2. Terminology
Finance – commercial or government activity of
managing money, debt, credit and investment
Investment – the current commitment of
resources in order to achieve later benefits
• present commitment of money for the purpose of
receiving more money later – invest amount of
money then your capital will increase
• Investor is a person or an organization that buys
shares or pays money into a bank in order to receive
a profit
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3. Definition
(Figure 1.1)
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INVESTMENT SPECULATION GAMBLING
Objective Specific
goal/objectives
Objectives, only
to gain high
return
Based on LUCK
Risk Low risk Moderate to
high risk
High risk
Period Long term Short term Short term
Analysis Fundamental
analysis
Technical
analysis or
based on
herding
behavior
No analysis
Return Current income
(dividend,
interest)
Capital Gain Capital Gain
4. Real Versus Financial Assets
Real assets are tangible things owned by persons and
businesses
• Residential structures and property
• Major appliances and automobiles
• Office towers, factories, mines
• Machinery and equipment
Financial assets are what one individual has lent to
another
• Consumer credit
• Loans
• Mortgages
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5. The Financial System (Overview)
The household is the primary provider of funds to
businesses and government.
• Households must accumulate financial resources throughout
their working life times to have enough savings (pension) to live
on in their retirement years
Financial intermediaries transform the nature of the
securities they issue and invest in
• Banks, trust companies, credit unions, insurance firms, mutual
funds
Market intermediaries simply help make markets work
• Investment dealers
• Brokers
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8. The Financial System (Financial
Intermediaries)
Banks and other deposit-taking institutions
Insurance companies
Pension Funds
Mutual Funds
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9. Financial Intermediaries (Insurance
Companies)
Insurers sell policies and collect premiums from customers
based on the pricing of those policies given the probability of
a claim and the size the policy and administrative fees.
They invest the premiums so that the accumulated value in
the future will grow to meet the anticipated claims of the
policyholders.
In this way, unsupportable risks (such as the death of wage
earner or the burning down of a business) are shared among
a large number of policyholders through the insurance
company.
Insurance allows households, business and government to
engage in risky activities without having to bear the entire risk
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10. Financial Intermediaries (Pension Plan
Assets)
Individuals and employers make payments over the entire
working life of a person with those funds invested to grow over
time.
Ultimately, the accumulated value in the pension can be
used by the person in retirement.
Pension plans accumulate considerable sums of money, and
their managers invest those funds with long-term investment
time horizons in diversified portfolios of investments. These
investments are a major source of capital, fuelling investment
in research and development, capital equipment, resource
exploration and ultimately contributing in a substantial way to
growth in the economy.
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11. Financial Intermediaries (Mutual Fund
Assets)
Mutual funds give small investors access to diversified,
professionally-managed portfolios of securities.
Small investors often do not have the funds necessary to
invest directly into market-traded stocks and bonds.
This is called denomination intermediation because the
mutual fund makes investments available in smaller,
more affordable amounts of money.
Canadian indirect investment in the markets through
managed products such as mutual funds and
segregated funds has grown exponentially.
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12. Investment/Financial Instruments
There are two major categories of financial securities:
1. Debt Instruments
• Commercial paper
• Bankers’ acceptances
• Treasury bills
• Mortgage loans
• Bonds
• Debentures
2. Equity Instruments
• Common stock
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19. Investment/Financial Instruments
(Non-marketable)
Characteristics of non-marketable
securities
• Cannot be traded between or among investors
• May be redeemable (a reverse transaction between
the borrower and the lender)
• Examples:
o Savings accounts
o Term Deposits
o Guaranteed Investment Certificates
o Canada Savings Bonds
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20. Investment/Financial Instruments
(Marketable)
Characteristics of Marketable securities
• Can be traded between or among investors after
their original issue in public markets and before they
mature or expire.
o Equity or debt instrument (share/stock, bond, note) that
is listed on an exchange and can be readily bought or
sold. A marketable security is a near-cash (liquid) asset
and is recorded at acquisition cost (purchase price plus
incidentals, commissions, and taxes) or market value
(whichever is lower) in the account books under current
assets. Non-marketable securities include savings bonds
and restricted shares/stock.
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21. Investment/Financial Instruments
(Marketable)
Markets can be categorized by the time to maturity:
• Money Market Securities (for short-term debt securities that are
pure discount notes)
o Bankers’ acceptances
o Commercial Paper
o Treasury Bills
• Capital Market Securities (for long-term debt or equity securities
with maturities greater than 1 year)
o Bonds
o Debentures
o Common Stock
o Preferred Stock.
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22. Financial Markets
Primary Market
• Markets that involve the issue of new securities by the
borrower in return for cash from investors (Capital
formation occurs)
Secondary Market
• Markets that involve buyers and sellers of existing
securities. Funds flow from buyer to seller. Seller
becomes the new owner of the security. (No capital
formation occurs)
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23. Financial Markets (Types of Secondary
Markets)
Exchanges or Auction Markets
• Secondary markets that involve a bidding process
that takes place in specific location
• For example TSX, NYSE, Malaysian Stock Exchange
Dealer or Over-the-counter (OTC) Markets
• Secondary markets that do not have a physical
location and consist of a network of dealers who
trade directly with one another.
• For example the bond market
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24. Financial Markets (Other Markets)
Third Market
• Trading of securities that are listed on organized
exchanges in the Over-the-counter market
Fourth Market
Trading of securities directly between investors
(usually between two large institutions) without the
involvement of brokers or dealers.
Operates through the use of privately owned
automated systems such as Instinet
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25. The Global Financial Community
Represents an important source of funds for
borrowers
Provides investors with important alternatives as
they seek to build wealth through diversified
portfolios
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26. Summary
In this chapter you have learned about:
• Financial systems in general.
• Major participants in the financial system,
including the different types of financial securities
and financial markets
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