Part 1 The Financial Environment
CHAPTER 1
AN INTRODUCTION TO FINANCE
CHAPTER LEARNING OBJECTIVES
1.1 Define finance and explain what is involved in the study of finance. Finance is the
study of how and under what terms savings (money) are allocated between lenders and
borrowers.
Finance is not just about how resources are allocated but also under what terms and through
what channels the allocations are made. Whenever funds are transferred, a financial contract
1.2 List the major financial and real assets held by Canadians. The four major sectors of the
economy are government, business, households, and non-residents. On an aggregate level, the
1.3 Explain how money is transferred from lenders to borrowers and the role played by
market and financial intermediaries. Money is transferred from lenders to borrowers through
1.4 Identify the basic types of financial instruments that are available and explain how
1.5 Explain the importance of the global financial system and how Canada is impacted by
global events such as the recent U.S. financial crisis. In addition to the domestic financial
markets discussed above, global financial markets represent important sources of funds for
borrowers and provide investors with important alternatives. Indeed, Canadian debt and equity
markets represent only a small proportion of the total global marketplace. Therefore, it makes
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MULTIPLE CHOICE QUESTIONS
1. Finance is the study of how and under what terms
a) savings are allocated between lenders and borrowers.
b) investments are allocated between investors and brokers.
c) institutions with excess money make share purchase decisions.
d) households allocate money between spending and saving.
2. A financial security is
a) a jail term for a financial manager that has committed fraud.
b) a contract that is created only when a new stock is issued to the public.
c) a financial contract created whenever funds are transferred.
d) a contract that is created only when a new bond is first sold.
3. Which of the following does NOT appear as an item on Canada’s balance sheet, as presented
in the text?
a) non-residential structures
b) net worth or equity
c) net foreign liabilities
d) net foreign assets
4. Human capital is
a) based on only the current skills, but not the education, of a country’s citizens.
b) based on only the education, but not the current skills, of a country’s citizens.
c) based on the skills and capital of citizens and should be included in a country’s wealth.
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d) difficult to measure and should therefore not be included in a country’s wealth.
5. Which of the following items is NOT a real asset?
a) land
b) television
c) bond
d) gold mine
6. In the following list, which item is a financial asset?
a) land
b) bond
c) building
d) inventory
7. What is the main difference between real assets and financial assets?
a) Real assets are tangible and financial assets are intangible.
b) Real assets have known values, while the values of financial assets are not known.
c) Real assets are intangible and financial assets are tangible.
d) Real assets have unknown values, while the values of financial assets are known.
8. If Canadian households, in aggregate, own real assets with a market value of $3.194 trillion,
and also own net financial assets with a market value of $2.344 trillion, the total net assets of
Canadian households have a market value of
a) $3.194 trillion
b) $5.538 trillion
c) $–0.850 trillion
d) $0.850 trillion
9. Given the following hypothetical information regarding the real and financial assets in Canada
for 2015 (numbers in $ billions):
Real Assets Net Financial Assets
Government 677 –658
Business 2,202 –1,635
Households 3,194 2,344
What is the value of the total net assets in Canada for 2015?
a) $5,842 billion
b) $6,086 billion
c) $6,124 billion
d) $6,105 billion
10. You are provided with the following hypothetical information regarding the real and financial
assets in Canada for 2015 (numbers in $ billions):
Real Assets Net Financial Assets
Government 677 –658
Business 2,202 –1,635
Households 3,194 2,344
What is the value of the net financial assets owned by non-residents for 2015?
a) $901 billion
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b) $51 billion
c) $2,293 billion
d) There is not enough information to answer the question.
11. Which of the following sectors is NOT a user of savings in the economy?
a) business sector
b) household sector
c) government sector
d) banking sector
12. In Canada, the primary provider of funds to business and government is (are)
a) international banks.
b) large Canadian banks.
c) the household sector.
d) market intermediaries.
13. Entities that invest funds on behalf of others and change the nature of the transactions are
called
a) brokers.
b) financial intermediaries.
c) dealers.
d) market intermediaries.
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14. Joe has just borrowed $5,000 from his aunt in order to make a down payment on a car. This
borrowing transaction is an example of
a) indirect intermediation.
b) direct intermediation.
c) external intermediation.
d) market transaction.
15. An example of direct intermediation would be
a) an individual borrowing money from a bank.
b) an individual borrowing money from her mother.
c) an individual using a real estate broker to finance her home purchase.
d) a stockbroker selling securities to an individual.
16. The three intermediation channels that transfer money from lenders to borrowers are
a) direct, indirect, and financial intermediation.
b) direct, indirect, and monetary intermediation.
c) direct, financial, and monetary intermediation.
d) indirect, financial, and monetary intermediation.
17. Although Canadian banks are involved in almost all areas of the financial system, which of
the following is their core activity?
a) stock market investment activity
b) retirement planning
c) wealth management
d) taking deposits and lending funds
18. Which of the following is NOT a financial intermediary?
a) chartered banks
b) insurance companies
c) pension funds
d) mutual funds
19. Which of the following is NOT one of the main functions performed by mutual funds?
a) pooling sums of money to make investments
b) paying out premiums to their clients
c) providing professional management expertise
d) acting as a “pass–through” for individuals to invest in the equity and debt markets
20. What is the major proportion of Canadian households’ financial assets?
a) stocks and bonds
b) deposits
c) foreign investment
d) claims on retirement and insurance funds
21. Two examples of marketable assets include
a) savings accounts and demand deposits held at financial institutions.
b) provincial and federal savings bonds.
c) demand deposits and provincial savings bonds.
d) equity securities and T-bills.
22. Since March 2000 the Montreal Exchange (ME) has functioned as Canada’s national market
for
a) hedge funds.
b) publicly traded stocks.
c) derivatives.
d) T-bills.
23. Financial markets are usually classified by the type and maturity of the financial assets
traded. The two main classifications are as follows:
a) bond market and money market.
b) money market and capital market.
c) bond market and foreign-exchange market.
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d) commodity market and capital market.
24. Of the following list, who are the dominant players in the money market?
I. individuals
II. corporations
III. governments
a) I and II
b) I and III
c) II and III
d) I, II, and III
25. All common shares are comprised of which two components?
a) ownership and voting rights
b) ownership and dividend rights
c) voting and dividend rights
d) dividend and yield rights
26. Though they are classified as equity, why are preferred shares also similar to debt?
a) Both carry the same interest rate.
b) Dividends on preferred shares must be paid out before any common share dividends.
c) The voting structures for preferred shares and debt are equivalent.
d) Preferred shares have similar maturity structures to debt.
27. Which of the following is NOT a component of debt securities?
a) maturity
b) repayment
c) dividends
d) interest payments
28. An example of a non-marketable financial asset is a
a) demand deposit.
b) T-bill.
c) commercial paper.
d) common share.
29. How do governments obtain the majority of their short- and long-term financing?
a) T-bills and Canada Savings Bonds
b) T-bills, traditional bonds, and Canada Savings Bonds
c) T-bills, equity, and traditional bonds
d) traditional bonds and Canada Savings Bonds
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30. Which of the following is NOT an example of a capital market security?
a) bond
b) debenture
c) common equity
d) T-bill
31. Which of the following is an existing stock exchange in Canada?
a) Toronto Stock Exchange (TSX)
b) Montreal Exchange (ME)
c) Vancouver Stock Exchange (VSE)
d) Winnipeg Stock Exchange (WSE)
32. Which of the following was NOT one of the major objectives in the restructuring of the
Canadian stock exchanges in 1999 and 2000?
a) to create a Canadian market for NASDAQ-listed companies
b) to combine all futures and options trading on one exchange
c) to make the TSX the official exchange for the trading of Canadian senior stocks
d) to create a single national exchange for trading in junior company stocks
33. A market where transactions are made directly between large institutions and wealthy
individuals that bypass brokers and dealers is an example of
a) the primary market.
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b) the secondary market.
c) the third market.
d) the fourth market.
34. The main difference between exchanges and dealer/OTC markets is
a) exchanges are a part of the primary market, while dealer and OTC markets are part of the
secondary market.
b) transactions in dealer markets are conducted entirely by humans, not electronically.
c) exchanges have a physical location while dealer and OTC markets do not.
d) All of the above are differences between exchanges and dealer markets.
35. The exchange that acts as the Canadian national derivatives market and conducts all
options and futures trading is called the
a) Bourse de Montreal.
b) Winnipeg Commodity Exchange.
c) TSX Venture.
d) Alpha Exchange.
36. Which is the only province where trades in unlisted securities need to be reported?
a) British Columbia
b) Quebec
c) Alberta
d) Ontario
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37. Which one of the following is NOT a function of brokers?
a) Manage money for clients.
b) Make the market work.
c) Charge a fee for their services.
d) Assist with the transaction process.
38. What was NOT a reason for the credit crunch of 2008–09?
a) mistrust between financial intermediaries
b) illiquidity of debt markets
c) the arrest of Bernard Madoff
d) bankruptcy of one of the leading financial institutions
39. Who are the biggest borrowers and lenders in Canada, respectively?
a) government and households
b) government and banks
c) banks and mutual funds
d) Crown corporations and banks
40. Why can’t the Canadian government issue equity?
a) because assets belong to all Canadians
b) it is not listed in the financial markets
c) it has too much debt
d) because expenditures exceed revenues
41. If the stock of a listed firm decreases by 50 percent, what does it mean to the shareholders?
a) Their ownership of the firm will decrease by 50 percent.
b) Total value of their holdings decreases by 50 percent.
c) The debt of the firm decreases by 50 percent.
d) nothing
42. The consolidation of U.S. and global stock markets has
a) been increasing recently, as shown by the merger of the NYSE and Euronext.
b) been decreasing recently, as shown by the decrease in multi-listed stocks.
c) led to lower risk in investments because markets have become less interdependent.
d) led to increased reliance on human interactions in securities trading.
43. The two sectors that are normally regarded as the lowest risk in the financial market are
a) T-bills and loans extended to PIIGS countries.
b) demand deposits and loans to countries that have taken austerity measures.
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c) household mortgages and government debt.
d) government debt and foreign company borrowings.
44. Which of the following is NOT a benefit of global financial markets?
a) They represent important sources of funds for borrowers.
b) They provide diversification benefits to Canadian investors.
c) Canadian companies can list their shares in different markets.
d) The value of Canadian shares becomes more stable.
45. Which is the world’s largest and most famous stock market?
a) New York Stock Exchange (NYSE)
b) Toronto Stock Exchange (TSX)
c) Tokyo Stock Exchange (TSE)
d) London Stock Exchange (LSE)
46. The spread of the financial crisis in the autumn of 2008 was NOT augmented by
a) linkages between global financial markets.
b) the cross listing of firms in different markets.
c) the consolidation of the global financial system.
d) excessive debt of the government.
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PRACTICE PROBLEMS
47. How do financial intermediaries help those with “too much money today” and those with “not
enough money today”?
48. What are the differences between the primary markets and the secondary markets?
49. Why is the secondary market important?
50. What is an over-the-counter market? Do all bonds in Canada trade over-the-counter?
51. Explain what an auction market is and how it works.
52. Define and describe the difference between the third and fourth markets.
53. Explain why primary markets are the key to the wealth creation process.
54. Explain the gravity of the situation of pension holders in Quebec after the loss of 25 percent
of La Caisse de Depot’s portfolio (pension fund manager of Quebec) in 2008.
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