MONETARY POLICY and

CENTRAL BANKING

Financial Markets, Financial

institution, and Financial instruments
 Financial Markets
Financial markets are the places where financial instruments are bought and sold. They are the
economy's central nervous system, relaying and reacting to information quickly, allocating resources,
and determining prices. In doing so, financial markets enable both and individuals to find financing for
their activities, When they working well, new firms can start and existing firms can grow; individuals
who don't have sufficient savings can borrow to purchase cars and houses. By ensuring that resources
are available to those who can put them to the best use, and by keeping the costs of transactions as low
as possible, these markets promote economic efficiency. When financial markets cease to function
properly, resources are no longer channeled to their best possible use, and we all suffer.

TABLE 3.2

Market liquidity: Ensure that owners of financial

The Role of Financial Markets
instruments can buy and sell them cheaply and
easily.
Information: Pool and communicate information
about the issuer of a financial instrument.
Risk sharing: Provide individuals with a place to buy
and sell risk , sharing them with others.
 TYPES OF FINANCIAL MARKETS

Stock Market

Perhaps the most well-known financial markets are stock

markets. These are venues where companies list their shares, which are bought
and sold by traders and investors. Stock markets, also called equity markets, are
used by companies to raise capital and by investors to search for returns.

Over-the-Counter Markets

An over-the-counter (OTC) market is a decentralized market—one without

physical locations where trading is conducted electronically—in which market
participants trade securities directly (meaning without a broker).

Certain derivatives markets, however, are exclusively OTC, making up an

essential segment of the financial markets. Broadly speaking, OTC markets and
the transactions that occur in them are far less regulated, less liquid, and more
opaque.
 Bond Market
A bond is a security where an entity issues a debt
instrument. Bonds can be thought of as an agreement between
the lender and borrower, but the lender is the investor. Bonds are
issued by corporations as well as by municipalities, states, and
sovereign governments to finance projects and operations.

Money Markets

Typically, the money markets trade in products with highly liquid

short-term maturities (less than one year) and are characterized by
a high degree of safety and a relatively lower interest return than
other markets.
 Derivatives Market
A derivative is a contract between two or more
parties whose value is based on an agreed-upon underlying financial
asset (like a security) or set of assets (like an index)

Futures markets are where futures contracts are listed and traded.
Unlike forwards, which trade OTC, futures markets utilize
standardized contract specifications, are well-regulated, and use
clearinghouses to settle and confirm trades.

Money Markets

Typically, the money markets trade in products with highly liquid

short-term maturities (less than one year) and are characterized by
a high degree of safety and a relatively lower interest return than
 Forex Market
The Forex (foreign exchange) market is where
participants can buy, sell, hedge, and speculate on the exchange rates
between currency pairs. The forex market is the most liquid market in
the world, as cash is the most liquid of assets. The currency market
handles more than $7.5 trillion in daily transactions, more than the
futures and equity markets combined.

Commodities Market

Commodities markets are venues where producers and consumers meet

to exchange physical commodities such as agricultural products (e.g.,
corn, livestock, soybeans), energy products (oil, gas, carbon credits),
precious metals (gold, silver, platinum), or "soft" commodities (such as
cotton, coffee, and sugar). These are known as spot commodity markets,
 Cryptocurrency Market
Thousands of cryptocurrency tokens are
available and traded globally across a patchwork of
independent online crypto exchanges. These exchanges host
digital wallets for traders to swap one cryptocurrency for
another or for fiat currency such as dollars or euro.

These exchanges allow direct peer-to-peer (P2P) trading

without an actual exchange authority to facilitate the
transactions. Futures and options trading are also available on
major cryptocurrencies.
The Role of Financial Markets

Financial markets serve three roles in our economic system (see Table 3.2). They
offer savers and borrowers liquidity; they pool and communicate information; and they
allow risk sharing. Liquidity is a crucial characteristic of financial markets.
Related to liquidity is the fact that financial markets need to be designed in a way
that keeps transactions costs—the cost of buying and selling—low. If you want to buy or sell
a stock, you must pay a licensed professional to complete the purchase or sale on your
behalf: A broker can find you a counterparty, a dealer can act as the counterparty, and a
broker-dealer can do either or both. While this service can't be free, it is important to keep its
cost relatively low.
Financial markets pool and communicate information about the issuers of financial
instruments, summarizing it in the form of a price. Does a company have good prospects for
future growth and profits? If so, its stock price will be high; if not, its stock price will be low.
Is a borrower likely repay a bond? The more likely repayment is, the higher the price of the
bond. Obtaining the answers to these questions is time consuming and costly. Most of us just
don’t have the resources or know-how to do it. Instead, we turn to the financial markets to
summarize the information for us so that we can look it up on a website.

Finally, while financial instruments are the means for transferring risk, financial markets are
the place where we can do it. The markets allow us to buy and sell risks, holding ones we
want and getting rid of the ones we don’t want. As we will see in chapter 5, a prudent
investor holds a collection of assets called a portfolio, which designed portfolio was a lower
overall risk than any individual stock or bond. An investor constructs it by buying and selling
financial instruments in the marketplace. Without the market, we wouldn’t be able to share
risk.
Primary versus Secondary Markets
A primary financial market is one in which a borrower
obtains funds from a lender by selling newly issued securities.
Businesses use primary markets to raise the resources they need to
grow. Governments use them to finance ongoing operations. Most of
the action in primary markets occurs out of public view. Everyone
knows about secondary financial markets. Those are the markets
where people can buy and sell existing securities. If you want to buy
a share of stock in Microsoft, you won't get it from the company
itself. Instead, you'll buy it in a secondary market from another
investor.
Debt and Equity Versus Derivative
Markets
Debt markets are the markets for loans, mortgages,
and bonds while Equity markets are the markets for
stocks and Derivatives market are the markets
where investors trade instruments like futures,
options, and swaps, which are designed primarily to
transfer risk

Two categories of a Debt instruments

Money Market – debt instruments that are
completely repaid less than a year.
Bond Market – debt instrument with a maturity of
more than a year.
FINANCIAL INSTRUMENTS

A financial instrument is a written legal obligation of one party to transfer

something of value, usually money, to another party at some future date,
under specified conditions.

GOVERNMENT ENFORCEMENT- That is, a person can be

compelled to take the action specified in the agreement. The
enforceability of the obligation is an important feature of a financial
instrument. Without enforcement of the specified terms, financial
instruments would not exist.
MADE AT SOME FUTURE DATE -a financial instrument specifies that payment
will be made at some future date . In some cases, such as a car loan that requires
payments, the dates may be very specific. In others, such as car insurance, the
payment is triggered when something specific happens, like an accident.

SPECIFIES CONDITIONS -a financial instrument under which a payment will be

made. Some agreements specify payments only when certain events happen. That is
clearly the case with car insurance and with stocks as well. The holder of a stock
owns a small part of a firm and so can expect to receive occasional cash payments,
called dividends, when the company is profitable. There is no way to know in
advance, however, exactly when such payments will be made. In general, financial
instruments specify a number of possible contingencies under which one party is
required to make a payment to another.
USES OF FINANCIAL INSTRUMENTS
Means of payment: Purchase of goods and
services

Store of value: Transfer of purchasing power

into the future

Transfer of risk: Transfer of risk from one person

or company to another
Financial Instruments Used Primarily as Store of Value

1. Bank loans. A borrower obtains resources from a lender immediately in exchange for a promised set of
payments in the future. The borrower, who can be either an individual or a firm, needs funds to make an
investment or purchase, while the lender is looking for a way to store value into the future.
2. Bonds. Bonds are a form of loan. In exchange for obtaining funds today, a corporation or government
promises to make payments in the future. While bond payments are often stated in fixed dollars, they need not
be. Unlike most bank loans, most bonds can be bought and sold in financial markets. Like bank loans, bonds
are used by the borrower to finance current operations and by the lender to store value.
3. Home mortgages. Most people who wish to purchase a home need to borrow some portion of the funds. A
mortgage is a loan that is used to purchase real estate. In exchange for the funds, the borrower promises to
make a series of payments. The house is collateral for the loan. Collateral is the term used to describe specific
assets a borrower pledges to protect the lender's interests in the event of nonpayment. If the payments aren't
made, the lender can take the house, a process called foreclosure.
4. Stocks. The holder of a share of a company's stock owns a small piece of the firm and is entitled to part of
its profits. The owner of a firm sells stock as a way of raising funds to enlarge operations as well as a way of
transferring the risk of ownership to someone else. Buyers of stocks use them primarily as stores of wealth.
5. Asset-backed securities. Asset-backed securities are shares in the returns or payments arising from
specific assets, such as home mortgages, student loans, credit card debt, or even movie box-office receipts.
Investors purchase shares in the revenue that comes from these underlying assets. The most prominent of
these instruments are mortgage-backed securities, which bundle a large number of mortgages together into a
pool in which shares are then sold.
Financial Instruments Used Primarily to Transfer Risk

l . Insurance contracts. The primary purpose of insurance policies is to ensure that payments will be made
under particular, and often rare circumstances. These instruments exist expressly to transfer risk from one
party to another.
2. Futures contracts. A futures contract is an agreement between two parties to exchange a fixed quantity of a
commodity (such as wheat or corn) or an asset (such as a bond) at a fixed price on a set future date. A futures
contract always specifies the price at which the transaction will take place. A futures contract is a type of
derivative instrument, since its value is based on the price of some other asset. It is used to transfer the risk of
price fluctuations from one party to another.
3. Options. Like futures contracts, options are derivative instruments whose prices are based on the value of
some underlying asset. Options give the holder the right, but not the obligation, to buy or sell a fixed quantity
of the underlying asset at a predetermined price either on a specified date or at any time during a specified
period.
4. Swaps. Swap contracts are agreements to exchange two specific cash flows at certain times in the future
(as discussed in Chapter 9). For example, an interest rate swap might involve the exchange of payments
based on a fixed rate of interest for payments based on a rate of interest that fluctuates (or "floats") with the
market. Swaps come in many varieties, reflecting differences in maturity, payment frequency, and underlying
cash flows. The cash flows and other contractual arrangements usually are designed so that there is no
upfront fee for the swap.

These are just a few examples of the most prominent financial instruments. Together, they allow
people to buy and sell almost any sort of payment on any date under any circumstances. Thus, they offer the
opportunity to store value and trade risk in almost any way that one might want. 5 When you encounter a
financial instrument for the first time, try to figure out whether it is used primarily for storing value or for
transferring risk. Then try to identify which characteristics determine its value.
FINANCIAL INSTITUTION
A company engaged in the business dealing with
financial and monetary transaction such as deposits,
loans, investments, and currency exchange.
The most common types of financial institutions
include banks, credit unions, insurance
companies, and investment companies, pension
funds. These entities offer various products and
services for individual and commercial clients, such
as deposits, loans, investments, and currency
exchange.
Role of Financial Institutions
Financial institutions reduce transactions costs by
specializing in the issuance of standardized
securities. They reduce the information costs of
screening and monitoring borrowers to make
sure they are creditworthy and they use the
proceeds of a loan or security issue properly. In
other words, financial institution curb information
ASYMMETRIES and the problems that go along
with them, helping resources flow to their most
productive use
Structure of Financial Industry

DEPOSITORY INSTITUTION take deposits and make

loans; they are what most people think of as banks
whether they are commercial banks, savings bank or
credit union,

NONDEPOSITORY INSTITUTIONS include insurance

companies, securities firms, asset managements firms
that operate mutual funds and exchange-trade funds,
hedge funds.
NONDEPOSITORY INSTITUTIONS
Ex.

1. INSURANCE COMPANIES – accept premiums, which

they invest in securities and real state (their assets) in
return for promising compensation to policyholders
should certain events occur (their liabilities).
2. PENSION FUNDS- invest individual and company
contributions in stocks, bonds, and real state ( their
asset) on order to provide payments to retired workers
(their liabilities)
3. FINANCE COMPANIES – raise funds directly in
financial markets in order to make loans to individuals
and firms.
3. SECURITIES FIRMS- include brokers, investment
banks, underwriters, asset management firms, private
equity firms, and venture capital firms. Brokers and
investment banks issue stocks and bonds for corporate
customers, trade them, and advise customer. Asset
management firms pool the resources of individuals
and companies and invest them in portfolios and bonds
and stocks, and real state. Hedge funds do the same for
small groups of wealthy investor. Customer own shares of
the portfolios, so they face the risk that the assets will
change in value. But portfolios are less risky than
individual securities and individual savers can purchase
smaller units than they could if they went directly to the
financial markets.
4. GOVERNMENT-SPONSORED ENTERPRISES (GSEs)
– are federal credit agencies that provide loans directly
for farmers and home mortgagors. They also guarantee
End of the topic
Thank you
 FINANCIAL SYSTEM
MONETARY POLICY and CENTRAL BANKING
Learning objectives

 List
and explain the six part of the
financial system

 Understand the concept of financial

intermediation and the structure of
financial system
FINANCIAL SYSTEM

A financial system is a network of financial institutions,

financial markets, financial instrument and financial
service to facilitate the transfer of funds. The system
consists of savers, intermediaries, instruments and the
ultimate user of funds. The financial system mobilizes
the savings and channelizes them into the productive
activity and thus influences the pace of economic
development. Broadly speaking, financial system deals
with three inter-related and independent variables, i.e.,
money, credit and finance
THE SIX PART OF THE FINANCIAL SYSTEM

MONEY – to pay for our purchases and to store our wealth

FINANCIAL INSTRUMENTS- to transfer from savers to investor and to transfer risk to those who are best equipped
to bear it. Stocks, mortgage and insurance policies are examples of financial instruments.

FINANCIAL MARKETS- allows us to buy and sell financial instrument quickly and cheapy. The Philippine Stock
Exchange, Inc.

FINANCIAL INSTITUTIONS- it provide a myriad of services, including access to the financial markets and collection
of information about prospective borrowers to ensure they are creditworthy. Banks, securities firms, and insurance
companies are examples of financial institutions.

REGULATORY AGENCIES- They are responsible for making sure that the elements of the financial system; including
its instruments, markets, and institutions; operate in a safe and reliable manner.

CENTRAL BANKS- monitor and stabilize the economy. CENTRAL BANK OF THE PHILIPPINES
MONEY
The first part of the financial system is money. Money
can be used to pay for purchases, and as such, money
stores wealth. Money once consisted of gold and silver
coins. These were eventually replaced by paper
currency, which today is being eclipsed by electronic
funds transfers. Money has taken many forms through
the ages, but money consistently has three functions:
store of value, unit of account, and medium of
exchange.
 FINANCIAL INSTRUMENT

Financial instruments (or securities, as they

are often called) is a written legal obligation
of one party to transfer something of value,
usually money, to another party at some
future date, under specified conditions .
FINANCIAL MARKET

The markets where stocks and bonds are sold have undergone
a similar transformation. Originally, financial markets were
located in coffeehouses and taverns where individuals met to
exchange financial instruments. The next step was to create
organized markets, like the New York Stock Exchange—
trading places specifically dedicated to the buying and selling
of stocks and bonds. Today, most of the activity that once
occurred at these big-city financial exchanges is handled by
electronic networks. Buyers and sellers obtain price
information and initiate transactions from their desktop
computers or from handheld devices.
FINANCIAL INSTITUTION
A company engaged in the business dealing with
financial and monetary transaction such as deposits,
loans, investments, and currency exchange.
The most common types of financial institutions
include banks, credit unions, insurance
companies, and investment companies. These
entities offer various products and services for
individual and commercial clients, such as deposits,
loans, investments, and currency exchange.
GOVERNMENT REGULATORY
AGENCIES
Four main regulatory agencies of the Philippine
financial system
In July 2004, the Financial Sector Forum (FSF)
was established, which institutionalized the
cooperative arrangements in supervision,
information exchange, and consumer protection
of four principal financial regulators: the BSP, the
SEC, the Insurance Commission (IC) and the
Philippine Deposit Insurance Corporation.
CENTRAL BANKS

PHILIPPINES- Bangko Sentral ng

Pilipinas

UNITED STATES OF AMERICA-

Federal Reserve System
FUNDS FLOWING THROUGH THE
FINANCIAL SYSTEM

FINANCIAL INSTRUMENT
FINANCIAL INSTRUMENT

Borrowers-Spender
Lenders-Savers (mostly
FINANCIAL
(primarily governments and
INSTITUTIONS
households) firms)

FUNDS
FUNDS
End of the topic
Thank you