The Montreal and Toronto exchanges announced a $1.3-billion merger on Monday that will see the country's two largest exchanges become one.

The new organization — to be known as TMX Group — will be managed from Toronto, but the trading of financial derivatives products will stay in Montreal.

In the stock and cash deal, Montreal Exchange shareholders would receive half a share of TSX Group and $13.95 in cash for each of their shares.

That values each share of the Montreal Exchange at $42.56, based on Friday's closing price for TSX shares.

On Monday, shares of the Montreal Exchange rose more than eight per cent to close at $40.18. TSX Group shares declined more than five per cent to $53.88.

"The combination is an important milestone in the development of the Canadian capital markets, delivering benefits to all market participants and the shareholders of both organizations," TSX Group CEO Richard Nesbitt said in a release.

"We believe that an integrated national exchange is the optimal solution to meet the evolving requirements of our broader customer base," he said.

The Montreal Exchange's board of directors is recommending that its shareholders vote in favour of the combination.

Under terms of a non-compete deal reached in 1999, the Montreal Exchange became Canada's only market for trading in financial derivatives, while the Toronto-based TSX Group consolidated the country's equity trading boards. That deal was to expire in 2009.

"I am enthusiastic about the future of the derivatives markets that Montreal Exchange has been building for many years," Montreal Exchange president Luc Bertrand said. "Through this agreement, Montreal will remain the centre of Canada's derivatives markets."

The merger had been rumoured for several months.

Negotiations are reported to have been rocky. When Bertrand's name was first put forward for president of the new exchange earlier this year, the TSX Group was uncomfortable and merger talks fell apart as a result, the CBC's Amanda Margison reported.

Residency requirement

Merger talks resumed last month.

Under the new agreement, Nesbitt will be the CEO of the TMX Group and Bertrand will be be deputy CEO. Bertrand will continue as the chief executive officer of the MX and will also assume responsibility for information technology of the TMX Group.

The agreement also requires that 25 per cent of TMX directors be residents of Quebec. 

The merger deal is expected to close in the first quarter of 2008.

Stock exchanges around the world have been consolidating rapidly as a way of cutting costs amid growing competition from alternative exchanges.

With files from the Canadian Press