Professional Documents
Culture Documents
Chapter 1
Chapter 1
1.1 Introduction:
User of capital = borrowers Investor = supplier of capital
Financial intermediary – institution (i.e. bank) that borrows money from suppliers of capital and lends it to
users of capital
Debt – money borrowed from lenders for various purposes borrowers pays interest for the use of the
money & obligated to repay it at a set date
Equity – ownership interest in a corporation’s stock that represents a claim on its revenue and assets
aka stock
Stock – ownership interest in a corp that represents a claim on its earnings & assets
Market activity is measured by the variety and size of new issues that are brought to the market + depth &
liquidity of trading of those issues
Market participants must have extensive, specialized, and up to date knowledge about securities issuers &
investors in a securities market that is constantly changing
Canadian securities industry is regulated by provinces
Have power to create and enforce their own laws and regulations through securities commission (aka
security administers)
Security commissions delegate some of their power to self-regulatory orgs (SRO) i.e. Investment
Regulatory Organization of Canada (IIROC)
SROs establish and enforce industry regulations that protect investors and maintain fair, equitable, and
ethical practices
SROs responsible for setting the rules that govern investment dealer’s operations (sales, finance, and
trading)
Suppliers and users of capital trade
financial instruments through financial
markets i.e. stock exchanges and money
markets
Investment dealers (aka brokers) act
as intermediaries by matching investors
w/ the users of capital each side of the
transaction has its own dealer who
matches trade through markets
o Investment dealers – a
person/company that engages in
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the business of trading in securities in the capacity of agent or principal and is a member of the
IIROC
o Brokers – investment dealer/duly registered individual that is registered to trade in securities
in the capacity of an agent/principal and is a member of the SRO
Trades and other transactions are cleared and settled through orgs such as CDS Clearing and
Depository Services Inc. and banks
o Clearing – the process of confirming and matching security trade details
o Settlement – irrevocable moment when cash and securities are exchanged
SROs set and enforce rules that govern market activity and monitor the markets to ensure fairness and
transparency
Canadian Investor Protection Fund & similar orgs provide insurance against dealer insolvency
Provincial regulators oversee the markets and the SROs
Canadian Securities Institute and similar orgs provide education for industry participants
Investment Industry Association of Canada – a member based professional association that represents
the interests of market participants
Any org that facilitates the trading/movement of financial instruments that transfer capital btwn
suppliers and users of capital
Investment dealers act on their clients’ behalf as agents in the transfer of financial instruments btwn investors
can also act as principals
Agents – investment dealer operates as an agent when it acts on behalf of a buyer or a seller of a
security and does not itself own title to the securities at any time during the transaction
Principals – the person whom a broker executes an order, of a dealer buying or selling for its own
account may also refer to a person’s capital or to the face amount of a bond
o Bond – a certificate evidencing a debt on which the issuer promises to pay the holder a
specified amount of interest based on the coupon rate, for a specified length of time and to
repay the loan on its maturity
Assets are pledged as security for a bond issue, except in the case of gov’t “bonds” but
the term is used to describe any funded debt issue
Coupon rate – the rate of interest that appears on the certificate of a bond
Multiplying the coupon rate times the principal tells the holder the dollar
amount of interest to be paid by the issuer until maturity
Ex/ a bond w/ a principal of $1000 and a coupon of 10% would pay $100
interest each year
Coupon rates remain fixed throughout the term of the bond aka yield
Principal and agents play a significant role in the securities industry’s two main functions:
1. Help transfer capital from suppliers to users through the underwriting and distribution of new
securities
a. Takes place in the primary market in the form of a primary market distribution (aka
primary offering)
i. Primary market distribution – the issuance of securities in the primary market
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b. When a private company goes public and issue stocks in the primary market for the very first
time sale is called initial public offering (IPO)
2. Maintain secondary markets in which previously issued or outstanding securities can be traded
a. Ex/ buying and selling stocks through the Toronto Stock Exchange
Retail firms include full-service investment dealers and self-directed brokers (aka discount
brokers)
o Full-service retail firms offer wide variety of products and services for retail investor
Provide various levels of advice, depending on the financial and wealth mgmt concern of
their investors
o Self-directed brokers do it yourself approach of investing
Execute trades for clients at reduced rates do not provide investment advice
o Discount brokers – brokerage house that buys and sells securities for clients at a greater
commission discount than full-service firms
Institutional firms – investment dealers that serve exclusively institutional clients, orgs that trade
large volumes of securities
o Institutional clients include pension funds and mutual funds (domestic of foreign
institutional firms)
o Pension funds – pool of assets managed w/ the goal of supplying its beneficiaries w/ income
during their retirement years
Integrated firms – offer products/services across the industry & participate fully in both retail and
institutional markets
o Integrated firms: investment deals that offers products and services that cover all aspect of
the industry, including full participation in both the institutional and retail markets
o Underwrite all types of federal, provincial, and municipal debt, corporate debt and equity issues
o Active in secondary markets money market & Canadian Stock Exchanges and some foreign
exchanges
Investment boutiques – smaller retailer/institutional investment deals specialize in particular market
segments
o Ex/ invest boutique might specialize in stock trading, bond trading, or trading strictly in
unlisted stocks
Chairperson, president, executive VP, directors and departmental VPs (e.g., directors)
Firm may have directors from outside the securities industry
Senior officers work at head office/regional branch officers
Front, Middle, And Back Officers:
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Most investment dealers – allows them to manage client portfolios and process trades in compliance
within regulatory requirements
Success of investment dealers
depend on profits generated by
sales department largest unit
in firm’s front office
Sales department separated into
institutional and retail sales
Retail sales serve individual
investors and smaller business
accounts
o Largest single group of a
firm’s employees
Retail investment advisors perform wide range of activities to meet the complete spectrum of investors’
types and needs
Investment dealers may own the securities as part of their inventory at some stage of buying and selling
transactions w/ investors
Difference btwn buying price and selling price of the securities is their gross profit/loss
Underwriting another principal transaction
o Underwriting in securities context – purchasing from a gov’t body or from a company a new
issue of securities on a given date at a specified price
o Investment dealers use their own capital to buy an issue and then sell it at a profit in the primary
market
After primary distribution is completed, investment dealers act as principals in secondary markets by
maintain an inventory of already issued, outstanding securities
o Dealers buy securities in the open
market hold them in inventory for
varying periods of time and then
sells them
Agency Transactions:
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Participating in secondary markets & maintaining an inventory of outstanding securities, investment
dealers provide several useful services:
o Provide informed advice about terms and features for new issues in primary market based on
their knowledge of current conditions in the secondary markets
o Add liquidity to the market w/ relative ease by making transactions from their inventory, rather
than waiting for simultaneous matching buy-sell orders from other investors
o Act as market makers and carry out market making duties by taking positions in assigned listed
stocks to enhance market liquidity and smooth out undue price distortions
o Buy listed stocks as principals accumulating large blocks of shares, becoming more
competitive in serving their larger institutional clients
o Liquidity they add to the secondary market enhances primary market by assuring that buyers of
new securities will be able to sell their holdings at reasonable prices
Investment dealers also trade from their own account to make a profit
Exchange members act as both buyers & sellers of many listed stocks
^ Doesn’t need each member making a separate settlement w/ another member of each trade during
the course of a trading day
CDS Clearing and Depository Services: provide customer w/ physical and electronic facilities to deposit
and withdraw depository-eligible securities and manage their related ledger positions (securities accounts)
Provides electronic clearing services both domestically and internationally, allowing customers to
report, confirm and settle securities trade transactions
Valued partner to dealers that operate in the securities market providing reliable clearing services
Operates CDSX the facility for clearing and settlement of trades in equity and debt securities in
Canada and for various cross-border transactions
o TSX. TSX Venture Exchange & alternative trading systems report trades to CDSX
Over the counter trades are reported to CDS by participants in the system
Participants w/ access to the clearing and settlement system banks, investment dealers, and trust
companies
Central clearing system uses a process called netting to establish and confirm a credit/debit position balance
in form of cash/security for each dealer member
Netting process complies each firm’s clearing settlement sheets & informs each member of the
securities/funds it must deliver to balance its account
Number of securities and amt of cash that must change hands among the various members each day is
reduced
Chartered Banks:
Primary function of chartered banks is to accept and safeguard deposits from individuals and businesses – in
the form of deposits
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Then lend or transfer those funds to users in form of mtgs, car loans, business loans, and other lending
instruments
Operate under the Bank Act and must function within its regulatory framework
Bank Act – federal legislation that sets out operating rules and restrictions for banks and is updated
regularly (5 year revision cycles)
Banks are designated as Schedule I, Schedule II, or Schedule III
o Each designation has unique rules and regulations surrounding banks’ activities
Canadian owned banks Schedule I
Foreign owned bank Schedule II or Schedule III banks
Sets controls of banks’ activities – particularly on sharing of CX info
Barriers that inhibit info sharing across bank’s various business units firewall
o Firewall: policies implemented to separate and isolate persons within a firm who make
investment decisions from person within a firm who are privy to undisclosed material info
which may influence those decisions
Ex/ separate fax machines for research departments and sales departments
Schedule I Chartered Banks:
Schedule I banks: Canadian-owned banks largest 6 banks in Canada stand out in terms of asset size of
other Canadian-owned banks
1. Bank of Montreal (BMO)
2. Canadian Imperial Bank of Commerce (CIBC)
3. National Bank of Canada
4. Royal Bank of Canada (RBC)
5. Scotiabank
6. Toronto-Dominion Bank (TD Bank Group)
Domestic banks even if they have foreign shareholders
More than 30 domestic Schedule I banks in Canada
6 major banks achieved their dominant asset sizes by establishing network of thousands of retail
branches and ATMS
o Attract and centralize most of the savings of Canadians
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Subsidiaries handle services such as investment dealer activities, self-directed investment & sale of insurance
products
Legislation allows banks to take part in diverse sectors of financial industry
Major source of income for banks activity of lending funds to individuals/companies at an interest rate that
is higher than the interest rate the banks pay out on deposits and other borrowings
Spread btwn two interest rate covers banks’ operating costs (rent, salary, admin, loan losses) & also
provide a margin of profit for the bank
Schedule II and Schedule III Banks:
Schedule II banks: incorporated and operate in Canada as federally regulated foreign bank subsidiaries
regulated by the Bank Act
Deposits that these banks accept may be eligible for deposit insurance provided by the CDIC
May also engage in all types of business permitted to a Schedule I bank
Derive most revenue from retail banking and electronic financial services
Ex/ AMEX Bank of Canada, Citibank Canada, UBS Bank (Canada)
Schedule III bank: federally regulated foreign bank branches of foreign institutions that have been
authorized under the Bank Act to do banking business in Canada
Foreign-owned banks in Canada also provide a conduit for investment of foreign capital in Canada
Providing alternative source of borrowed funds for Canadian corporate borrowers
Deposit taking services, lending, mtgs, mutual funds, insurance, investment dealer services, and debit &
credit cards
Credit unions cater to member-savers from common interest groups
i.e., individuals who live in the same neighbourhood, share similar ethnic backgrounds or belong to the
same business or social group
Federal legislation governing credit unions Cooperative Credit Associations Act (CCAA)
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Sets out a number of limits designed to restrict the exposure of associations to real property and equity
securities
Federally & provincially incorporated trust companies only corps in Canada authorized to engage in
a trust business
Trust companies act as a trustee in charge of corporate and individual assets such as property, stocks,
and bonds
Offer various financial services that overlap services provided by the chartered banks
o Ex/ trust companies accept savings, issue term deposits, make personal and mtg loans, and sell
RRSP and other tax deferred plans, estate planning & asset mgmt
Insurance Companies:
Insurance industry has two main lines of business
1. Life insurance 2. Property & casualty insurance
Life insurance:
Underwriting evaluating the risk and associated contractual responsibility that the insurance
company is willing to accept in exchange for its clients’ insurance premiums
Reinsurance practice of exchanging risk btwn insurance companies to facilitate better risk mgmt
Insurance Companies Act federal legislation governing insurance companies
Bank Act forbids them from selling insurance through their branch networks w/ exception of insurance
related to loans and mtgs
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Other Financial Intermediaries:
Investment funds: companies/trusts that sell shares or units to the public and invest the proceeds in
a diverse securities portfolio, there are two types:
o Closed-end funds: readily transferable in the open market and are bought and sold like other
shares
Capitalization is fixed
o Open-end funds/mutual funds: sell their own new shares to investors, buy back their old
shares, and are not listed
Capitalization is not fixed issue more shares or units as people want them
o Mutual funds: investment fund operated by a company that uses the proceeds from shares
and units sold to investors to invest in stocks, bonds, derivatives and other financial securities
Offer investors the advtgs of diversification and professional mgmt and are sold on a load
or no-load basis
Shares/units are redeemable on demand at the fund’s current net asset value per
share (NAVPS)
Net asset value per share (NAVPS): net asset value represents the market
value of the fund’s share and is calculated as total assets of a corporation less its
liabilities
o Calculated at the close of each trading day
o AKA book value of a company’s difference classes of securities
Savings banks: financial institution whose main role is to accept savings deposits and pay interest on
those deposits
o Set up by gov’t and is similar in function to a credit union
o The Alberta Treasury Branches (ATB Financial) formed in 1938 when chartered banks pulled
out their branches from many smaller towns
o ATB became a provincial crown corporation in 1997 renamed ATB Financial in 2002
Provide full range of financial services to Albertans
Consumer finance companies: makes direct cash loans to consumers, who unusually are unable to
secure a loan from a bank
o Charge higher int rate than banks
Sales finance companies: purchases, at a discount, instalment sales contracts from retailers and
dealers when such items as new cars and appliances are bought on instalment plans
Pension plans: remarkable grown in the institutionalization of savings during the past 60 years
Enable variety of banking and financial products and services online loans, electronic wallets and
automated financial planning software
Challenging role of traditional financial services institutions
Robo-Advisors:
Robo-advisors: online investment service that provides clients with automated investment advice
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Attributes:
Affects all aspects of life education, product delivery, and health care
Baby boomer population reaches retirement age advisors are expected to adjust their service offering
to reflect the needs of their client base
Millennials
High mtg debt, higher student loan debt, lower net worth than baby boomers
Still have time and resource to catch up by employing sound savings and investment strategies
Defined Benefit and Defined Contribution Pension Plans:
Defined benefit (DB) pension plan provides employees w/ a pre-determined specified payment amt of funds
when they retire
Risk longevity, market volatility, and low interest rates are borne entirely by the employer b/c they
have to cover a pension shortfall
Defined Contribution (DC) pension plan employees and employers to contribute to a plan that invest funds
over time to save for retirement
Final benefit amt at retirement will depend on how the contributions are invested over plan’s life
More employers shifting to this to pass the risk of DC to employees
Hybrid pension plans – comb o of DC and DB gaining traction
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Savings Rates:
Common sources of retirement income:
Recommendation: individuals save 10%-20% of their pre-tax income during their working years
Household Debt Levels:
Mortgage debt on principal residence, vacation homes, and other real estate as well as consumer debt
Consumer debt
Cryptocurrency:
Assets that exist only in digital form and use cryptography to prevent counterfeiting and fraudulent
transactions
Relies on peer-to-peer networking and a public ledger to regulate the creation and transfer of assets w/o the
use of intermediary
Ex/ Bitcoin largest and most actively traded cryptocurrency – making its way to traditional investing world
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