5.1
Basic Economic Theories
Economics provides the theoretical foundation for understanding why markets behave as they do. Three major schools of economic thought underpin modern policy-making: Keynesian, Monetarist, and Supply-Side. Each has different prescriptions for how governments should respond to recessions, inflation, and economic growth challenges.
Keynesian, Monetarist & Supply-Side Theories
📈 Keynesian Economics
Origin: John Maynard Keynes, 1930s (Great Depression era).
Core belief: Markets are not self-correcting in the short run. In recessions, private demand falls, causing prolonged unemployment. Government must step in with fiscal stimulus.
Policy prescription: Increase government spending during downturns (deficit spending). Use fiscal policy actively. The "multiplier effect" — $1 of government spending generates more than $1 of economic activity.
Weakness: Risk of government crowding out private investment. Deficits accumulate debt. Time lags mean stimulus arrives late.
Canadian relevance: The 2008–09 and 2020 COVID stimulus packages were Keynesian responses.
Core belief: Markets are not self-correcting in the short run. In recessions, private demand falls, causing prolonged unemployment. Government must step in with fiscal stimulus.
Policy prescription: Increase government spending during downturns (deficit spending). Use fiscal policy actively. The "multiplier effect" — $1 of government spending generates more than $1 of economic activity.
Weakness: Risk of government crowding out private investment. Deficits accumulate debt. Time lags mean stimulus arrives late.
Canadian relevance: The 2008–09 and 2020 COVID stimulus packages were Keynesian responses.
💵 Monetarist Economics
Origin: Milton Friedman, 1960s–70s.
Core belief: Inflation is "always and everywhere a monetary phenomenon." The money supply drives nominal economic activity. Markets are generally efficient and self-correcting if left alone.
Policy prescription: Control the money supply at a steady, predictable rate. Avoid erratic fiscal policy. Let markets adjust. Central banks should follow rules, not discretion.
Weakness: Assumes stable velocity of money (V in MV=PQ). Fails to account for credit creation by banks and non-bank lenders.
Canadian relevance: The Bank of Canada's inflation targeting framework reflects monetarist influence.
Core belief: Inflation is "always and everywhere a monetary phenomenon." The money supply drives nominal economic activity. Markets are generally efficient and self-correcting if left alone.
Policy prescription: Control the money supply at a steady, predictable rate. Avoid erratic fiscal policy. Let markets adjust. Central banks should follow rules, not discretion.
Weakness: Assumes stable velocity of money (V in MV=PQ). Fails to account for credit creation by banks and non-bank lenders.
Canadian relevance: The Bank of Canada's inflation targeting framework reflects monetarist influence.
⚙️ Supply-Side Economics
Origin: 1980s (Reagan "Reaganomics," UK Thatcherism).
Core belief: Economic growth is driven by increasing the productive capacity of the economy. Stimulate the supply side, not demand. High taxes reduce incentives to invest and work.
Policy prescription: Cut taxes (especially business/capital gains taxes), reduce regulation, privatize state enterprises. "Trickle-down" economics — benefits flow from producers to workers/consumers.
Weakness: Tax cuts often increase inequality. Benefits may not "trickle down" as expected. Can result in large deficits.
Relevance: Corporate tax cuts in the US (2017 Tax Cuts and Jobs Act) were supply-side measures.
Core belief: Economic growth is driven by increasing the productive capacity of the economy. Stimulate the supply side, not demand. High taxes reduce incentives to invest and work.
Policy prescription: Cut taxes (especially business/capital gains taxes), reduce regulation, privatize state enterprises. "Trickle-down" economics — benefits flow from producers to workers/consumers.
Weakness: Tax cuts often increase inequality. Benefits may not "trickle down" as expected. Can result in large deficits.
Relevance: Corporate tax cuts in the US (2017 Tax Cuts and Jobs Act) were supply-side measures.
How Fiscal and Monetary Policies Interact
Fiscal policy is controlled by the government (Ministry of Finance) — taxes and spending. Monetary policy is controlled by the central bank (Bank of Canada) — interest rates and money supply. Both affect aggregate demand, but through different channels.
Policy Mix
The combination of fiscal and monetary policy at any given time is called the policy mix. Both can be expansionary (stimulative) or contractionary (restrictive). The mix matters — tight monetary policy (high rates) combined with loose fiscal policy (deficit spending) can result in higher interest rates as the government borrows more, potentially crowding out private investment.
Crowding Out
When the government borrows heavily, it competes with private borrowers for available capital, pushing up interest rates and crowding out private investment. This is why some economists argue Keynesian stimulus can be self-defeating in practice.
Policy Coordination
In Canada, the Bank of Canada operates independently but the government and central bank coordinate their policy outlooks. For example, during COVID, both the government (massive spending) and the Bank (zero interest rates + QE) acted simultaneously in the same expansionary direction.
Automatic Stabilizers
Built-in fiscal mechanisms that automatically stimulate the economy in downturns without legislative action. Key examples: unemployment insurance (payments rise automatically in recessions), progressive income tax (tax revenues fall automatically as incomes decline). These dampen the business cycle without requiring active policy decisions.
How Interest Rates Are Determined & How They Affect Inflation
Interest rates are the price of borrowing money. In Canada, the key short-term rate is the Bank of Canada's overnight rate — currently held at 2.25% as of March 2026. This rate directly influences all other short-term rates in the economy.
The Loanable Funds Theory
Interest rates are determined by the supply of and demand for loanable funds (savings). When savings supply increases, rates fall. When investment demand increases, rates rise. Central banks influence rates by adjusting the supply of reserves in the banking system.
The Yield Curve — Normal, Flat, Inverted
Normal Yield Curve
Long-term rates exceed short-term rates. Investors demand a premium for holding longer-term securities (time value, uncertainty). Signals positive economic expectations. Most common state.
Flat Yield Curve
Short and long-term rates are approximately equal. Signals uncertainty or transition — market is unsure about economic direction. Can precede inversion.
Inverted Yield Curve
Short-term rates exceed long-term rates. Historically one of the strongest predictors of recession. Signals that markets expect the central bank to cut rates significantly in the future (i.e., the economy will weaken). Canada experienced an inverted yield curve in 2022–23 before the Bank began cutting rates.
Interest Rates and Inflation — The Relationship
Higher interest rates reduce inflation by:
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Reducing borrowing and spending — mortgages, car loans, business credit all become more expensive, reducing aggregate demand
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Strengthening the currency — higher rates attract foreign capital seeking yield, pushing up the exchange rate, making imports cheaper
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Reducing asset prices — higher discount rates reduce the present value of future cash flows (stocks, real estate), reducing the "wealth effect" on consumer spending
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Signalling credibility — markets trust the central bank will keep inflation low, so inflation expectations stay anchored
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Current Context
The Bank of Canada cut its overnight rate from 5.00% (June 2024) to 2.25% (October 2025) — 275 basis points of cuts — in response to slowing inflation and economic weakness. As of March 2026, the rate remains at 2.25% amid global trade uncertainty. CPI inflation was 1.8% in February 2026 — below the 2% target.
Market Equilibrium
Market equilibrium is the price at which the quantity of a good or service demanded equals the quantity supplied. At equilibrium, there is no tendency for the price to change. Key concepts:
Supply & Demand
Prices rise when demand exceeds supply (shortage). Prices fall when supply exceeds demand (surplus). The equilibrium price clears the market. In securities markets, equilibrium price is the market price where buyers and sellers agree.
Shifts vs Movements
A movement along the demand curve occurs when price changes. A shift of the entire demand curve occurs when a non-price factor changes (income, expectations, preferences). The exam may test whether a scenario describes a shift or a movement.
Price Mechanism
The price mechanism allocates resources in a market economy. Rising prices signal producers to produce more; falling prices signal consumers to demand more. This is how supply and demand equilibrate without central direction.
The Business Cycle / Economic Cycle
The business cycle describes the recurring pattern of expansion and contraction in economic activity. It has four phases. Understanding each phase is critical for investment strategy and industry analysis (section 5.5).
THE FOUR PHASES OF THE BUSINESS CYCLE
🟢 Expansion / Recovery
GDP: Rising
Unemployment: Falling
Inflation: Moderate, rising
Interest rates: Low to moderate
Markets: Bull market, equities rise
Best sectors: Consumer discretionary, technology, financials
Unemployment: Falling
Inflation: Moderate, rising
Interest rates: Low to moderate
Markets: Bull market, equities rise
Best sectors: Consumer discretionary, technology, financials
🟡 Peak
GDP: Maximum
Unemployment: Minimum
Inflation: High
Interest rates: Rising (central bank tightening)
Markets: Topping out
Best sectors: Energy, materials, commodities
Unemployment: Minimum
Inflation: High
Interest rates: Rising (central bank tightening)
Markets: Topping out
Best sectors: Energy, materials, commodities
🔴 Contraction / Recession
GDP: Falling
Unemployment: Rising
Inflation: Falling
Interest rates: Central bank cuts
Markets: Bear market, equities fall
Best sectors: Consumer staples, utilities, healthcare (defensive)
Unemployment: Rising
Inflation: Falling
Interest rates: Central bank cuts
Markets: Bear market, equities fall
Best sectors: Consumer staples, utilities, healthcare (defensive)
🔵 Trough
GDP: Minimum
Unemployment: Maximum
Inflation: Low
Interest rates: Lowest
Markets: Bottoming out, recovery starting
Best sectors: Begin rotating back to cyclicals as recovery approaches
Unemployment: Maximum
Inflation: Low
Interest rates: Lowest
Markets: Bottoming out, recovery starting
Best sectors: Begin rotating back to cyclicals as recovery approaches
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Technical Definition of Recession
A recession is technically defined as two consecutive quarters of negative real GDP growth. However, in Canada, the C.D. Howe Institute's Business Cycle Council provides the official recession dating, which considers multiple economic indicators beyond just GDP. The COVID recession of 2020 was severe but brief (two quarters); Canada experienced a mild contraction in 2022–23 due to rate hikes.
Determinants of Long-Term Economic Growth
Labour Force Growth
More workers = more output, assuming other factors constant. Canada's immigration policy is explicitly designed to grow the labour force to counteract an aging population and maintain economic growth.
Capital Accumulation
Investment in physical capital (machinery, equipment, infrastructure, buildings) increases the productive capacity of the economy. Higher savings rates support more capital investment.
Technological Progress
The most powerful long-term driver of growth. Productivity improvements allow more output from the same inputs. R&D, education, innovation, and digital transformation all contribute.
Human Capital
Education, skills, and health of the workforce. More educated workers are more productive. Canada's investment in post-secondary education contributes to human capital development.
Institutions & Rule of Law
Stable legal institutions, property rights, contract enforcement, and low corruption enable economic activity. Countries with weak institutions consistently underperform economically.
International Trade, Balance of Payments & Exchange Rates
Balance of Payments (BoP)
The balance of payments is a record of all economic transactions between residents of a country and the rest of the world in a given period. It has two main components:
Current Account
Records trade in goods and services, plus net income (dividends, interest) and current transfers. A current account deficit means the country is importing more than it exports — the country is a net borrower from abroad. Canada typically runs a current account deficit. The US runs a large chronic current account deficit.
Capital & Financial Account
Records investment flows — foreign direct investment (FDI), portfolio investment (stocks, bonds), and other capital movements. When Canada runs a current account deficit, the capital account must be in surplus — foreigners are net investors in Canadian assets to finance the deficit.
BoP Must Balance
By accounting identity, the current account + capital account = 0 (plus statistical discrepancy). A deficit in one must be offset by a surplus in the other.
Exchange Rates
The exchange rate is the price of one currency in terms of another. For Canada, the CAD/USD rate is the most important — the US accounts for ~75% of Canadian trade.
Factors that Strengthen CAD
Rising commodity prices (Canada is a commodity exporter — oil, metals, grains). Higher interest rates (attract foreign capital). Stronger Canadian economic growth relative to US. Narrowing current account deficit. Positive risk sentiment.
Factors that Weaken CAD
Falling oil prices. Lower Canadian interest rates relative to US. US dollar strength (safe haven flows). Canadian economic weakness. Trade deficits. Risk-off market sentiment (CAD is a risk currency).
Impact on Investments
A stronger CAD reduces returns from US/foreign investments when converted back to CAD. Currency risk is a key consideration for portfolio management. Hedged vs unhedged ETFs differ in their currency exposure.
Purchasing Power Parity (PPP)
Long-run theory that exchange rates adjust so that the same goods cost the same in both countries (when converted). The Big Mac Index is a famous (informal) PPP measure. Useful for long-term analysis but rates can deviate from PPP for extended periods.
5.2
Factors that Influence the Macroeconomy
Bank of Canada — Monetary Policy
The Bank of Canada (BoC) is Canada's central bank, established in 1935. It operates independently from the federal government but works within the framework of a joint Inflation Control Agreement with the government, renewed every 5 years. The current target is 2% CPI inflation, with a 1–3% control range.
The Bank of Canada's Primary Tools
Overnight Rate Target
The primary tool. The Bank sets the target for the overnight interest rate — the rate at which major financial institutions lend to each other overnight. Currently 2.25% (March 2026). The Bank Rate (charged on overnight loans to financial institutions) is set at the target + 0.25%. Changes announced on 8 fixed dates per year.
Open Market Operations
The Bank buys and sells government securities to manage liquidity in the banking system. Buying securities injects money (expansionary); selling withdraws money (contractionary). Primary mechanism for hitting the overnight rate target.
Quantitative Easing (QE)
Used when conventional rate cuts are insufficient (rates near zero). The Bank purchased government bonds and other securities directly, expanding the money supply and pushing down long-term rates. Canada used QE extensively in 2020–21 during COVID. The Bank began quantitative tightening (QT) — allowing bonds to mature without replacement — in 2022.
Forward Guidance
The Bank communicates its future policy intentions through speeches, Monetary Policy Reports (MPR — published 4 times/year), and press conferences. Forward guidance shapes market expectations, affecting bond yields and the exchange rate even without actual rate changes.
CORRA — Canadian Overnight Repo Rate Average
The benchmark overnight rate that replaced CDOR (Canadian Dollar Offered Rate) as of July 2024. CORRA is the risk-free overnight reference rate for Canadian dollars, used for pricing floating-rate securities and derivatives.
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2024–2026 Rate Cycle Context
The Bank of Canada cut rates 7 times between June 2024 and October 2025 — 275 basis points total — from 5.00% to 2.25%. This was a response to inflation falling back to the 2% target and economic softness. Since October 2025 the rate has been held at 2.25% (3 consecutive holds). As of March 2026, CPI inflation was 1.8% and GDP contracted 0.6% in Q4 2025.
Monetary Policy Transmission Mechanism
How does changing the overnight rate affect the real economy? There are multiple channels:
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Interest rate channel: Higher rates → higher borrowing costs → less consumer/business borrowing → lower spending → lower inflation
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Exchange rate channel: Higher rates → stronger CAD → cheaper imports → lower inflation; weaker exports
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Asset price channel: Higher rates → lower equity and real estate values → negative wealth effect → reduced consumer spending
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Credit channel: Higher rates → tighter lending standards → less credit available → reduced economic activity
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Expectations channel: Credible inflation targeting → anchored inflation expectations → self-fulfilling price stability
Government Fiscal Policy & Intervention
Fiscal policy is the use of government spending and taxation to influence economic activity. It is the domain of the federal and provincial governments, not the central bank.
Expansionary Fiscal Policy
Increase government spending and/or cut taxes → increases aggregate demand → stimulates GDP growth → appropriate during recessions. Risk: increases fiscal deficit and government debt. Canada's debt-to-GDP ratio rose significantly during COVID (from ~31% to ~48%) due to emergency spending.
Contractionary Fiscal Policy
Decrease government spending and/or raise taxes → reduces aggregate demand → appropriate when economy is overheating. Risk: can tip a slowing economy into recession if poorly timed.
Government Intervention Types
Direct: Crown corporations, public ownership of industries. Regulatory: Setting prices, standards, operating rules for private firms. Tax incentives: SR&ED credits for R&D, flow-through shares for mining. Subsidies: Supporting strategic industries. Trade policy: Tariffs, quotas, free trade agreements (CUSMA/USMCA).
Federal Budget
Canada's federal budget is presented annually (typically March/April) by the Minister of Finance. It outlines expected revenues (taxes), expenditures (programs, transfers), and the resulting surplus/deficit. Bond markets react to budget announcements — large deficits can push up government bond yields.
5.3
Economic Indicators
Economic indicators are statistics that provide information about the current state and direction of the economy. They fall into three categories based on their timing relative to the business cycle.
Leading Indicators
Change before the economy changes — used to predict future economic direction. Examples: stock market, building permits, new manufacturing orders, consumer confidence, yield curve slope, money supply (M2).
Coincident Indicators
Change at the same time as the economy. Provide current status. Examples: GDP, employment levels, personal income, retail sales, industrial production.
Lagging Indicators
Change after the economy changes — confirm trends already underway. Examples: unemployment rate, CPI inflation, prime lending rate, outstanding loans, average duration of unemployment.
Business Conditions Indicators
Leading
Building Permits
New permits for construction indicate future economic activity. A rise signals business and residential investment expansion is coming.
Leading
Manufacturing Orders
New orders for durable goods signal future manufacturing activity. Released by Statistics Canada as part of Survey of Manufacturing.
Leading
Consumer Confidence
The Conference Board of Canada Consumer Confidence Index measures households' optimism about economic conditions and future spending intentions.
Coincident
GDP Growth Rate
The most comprehensive measure of economic activity. Statistics Canada releases GDP data monthly (unique globally) and quarterly. Canada's GDP contracted 0.6% in Q4 2025.
Coincident
Retail Sales
Monthly data showing consumer spending on goods. A key indicator of consumer confidence and economic health. Canada retail sales data is released by Statistics Canada.
Lagging
Business Investment
Capital expenditures by businesses on machinery, equipment, and structures. Lags the cycle because companies invest after they're confident in the expansion.
Labour Market & Unemployment
Canada's Labour Force Survey (LFS) is released monthly by Statistics Canada. It is one of the most closely watched economic indicators.
Unemployment Rate
Percentage of the labour force that is unemployed and actively seeking work. Canada's unemployment rate was 6.7% in March 2026. Note: it is a lagging indicator — it peaks after the recession has already ended.
Frictional Unemployment
Temporary unemployment from workers transitioning between jobs. Normal and unavoidable in a dynamic economy. Part of the "natural rate" of unemployment.
Structural Unemployment
Mismatch between worker skills and available jobs, often due to technological change (automation) or geographic mismatch. More persistent than frictional unemployment. Addressed through retraining programs.
Cyclical Unemployment
Unemployment caused by the business cycle (economic downturns). Rises during recessions, falls during expansions. The primary focus of monetary and fiscal policy responses.
Natural Rate of Unemployment (NAIRU)
The rate of unemployment consistent with stable inflation — also called the "Non-Accelerating Inflation Rate of Unemployment." In Canada, estimated at approximately 5–6%. When unemployment is below the NAIRU, inflation tends to rise (labour market overheating).
Labour Force Participation Rate
The percentage of the working-age population that is either employed or actively seeking work. A declining participation rate can mask the true weakness of the labour market (discouraged workers drop out of the labour force, reducing the headline unemployment rate).
Inflation & the Consumer Price Index (CPI)
Inflation is the general, sustained increase in the price level of goods and services over time. It erodes purchasing power and is the primary target of monetary policy.
CPI
The Consumer Price Index measures the change in prices of a fixed basket of goods and services purchased by typical Canadian households. Statistics Canada publishes CPI monthly. Canada's CPI inflation was 1.8% in February 2026 — below the Bank of Canada's 2% target. The basket includes food, shelter, transportation, health, clothing, recreation, and other categories.
Core CPI
Inflation measures that exclude volatile components. The Bank of Canada focuses on three measures of core inflation: CPI-trim (trims extreme price changes), CPI-median (the median price change), and CPI-common (tracks common price changes across categories). Core inflation was approximately 2.5–3% in late 2025.
Headline vs Core
Headline CPI includes all goods including food and energy (volatile). Core excludes volatile items to give a cleaner signal of underlying inflation trends. Policy-makers focus on core, but headline affects consumer expectations.
Demand-Pull Inflation
Inflation caused by excess demand — "too much money chasing too few goods." Occurs when the economy is growing above potential. The primary inflation type targeted by monetary policy.
Cost-Push Inflation
Inflation caused by rising production costs (wages, commodity prices, supply chain disruptions). Can create "stagflation" — simultaneous inflation and economic weakness. The 1970s oil shocks caused cost-push stagflation. COVID supply chain disruptions caused a cost-push element in the 2021–23 inflation episode.
Deflation / Disinflation
Deflation: negative inflation (prices falling). Very dangerous — encourages postponing purchases, causing debt deflation spirals (Japan's "lost decade"). Disinflation: falling rate of inflation (still positive but slowing). Canada experienced disinflation through 2023–2025 as the Bank's rate hikes took effect.
5.4
How Macroeconomic Factors Affect Financial Markets
Investor Expectations & the Price of Securities
Security prices are forward-looking — they reflect expectations about future earnings, interest rates, and economic conditions. This is why markets often "sell on the news" even when news is positive (already priced in). Key relationships:
Interest Rates ↑ → Equities ↓
Higher rates increase the discount rate applied to future earnings, reducing the present value of stocks. Also makes bonds relatively more attractive. Higher borrowing costs reduce corporate profitability. This is the most tested relationship in 5.4.
Interest Rates ↑ → Bond Prices ↓
Bond prices move inversely to yields. When new bonds offer higher yields, existing bonds with lower fixed coupons become less attractive and fall in price to equate their yield to the new rate. Duration determines the sensitivity.
Economic Growth ↑ → Equities ↑
Strong GDP growth → higher corporate earnings → higher share prices. Cyclical stocks (consumer discretionary, industrials, financials) benefit most from economic expansion.
Inflation ↑ (unexpected)
Hurts bonds (real return erodes). Hurts long-duration growth stocks. May initially help some equities if they can pass costs to consumers. Real assets (real estate, commodities, TIPS/RRBs) typically benefit from inflation.
CAD Strengthens
Hurts Canadian exporters (oil, mining, manufacturing) as their products become more expensive for foreign buyers. Reduces returns from US/foreign investments when converted back to CAD. Positive for importers (cheaper imports).
Valuation Techniques and Models
Discounted Cash Flow (DCF)
Intrinsic value = sum of all future cash flows discounted back to present value at the required rate of return. Most theoretically rigorous. Highly sensitive to the discount rate (required return) and terminal growth rate assumptions.
Dividend Discount Model (DDM)
Special case of DCF for dividend-paying stocks: P = D₁ / (r – g) where P = current price, D₁ = next year's dividend, r = required return, g = dividend growth rate. The Gordon Growth Model. Useful for mature, stable dividend payers.
Price-to-Earnings (P/E)
Market price per share ÷ Earnings per share. The most widely used relative valuation metric. Compare to historical average, sector peers, or market index. A high P/E signals growth expectations or potential overvaluation.
Price-to-Book (P/B)
Market price per share ÷ Book value per share. P/B < 1 suggests market values the firm below its accounting net assets. Used especially for financial institutions (banks, insurance companies).
EV/EBITDA
Enterprise Value ÷ EBITDA. Capital-structure-neutral valuation metric used extensively in M&A and leveraged buyout analysis. Removes distortions from financing choices and depreciation accounting.
5.5
Industry Analysis
Industry analysis sits between macroeconomic analysis (top-down) and company analysis (bottom-up). It helps identify which sectors are attractive at a given point in the business cycle and competitive landscape.
Industry Classification Systems
GICS
The Global Industry Classification Standard — developed by MSCI and S&P. The most widely used system in investment management globally. 11 sectors → 24 industry groups → 69 industries → 158 sub-industries. Used to classify companies in the S&P/TSX Composite. The 11 GICS sectors: Energy, Materials, Industrials, Consumer Discretionary, Consumer Staples, Health Care, Financials, Information Technology, Communication Services, Utilities, Real Estate.
NAICS
The North American Industry Classification System — used for government statistical purposes (Statistics Canada, Census Bureau). More granular than GICS. Used in economic reports and GDP sector breakdowns.
SIC
The older Standard Industrial Classification system — now largely replaced by NAICS for North American use. Still encountered in some older data sources.
Industry Performance Across the Business Cycle
Different industries perform better at different points in the business cycle. This sector rotation framework is a core concept for the exam:
| Business Cycle Phase | Outperforming Sectors | Underperforming Sectors | Why |
|---|---|---|---|
| Early Expansion | Financials, Consumer Discretionary, Real Estate | Utilities, Staples | Low rates boost lending, consumers start spending on non-essentials, real estate revives |
| Mid Expansion | Technology, Industrials | Utilities | Business investment picks up, tech adoption accelerates |
| Late Expansion / Peak | Energy, Materials, Commodities | Bonds, long duration assets | Rising inflation boosts commodity prices; inflation pressures build |
| Contraction / Recession | Consumer Staples, Healthcare, Utilities | Consumer Discretionary, Financials, Industrials | Defensive sectors — demand for food, medicine, electricity is inelastic |
Porter's Five Forces — Industry Competitive Analysis
Michael Porter's framework assesses the attractiveness of an industry by analyzing five competitive forces that determine industry profitability:
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Threat of new entrants — high barriers to entry protect incumbents (economies of scale, capital requirements, regulatory approvals, brand loyalty). Banks in Canada have very high barriers to entry.
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Bargaining power of suppliers — if suppliers are concentrated or switching costs are high, they can squeeze industry margins. OPEC's pricing power over oil supply is an example.
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Bargaining power of buyers — large concentrated buyers (Walmart, major retailers) can force down prices and squeeze supplier margins.
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Threat of substitutes — products or services that can replace the industry's output. Netflix was a substitute for DVD rentals. Electric vehicles are a substitute for gasoline-powered cars.
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Rivalry among existing competitors — the intensity of competition within the industry. Highly competitive industries (airlines, commodities) have compressed margins; oligopolies (Canadian banking) have wider margins.
5.6
Company Analysis Tools
Financial Statements
Public companies in Canada report under IFRS (International Financial Reporting Standards) — adopted by all Canadian publicly accountable enterprises in 2011. Private enterprises may use ASPE (Accounting Standards for Private Enterprises). There are four primary financial statements:
Statement of Financial Position (Balance Sheet)
What it shows: A snapshot of the company's financial position at a point in time. Assets = Liabilities + Shareholders' Equity.
Key sections: Current assets (cash, receivables, inventory), non-current assets (PP&E, goodwill, intangibles), current liabilities (accounts payable, short-term debt), non-current liabilities (long-term debt, deferred tax), shareholders' equity (share capital, retained earnings).
What to look for: Liquidity (current ratio), leverage (debt/equity), asset quality (goodwill as % of assets).
Key sections: Current assets (cash, receivables, inventory), non-current assets (PP&E, goodwill, intangibles), current liabilities (accounts payable, short-term debt), non-current liabilities (long-term debt, deferred tax), shareholders' equity (share capital, retained earnings).
What to look for: Liquidity (current ratio), leverage (debt/equity), asset quality (goodwill as % of assets).
Statement of Comprehensive Income (Income Statement)
What it shows: Revenue, expenses, and profitability over a period (quarter or year). Structure: Revenue → Gross Profit (after COGS) → EBIT (after operating expenses) → EBT (after interest) → Net Income (after tax) → Earnings Per Share (EPS).
Also includes: Other Comprehensive Income (OCI) — gains/losses not recognized in net income (translation differences, unrealized hedging gains).
Key metrics: Revenue growth rate, gross margin, EBITDA margin, net margin, EPS growth.
Also includes: Other Comprehensive Income (OCI) — gains/losses not recognized in net income (translation differences, unrealized hedging gains).
Key metrics: Revenue growth rate, gross margin, EBITDA margin, net margin, EPS growth.
Statement of Changes in Equity
What it shows: How shareholders' equity changed during the period. Includes: net income, dividends paid, share issuances/buybacks (repurchases), other comprehensive income items. Bridges the balance sheet equity from beginning to end of period.
Statement of Cash Flows
What it shows: Actual cash generated and used, divided into three sections:
Operating activities: Cash from running the business (net income adjusted for non-cash items and working capital changes). This is the most important — it shows if the business actually generates cash.
Investing activities: Cash spent on capital expenditures, acquisitions, and disposals of assets. Typically negative for growing companies.
Financing activities: Cash from issuing/repaying debt and equity; dividends paid.
Free Cash Flow = Operating CF − Capital Expenditures. The most important metric for valuation.
Operating activities: Cash from running the business (net income adjusted for non-cash items and working capital changes). This is the most important — it shows if the business actually generates cash.
Investing activities: Cash spent on capital expenditures, acquisitions, and disposals of assets. Typically negative for growing companies.
Financing activities: Cash from issuing/repaying debt and equity; dividends paid.
Free Cash Flow = Operating CF − Capital Expenditures. The most important metric for valuation.
Notes to Financial Statements & Auditor's Report
Notes to Financial Statements
Equally important as the statements themselves. Notes disclose: accounting policies used, detailed breakdowns of line items, contingent liabilities (lawsuits, guarantees), off-balance-sheet items, related party transactions, segment information, and subsequent events. Analysts read notes carefully — management can use accounting choices to flatter the headline numbers while disclosing the real picture only in the notes.
Auditor's Report
An independent auditor (CPA firm) provides an opinion on whether financial statements are presented fairly in accordance with IFRS. Unqualified (clean) opinion: No material misstatements found. Qualified opinion: Statements are fair except for a specific issue. Adverse opinion: Statements do not present fairly — very rare and very serious. Disclaimer of opinion: Auditor unable to form an opinion (scope limitation). Investors should always read the auditor's report first.
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Going Concern
If auditors have significant doubt about a company's ability to continue as a going concern (stay in business for the next 12 months), they must include an Emphasis of Matter paragraph in their report. This is a red flag for investors — it signals potential insolvency risk. The company's stock will typically fall sharply on such a disclosure.
Continuous Disclosure
Canadian public companies (reporting issuers) have ongoing disclosure obligations to keep the market informed. These are enforced by provincial securities regulators (CSA) and the relevant stock exchange.
Annual Information Form (AIF)
Comprehensive annual document describing the company's business, risk factors, operations, and capital structure. Filed within 90 days of fiscal year end for most companies.
Management Discussion & Analysis (MD&A)
Management's narrative explanation of financial results — context for the numbers. Discusses business performance, material changes, risks, and outlook. Filed with annual and quarterly financials.
Material Change Reports
Any change in a company's business or affairs that a reasonable investor would expect to significantly affect the market price must be disclosed promptly — typically within 2 business days. Examples: major acquisition, loss of key customer, CEO departure, significant lawsuit.
Quarterly Reports
Financial statements and MD&A filed within 45 days of quarter end. Allows investors to track performance between annual reports.
Key Financial Ratios
Current Ratio
Current Assets ÷ Current Liabilities
Measures short-term liquidity. Ratio > 1 means current assets exceed current liabilities. Ratio < 1 signals potential liquidity risk.
Quick Ratio
(Cash + Receivables) ÷ Current Liabilities
More conservative liquidity measure — excludes inventory (may be hard to liquidate). Also called "acid test."
Debt-to-Equity
Total Debt ÷ Shareholders' Equity
Leverage measure. High D/E = more financial risk (higher fixed interest obligations). Capital-intensive industries (utilities) typically carry higher D/E.
Interest Coverage
EBIT ÷ Interest Expense
Ability to service debt from operating earnings. Coverage < 1.5× signals financial distress risk. Credit analysts focus heavily on this ratio.
Return on Equity (ROE)
Net Income ÷ Shareholders' Equity
Profitability from the equity holders' perspective. DuPont analysis decomposes ROE into: Profit Margin × Asset Turnover × Leverage.
Return on Assets (ROA)
Net Income ÷ Total Assets
Efficiency of asset use. Comparable across companies with different capital structures. Lower than ROE because it includes debt-financed assets.
Price-to-Earnings (P/E)
Market Price ÷ EPS
Most common valuation multiple. Forward P/E uses estimated next year's EPS. TSX average P/E is typically 14–18×. S&P 500 averages 20–25×.
Dividend Yield
Annual Dividend ÷ Market Price
Income return from holding a stock. Canadian dividend payers in utilities/telecom/banks typically yield 3–6%. High yield can signal either generous dividend or depressed stock price.
5.7
Corporate Rules & Regulations
Takeover Process & Legislation
A takeover bid (governed primarily by NI 62-104 — Take-Over Bids and Issuer Bids) is an offer to purchase a sufficient number of securities to acquire control of a corporation. Canadian takeover rules protect the rights of target company shareholders.
When a Formal Takeover Bid is Required
A formal take-over bid is required when a person (or group) acquires or proposes to acquire 20% or more of a class of voting or equity securities. The formal bid rules include:
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The bid must be open for a minimum of 105 days (unless the target's board supports the bid, in which case a minimum of 35 days applies)
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The bid must be made to all security holders of the class (equal treatment principle)
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At least 50% of the target's securities not held by the bidder must be deposited before any can be taken up (mandatory minimum tender condition)
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After satisfying the minimum tender condition, the bid must be extended for an additional 10 days to allow remaining shareholders to tender
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The bidder must offer the same price to all holders of the same class (equal consideration)
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A formal bid circular must be filed and delivered to all shareholders
Insider Bid
An insider bid occurs when a person who is already an "insider" (director, officer, significant shareholder) of the target company makes a bid to acquire its remaining shares (going-private transaction). Because of the obvious conflict of interest, insider bids require special protections:
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A formal valuation by an independent valuator must be prepared and delivered to shareholders
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The bid price must be at least equal to the valuator's determined fair market value
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The bid must be approved by a majority of the minority — majority of shareholders other than the insider and their associates must approve
Issuer Bid
An issuer bid is when a company purchases its own shares in the market (share buyback/repurchase). Requires regulatory approval and filing. Two forms:
Normal Course Issuer Bid (NCIB)
The most common form. A company can repurchase up to 10% of its public float over a 12-month period through the stock exchange. Must file a notice with the exchange and announces publicly. Typically used when management believes shares are undervalued.
Substantial Issuer Bid (SIB)
A formal bid to repurchase a larger percentage of shares (more than 10% of outstanding). Treated similarly to a formal take-over bid — requires a formal bid circular, equal treatment of all shareholders, and a minimum open period.
Rules of Company Disclosure & Statutory Rights of Investors
All public companies must meet continuous disclosure obligations (see 5.6). Beyond reporting, shareholders have specific statutory rights under corporate law and securities legislation:
Right of Rescission
If a prospectus or offering memorandum contained a misrepresentation, a purchaser of securities can rescind (cancel) the purchase and get their money back. This right must be exercised within a specified limitation period (typically 2 years from purchase or 180 days from discovery).
Right of Action for Damages
If a securities document contained a misrepresentation that caused the investor to suffer a loss (but they cannot or choose not to rescind), they can sue for damages. This creates a powerful incentive for issuers to ensure accurate disclosure.
Voting Rights
Common shareholders vote on: election of directors, appointment of auditors, major corporate changes (mergers, amendments to articles, new share classes), and any other matters requiring shareholder approval under the corporation's constating documents or statute.
Dissent Rights
In fundamental corporate changes (amalgamations, continuances, certain asset sales), a dissenting shareholder can require the corporation to buy back their shares at "fair value" — as determined by agreement or court. Provides an exit right for shareholders who disagree with major corporate changes.
Pre-emptive Rights
Some corporations grant existing shareholders the right to purchase new shares before they are offered to the public (rights offerings), allowing them to maintain their proportional ownership. This protects against dilution.
Derivative Action
A shareholder can bring a lawsuit on behalf of the corporation against directors or officers who have caused harm to the company. The proceeds go to the corporation, not the individual shareholder. Requires court approval to proceed.
5.8
Basic Market Theories — Three Analytical Frameworks
Investment analysis can be approached from three distinct but complementary perspectives. Understanding the purpose, tools, and limitations of each is essential for the exam.
📊 Fundamental Analysis
What it is: Evaluating the intrinsic value of a security by examining the underlying economic, financial, and qualitative factors that determine the company's value.
Approach: Top-down (macro → sector → company) or bottom-up (start with company, ignore macro).
Tools: Financial statements, earnings models, DCF valuation, P/E ratios, industry analysis, management assessment, competitive analysis.
Core belief: The market occasionally misprices securities. By determining intrinsic value and comparing to market price, analysts find buy/sell opportunities.
Time horizon: Medium to long-term (months to years).
Limitation: Time-consuming. Intrinsic value calculations require many assumptions. Markets can stay "wrong" for long periods.
Approach: Top-down (macro → sector → company) or bottom-up (start with company, ignore macro).
Tools: Financial statements, earnings models, DCF valuation, P/E ratios, industry analysis, management assessment, competitive analysis.
Core belief: The market occasionally misprices securities. By determining intrinsic value and comparing to market price, analysts find buy/sell opportunities.
Time horizon: Medium to long-term (months to years).
Limitation: Time-consuming. Intrinsic value calculations require many assumptions. Markets can stay "wrong" for long periods.
🔢 Quantitative Analysis
What it is: Using mathematical, statistical, and algorithmic models to identify investment opportunities and manage risk.
Approach: Data-driven, systematic, rules-based. Removes emotional and behavioral biases from decision-making.
Tools: Statistical factor models (value, momentum, quality, low volatility factors), mean-variance optimization (Markowitz), regression analysis, machine learning, algorithmic trading strategies.
Core belief: Persistent patterns exist in market data that can be systematically exploited. Empirical research can identify factors that predict returns.
Time horizon: Varies — can be very short (high-frequency trading) to long (factor investing).
Limitation: Models are based on historical data and may not predict future behavior. "Quant crowding" — many similar models can fail simultaneously.
Approach: Data-driven, systematic, rules-based. Removes emotional and behavioral biases from decision-making.
Tools: Statistical factor models (value, momentum, quality, low volatility factors), mean-variance optimization (Markowitz), regression analysis, machine learning, algorithmic trading strategies.
Core belief: Persistent patterns exist in market data that can be systematically exploited. Empirical research can identify factors that predict returns.
Time horizon: Varies — can be very short (high-frequency trading) to long (factor investing).
Limitation: Models are based on historical data and may not predict future behavior. "Quant crowding" — many similar models can fail simultaneously.
📈 Technical / Statistical Analysis
What it is: Analyzing historical price and volume data to forecast future price movements, without reference to the underlying business fundamentals.
Core belief: All information is reflected in price. Historical price patterns repeat. Price moves in trends.
Tools: Charts, trend lines, moving averages, RSI, MACD, Bollinger Bands, support and resistance levels, volume analysis.
Core assumption: Three tenets of technical analysis — (1) market discounts everything; (2) prices move in trends; (3) history repeats itself.
Time horizon: Short to medium-term. Widely used for entry/exit timing even by fundamental analysts.
Limitation: Self-fulfilling to a degree (when many follow the same signals). Doesn't explain WHY price moves, only what it might do next.
Core belief: All information is reflected in price. Historical price patterns repeat. Price moves in trends.
Tools: Charts, trend lines, moving averages, RSI, MACD, Bollinger Bands, support and resistance levels, volume analysis.
Core assumption: Three tenets of technical analysis — (1) market discounts everything; (2) prices move in trends; (3) history repeats itself.
Time horizon: Short to medium-term. Widely used for entry/exit timing even by fundamental analysts.
Limitation: Self-fulfilling to a degree (when many follow the same signals). Doesn't explain WHY price moves, only what it might do next.
💡
Efficient Market Hypothesis (EMH) — Connection
The Efficient Market Hypothesis (Eugene Fama) states that market prices reflect all available information, making it impossible to consistently beat the market through analysis. Three forms: Weak form (price history reflected — undermines technical analysis). Semi-strong form (all public info reflected — undermines fundamental analysis). Strong form (all info including insider info reflected — undermines even insider trading). Most evidence supports semi-strong efficiency in developed markets, which is why most active managers fail to outperform consistently after fees.
5.9
Technical Analysis Tools & Sources
Technical analysis relies on specific tools and chart patterns to generate buy/sell signals. The exam expects familiarity with the most common tools and their purposes.
Price Charts — Types
Line Chart
Connects closing prices over time. Simplest chart type. Shows the trend clearly but loses intraday information. Most useful for long-term trend identification.
Bar Chart (OHLC)
Shows Open, High, Low, and Close for each period. Each "bar" shows the range of trading for that period. More informative than line charts. Widely used by technical analysts.
Candlestick Chart
Japanese origin. Each "candle" shows OHLC with the body filled (bearish — close below open) or hollow/green (bullish — close above open). Very popular. Specific candlestick patterns (Doji, Hammer, Engulfing) signal potential reversals.
Point and Figure Chart
Filters out time and minor price movements, recording only significant price changes. Focuses purely on supply/demand dynamics. Used to identify support and resistance levels.
Key Technical Indicators
Moving Averages
Simple Moving Average (SMA): Average closing price over N periods (e.g., 50-day SMA, 200-day SMA). Smooths volatility to show the trend. Golden Cross: Short-term MA crosses above long-term MA → bullish signal. Death Cross: Short-term MA crosses below long-term MA → bearish signal. Exponential Moving Average (EMA): Gives more weight to recent prices; more responsive to new information.
Relative Strength Index (RSI)
Oscillator measuring the speed and change of price movements. Range 0–100. RSI > 70 = overbought (potential sell signal). RSI < 30 = oversold (potential buy signal). Developed by J. Welles Wilder. One of the most used momentum indicators.
MACD (Moving Average Convergence-Divergence)
Difference between 12-day and 26-day EMAs, plotted against a 9-day signal line. When MACD crosses above signal line → buy signal. When MACD crosses below → sell signal. Also shows momentum divergence from price trends.
Bollinger Bands
A 20-day SMA with bands set 2 standard deviations above and below. Price touching the upper band signals overbought; lower band signals oversold. Bands widen in volatile markets, narrow in calm periods. "Squeeze" (very narrow bands) often precedes a major price breakout.
Volume Analysis
Volume confirms price movements. A price breakout accompanied by high volume is more reliable than one on low volume. On-Balance Volume (OBV): Cumulative indicator that adds volume on up days and subtracts on down days — divergence from price can signal reversals.
Support & Resistance
Support: Price level where buying interest is strong enough to prevent further decline — a "floor." Resistance: Price level where selling interest prevents further advance — a "ceiling." When price breaks through resistance, it often becomes new support (and vice versa). These levels are derived from historical price data.
Technical Research Reports & Other Sources
Research Reports
Investment dealers publish equity research reports covering both fundamental (earnings estimates, target price, recommendation) and technical (charts, support/resistance, momentum signals) analysis. Technical reports focus on price-based analysis, often used for short-term trading recommendations.
Market Data Terminals
Bloomberg Terminal, Refinitiv Eikon — provide real-time and historical price/volume data, news, charts, economic data, and analytical tools. Used by institutional investors and professional traders.
SEDAR+ / EDGAR
SEDAR+ (Canada) and EDGAR (US) are the official databases of regulatory filings — prospectuses, annual reports, material change reports, insider trading reports. Primary source for fundamental analysis documents.
Statistics Canada
Primary source for Canadian economic data: GDP, CPI, Labour Force Survey, retail sales, trade data. Monthly and quarterly releases drive market movements.
Element 5 — Master Summary
15 exam-critical points
01
3 Economic Theories: Keynesian = government spending to stimulate demand. Monetarist = control money supply, markets self-correct. Supply-side = cut taxes/regulation to increase productive capacity. Know the policy prescription of each.
02
Business Cycle — 4 Phases: Expansion → Peak → Contraction → Trough. Know which sectors outperform at each phase. Defensive sectors (staples, utilities, healthcare) outperform during contractions. Cyclicals outperform during expansions.
03
Interest rates and asset prices: Rates ↑ → Bond prices ↓ (always). Rates ↑ → Equities typically ↓ (higher discount rate). Rates ↓ → CAD weakens relative to USD. This is the most tested macro-market relationship.
04
Bank of Canada: Targets 2% CPI inflation (1–3% range). Current rate 2.25% (March 2026, held after 275bps of cuts). 8 fixed announcement dates/year. Primary tool = overnight rate target.
05
CPI vs Core CPI: Headline CPI includes food and energy. Core CPI excludes volatile items — BoC focuses on 3 core measures (CPI-trim, CPI-median, CPI-common). Canada CPI = 1.8% Feb 2026.
06
Yield Curve: Normal = long > short rates (positive economic outlook). Inverted = short > long rates (recession predictor — historically very reliable). Flat = transition state.
07
Leading vs Lagging Indicators: Leading (predict future): stock market, building permits, consumer confidence, yield curve. Lagging (confirm past): unemployment rate, CPI, prime rate. Coincident (current state): GDP, retail sales, employment levels.
08
3 Types of Unemployment: Frictional (between jobs, normal). Structural (skills mismatch, technology-driven). Cyclical (recession-driven, target of policy). NAIRU = natural rate, consistent with stable inflation (~5-6% in Canada).
09
4 Financial Statements (IFRS): Statement of Financial Position (balance sheet, snapshot). Statement of Comprehensive Income (income statement, period). Statement of Changes in Equity. Statement of Cash Flows (operating/investing/financing). FCF = Operating CF − CapEx.
10
Auditor's Report: Unqualified = clean opinion. Qualified = fair except for specific issue. Adverse = does not present fairly. Disclaimer = unable to form opinion. Going concern emphasis = serious warning.
11
Takeover Bid Rules (NI 62-104): Triggered at 20%+ of voting shares. Must be open 105 days (35 if board supports). 50% minimum tender condition. 10-day extension after minimum met. Equal treatment of all shareholders.
12
Insider Bid vs Issuer Bid: Insider bid = insider buys out remaining shareholders (needs formal valuation + majority of minority approval). Issuer bid = company buys own shares (NCIB = up to 10% of float; SIB = formal bid for more).
13
3 Analysis Types: Fundamental (intrinsic value, financial statements). Quantitative (mathematical models, factor analysis). Technical (price/volume charts, patterns, indicators). All three are used in practice — not mutually exclusive.
14
Key Technical Tools: RSI: >70 overbought, <30 oversold. Golden Cross: short MA crosses above long MA (bullish). Death Cross: opposite (bearish). MACD: crossing signal line = buy/sell signal. Support = price floor. Resistance = price ceiling.
15
Key Valuation Metrics: P/E = price/EPS (most common). P/B = price/book (banks). EV/EBITDA (M&A). DDM: P = D1/(r-g) for dividend stocks. DCF = sum of discounted future cash flows. All are relative — compare to peers and history.