FINANCIAL MARKETS

DEFINITION OF TERMS
1. Financial Markets - Structures through which funds flow; institutions
and systems That facilitate transactions in all types of financial claim;
meeting place for those with excess funds

2. Financial Claim-Entitles a creditor to receive payment from a debtor

3. Surplus Savings Units - Investors or lenders with excess funds

4. Deficit Units- Borrowers or issuers of securities

5. Financial Intermediary- middleman or bridge that will satisfy the needs

of the deficit units And the surplus units
6. Primary securities - new issues of financial instruments like stocks and
bonds

7. Secondary securities - currently outstanding securities

8. Investment banks - also called merchant banks where primary market

transactions Are done

9. Initial Public Offerings- IPOs, first time issues to the public

10. Security dealer - financial institution formed to buy and sell

securities
 Classification of Financial Markets

Primary Markets - markets to which users of funds

(corporations) raise funds through New issues of
financial instruments
A. Primary Market Transactions
B. Services provided by Investment Banks:
1. Provide funds in advance
2. Give advice to issuing corporations as to the price
and
Number of securities to issue
3. Attract the initial public purchasers of the securities
4. Act as a market analyst and advisor to the issuing
company
5. Absorb the risk and cost of creating a market for the
securities
Secondary Markets- markets for
secondary securities
Purposes of Securities Exchange
1. Provides marketability by allowing savers to sell
their securities Immediately
2. Provides liquidity by raising cash anytime
3. Provides valuation by serving as a means for
determining currentValues of shares and ultimately
of companies
 MONEY MARKETS

Money markets covers markets for short-term debt

instruments. Dealers and brokers are at the core of
money market transactions
1. Open market transaction – money market transaction; an order
Placed by an insider after all appropriate documentation has Been
filed The Philippine money market started in 1965 primarily as a
facility For trading excess funds among commercial banks
Requirements by the Bangko Sentral ng Pilipinas (BSP) on banks:
1. Banks with temporary cash surpluses led commercial banks to
Set up money market called interbank call market.
2. Small bank deposits are funded through the money market
3. Interbank call loans - credits of one bank to another for a
period Not exceeding 4 days
4. Deposit substitutes - alternative ways of getting money from the
Public other than traditional bank deposits Interbank call loans are
deposit substitutes
International Monetary Market (IMM) –opened in May
1972 by the Chicago Mercantile Exchange (CME)
pioneering the trading of international Financial
derivatives, most notably futures.

London Interbank Offered Rate (LIBOR)- trade

derivative with IMM

Repo Rate - rate at which central bank of a country

lends money to Commercial bank; used to control
inflation
Repo Markets - allow participants to undertake
rapid refinancing in the Interbank market

Repurchase Agreement (REPO) – sale of securities

for cash with a commitment To repurchase them at a
specified price at future date
Trading Government Securities
1. T-Bills – mature in less than a year
Three Tenors: :
a. 91-day
b. 182-day
c. 364-day
Sold at a discount:
Yield to investor = Principal - Purchase Price
2. T-Bonds – mature beyond one year
Five Maturities:
a. 2-year
b. 5-year
c. 7-year
d. 10-year
e. 20-year
Sold at Face Value (Principal)
Yield (Coupons)= % Face Value payable
semi-annually
Automated Debt Auction Processing System
(ADAPS)- electronic mode of selling
Government securities to GSEDs (Government
Securities Eligible Dealers
Linked to BTR using BIS (Bridge Information
Systems) for
a. T-bills- every Monday
b. T-bonds- every second and fourth Tuesday
Types of Bids

a. Competitive - maximum of 7 bids for a

minimum amount of P10M

b. Non-competitive - one non-competitive

bid for above P10M
Qualifications for GSEDs:
1. licensed by SE
2. P100 M unimpaired capital and surplus
account
3. met the statutory ratios prescribed for the
industry
4. has the infrastructure for an electronic
interface
Yield - increment or interest on an investment in
GS
Competitive Bid - a tender to buy an amount of GS
at an indicated rete/annum

Price Discrimination or English Auction – a method

in which successful Competitive bidders pay the
price they have bid and all the
Winning bidders may pay different prices
Uniform Price of Dutch Auction – method of pegging a
uniform coupon rate Of a T-bond

Settlement of Trades – a payment process both in the

primary and secondary Markets for GS traded

Price of a GS – value based on 100 points per unit

T-bills = discount rate
T-bonds= price; at a discount, at par or at a premium
Coupon= rate in relation to maturity date of bond
Formula for Yield of T-bill:

Y = F - P X 360
F t
Where Y = Discount Yield
F = Face Value of the T-bill
P = Purchase price of the T-
bill
T = Term of the T-bill
CAPITAL MARKETS
Markets for Long-Term Securities:
a. Debt securities - notes, bonds, mortgages,
leases
b. Equity securities – stocks
 Securities Market
1. Stock market - for equity or stock securities
Stock index – price level of the shares listed in PSE
Prices in a trading day:
a. Open – stock price for the first transaction at the
start oftrading day
b. Low - the lowest stock price for transactions
during the day
c. High - highest stock price for transactions during
the day
d. Close- stock price for the last transaction of the
day
2. Bond market
a. Treasury notes and bonds market
Treasury notes and bonds are issued by the
Government’s treasury; pay coupon interest Semi-
annually; have maturities of over 1 – 10 Years
b. Municipal bonds market
Municipal bond (LGU) –an important instrument
for Development
c. Corporate bonds market
Corporate bonds are long-term bonds issued by
Private corporation
Bond indenture – legal contract between bond
issuer And bondholders (investors)
3. Derivative Securities Market
a. Derivative securities – market value is related
to or derived another traded security
b. Examples are options, futures,forward, swaps,
warrants
4. Exchanges - where securities/financial
instruments are traded/sold
a. Organized - PSE, ASX,SZSE, National Stock
Exchange of India OSE, American Stock Exchange
AMEX, NUSDAQ Stock Market of US
Electronic exchanges- US Futures Exchange,
Bats, Boston Equities Exchange
b. Informal - OTC over-the-counter
 Negotiated/ Non-securities Market

1. Loan Market
a. One – on – one transaction between a
borrower and a lender
b. Examples – loan by an individual or company
from a bank
- government borrow from World Bank
2. Mortgage Market
a. real properties or big machineries are used
to secure loans
b. includes market for foreclosed properties,
NHMFC(National Home Mortgage Finance
Corporation ,GSIS, SSS, Pag-ibig
 Other Markets

1. Consumer Credit Market

a. Consumer Credit – character loan, car loan,
appliance loan, educational loan,

b. Borrowers are the consumers

2. Organized Market
a. Organized markets are exchange
b. NYSE best-known was formed in 1792
Chicago Board of Trade since 1851
3. Over-the-counter (OTC) Market
a. Less formal but well organized networks of
trading
b. Dealers act as market makers
c. Less transparent and operate with fewer rules
d. Brokers act as agents in bringing together
dealers and investors
e. Operate with computers and electronic
networks
4. Auction Market
a. Trading is done by an independent third party
called trader
b. Highest bidder- offered the highest price for a
particular security
c. PSE – buyers of securities make their bid and
sellers make their offer
5. Foreign Exchange Markets
a. Provides the physical and institutional
structure through which the money of one country is
exchanged for that of another country
b. The rate of exchange between currencies is
determined
c. Foreign exchange transactions are physically
completed
6. Spot market
a. Buying and selling is done on the spot
b. Immediate delivery and payment
c. On the spot may mean 1 day to 1 week
depending on the practice where the spot market is
conducted
7. Futures Market
a. Buy something in the future at a price specified in the contract
b. Price is adjusted daily
c. Speculators- establish anticipation of a price change
d. Hedgers - employ futures to reduce the risk from price
changes
e. Hedging – hedgers pass the risk to speculators
f. Types - T-bonds , T-notes, federal funds, Eurodollars, short
sterling, Euro LIBOR, Euroyen, British pound,Swiss franc, Australian
dollar, Euro ,US dollars
g. Trading Pits- circular steps leading down to the center of the
pit where traders for each delivery date informally group together
h. Clearing house ensures that all trading obligations are met
8. Forward Market
a. Future delivery of financial instruments,
commodities or currencies
b. Commodities – gold, copper, oil , copra,
c. Involved non-standardized underlying assets
9. Options Market
a. Formal market where options are bought and sold
b. Offers investors an opportunity to reduce risk
c. Options are derivatives, option market is a
derivative market
d. Options not exercised expire and become worthless
e. Option contract is defined by the following:
1. type (put or call)
2. underlying security
3. unit of trade (number of shares)
4. strike price
5. expiration date
10. Swap Market
a. Swaps – agreements between two parties
(counterparties)
b. Types of Swaps
1. interest rate swaps
2. currency swaps
3. credit risk swaps
4. commodity swaps
5. equity swaps
11. Third and Fourth Markets
a. Third Market– transactions between broker-
dealers and large institutions
b. Fourth Market- transactions between
securities firms and large institutional investors
like pension funds and investment companies
c. Advantages:
1. speed
2. reduced trading costs
3. anonymity
 TYPES OF INVESTORS
A. Risk – averse (bulls and chicken) - when faced
with two investment alternatives, will Choose the less
risky investment Prefer risk-free assets

B. Risk – taker (bears and pigs) - ready to pay

a higher price for an investment Regardless of the risks
involve

C. Risk-neutral - do not take into account the risks

involved in the Investment and focused only on the
expected Returns