Chapter 2 | The Capital Market


Characteristic of capital: mobility, sensitivity to its environment, and scarcity

Components of country risk factors: political environment, Economic trends, Fiscal policy, Monetary policy, Investment opportunities, labour force.

Suppliers of capital: Individuals, Non-financial domestic corporations, Governments, Foreign investors

The Sources and Users of Investment Capital

Sources of Capital

-Retail investors are individual clients who buy and sell securities for their personal accounts.

-Institutional investors are organizations, such as pension and mutual fund companies, that trade in large-share quantities or dollar amounts. They typically have a steady flow of money to invest.

-Foreign direct investment in Canada tends to concentrate in manufacturing, petroleum, natural gas, mining, and smelting. Some industries have restrictions on foreign investment.

Users of Capital

-Individuals need capital to finance large purchases such as houses, cars, and major appliances. They usually obtain it in the form of personal loans, mortgage loans, and charge accounts.

-Businesses require massive sums of capital to finance day-to-day operations, renew and maintain plants and equipment, and expand and diversify their activities. They generate much of that capital internally, in the form of profits retained in the business. They borrow from financial intermediaries for other needs, and they raise the remainder in securities markets.

-Governments are major issuers of securities in public markets, either directly or through guaranteeing the debt of their Crown corporations. When revenues fail to meet expenditures, or when they undertake large capital projects, governments must borrow.


The Different Types of Financial Instruments

-Fixed-income securities (also called debt securities) formalize a relationship in which the issuer promises to repay the loan at maturity and, in the interim, makes interest payments to the investor. The term of the loan varies depending on the type of instrument.

-Equity securities (commonly called stocks, equities, or shares) represent some form of ownership stake in the company that issued them. For example, if the value of a company increases, the owner of stock in that company receives a capital gain upon selling it.

-A derivative is a product whose value is derived from the value of an underlying instrument, such as a stock or an index. Unlike stocks and bonds, derivatives are more suited to sophisticated investors.

-Managed products (also called investment funds) are typically pools of capital gathered from investors to buy securities according to a specific investment mandate.

-A structured product is a financially engineered product with the characteristics of debt, equity, and an investment fund.


The capital market is made up of many individual financial markets, including stock markets, bond markets, and money markets. Only short-term fixed-income securities with a term of one year or less trade in the money market.

Primary markets and secondary markets

-In the primary market, newly issued securities are sold by companies and governments to investors. IPO

-In the secondary market, investors trade securities that have already been issued by companies and governments.

Auction market

In an auction market, securities are bought and sold by investors. Investment dealers, who typically act as agents, execute the buy and sell orders on behalf of their clients.

Stock exchanges

A stock exchange is an auction market where buyers and sellers of securities meet to trade with each other and where prices are established according to the laws of supply and demand.

Exchange liquidity

• Frequent trades

• Narrow price spread between bid and ask prices

• Small price fluctuations from trade to trade

Canadian exchanges

• Toronto Stock Exchange (TSX)

• TSX Venture Exchange

• TSX Venture Exchange

• TSX Venture Exchange

• ICE NGX Canada

• Canadian Securities Exchange

• NEO Exchange

Dealer market OTC

OTC consist of a network of banks and investment dealers. Unlike an auction market, where the orders of individual buyers and sellers are entered in a centralized marketplace, a dealer market is a negotiated market where market makers post bid-and-ask quotations via electronic platforms and computer networks. In the OTC market, investment dealers typically act as principals.

-Almost all bonds and debentures are sold through dealer markets.

-Dealer markets are also called unlisted markets.


Investment dealers, who act as market makers, quote their own bids and offers. These market makers hold an inventory of the securities in which they have agreed to make a market.


They can be custom designed by the buyer and seller, with special features added to the basic properties of options and forwards.

Open 24 hours a day


In Canada investment dealers do not have to report unlisted trades except in Ontario.

-web-based system named the Canadian Unlisted Board Inc.


Electronic marketplaces that provide automated matching and execution of trades in both the equity and fixed-income markets.


Alternative trading systems in the equity markets provide automated trade matching and execution of orders from multiple buyers and sellers, a role once performed exclusively by stock exchanges.


All bond and money market securities are sold through dealer markets.

• CanDeal


• MarketAxess

• CanPX