FINANCIAL INSTRUMENTS

SUBMITTED BY:
Batbatan, Leslie
Del Rosario, Jessamine
Hempiso, Aya
Landicho, Lorelyn
Marquina, Sharmaine
Novo, Sharmaine
Sermonia, Ellen Mae

Financial Instruments

THE MONEY MARKET

The money market is used by a wide array of participants, from a company
raising money by selling commercial paper into the market to an investor purchasing CDs
as a safe place to park money in the short term. The money market is typically seen as a
safe place to put money due the highly liquid nature of the securities and short maturities,
but there are risks in the market that any investor needs to be aware of including the risk
of default on securities such as commercial paper.
TYPES OF SECURITIES:
Treasury Bills
Bankers Acceptance
Eurodollar market time deposits
Negotiable Certificates of Deposits
Commercial Paper
TREASURY BILLS

Treasury Bills (T-bills) are the most marketable money market security. Their
popularity is mainly due to their simplicity. Essentially, T-bills are a way for the
U.S. government to raise money from the public. In this tutorial, we are referring
to T-bills issued by the U.S. government, but many other governments issue Tbills in a similar fashion. T-bills are short-term securities that mature in one year
or less from their issue date. They are issued with three-month, six-month and
one-year maturities. T-bills are purchased for a price that is less than
their par (face) value; when they mature, the government pays the holder the full
par value. Effectively, your interest is the difference between the purchase price
of the security and what you get at maturity. T-bills are issued through a
competitive bidding process at a discount from par, which means that rather than
paying fixed interest payments like conventional bonds, the appreciation of the
bond provides the return to the holder.

Financial Instruments

BANKERS ACCEPTANCE

A bankers' acceptance (BA) is a short-term credit investment created by a nonfinancial firm and guaranteed by a bank to make payment. Acceptances are
traded at discounts from face value in the secondary market. For corporations, a
BA acts as a negotiable time draft for financing imports, exports or other
transactions in goods. This is especially useful when the creditworthiness of a
foreign trade partner is unknown. One advantage of a banker's acceptance is that
it does not need to be held until maturity, and can be sold off in the secondary
markets where investors and institutions constantly trade BAs.

EURODOLLAR MARKET TIME DEPOSITS

Contrary to the name, eurodollars have very little to do with the euro or
European countries. Eurodollars are U.S.-dollar denominated deposits at
banks outside of the United States. This market evolved in Europe
(specifically London), hence the name, but eurodollars can be held anywhere
outside the United States.

The eurodollar market is relatively free of regulation; therefore, banks can

operate on narrower margins than their counterparts in the United States. As a
result, the eurodollar market has expanded largely as a way of circumventing
regulatory costs.

NEGOTIABLE CERTIFICATE OF DEPOSITS

A certificate of deposit (CD) is a time deposit with a bank. CDs are generally
issued by commercial banks but they can be bought through brokerages.
They bear a specific maturity date (from three months to five years), a
specified interest rate, and can be issued in any denomination, much like
bonds. Like all time deposits, the funds may not be withdrawn on demand
like those in a checking account.

CDs offer a slightly higher yield than T-Bills because of the slightly higher
default risk for a bank but, overall, the likelihood that a large bank will go

Financial Instruments

broke is pretty slim. Of course, the amount of interest you earn depends on a
number of other factors such as the current interest rate environment, how
much money you invest, the length of time and the particular bank you
choose. While nearly every bank offers CDs, the rates are rarely competitive,
so it's important to shop around.

COMMERCIAL PAPER

Commercial paper is an unsecured, short-term loan issued by a

corporation, typically for financing accounts receivable and inventories. It
is usually issued at adiscount, reflecting current market interest rates.
Maturities on commercial paper are usually no longer than nine months,
with maturities of between one and two months being the average.
For the most part, commercial paper is a very safe investment because the
financial situation of a company can easily be predicted over a few
months. Furthermore, typically only companies with high credit
ratings and credit worthiness issue commercial paper. Over the past 40
years, there have only been a handful of cases where corporations
have defaulted on their commercial paper repayment

THE CAPITAL MARKET

Long-term securities (maturities over one year) trade in the capital market.
Federal, state, and local governments, as well as large corporations, raise long term funds
in the capital market. Firms usually invest proceeds from capital market securities sales in
long-term assets such as buildings, production equipment, and so on. Initial offerings of
securities in the capital market are usually large deals put together by investment bankers,
although after the original issue, the securities may be traded quickly and easily among
inventors. The two most widely recognized securities in the capital market are bonds and
stocks.

Financial Instruments

TYPES OF SECURITIES:
Preferred Stocks
Common Stocks
Corporate Bonds
Treasury Bonds
State and Local Government Bonds
Government Securities
Mortgages
PREFERRED STOCKS

A class of ownership in a corporation that has a higher claim on the assets

and earnings than common stock. Preferred stock generally has a dividend
that must be paid out before dividends to common stockholders and the
shares usually do not have voting rights. The precise details as to the
structure of preferred stock are specific to each corporation. However, the
best way to think of preferred stock is as a financial instrument that has
characteristics of both debt (fixed dividends) and equity (potential
appreciation). Also known as "preferred shares".

COMMON STOCKS

A security that represents ownership in a corporation. Holders of common

stock exercise control by electing a board of directors and voting on
corporate policy. Common stockholders are on the bottom of the priority
ladder for ownership structure. In the event of liquidation, common
shareholders have rights to a company's assets only after bondholders;
preferred shareholders and other debt holders have been paid in full. In the
U.K., these are called "ordinary shares." If the company goes bankrupt, the
common stockholders will not receive their money until the creditors and

Financial Instruments

preferred shareholders have received their respective share of the leftover

assets. This makes common stock riskier than debt or preferred shares.
The upside to common shares is that they usually outperform bonds and
preferred shares in the long run.

CORPORATE BONDS

A debt security issued by a corporation and sold to investors. The backing

for the bond is usually the payment ability of the company, which is
typically money to be earned from future operations. In some cases, the
company's physical assets may be used as collateral for bonds. Corporate
bonds are considered higher risk than government bonds. As a result,
interest rates are almost always higher, even for top-flight credit quality
companies.

TREASURY BONDS

Long-term (maturity over 10 years) fixed interest rate debt security issued
by a national (federal) government backed by its 'full faith and credit.'
Next to treasury bills (maturity less than one year), and treasury notes
(maturity one to ten years) T-bonds are the safest form of marketable
investment. They have an active secondary market, and usually pay semiannual interest.

STATE AND LOCAL GOVERNMENT BONDS

It is also known as Municipal Bonds. A debt security issued by a state,

municipality or county to finance its capital expenditures. Municipal
bonds are exempt from federal taxes and from most state and local taxes,
especially if you live in the state in which the bond is issued.

GOVERNMENT SECURITIES

A bond (or debt obligation) issued by a government authority, with a

promise of repayment upon maturity that is backed by said government. A

Financial Instruments

government security may be issued by the government itself or by one of

the government agencies. These securities are considered low-risk, since
they are backed by the taxing power of the government.
MORTGAGES

A debt instrument, secured by the collateral of specified real estate

property, that the borrower is obliged to pay back with a predetermined set
of payments. Mortgages are used by individuals and businesses to make
large real estate purchases without paying the entire value of the purchase
up front. Over a period of many years, the borrower repays the loan, plus
interest, until he/she eventually owns the property free and clear.
Mortgages are also known as "liens against property" or "claims on
property." If the borrower stops paying the mortgage, the bank can
foreclose.

SUMMARY
Financial markets that facilitate the flow of short-term funds (with maturities of 1 year or
less) are referred to as money markets. In contrast, financial markets that facilitate the flow of
long-term funds (with maturities of more than 1 year) are referred to as capital markets.
Although stocks do not have maturities, they are classified as capital market securities because
they provide long-term funding.
All types of firms that need short-term funds issue a commercial paper as a means of
obtaining funds. They also invest in other money market securities such as Treasury bills when
they have temporary funds available.
Investors invest in all kinds of securities disclosed in the table. In general, they tend to
focus on the money market securities if they wish to invest their funds for a very short period of
time and to choose capital market securities here they can invest their funds for long periods. The
money market securities provide relatively low expected return, but offer some liquidity

and

generate a positive return until the investor determines a better use of funds.
The capital market securities offer more potential for higher returns, but their expected
return are subject to a higher degree of uncertainty (risk). Because the capital markets facilitate

Financial Instruments

the exchange of long-term securities, they help to finance the long-term growth of government
agencies and firms. Institutional investors play a major role in supplying the funds in the capital
market. In particular, institutional investors such as commercial banks, insurance companies,
pension funds and bond mutual funds are major investors in the primary and secondary market
for bonds. Insurance companies, pension funds and stock mutual funds are major investors in the
primary and secondary market for stocks.

Financial Instruments