companies




Mutual or stock company that shares risks with
policy holders for payment of premiums
Some money from premiums is lent back out
Substantial investments in real estate, mortgages
and government bonds
Largest financial intermediaries in Canada next to
the chartered banks
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Factoring Companies
Buy uncollected accounts receivable from a
firm for less than its face value


Attempts to collect the face value of the
receivables from customers
The difference between the amount collected and
the cost of the receivables is the firm’s profit
Allows firms with old, or uncollectible,
accounts receivable to redeem at least part of
their value rather than writing them off
completely
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15-23
Financial Corporations
Sales finance company


Finances instalment purchases made by
individuals or businesses
Loans are secured by the item being
financed (e.G.: Computer)
Consumer finance company


Makes personal loans to consumers
Collateral may or may not be required
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15-24
Venture Capital Firms
Provide funds for new or expanding
firms that have great potential
Obtains funds from individual investors,
financial intermediaries, retained
earnings
While accepting increased risk with new
ventures, VC firms seek to earn higher
than normal returns
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15-25
Pension Funds
Accumulate cash that will be paid out to
subscribers in the future in the form of
pension income


Money is invested until it is needed
Investments include stocks and bonds,
mortgages
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15-26
Pillar #4: Investment Dealers
Stock brokers or underwriters
Primary distributors of new stock and
bond issues (underwriting)
Facilitate trading of stocks and bonds,
both on stock exchanges and on overthe-counter stock and bond markets
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15-27
Other Sources of Funds
Government financial institutions and
granting agencies



Business Development Bank of Canada (BDC)
Canada Mortgage and Housing Corporation
(CMHC)
Export Development Corporation
Canada and its provinces borrow from
international sources of funds, including other
nations
The Canadian Capital Market (international
funds)
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15-28
Exchange Rates and Trade
Exchange rates influence the willingness of
Canadians to invest abroad and buy imported
items (or vice versa)
A trade surplus occurs when Canada is exporting
more products than it is importing (likely to occur
when the dollar is undervalued)
A trade deficit occurs when Canada is importing
more products than it is exporting (likely to occur
when the dollar is overvalued)
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15-29
The Law of One Price
A basic commodity should be priced equally across all
countries

If prices differ it is assumed to be due to over or under
valuation of the local currency
Country
The
Big
Mac
Index
Big Mac Price
(Local Dollar)
Big Mac
Price Equiv.
(US Dollars)
Over/Under
Valuation
$2.71
$2.71
--
Denmark
27.75 krone
4.10
+51%
Switzerland
6.30 Francs
4.50
+69%
Britain
1.99 pounds
3.14
+16%
Japan
262 yen
2.19
-19%
United States
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15-30
International Payments
Process
Local banks convert payments to the currency
required by foreign trade associates
Local banks then send payment, in foreign
currency, to the foreign trade partner
The foreign trade partner deposits the payment
in his/her own foreign-based bank
When equal values of money are moving back
and forth between nations, no real funds need to
be transferred between nations because the
payments are in balance
Banks also trade currencies
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15-31
International Bank Structure
International banking is governed by a
network of loose agreements between
individual countries or groups of countries.
The World Bank and the International
Monetary Fund (IMF) assist by financing
international trade

IMF
 150 nations who combined resources to promote stable
exchange rates, provide temporary short-term loans,
encourage cooperation on international monetary issues,
and develop a system for international payments
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15-32
Securities
Primary securities market

Sale and purchase of newly issued stocks or bonds
offered by firms and governments
Secondary securities market

Sale & purchase of previously issued stocks &
bonds
Investment banker

Any financial institution engaged in purchasing
and reselling new stocks and bonds
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Characteristics of Common
Stocks
Market value

Current price of a share the secondary securities
market
Capital gains

Profits from the sale of an asset (i.e.: Stocks)
Book value


Shareholders’ equity divided by the number of
shares of common stock outstanding
Of limited usefulness in evaluating investments
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Preferred Stock
Issued with a stated par value

Dividends paid based on a percentage of
par value
Value of the stock can rise or fall with
the fortunes of the company
Less risky than common stock
Limited growth potential due to the
fixed dividend
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15-35
Stock Exchanges
Voluntary organization of individuals formed
to provide an institutional setting where
members can buy and sell stock for
themselves and their clients in accordance
with the rules of the exchange

To become a member a firm must purchase seats

Only members (or their representatives) are
allowed to trade on the exchange

All trading must go through members of the
exchange
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15-36
Stockbrokers
Individuals licensed to buy and sell securities
for customers in the secondary market
Full-service brokerage

For a reasonable fee, offers a variety of services
including buying, selling, and investment advice
Discount brokerage

For a reduced fee, buys and sells securities, but
has limited service offerings
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15-37
The Over-the-Counter
Market (OTC)
Organization of securities dealers formed to
trade stock outside the formal institutional
setting of the organized stock exchanges



Many securities are not listed on a stock exchange
OTC markets consist of numerous dealers who
own the securities that they buy and sell at their
own risk
Also trade all fixed-income securities, which
includes bonds and debentures
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15-38
Bonds
Bond
A written promise that the borrower (firm) will pay
the lender (investor) at a stated future date, the
principal plus a stated rate of interest
Bonds differ from one another in terms of maturity
(payment date), tax status, potential yield (interest
rate)
 Several companies rate the quality of various
bonds (Moody’s, Standard and Poor’s)

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Corporate Bonds
Secured

Assets are pledged as security for the bond
Unsecured (debentures)


These bonds are not backed by any security
Only sold by financially strong corporations that carry
lower risk for investors
Bearer (coupon) bonds

Holders clip coupons from the bond to receive interest
payments: anyone with the coupon can redeem it
Registered bonds

Certificates are only of value to registered holders
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15-40
Retiring Bonds
Callable bonds

May be called at anytime, or after a certain minimum
period of time, for a specified fee
Sinking fund provision

The company must put money into a special bank
account each year, such that at the time of maturity,
there is sufficient money to retire the bonds
Serial bond

Redemption rates are staggered so that the bond is paid
off gradually over time
Convertible

Option of receiving common stock in lieu of cash
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15-41
Mutual Funds
A company pools the resources of many
investors and uses funds to purchase various
types of financial securities (a portfolio)
Different funds have different goals (stability,
growth, etc.) And different levels of risk
Investments are professionally managed
No-load fund

Investors are not charged a sales commission
when they buy into or sell out of a fund
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15-42
Commodities
Futures contract


Agreement to purchase specific amounts of a
commodity at a certain price on a set date in the
future
Risky investment with many variables
Commodities market

A market in which futures contracts are traded
Investors can buy on “margin,” with a
minimal amount as a down payment
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Stock Options
Stock option

The purchased right to buy or sell a stock
Call option

The purchased right to buy a particular stock at a
certain price until a specified date
Put option

The purchased right to sell a particular stock at a
certain price until a specified date
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15-44
Reading Bond Quotations
Company Name
Maturity Date
Coupon
(April 8, 2022)
(interest rate %)
Your Daily Paper
Issuer
Coupon
BC Tel
9.65
Maturity
Price
Apr 8-22 138.5
Yield
Change
6.488
+1.118
Change
Price
(Last transaction
price = $138.50)
Yield
(Annual interest
Market price)
Copyright © 2006 Pearson Education Canada Inc.
(Closing
price up
$1.11 from
previous day)
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Reading Stock Quotations
Stock
Sales
Close
(Total number of
shares traded)
(Last price paid
at close of trading)
Your Daily Paper
Company
Inco
Sales
High
Low
Close
376 030
29.150
28.500
28.600
High
(Highest price paid
per share for the
day
was $29.15)
Change
-.400
Change
Low
(Lowest price paid
per share for the day
was $28.50)
(Difference
between
today’s price and
previous day’s. A
.40 decrease)
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15-46
Reading the Market
Market indexes




A measure of the market value of stocks
Summarize trends in the stock market and specific
industries
S&P/TSE Average, Dow Jones Industrial Average
Standard & Poor’s composite index, NASDAQ
Composite Index
Bear market: a period of falling stock prices
Bull market: a period of rising stock prices
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15-47
Buying and Selling Stocks
Market order

Order to buy/sell a security at the current market price
Limit order

An order to buy a security but only if its price is less
than, or equal to, a certain level
Stop order

Order to sell a security if its price falls below a level
Round lot

The purchase or sale of shares in units of 100
Odd lot

The purchase or sale of shares in units of other than
100
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Margin Trading
The investor makes a down payment on a
portion of the price with the rest financed
by the broker




The broker borrows the amount from the bank,
secured by stock
The broker charges the investor a higher rate of
interest than he/she pays the bank
Investors can pay off the financing when they
sell the stock, hopefully at a profit
Margin trading is very risky
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15-49
Short Sale
An investor sells shares from the broker
without paying for them
The investor is “borrowing” the shares from
the broker for a period of time
In order to return the borrowed shares, the
investor must purchase the equal number of
shares later and return them to the broker
Profit or loss is based on the spread
between the selling price and the
purchasing price
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15-50
Securities Regulations
Brokers are licensed and securities are
registered
Blue-sky law

Laws regulating how firms back up securities
Prospectus

A detailed registration statement about a new
stock
Insider trading

Illegal activity of using special (inside) knowledge
about a firm to make a profit
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15-51