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DE LA SALLE LIPA The Role of Financial Markets and

Institutions
CBEAM - BA

Tess R. Dimayacyac, MMT

SY 2019 - 2020

LEARNING OBJECTIVES TOPIC OUTLINE

1. Define and explain the Role of 1. Why Study Financial Markets

Financial Markets and and Institutions?
Institutions in economy. 2. Function of Financial Market
2. Discuss the importance of 3. Structure of Financial Market
Financial Markets and
4. Types of financial markets
Institutions in economy.
3. Analyze the capital markets 5. Securities traded in financial
structure and position in the markets
economy 6. Global financial markets
.

What is Financial Market? What is Financial Market?

All institutions and  Market in which
procedures for funds are
transferred from
bringing buyers
people who have
and sellers of excess funds to
financial people who have a
instruments shortage of funds
together is called  Important in
financial market channeling funds

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Why Study Financial Market? Types of Financial Markets

1. Debt market
Financial markets, such as bond and stock
markets, are crucial in our economy. 2. Stock market
1. These markets channel funds from savers to 3. FX market
investors, thereby promoting economic
efficiency. Well functioning financial markets, such as the
2. Market activity affects personal wealth, the bond market, stock market, and foreign exchange
behavior of business firms, and economy as a market, are key factors in producing high
whole economic growth.

Debt Market & Interest Rates Interest Rates

• Debt markets, or bond markets, allow
governments, corporations, and individuals to borrow
to finance activities.
• In this market, borrowers issue a security, called
a bond, that promises the timely payment of interest
and principal over some specific time horizon.
• The interest rate is the cost of borrowing – coupon
rate
• The interest rate is the cost of borrowing or the price paid for the
rental of funds which is usually expressed as a percentage
• Interest Rates are important on a number of levels
• Conversely, high on a personal level, high interest rates could
deter you from buying a house or a car because the cost of
financing it would be high.
• Interest rates could encourage you to save because you can earn
more interest income by putting aside some of your earnings as
savings

The Stock Market Stock Market

• The stock market is the market where common stock

(or just stock), representing ownership in a company,
are traded.
• Companies initially sell stock (in the primary market)
to raise money. But after that, the stock is traded
among investors (secondary market).
• Of all the active markets, the stock market receives
the most attention from the media. Why?

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The Foreign Exchange Market The Foreign Exchange Market

• The foreign exchange market is where
international currencies trade and exchange
rates are set.
• Although most people know little about this
market, it has a daily volume around
$1 trillion!
• For funds to be transferred from one country to
another, they have to be converted from the currency
in the country of origin ( say $ ) into the currency of
the country they are going to ( say Peso )
• The foreign exchange market is where this conversion
takes place
• It is where the foreign exchange rate, the price of one
country's currency in terms of another, is determined

Why Study Financial Institutions? Why Study Financial Institutions?

The financial institutions—the corporations,

organizations, and networks that operate the so-
called “marketplaces.” The Financial System 4. Financial Innovation – focusing on the improvements in
technology and its impact on how financial products are
1. Structure of the Financial System –Helps get funds from savers delivered
to investors 5. Managing Risk in Financial Institutions – focusing on risk
2. Financial Crises – 2007 – 2009 was the worst financial crisis management in financial institution.
since the Great Depression
3. Banks and Other Financial Institutions – includes the role of
insurance companies, mutual funds, pension funds, etc.

Transfer of Funds on Financial Market

Functions of Financial Market

Financial Market is a market in which financial assets

(securities) can be purchased or sold.

Financial markets facilitate transfers of funds from

person or business without investment opportunities
(i.e., “Lender-Savers”, or “Surplus Unit”) to those who
have investment opportunities (i.e., “Borrower-
Spenders”, or “Deficit Unit”).

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Functions of Financial Markets
1. Borrowing and Lending
 Financial markets channel funds from
households, firms, governments and foreigners
that have saved surplus funds to those who
encounter a shortage of funds (for purposes of
consumption and investment)
Functions of Financial Markets
3. Continuation and Provision of Information
 The exchange of funds is characterized by a
high amount of incomplete and asymmetric
information.
 Financial markets collect and provide much
information to facilitate this exchange.
Functions of Financial Markets
5. Liquidity
 The existence of financial markets enables the
owners of assets to buy and resell these
assets.
 Generally this leads to an increase in the
liquidity of these financial instruments
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Functions of Financial Markets
2. Price Determination
 Financial markets determine the prices of
financial assets.
 The secondary market herein plays an
important role in determining the prices for
newly issued assets
Functions of Financial Markets
4. Risk Sharing
 Trade in financial markets is partly motivated
by the transfer of risk from borrowers to
lenders who use the obtained funds to invest
Functions of Financial Markets
6. Efficiency
 The facilitation of financial transactions through
financial markets lead to a decrease in
informational cost and transaction costs, which
from an economic point of view leads to an
increase in efficiency.
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Structure of Financial Markets
Debt VS Equity
Debt titles are the most commonly traded security. In these
arrangements, the issuer of the title (borrower) earns some initial
amount of money (such as the price of a bond) and the holder
(lender) subsequently receives a fixed amount of payments over a
specified period of time, known as the maturity of a debt title.
The holder of a debt title does not achieve ownership of the
borrower’s enterprise.
Common debt titles are bonds or mortgages.
Primary VS Secondary Markets
• Primary markets are markets in which financial instruments
are newly issued by borrowers.
• Secondary markets are markets in which financial instruments
already in existence are traded among lenders.
Secondary markets can be organized as exchanges, in which
titles are traded in a central location, such as a stock exchange,
or alternatively as over-the-counter markets in which titles are
sold in several locations.
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Structure of Financial Markets
Debt VS Equity
Equity titles are somewhat different from bonds. The most
common equity title is (common) stock.
An equity instruments makes its buyer (lender) an
owner of the borrower’s enterprise.
Equity titles do not expire and their maturity is, thus, infinite.
Hence
they are considered long term securities.
Money Market VS Capital Market
Money markets are markets in which only short term debt
titles are traded. (< 1 year)
Capital markets are markets in which longer term debt and
equity instruments are traded. (> 10 years)
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Securities Traded in Financial Markets
•Money market securities:
–Money market securities are debt
securities with a maturity of one
year or less
–Characteristics:
•Liquid
•Low expected return
•Low degree of risk
Securities Traded in Financial Markets
•Bonds and Mortgages:
–Bonds are long-term debt
obligations issued by corporations
and government agencies
–Mortgages are long-term debt
obligations created to finance the
purchase of real estate
–Bonds and mortgages specify the
amount and timing of interest and
principal payments
Market Efficiency
•When security prices fully reflect
all available information, the
markets for those securities are said
to be efficient.
•When Markets are inefficient,
investors can use available
information ignored by the market
to earn abnormally high returns on
their investments.
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Securities Traded in Financial Markets
Securities Traded in Money Securities Traded in Capital
Markets Markets
•Capital Market Securities:
•Treasury Bills. •Treasury Notes and Bonds.
–Capital market securities are those with
•Certificate of Deposit (CDs). •Municipal Bonds.
a maturity of more than one year
•Commercial Papers. •Corporate Bonds.
•Bonds and mortgages
•Dollar Deposits. •Mortgages.
•Stocks
•Banker’s Acceptance. •Commons Stocks.
–Capital market securities have a higher
•Federal Funds. •Preferred Stocks.
expected return and more risk than
•Repurchase Agreements.
money market securities.
Valuation of Securities in Financial Markets
•Derivative Securities:
–Derivative securities are financial
contracts whose values are derived from
•The valuation of a security is measured
the values of underlying assets
as the present value of its expected cash
–Speculating with derivatives allow
flows, discounted at a rate that reflects
investors to benefit from increases or
the uncertainty of the cash flows (Risk).
decreases in the underlying asset •Impact of Information on Valuation.
–Risk management with derivatives •Impact of Valuation on Pricing.
generates gains if the value of the •Impact of the internet on the Valuation
underlying security declines Process.
Financial Market Regulations Global Financial Markets
•Financial Markets are regulated to ensure
that the participants are treated fairly.
•Global Integration.
•Many regulations were enacted in
response to fraudulent practices.
•Barriers to Global Integration.
•Financial Markets Integration .
•Role of the Foreign Exchange
Market.
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Comparison of Roles among Financial Institutions

Deposits
Depository
Institutions

Purchase
Individual Finance
Surplus Units Securities Companies

Purchase Shares
Mutual Funds Deficit Units

Premiums Insurance
Policyholders
Companies

Employee
Employers Contributions
Pension Funds
Employees