Canadian Financial Environment Lakehead University September 2004
Introduction Let all participants to financial markets be referred to as economic units. These participants may be surplus-spending units or deficit spending units. Financial markets and financial intermediaries bring these units together and extract some of the gains from trade. 2
The Role of Financial Assets Real versus Financial Assets Physical properties such as land, buildings and inventories are real assets. Assets that provide a claim on a stream of income, such as stocks or bonds, are financial assets. 3
The Role of Financial Assets Real versus Financial Assets Financial assets involve two parties. Financial assets can take the form of debt or equity. There exist other financial assets called derivatives. 4
Financial Markets Primary Markets A primary market is one where a party issues new securities in exchange of cash from an investor. An initial public offering (IPO) is an example of a primary market transaction. The issue of new securities usually involves an investment dealer. A dealer takes risk in exchange of the potential profits from the sale of the new securities. 5
Financial Markets Secondary Markets Secondary markets give investors the opportunity to trade financial assets. These market may or may not have a physical location. In secondary markets with a physical location (exchanges), such as the TSX and the NYSE, trade operates through registered traders and market specialists. In secondary markets without a physical location (over-the-counter markets), trade operates through dealers. 6
Financial Markets Secondary Markets Does the trade of securities in secondary markets affect the original issuers? 7
Financial Markets Third and Fourth Markets Third market refers to trades of exchange-listed stocks over the counter (i.e. not through the exchange). A firm cannot make a market with a listed stock if it is a member of the exchange where the stock is listed but other firms can. Fourth market refers to trades without brokers. These trades are beneficial when they involve large blocks of shares. 8
Financial Markets Global Perspective Euromarkets Eurodollars Eurobonds 9
Classification of Financial Markets Money Market The money market is a dealer (or over-the-counter) market. It involves securities with maturity of less than one year: T-bills, commercial papers, bankers acceptances, etc. 10
Classification of Financial Markets Bond Market Mostly an over-the-counter market. Involves debt securities with maturity of more than one year. Asset-backed securities (ABS) are traded in such markets. 11
Classification of Financial Markets Equity Markets The Toronto Stock Exchange (TSX), The Montreal Exchange (ME) and the Canadian Venture Exchange (CDNX). The New York Stock Exchange (NYSE), the Tokyo Stock Stock Exchange (TSE). These are auction markets. 12
Classification of Financial Markets Derivatives Markets Markets where derivatives such as options and futures are traded. Chicago Board of Trade (CBOT), New York Mercantile Exchange (NYME), etc. Derivatives may also be traded over the counter. 13
Stock Market Indicators Canadian Indices TSE 300, S&P/TSE 60, TSE 100, TSE 200. These are market-weighted indices. An index can also be price weighted (DJIA) or equally weighted. 14
Stock Market Indicators How to calculate the value of an index? Find a list of companies that can be included in the index (because they represent well the stock exchange as a whole or because they represent well small stocks within the exchange, for example). This number must be fixed. Let Pi t and S t i denote the price and number of shares, respectively, of stock i in the index (not necessarily the same from one year to the other) at time t, i = 1,2,...,n. 15
Stock Market Indicators How to calculate the value of an index? The value of a market-weighted index at time t is calculated as follows: I t mv = St 1 Pt 1 + St 2 Pt 2 +... + St np t n S 0 1 P0 1 + S0 2 P0 2 +... + S0 np 0 n K, where K can be 100, 1,000, or any other number. 16
Stock Market Indicators How to calculate the value of an index? For a price-weighted index, the value of the index can be the average price (this is the case of the DJIA), i.e. Ipw t = 1 d t ( P1 t + Pt 2 +... + n) Pt. Note that the divisor (d t ) has to be adjusted over time because of stock splits. When created, the divisor of such a price-weighted index should be the number of stocks in the index. 17
Stock Market Indicators How to calculate the value of an index? A price-weighted index could also be calculated as follows: Ipw t 1 n = ( P1 t + Pt 2 +... + ) Pt n 1 n ( P1 0 + P0 2 +... + ) K, P0 n where, as before, K can be 100, 1,000 or any convenient number. Note that n = d 0. 18
Stock Market Indicators How to calculate the value of an index? An equally-weighted index, on the other hand, is calculated as follows: I t ew = 1 n ( P t 1 P 0 1 + Pt 2 P 0 1 +... + Pt n P 0 1 ) K where as before, K is the starting value of the index. 19