Subject Instructor

MODULE 3:
FINANCIAL markets

Lesson
1

4
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Lesson 1:
FINANCIAL MARKETS: AN OVERVIEW

Learning Objectives

After studying Lesson 1, you should be able to:

Explain what financial market is.

Distinguish between “primary” market and “secondary” market.
Explain the main function of financial markets
Enumerate and discuss the activities of financial markets.
Enumerate and explain the attributes of financial markets that investors look for.
Distinguish between “debt market” and equity market”

Introduction

A developed economy relies on financial markets and institutions for efficient transfer of funds
from savers to borrowers.

Financial markets are the meeting place for people, corporations and institutions that either
need money or have money to lend to invest. The financial markets exist as a vast global network of
individuals and financial institutions that may be lenders, borrowers or owners of public companies
worldwide.

Participants in the financial markets also include national, state and local governments that
are primarily borrowers if funds for highways, education, welfare and the public activities; their
markets are referred to as public financial markets. Large corporations raise funds in the corporate
financial markets.

FINANCIAL MARKETS IN ACTION

Thanks to the global financial markets, money flows around the world between investors,
businesses, customers and stock markets. Investors are not restricted to placing their money with
companies in the country where they live, and big business now have international offices, so money
needs to move efficiently between countries and continents.

When a corporation uses the financial markets to raise new funds, the sale of securities is said
to be made in the primary market by way of a new issue.

After the securities are sold to the public (institutions and individuals), they are traded in the
secondary market between investors. It is in the secondary market that prices are continually
changing as investors buy and sell securities based on their expectations of a corporation’s
prospects.

FUNCTIONS OF FINANCIAL MARKETS

Financial markets (bonds and stock markets) and financial intermediaries (banks, insurance
companies among others) have the basic function of getting people together by moving funds form
those who have a surplus of funds to those who have a shortage of funds.

The function that financial markets perform is shown schematically in the chart below.
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Indirect Finance

Funds Financial Funds

Intermediaries

Funds

Lender-Savers Funds Financial Funds Borrower-Spenders

1. Households Markets 1. Business Firms
2. Business Firms 2. Government
3. Government 3. Households
4. Foreigners 4. Foreigners

Direct Finance

Discussion:

Those who have savings and are lending funds (the lender – savers), are at the left and those
who must borrow funds to finance their spending (the borrowers – spenders), are at the right.

The principal lender – savers are households, but business enterprises and the government as
well as foreigners and their government, sometimes also finds themselves with excess funds and so
lend them out.

The most important borrower – spenders are businesses and the government (particularly the
material government) but household and foreigners also borrow to finance their purchases of cars,
furniture and houses.

The arrow show that funds flow from lenders – savers to borrowers – spenders, both directly
and indirectly.

Funds flow from lenders to borrowers indirectly through financial intermediaries such as banks
or directly through financial markets, such as the Philippine Stock Exchange.

WHAT FINANCIAL MARKETS DO

 Raising capital. Firms often require funds to build new facilities, replace machinery or expand
their business in other ways. Shares, bonds and other types of financial instruments make this
possible.

 Commercial transactions. As well as long-term capital, the financial markets provide the
grease that make many commercial transactions possible. This include such thing as
arranging payment for the sale of a product abroad, and providing working capital so that
a firm can pay employees if payments from customers run late.

 Price setting. Markets provide price discovery, a way to determine the relative values if
different items, based upon the prices at which individuals are willing to buy and sell them.

 Asset valuation. Market prices offer the best way to determine the value of a firm or of the
firm’s assets, or property. This is important not only to those buying and selling business, but
also to regulators.

 Arbitrage. In counties with poorly developed financial markets, commodities and currencies
may trade at very different prices in different locations. As traders in financial markets
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attempt to profit from this divergences, prices move towards a uniform level, making the
entire economy more efficient.

 Investing. The stock, bond and money markets provide an opportunity to earn a return on
funds that are not needed immediately, and to accumulate assets that will provide an
income in future.

 Risk management. Futures, options and other derivatives contracts can provide protection
against many type of risks, such as the possibility that a foreign currency will lose value against
the domestic currency before an export payment is received.

STRUCTURE OF FINANCIAL MARKETS

Debt and Equity Markets

Funds in a financial market can be obtained by a firm or an individual in two ways:

1. The most common method us to issue a debt instrument, such as a bond or a

mortgage, which is a contractual agreement by the borrower to pay the holder of
the instrument fixed peso amounts at regular intervals (interest and principal
payments) until a specified date (the maturity date), when a final payment is made.

2. The second method of raising funds us by issuing equity instruments, such as common
or ordinary stock, which are claims to share in the net income (income after expenses
and taxes) and the assets of a business. Equities often make periodic payments
(dividends) to their holders and are considered long-term securities because they
have no maturity date.

The following markets are of most interest to the financial manager:

Financial market functions as both primary and secondary markets for debt and equity
securities.

 Primary Market

o It refers to original sale of securities by governments and corporations. The primary

markets for securities are not well known to the public because the selling of
securities to initial buyers often takes place behind closed doors.
o An important financial institution that assist in the initial sale of securities in the
primary markets is the investment bank. It does this by underwritings securities. It
guarantee a price for a corporation’s securities and then sell them to the public.

 Secondary Market

o After the securities are sold to the public (institutions and individuals) they can be
traded in the secondary market (Between investors. Secondary market is
popularly known as Stock Market or Exchange.

o Brokers are agents of investors who match buyers with sellers of securities; dealers
link buyers and sellers by buying and selling securities and stated prices.

THE RISE OF THE FORMAL MARKETS

Investors have many reasons to prefer financial markets to street-corner trading. Yet not all
formal markets are successful, as investor gravitate to certain markets and leave others underutilized.
The busier ones, generally, have important attributes that smaller markets often lack:
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 Liquidity, the ease with which trading can be conducted. Trading is easier and spreads
are narrower in more liquid markets. Because liquidity benefits almost everyone, trading
usually concentrates in markets that are already busy.

 Transparency, the availability of prompt and complete information about trades and
prices. Generally, the less transparent the market, the less willing people are to trade
there.

 Reliability, particularly when it comes to ensuring that trades are completed quickly
according to the terms agreed.

 Legal procedures adequate to settle disputes and enforce contracts.

 Suitable investor protection and regulation. Excessive regulation can stifle a market.
However, trading will also be deterred if investors lack confidence in the available
information about the securities they may wish to trade.

 Low transaction costs. Many financial-market transactions are not tied to a specific
geographic location, and the participants will strive to complete them in places where
trading costs, regulatory costs and taxes are reasonable.

CODE OF ETHICS GOVERNING MARKET ACTIVITIES IN THE PHILIPPINES

On February 24, 2010, Former Deputy Governor Nestor A. Espenilla, Jr. issued Circular Letter
No. CL 2010-013 addressed to all banks, their subdivision and other affiliates to non-bank which
contains financial institutes supervised by the BSP.
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ASSIGNMENT

R E V I E W Q U E S T I O N S

Direction: Answer comprehensively the following questions.

1. Describe what financial markets are.

2. Distinguish between primary market and secondary market.

3. What are the two principal sources if funds in the financial market? Explain
briefly.

4. What benefits could be achieved if the Code of Ethics governing Financial

Market Activities would be implemented and followed by the participants?
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Lesson 2:
MONEY MARKETS AND CAPITAL MARKETS

Learning Objectives

After studying Lesson 2, you should be able to:

MONEY MARKETS

Explain what money market is and how money market works

Discuss who the users of money market are
Explain how money market facilitates the development of a market for long-term
securities
Enumerate and explain the features of money market instruments

CAPITAL MARKETS

Explain what capital market is

Discuss the role of the various capital market participants
Discuss capital market trading
Enumerate and explain the types of bonds
Discuss ordinary (common) equity shares and preferred shares

MONEY MARKETS

The term “money market” refers to the network of corporations, financial institutions, investors
and governments which deal with the flow of short-term capital. When a business needs cash for a
couple of months until a big payment arrives, or when a bank wants to invest money that depositors
may withdraw at any moment, or when a government tries to meet its payroll in the face of big
seasonal fluctuations in tax receipts, the short-term liquidity transactions occur in the money market.

How it Works

The money markets exists to provide the loans that financial institutions and governments
need to carry out their day-to-day operations. For instance, banks may sometimes need to borrow
in the short term to fulfill their obligations to their customers, and they use the money market to do
so.

The money markets are the mechanisms that bring these borrowers and investors together
without the comparatively costly intermediation of banks. They make it possible for borrowers to
meet short-run liquidity needs and deal with irregular cash flows without resorting to more costly
means of raising money.

Who Uses the Money Market?

Companies Banks Investors

a. When companies need a. If demand for long-term a. Individuals seeking to
to raise money to cover loans and mortgages is invest large sums of
their payroll or running not covered by deposits money at relatively low
costs, they may issue from savings accounts, risk may invest in
commercial paper – banks may then issue financial instruments.
short-term, unsecured certificates of deposit, Sums of less than P50,000
loans for P100,000 or with a set interest rate can be invested un
more that mature within and fixed-term maturity money market funds.
1-9 months. of up to five years.
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b. A company that has a

cash surplus may “park”
money for a time in
short-term. Debt-based
financial instruments
such as treasury bills and
commercial paper,
certificates of deposit, or
bank deposits.

What Money Markets Do

A well-functioning money market facilitates the development of a market for longer-term

securities. Money markets attach a price to liquidity, the availability of money for immediate
investment. The interest rates for extremely short-term use of money serve as benchmarks for longer-
term financial instruments.

If the money markets are active, or “liquid”, borrowers and investors always have the option
of engaging in a series of short-term transactions rather than in longer-term transactions, and this
usually holds down longer term rates.

Types of Money-Market Instruments

1. Commercial Paper

 It is a short-term debt obligation of a private sector firm or a government-

sponsored corporation. Only companies with good credit ratings issue
commercial paper because investors are reluctant to bring the debt of financially
compromised companies.
 In most cases, the paper has lifetime, or maturity, greater than 90 days but less
than nine months.

2. Bankers’ Acceptances

 Before the 1980s, bankers’ acceptances were the main way for forms to raise
short-term funds in the money markets. An acceptance is a promissory note issued
by a non-financial firm to a bank in return for a loan.
 Bankers’ acceptances are nit issued at all by financial-industry firms. They do not
bear interest; instead, an investor purchases the acceptance at a discount from
face value and them redeems it for face value at maturity.

3. Treasury Bills

 It is often referred to as T-bills, are securities with a maturity of one year or less,
issued by national governments. Treasury bills issued by a government in its own
currency are generally considered the safest of all possible investments in that
currency.

4. Government Agency Notes

 National government agencies and government-sponsored corporations are

heavy borrowers in the money markets in many countries. These include entities
such as development banks, housing finance corporations, education lending
agencies and agricultural finance agencies.
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5. Local Government Notes

 Local government notes are issued by, provincial or local governments, and by
agencies of these governments such as schools authorities and transport
commissions.
 In some case, the approval of national authorities is required; in others, local
agencies are allowed to borrow only from banks and cannot enter the money
markets.

6. Interbank Loans

 Interbank loans are loans extended from one bank to another with which it has
no affiliation. Many of these loans are across international boundaries and are
used by the borrowing institutions to re-lend to its own customers.

7. Time Deposits

 Time deposits, another name for certificates of deposit or CDs, are interest-
bearing bank deposits that cannot be withdrawn without penalty before a
specified date. Interest rates depend on length of maturity, with longer terms
getting better rate.

8. Repos

 Repurchase agreements known as repos, play a critical role in the money

markets. They serve to keep the markets highly liquid, which in turn ensures that
there will be a constant supply of buyers for new money-market instruments.

CAPITAL MARKETS

The capital market is a financial market in which longer-term debt (original maturity of one
year or greater) and equity instruments are traded. Capital markets securities include bonds, stocks
and mortgages.

Capital Market Participants

The primary issuers of capital market securities:

 The national government issues long-term notes and bonds to fund the national debt
while local governments issue notes and bonds to finance capital projects.

 Corporations issue both bonds and stock to finance capital investment expenditures
and fund other investment opportunities.

Capital Market Trading

Capital market trading occurs in either the primary market or the secondary market. The
primary market is where new issues of stocks and bonds are introduced. Investment funds,
corporations and individual investors can all purchase securities offered in the primary market.

The capital markets have well developed secondary markets. A secondary market is where
the sale of previously issued securities take place, and it is important because most investors plan to
sell long-term bonds before they reach maturity and eventually sell their holdings of stock as well.

A. BONDS

A bond is any long-term promissory note issued by the firm. A bond certificate is the tangible
evidence of debt issued by a corporation or a governmental body and represents a loan
made by investors to the issue.
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Types of Bonds:

1. Unsecured Long-Term Bonds

Debentures
 These are unsecured long-term debt and backed only by the reputation and
financial stability of the corporation. Because these bonds are unsecured, the
earning ability of the issuing corporation is of great concern to the bondholder.

Subordinated Debentures
 Claims of bondholders of subordinated debentures are honored only after the
claims of secured debt and unsubordinated debentures have been satisfied.

Income Bonds
 An income bond requires interest payments only if earned and non-payment of
interest does not lead to bankruptcy. Usually issued during the reorganization of
a firm facing financial difficulties, these bonds have longer maturity and unpaid
interest is generally allowed to accumulate for some period of time and must be
paid prior to the payment of any dividends to stockholders.

2. Secured Long-Term Bonds

Mortgage Bonds
 A mortgage bond is a bond secured by a lien on real property. Typically, the
market value of the real property is greater than that of the mortgage bonds
issued.

 Mortgage bonds can further be sub-classified as follows:

o First Mortgage Bonds. It have the senior claim on the secured assets if the
same property has been pledged in more than one mortgage bond.

o Second Mortgage Bonds. These bonds have the second claim on assets
and are paid only after the claims of the first mortgage bonds have been
satisfied.

o Blanket or General Mortgage Bonds. All the assets of the firm are used as
security for this type of bonds.

o Closed-end Mortgage Bonds. It forbid the further use of the pledged assets
security for other bonds. This protects the bondholders from dilution of their
claims on the assets by any future mortgage bonds.

o Open-end Mortgage Bonds. These bonds allow of additional mortgage

bonds using the same secured assets as security.

o Limited Open-end Mortgage Bonds. These bonds allow the issuance of

additional bonds up to a limited amount at the same priority level using
the already mortgaged assets as security.

Other Types of Bonds:

1. Floating Rate or Variable Rate Bonds

A floating rate bonds is one in which the interest payment changes with market
conditions. In periods of unstable interest rates this type of debt offering becomes
appealing to issuers and investors.
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A common feature if all the floating rate bonds is that an attempt is being made to
counter uncertainty by allowing the interest rate to float. In this way a change in cash
inflows to the firm may be offset by an adjustment in interest payments.

2. Junk or Low-rated Bonds

Junk or low-rated bonds are bonds rated BB or below. The major participants of this
market are new firms that do not have an established record of performance, although
in recent years, junk bonds have been increasingly issued to finance corporate buyouts.

3. Eurobonds

These are bonds payable or denominated in the borrower’s currency, but sold
outside the country if the borrower, usually by an international syndicate of investment
bankers. This market is denominated by bonds stated in U.S. dollars.

An example might be a bond of a U.S. company payable in dollars and sold in

London, Paris, Tokyo or Frankfurt.

Eurobonds are also referred to as bonds issued in Europe by an American company

and pay interest and principal to the lender in U.S. dollars.

4. Treasury Bonds

Treasury bonds carry the “full-faith-and credit” backing of the government and
investors consider them among the safest fixed-income investments in the world. The BSP
sells Treasury securities through public auctions usually to finance the government’s
budget deficit.

When the deficit is large, more bonds come to auction. In addition, the BSP uses
Treasury securities to implement monetary policy.

B. ORDINARY (COMMON) EQUITY SHARES

Ordinary equity shares is a form of long0term equity that represents ownership interest
of the firm. Ordinary equity shareholders are called residual owners because their claims to
earnings and assets is what remains after satisfying the prior claims to various creditors and
preferred shareholders.

Ordinary (common) equity shareholders are the true owners of the corporation and
consequently bear the ultimate risks and rewards of ownership. As owners of the firm, ordinary
shareholders are considered to be residual domains. This means that ordinary shareholders
have the right to claim any cash flows or value after all other claimants have received what
they are owed.

Features of Ordinary Equity Shares:

1. Par value/No par value

Ordinary equity share may be sold with or without par value. Par value of ordinary
equity share is the stated value attached to a single share at issuance. If ordinary equity
share is initially sold for more than its par value, the issue price in excess of par is recorded
as additional paid-in capital, capital surplus, or capital in excess of par.

2. Authorized, issued and outstanding

Authorized shares is the maximum number of shares that a corporation may issue
without amending its charter. Issued shares is the number of authorized shares that have
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been sold. Outstanding shares are those share held by the public. Previously issued shares
that are reacquired and held by the firm are called treasury shares.

3. No maturity

Ordinary equity share has no maturity and is a permanent form of long-term

financing. Although ordinary shares is neither callable nor convertible, the firm can
repurchase its shares in the secondary markets either through a brokerage firm a tender
offer. A tender offer is a formal offer to purchase shares of a corporation.

4. Voting rights

Each share of ordinary equity generally entitles the holder to vote on the selection of
directors and in other matters. Shareholders unable to attend the annual meeting to vote
may be vote by proxy. A proxy is a temporary transfer if the right to vote to another party.

There are two common systems of voting:

a. Majority voting. A voting system that entitles each shareholder to cast one
vote for each share owned. If a group controls over 50% of the votes, it can
elect all of the directors and prevent minority shareholders from electing any
directors.

b. Cumulative voting. A voting system that permits the shareholder to cast

multiple votes for a single director. It assist minority shareholders in electing at
least one director.

5. Book value per share

The accounting value of an ordinary equity share is equal to the ordinary share equity
(ordinary share plus plaid-in capital plus retained earnings) divided by the number of
shares outstanding.

6. Numerous voting rights of stockholders

a. Right to vote on specific issues as prescribed by the corporate charter such as

election of the board of directors, increasing the amount of authorized stock,
amending the articles of incorporation and bylaws, and etc.

b. Right to receive dividends if declared by the firm’s board of directors.

c. Right to share in the residual assets in the events of liquidation.

d. Right to transfer their ownership in the firm to another party.

e. Right to examine the corporate banks.

f. Right to share proportionally in the purchase of any new issuance of equity

shares. This is known as pre-emptive right.

C. PREFERRED SHARE

Preferred share is a class of equity shares which has preference over ordinary
(common) equity shares in the payments of dividends and in the distribution of corporation
assets in the event of liquidation.

Preference means only that the holders of the preferred share must receive a
dividend (in the case of a going concern firm) before the holder of ordinary (common) equity
shares are entitle to anything.
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Preferred Shares Features:

1. Par value

Par value is the face value that appears in the stock certificate. In some cases, the
liquidation value per share is provided for in the certificate.

2. Dividends

Dividends are stated as a percentage if the par value and are commonly fixed and
paid quarterly but are not guaranteed by the issuing firm.

3. Cumulative and Noncumulative dividends

If preferred dividends are cumulative and are not paid in a particular year, they will
be carried forward as an arrearage. Usually, both accumulated (past) preferred
dividends and the current preferred divided must be paid before the ordinary equity
shareholders receive anything.

If the preferred dividends are noncumulative, dividends not declared in any

particular year are lost forever and the preferred shareholders cannot claim such
anymore.

4. Convertible preferred share

Owners of convertible preferred share have the option of exchanging their preferred
share for ordinary (common) equity share based in specified terms and conditions.

5. Voting rights

Preferred share does not ordinarily carry voting rights. Special voting procedures may
take effect if the issuing firm omits its preferred dividends for a specific time period.

6. Participating features

Participating preferred share entitles its holders to share in profits above and beyond
the declare dividend, along with ordinary (common) equity shareholders.

7. Call provision

A call provision gives the issuing corporation the right to call in the referred share for
redemption.

8. Maturity

Three decades ago, most preferred share was perpetual – it had no maturity and
never needed to be paid off. However, today most new preferred share has a sinking
fund and this an effective maturity date.

COMPARATIVE FEATURES OF ORDINARY EQUITY SHARES, PREFERRED SHARES AND BONDS

Ordinary Equity
Preferred Shares Bonds
Shares
a) Ownership and Belongs to ordinary Limited rights under
Limited rights when
control of the equity shareholders default in interest
dividends are missed.
firm through voting right payments
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and residual claim to

income
Must receive payment
b) Obligation to Contractual
None before ordinary
provide return obligation
shareholder
Bondholders and
c) Claim to assets Lowest claim of any
creditors must be Highest claim
in bankruptcy security holder
satisfied first
d) Cost of
Highest Moderate Lowest
distribution
Highest risk, highest
e) Risk-return trade Moderate risk, Lowest risk, moderate
return (at least in
off moderate return return
theory)
f) Tax status of
payment by Not deductible Not deductible Tax deductible
corporation
A portion of dividend
g) Tax status of
paid to another Same as ordinary Government bond
payment to
corporation is tax shares interest is tax exempt
recipient
exempt
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ASSIGNMENT

R E V I E W Q U E S T I O N S

Direction: Answer comprehensively the following questions.

1. Describe how the money market mechanism works to bring g providers and
users of short-term fund together.

2. Explain how banks, companies and investors use financial instruments in the
money market.

3. Who are the primary issuers if capital market securities? Explain each.

4. Enumerate the advantages and disadvantages of issuing bonds as a source

of long-term funds.
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Lesson 3:
FOREIGN EXCHANGE MARKET

Learning Objectives

After studying Lesson 3, you should be able to:

Discuss what factors significantly influence the currency exchange rates of a country.
Explain how foreign exchange market provides the mechanism for the transfer
purchasing power from one currency to another.
Explain what exchange rate is.
Distinguish between spot transactions and forward transactions; spot exchange rate
and forward exchange rate.
Discuss the significance of foreign exchange risks

Introduction

Most countries of the world have their own currencies. The United Sates has its dollar; France,
the euro; Brazil, its real; India, its rupee and in the Philippines its peso. Trade between countries
involves the mutual exchange of different currencies. Firms that do business internationally must be
concerned with exchange rates, which are the relationships among values of currencies.

The constant change in exchange rates causes problems for financial managers as the
change in relative purchasing power between countries affects imports and exports, interest rates
and other economic variables. The relative strength of particular currency to other currencies
changes many times over a business cycle.

RECENT HISTORICAL PERSPECTIVE OF EXCHANGE RATES

From the end of World War II until the early 70’s, the world was on a fixed exchange rate
system administered by the International Monetary Fund (IMF). Under this system, all countries were
required to set a specific parity rate for their currency vis-à-vis the United States dollar. A country
could effect a major adjustment in the exchange rate by changing the parity rate with respect to
the dollar. Then the currency was made cheaper with respect to the dollar, the adjustment was
called a devaluation. An upvaluation or revaluation resulted when a currency became more
expensive with respect to the dollar.

A floating rate international currency system has been operating since 1973. Most major
currencies fluctuate freely depending upon their values as perceived by the traders in foreign
exchange markets.

THE FOREIGN CURRENCY EXCHANGE MARKET

The forex market provides a service to individuals, businesses and governments who need to
buy or sell currencies other than that used in their country. This might be in order to travel abroad, to
make investments in another country, or to pay for import products or convert export earnings.

The foreign exchange (or forex) market provides a mechanism for the transfer of purchasing
power dorm one currency to another. This is where traders convert one foreign currency into another
and is one of the largest financial markets in the world. They communicate using electronic networks.
Any firm’s banks or experts within the firm, can access this market to exchange one currency for
another.
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EXCHANGE RATES

An exchange rate is simply the price of one country’s currency expressed in terms of another
country’s currency. In practice, almost all trading of currencies takes place in terms of the U.S dollar.
For example, both the Euros, the Swiss franc, and the Japanese yen are traded with prices quoted
in U.S dollar. Exchange rates are constantly changing.

Figure 3.1
BANGKO SENTRAL NG PILIPINAS

FINANCIAL MARKETS

REFERENCE EXCHANGE RATE BULLETIN

April 26, 2024

COUNTRY COUNTRY COUNTRY COUNTRY COUNTRY COUNTR

I. CONVERTIBLE CURRENCIES WITH BANGKO SENTRAL:

1 UNITED 1 UNITED 1 UNITED 1 UNITED 1 UNITED 1 UNIT

STATES STATES STATES STATES STATES STA

2 JAPAN 2 JAPAN 2 JAPAN 2 JAPAN 2 JAPAN 2 JAP

3 UNITED 3 UNITED 3 UNITED 3 UNITED 3 UNITED 3 UNIT

KINGDOM KINGDOM KINGDOM KINGDOM KINGDOM KINGD

4 HONGKONG 4 HONGKONG 4 HONGKONG 4 HONGKONG 4 HONGKONG 4 HONGKO

5 5 5 5 5
SWITZERLAND SWITZERLAND SWITZERLAND SWITZERLAND SWITZERLAND SWITZERLA

6 CANADA 6 CANADA 6 CANADA 6 CANADA 6 CANADA 6 CANA

7 SINGAPORE 7 SINGAPORE 7 SINGAPORE 7 SINGAPORE 7 SINGAPORE 7 SINGAPO

8 AUSTRALIA 8 AUSTRALIA 8 AUSTRALIA 8 AUSTRALIA 8 AUSTRALIA 8 AUSTRA

9 BAHRAIN 9 BAHRAIN 9 BAHRAIN 9 BAHRAIN 9 BAHRAIN 9 BAHR

10 KUWAIT 10 KUWAIT 10 KUWAIT 10 KUWAIT 10 KUWAIT 10 KUW

11 SAUDI 11 SAUDI 11 SAUDI 11 SAUDI 11 SAUDI 11 SA

ARABIA ARABIA ARABIA ARABIA ARABIA ARA

12 BRUNEI 12 BRUNEI 12 BRUNEI 12 BRUNEI 12 BRUNEI 12 BRU

13 INDONESIA 13 INDONESIA 13 INDONESIA 13 INDONESIA 13 INDONESIA 13 INDONE

14 THAILAND 14 THAILAND 14 THAILAND 14 THAILAND 14 THAILAND 14 THAILA

15 UNITED 15 UNITED 15 UNITED 15 UNITED 15 UNITED 15 UNIT

ARAB ARAB ARAB ARAB ARAB AR
EMIRATES EMIRATES EMIRATES EMIRATES EMIRATES EMIRA
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BANGKO SENTRAL NG PILIPINAS

FINANCIAL MARKETS

REFERENCE EXCHANGE RATE BULLETIN

April 26, 2024

COUNTRY COUNTRY COUNTRY COUNTRY COUNTRY COUNTR

16 EUROPEAN 16 EUROPEAN 16 EUROPEAN 16 EUROPEAN 16 EUROPEAN 16 EUROPE

MONETARY MONETARY MONETARY MONETARY MONETARY MONETA
UNION UNION UNION UNION UNION UN

17 KOREA 17 KOREA 17 KOREA 17 KOREA 17 KOREA 17 KOR

18 CHINA 18 CHINA 18 CHINA 18 CHINA 18 CHINA 18 CH

II. OTHERS (NOT CONVERTIBLE WITH BSP)

19 19 19 19 19
ARGENTINA ARGENTINA ARGENTINA ARGENTINA ARGENTINA ARGENT

20 BRAZIL 20 BRAZIL 20 BRAZIL 20 BRAZIL 20 BRAZIL 20 BRA

21 DENMARK 21 DENMARK 21 DENMARK 21 DENMARK 21 DENMARK 21 DENMA

22 INDIA 22 INDIA 22 INDIA 22 INDIA 22 INDIA 22 IN

23 MALAYSIA 23 MALAYSIA 23 MALAYSIA 23 MALAYSIA 23 MALAYSIA 23 MALAY

24 MEXICO 24 MEXICO 24 MEXICO 24 MEXICO 24 MEXICO 24 MEX

25 NEW 25 NEW 25 NEW 25 NEW 25 NEW 25 N

ZEALAND ZEALAND ZEALAND ZEALAND ZEALAND ZEALA

26 NORWAY 26 NORWAY 26 NORWAY 26 NORWAY 26 NORWAY 26 NORW

27 PAKISTAN 27 PAKISTAN 27 PAKISTAN 27 PAKISTAN 27 PAKISTAN 27 PAKIS

28 SOUTH 28 SOUTH 28 SOUTH 28 SOUTH 28 SOUTH 28 SOU

AFRICA AFRICA AFRICA AFRICA AFRICA AFR

29 SWEDEN 29 SWEDEN 29 SWEDEN 29 SWEDEN 29 SWEDEN 29 SWED

30 SYRIA 30 SYRIA 30 SYRIA 30 SYRIA 30 SYRIA 30 SY

31 TAIWAN 31 TAIWAN 31 TAIWAN 31 TAIWAN 31 TAIWAN 31 TAIW

32 32 32 32 32
VENEZUELA VENEZUELA VENEZUELA VENEZUELA VENEZUELA VENEZU

BSP Buying BSP Buying BSP Buying Rate (T/T): P

Rate (T/T): Rate (T/T): PHP
PHP
 19

BANGKO SENTRAL NG PILIPINAS

FINANCIAL MARKETS

REFERENCE EXCHANGE RATE BULLETIN

April 26, 2024

COUNTRY COUNTRY COUNTRY COUNTRY COUNTRY COUNTR

BSP Selling BSP Selling BSP Selling Rate (T/T): P

Rate (T/T): Rate (T/T): PHP
PHP

BSP BSP Reference BSP Reference Rate: P

Reference Rate: PHP
Rate: PHP

PDS PDS Closing PDS Closing Rate (25-Apr-2024): P

Closing Rate (25-Apr-
Rate (25- 2024): PHP
Apr-2024):
PHP

SDR Rate: SDR Rate: $ SDR Ra

$

GOLD GOLD GOLD BUYIN

BUYING: $ BUYING: $

SILVER SILVER SILVER BUYIN

BUYING: $ BUYING: $

**** THB On-shore price

Source: REUTERS' FOREX CLOSING PRICES as of NY Time - 25-Apr-2024

* Various banks in Bahrain as quoted in Reuters' Screen

** Asian Time Closing Rate as of 25-Apr-2024

*** Effective 01 October 2021, Venezuela has removed six zeros from their official exchange rate (e.g.
0.000004 bolivars per dollar to 0.162215 bolivars per dollar)

WHY ARE EXCHANGE RATES IMPORTANT?

Exchange rates are important because they affect the relative prices of domestic and
foreign goods. The dollar price of French goods to an American is determined by the interaction of
two factors: the price of French goods in euros and the euro/dollar exchange rate.

When a country’s currency appreciates (rises in value relative to other currencies), the
country’s goods abroad become more expensive and foreign goods in that country become
cheaper (holding domestic prices constant in the two countries). Conversely, when a country’s
 20

currency depreciates, its goods abroad become cheaper and foreign goods in that country
become more expensive.

Appreciation of a currency can make it harder for domestic manufacturers to sell their goods
abroad and can increase competition from foreign goods because they cost less.

FACTORS INFLUENCING EXCHANGE RATES

The major reasons for exchange rates movements which includes:

1. Inflation. Inflation tends to deflate the value of a currency because holding the currency
results in reduced purchasing power.

2. Interest rates. If interest returns in a particular country are higher relative to other countries,
individuals and companies will be enticed to invest in that country. As a result, there will
be an increased demand for the country’s currency.

3. Balance of payments. Balance of payments is used to refer to a system of accounts that

catalogs the flow of goods between the residents of two countries.

4. Government intervention. Through intervention (e.g., buying or selling the currency in the
foreign exchange markets), the central bank of a country may support or depress the
value of its currency.

5. Other factors. Other factors that may affect exchange rates are political and economic
stability, extended stock market rallies and significant declines in the demand for major
exports.

WHAT ARE THE FOREIGN CURRENCY EXCHANGE RATE TRANSACTIONS?

The two kinds of Foreign Exchange Rate Transactions are:

A. Spot Transactions

Spot transactions are those which involve immediate two-day) exchange of bank deposits.
The spot exchange rate is the exchange rate for the spot transactions.

B. Forward Transactions

Forward transactions involve the exchange of bank deposits at some specified future date.
The forward exchange rate is the exchange rate for the forward transaction.

SPOT EXCHANGE RATES

If we are exchanging one currency for another immediately, we participate in spot

transaction. A typical spot transaction may involve a Philippine firm buying foreign currency from its
bank and paying for it in Philippine pesos.

The price of the foreign currency in terms of the domestic currency is the exchange rate – in
this instance, the Philippine peso. Another case is when a Philippine firm receives foreign currency
from abroad. The firm would typically sell the foreign currency to its bank Philippine peso. There are
both spot transactions, where one currency is exchanged for another currency immediately.

The spot rate for a currency is the exchange rate at which the currency is traded for
immediate delivery.
 21

DIRECT AND INDIRECT QUOTES

In the spot exchange market, the quoted exchange rate is typically called a direct quote. A
direct quote indicates the number of units of the home currency required to buy one unit of the
foreign currency. An indirect quote indicates the number of units of foreign currency that can be
bought for one unit of the home currency.

In summary, a direct quote is the peso/foreign currency rate, and an indirect quote is the
foreign currency/peso rate. Therefore, an indirect quote is the reciprocal of a direct quote and vice
versa.

Illustrative Case:

Compute the indirect quote from the Philippine direct quotes of spot rates for US dollars, UK
pound, EU euros, and Japanese yen as of April 26, 2024 given in Figure 3.1. The related indirect quotes
are computes as follows:

Indirect = 1_ ___
Quote Direct quote

Thus:
US dollars = ___1___ = .01728 (dollar/P1)
57.8690

UK pounds = ___1___ = .01380 (pound/P1)

72.4346

EU euros = ___1___ = .01610 (euro/P1)

62.0992

Japan yen = __1__ = 2.68817 (yen/P1)

0.3720

The direct and indirect quotes are useful in computing foreign currency requirements. Consider the
following examples:

a) A Filipino businessman wanted to remit 1,000 UK pounds to London on April 26, 2024. How
much in pesos would have been required for this transaction?

P72.4346/pounds x 1,000 pounds = P 72,434,60

b) A Filipino businessman paid P112,148.20 to an Italian supplier on April 26, 2024. How many
euros did the Italian supplier receive?

P112,148.20 x .01610 = € 1,805.59 euros

CROSS RATES

Also important in understanding the spot-rate mechanism is the cross rate. A cross rate is the
indirect computation of the exchange rate of one currency from the exchange rate of two other
currencies.
 22

For instance:

The peso/pound and the euro/peso rates are given in Figure 3.1. From this
information, we could determine the euro/pound and pound/euro exchange rates.

We see that:

P72.4346 = £1
P62.0992 = €1
P72.4346 / P62.0992 = 1.1664 euro per 1 pound

Thus, the pound/ euro exchange rate is:

P62.0992 / P72.4346 = .87342 pound per 1 euro

Cross rate computations make it possible to use quotation in New York to compute, the
exchange rate between pounds, euros and so forth in other foreign currency exchange markets. If
the rates prevailing in London and Paris were different from the computed cross rates, using quotes
from New York, a trader could use three different markets and make arbitrage profits. The arbitrage
condition for the cross rates is called triangular arbitrage.

FORWARD RATES

The forward rate for a currency is the exchange rate at which the currency for future delivery
is quoted. The trading of currencies for future delivery is called a forward market transaction.

Suppose Sta. Lucia Corporation expects to pay US$1.0 million to a US supplier 30 days from
now. It is not certain however, what these dollars will be worth in Philippine pesos 30 days from today.
To eliminate this uncertainty, Sta. Lucia Corporation calls a bank and offers to buy US$1.0 million to
a US supplier 30 days from now. In their negotiation, the two parties may agree on an exchange rate
of P46 million to the bank and receives $1 million.

FACTORS THAT AFFECT EXCHANGE RATES IN THE LONG RUN

1. Relative Price Levels

In the long run, a rise in a country’s price level (relative to the foreign price level)
causes its currency to depreciate, and a fall in the country’s relative price level causes its
currency to appreciate.

2. Trade Barriers

Increasing trade barriers causes a country’s currency to appreciate in the long run.

3. Preferences for Domestic Versus Foreign Goods

Increased demand for a country’s exports causes its currency to appreciate in the
long run; conversely, increased demands for imports causes the domestic currency to
depreciate.

4. Productivity

In the long run, as a country becomes more productive relative to other countries, its
currency appreciates.
 23

EXCHANGE RATES IN THE SHORT RUN

The key to understanding the short run behavior of exchange rates id to recognize that an
exchange rate is the price of domestic bank deposits )those denominated in the domestic currency)
in terms of foreign bank deposits (those denominated in the foreign currency).

Earlier approaches to exchange rate determination emphasized the role of import and
export demand. The more modern asset market approach used here does not emphasize the flows
of purchase of exports and imports over short periods because these transactions are quite small
relative to the amount of domestic and foreign bank deposits at any given time.

MANAGING FOREIGN EXCHANGE RISK

Foreign exchange risk refers to the possibility of a drop in revenue or an increase in cost in an
international transaction due to a change in foreign exchange rates. Importers, exporters, investors
and multinational firms are all exposed to this foreign exchange risk.

In today’s global monetary system, the exchange rates if major currencies are fluctuating
rather freely. These “freely” floating exchange rates expose multinational business firms to foreign
exchange risk. To deal with this foreign currency exposure effectively, the financial manager must
understand foreign exchange rates and how they are determined. Foreign exchange rates are
influenced by differences in inflation rates among countries, differences in interest rates, government
policies and the expectations of the participants in the foreign exchange markets.
 24

ASSIGNMENT

R E V I E W Q U E S T I O N S

Direction: Answer comprehensively the following questions.

1. List the factors that affect the value of a currency in foreign exchange
markets.

2. Explain how imports and exports tend to influence the value of a currency.

3. Differentiate between the spot exchange rate and the forward exchange
rate.
 25

Lesson 4: INTERNALIZATION OF FINANCIAL MARKETS

Learning Objectives

After studying Lesson 4, you should be able to:

Discuss the importance of global financial markets

Familiarize yourself of the largest financial markets in the world
Explain the factors affecting the long-run trends of increased financial market activity
Distinguish between individual and institutional investors
Explain the types of institutional investors
Discuss the major types of international credit markets

Introduction

The flow of money around the world is essential for business to operate and grow. Stock
markets are places where individuals as well as institutional (corporation) investors can trade
currencies, invest in companies and arrange loans.

Without the global financial markets, governments would not be able to borrow money,
companies would not have access to the capital they need to expand and, investors and individuals
would be unable to buy and sell foreign currencies.

FINANCIAL MARKETS AROUND THE WORLD

New York, US

The New York Stock Exchange (NYSE) is the largest in the world (market capitalization – the
market value of its outstanding shares: $14.14 trillion), followed by the NASDAQ, which is also based
in New York, ($5.63 trillion).

Toronto, Canada

The Toronto Stock Exchange (TSE) in Canada is run by the TMX Group ($1.45 trillion).

Tokyo, Japan

The Japan Exchange Group (JPX), based in Tokyo, is the largest exchange in Asian ($3.73
trillion).

China

China has three stock exchanges: the Shanghai Stock Exchange (SSE), ($2.9 trillion); Shenzhen
Stock Exchange (SZSE) ($2.36 trillion); and the Stock Exchange of Hong Kong (SEHK) ($3.32 trillion)

London, UK

The London Stock Exchange (LSE) is Europe’s largest ($2.68 trillion).

 26

European Union

Euronext has headquarters in Amsterdam, Brussels, Lisbon, London and Paris ($2.56 trillion).

Frankfurt, Germany

Deutsche Borse is based in Frankfurt (FWB) ($1.24 trillion).

FACTORS AFFECTING THE LONG-RUN TRENDS OF INCREASED FINANCIAL MARKET ACTIVITY

A. Lower Inflation

Inflation rates around that have fallen markedly since the 1990s. Inflation erodes the value
of financial assets and increases the value of physical assets, such as houses and machines,
which will cost far more to replace than they are worth today. In a low inflation environment,
however, financial-market investors require less of an inflation premium, as they do not expect
general increases in prices to devalue their assets.

B. Pensions

A significant change in pension policies occurred many countries starting in the 1990s.
Changes in demography and working patterns have made pay-as-you-go schemes increasingly
costly to support, as there are fewer young workers relative to the number of pensioners. This has
stimulated interest in pre-funded individual pensions, whereby each worker has an account in
which money must be saved, and therefore invested, until retirement.

C. Stock and bond market performance

Stock markets, after several difficult years, rose steeply on many countries in 20212 and
2013 and again in 20916 and 2017. A rapid increase in financial wealth feeds on itself: investors
whose portfolios have appreciated are willing to reinvest some of their profits in the financial
markets. And the appreciation in the value of their financial assets gives investors the collateral
to borrow additional money, which can then be invested.

D. Risk management

Innovation has generated many new financial product, such as derivatives and asset-
backed securities, whose basic purpose is to redistribute risk. This led to enormous growth in the
use of financial markets for risk-management purposes. The credit crisis that began in 2007,
however, revealed that the pricing of many of these risk-management products did not properly
reflect the risks involved. As a result, these products have become more costly, and are being
used more sparingly, then in earlier years.

E. The Investors

The driving fierce behind financial markets is the desire of investors to earn a return on
their assets. This return has two distinct components:

 Yield is the income investor receives while owning an investment.

 Capital gains are increase in the value if the investment itself, and are often not
available to the owner until the investment is sold.
 27

THE CATEGORIES OF INVESTORS

Individuals

Collectively, individuals own a small proportion of financial assets. Most household in the
wealthier countries own some financial assets, often on the form of retirement savings or of shares in
the employer of a household member.

Institutional Investors

Insurance companies and other institutional investors, including high-frequency traders, are
responsible for cost of the trading in financial markets. The size of institutional investors varies greatly
from country to country, depending on the development of collective investment vehicles.

Types of Institutional Investors:

 Mutual funds. Mutual funds and unit are investment companies that typically accept an
unlimited number of individual investments. The fund declares the strategy it will pursue,
and as additional money is invested the fund managers purchase financial instruments
appropriate to that strategy.

 Hedge funds. It can accept investments from only a small number of wealthy individuals
or big institutions. Hedge funds are able to employ aggressive investment strategies, such
as using borrowed money to increase the amount invested and focusing investment in
one or another type of asset rather than diversifying.

 Insurance companies. It is the most important type of institutional investor, owning one-
third of all the financial assets owned by institutions. In recent years, a growing share of
insurers’ business has consisted of annuities, which guarantee policy holders a sum of
money each year as long as they live, rather than merely paying their heirs upon death.

 Pension funds. Pension funds aggregates the retirement savings of a large number of
workers. In the Philippines, the SSSS and GSIS represent the largest investors of pension
fund. Unlike individual pension accounts, pension funds do not give individuals control
over how their savings are invested, but they do typically offer a guaranteed benefit
once the individual reaches retirement age.

 Algorithmic traders. It also known as high-frequency trading and has expanded

dramatically in recent years as a result of increased computing power and the availability
of low-cost, high-speed communications. Algorithmic trading firms control only a tony
proportion of the world’s financial assets, but they account for a large proportion of the
trading in some markets.

INTERNATIONAL MONEY AND CAPITAL MARKETS

There are three major types of international credit markets:

1. Eurocredits

This is the market for floating-rate bank loans whose rates are tied to LIBOR, which stands
for London Interbank Offer Rate. LIBOR is the interest rate offered by the largest and strongest
banks on large deposits. Eurocredits exist for major trading currencies. An example of a
Eurocredits is a Eurodollar deposit, which is a U.S. dollar deposited in a bank outside the United
States.
 28

2. Eurobond Market

A Eurobond is an international bond underwritten by an international syndicate of banks

and sold to investors in countries other than the one in whose money unit the bond is
denominated.

3. Foreign Bond Market

Foreign bonds are international bonds issued in the country whose currency the bond is
denominated, and they are underwritten by investment bank in that country. The borrower may
be located in a different country.
 29

ASSIGNMENT

R E V I E W Q U E S T I O N S

Direction: Answer comprehensively the following questions.

1. In what way do global financial markets help government individuals,

businesses and investors?

2. Explain the development of financial instruments in the international markets.

3. Is it easy to estimate the worldwide size of its financial markets? Discuss.