CSC® Exam 1 Study Guide PDF - Investing and Finance
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Uploaded by ProdigiousWaterfall6806
UBC Sauder School of Business
2024
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This document is a study guide for the Canadian Securities Course (CSC®) Exam 1, published in 2024 by SeeWhy Financial Learning. It covers various aspects of the Canadian financial market. The guide includes chapters on the Canadian investment marketplace, the capital market, the Canadian regulatory environment, economics, and economic policy.
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Canadian Securities Course ® CSC® Exam 1 Study Guide © 2024 SeeWhy Financial Learning All rights reserved. No part of this publication may be reproduced or transmitted by any means, electronic, mechanical, photocopying, recording, or otherwise, witho...
Canadian Securities Course ® CSC® Exam 1 Study Guide © 2024 SeeWhy Financial Learning All rights reserved. No part of this publication may be reproduced or transmitted by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of SeeWhy Financial Learning Inc. v10.16 The trademarks CSI, CSC, and Canadian Securities Course are owned by Canadian Securities Institute ("CSI"). CSI does not sponsor, license, or necessarily recommend these notes and study material for its CSC course. SeeWhy Financial Learning is an independent supplier of educational services. Exam preparation materials are not sponsored by any other industry organization. Designed for use with the money-back-guaranteed Online Exam Preparation Tools available at www.SeeWhyLearning.com. SeeWhy Financial Learning Make sure to watch any related CSC® Video Lessons in each study area. If you have not yet added them, you can register using the link in your student account. Designed for use with the money-back-guaranteed Online Exam Preparation Tools available at www.SeeWhyLearning.com. SeeWhy Financial Learning CSC® Volume 1 Study Guide Table of Contents Exam-Writing Skills vs. Knowledge of the Material...................................................... 1 How to Use This Study Guide........................................................................................... 3 SeeWhy Financial Learning's CSC® Exam 1 Complete Study Plan............................. 5 CH. 1: THE CANADIAN INVESTMENT MARKETPLACE................................. 7 Introduction.............................................................................................................. 7 Overview of the Canadian Securities Industry..................................................... 7 The Investment Dealer as Financial Intermediary............................................... 9 Types of Investment Dealers............................................................................... 10 Organization within Firms................................................................................... 10 Principal and Agency Functions.......................................................................... 11 The Clearing System............................................................................................ 12 Financial Intermediaries Other Than Investment Dealers................................ 13 Chartered Banks................................................................................................... 13 Credit Unions and Caisses Populaires................................................................. 14 Trust and Loan Companies.................................................................................. 14 Insurance Companies........................................................................................... 15 Other Financial Intermediaries............................................................................ 15 Financial Market Trends....................................................................................... 16 Financial Technology........................................................................................... 16 Robo-Advisors..................................................................................................... 17 Social and Economic Shifts................................................................................. 17 Cryptocurrency..................................................................................................... 19 CH. 2: THE CAPITAL MARKET............................................................................ 23 Introduction............................................................................................................ 23 Investment Capital................................................................................................. 23 Characteristics of Capital..................................................................................... 24 Suppliers and Users of Capital............................................................................. 25 The Financial Instruments.................................................................................... 26 The Financial Markets........................................................................................... 28 Primary and Secondary Markets.......................................................................... 28 Designed for use with the money-back-guaranteed Online Exam Preparation Tools available at www.SeeWhyLearning.com. SeeWhy Financial Learning CSC® Volume 1 Study Guide Table of Contents Auction Markets................................................................................................... 28 Dealer Markets..................................................................................................... 30 Alternative Trading Systems (ATSs)................................................................... 32 CH. 3: THE CANADIAN REGULATORY ENVIRONMENT............................. 35 Introduction............................................................................................................ 35 The Regulators........................................................................................................ 35 The Canadian Securities Administrators (CSA).................................................. 35 The Self-Regulatory Organizations (SROs)........................................................ 36 Investor Protection Funds.................................................................................... 38 Regulation and Supervision.................................................................................. 42 Purpose of Regulation.......................................................................................... 42 Principles-Based Regulation................................................................................ 42 Securities Regulation in Canada.......................................................................... 43 Disclosure............................................................................................................. 43 The National Registration Database (NRD)........................................................ 45 The Gatekeeper Role............................................................................................ 46 Client Focused Reforms (CFRs).......................................................................... 46 Remediation............................................................................................................ 50 Arbitration............................................................................................................ 50 Ombudsman for Banking Services and Investments (OBSI).............................. 51 Ethical Standards in the Financial Services Industry........................................ 51 Examples of Unethical and Prohibited Sales Practices....................................... 51 CH. 4: OVERVIEW OF ECONOMICS................................................................... 53 Economics Defined................................................................................................. 53 Microeconomics and Macroeconomics............................................................... 53 The Decision-Makers........................................................................................... 54 The Market........................................................................................................... 54 Measuring Economic Growth............................................................................... 57 Gross Domestic Product (GDP)........................................................................... 57 Productivity and Determinants of Economic Growth......................................... 59 The Business Cycle................................................................................................. 59 Economic Indicators............................................................................................ 61 Designed for use with the money-back-guaranteed Online Exam Preparation Tools available at www.SeeWhyLearning.com. SeeWhy Financial Learning CSC® Volume 1 Study Guide Table of Contents Identifying Recessions......................................................................................... 63 The Labour Market............................................................................................... 63 Types of Unemployment...................................................................................... 65 The Role of Interest Rates..................................................................................... 66 Determinants of Interest Rates............................................................................. 66 How Interest Rates Affect the Economy............................................................. 67 Expectations and Interest Rates........................................................................... 68 Negative Interest Rates........................................................................................ 68 The Impact of Inflation.......................................................................................... 70 Inflation, Deflation, and Disinflation................................................................... 70 Measuring Inflation.............................................................................................. 72 Other Inflationary Environments......................................................................... 74 International Finance and Trade.......................................................................... 74 The Balance of Payments..................................................................................... 74 The Exchange Rate.............................................................................................. 76 CH. 5: ECONOMIC POLICY................................................................................... 79 Fiscal Policy............................................................................................................ 79 Role and Function of the Bank of Canada........................................................... 80 Monetary Policy...................................................................................................... 81 Implementing Monetary Policy........................................................................... 82 The Challenges of Government Policy................................................................. 84 CH. 6: FIXED-INCOME SECURITIES: FEATURES AND TYPES................... 87 The Fixed-Income Marketplace............................................................................ 87 The Rationale for Issuing Fixed-Income Securities............................................ 87 The Basic Features and Terminology of Fixed-Income Securities.................... 88 Bonds and Debentures......................................................................................... 88 Bond Terminology............................................................................................... 90 Bond Features...................................................................................................... 91 Callable Bonds..................................................................................................... 93 Extendible and Retractable Bonds....................................................................... 93 Convertible Bonds and Debentures..................................................................... 94 Designed for use with the money-back-guaranteed Online Exam Preparation Tools available at www.SeeWhyLearning.com. SeeWhy Financial Learning CSC® Volume 1 Study Guide Table of Contents Protective Provisions of Corporate Bonds........................................................... 98 Government of Canada Securities........................................................................ 99 Real Return Bonds............................................................................................. 100 Provincial and Municipal Government Securities............................................ 101 Guaranteed Bonds.............................................................................................. 101 Other Provincial Securities................................................................................ 101 Municipal Securities.......................................................................................... 101 Types of Corporate Bonds................................................................................... 102 Mortgage Bonds................................................................................................. 102 Floating-Rate Securities..................................................................................... 102 Other Types of Corporate Debt Issues............................................................... 103 Reading Bond Quotes.......................................................................................... 104 Bond Ratings...................................................................................................... 105 Other Fixed-Income Securities........................................................................... 105 Guaranteed Investment Certificates (GICs)....................................................... 107 Strip Bonds (Also Known as "Zero Coupon Bonds")....................................... 108 Domestic Bonds, Foreign Bonds, and Eurobonds............................................. 109 Liquidity, Negotiability, and Marketability...................................................... 111 CH. 7: FIXED-INCOME SECURITIES: PRICING AND TRADING............... 113 Calculating the Price of a Bond.......................................................................... 113 Calculating the Fair Price of a Bond.................................................................. 113 Fundamental Bond Pricing Properties............................................................... 115 Calculating the Yield on a Bond......................................................................... 118 Current Yield (CY)............................................................................................ 118 Yield to Maturity (YTM)................................................................................... 119 Current Yield Worksheet................................................................................... 121 Approximate Yield to Maturity Worksheet....................................................... 122 Reinvestment Risk............................................................................................. 128 Duration............................................................................................................. 128 Term Structure of Interest Rates....................................................................... 129 The Yield Curve................................................................................................. 129 Bond Market Trading.......................................................................................... 132 Designed for use with the money-back-guaranteed Online Exam Preparation Tools available at www.SeeWhyLearning.com. SeeWhy Financial Learning CSC® Volume 1 Study Guide Table of Contents The Sell Side...................................................................................................... 132 The Buy Side...................................................................................................... 132 Buying Bonds through an Investment Dealer.................................................... 132 Mechanics of the Trade...................................................................................... 133 Clearing and Settlement..................................................................................... 133 Fixed-Income Securities Ownership.................................................................. 134 Accrued Interest................................................................................................. 135 Bond Indexes......................................................................................................... 137 Canadian Bond Market Indexes......................................................................... 137 Global Indexes................................................................................................... 137 Calculating the Yield on Treasury Bills and Strip Bonds................................ 137 CH. 8: EQUITY SECURITIES: COMMON AND PREFERRED SHARES..... 141 Common Shares.................................................................................................... 142 Benefits and Risks of Common Share Ownership............................................ 143 Dividends........................................................................................................... 146 Voting Privileges............................................................................................... 150 Responsible Investment..................................................................................... 151 Stock Splits and Consolidations........................................................................ 153 Canadian Depositary ReceiptsTM....................................................................... 155 Reading Stock Quotes........................................................................................ 157 Preferred Shares................................................................................................... 158 Overview of Preferred Shares............................................................................ 158 Entitlement upon Liquidation (i.e. Preference to Assets).................................. 160 Bringing the Basics Together: An Example of a Preferred Share..................... 161 Potential of Dividends Being Skipped on a Preferred Share............................. 161 Preferred Share Features.................................................................................... 162 Types of Preferred Shares.................................................................................. 164 Floating-Rate Preferred Shares.......................................................................... 166 Why Companies Issue Preferred Shares............................................................ 166 Why Investors Buy Preferred Shares................................................................. 167 Risks of Investing in Preferred Shares............................................................... 168 Types of Preferred Shares.................................................................................. 169 Straight Preferred Shares................................................................................... 170 Convertible Preferred Shares............................................................................. 170 Retractable Preferred Shares.............................................................................. 171 Designed for use with the money-back-guaranteed Online Exam Preparation Tools available at www.SeeWhyLearning.com. SeeWhy Financial Learning CSC® Volume 1 Study Guide Table of Contents Floating-Rate Preferred Shares.......................................................................... 172 Participating Preferred Shares........................................................................... 172 Stock Indexes and Averages................................................................................ 172 Value-Weighted vs. Price-Weighted................................................................. 173 International Indexes.......................................................................................... 176 Environmental, Social, and Governance (ESG) Indexes................................... 176 CH. 9: EQUITY SECURITIES: EQUITY TRANSACTIONS............................ 177 Long and Short Positions..................................................................................... 177 Long Position..................................................................................................... 177 Short Position..................................................................................................... 178 Margin Account Transactions............................................................................ 179 Long Margin Accounts...................................................................................... 180 *Securities Eligible for Reduced Margin........................................................... 181 Short Margin Accounts...................................................................................... 183 A More Detailed Discussion on Short Positions............................................... 186 Risks of Short Selling........................................................................................ 187 Trading and Settlement Procedures................................................................... 188 How Securities Are Bought and Sold................................................................. 189 Types of Orders.................................................................................................. 190 CH. 10: DERIVATIVES............................................................................................. 195 What Is a Derivative?.......................................................................................... 195 The Role of Derivatives........................................................................................ 196 Features Common to All Derivatives................................................................ 197 Derivative Markets – Exchange-Traded vs. Over-the-Counter (OTC)............. 197 Types of Underlying Assets................................................................................. 199 Users of Derivatives.............................................................................................. 199 Individual Investors........................................................................................... 199 Institutional Investors......................................................................................... 199 Corporations and Businesses............................................................................. 200 Derivative Dealers............................................................................................. 201 Options.................................................................................................................. 201 Designed for use with the money-back-guaranteed Online Exam Preparation Tools available at www.SeeWhyLearning.com. SeeWhy Financial Learning CSC® Volume 1 Study Guide Table of Contents Types of Options Contracts............................................................................... 201 Options Terminology......................................................................................... 204 Option Strategies for Individuals....................................................................... 205 Option Strategies for Corporations.................................................................... 207 In, At, and Out of the Money Option Contracts................................................ 207 Intrinsic Value of an Options Contract.............................................................. 209 Time Value of an Options Contract................................................................... 209 Option Exchanges.............................................................................................. 210 Reading Options Quotes.................................................................................... 211 Futures and Forwards......................................................................................... 212 Key Terms and Definitions................................................................................ 213 Futures Trading and Leverage........................................................................... 215 Futures Strategies for Investors......................................................................... 216 Rights and Warrants............................................................................................ 217 Warrants............................................................................................................. 217 Rights................................................................................................................. 218 CH. 11: CORPORATIONS AND THEIR FINANCIAL STATEMENTS............ 223 Corporations and Their Structure..................................................................... 223 Advantages of Incorporation.............................................................................. 224 Disadvantages of Incorporation......................................................................... 225 Private and Public Corporations........................................................................ 225 The Corporate Structure..................................................................................... 228 Financial Statements of a Corporation........................................................................ 229 Statement of Financial Position......................................................................... 230 A Further Discussion on Retained Earnings...................................................... 235 Statement of Comprehensive Income................................................................ 237 Statement of Changes in Equity......................................................................... 239 Depreciation Methods........................................................................................ 241 Inventory Valuation Methods............................................................................ 243 Share of Profits from Associate Companies...................................................... 245 The Annual Report.............................................................................................. 246 Notes to the Financial Statements...................................................................... 246 The Auditor's Report.......................................................................................... 246 Designed for use with the money-back-guaranteed Online Exam Preparation Tools available at www.SeeWhyLearning.com. SeeWhy Financial Learning CSC® Volume 1 Study Guide Table of Contents Public Company Disclosures and Investor Rights............................................ 247 Continuous Disclosure....................................................................................... 247 Statutory Rights of Investors............................................................................. 248 Takeover Bids and Insider Trading................................................................... 249 Takeover Bids.................................................................................................... 249 Insider Trading................................................................................................... 250 CH. 12: FINANCING AND LISTING SECURITIES............................................. 253 Government and Corporate Finance................................................................. 253 Investment Dealer Finance Department............................................................ 253 Canadian (Federal) Government Issues............................................................. 253 Provincial and Municipal Issues........................................................................ 255 Corporate Financing........................................................................................... 255 The Corporate Financing Process...................................................................... 257 The Dealer's Advisory Relationship with Corporations.................................... 257 Method of Offering............................................................................................ 257 Bringing Securities to Market............................................................................. 258 Bought Deal (The Dealer as Principal).............................................................. 258 Best Efforts (The Dealer as Agent).................................................................... 259 When a Prospectus Is Required......................................................................... 259 Preliminary Prospectus...................................................................................... 260 Permitted Activities during the Waiting Period................................................. 262 Final Prospectus................................................................................................. 262 The Short Form Prospectus System................................................................... 263 After-Market Stabilization................................................................................. 265 Securities Distribution through the Exchanges.................................................. 267 Other Methods of Distributing Securities to the Public................................... 267 Junior Company Distributions........................................................................... 267 Options of Treasury Shares and Escrowed Shares............................................ 267 Capital Pool Company Program........................................................................ 268 Crowdfunding.................................................................................................... 268 The Listing Process.............................................................................................. 269 APPENDIX: Calculating the Present Value (Fair Price) of a Bond Using a Financial Calculator....................................................................................................... 273 Designed for use with the money-back-guaranteed Online Exam Preparation Tools available at www.SeeWhyLearning.com. SeeWhy Financial Learning CSC® Volume 1 Study Guide Exam-Writing Skills vs. Knowledge of the Material Exam-Writing Skills vs. Knowledge of the Material When a student fails a regulatory exam, it is not always because he or she did not understand the material. Sometimes, he or she failed because of the way the questions were asked. We have often heard students say, "I knew my stuff, but I just wasn't sure what the question was really asking me". This study guide will help you understand the basics, and the online study tools will make up the difference. The online tools* include exam preparation multiple- choice questions with detailed answer keys and available eLearning Video Lessons. Our online study tools will: Help focus your studies further. Give you practice on dealing with realistic exam questions. Help you learn from your mistakes. *When combined with SeeWhy Financial Learning's study guide, the online study tools are so effective that they come with a money-back guarantee. If you don't pass, you don't pay. Period! There is no risk to you! www.SeeWhyLearning.com The information contained in this study guide is for general informational purposes only. The information is provided by "SeeWhy Financial Learning", and while we endeavour to keep the information up to date and correct, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the study guide or the information, products, services, or related graphics contained in the study guide for any purpose. Information in this study guide should not be interpreted as a recommendation for any specific products or services, nor should it be used as a basis for any real-world course of action. Any reliance you place on such information is therefore strictly at your own risk. In no event will SeeWhy Financial Learning be liable for any loss or damage including, without limitation, indirect or consequential loss or damage, or any loss or damage whatsoever arising from the use of this study guide. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 1 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. 2 CSC® Volume 1 Study Guide How to Use This Study Guide How to Use This Study Guide With a quick glance at the table of contents, you will see that these study notes follow the flow of the actual securities textbook. While we have aligned the order of this guide's sections with the actual textbook, it is not the order in which we suggest you study them. We recommend you start with the fixed-income section (Chapters 6 and 7) and leave Chapters 1 to 5 for last. There are three reasons for this: 1. Chapters 1 to 3 ("The Canadian Investment Marketplace") and Chapters 4 to 5 ("The Economy") discuss the securities industry, the industry participants, how financial instruments are distributed and traded, and the economy as a whole. How can you understand how a financial security is traded if you don't yet have a good handle on what a financial security is? How can you understand how a securities firm is structured if you don't know what a bond is, what a stock is, or what the word "underwriting" means? We believe Chapters 1 to 5 will make much more sense after you have learned the above-mentioned concepts. 2. Much of the content in Chapters 1 to 5 is memorization-type stuff. For example: What is CanPx? or What is CBID? Memorizing these items now is pointless because you will likely forget them by exam day. 3. Students stick to their study plan if they are enjoying what they are learning. Frankly, Chapters 1 to 5 are flat-out boring (for most students). If students start with these chapters, they often lose interest and procrastinate, and by the time they get back to studying, they have forgotten much of what they learned. Most students take the CSC® because they like investments. Learning about stocks and bonds is fun! So why not start there? Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 3 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. 4 CSC® Volume 1 Study Guide Complete Exam 1 Study Plan SeeWhy Financial Learning's CSC® Exam 1 Complete Study Plan Step Section Success Goal Read study guide Study: Fixed-Income Securities 1 Do online flash cards (Chapters 6, 7) Do online quiz questions Read study guide Study: Equity Securities 2 Do online flash cards (Chapters 8, 9) Do online quiz questions Read study guide Study: Derivatives 3 Do online flash cards (Chapter 10) Do online quiz questions Review: Fixed-Income Securities, Re-read study guide sections 4 Equity Securities, and Re-do online flash cards Derivatives Re-do online quiz questions Study: Corporations and Their Read study guide 5 Financial Statements Do online flash cards (Chapter 11) Do online quiz questions Study: Financing and Listing Read study guide 6 Securities Do online flash cards (Chapter 12) Do online quiz questions Study: The Canadian Investment Read study guide 7 Marketplace Do online flash cards (Chapters 1, 2, 3) Do online quiz questions Read study guide Study: The Economy 8 Do online flash cards (Chapters 4, 5) Do online quiz questions Do the randomized exam again Do Randomized Exam 9 and again until you are on SeeWhy's online tools consistently scoring 90%+ Make sure to watch any related CSC® Video Lessons in each study area, if you have added them to your student account. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 5 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. 6 CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace If you have added the full suite of CSC® Video Lessons to your student account, please watch the videos from "The Canadian Investment Marketplace" section. CH. 1: THE CANADIAN INVESTMENT MARKETPLACE Introduction Consider the following scenario: Michael has $1,000,000 in cash that has been ear-marked for his retirement in 10 years. In other words, he has no immediate use for the money. Peter would like to purchase a $1,050,000 home and has saved $50,000 for the down payment. To summarize, Michael has excess capital and is considered a supplier of capital. Peter needs to borrow money and is considered a user of capital. Financial intermediaries such as a bank assist in channelling funds between lenders and borrowers. For instance, an individual with savings (i.e. a supplier of capital) may deposit those funds at the bank in exchange for interest. The bank can then use money on deposit to provide mortgage and consumer loans to borrowers (i.e. users of capital). An intermediary could play a more direct role by assisting a company with the underwriting and distribution of a new security. Example: ABC Enterprise wants to expand operations outside of Canada but requires $1,000,000 in capital. ABC approached a dealer, which suggested issuing five-year bonds with a 4% interest rate. This would allow ABC to raise the capital to fund the expansion. Overview of the Canadian Securities Industry The Canadian capital market is arguably one of the most efficient and sophisticated markets in the world. The entrepreneurial spirit and risk-taking are two of its hallmarks. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 7 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace Market activity is measured by the variety and size of new issues and the trading liquidity associated with such securities. The Canadian market is extremely competitive and requires participants to have extensive, up-to-date knowledge. Regulation While the provinces' securities commissions have ultimate regulatory authority, some responsibilities are delegated downward to allow the investment industry's self-regulatory organization (or SRO) known as CIRO (formerly IIROC and the MFDA) the privilege of regulating their own RRs. The Canadian Investment Regulatory Organization (CIRO) is the national SRO in Canada. It was formed on June 1, 2023, by merging the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association (MFDA). CIRO oversees all investment dealers, mutual fund dealers, and trading activity on debt and equity marketplaces within Canada. Their functions include setting and enforcing rules for the business conduct and financial compliance of Canadian investment and mutual fund firms and their individual registrants in Canada. Various market participants interact with each other in the following ways: Investment dealers (also known as "brokers") Act as financial intermediaries that bring suppliers and users of capital together. Suppliers and users of capital Trade securities through various financial markets (e.g. stock exchanges). CDS Clearing and Depository Services Inc. Clears and settles trades and other transactions through this service. "Clearing" is defined as the process of consolidating and matching security trade details. "Settlement" refers to the moment securities and cash are exchanged (i.e. the purchased securities are paid for). Self-regulatory organization (SRO) Establish and enforce market rules. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 8 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace Canadian Investor Protection Fund (CIPF) Protects investors in the event of the insolvency of a member firm. Provincial regulators Oversee the markets and the SRO. Industry educational providers Provide education for industry participants. The Investment Dealer as Financial Intermediary Recall that a "financial intermediary" is any organization that facilitates the transfer of capital from a saver of capital to a user of capital, typically through financial instruments (stocks, bonds, etc.). Financial intermediaries can include banks, trust companies, insurance companies, and of course investment dealers. As financial intermediaries, dealers can act as a principal (when selling securities from its own inventory) or as an agent (acting as the middleman between the buyer and seller of the security). Investment dealers fulfill two main functions: 1. Underwriting and distributing new securities. This takes place in the primary market. If it is the very first time the company has issued shares, it is known as an "initial public offering" (IPO). 2. Maintaining secondary markets. This is where existing securities can be traded among investors. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 9 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace Types of Investment Dealers The Canadian securities industry is made up of three different types of firms: 1. Retail firms Deal with individual investors. For example, you would likely be considered a retail customer. Dealers can be structured as full-service firms or as discount brokers (also referred to as "self-directed brokers"), which cater to do-it-yourself investors as they do not offer financial advice. 2. Institutional firms Deal with institutional clients. Institutional accounts belong to institutions such as pension funds and mutual funds. Institutional clients can either be domestic or foreign firms (about one-third of all institutional accounts are for foreign firms). 3. Integrated firms Offer products and services to both institutional and retail investors. Note: Some smaller dealers known as "investment boutiques" will specialize in a particular market segment, such as bond trading. Organization within Firms The operational structure of securities firms varies from firm to firm. For example, a larger integrated firm could be organized into front, middle, and back offices (described later), which are each overseen by senior management. Senior Management Senior management usually includes a chairman, president, vice presidents, directors, etc. Senior management will sometimes include directors from outside of the securities industry; for example, perhaps a marketing professional could be a director at the firm. Senior management usually works at the head office level but in some cases could oversee a specific branch region. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 10 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace Three-Level Organization Structure of Most Investment Dealers Level Responsibilities Front Office Fulfills functions pertaining to portfolio management. Has direct contact with the client. Functions include marketing, sales, trading, and portfolio management. Middle Office Fulfills functions essential to efficient operations. Functions include compliance, accounting, auditing, and legal. Back Office Functions include settling the firm's trade transactions. As with most businesses, it should be noted that the success of an investment dealer depends largely on the revenue generated by its sales department. In larger, more integrated firms, the sales department is generally divided into retail and institutional sales divisions. Principal and Agency Functions In the course of conducting their business, investment firms can act as either a "principal" or "agent". Principal Transactions When acting as a principal, firms are selling securities out of their own inventory. The difference, or "spread", between the price the firm pays for the security and the proceeds received when the security is sold represents the profit or loss. The dealer can sometimes act as a principal when underwriting a new issue. In other words, the dealer may buy the security directly from the issuer and then resell the issue to investors. This is referred to as a "bought deal". The dealer can also act as principal in the secondary market by holding an inventory of securities that it sells directly to clients. Agency Transactions Unlike with principal transactions, the dealer does not hold title to the security (i.e. own) with agency transactions. Instead, it acts as the middleman between the seller and buyer of a security. The dealer (broker) earns a commission on the transaction. Note: For most debt securities, the investment dealer acts as a principal selling inventory from its bond desk. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 11 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace Services Provided by Investment Dealers Dealers provide useful services when participating in the secondary market (i.e. where investors trade securities), including the following: Using knowledge based on current conditions in the secondary market to provide valuable advice to a company considering a new issue. Adding liquidity to the marketplace by quickly filling orders from the dealer's own inventory as opposed to trying to match a buyer and seller. Acting as a market maker for a specific security, which involves maintaining a two-sided market for a security where the dealer will hold itself out as a buyer and seller of that security. Buying large blocks of securities as principal, which allows the dealer to better serve institutional clients. The Clearing System To understand what a "clearing system" is, it may help to think of the banking industry. Each day, customers from the various banks write cheques to customers of other banks. In this example, let's just consider two banks, Royal Bank and Bank of Montreal (BMO). Thousands of Royal Bank customers will write cheques that are deposited in Bank of Montreal accounts. Likewise, thousands of Bank of Montreal clients will write cheques that are deposited in Royal Bank accounts. To simplify the clearing process, a clearinghouse will figure out what the net difference is. If Royal Bank owes Bank of Montreal $2 million, but Bank of Montreal owes Royal Bank $3 million, only the net difference of $1 million will change hands (in this case, BMO would pay Royal Bank). The same process takes place in the Canadian securities industry with cash but also with securities. In Canada, securities are cleared through the Canadian Depository for Securities (CDS). By using a clearing system, the amount of cash and securities that needs to change hands each day is substantially reduced. This process is referred to as "netting". It is important to distinguish between "clearing" and "settlement": "Clearing" is the process of matching and confirming the details of a trade. In our example, we match up the cheques that are payable from one bank to another. "Settlement" is the moment when the actual exchange of securities (or cash) takes place. In our example, this occurs when the payment is made from BMO to Royal Bank. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 12 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace Note: The CDS is not considered a financial intermediary; however, it is a valuable partner to such institutions. Financial Intermediaries Other Than Investment Dealers Chartered Banks The primary functions of banks are to collect money from savers (deposits), to safeguard those deposits, and to lend those funds to users of capital through mortgage loans, car loans, lines of credit, etc. All chartered banks in Canada operate under the Bank Act. The Bank Act establishes rules and restrictions for banks. The Bank Act is updated regularly, usually every five years. Under the Bank Act, banks are designated as either Schedule I, Schedule II, or Schedule III banks. Schedule I Chartered Banks (Most Canadian Banks) A Schedule I bank is a Canadian-owned bank (i.e. not a subsidiary of a foreign bank operating in Canada). There are over 30 Schedule I banks in Canada. You are likely familiar with the "big six" banks (CIBC, TD, BMO, RBC, Scotiabank, and National Bank). Voting shares of large Schedule 1 banks must be widely held. To this end, an individual (or group of individuals) is not permitted to own more than 20% of the voting shares. To exaggerate, consider how risky it could be to Canada's financial industry if one extremely rich celebrity decided to buy an entire big-six bank. Schedule I banks offer a wide variety of consumer and commercial banking products. These banks commonly have subsidiaries, such as a life insurance company or investment dealer, that can handle other financial products. The Bank Act controls these activities. For instance, a bank is not allowed to share its client list with one of its subsidiaries. In fact, the bank can refer a client to a subsidiary only with the client's specific approval. Barriers (physical or otherwise) that inhibit the sharing of information between subsidiaries, or even between certain units within the bank, are referred to as "firewalls". Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 13 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace A good example of a firewall would be an advisor at a subsidiary investment dealer not having access to bank client lists, bank account balances, etc. Schedule II Banks Schedule II banks are incorporated and operate in Canada but are owned by a foreign parent bank or other financial institution. They are permitted to engage in the same types of business as a Schedule I bank. Schedule III Banks Schedule III banks are bank branches of foreign institutions that have been authorized under the Bank Act to do banking business in Canada. The government allows foreign banks to operate in this way within Canada. In turn, it helps Canadian banks operate outside of Canada. Credit Unions and Caisses Populaires Credit unions cater to member-savers from groups of individuals that have some common interest or other similarity, such as ethnic background (e.g. Buduchnist Credit Union), business/industry (e.g. Airline Financial Credit Union), or social group/geographic area (e.g. Greater Vancouver Community Credit Union). These institutions offer a wide range of banking services. Credit unions are governed by the Cooperative Credit Associations Act (CCAA). The CCAA requires credit unions to follow a "prudent portfolio approach". For instance, it prohibits substantial investment (over a certain threshold) in other entities unless the entity is on a list of authorized financial and quasi-financial entities. Trust and Loan Companies Trust companies offer many of the same products as banks, but trust companies are currently the only corporations in Canada authorized to act as trustees. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 14 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace Insurance Companies Insurance companies have two main lines of business: 1. Life insurance 2. Property and casualty insurance 1. Life Insurance Offers life, health, and disability insurance, pension plans, RRSPs, and annuities. "Underwriting" is the most important aspect of an insurance business. Underwriting involves evaluating risk, determining what policies to issue, and the appropriate premium. Life insurance companies are entrusted with client premiums. The insurer will invest those premiums but is required to exercise extreme caution. 2. Property and Casualty Insurance Offers home, auto, and commercial insurance. The largest aggregate premium (overall revenue) is for automobile insurance. Other Financial Intermediaries Investment Funds There are two main types of investment funds: 1. Closed-end funds 2. Open-end funds (commonly referred to as "mutual funds"). Closed-end funds The fund company issues a set number of units and then no more. The fund company will not redeem any units until a stated maturity date. In the meantime, an investor can buy or sell existing units on an exchange. Open-end funds The fund company will issue more units upon request. If you want to invest in the fund, the fund company will simply create new units and sell them to you. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 15 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace Upon request, the fund company will redeem your units at the next valuation point based on the "net asset value per share", or NAVPS (a fancy word for "price") at that time. The Alberta Treasury Branches (ATB Financial) ATB Financial (Alberta Treasury Branches) traces its history back to 1938. It was formed to offer financial services when chartered banks withdrew their branches from many smaller towns. Consumer Finance Companies These companies make interest cash loans to individuals who cannot get financing from a traditional lender (e.g. banks). These loans generally carry higher interest rates than those from banks. Sales Finance Companies These companies purchase instalment sales contracts from retailers at a discount. For example, a computer store may sell a computer for $1,000, and the customer contracts to pay the loan in 12 monthly installments. The sale finance company would buy the contract from the store for $930 (a discounted amount) and will then receive principal payments totalling $1,000 plus interest over the year. Pension Plans Pension funds can be either private (an employer or association pension fund) or public (Canada Pension Plan program). Changing demographics (i.e. an aging population) have caused concern over the future viability of the Canada Pension Plan (and Québec Pension Plan). The CPP and QPP will be discussed in greater detail in CSC® Volume 2. Financial Market Trends Financial Technology The financial technology industry (also known as "fintech") uses computer technology to support a variety of banking products and services. Examples include credit card apps on your smartphone or automated financial planning software. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 16 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace Robo-Advisors Traditionally, online investment services provided an execution-only model of self- directed brokerage (i.e. no advice). In recent years, new online investment services that do offer advice have emerged, commonly known as "robo-advisors". While many variations of robo-advisors exist, the following attributes are typical: Portfolios are created using algorithms based on modern portfolio management and online client questionnaires. Portfolios employ goal-based investment management, optimized with tax-efficient rebalancing. Portfolios are largely built with exchange-traded funds and are rebalanced regularly. A human advisor will provide support to varying degrees, usually online or by telephone. Financial planning services may be available to some degree. Social and Economic Shifts The financial industry is affected by social and lifestyle trends, particularly in the following areas: Demographics Pension plans (defined benefit and defined contribution) Savings rates Household debt levels Demographics An important trend is the growing segment of Canadians over age 65 who fall into the "baby boomer" generation. Advisors must adapt the services they offer to better reflect the needs of their aging clients (e.g. offer advice on wealth transition). Over the next 20 years, the number of baby boomers retiring will continue to rise. This will result in a higher demand for products that retirees living on a fixed income will need, such as products that offer interest income and principal replacement. As a result, advisors need to adjust the products and services they offer to meet their clients' needs, which will include a higher percentage of retirees. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 17 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace "Millennials" (born between 1980 to 1995) are the largest segment of the population, accounting for 27% of all Canadians. Millennials present very different characteristics from baby boomers. They have more debt (mortgage and student loan) and lower net worth than baby boomers did at the same age, but they also have a long time horizon. Advisors can recommend appropriate savings and investment strategies to help these young Canadians put themselves in a better financial position. Defined Contribution and Defined Benefit Pension Plans There are two basic types of registered pension plans: Defined contribution plans Defined benefit plans Under "defined contribution plans", the employer (and sometimes the employee) contributes a certain amount each year to the employee's plan. The employee then chooses how he or she wants the money invested, selecting one or more from a limited assortment of investment options (usually a few different mutual funds). Whatever accumulates by the time the employee retires will determine the amount of pension income he or she will receive. Under "defined benefit plans", the employee's eventual pension will be based upon a previously defined formula, and the employer is responsible for depositing enough money in order to make the end benefit possible. If down the road it is determined that the plan is under-funded, the employer may have to deposit more funds, which is captured as a liability on the company's financial statements. Because the employer is promising a set retirement benefit in the future, this makes defined benefit plans susceptible to longevity risk, market volatility risk, and the risk of prolonged low interest rates. Savings Rates Most experts agree that individuals require 70% of their pre-retirement income once they retire, although this is just a general guideline. To reach this goal, it is estimated that 10%–20% of one's pre-tax income should be saved each year, although on average, most Canadians save less than 6%! Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 18 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace There are many potential sources of income in retirement, including the following: Pension plans (employer and government) Social security (e.g. OAS, GIS) Savings (e.g. RRSPs, TFSAs) Selling assets (e.g. fixed assets, businesses) Creating a succession plan for a business (e.g. passing a business on to another family member) Household Debt Levels Household debt is calculated as follows: Household debt = Mortgage debt + Consumer debt Mortgage debt includes mortgages on most kinds of real estate, including the principal residence, vacation homes, and rental properties. Consumer debt includes credit card balances, lines of credit, loans, and other unpaid liabilities such as taxes. When an individual's debt-to-equity ratio makes it difficult to service the debt, especially as interest rates begin to rise, it can lead to stress and bankruptcies for Canadians. While the average debt-to-equity ratio has remained steady recently (at around 170%), it is considerably higher than in 2000 (at around 100%). Education According to the Investor Economics report, education, specifically designations, is an important distinguishing factor for advisors who want to stand out from their competitors as competition continues to grow in the financial services industry. Cryptocurrency "Cryptocurrency" is a form of digital currency that is encrypted using cryptography. This allows for more secure electronic transactions and the transfer of assets by eliminating counterfitting and fraud. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 19 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace Cryptocurrencies all use open-source, decentralized, peer-to-peer technology called "blockchain", which records information in a way that makes it virtually impossible to change it. This creates a shared "public ledger" of transactions that is duplicated and distributed across the entire network of computer systems on the blockchain. Cryptocurrencies carry their own risks, one of which is that they more readily allow for anonymity (the buyers and sellers are unknown), which makes it difficult to monitor transactions for money laundering. By now, just about everybody has heard of Bitcoin (sometimes called "digital gold"), which as of the writing of this study guide is the largest and most actively traded of the many cryptocurrencies in the world. As a result, the majority of this section will focus on Bitcoin. In Chapter 4, we will discuss the "nature of money". For now, know that just as with cash, Bitcoin is both a medium of exchange and a store of value. "Medium of exchange" means it has intrinsic value. "Store of value" means it has monetary value. Bitcoin, the "token" Essentially a piece of computer code that represents ownership of a bitcoin (or fractional ownership), and has financial value. If you wanted to spend your bitcoin it is the "token" that you would be spending. While you can't actually hold a bitcoin token in your hand (remember, it is a piece of computer code), it may help to think of the "token" like a digital coin. Bitcoin, the "protocol" Bitcoin (capital 'B') the protocol is the name given to the "blockchain" network that was described at the beginning of this section. Yes, the same term is used to describe two related things! Private and public keys Bitcoin "wallets", where one's bitcoins are stored, contain a public key and private a key. The private key is like a secret password that allows bitcoins to be spent by the owner. The public key works with the private key to authenticate and authorize transactions. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 20 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 1: The Canadian Investment Marketplace Bitcoin mining All transactions that occur on the platform are independently confirmed by members of the peer-to-peer platform by solving complex mathematical formulas. To do this, members ("miners") use high-powered computers, often called "rigs". The miners are compensated for their efforts in the form of new bitcoins. It is called bitcoin mining because it is kind of like the mining of other commodities, like gold or oil, where you basically have to dig them out of the ground. They're there, but you have to find them and work to extract them. It is very hard and expensive to do, which results in the rewards (newly mined bitcoins) coming slowly to anybody who is willing to make the investment and put in the work. Each bitcoin is a computer file that is stored in a digital wallet through a computer or smart phone. It has the trading symbol BTC. There are many ways investors can purchase bitcoins, most commonly through crypto-exchanges and specific investment products like closed-end mutual funds or ETFs that invest in them. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 21 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 22 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 2: The Capital Market CH. 2: THE CAPITAL MARKET Introduction As discussed in the previous chapter, financial intermediaries assist in the transfer of capital from savers to users. Clearly, the securities industry plays a significant role in expanding the economy. Three elements are of utmost importance to the industry: Financial intermediaries Financial markets Financial instruments This chapter will focus on the characteristics of capital and how it is transferred through intermediaries. Investment Capital "Capital" is nothing more than wealth. Wealth can be measured by physical assets such as buildings, cars, and precious resources, or by "representational" items such as money or bond certificates. Representational items such as stocks and bonds will be the primary focus of this course. Capital savings (cash) is useless by itself. For instance, if you had $1,000,000 but were so afraid of losing it that you put it under your pillow, your money would have done nothing for you. In fact, the real value of your $1,000,000 would have been partially eroded by the effects of inflation. However, when capital savings are used by individuals and corporations, it gains economic significance. If instead you used that same $1,000,000 to start a successful business, that business would create employment opportunities for others and in turn generate tax revenue for the government. The ongoing success of your company would benefit generations to come! Representational capital becomes more significant when it is invested directly or indirectly. Direct investment: Purchasing a house Government investment in roads Starting a new business Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 23 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 2: The Capital Market Indirect investment: Purchasing stock Purchasing a bond Depositing money in a bank You may be wondering, "If I buy shares in a company, why is that indirect investment?" As a memory aid, it may help to think of it this way: if you own your own business, you have direct control over it, but you don't have the same control if you own shares in a company. Characteristics of Capital Capital has three important characteristics. 1. It is mobile. Capital can be easily moved from one investment to another, from one country to another, etc. 2. It is sensitive to its environment. Unless the return of a risky investment adequately rewards the risk incurred, its owner will often move capital to a safer environment. 3. It is scarce. There is limited supply of capital. Country Risk Evaluation Given the three characteristics of capital, investors are extremely selective about where they place their capital. For instance, the flow of investment capital between countries is often guided by country risk evaluation, which includes an analysis of the following: The political environment Economic trends Fiscal policy being implemented by the government (e.g. spending and taxation) Monetary policy being implemented by the government (e.g. interest rates) Investment opportunities The labour force (e.g. skilled, not skilled, etc.) Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 24 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 2: The Capital Market Simply put, capital tends to move towards uses that generate the best risk-adjusted return. Suppliers and Users of Capital The only source of capital is savings! When non-financial institutions, individuals, governments, and non-residents have earnings that exceed their expenditures, they have savings to invest. Individuals, non-financial corporations, and governments can be users and/or suppliers of capital. Who? Supplier User Individuals When revenues exceed When making purchases such expenditures. as a car or home. In other words, the individual is delaying consumption. Non-financial Corporations often generate Businesses require large corporations large savings through amounts of capital to fund day- revenues. to-day operations, expansions, Such funds are often reserved etc. for the company's own business use and therefore are not a significant source of capital. Government Some governments are able to Governments are major issuers operate at a surplus, which is of bond securities. invested. For instance, a government may borrow capital through the issuance of a bond in order to fund a new highway. You may be thinking, "Wouldn't financial institutions such as banks be suppliers of capital?" The fact is that financial institutions are generally not suppliers of capital because they are lending out someone else's money. As previously discussed, banks are an example of a financial intermediary, or "middleman", in the transfer of capital from savers to users. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 25 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 2: The Capital Market The Financial Instruments Later in the course, we will discuss the ways that a corporation can raise investment capital by issuing bonds, where money is borrowed from investors for a specific term in exchange for a fixed interest rate. A bond is an example of a financial instrument as it aids in the transfer of capital from suppliers to users. The following are examples of financial instruments. Don't worry if you aren't overly familiar with these investments...yet! We will discuss them in greater detail as we move through the course. Fixed-Income Securities Bonds, debentures, money market instruments, mortgage-backed securities, and, from an investor's point of view, even preferred shares are all considered "fixed-income" investments. This is because they all pay a fixed income to the holder of the investment. For example, a five-year $1,000 bond with a 5% coupon rate (fancy term for interest rate) would pay the investor $50 in interest per year, plus repay the principal upon maturity. Equity Securities In the simplest of terms, "equity" can be defined as ownership. For example, if you were asked how much equity you have in your home, what you are really being asked is, how much of your home do you actually own (as opposed to how much is still owing on your mortgage)? When you own common shares in a company, you own part, or a "share", of that company. There are two main types of equities: common shares and preferred shares. Derivatives A "derivative" is a contract between two parties wherein one of the individuals can buy or sell the underlying asset at the agreed-upon price. These contracts are called "derivatives" because the value of the contract is based on (or derived from) the value of the underlying asset. Examples of derivatives are "options" and "forward contracts". Managed Products Managed products include mutual funds, exchange-traded funds, and private equity funds. One of the most basic managed products is a mutual fund. Let's explore why managed products exist. Consider the following scenario: Amanda has $3,000 in her bank account to invest. She knows she will not need the money for several years and that she would probably earn a Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 26 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 2: The Capital Market greater return if she invests in the common shares of some good-quality companies. What issues could she face? 1. She may not be comfortable selecting companies in which to invest. 2. If she is comfortable selecting specific companies, she may not have the time to do the required research. 3. She doesn't have sufficient money to invest in enough different companies to properly diversify her portfolio (i.e. to spread out her risk). Investing in a mutual fund solves all three problems. Money from several investors is pooled together. Each investor is given "units" based on how much he or she contributed to the fund. A fund manager is hired to oversee the pooled assets according to the stated objectives of the fund. Return varies for each investor according to the performance of the fund and the number of units he or she holds. Structured Products A "structured product" is a financially engineered investment product that can have the characteristics of bonds, equities, and investment funds. Examples are principal-protected notes and index-linked guaranteed investment certificates. Summary of the Different Financial Instruments Financial Instrument Examples Fixed-Income Security Treasury bill Bond Equity Security Common share Preferred share Derivative Options contract Forward contract Managed Product Mutual fund Exchange-traded fund Private equity fund Structured Product Principal-protected note Index-linked guaranteed investment certificate Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 27 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 2: The Capital Market The Financial Markets Financial markets provide a forum where buyers and sellers of securities can meet. It should be noted that such meeting places are not physical locations. In Canada, the trading of securities takes place on electronic platforms. Primary and Secondary Markets The financial markets include the money market, bond markets, and equity markets. These markets can be categorized as follows: Primary market: The market on which a security is first issued (by a corporation or the government) and sold to an investor. Companies raise money by selling stocks, bonds, etc. to investors. When a company issues stocks for the first time, it is referred to as an "initial public offering" (IPO). Governments raise money by selling Treasury bills, bonds, etc. to investors. Secondary market: Once a security is issued (on the primary market), it can often be traded by one investor to another. This takes place on the secondary market. Investors trade securities with other investors based on mutually agreeable prices. It is important to note that when securities change hands in the secondary market, the trade is strictly between two investors, and therefore the issuing company does not receive any of the proceeds from the trade. Auction Markets One of the purposes of an exchange is to increase liquidity in the marketplace. A "stock exchange" is a marketplace where buyers and sellers of securities meet to trade and where prices are determined by supply and demand. Exchanges are often referred to as "auction markets" because the price agreed upon between a buyer and seller is based on a "bid" and "ask" process. To use an analogy, it is similar to buying a new car. When you walk into a dealership, they tell you their asking price. The customer will then bid a different price. Through negotiation, the buyer and seller will hopefully agree on a price that each of them will accept. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 28 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 2: The Capital Market You need to understand the following terms that pertain to an auction market: Term Meaning Bid The highest price a buyer is willing to pay. Ask The lowest price a seller is willing to accept. Spread The difference between the bid and the ask price. The price at which the last trade on the security took place. It Last price is also referred to as the "market price". A trade takes place only when there is a match in the bid and ask price. Example: Assume the highest bid on a stock is $10.00, and the lowest ask is $10.50. The spread is $0.50. The only way a trade will take place is if either the buyer or the seller, or perhaps both, compromise. For example, if the buyer agrees to raise his bid price to $10.25 and the seller agrees to lower her ask price to $10.25, a trade would take place. Liquidity in the Marketplace A "liquid market" is one where the following conditions exist: Frequent sales. Small price spreads between bid and ask prices. Small price fluctuations from sale to sale. The opposite of a liquid market is a "thin market". Exchanges Stock exchanges help promote liquidity in the marketplace. The following exchanges operate in Canada: Toronto Stock Exchange (TSX) Lists senior equities, income trusts, exchange-traded funds (ETFs), and some debt instruments that are convertible into a listed equity. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 29 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 2: The Capital Market TSX Venture Exchange Trades junior equities (smaller companies) and some debentures. TSX Alpha Exchange Offers trading in some securities that are listed on the TSX and TSX Venture Exchange. The Montréal Exchange Trades all financial and equity futures and options. ICE NGX Canada (formerly The Natural Gas Exchange) Provides a trading mechanism for North American natural gas and electricity markets. The Canadian Securities Exchange Lists equities of emerging (newer) companies. CBOE Exchange Provides listing services and facilitates the trading of securities in public companies, exchange-traded funds, Canadian Depositary Receipts™, special purpose acquisition companies, and closed-end funds. The CBOE exchange is responsible for 15% of all volume traded in Canadian- listed securities. Note: TMX Group is a publicly traded company that owns the TSX, TSX Venture, Montréal (MX), and TSX Alpha exchanges. The TMX Group actually trades on the TSX under the trading symbol "X". Dealer Markets "Dealer markets" consist of networks of dealers who trade with each other either through a computer network or over the telephone. Unlike auction markets, where individual buyers and sellers bid and ask prices are entered, on dealer markets, the actual dealers post the bid and ask prices, thereby acting as market makers for a particular security. Almost all bonds and securities are sold through dealer markets. The volume of trading for debt securities is significantly larger than equities (in dollars). Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 30 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 2: The Capital Market Dealer markets are referred to as "unlisted" markets because securities traded are not listed on an organized exchange. Accordingly, dealer markets are less visible. Over the Counter (OTC) A company's shares may not trade on an exchange for various reasons, including: The company does not meet one or more exchange requirements (e.g. is too small). There is low investor interest. There is low volume of trading in its shares. The company doesn't want the costs associated with listing. The company is unwilling to abide by the exchange rules (e.g. regular reporting). While the shares may not be listed on an exchange, it is still important for investors who own a company's shares to be able to sell them or for investors who want the shares to be able to buy them. For this reason, the "over-the-counter" (OTC) market exists. The name "over the counter" originated in the early days of investing when investors literally traded stocks and bonds over a counter at the local bank. Today, unlisted stocks generally trade in the OTC market through a network of dealers. Trading in the Unlisted Equity Market If a stock is not listed on an exchange, it can trade in the unlisted market. Trades work similar to bond trading, where a dealer acts as a market maker for a particular security. For instance, a dealer making a market for ABC stock would post a bid price (the price at which it is willing to buy ABC shares) and an ask price (the price at which it is willing to sell ABC shares). This creates liquidity for the security, although the dealer can refuse to trade at quoted prices. When an investor wants to buy or sell an unlisted security, the dealer will consult with other market makers to try to obtain the best price for the client. It will charge a commission for this service. OTC Derivatives Market While the majority of derivatives trade on exchanges, some do trade over the counter. The OTC derivative market is dominated by large international financial institutions. The OTC market has no trading floor; instead, the trades take place directly between dealers. The market is open 24 hours. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 31 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 2: The Capital Market Derivatives that trade on an exchange are standardized. For example, all call options represent 100 shares per contract. Alternatively, OTC derivatives can be customized to suit the buyer and seller and therefore can be more complex. Note: If you are still unsure of the definition of "derivatives", don't worry; they will be fully explained in a later chapter. Reporting Trades in the Equity Unlisted Market In most of Canada, investment dealers are not required to report trades of unlisted securities. An exception is in Ontario, where trades must be reported through the Canadian Unlisted Board Inc. web-based system. Alternative Trading Systems (ATSs) ATSs are privately owned computerized trading systems that match buy and sell orders. These alternative systems can be owned by one or more brokerage firms, and they compete with exchanges and other ATSs. Equity Electronic Trading Systems An equity ATS must be registered as an investment dealer and member of CIRO, and it is subject to regulatory filings. While equity ATSs do many of the same things as traditional stock exchanges (e.g. execution of orders), they are not permitted to fulfill all of the same functions. For example, while they can trade securities that are listed on an exchange, the ATS itself cannot list securities. Fixed-Income Electronic Trading Systems With few exceptions, all bond and money market securities are sold through dealer markets. This includes the following fixed-income electronic trading systems: CanDeal Member of CIRO. Recognized as an ATS. Operated by the TMX Group, is a joint venture between Canada's largest investment dealers and is itself an investment dealer. Offers institutional investors (pension funds, mutual funds, etc.) access to government and money market securities. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 32 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 2: The Capital Market CBID An ATS that operates two fixed-income marketplaces, one being retail and the other institutional. MarketAxess Member of CIRO that operates in Québec and Ontario. Provides market data and a trading platform with access to competitive pricing through multiple dealers for a wide range of fixed-income instruments. CanPX A joint venture with several CIRO member firms. Provides investors with real-time bid and offer prices, with volume information on Government of Canada (GOC) bonds and Treasury bills. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 33 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 34 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 3: The Canadian Regulatory Environment CH. 3: THE CANADIAN REGULATORY ENVIRONMENT Introduction The primary goal of regulators is the protection of investors. The regulatory bodies also play a key role in fostering market integrity. Market integrity entails making investors feel confident that they will be treated fairly as market participants. Otherwise, they would not have the confidence to put their savings at risk. To promote market integrity: Industry employees must meet high proficiency standards. Protection funds such as the Canadian Investor Protection Fund provide some protection for investors if a dealer firm goes bankrupt. Regulators have the authority to prosecute wrongdoers in the form of reprimands, fines, suspensions, and even expulsion of licensing. In this chapter, we will discuss the Canadian securities industry as well as the various regulatory bodies. The Regulators Ultimately, it is the applicable provinces' securities commission that has responsibility for regulating the securities industry. However, as each province recognizes the enormity of this task, it has delegated some of its powers down to the self-regulatory organization (SRO), the exchanges, and some of the protection funds. Provinces work closely with these organizations. The Canadian Securities Administrators (CSA) No federal regulatory body exists in Canada; therefore, the provinces and territories formed a joint panel known as the Canadian Securities Administrators (CSA). The purpose of the CSA is to coordinate, improve, and harmonize the regulation of the securities industry across Canada. Its mission is to develop a national regulatory system that fosters fairness and efficiency while protecting investors from unfair or improper sales practices. Designed for use with the money-back-guaranteed CSC® Online Exam Preparation Tools 35 available at www.SeeWhyLearning.com. SeeWhy Financial Learning, Inc. CSC® Volume 1 Study Guide Ch. 3: The Canadian Regulatory Environment The Self-Regulatory Organizations (SROs) As mentioned earlier, the provincial securities commission in each province has delegated some of its supervisory responsibilities down to allow the investment industry's self-regulatory organization (or SRO) known as CIRO the privilege of regulating their own RRs. If it happens that an SRO rule and a provincial securities commission's rule are different, the more stringent (i.e. strict) of the two rules will apply. Trainer's Tip: An SRO regulates their own member's (in accordance with applicable securities legislation). It should be noted that self-regulation is a privilege, not a right! The Canadian Investment Regulatory Organization (CIRO) CIRO is the national SRO in Canada. It was formed on June 1, 2023, by merging the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association (MFDA). CIRO oversees all investment dealers, mutual fund dealers, and trading activity on debt and equity marketplaces within Canada. CIRO performs the following functions: Financial compliance Ensuring firms meet adequate capital requirements to safeguard their stability. Business conduct (sales) compliance. Registration of firms and their licensed associates. Enforcement of rules. Market surveillance of trading and market-related activities Real-time monitoring of trading activity, ensuring dealers comply with disclosure requirements, analyzing trades to ensure compliance with
