Ch01
- 1. INTRODUCTION TO CORPORATE FINANCE Laurence Booth • W. Sean Cleary Prepared by Ken Hartviksen
- 2. CHAPTER 1 An Introduction to Finance
- 3. Lecture Agenda • Learning Objectives • Important Terms • Finance Defined • Real versus Financial Assets • The Financial System • Financial Instruments and Markets • The Global Financial Community • Summary and Conclusions – Concept Review Questions CHAPTER 1 - An Introduction to 1-3 Finance
- 4. Learning Objectives 1. What finance is and what is involved in the study of finance. 2. How financial securities can be used to provide financing for borrowers and simultaneously to provide investment opportunities for lenders. 3. How financial systems work in general. 4. The channels of intermediation and the role played by market and financial intermediaries within this system. 5. The basic types of financial instruments that are available and how they are traded. 6. The importance of the global financial system. CHAPTER 1 - An Introduction to 1-4 Finance
- 5. Key Terms • Bourse de Montréal • brokers • Canadian Trading and Quotation System Inc. (CNQ) • capital market securities • common share • corporate finance • Crown corporations • dealer or over-the-counter (OTC) markets • debt instruments • equity instruments • exchanges or auction markets • finance • financial assets • financial intermediaries • fourth market • intermediation • investments CHAPTER 1 - An Introduction to 1-5 Finance
- 6. Key Terms • market capitalization • market intermediary • marketable financial assets • money market securities • New York Stock Exchange (NYSE) • non-marketable financial assets • Ontario Securities Commission • preferred shares • primary markets • real assets • secondary markets • third market • Toronto Stock Exchange (TSX) • TSX Group Inc. • TSX Markets • TSX Venture Exchange • Winnipeg Commodity Exchange CHAPTER 1 - An Introduction to 1-6 Finance
- 7. What Is Finance? • Finance is the study of how and under what terms savings (money) are allocated between lenders and borrowers. – Finance is distinct from economics in that it addresses not only how resources are allocated but also under what terms and through what channels • Financial contracts or securities occur whenever funds are transferred from issuer to buyer. CHAPTER 1 - An Introduction to 1-7 Finance
- 8. The Study of Finance • The study of finance requires a basic understanding of: – Securities – Corporate law – Financial institutions and markets CHAPTER 1 - An Introduction to 1-8 Finance
- 9. 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 CHAPTER 1 - An Introduction to 1-9 Finance
- 10. Assets and Liabilities of Households, 2005 Table 1-2 Assets and Liabilities of Households, 2005 Assets $ Billion Liabilities $ Billion Houses 1,086 Consumer credit 260 Consumer Durables 435 Loans 131 Land 827 Mortgages 588 Real Assets 2,348 Total Liabilities 979 Deposits 683 Debt 114 Pensions and insurance 1,200 Shares 1,254 Foreign and other 72 Financial Assets 3323 Total Assets 5,671 So urce: Statistics Canada. N ationalB al ance Sheet A ccounts, Quar l E stimates, F our tery th Quar 2005. Ottawa: M inister o f Industry, 2006 (Catalo gue No . 1 ter 3-214-XIE). CHAPTER 1 - An Introduction to 1 - 10 Finance
- 11. 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 CHAPTER 1 - An Introduction to 1 - 11 Finance
- 12. The Financial System FIGURE 1-2 CHAPTER 1 - An Introduction to 1 - 12 Finance
- 13. The Financial System Channels of Intermediation • Funds can be channeled from saver to borrower in three ways: – Direct intermediation (direct transfer from saver to borrower – a non-market transaction) – Direct intermediation (a market-based transaction usually through a market intermediary such as a broker) – Indirect claims through a financial intermediary (where the financial intermediary such as a bank offers deposit-taking services and ultimately lends those deposits out as mortgages or loans) CHAPTER 1 - An Introduction to 1 - 13 Finance
- 14. Channels of Intermediation FIGURE 1-3 CHAPTER 1 - An Introduction to 1 - 14 Finance
- 15. The Financial System Financial Intermediaries • Banks and other deposit-taking institutions • Insurance companies • Pension Funds • Mutual Funds CHAPTER 1 - An Introduction to 1 - 15 Finance
- 16. Financial Intermediaries Canadian Chartered Banks • Banks take deposits from numerous depositors from across Canada • The deposits are ‘pooled’ in the Bank • The bank takes these pooled funds and lends them out to households and businesses in the form of mortgages and loans • The bank transforms the original nature of the savers (depositors) money: – Deposits are usually small in amount…face little or no risk, and depositors expect to withdraw the amount at any time – Loans and mortgages on the other hand usually have the following characteristics: • Large sums • Borrowed for long periods of time • Borrowed for risky purposes. • Banks can perform this transformation function because they become experts at risk assessment, financial contracting (pricing the risk) and monitoring the activities of borrowers. CHAPTER 1 - An Introduction to 1 - 16 Finance
- 17. Financial Intermediaries Canadian Chartered Banks Table 1-3 Chartered Banks: Financial Statistics, 2005 Revenue Assets Profits Bank ($ million) ($ million) ($ million) Royal Bank of Canada 29,403 469,521 3,387 Canadian Imperial Bank of Commerce (CIBC) 18,677 280,370 -32 Bank of Nova Scotia 18,332 314,025 3,209 TD Canada Trust 18,665 365,210 2,229 Bank of Montreal 15,138 297,532 2,400 National Bank 5,320 107,598 855 So urce: B M O Investo rLine website: www.bmo investorline.com, October 31 2006. , CHAPTER 1 - An Introduction to 1 - 17 Finance
- 18. 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 of loss themselves. CHAPTER 1 - An Introduction to 1 - 18 Finance
- 19. Financial Intermediaries Insurance Companies Table 1-4 Insurance Companies: Financial Statistics, 2005 Revenue Assets Profits Insurer ($ million) ($ million) ($ million) Manulife Financial 32,187 322,171 3,294 Sun Life Financial 21,871 171,850 1,867 Great-West Lifeco 23,883 102,161 1,775 ING Canada 4,446 9,926 782 So urce: Data fro m B M O InvestorLine website: www.bmoinvesto rline.com, Octo ber 31 2006. , CHAPTER 1 - An Introduction to 1 - 19 Finance
- 20. 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. CHAPTER 1 - An Introduction to 1 - 20 Finance
- 21. Financial Intermediaries Pension Plan Assets Table 1-5 Pension Plan Assets, 2005 Net Assets Pension Plan Managers ($ billion) Caisse de depot et placement du Quebec 216.1 Canada Pension Plan (CPP) 98.0 Ontario Teachers (Teachers) 96.1 Ontario Municipal Employees (OMERS) 41.6 * The Caisse manages the investments o f several pensio n plans. CHAPTER 1 - An Introduction to 1 - 21 Finance
- 22. Financial Intermediaries Canadian 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. (see Figure 1-4 on the next slide) CHAPTER 1 - An Introduction to 1 - 22 Finance
- 23. Financial Intermediaries Canadian Mutual Fund Assets FIGURE 1-4 CHAPTER 1 - An Introduction to 1 - 23 Finance
- 24. The Financial System The Major Borrowers • Public Debt – Governments • Federal • Provincial • Municipal • Crown Corporations • Private Debt – Households – Non-financial Corporations CHAPTER 1 - An Introduction to 1 - 24 Finance
- 25. The Financial System Largest Non-financial Companies Table 1-6 Non-Financial Canadian Companies: Financial Statistics, 2005 Revenue Assets Non-financial Companies ($ million) ($ million) General Motors of Canada Ltd. 34,991 n/a Loblaw Companies Ltd. 27,812 13,761 Magna International Inc. 22,873 12,321 Imperial Oil Ltd. 26,936 15,582 Alcan Inc.* 20,408 26,638 BCE Inc. 19,150 40,630 Bombardier Inc.* 14,882 17,483 Petro-Canada 17,673 20,655 Onex Corp. 17,626 14,845 EnCana Corp.* 14,322 34,148 *Co mpany repo rts in U.S. do llars. So urce: Data fro m "The To p 1000 in 2005." Glo be and M ail Repo rt o n B usiness website: www.theglo beandmail.co m . CHAPTER 1 - An Introduction to 1 - 25 Finance
- 26. 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 – Preferred stock CHAPTER 1 - An Introduction to 1 - 26 Finance
- 27. 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: • Savings accounts • Term Deposits • Guaranteed Investment Certificates • Canada Savings Bonds CHAPTER 1 - An Introduction to 1 - 27 Finance
- 28. 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 • Market Capitalization – Is an important term in finance – It is the total market value of a company – It is found by multiplying the number of shares outstanding by the market price per share. Market Capitalization = Number of shares × Price per share CHAPTER 1 - An Introduction to 1 - 28 Finance
- 29. 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) – Bankers’ acceptances – Commercial Paper – Treasury Bills • Capital Market Securities (for long-term debt or equity securities with maturities greater than 1 year) – Bonds – Debentures – Common Stock – Preferred Stock CHAPTER 1 - An Introduction to 1 - 29 Finance
- 30. 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) CHAPTER 1 - An Introduction to 1 - 30 Finance
- 31. 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 • 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 CHAPTER 1 - An Introduction to 1 - 31 Finance
- 32. 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 CHAPTER 1 - An Introduction to 1 - 32 Finance
- 33. 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 CHAPTER 1 - An Introduction to 1 - 33 Finance
- 34. The Global Financial Community Table 1-7 Canada's International Investments, 2005 ($ million) Total Assets 1,016,031 Canadian direct investments abroad 465,058 Canadian portfolio investments 284,604 Portfolio foreign bonds 82,374 Portfolio foreign stocks 189,175 Other portfolio investments 13,055 Other Canadian investments 266,369 Loans 48,325 Allowances Deposits 120,694 Official international reserves 38,030 Other assets 59,319 Total Liabilities 1,184,534 Foreign direct investments in Canada 415,561 Foreign portfolio investments 508,398 Portfolio Canadian bonds 380,017 Portfolio Canadian stocks 107,598 Portfolio Canadian money market instruments 20,783 Other foreign investments 260,575 Loans 36,107 Deposits 201,639 Other liabilities 22,829 Canada's Net International Investment Position -168,503 So urce: Statistics Canada. CHAPTER 1 - An Introduction to 1 - 34 Finance
- 35. Summary • In this chapter you have learned about: – Financial systems in general, and the Canadian financial system in particular – Major participants in the Canadian financial system, including the different types of financial securities and financial markets CHAPTER 1 - An Introduction to 1 - 35 Finance
- 36. Internet Links • BMO InvestorLine: www.bmoinvestorline.com • Investment Funds Institute of Canada: www.ific.ca • Globe and Mail Report on Business: www.theglobeandmail.com • Toronto Stock Exchange (TSX): http://www.tsx.com/ • Canadian Trading and Quotation System Inc.: http://www.cnq.ca/ • Ontario Securities Commission: http://www.osc.gov.on.ca/index.jsp • Winnipeg Commodity Exchange: http://www.wce.ca/ • New York Stock Exchange (NYSE) Euronext: http://www.nyse.com/ CHAPTER 1 - An Introduction to 1 - 36 Finance
- 37. Copyright Copyright © 2007 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (the Canadian copyright licensing agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these files or programs or from the use of the information contained herein. CHAPTER 1 - An Introduction to 1 - 37 Finance