FINANCIAL

MARKET
 What is a market?

• A market is a venue where goods and

services are exchanged.

• A financial market is a place where

individuals and organizations wanting to
borrow funds are brought together with
those having a surplus of funds.

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 The Importance of Financial Markets
• Well-functioning financial markets facilitate the
flow of capital from providers of funds (e.g
inventors) to the users of capital.

• Well-functioning markets promote economic

growth. The users can make use of the funds for
expansion and the providers of funds obtained
additional income.

• Economies with well-developed markets perform

better than economies with poorly-functioning
markets.
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 How is capital transferred between
providers of funds and users of funds?
Direct Transfer
Money
Users of Providers of
funds funds
Shares and dividends, Bonds and
interest
Problems that can be encountered
1. Costly on the part of the users of funds (e.g.
borrower)
2. Risky on the part of the providers of funds (e.g.
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 How is capital transferred between providers
of funds and users of funds?
Indirect Transfer
Money Money
Users of Investme Providers
funds nt Banks of funds

Issue Dividends,
• Stock Interest
s Capital
• Bond Appreciation
s
How is capital transferred between providers
of funds and users of funds?
Indirect Transfer
Money Money

Users Financial Providers

of funds Intermediaries of funds

Issue Receive
• Certificate of deposit • Interest
• Insurance Policy • Life and Health benefits
• Mutual Funds/UITF • Capital appreciation
Banks
Insurance Companies
Mutual Fund Companies
Why companies go to Financial Intermediaries?
• Financial intermediaries hire highly qualified people to assess
risky investments.

• These know how to diversify (scatter) money/funds to

different investments instead of only to a single investment.

• These have cost advantage or economies of scale (especially

in the case of mutual funds).

• These help reconcile conflicting interests of users and

providers of funds.

• These give providers of funds (particularly savers) liquidity

(as in the case of commercial banks on deposits).
 FINANCIAL MARKET
Financial markets are generally separated
into two and they are:

1. Short term (money market)

The short-term market is primarily dealing
with securities whose life is less than one
year like treasury bills, commercial papers,
and negotiable certificates of deposits.

2. Long term market (capital market).

 FINANCIAL MARKET
The capital market is further divided into two.
1. Primary markets, dealing with the issue of new securities
by business firms, governmental bodies, or other
organizations to raise new funds.

2. Secondary markets, which are involved in trading

securities already outstanding among investors.
 What is an IPO?
• An initial public offering (IPO) occurs when a company issues stock
in the public market for the first time.

• “Going public” enables a company’s owners to raise capital from a

wide variety of outside investors. Once issued, the stock trades in the
secondary market.

• Public companies are subject to additional regulations and reporting

requirements.

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 FINANCIAL INTERMEDIARY
Financial intermediaries are as follows:
1. Banking Institutions
a. Private Banking Institutions
i. Commercial Banks
a) Universal Bank
b) Commercial Banks
ii. Thrift Banks
a) Savings and Mortgage Banks
b) Private Development Banks
iii. Rural Banks
b. Government Banks
i. Development Bank of the Philippines
ii. Land Bank of Philippines
 FINANCIAL INTERMEDIARY
2. Non-Bank Financial Institutions
a. Private Non-bank Financial Institutions
i. Investment Bank
ii. Securities Dealers/Brokers
iii. Insurance Companies
iv. Credit Unions
v. Pawnshops
b. Government Non-Bank Financial Institution
i. Government Service Insurance System
ii. Social Security System
FUNCTIONS OF INVESTMENT BANKER
1. To originate securities issues – negotiation between the
officers of the issuing firm and officers of the investment
bank.
2. To underwrite the issues by guaranteeing their sale in the
primary capital markets
3. To manage the distribution of these securities to the
ultimate investors. Members of the underwriting
syndicate will form a selling group comprising of dealers
that will reach the ultimate investors.
4. To advice their corporate clients on long-term financial
matters
 Money Market
This is a market intended for short-term placements.
The placement usually takes one year or less to mature.
1. Treasury bills (T-Bills)

2. Repurchase agreements

3. Commercial paper

4. Negotiable certificates of deposit

5. Banker’s acceptances
 Money Markets
Treasury Bills (T-bills).
It is an obligation by the national government. The interest is
normally higher than the savings and time deposit. T-bills are
regarded as risk free investment because the payment of
which are guaranteed by the government.

Repurchase Agreement (repo).

It is a financial instrument wherein one party sells a financial
instrument to another party at a specified price with a
commitment to repurchase the financial instrument at a fixed
amount agreed at specific date. Many repos have a maturity
date of 1 to two weeks.
 Money Markets
Commercial paper.
It is an unsecured promissory note with a fixed maturity of 1 to
270 days. Commercial paper is a money-market security issued
by high credit rating companies to raise money to meet short
term obligations.

Negotiable Certificate of Deposit.

It is a time deposit where the investor and the bank agrees on the
term of placement. The investor may invest in span of at least 14
days to less than a year and is entitled to receive the agreed
interest payment.
 Money Markets
Banker’s Acceptance
It is a bank draft where the bank is required to pay the
holder at specified amount on a specified date. It has a
maturity of 90 days from the date of issue, but can be
extended of up to 180 days. The bank draft normally
transpired from export and import transactions. It less
risky compared to other instruments because the
payment of which is guaranteed by the importer’s
bank.
 Capital Market
It is a market that trades equity and debt instruments with
maturities of more than one year.

There are two important elements of the capital market. They are:
1. Organized security exchanges. A securities exchange that
operates under the rules and regulations formulated by an
exchange.

2. Over-the-counter-markets (OTC). It is involved in the buying

and selling of financial instruments but not in organized
securities exchanges.
 Capital Market Investments
Stocks
Issued by corporations who would like to raise money in the financial market.
The investors may invest in the primary market and/or in the secondary market.

Returns that are expected in investing in stocks are dividends and capital
appreciation.

Below is a simple formula for the valuation for stock:

P0 = D1 or P0 = D1
rs rs - g

Where:
P0 = price of the stock at year 1
D1 = expected dividend at year 1
rs = required return on the stocks
g= growth and computed as ROE(1 – DPO)
 Capital Market Investments
Bonds
It is a long-term debt where the issuer is obliged to repay the
principal at its face value on the maturity date and to make
periodic interest payments until such time the principal value
has been paid.

Return from bonds are interest income and capital appreciation.

VB = FV(1+i)-n + CP 1-(1+i)-n
i
Where:
VB = Value of the bond at the time of issuance.
FV = Face value of the bond.
CP = Coupon or interest payment
i = required rate of return or discount rate
n = total no. of conversion periods for the whole term
 Foreign Exchange Market

It is a venue for the exchange of currencies.

Banks normally have this as one of their
functions.

Direct quotation
P1 = US $0.0192308

Indirect quotation
1US$ = P52
 Derivatives Market
Financial securities whose payoffs are linked to other, previously
issued (or underlying) primary securities or indexes.

It generally involves an agreement between to parties to

exchange a standard quantity of an asset or cash flow at a
predetermined price and at a specified date in the future.
• Forward contract
• Futures contract
• Option: Call and Put
• Swap
 Financial Market Regulation
Financial Instruments are subject to rules and
regulations imposed by regulatory agencies.

Securities and Exchange Commission. The

main concern is to give full and fair disclosure
of information on securities issues to actual
and potential investors.
 Efficient Market Hypothesis (EMH)
It states that the stock prices already reflect all available
information in the market and this information are
immediately available to the investing public.

It directly implies that nobody can beat the market

consistently on a risk-adjusted basis because the market
prices only react to new information.

This hypothesis also describe that the market is perfect and

nobody should benefit from the fluctuation of the prices.
 Efficient Market Hypothesis (EMH)
According to Eugene Francis Fama , there are three types of market
efficiency. They are:
1. Strong-form. It is concern with all information sets, including
private information, are incorporated in price trend;

2. Semi-strong form. It requires that all public information is

reflected in prices already, such as companies' announcements or
annual earnings figures.

3. Weak efficiency. It is saying that the information set is just

historical prices, which can be predicted from historical price
trend