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Tuesday January 17, 2012
An Overview of Financial Markets
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Flow of Funds through the Financial
System
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Structure of Financial Markets
Defining the Markets
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Debt Markets
Debt markets: e.g. bond Contractual agreement by the borrower to pay the holder of the
instrument fixed dollar amounts at regular intervals (interest +principal) until a specified time (maturity date)
Maturity: Time until expiry
Short term: Less than one year
Intermediate Term: Greater than one year and less than 10
years Long term: Greater than 10 years
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Equity markets
Equity markets e.g. common stock
Claims to a share in net income (income after expenses andtaxes)
Dividends Long term
Residual claimants
Equity holders benefit directly from increases in the
corporations profitability of asset value Differences between debt and equity position
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Primary and Secondary Markets
Primary Market; Financial market in which new issues ofstocks are bonds are sold.
Secondary Market: securities that have been previouslyissued are resold
Primary markets:
Underwriting
Investment bank
Brokers ; executes the trade on behalf of others Dealers trades business on their own behalf.
Importance of secondary markets are liquidity.
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World Stock Markets
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Rank Name Market Capitalization
1 NYSE $11,837 billion
2 Tokyo Stock Exchange $3,306 billion
3 NASDAQ $3,239 billion
4 Euro Next (Belgium, France,Holland and Portugal) $2,869 billion
5 London Stock Exchange $2,796 billion
6 Shanghai Stock Exchange $2,704 billion
7 Hong Kong Stock Exchange $2,345 billion
8 Toronto Stock Exchange $1,608 billion
9 BM&F ovespa (Brazil) $1,337 billion
10 Bombay Stock Exchange $1,306 billion
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IPO Process In Canada
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Process takes 100 days in Canada
Different but similar process in the US
Company must follow processes set out by provincial law and subject tosecurities regulations.
Process is detailed and includes specifications as to the size of the paperand the colour of the ink used in the prospectus.
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The Underwriter
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Company selects lead underwriter. Underwriter is part of an investment banking firm that
organizes a group of underwriters (known as a syndicate).
Syndicate buys shares in the IPO and sell them to the public.
Underwriter also helps prepare the description of thebusiness ( prospectus)
Prospectus includes information on history of company,future prospects, and risks
Describes the securities that will be used and how theproceeds of the sale will be used.
Content depends on provincial securities act
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Preliminary Prospectus
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Includes all provincially required information Does NOT include:
Final price of share
Underwriters commission,
The number of shares to be sold Net proceeds
That information is decided in the days prior to the offering.
Preliminary prospectus goes through provincial review which
takes up to a month. Provincial regulator could ask for more information or
revisions
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Selling the IPO
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Use the preliminary prospectus as a means of marketing thesecurities.
On Tourdog-and-pony show or a road show
Take prospectus to institutional investors and investmentdealers
Marketing IPO is also subject to strict regulation
Preliminary prospectus is also known as the red herring
Green sheet is the summary of key information from thepreliminary prospectus.
Hit many cities over a several week period
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Selling Continued
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Companies must only discuss information made public viathe green sheet and preliminary prospectus.
May not disclose any confidential information during theroad show.
Violations can result in the postponement of the offering.
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Final Prospectus
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Throughout road show underwriters try to determine levelof interest in the security.
Helps determine how much of the security and at what pricethe offering should be made.
Once those determinations have been made the finalprospectus is filed.
Securities commission issues a receipt and the selling of
shares begins.
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Exchanges and OTC Markets
Two ways to organize secondary markets Exchanges
Buyers and sellers meet in central location
TSE ($2,174 b) and InterContinental Exchange (ICE -Winnipeg)
Over-the-counter
Flexibility
Risk Counterparties?
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Money and Capital Markets
Can also distinguish between markets on basis of maturities Money market is financial market in which only short term
debt instruments (1 year) Money markets are more widely traded
Money markets are more liquid.
Short term securities have smaller fluctuations in price and
so they are safer investments. Money markets are used by corporations to earn interest on
surplus funds that they expect to have only temporarily
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Financial Market Instruments
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Money Market Instruments
Government of Canada Treasury Bills 1,3,6 & 12 month maturities to finance fed govt
Discount to face value
Most liquid
Almost no risk of default
Certificates of Deposit
Sold by bank
Can be resold on secondary markets Small ($10K) or Jumbo (+$100K)
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Money Market Instruments II
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Commercial Paper Unsecured short term debt
Issued by large corporations
Issued at a discount to face value but may trade in interest
bearing form on short maturities Repurchase Agreements (aka repos)
Short term loans (maturity < 14 days)
Secured loan
Overnight Funds Overnight loans to other banks
Fundamental part of Canadas monetary system
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Capital Market Instruments
Debt and Equity instruments with maturities greater than 1 year More price fluctuations implies greater risk
Stocks Equity claims on net income and assets
Mortgages: Loans to households Corporate Bonds: long term bonds
Government of Canada Bonds: these ones do not fluctuate in value
Canada Savings Bonds
Provincial and Municipal Bonds Government Agency Securities
Consumer and Bank Commercial Loans
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Functions of Financial Intermediaries:
Indirect Finance
Transactions Costs: time and money spent carrying out financialtransactions Economies of Scale: reduction in transaction costs as # of transaction
increases
Liquidity: make it easier for customers to conduct transactions
Risk Sharing Asset Transformation: turn risky assets into safer assets
Diversification : invest in portfolio to lower risk
Asymmetric Information: counter parties with unequal
information Adverse Selection (before the transaction)
Moral Hazard (after the transaction)
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Types of Financial Intermediaries
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Depository Institutions (Banks) Chartered Banks Trust and Mortgage Loan Companies (TMLs) Credit Unions and Caisses Populaires (CUCPs)
Contractual Savings Institutions Life Insurance Companies Property and Casualty (P&C) Insurance Companies Pensions funds and government retirement funds
Investment Intermediaries Finance Companies Mutual Funds
Money Market Mutual FundsFor a list of organization operating in Canada see:
http://www.osfi-bsif.gc.ca/app/DocRepository/1/eng/reports/osfi/ar3_e.pdf
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Regulation
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Increasing information available to investors Ensuring the Soundness of Financial Intermediaries
Restrictions on Entry
Disclosure
Restrictions on Assets and Activities
Deposit Insurance
Limits on Competition