Introduction to Financial Markets - Financial system may be defined as

diversified financial activities being

FINANCIAL MARKETS performed by different economic units.
- Volume of goods and services that can be
- Part of the entire financial system of the produced in an economic system depends
country and helps to efficiently direct the flow upon the loanable funds as financial
of savings and investments in the economy. resources and the credit facilities of the
- May refer to any marketplace where security financial system.
trading occurs, including stock market, bond
market, forex market, and derivatives
market.
Classification of Financial System in the Philippines
- Acts as an intermediary between providers
and users of funds. BANKING INSTITUTIONS
- Helps the users of funds to create products
or serves and provide a return for those who Private Banking Institutions
have excess funds. ➢ Commercial Banks
The Need to Study Financial Markets Universal Bank
- Involves a huge flow of funds throughout the - Provides financial conglomerate that
world economy which affect business profits, combine investment banking, commercial
production of goods and services and the banking, development banking, and
economic well-being of the countries around insurance to encompass a wider variety of
the world. services.
The Need to Study Financial Institutions - Has the authority to exercise power of an
investment house and power to invest in
- These are what makes financial markets non-allied enterprises as a commercial bank.
work. - Under the supervision of BSP.
- Financial intermediaries that acquire funds
by issuing liabilities and use those funds to Commercial Banks
acquire assets. - Accept drafts and issues letters of credit.
- These are among the largest employers in - Discount and negotiate promissory notes,
the country that frequently pay very high drafts, bills of exchange, and other evidence
salaries. of debt.
Approach In Studying Financial Markets - Accept or create demand deposits and
receive other types of deposits and deposits
1. Understanding substitutes.
2. Evaluating the market - Buy and sell foreign exchange and gold or
3. Predicting the market silver bullion.
- Acquire a marketable bonds and other debt
securities.
Basic Functions of the Financial System - Extend credit, subject to such rules as the
Monetary Board may promulgate.
• Promote saving functions.
• Payment functions. ➢ Thrift Banks
• Protection against risk function. - Primarily concerned with the mobilization of
• Means to wealth function. savings and loans, and provide short-term
• Provide liquidity function. working capital, medium, and long-term
• Credit facility function. financing, and diversified and allied services
for their chosen market and constituencies
especially for the small and medium
The Philippine Financial System enterprises and individuals.
- Economic system is involved in the aspect of Savings and Mortgage Banks
producing goods and services while financial
system interacts in a variety of ways to Stocks Savings and Loan Associations
create and manage credit facilities. Private Development Banks
 ➢ Rural Banks ➢ Insurance Companies
➢ Cooperative Banks
- Provides insurance in case of loss to the
- Accepts deposits and provides loans to insured individuals and firms.
individuals to undertake venture using the - Insurance came in the form of health, real
principle of the cooperative. estate, fire, accident etc.
- These are carried out by credit unions,
➢ Credit Unions
mutual savings banks, building societies,
and cooperatives. - Composed of member-owner producers and
➢ Islamic Bank consumers.
- Supports community development.
- It has the function and purpose of
➢ Pawnshops
conventional banking.
- Islam forbids lending money for interest. - These cater to financing relatively low-
- It is based on risk-sharing which is a income individuals.
component of trade rather than risk-transfer - Borrowing requires collateral to guarantee
which is a component of trade rather than payment, for instance jewelry, appliances,
risk [Link] which is seen in conventional etc.
banking
- Introduces concepts such as profit sharing,
safekeeping, joint venture, cost plus, and Government Non-Bank Financial Institutions
leasing. ➢ Government Service Insurance System
➢ Social Security System
Government Banks
➢ Development Bank of the Philippines
➢ Land Bank of the Philippines Financial Intermediaries
- Indirect form of funds channeling
NON-BANK FINANCIAL INSTITUTIONS - Bring together the users and the providers of
funds without having them to meet face to
Private Non-Bank Financial Institutions face.
➢ Investment Bank Advantages of Financial Intermediaries
- Its function is to underwrite securities of - Knows how to diversify funds.
another person or enterprise. - Has a cost advantage or economies of scale.
- It provides planning, consultancy, fund - Helps reconcile conflicting interest of the
management, and raising fund. users and lenders of fund.
➢ Investment Companies
- Engaged in buying and selling of securities. Financial Market
- This may be an open-end fund, otherwise - Is a mechanism where buyers and sellers
known as a mutual fund – there are no participate in the trade of financial assets.
restrictions on the number of shares the fund - Characterized by having formal regulations,
will issue. transparent pricing, basic regulations on
- This may also be a closed-end fund. trading cost and fees.
➢ Securities Dealers/Brokers
- Buy and sell stocks of other companies to Money Market
resell them for a profit. - People who are looking for temporary
- Engages in buying or selling stocks for investments where their idle funds can be
commission. placed and earn income; used for short term
placements which are one year or less to
mature.
- Funds are used for short-term borrowings for
the users to meet their temporary needs.
Money Market Instruments ➢ Over the Counter Markets (OTC)
Negotiable Certificate of Deposit - Involved in the buying and selling of financial
instrument but not in organized securities
- A time deposit where the investor and the
exchange.
bank agree on the term of placement.
- These are stocks of corporation that were
- The amount in consideration for this kind of
registered and licensed by the SEC to sell
security is considerably higher than the
stocks, which were not being traded in the
regular time deposit.
PSE to the public.
Commercial Paper
- An unsecured promissory note with a fixed Types of Capital Market
maturity of 1 to 270 days. Primary Markets
- A money-market security issued by high
credit rating companies to raise money to ➢ Players in the Primary Market
meet short-term obligations.
- Issuers. Public or private corporations
Repurchase Agreement - Financial Instruments. Instruments
purchase by investors.
- A financial instrument which one party sells a
- Financial Intermediaries. Institutions that
financial instrument to another party at a
facilitate issuance of securities.
specified price with commitment to
- Investors. Individual of firm who have
repurchase the financial instrument at a fixed excess funds which are willing to invest.
amount agreed at a specific date.
Secondary Markets
Treasury Bills (T-Bills)
- Aftermarkets – instruments issued are
- A risk-free investment because the payment
traded.
of which is guaranteed by the government.
- Securities were sold by investor to another
- Interest is normally higher than the savings
investor.
and time deposit.
- First owner of the issued securities to be sold
Banker’s Acceptance on the market.

- A bank draft where the bank required to pay

the holder a specified amount on a specific Other Examples of Financial Markets
date.
➢ Bond Market – place where long-term debt
- Has a maturity of 90 days from the date of
is issued by firms to raise money.
issue, but can be extended up to 180 days.
➢ Interest Rate and Bond Price have an
- Less-risky compared to other instruments
Inverse Relationship – interest is high,
because the payment which is guaranteed
price of the bond is low.
by the importer’s bank.
➢ Commodity Market – place where raw or
primary commodities are traded.
Capital Market ➢ Stock Market – place where publicly listed
stocks are bought and sold.
- Geared towards long-term financial ➢ Derivatives Market – provides instrument to
instruments. manage financial risk.
- Includes issuance of securities and long- ➢ Foreign Exchange Markets – global
term obligations by the government decentralized or over-the-counter market.
agencies. This determines foreign exchange rates for
- May have or have no due dates. every currency.

Elements of a Capital Market Efficient Market Analysis

➢ Organized Security Exchanges - Serves as one of the foundations of modern

finance theory.
- Operates under the rules and regulations - States that stock prices already reflect all
formulated by an exchange. Investors available information in the market.
actively trading on the exchange are aware - Market is perfect and nobody should benefit
of the rules and conduct trades accordingly. from the fluctuation of prices.
A perfect market specially states that: Primary Market
- Securities are typically in equilibrium, which - Initial Public Office (Stock Market)
means that they are fairly priced and that - Bureau of Treasury
their expected returns equal their required
Secondary Market
returns.
- Security prices fully reflects all public - Stock Exchange (Stock Market)
information available about the firm and its - Bond – Philippine Dealing and Exchange
securities, and these prices react swiftly to Corporation (PDEx)
next information.
- Because stocks are fully fairly priced, Players in the Stock Market
investors need not waste their time trying to - Investors
find and to capitalize on mispriced securities. - Stockbroker
- Transfer Agent
Three Types of Market Efficiency - Clearing House
- Listed Company
➢ Strong-form – it is a concern with all
information sets, including private
information, are incorporated in price tends
and it states no monopolistic information can
entail profits.
➢ Semi-strong form – requires that all public
information is reflected in prices already,
such as companies announcements or
annual earnings figure.
➢ Weak Efficiency – information set is just
historical prices, which can be predicted from
historical price trends; thus profit is
impossible.

International Financial Markets

- Philippine Financial Market institutions has
developed good ties with other countries.
- International debts and equity markets done
here.
- Maintaining good tie-ups with other country
helps to grow the economy of one country.
- Financing the needs of one country, at times
are not enough to support government and
private projects.

LECTURE (from vids):

Money Market
- Short term (less than 1 year maturity)
- Time deposit, T-bills
- Government ang nagpapautang
Capital Market
- Long term
- Usually companies nagpapautang kasi long
term.
- Bond market is utang while stock market is
ownership.
Structure of Interest Rates Economic Condition
If the economic growth of the country is low,
Introduction to Nominal Interest Rate
chances are the different sectors will be hesitant
- In financial market, funds are transferred to supply loanable funds.
from the providers of the funds to the users
Monetary Policy
of the funds.
- Nominal interest rate serves as a guide in Policies instituted by the government to support
establishing the acceptable level of required the economy as a whole. The government will
return for the different types of financial increase its funds it supplies to business and
securities such as debt securities. households to rescue the economy from a
recission.
Loanable Funds Theory Foreign Investors
- Nominal interest determines how much Increase the supply of loanable funds in the
funds will circulate from the savers to the country by supplying foreign direct investments
users and it determines how financial and other sort of short-term investments.
instruments will be valued in the money and
capital markets.
Factors that Affect Loanable Funds In General, Demand for Loanable Funds:

The Provider of Funds: - Curve has a downward slope which means

that as the number of loans demanded
➢ Households increases, the lower the interest rate.
➢ Government Agencies - Reasons may include a purchase of house
➢ Private and Public Companies and lots, appliances etc. of the household
➢ Foreign Investors sector.
In General Supply for Loanable Funds
➢ As interest rates increase, the supply of Factors that Affect the Demand for Loanable Funds
loanable funds also increase. Interest Rate
➢ All other things constant, the higher the
interest, the higher the supply of loanable If interest is high, quantity of demand for
funds. loanable funds is low. If company will raise
➢ The highest supplier of these funds are the money in the financial market and interest is
household sector. high, the company will result in high cost of
➢ When the interest rate is low, the providers capital. If interest rate is low, cost of capital is
of fund will also be low. also low.

Factors that Affect the Supply of Loanable Funds Demands for Funds

Level of Interest Rates The price of obtaining money for different trends
depends on the rate of interest. If interest is low,
As the interest rates increases, the supply of the demand of loanable products is high and vice
loanable funds also increases. versa.
Risk of the Securities Spending Needs
The higher the perceived risk of financial An increase in spending needs of the household
securities offered in the financial market, the sector also increases the demand for loanable
lesser the supplier of loanable funds. funds.
Spending Needs Economic Conditions
If the need for spending for the different sectors The government sector that needs additional
of the economy is high, the supply of loanable funding for government projects will also be
funds is lesser. asking for additional financing by issuing
securities such as treasury bills etc.
Foreign Participants Monetary Policy
Foreign institutions may also increase the - During the time of recession, the government
demand for loanable funds to look for funding for institutes monetary policies to help pump-
their needs even if coming from a foreign land. prime the economy.
- It reduces reserve requirements of the
financial institutions to increase loanable
Equilibrium Interest Rates
funds coming from the deposits.
Factors that cause the Supply of Loans Shift
Provided that Other Factors held Constant
Demand for Funds
- When demand for loanable funds increases,
the demand curve will move to the right
causing the interest rate to move.
Economic Conditions
- If the economic conditions of the country is
good or growing, the demand for loanable
Shift of Supply and Demand will increase. This many companies will
result in borrowing pushing the demand
- Once the number of financial instruments curve to shift to the right.
supplied or demand changes, a shift in
Changes in Perceived Business Opportunities
supply or demand curve will occur.
- Interest rate will move every time there is a - When business see a growing opportunity in
change in supply or demand of loanable one country, chances are these business will
funds. result in borrowing. The borrowing will result
for the demand to increase for loanable
Factors that cause the Supply of Loans Shift
funds. Thus increasing the interest rate.
Provided that Other Factors held Constant
Change in Government Spending
Supply of Funds
- When the government is experiencing a
- The more the interest rate increases. The
budget deficit, the tendency is to result in
supply of funds will also increase.
borrowing. With this borrowing, the demand
- This provides a favorable return to the savers
of fund because of a better return. for loanable funds increases causing the
demand curve to move right, this results in
Economic Condition an increase in interest rate.
- As the economic condition of the country
improves, it is also expected for total wealth Cost Concept of Money
of different economic sectors of economy to
improve. - The cost of money is the amount you are
paying or receiving for the use of money. The
Risk money may have been borrowed or
personally owned which will be used for its
- Refers to the uncertainty of fulfilment of the
intended purpose.
financial instruments when it is due.
- If an individual or firm borrowed money to do
Spending Needs business, the return on the use of money
must be covered by the return.
- When the different economic sectors have
allotted their excess money for some other
than providing funds to the users, the supply
of loanable funds will decrease.
Factors that Affecting the Cost of Money
Production Opportunities
- Refers to investment opportunities in
productive assets.
- The higher the expected return on the
investment, the more the investor can afford
to pay for the interest or cost of money.
Time Preferences for Consumption
- Dependent on the need of the investor to use
his excess money in short-term or long-term
period.
- The needs of the investor to receive interest
payment depends on the time of preference
for consumption.
Risk
- Refers to the uncertainty of not achieving
what has been set to attain or to achieve.
- If an investor perceives a high degree of risk
from lending money, he or she demands a
higher rate of return.
Inflation
- Refers to the tendency of prices to go up
over periods.
- If inflation goes up, so as the interest rate.
- When inflation rate increases, it results to a
decline in the purchasing power of the
investors.
Determinants of Interest Rate
1. Real-risk free rate (r*)
2. Inflation Premium (IP)
3. Default Risk Premium (DRP)
4. Liquidity Premium (LP)
5. Maturity Risk Premium (MRP)
6. Special Provision or Covenant (SPC)