copyright © 2006 pearson education canada inc. 15-1 chapter 15 money, banking, and securities...
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15-1
Copyright © 2006 Pearson Education Canada Inc.
Chapter 15
Money, Banking, and Securities Markets
15-2 Copyright © 2006 Pearson Education Canada Inc.
Learning ObjectivesDefine 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.
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Learning ObjectivesDiscuss 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.
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Money
Any object generally accepted by people as payment for goods and servicesCharacteristics: 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 moneyThe 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 suppliesMajor source of consumer spendingAre a substitute for money, but they are not moneyAre 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 BanksPrivately 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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Services Offered by Banks
Pension services Trust services International services Financial adviceBuy/sell securities
Electronic Fund Transfer (EFT)Debit CardBank depositsBank loansBank accounts
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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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Bank Loans
Major source of short-term financing for businessBanks prefer to finance inventories or accounts receivable rather than provide long-term 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
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Banks As Creators of Money
Bank New DepositReserve
Requirement New Loan
1 $100.00 $10.00 $90.00
2 $90.00 $9.00 $81.00
3 $81.00 $8.10 $72.90
4 $72.90 $7.29 $65.61
5 $65.61 $6.56 $59.05
6 $59.05 $5.91 $53.14
7 $53.14 $5.31 $47.83
8 $47.83 $4.78 $43.05
9 $43.05 $4.31 $38.74
Totals for the first nine banks $612.58 $61.26 $551.32
Expansion limit for entire banking system $1,000.00 $100.00 $900.00
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Other Changes in BankingChanges 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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The Bank of Canada
The central bank of CanadaManaged by a Board of Governors Regulates operations of the chartered banksManages the economy by manipulating the money supply to expand or restrict the economy
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Monetary Policy Actions of the Bank of Canada
Expansionary Policy Restrictive PolicyTools (stimulate business (slow down business activity
activity and increase the and decrease the moneymoney supply) supply)
Open Buy government securities: Sell government securities:
Market (increases bank reserves (decreases bank reserves
Operations enabling banks to make loans limiting the banks' abilities to businesses and to make loans to businesses
consumers) 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 banks to borrow, fewer loans canbe made to businesses and be made to businesses and
consumers) consumers)
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Pillar #2: Alternate BanksTrust 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 firmsFactoring companiesFinancial corporationsVenture capital or development firmsPension 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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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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Venture Capital Firms
Provide funds for new or expanding firms that have great potentialObtains funds from individual investors, financial intermediaries, retained earningsWhile accepting increased risk with new ventures, VC firms seek to earn higher than normal returns
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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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Pillar #4: Investment Dealers
Stock brokers or underwritersPrimary distributors of new stock and bond issues (underwriting)Facilitate trading of stocks and bonds, both on stock exchanges and on over-the-counter stock and bond markets
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Other Sources of FundsGovernment 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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Exchange Rates and TradeExchange 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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The Law of One PriceA 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 Big Mac Price(Local Dollar)
Big Mac Price Equiv.
(US Dollars)
Over/Under
Valuation
United States $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%
TheBigMacIndex
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International Payments Process
Local banks convert payments to the currency required by foreign trade associatesLocal banks then send payment, in foreign currency, to the foreign trade partnerThe foreign trade partner deposits the payment in his/her own foreign-based bankWhen 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 balanceBanks also trade currencies
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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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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 StockIssued 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 companyLess risky than common stockLimited growth potential due to the fixed dividend
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Stock ExchangesVoluntary 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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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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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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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 BondsSecured 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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Retiring BondsCallable 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 timeConvertible Option of receiving common stock in lieu of cash
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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 riskInvestments 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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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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Reading Bond Quotations
Your Daily Paper Issuer Coupon Maturity Price Yield Change
BC Tel 9.65 Apr 8-22 138.5 6.488 +1.118
Company NameCompany NameCouponCoupon(interest rate %)(interest rate %)
Maturity DateMaturity Date(April 8, 2022)(April 8, 2022)
PricePrice(Last transaction(Last transactionprice = $138.50)price = $138.50)
YieldYield((Annual interestAnnual interestMarket price)Market price)
ChangeChange(Closing (Closing price upprice up$1.11 from$1.11 fromprevious day)previous day)
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Reading Stock Quotations
Your Daily Paper Company Sales High Low Close Change
Inco 376 030 29.150 28.500 28.600 -.400
StockStock
SalesSales(Total number of(Total number ofshares traded)shares traded)
CloseClose(Last price paid(Last price paidat close of trading)at close of trading)
HighHigh(Highest price (Highest price paidpaidper share for per share for the day the day was $29.15)was $29.15)
LowLow(Lowest price paid(Lowest price paidper share for the per share for the day day was $28.50)was $28.50)
ChangeChange(Difference (Difference betweenbetweentoday’s price today’s price andandprevious day’s. previous day’s. A A .40 decrease).40 decrease)
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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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Buying and Selling StocksMarket 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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Short SaleAn investor sells shares from the broker without paying for them The investor is “borrowing” the shares from the broker for a period of timeIn order to return the borrowed shares, the investor must purchase the equal number of shares later and return them to the brokerProfit or loss is based on the spread between the selling price and the purchasing price
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Securities Regulations
Brokers are licensed and securities are registeredBlue-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