Chapter Summary
In this chapter, we comprehensively discussed the following key aspects of the capital market:
Characteristics of Capital
- Mobility: Capital can move from one investment to another, seeking the highest return.
- Sensitivity: Capital is responsive to economic, political, and social changes.
- Scarcity: Limited availability of capital necessitates optimal allocation.
Capital can be invested directly (e.g., buying a house) or indirectly (e.g., purchasing company stock).
Uses of Investment Capital
- Individuals: Use capital for major purchases (e.g., homes, education) and savings accounts.
- Businesses: Use capital to finance operations, plants, equipment, or growth initiatives.
- Governments: Use capital to finance social programs and infrastructure projects.
- Foreign Investors: Utilize Canadian capital when it offers lower borrowing costs compared to other currencies.
Types of Securities
- Bonds and Debentures: Represent the issuer’s debt and come with a promise of repayment at maturity with interest.
- Equity: Represents ownership shares in a company, with investors aiming to profit as the company’s value appreciates.
Financial Markets
Financial markets facilitate capital transfer between investors and users in the following ways:
- Primary Market: Where new issues and initial public offerings (IPOs) are bought and sold.
- Secondary Market: Where previously issued securities are traded among investors.
- Individual Markets: Include stock markets, bond markets, and money markets.
Market Classifications
- Auction Markets: Clients’ bid and ask quotations for a stock are channelled to a stock exchange where they compete.
- Dealer Markets: Networks of dealers who negotiate prices among themselves.
Review Questions
After completing this chapter, you should be able to answer the Chapter 2 Review Questions. Refer to your text materials and class notes to ensure a thorough understanding of the concepts discussed.
Frequently Asked Questions
Should you have any questions about this chapter, you may find the answers in the online Chapter 2 FAQs:
- What is the difference between primary and secondary markets?
- How does investment capital benefit individuals and businesses differently?
- What are the main characteristics of capital?
- How do auction markets differ from dealer markets?
- What role do foreign investors play in the Canadian capital market?
Additional Resources
Consider reviewing the following terms and their definitions to solidify your understanding:
- Capital Mobility: The ability to transfer capital from one investment to another.
- Capital Sensitivity: The responsiveness of capital to changes in the global market environment.
- Capital Scarcity: The limited supply of investable funds, requiring careful allocation.
- Bonds: Debt securities where issuers promise to repay the principal along with interest at maturity.
- Debentures: Unsecured bonds that are backed only by the general creditworthiness of the issuer.
- Equity: Shares representing ownership in a corporation.
Key Takeaways
- Capital’s three characteristics majorly impact how it is strategically invested; these characteristics are mobility, sensitivity, and scarcity.
- Various actors, including individuals, businesses, governments, and foreign investors, utilize capital to achieve distinct objectives.
- Markets, both primary and secondary, play a crucial role in the efficient allocation of capital.
- Understanding market types such as auction and dealer markets can significantly enhance your investment strategizing and decision-making processes.
Mermaid Chart
flowchart TD
A[Capital Markets] -->|Primary Markets| B[New Issues]
A -->|Secondary Markets| C[Existing Securities]
B --> D[IPOs]
B --> E[New Bonds]
C --> F[Stock Trades]
C --> G[Bond Trades]
H[Auction Markets] -->|Exchange Traded| F
I[Dealer Markets] -->|OTC Trades| G
📚✨ Quiz Time! ✨📚
## What are the three characteristics of capital?
- [ ] Portability, profitability, and availability
- [x] Mobility, sensitivity, and scarcity
- [ ] Stability, liquidity, and flexibility
- [ ] Durability, scarcity, and feasibility
> **Explanation:** Capital is characterized by its mobility, sensitivity, and scarcity. These characteristics affect how and where capital is deployed.
## Which of the following is an example of direct investment of capital?
- [ ] Purchasing savings bonds
- [ ] Buying government treasury bills
- [x] Buying a house
- [ ] Investing in mutual funds
> **Explanation:** Direct investment of capital involves purchasing tangible assets like a house, as opposed to financial instruments like stocks or bonds.
## How do businesses primarily use capital?
- [ ] To make major purchases like houses
- [ ] To fund social programs
- [x] To finance operations, plants, equipment, or growth
- [ ] To invest in stocks and bonds
> **Explanation:** Businesses use capital to finance their operations, purchase plants and equipment, and fund growth initiatives.
## How do governments use capital?
- [x] To finance social programs and infrastructure
- [ ] To invest in stock markets
- [ ] To purchase foreign currencies
- [ ] To reduce inflation
> **Explanation:** Governments primarily use capital to finance social programs and infrastructure developments.
## What do bonds and debentures represent for the issuers?
- [ ] Shares of ownership
- [ ] Income from stock market investments
- [x] Debt obligation
- [ ] Equity in the company
> **Explanation:** Bonds and debentures represent a debt obligation where the issuer promises to repay the principal along with interest at maturity.
## What type of equity do investors purchase in a company?
- [ ] Bonds
- [ ] Debentures
- [ ] Government securities
- [x] Shares of ownership
> **Explanation:** Equity represents shares of ownership in a company, offering investors a stake in the company's value appreciation.
## What is the primary function of the financial markets?
- [ ] Only to facilitate stock transactions
- [ ] To support government policies
- [x] To facilitate the transfer of capital between investors and users
- [ ] To reduce interest rates on savings
> **Explanation:** Financial markets function to facilitate the transfer of capital from investors to users, enabling investment and funding needs.
## What distinguishes primary markets from secondary markets?
- [x] Primary markets deal with new issues, while secondary markets deal with previously issued securities
- [ ] Primary markets only sell stocks, while secondary markets only sell bonds
- [ ] Primary markets are regulated, while secondary markets are not
- [ ] There is no distinction; they function the same way
> **Explanation:** Primary markets handle the issuance of new securities, whereas secondary markets trade previously issued securities.
## How are auction markets different from dealer markets?
- [ ] Auction markets are unregulated, while dealer markets are regulated
- [x] In auction markets, bid and ask quotations compete on a stock exchange; dealer markets involve dealers negotiating prices
- [ ] Auction markets deal only with IPOs; dealer markets deal with secondary trading
- [ ] Auction markets are more profitable than dealer markets
> **Explanation:** Auction markets involve competitive bidding on a stock exchange, whereas dealer markets involve price negotiations between dealers.
## Why might foreign investors use Canadian capital?
- [ ] To invest in Canadian retail businesses
- [ ] Due to lower Canadian interest rates compared to other currencies
- [ ] To avoid taxes in their home countries
- [x] Because it costs less to borrow than other currencies
> **Explanation:** Foreign investors may use Canadian capital when it is cheaper to borrow than in other currencies.