FINANCE IN A CANADIAN
SETTING
Sixth Canadian Edition
Lusztig, Cleary, Schwab
CHAPTER TWO
The Canadian Financial
Environment
Learning Objectives
1. Describe the difference between surplusspending units and deficit-spending units, and
discuss how each contributes to the
development of efficient financial markets.
2. Explain how financial intermediation operates
in channelling funds between savers and
users of funds.
Learning Objectives
3. Describe the different functions of primary
and secondary markets.
4. Discuss the difference between traditional
stock exchanges and over-the-counter (OTC)
markets using examples from Canada and the
United States.
5. Identify some major stock indexes, and
discuss their strengths and weaknesses.
The Role of Financial Assets

Two types of assets:
Real assets – physical property such
as land, buildings, inventories
Financial assets – paper claims
entitling the holder to some future
payment such as interest and principle
on a debt certificate
Financial Assets

Two categories of financial assets:
Debt – entails a contractual loan with
the purchaser entitled to future
interest and repayment of principle
Equity – the sale of ownership
certificates in a firm
Financial Intermediaries



Financial intermediaries create a
system of indirect financing.
Sources of indirect capital
- Individuals
- Foreign investors
Governments have been net
borrowers in recent years to fund their
deficits
Financial Intermediaries

The “four pillars” of Canada’s financial
system include:
1.
2.
3.
4.
Chartered banks
Trust companies
Insurance companies
Investment dealers
Financial Markets

Encompass the institutions and
procedures involved in the buying and
selling financial assets

Their main purpose is to efficiently
match buyers and sellers
Primary Markets
Primary market - where borrowers issue
new securities in exchange for cash
from investors
 Selling of new securities is handled by
investment dealers
 Investment dealers act as
intermediaries between buyers and
sellers

Secondary Markets
Secondary market - where existing
securities trade
 Secondary markets exist for:
- T- Bills
- Stocks
- Bonds & debentures
- Derivatives

Global Perspective


Investment banks act as global coordinators
linking separate underwriting syndicates
globally in selling equity issues
Reasons for raising fund internationally
include:
1. The limited size of the Canadian market
2. Management of foreign exchange
exposure
3. Interest rate differentials
4. Availability of private placements
Money Market






Dominated by financial institutions
Operates as a dealer or over-the-counter
market (OTC)
Sold in denominations > $100,000
Most recognized money market instrument
are T-bills
T-bills are highly liquid and sold in 91, 182,
364 day maturities
Other money market instruments include
commercial paper, Banker Acceptances,
eurodollars
Debt Markets
Bond markets represent the most
important markets for intermediate and
long-term debt
 The bond market operates as OTC
market
 Other important debt markets include
- Asset-backed Securities (ABS)
- Mortgage-backed securities (MBS)

Equity Markets
-
Common stocks, preferred stock and warrants
trade in equity markets
Equity securities trade on stock exchanges
Stock exchanges operate as:
Auction markets (TSE, NYSE, CDNX, ME)
-
or
Over-the-counter (NASDAQ)



Other Markets
Third market – an OTC market for
trading securities listed on organized
exchanges
 Fourth Market – involves transactions
made directly with large institutions by
passing brokers and dealers

Derivatives Markets




-
Derivative securities - derive the value from
underlying assets such as common shares or
bonds
Option - a contract that grants the holder the
right to buy or sell a security at a given price
on or before a given date
Future contracts - agreements to trade assets
at a specific price and time in the future
Two types of futures:
Real commodities  commodity futures contract
Financial obligations  financial future contract
Derivative Markets


-
Options trading occurs on:
Montreal exchange (ME) - Canada
Chicago Board Options Exchange (CBOT) - US
Option positions are issued and guaranteed
by a clearing corporation:
Canadian Derivatives Clearing Corporation
(CDCC) (Canada)
Options clearing corporation (OCC) (US)
Derivative Markets
Canada’s only commodity exchange is
the Winnipeg commodity exchange
(WCE)
 Major North American Commodity
exchanges include:
- Chicago Board of Trade (CBOT)
- Chicago Mercantile Exchange (CME)

Stock Market Indicators

-

-
Canadian indicators include:
TSE 300
S & P TSE 60
CDNX
International indicators include
Dow Jones Industrial Average (US)
S & P 500 Index (US)
Nasdaq Composite Index (US)
Nikkei 225 Average (Japan)
FTSE 100 Index (UK)
Summary
1. Efficient financial markets are required to
channel funds from surplus-spending units
(savers) to deficit-spending units. Typically,
such securities entitle the holder to a stream
of periodic future cash payments.
2. Financial intermediaries allow economies of
scale to be realized when matching surplusspending units with deficit-spending units.
Greater opportunities for portfolio
diversification and money management can
be gained.
Summary
3. Financial markets encompass the
institutions and procedures involved in the
trading of financial assets. They include the
money market (trading of short-term debt
instruments) and the capital market (trading
of long-term securities). The capital market
can be subdivided further into the equity
market and the bond market.
4. Equities are traded either on organized
security exchanges, or on the over-thecounter market.
Summary
5. The Toronto Stock Exchange (TSE) is the
largest secondary market in Canada. The
New York Stock Exchange (NYSE) is the
world’s premier secondary market.
6. Canadian OTC trading takes place through
the Canadian Venture Exchange (CDNX).
Most OTC trading in the United States takes
place on the Nasdaq Stock Market.
Summary
7. The best-known market indicator in Canada
is the TSE 300 Composite Index. The bestknown stock market indicator in the United
States is the Dow Jones Industrial Average
(DJIA).