Economics of Capital Markets and Corporations

Non-Financial Corporations

• Domestic corporations in sectors such as steel, food distribution, and machinery primarily generate savings through corporate earnings.
• Internally generated funds are usually retained for internal use and not typically invested in other companies’ securities.
• This limits their role in providing permanent capital to external entities in the capital market.

Governments as Capital Players

• Some governments operate with budget surpluses and invest profits, acting as capital suppliers.
• Others, facing deficits, borrow from capital markets, thus becoming capital users.
• Governments are significant issuers of securities, particularly when revenues do not cover expenditures or for large capital projects.

Foreign Investment in Canada

• Canada is viewed favorably by foreign investors, both corporate and individual, resulting in reliance on foreign savings for direct and portfolio investments.
• Capital flows both into and out of Canada, as foreign entities engage in borrowing from Canadian banks or participate in Canadian markets.

Capital Users

• Capital users include individuals, businesses, and governments, both domestically and internationally.
• Capital moves across borders as foreign businesses and governments engage in borrowing and investments in Canada.

Financial Instruments

• Financial instruments formalize relationships between capital suppliers (buyers) and users (sellers) within securities transactions.
• These instruments facilitate capital distribution in a sophisticated economy and typically feature standard characteristics to ease trading.

Types of Financial Instruments

• Fixed-Income Securities: Debt instruments with fixed repayment terms and interest payments, including treasury bills and bonds.
• Equity Securities: Represent ownership stakes in companies with potential for capital gains, e.g., common stock and preferred shares.
• Derivatives: Contracts whose value stems from underlying assets, such as stocks or indices; include options and forwards.
• Managed Products: Investment funds pooling capital to buy securities, examples are mutual funds and exchange-traded funds.
• Structured Products: Financially engineered products combining features of debt, equity, and funds, e.g., principal-protected notes.

Financial Markets Overview

• Financial markets facilitate transactions between buyers and sellers, often using intermediaries like investment advisors.
• Key benefits of financial instruments are maximized in efficient markets that ensure quick transactions and low costs.

Capital Market Structure

• Comprises multiple individual financial markets like stock, bond, and money markets.
• Can be divided into primary markets (newly issued securities sold directly) and secondary markets (trading existing securities).

Primary and Secondary Markets

• Primary Market: Securities are sold for the first time to investors, facilitating capital raising for companies and governments through initial public offerings (IPOs).
• Secondary Market: Investors trade previously issued securities among themselves, with mutual pricing benefiting both buyers and sellers.

Auction Markets

• In an auction market, securities are traded through competitive bidding; investment dealers execute orders on behalf of clients.
• Orders are centralized, allowing buyers and sellers to interact transparently.

This quiz explores the role of non-financial corporations and governments in capital markets. It examines how these entities generate savings, invest, and interact with foreign investors, particularly focusing on Canada. Test your understanding of these economic dynamics.