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Prepared by

Ken Hartviksen

INTRODUCTION TO
CORPORATE FINANCE
Laurence Booth W. Sean Cleary
CHAPTER 1
An Introduction to Finance
CHAPTER 1 - An Introduction to Finance 1 - 3
Lecture Agenda
Learning Objectives
Important Terms
Finance Defined
Real versus Financial Assets
The Financial System
Financial Instruments and Markets
The Global Financial Community
Summary and Conclusions
Concept Review Questions
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Learning Objectives
1. What finance is and what is involved in the study of finance.
2. How financial securities can be used to provide financing for
borrowers and simultaneously to provide investment
opportunities for lenders.
3. How financial systems work in general.
4. The channels of intermediation and the role played by
market and financial intermediaries within this system.
5. The basic types of financial instruments that are available
and how they are traded.
6. The importance of the global financial system.

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Key Terms
Bourse de Montral
brokers
Canadian Trading and Quotation System Inc. (CNQ)
capital market securities
common share
corporate finance
Crown corporations
dealer or over-the-counter (OTC) markets
debt instruments
equity instruments
exchanges or auction markets
finance
financial assets
financial intermediaries
fourth market
intermediation
investments
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Key Terms
market capitalization
market intermediary
marketable financial assets
money market securities
New York Stock Exchange (NYSE)
non-marketable financial assets
Ontario Securities Commission
preferred shares
primary markets
real assets
secondary markets
third market
Toronto Stock Exchange (TSX)
TSX Group Inc.
TSX Markets
TSX Venture Exchange
Winnipeg Commodity Exchange
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What Is Finance?
Finance is the study of how and under what
terms savings (money) are allocated between
lenders and borrowers.
Finance is distinct from economics in that it
addresses not only how resources are allocated but
also under what terms and through what channels
Financial contracts or securities occur whenever
funds are transferred from issuer to buyer.
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The Study of Finance
The study of finance requires a basic
understanding of:
Securities
Corporate law
Financial institutions and markets
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Real Versus Financial Assets
Real assets are tangible things owned by
persons and businesses
Residential structures and property
Major appliances and automobiles
Office towers, factories, mines
Machinery and equipment
Financial assets are what one individual has lent
to another
Consumer credit
Loans
Mortgages
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Assets and Liabilities of Households,
2005
Assets $ Billion Liabilities $ Billion
Houses 1,086 Consumer credit 260
Consumer Durables 435 Loans 131
Land 827 Mortgages 588
Real Assets 2,348 Total Liabilities 979
Deposits 683
Debt 114
Pensions and insurance 1,200
Shares 1,254
Foreign and other 72
Financial Assets 3323
Total Assets 5,671
Source: Statistics Canada. National Balance Sheet Accounts, Quarterly Estimates, Fourth
Quarter 2005. Ottawa: Minister of Industry, 2006 (Catalogue No. 13-214-XIE).
Table 1-2 Assets and Liabilities of Households, 2005
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The Financial System
Overview
The household is the primary provider of funds to
businesses and government.
Households must accumulate financial resources throughout their
working life times to have enough savings (pension) to live on in
their retirement years
Financial intermediaries transform the nature of the
securities they issue and invest in
Banks, trust companies, credit unions, insurance firms, mutual
funds
Market intermediaries simply help make markets work
Investment dealers
Brokers
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The Financial System
FIGURE 1-2
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The Financial System
Channels of Intermediation
Funds can be channeled from saver to borrower
in three ways:
Direct intermediation (direct transfer from saver to
borrower a non-market transaction)
Direct intermediation (a market-based transaction
usually through a market intermediary such as a
broker)
Indirect claims through a financial intermediary
(where the financial intermediary such as a bank
offers deposit-taking services and ultimately lends
those deposits out as mortgages or loans)
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Channels of Intermediation
FIGURE 1-3
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The Financial System
Financial Intermediaries
Banks and other deposit-taking institutions
Insurance companies
Pension Funds
Mutual Funds
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Financial Intermediaries
Canadian Chartered Banks
Banks take deposits from numerous depositors from across Canada
The deposits are pooled in the Bank
The bank takes these pooled funds and lends them out to households and
businesses in the form of mortgages and loans
The bank transforms the original nature of the savers (depositors) money:
Deposits are usually small in amountface little or no risk, and depositors
expect to withdraw the amount at any time
Loans and mortgages on the other hand usually have the following
characteristics:
Large sums
Borrowed for long periods of time
Borrowed for risky purposes.
Banks can perform this transformation function because they become
experts at risk assessment, financial contracting (pricing the risk) and
monitoring the activities of borrowers.
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Financial Intermediaries
Canadian Chartered Banks
Bank
Revenue
($ million)
Assets
($ million)
Profits
($ million)
Royal Bank of Canada 29,403 469,521 3,387
Canadian Imperial Bank of Commerce
(CIBC) 18,677 280,370 -32
Bank of Nova Scotia 18,332 314,025 3,209
TD Canada Trust 18,665 365,210 2,229
Bank of Montreal 15,138 297,532 2,400
National Bank 5,320 107,598 855
Source: BMO InvestorLine website: www.bmoinvestorline.com, October 31, 2006.
Table 1-3 Chartered Banks: Financial Statistics, 2005
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Financial Intermediaries
Insurance Companies
Insurers sell policies and collect premiums from customers
based on the pricing of those policies given the probability of a
claim and the size the policy and administrative fees.
They invest the premiums so that the accumulated value in the
future will grow to meet the anticipated claims of the
policyholders.
In this way, unsupportable risks (such as the death of wage
earner or the burning down of a business) are shared among a
large number of policyholders through the insurance company.
Insurance allows households, business and government to
engage in risky activities without having to bear the entire risk of
loss themselves.
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Financial Intermediaries
Insurance Companies
Insurer
Revenue
($ million)
Assets
($ million)
Profits
($ million)
Manulife Financial 32,187 322,171 3,294
Sun Life Financial 21,871 171,850 1,867
Great-West Lifeco 23,883 102,161 1,775
ING Canada 4,446 9,926 782
Source: Data from BMO InvestorLine website: www.bmoinvestorline.com, October 31, 2006.
Table 1-4 Insurance Companies: Financial Statistics, 2005
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Financial Intermediaries
Pension Plan Assets
Individuals and employers make payments over the
entire working life of a person with those funds
invested to grow over time.
Ultimately, the accumulated value in the pension can
be used by the person in retirement.
Pension plans accumulate considerable sums of
money, and their managers invest those funds with
long-term investment time horizons in diversified
portfolios of investments. These investments are a
major source of capital, fuelling investment in
research and development, capital equipment,
resource exploration and ultimately contributing in a
substantial way to growth in the economy.
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Financial Intermediaries
Pension Plan Assets
Pension Plan Managers
Net Assets
($ billion)
Caisse de depot et placement du Quebec 216.1
Canada Pension Plan (CPP) 98.0
Ontario Teachers (Teachers) 96.1
Ontario Municipal Employees (OMERS) 41.6
* The Caisse manages the investments of several pension plans.
Table 1-5 Pension Plan Assets, 2005
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Financial Intermediaries
Canadian Mutual Fund Assets
Mutual funds give small investors access to diversified,
professionally-managed portfolios of securities.
Small investors often do not have the funds necessary to
invest directly into market-traded stocks and bonds.
This is called denomination intermediation because the
mutual fund makes investments available in smaller,
more affordable amounts of money.
Canadian indirect investment in the markets through
managed products such as mutual funds and segregated
funds has grown exponentially.

(see Figure 1-4 on the next slide)
CHAPTER 1 - An Introduction to Finance 1 - 23
Financial Intermediaries
Canadian Mutual Fund Assets
FIGURE 1-4
CHAPTER 1 - An Introduction to Finance 1 - 24
The Financial System
The Major Borrowers
Public Debt
Governments
Federal
Provincial
Municipal
Crown Corporations
Private Debt
Households
Non-financial Corporations

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The Financial System
Largest Non-financial Companies
Non-financial Companies
Revenue
($ million)
Assets
($ million)
General Motors of Canada Ltd. 34,991 n/a
Loblaw Companies Ltd. 27,812 13,761
Magna International Inc. 22,873 12,321
Imperial Oil Ltd. 26,936 15,582
Alcan Inc.* 20,408 26,638
BCE Inc. 19,150 40,630
Bombardier Inc.* 14,882 17,483
Petro-Canada 17,673 20,655
Onex Corp. 17,626 14,845
EnCana Corp.* 14,322 34,148
Source: Data from "The Top 1000 in 2005." Globe and Mail Report on Business website:
www.theglobeandmail.com.
Table 1-6 Non-Financial Canadian Companies: Financial Statistics, 2005
*Company reports in U.S. dollars.
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Financial Instruments
There are two major categories of financial
securities:
1. Debt Instruments
Commercial paper
Bankers acceptances
Treasury bills
Mortgage loans
Bonds
Debentures
2. Equity Instruments
Common stock
Preferred stock
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Financial Instruments
Non-marketable
Characteristics of non-marketable securities
Cannot be traded between or among investors
May be redeemable (a reverse transaction
between the borrower and the lender)
Examples:
Savings accounts
Term Deposits
Guaranteed Investment Certificates
Canada Savings Bonds
CHAPTER 1 - An Introduction to Finance 1 - 28
Financial Instruments
Marketable
Characteristics of Marketable securities
Can be traded between or among investors after their original
issue in public markets and before they mature or expire

Market Capitalization
Is an important term in finance
It is the total market value of a company
It is found by multiplying the number of shares outstanding by
the market price per share.
share per Price shares of Number tion Capitaliza Market
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Financial Instruments
Marketable
Markets can be categorized by the time to maturity:
Money Market Securities (for short-term debt securities that are
pure discount notes)
Bankers acceptances
Commercial Paper
Treasury Bills
Capital Market Securities (for long-term debt or equity
securities with maturities greater than 1 year)
Bonds
Debentures
Common Stock
Preferred Stock

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Financial Markets
Primary Market
Markets that involve the issue of new securities by the
borrower in return for cash from investors (Capital
formation occurs)
Secondary Market
Markets that involve buyers and sellers of existing
securities. Funds flow from buyer to seller. Seller
becomes the new owner of the security. (No capital
formation occurs)
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Financial Markets
Types of Secondary Markets
Exchanges or Auction Markets
Secondary markets that involve a bidding process that takes
place in specific location
For example TSX, NYSE
Dealer or Over-the-counter (OTC) Markets
Secondary markets that do not have a physical location and
consist of a network of dealers who trade directly with one
another.
For example the bond market
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Financial Markets
Other Markets
Third Market
Trading of securities that are listed on organized exchanges
in the Over-the-counter market
Fourth Market
Trading of securities directly between investors (usually
between two large institutions) without the involvement of
brokers or dealers.
Operates through the use of privately owned automated
systems such as Instinet
CHAPTER 1 - An Introduction to Finance 1 - 33
The Global Financial Community
Represents an important source of funds for
borrowers
Provides investors with important alternatives as
they seek to build wealth through diversified
portfolios
CHAPTER 1 - An Introduction to Finance 1 - 34
The Global Financial Community
Total Assets
($ million)
1,016,031
Canadian direct investments abroad 465,058
Canadian portfolio investments 284,604
Portfolio foreign bonds 82,374
Portfolio foreign stocks 189,175
Other portfolio investments 13,055
Other Canadian investments 266,369
Loans 48,325
Allowances
Deposits 120,694
Official international reserves 38,030
Other assets 59,319
Total Liabilities 1,184,534
Foreign direct investments in Canada 415,561
Foreign portfolio investments 508,398
Portfolio Canadian bonds 380,017
Portfolio Canadian stocks 107,598
Portfolio Canadian money market instruments 20,783
Other foreign investments 260,575
Loans 36,107
Deposits 201,639
Other liabilities 22,829
Canada's Net International Investment Position -168,503
Source: Statistics Canada.
Table 1-7 Canada's International Investments, 2005
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Summary
In this chapter you have learned about:
Financial systems in general, and the Canadian
financial system in particular
Major participants in the Canadian financial system,
including the different types of financial securities and
financial markets

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Internet Links
BMO InvestorLine: www.bmoinvestorline.com
Investment Funds Institute of Canada: www.ific.ca
Globe and Mail Report on Business: www.theglobeandmail.com
Toronto Stock Exchange (TSX): http://www.tsx.com/
Canadian Trading and Quotation System Inc.: http://www.cnq.ca/
Ontario Securities Commission: http://www.osc.gov.on.ca/index.jsp
Winnipeg Commodity Exchange: http://www.wce.ca/
New York Stock Exchange (NYSE) Euronext: http://www.nyse.com/

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