FINANCIAL MARKETS Pictures of items were used to record trade exchanges,

becoming more complex as values were established and

Chapter 2 Introducing Money and Interest Rates
documented.
Money - is any item or commodity that is generally accepted
Coinage (600bce-1100ce)
as a means of payment for goods and services or for
repayment of debt, and that serves as an asset to its holder. Defined weights of precious metals used by some merchants
were later formalized as coins that were usually issued by
- Composed of the bills and coins which have been
states.
printed or minted by the National Government
(these are called currency). Bank Notes (1100-2000)
- The oil that keeps the machinery of our world
States began to use bank notes, issuing paper IOUs that were
turning
traded as currency, and could be exchanged for coins at any
Fiduciary basis- relying on the public’s confidence in the time.
established forms of monetary exchange.
Digital Money (2000 onward)
CHARACTERISTICS AND KEY FUNCTIONS OF MONEY
Money can now exist virtually, on computers, and large
Store of Value- money acts as a means by which people can transactions can take place without any physical cash
store their wealth for future use. changing hands.

Item of worth – most money originally has an intrinsic value, Basaha nala an iba
such as that of the precious metal that was used to make the
THE SUPPLY AND DEMAND FOR MONEY
coin.
The key measures for the money supply
Means of Exchange- it must be possible to exchange money
freely and widely for goods, and its value should be as stable  MI. The narrowest measure of the money supply. It
as possible. includes currency in circulation held by the nonbank
public, demand deposits, other checkable deposits,
Unit of account – money can be used to record wealth
and travelers’ checks. It refers to money used as a
possessed, traded or spent personally and nationally.
medium of exchange.
Standard of Deferred Payment – money can facilitate  M2. It includes money held in savings deposits,
exchange at a given point by providing a medium of exchange money market deposit accounts, non-institutional
and unit of account. money market mutual funds and other short-term
money market assets. It refers primarily to money
THE EVOLUTION OF MONEY
used as a store if value.
Barter (10,000-3000bce)- the direct exchange of goods  M3. It includes the financial institutions. It refers
primarily to money used as a unit of account.
Advantages:  L. It includes liquid and near-liquid assets.
 Trading relationship – foster strong links between The Demand for Money
partners
 Physical goods are exchanged – barter does not rely  Transaction demand. Money demanded for day-to-
on trust that money will retain its value. day payments through balances held by households
and firms. It varies with GDP; it does not depend on
Disadvantages: the rate of interest.
 Precautionary demand. Money demanded as a
 Market needed- both parties must want what the
result of unanticipated payments. It varies with GDP.
other offers
 Speculative demand. Money demanded because of
 Hard to establish a set value on items- two goats
expectations about interest rates in the future.
may have a certain value to one party one day, but
less a week later. The rate of interest is the price paid in the money market for
 Goods may not be easily divisible the use of money. The rate is a percentage of the amount
 Large-scale transactions can be difficult borrowed.
Evidence of trade records (7000bce) The demand for currency has a negative relationship with the
interest rate.
Increase in the economy’s price level will increase the You value something as money only if you believe that others
demand for money (the demand for money Is tied to the will accept it from you as payment. It is a case of self-fulfilling
interest rate, not the price level). expectations.

The real GDP growth and the inflation rate slow when the BSP Checks are promises to pay on demand money deposited
raises interest rate. with a bank or other financial institution.

The Quantity Theory of Money 5 more desirable outcomes for a payment systems

The quantity theory of money holds that changes in the 1. Security. Better security increases consumers and
money supply MS directly influences the economy’s price businesses’ confidence that funds will not be stolen
level, but nothing else. electronically.
2. Efficiency. Increasing the efficiency of the payments
The Time Value of Money
system allows it to function using fewer workers and
Interest is defined as the cost of using money over time. It computers, or other capital, which benefits the
represents the time value of money. economy.
3. Speed. Fast settlement of payment facilitates
Present Value. Based on the common sense notion that a transactions by both households and businesses.
peso of cash flow paid to you one year from now is less 4. Smooth International transactions. The increasing
valuable to you than a peso paid to you today. amount of business that takes place across borders
can be facilitated if payments can be made quickly
Interest Rates. It links the future to the present. It is the
and conveniently.
market price of earlier availability.
5. Effective collaboration and participants in the
Viewpoint of a potential borrower, it is the premium that system.
must be paid In order to acquire goods sooner and pay for
Basaha nala
them later. From lenders viewpoint, it is a reward for waiting.

The amount of funds demanded by borrowers is inversely

related to the interest rate. Chapter 4 Financial Instruments
As the interest rate rises, the quantity of funds supplied to A Financial Instrument is any contract that gives rise to a
the loanable funds market will increase. financial asset of one entity and a financial liability or
equity instrument of another entity.
The Three Components of Money Interest
A contract refers to an agreement between two or more
1. Pure-Interest component is the real price one must
parties that has a clear economic consequences that the
pay for earlier availability.
parties have little, if any, discretion to avoid, usually
2. Inflationary premium component reflects the
because the agreement is enforceable by law.
expectation that the loan will be repaid with peso of
less purchasing power as the result of inflation. A financial asset is any asset that is cash, equity
3. Risk-premium component reflects the probability of instrument of another entity, and receivable.
default
Examples:

A. Cash on hand and in banks

Chapter 3 The Payments System: An Overview 1. Petty cash. Refers to cash balances kept on hand at
various locations to pay for minor expenditures.
Payment systems – the mechanism for conducting
2. Demand savings and time deposits. Represent
transactions in the economy.
amounts on deposit In checking, savings and time
Commodity money refers to a good used as money that has deposit accounts respectively.
value independent of its use as money. 3. Undeposited checks. Are checks payable to the
enterprise or bearer but not yet presented to the
Fiat money refers to money, such as paper currency that has bank for payment.
no value apart from its use as money. 4. Foreign currencies
Legal tender means the government accepts paper currency 5. Money orders are financial instruments similar to
in payment of taxes and requires that individuals and firms bank drafts but are drawn generally from authorized
accept it in payment of debts. post offices or other financial institutions.
 6. Bank drafts are commitments by banking institutions 1. Futures Contracts. An agreement between a seller
to advance funds on demand by the party to whom and a buyer that requires the seller to deliver a
the draft was directed. particular commodity at a designated future date, at
B. Accounts, notes, and loans receivable and a predetermined price.
investment in bonds and other debt instruments 2. Forward Contracts. Calls for delivery on a specified
issued by other entities: date. It is usually not traded on a market exchange. It
1. Trade receivables (signed delivery receipts does not call for a daily cash settlement for price
and sales invoice changes in the underlying contract. Gains and losses
2. Promissory notes on forward contracts are paid only when they are
3. Bond certificates closed out.
C. Interest in shares or other equity instruments issued 3. Call options. Option give its holder the right either to
by other entities buy or sell an instrument, at a specified price and
1. Stock certificates within a given time period.
2. Publicly listed securities 4. Foreign Currency Futures. Foreign loans frequently
are denominated in the currency of the lender.
A financial liability is any liability that is a
5. Interest Rate Swaps. These are contracts to
 contractual obligation to deliver cash or another exchange cash flows as of a specified date or a series
financial asset to another entity or to exchange of specified dates based on a notional amount and
financial asset or financial liabilities with another fixed and floating rates.
entity under conditions that are potentially
Chapter 5 Overview of the Financial System
unfavorable to the entity
 A contract that will or may be settled in the entity’s Direct Finance: borrowers borrow funds directly from lenders
own equity instruments and is a non-derivative for in financial markets by selling them securities (financial
which the entity is or may be obligated to deliver a instruments), which are claims on the borrower’s future
variable number of the entity’s own equity income or assets.
instruments or a derivative that will or may be
Key Components of the Financial System
settled other than by the exchange of a fixed amount
of cash or another financial asset for a fixed number A. Financial Instruments
of the entity’s own equity instruments. B. Financial Markets and Financial Institutions
C. The Central Bank and Other Financial
Examples:.
Regulators
 Accounts, notes, loans payable
3 Key Services of FS
 Derivative financial liabilities
 Obligation to deliver own shares worth of a fixed A. Risk sharing. Risk is the chance that the value of
amount of cash. financial assets will change relative to what one
 Some derivatives on own equity instruments expects. Diversification is the splitting of wealth into
many assets to reduce risk.
An equity instruments is any contract that evidences a
B. Liquidity. It is the ease with which an asset can be
residual interest in the assets of an entity after deducting all
exchanged for money which savers view as a benefit.
of its liabilities.
Securitization increases the liquidity of many assets
Examples: besides stocks and bonds. This process has made it
possible to buy and sell securities based on loans.
1. Ordinary Shares
C. Information. Banks collect information on borrowers
2. Preference Shares
to forecast their likelihood of repaying loans.
3. Warrants or written call option that allow the holder
to subscribe ordinary shares in exchange for a fixed Asymmetric Information describes the situation in which one
amount of cash or financial asset. party to an economic transaction has better information than
does the other party.
Derivatives are financial instruments that derive their value
on contractually required cash flows from some other 2 problems
security or index (derives its value from expected and actual
1. Adverse Selection. This is the problem investors
changes in the price of the underlying asset.
experience in distinguishing low-risk borrowers from
Examples: high-risk borrowers before making an investment.
 2. Moral hazard. This is the problem investors obligations of the savings and mortgage bank. It
experience in verifying that borrowers are using their helps construct, expand and rehabilitate agricultural
funds as intended. and industrial sectors.
-Stock Savings and Loan Associations (SLA) is any
Transaction cost- the cost of a trade or a financial
corporation engaged in the business of accumulating
transaction
the savings of its members or stockholders.
Information cost – the costs that savers incur to Rural Bank (RB) is any bank authorized by the
determine the creditworthiness gf borrowers and to Central Bank to accept deposits and make credit
monitor how they use the funds acquired. available to farmers, businessmen and cottage
industries in the rural areas.
Because of transaction costs and information costs, savers Cooperative Banks are banks established to assist
receive lower return on their investments and borrowers the various cooperatives by lending those funds at
must pay more for the funds they borrow. reasonable interest rates.
2. Government Banks or Specialized Government
How Financial Intermediaries Reduce Adverse Selection
Banking Institutions
1. Requiring borrowers to disclose material
Development Bank of the Philippines (DBP) provides
information on their financial performance and
loans for developmental purposes, gives loans to the
financial p
agricultural sector, commerical sector and the industrial
2. Collecting information on firms and selling that
sector.
information to investors.
3. Convincing leaders to require borrowers to pledge Land Bank of the Philippines (LBP) is a government bank,
some of their assets as collateral which the lender which provides financial support in the implementation
can claim of the borrower defaults. of the Agrarian Reform Program (CARP) of the
government.
How Financial Intermediaries Reduce Moral Hazard
Problems Al-Amanah Islamic Investment Bank promotes and
accelerates the socio-economic development of the
1. Specializing in monitoring borrowers and developing
Autonomous Region of Muslim Mindanao.
effective technique to ensure that the funds they
loan are actually used for their intended purpose.  Non-bank Financial Institutions
2. Imposing Restrictive Covenants 1. Private Non-bank Financial Institutions
Chapter 6 The Philippine Financial System Investment House is any enterprise, which engages in
underwriting securities of other corporation.
Structure of the Philippine Financial System
Investment Banks provide advice to firms issuing stocks
 Bangko Sentral ng Pilipinas
and bonds or considering mergers with other firms. They
 Banking Institutions
also underwrite and guarantee a price.
1. Private Banking Institutions
Universal Bank (UB) Expanded Commercial Bank Financing Company is any business enterprise where the
(EKB) is any commercial bank, which performs the primary purpose is to extend credit facilities to
investment house function in addition to its consumers and to industrial, commercial or agricultural
commercial banking authority. sectors.
Commercial Bank or Domestic bank (KB) is any
commercial bank that is confined only to commercial Securities Dealer is any person or entity engaged in the
bank functions. business of buying and selling securities for his own or its
Thrift Bank (TB) shall include savings and mortgage client’s account thereby making a profit from the
banks, stock savings, and loan associations and difference between the purchase prices and selling price
private development banks. of securities.
-Stock Savings and Mortgage Bank (SSMB) is any
Savings and Loan Associations (S&Ls) accumulates the
corporation organized for the purpose of
funds of many small savers and then lend this money to
accumulating the savings of depositors and investing
home buyers and other types of borrowers. Its most
them, together with its capital, in readily marketable
significant economic function is to create liquidity.
bonds and debt securities.
-Private Development Bank (PDB) is a bank that Mutual Funds are corporations which accept money
exercises all the power and assumes all the from savers and then use these funds to buy stock, long-
 term bonds, or short-term debt instruments issued by - Raising Capital. Firms often require funds to build
businesses or government units. new facilities, replace machinery or expand their
business in other ways.
- Commercial Transactions. This includes such
Pawnshops refer to persons or entities engaged in the things as arranging payment for the sale of a
business of lending money with personal property, product abroad, and providing working capital so
jewelry, and other durable goods as collateral for the that a firm can pay employees if payments from
loans given. customers run late.
- Price Setting. Markets provide price discovery, a
Lending Investor is any person or entity engaged in the way to determine the relative values of different
business of effecting securities transactions, giving loans items, based upon the prices at which individuals
and earns interest from them. are willing to buy and sell them.
- Asset Valuation. Market prices offer the best way
Pension Funds are retirement plans funded by
to determine the value of a firm or of the firm’s
corporation or government agencies for their workers
assets, or property.
and administered primarily by the trust departments of
- Arbitrage. Commodities and currencies may trade
commercial banks or by life insurance companies.
at very different prices in different locations.
Insurance companies take savings in the form of annual - Investing. The stock, bond and money markets
premiums, then invest these funds in stocks, bonds, real provide an opportunity to earn a return on funds
estate and mortgages, and finally make payments to the that are not needed immediately, and to
beneficiaries of the insured party. accumulate assets that will provide an income in
future.
Credit unions are cooperative associations whose - Risk management. Futures, options, and other
members have a common bond, such as being derivatives contracts can provide protection
employees of the same. (Cheapest source of funds) against new types of risks, such as the possibility
2. Government Non-bank Financial Institutions that a foreign currency will lose value against the
domestic currency before an export payment is
Government Service Insurance System (GSIS) provides received.
retirement benefits, housing loans personal loans,
emergency and calamity loans to government Methods of Raising Funds
employees. 1. To issue a debt instrument, such as bond or a
Social Security System (SSS) provides retirement mortgage, which is a contractual agreement by the
benefits, funeral benefits, housing loans, personal loans, borrower to pay the holder of the instrument fixed
and calamity loans to employees who are working in peso amounts at regular intervals until a specified
private companies and offers. date.

Pag-ibig provides housing loans to both government and Maturity – the number of years until that instrument’s
private employees. expiration date.

Chapter 7: Financial Markets: An Overview Short-term- less than a year

Financial Markets are the meeting place for people, Long-term – ten years or longer
corporations and institutions that either need money or Intermediate-term- between one and ten years
have money to lend or invest.
2. To issue equity instruments, such as common or
Primary Market – new issues of stock ordinary stock, which are claims to share in the net
Secondary Market – after the securities are sold to the income and the assets of a business.
public Dividends- equities often make periodic payments to
- Prices are continually changing as investors buy their holders and are considered long-term securities
and sell securities based on their expectations of a because they have no maturity date.
corporations prospect. Disadvantage: Equity holders is a residual claimant; that
- Financial managers are given feedback about their is the corporation must pay all its debt holders before it
firm’s performance pays its equity holders.
Financial Market Basic Functions
 Advantage: Equity holders benefit directly from any Listing means admission of securities to dealings ona
increase in the corporation’s profitability or asset value recognized stock exchange of any incoporrated company,
because equities confer ownership rights on the equity central and stage governments, quasi-governmental and
holders. other financial institutions/corporations, municipalities,
electricity boardsz housing boarda and so forth.
2 Markets
7. To provide liquidity and marketability to listed
1. Primary Market refers to original sale of securities
securities and ensure effective monitoring of trading
by governments and corporations.
for the benefits of all participants in the market.
Investment Bank- a financial institutions that assists in
A recognized stock exchange means a stock exchange being
the initial sale of securities in the primary market.
recognized by the national government through the SEC.
2. Secondary Market – this is where the securities are
Official quotation is the price at which securities are brought
being traded after the securities are sold to the
and sold on a recognized stock exchange.
public.
3. Most popularly known as Stock Market or Exchange Stages of Listing of Securities

Brokers are agents of investors who match buyers with  At the time of public issue of shares or debentures
sellers of securities  At the time of right issue of shares or debentures
 At the time of bonus issue of shares
Dealers link buyers and sellers by buying and selling
 Shares issued on amalgamation or merger
securities and stated prices.
(Basaha nala an iba)
2 broad segment of the stock market
Chapter 8 Money Markets and Capital Markets
1. The Organized Stock Exchange – have a physical
location where stocks buying and selling transactions Money Market refers to the network of corporations,
take place in the stock exchange floor. (Ex. Philippine financial institutions, investors and governments which deal
Stock Exchange) with the flow of short-term capital.
2. The Over-the-counter Exchanges – where shares,
bonds, and money market instruments are traded
using a system of computer screens and telephonea. Types of Money-Market Instruments
(Ex. NASDAQ)
Commercial Paper ia a short-term debt obligation of a
2 important functions of stock market private- sector firm or a government-sponsored corporation.
1. They make it easier to sell these financial - Usually unsecured although a particular
instruments to raise cash; that is they make the commerical paper issue may be secured by a
financial instruments more liquid. specific asset of the issuer or may be guaranteed
2. They determine the price of the security that the by a bank.
issuing firm sells in the primary market.
Banker’ Acceptance. An acceptance is a promissory note
Stock Exchange is an organized secondary market where issued by a non-financial firm to a bank in return for a loan.
securities like shares, debentures of public companies, The bank resells the note in the money market at a discount
government securities and bonds issued by municipalities, and guarantee payment. (Maturity of less than 6months)
public corporation, utility undertakings, port trusts and such
other local authorities are purchased and sold. Treasury bills, often referred to as T-bills, are securities with a
maturity of one year or less, issued by national governments.
4. To facilitate the exchange of securities between
buyers a d sellers, thus providing a market place, Government agency notes. National government agencies a
virtual or real. d government-sponsored corporations are heavy borrowers
5. Share brokers may be assembled in a place called in the money markets in many countries (ex. Development
the trading ring and bought and sold shares. banks)
6. Listing agreement ensures that the company
Local government notes are issued by, provincial or local
provides all the information pertaining to its working
governments, and by agencies of these governments such as
from time to time, including events that affect its
school authorities and transport commissions.
valuation.
Interbank loans- loans extended from one bank to another 3. Best Efforts Underwriting Basis- the underwriter
with which it has no affiliation. Overnight loans are short- does not guarantee a firm price to the issuer.
term unsecured loans from one bank another.
Advantages of using bonds
Time deposits, another name for certificates of deposit or
1. Long-term debt is generally less expensive than
CDs, are interest-bearing bank deposits that cannot be
other forms of financing because (a) investors view
withdrawn without penalty before a specified date.
debt as a relatively safe investment alternative and
Repos serve to keep the markets highly liquid, which in turn demand a lower rate of return (b) interest expenses
which in turn ensures that there will be a constant supply of are less deductible
buyers for new money-market instruments. 2. Bondholders do not participate in extraordinary
profits; the payments are limited to interest.
3. Bondholders do not have voting rights.
Capital Market is a financial market in which longer-term 4. Flotation costs of bonds are generally lower than
debt equity instruments are traded. It includes bonds, stock those of ordinary (common) equity shares.
and mortgages.
Disadvantages.
2 Capital Market Participants
1. Debt (other than income bonds) results in interest
1. National government issues long-term notes and payments that, if not met, can force the firm into
bonds to fund the national debt while local bankruptcy.
governments issue notes and bonds to finance 2. Debt (other than income bonds) produces fixed
capital projects. charges, increasing the firm’s financial leverage.
2. Corporations issue both bonds and stock to finance 3. Debt must be repaid at maturity and thus at some
capital investment expenditures and fund other point involves a major cash outflow.
investment opportunities. 4. The typically restrictive nature of indenture
covenants may limit the firm’s future financial
Bond is any long-term promissory note issued by the firm. flexibility.
Bond certificate is the tangible evidence of debt issued by a Bond Features and Prices
corporation or a government body represents a loan made by
investors to the issuer. Par Value – the face value of the bond that is returned to the
bondholder at maturity date.
Trading Process
Coupon Interest Rate – the percentage of the par value of
Public offering – using an investment bank serving as a the bond that will be paid out annually in the form of interest.
security underwriter
Maturity – the length of time until the bond issuer returns
Private placement – small group of investors (often financial the par value to the bondholder and terminates the bond.
institutions)
Indenture – the agreement between the firm issuing the
Firm commitment underwriting – the investment bank bonds and the bond trustee who represents the bondholders.
guarantees the firm a price for newly issued bonds by buying
the whole issue at a fixed price (the bid price) from the bond- Current Yield refers to the rate of the annual interest
issuing firm at a discount from par. The investment bank then payment to the bond’s market price.
seeks to resell these securities to investors at a higher price
Yield to Maturity – refers to the bond’s internal rate of
(the offer price).
return.
Other arrangements

1. Competitive Sale – the investment bank can

Credit Quality Risk is the chance that the bond issuer will not
purchase the bonds through competitive bidding
be able to make timely payments.
against other investment banks or by directly
negotiating with the issuer. Bond ratings involve a judgement about the future risk
2. Negotiated Sale – a single investment bank obtains potential of the bond provided by rating agencies
the exclusive right to originate, underwriter and
Bond ratings are favorably affected by:
distribute the new bonds through a one-on-one
negotiation process. 1. A low utilization of financial leverage
2. Profitable operations
 3. A low variability of past earnings
4. Large firm size
5. Little use of subordinated debt

The poorer the bond rating, the higher the rate of return
demanded in the capital markets.

High quality corporate bonds are considered investment

grade, while higher credit risk bonds are speculative, also
called junk bonds and high-yield bonds.