Capital Market

By : JAY-AR C. DIMACULANGAN
Define what a financial system is and illustrate its role in the
economy

Identify the different participants of the financial system and

their roles

Elaborate on the role of the BSP in the economic development

of the Philippines

Explain monetary policy and its role in the economic

development of the country

Discuss the relationship between monetary policy and financial

system

Illustrate how the tools of monetary policy are used to

influence money supply and interest rates
Two International Organizations
that provide support to member
countries

• World Bank

• International Monetary Fund

Financial System

The financial system describes collectively

the financial markets, the financial system
participants, and the financial instruments and
securities that are traded in the financial markets.
Functions of the Financial system

With the advent of globalization, we have a

multinational financial system.

Multinational Financial System refers to the

collective financial transfer mechanisms that
facilitate the movement of money and profits
between and among financial system
participants throughout the world.
Basic functions of the financial system
which are also the functions of finance and
financial managers
• Fund acquisition (acquire)

• Fund allocation (allocate)

• Fund Distribution (distribute)

• Fund Utilization (utilize)

Financial System Participants
• There are six sectors or participants in the financial system

• Households or consumers
• Financial institutions/intermediaries
• Non-financial institutions
• Government
• Central Bank
• Foreign Participants
1. Household or Consumers
• It is described as the group that receives income, majority of
which typically comes from wages and salaries.
• Such income is spent on goods and services
• Gross savings is equal to current income less current
expenditures
• What is spent is termed as Consumption
• Goods that are consumed within the current period are termed
as “non-durable consumer goods or non-durables”
• Goods that will last for more than a year are termed as
“durable consumer goods or durables”
2. Financial Institutions/Intermediaries

• These are the firms that bridge the GAP between surplus
units or investors/lenders and deficit units or borrowers.
• They channel fund from lenders to borrowers
• They include depository and non-depository institution
• When they underwrite or acts as brokers or dealers, they are
intermediaries.
• If they buy securities, they are investors or lenders, and when
they are the ones issuing the securities, they are borrowers.
3. Non-Financial Institutions

• Businesses other than financial institutions or

intermediaries
• They include manufacturing, trading, construction, and
others.
• They are also borrowers or lenders or both at one time or
another.
• When they buy securities, they are lenders, investors, or
savers; when they issue the securities, they are the
borrowers.
4. Government

• It means the national, provincial, municipal or city

governments, and barangays or towns comprising the
Philippines as a whole.
• The Bureau of the Treasury is part of the government
that is a participant in the financial system.
• When the BTr issue their own securities, they act as
borrowers/deficit units, and then the BTr or any other
subdivisions of government buy securities, they act as
investors or savers/surplus units.
5. Central Bank

• The BSP is the central monetary authority of the Philippines

• The BSP is known as the “Bank of all banks” or the “Banker to
banks”
• The BSP oversees the overall operation of the financial system
and mandate the rules, regulations, and monetary policies
that will help them maintain a healthy and stable economy.
• The BSP provides different services to banks
• It supervises banking institutions and regulates non-bank
financial institutions
6. Foreign Participants

• It refers to the participants from the rest of the

world
• Goods and services and financial
instruments/securities are exchanged across
national boundaries, as well as within these
boundaries.
The BSP and the Philippine
Financial System

• The BSP was established on _____________?

• It was created under R.A _ _ _ _?
• Its first governor was ____________?
• It was created under the administration of
President______?
The BSP
Vision
The BSP aims to be a world-class monetary authority and a catalyst for a
globally competitive economy and financial system that delivers a high
quality of life for all Filipinos.

Mission
BSP is committed to promote and maintain price stability and provide
proactive leadership in bringing about a strong financial system conducive
to a balanced and sustainable growth of the economy. Towards this end, it
shall conduct sound monetary policy and effective supervision over financial
institutions under its jurisdiction

Overview of the BSP

The Bangko Sentral ng Pilipinas (BSP) is the central bank of the Republic of
the Philippines. It was established on 3 July 1993 pursuant to the provisions
of the 1987 Philippine Constitution and the New Central Bank Act of 1993.
The BSP took over from the Central Bank of Philippines, which was
established on 3 January 1949, as the country’s central monetary authority.
The BSP enjoys fiscal and administrative autonomy from the National
Government in the pursuit of its mandated responsibilities.
The BSP Logo

The new BSP logo is a perfect round shape in blue that features
three gold stars and a stylized Philippine eagle rendered in white
strokes. These main elements are framed on the left side with
the text inscription “Bangko Sentral ng Pilipinas” underscored by
a gold line drawn in half circle. The right side remains open,
signifying freedom, openness, and readiness of the BSP, as
represented by the Philippine eagle, to soar and fly toward its
goal. Putting all these elements together is a solid blue
background to signify stability.
The BSP Logo
Principal Elements:
• 1. The Philippine Eagle, our national bird, is the world’s largest
eagle and is a symbol of strength, clear vision and freedom,
the qualities we aspire for as a central bank.

• 2. The three stars represent the three pillars of central

banking: price stability, stable banking system, and a safe and
reliable payments system. It may also be interpreted as a
geographical representation of BSP’s equal concern for the
impact of its policies and programs on all Filipinos, whether
they are in Luzon, Visayas or Mindanao.
The BSP Logo
Colors
• 1. The blue background signifies stability.
• 2. The stars are rendered in gold to symbolize wisdom, wealth, idealism,
and high quality.
• 3. The white color of the eagle and the text for BSP represents purity,
neutrality, and mental clarity.

Font or Type Face

• Non-serif, bold for “BANGKO SENTRAL NG PILIPINAS” to suggest solidity,
strength, and stability. The use of non-serif fonts characterized by clean
lines portrays the no-nonsense professional manner of doing business at
the BSP.

Shape
• Round shape to symbolize the continuing and unending quest to
become an excellent monetary authority committed to improve the
quality of life of Filipinos. This round shape is also evocative of our coins,
the basic units of our currency.
Banking Institutions
A. Private Banking Institutions 2. Government Banking
1. Commercial Banking Institutions
Institutions 1. Philippine National Bank
a. Ordinary Commercial Banks 2. Development Bank of the
b. Universal Banks Philippines
2. Thrift Banks 3. Land Bank of the Philippines
a. Savings and Mortgage Banks 4. Philippine Amanah Bank
b. Private Development Banks
c. Savings and Loan
Associations
3. Rural Banks
Non-Bank Financial Institutions
A. Private Non-Bank FIs 2. Government Non-Bank FIs
1. Investment Banks/Companies 1. Government Service
2. Finance Companies Insurance System (GSIS)
3. Securities Dealers/Brokers 2. Social Security System
4. Pawnshops
5. Lending Investors
6. Fund Managers
7. Trust Companies/
Departments
8. Insurance Companies
Objectives of BSP
1. Maintain monetary policies conducive to a balanced
and sustainable growth of the economy;
2. Maintain price stability in the country;
3. Promote and maintain monetary stability and the
convertibility of the peso;
4. Maintain stability of the financial system;
5. Provide payment and other financial services to the
government, the public, financial institutions, and
foreign official institutions; and
6. Supervise and regulate depository institutions.
Functions of BSP
1. Bank of Issue – BSP has the monopoly of printing money bills
and minting money coins
2. Government’s banker, agent, and adviser – BSP handles the
banking accounts of government agencies and
instrumentalities.
3. Custodian of the cash reserves of banks – All banks are
regulated to have adequate reserves in proportion to their
deposit liabilities with BSP to ensure availability of cash to
depositors who wish to withdraw deposits.
• Interbank Call Loans – when one bank lacks funds to comply
with the reserve requirement of BSP, it borrows money from
other bank’s reserves with BSP for say, overnight.
• Reverse Repo Rate (RRP) – the interest rate on the interbank
call loans
Functions of BSP
4. Custodian of the nation’s reserves of international
currency
5. Bank of rediscount and lender of last resort – The
central bank lends money to banks in distress on the
basis of their promissory notes or the promissory notes
of bank borrowers
6. Bank of central clearance and settlement – The central
bank acts as a clearing house. This means that banks
send representatives to the clearing house at the
central bank where claims are demanded by one bank
against another.
Functions of BSP
7. Controller of credit
• Increasing or decreasing interest rates;
• Increasing or decreasing the legal reserve requirements of banks;
• Regulating the margin requirements of stock exchange securities;
• Open market operations (buying and selling of government
securities);
• Imposing ceilings on total amounts bank can lend;
• Rationing central bank credit;
• Restricting imports;
• Selecting projects for funding; and
• Moral suasion (i.e. encouraging people and businesses to support
and cooperate with central bank policies and regulations)
Organizational Structure
MONETARY BOARD – exercises the powers and functions of the
BSP, such as conduct of monetary policy and supervision of the
financial system.
• CHAIRMAN – governor of BSP/chief executive officer of BSP;
required to direct and supervise the operations and internal
administration of BSP. He heads each of the BSP’s operating
sectors.
• Five full time members from PRIVATE SECTOR; One member
from the CABINET

EXECUTIVE MANAGEMENT SERVICES – functional grouping of

all units directly reporting to the Monetary Board or Governor.
Organizational Structure
FUNCTIONAL SECTORS:
• Monetary Stability Sector - takes charge of the formulation
and implementation of BSP’s monetary policy, including
serving the banking needs of all banks through accepting
deposits, servicing withdrawals and extending credit through
rediscounting facility.
• Supervision and Examination Sector – enforces and monitors
compliance to banking laws to promote a sound and healthy
banking system.
• Resource Management Sector – serves the human, financial,
and physical resource needs of BSP.
• SECURITY PLANT COMPLEX – responsible for the production of
Philippine currency, security documents, and commemorative
medals and medallions.
The Monetary Board
- Governs the Central Bank
- Exercises the powers and functions of Bangko Sentral ng
Pilipinas
- Consists of 7 members appointed by the President of the
Philippines
- With the exception of the members of the Cabinet, the
Governor and the other members of the Monetary Board
serve terms of six years and may only be removed for cause
- Meets at least once a week; usually meets every Thursday but
on some occasions, it convenes to discuss urgent issues.
- May be called to a meeting by the Governor of BSP or by two
other members of the Board
The Monetary Board
The major functions of the Monetary Board include the
power to:
1. Issue rules and regulations it considers necessary for the
effective discharge of the responsibilities and exercise of the
powers vested in it.
2. Direct management, operations, and administration of
Bangko Sentral, organize its personnel, and issue such rules
and regulations as it may deem necessary or desirable.
3. Establish a human resource management system which
governs the selection, hiring, appointment, transfer,
promotion, or dismissal of all personnel. Such system shall
aim to establish professionalism and excellence at all levels
of the Bangko Sentral in accordance with sound principles of
management
The Monetary Board
4. Adopt an annual budget for and authorize such
expenditures by Bangko Sentral in the interest of the
effective administration and operations of Bangko Sentral in
accordance with applicable laws and regulations.
5. Indemnify its members and other officials of Bangko Sentral,
including personnel of the departments performing
supervision and examination functions, against all costs and
expenses reasonably incurred by such persons in connection
with any civil or criminal action, suit, or proceeding, to
which any of them may be made a party by reason of the
performance of his functions or duties, unless such
members or other officials are found to be liable for
negligence or misconduct.
The Monetary Board
THE MONETARY BOARD
CHAIRMAN Nestor Espenilla, Jr.
MEMBERS Carlos Dominguez III
Antonio Abacan, Jr.
Juan De Zuñiga, Jr.
Valentin Araneta
Felipe Medalla
Peter Favila
Monetary Policy
Monetary policy refers to the manipulation of money supply to
affect the economy of a country as a whole.
When central bank wishes to increase money supply, it can do a
combination of three things:
1. Purchase securities in the open market, known as open market
operations.
2. Lower the government discount rate.
3. Lower reserve requirement on banks.
When central bank wishes to decrease money supply, it can do a
combination of three things:
1. Sell securities in the open market, known as open market
operations.
2. Raise the discount rate.
3. Raise the reserve requirements.
Financial Markets
By : JAY-AR C. DIMACULANGAN
Explain the meaning of financial markets

Differentiate primary market from secondary market; primary

security from secondary security

Discuss fully the difference between money market and capital

market

Explain the difference between the different types of investors

Elaborate on the role of securities exchange in financial markets

Discuss fully the different government-issued securities (GS)

and how the markets for GS work

Explain the difference between stock market, bond market, and

derivative securities

Discuss the other markets as participant in the financial market

Financial Markets
• Financial Markets are structures through which
funds flow. They are the institutions and systems
that facilitate transactions in all types of financial
claim.

• A financial claim entitles a creditor to receive

payment from a debtor in circumstances specified in
a contract between them, oral or written.

• Financial markets are classified as either (1) primary

or secondary market or (2) money or capital market.
Primary Markets
• Primary Markets are markets in which users of funds raise
funds, through new issues of financial instruments such as
stocks and bonds. They consist of underwriters, issuers, and
instruments involved in buying and selling original or new
issues of securities referred to as primary securities.

Funds flow
Deficit Units
Borrowers/Users of funds; Surplus Units
Corporations issuing Initial supplier of funds;
new/original issues of Households and businesses
stocks or bonds Securities flow

Primary Markets Involving Direct Selling

Primary Markets
• Financial Intermediary acts as the middleman or
bridge that will satisfy the needs of the deficit units
and the surplus units.

Funds flow

Deficit Units
Borrowers/Users of Surplus Units
Underwriters
funds; Initial supplier of
Investment/
Corporations funds;
Merchant banks
issuing Households and
intermediary
new/original issues businesses
of stocks or bonds

Securities flow
Primary Markets Involving an Intermediary
Primary Markets

• Most primary market transactions are done through

investment banks, also called as merchant banks,
which help the corporations issuing the stocks or
bonds sell these stocks or bonds to investors.

• An underwriter guarantees the sale of the issues,

but does not intend to hold the shares or bonds in
his own account.
Primary Markets
Investment banks provide the following services:
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
Primary Markets
• Primary market issues are generally for public offerings
or publicly traded securities like stocks of companies
already selling stocks in the stock market or stock
exchanges. First-time issues for the public are called
initial public offerings or IPOs.

• Rather than a public offering, primary market sales can

take the form of a private placement, particularly for
closed corporations, that is, corporations whose stocks
are only sold to family or a few close friends, relatives,
and some other private individuals.
Secondary Markets
• Secondary Markets are markets for currently
outstanding securities, referred to as secondary
securities.
• All transactions after the initial issue in the primary
market are done in the secondary markets. (i.e. A owns
stocks initially issued by Company X and later sells these
Co. X stocks to B; the sale of A to B or anyone else is done
in the secondary market).
• Shares held by the public are termed outstanding
shares/securities.
• Secondary markets only transfer ownership, but do not
affect the total outstanding shares or securities in the
market.
Secondary Markets
Funds flow

Other Suppliers
Financial Markets Securities
of Funds
(Owners of
(Buyers of
outstanding Brokers
outstanding
securities;
securities:
investors) Dealers
investors)

Securities flow
Secondary Market With Secondary Securities Offered for Sale

Secondary markets exist for the purpose of:

1. Marketability – easy selling/transfer of ownership
2. Liquidity – easy conertability to cash of securities
Secondary Markets
Participants in the Secondary Market
1. Commercial banks
• Trust departments – recommend money market and
capital market securities for their clients.
• Treasury departments – carry inventories of market
securities as part of the bank’s trading portfolio
2. Investment houses
3. Finance Companies
4. Insurance Companies
5. Other Financial Institutions
6. Securities Brokers – do not buy for their own account; finds
the purchasers for the securities that owners wish to sell
7. Securities Dealers – buy the securities as their assets and
resell them
Secondary Markets
• The securities exchange serves the following purposes:
1. Provides marketability by allowing savers to sell their
securities immediately
2. Provides liquidity by raising cash any time
3. Provides valuation by serving as means for determining
current values of shares and ultimately of companies

• The value of the companies’ shares reflects the companies’

own value or worth. The higher the value of the shares in the
exchange, the better the companies will be in the eyes of
investors, reflecting good company performance.
Money Markets
• Money markets cover markets for short-term debt
instruments, usually issued by companies with high credit
standing.
• They consist of a network of institutions and facilities for
trading debt securities only with a maturity of one year or
less. (Saldana, 1997)
• They are markets in which commercial banks and other
businesses adjust their liquidity position by borrowing,
lending, or investing for short periods of time. (Kidwell et. al 2013)
• The government treasury uses money market to finance its
day-to-day transactions.
• Businesses and households also uses money markets to
borrow and lend.
Money Markets
• Only debt securities are short term (a period of one year
or less).

• These comprises: Treasury Bills (T-bills) issued by the

government; bankers’ acceptances; negotiable
certificates of deposit; money market deposit accounts
(MMDAs); money market mutual funds (MMMFs); and
commercial papers (CPs).

• Often termed as Marketable Securities because they are

highly marketable and highly liquid.
Money Markets
• Open Market Transaction – is an order placed by an
insider after all appropriate document has been filed, to
buy or sell restricted securities openly in an exchange.
• Interbank Call Market – is an auction house for excess
reserves set up by commercial banks because other
banks had temporary cash surpluses.
• Interbank Call Loans – are credits of one bank to another
for a period not exceeding 4 days.
• Deposit Substitutes – are alternative ways of getting
money from public other than traditional bank deposits.
• Repurchase Agreement – is a sale of securities for cash
with a commitment to repurchase them at a specified
price at a future date.
Money Markets
• Securities issued by the government:
1. Treasury Bills
• matures less than a year;
• three tenors: 91-day, 182-day, 364-day bills.
2. Treasury Bonds
• matures beyond one year
• Five maturities of bonds: 2-year, 5-year, 7-year, 10-year, and
20-year

• Eurodollar certificates of deposits are US-dollar-denominated CDS in

foreign banks. Maturities of these are less than 1 year, and most
have a maturity of 1 week to 6 months. These are traded in the
Eurodollar market, a type of money market.
Capital Markets
• Capital Markets are for long-term securities. Long-term
securities are either debt securities (notes, bonds,
mortgages, leases) or equity securities (stocks).
• The need for long-term assets or capital goods as
purchase of land or building or plant expansion will
resort to the capital market as source of funds. Capital
goods are used to produce goods and services to
generate revenues.
• The capital market consists of:
1. Securities Market; and
2. Negotiated (or non-securities) market.
1. Securities Market
• Securities Market is where companies issue common
stocks or bonds, which are marketable/negotiable, to
obtain long-term funds. An instrument that is
transferable by endorsement or delivery is negotiable.

• Securities market is composed of:

1. Stock market for equity or stock securities;
2. Bond market for debt securities; and
3. Derivative securities market for securities deriving
their value from another security.
Stock Market
• Stock Market serves as the medium or agent of exchange
transaction dealing with equity securities. It involves
institutions and analysts who review the performance of listed
companies.

• Stock Index – is a measure of the price level of the shares

listed in the exchange by the indicated category. It is useful as
a track record of changes in stock prices over time.

• PSE tracks four indices

• commercial and industrial;
• property;
• mining;
• and oil.
Stock Market
• Prices in a trading day:
• Open – the stock price for the first transaction at the start
of the trading day
• Low – the lowest stock price for transactions during the
day
• High – the highest stock price for transactions during the
day
• Close – the stock price for the last transaction of the day

• Value of the Stock – is the relationship between the benefits

and cost of the stock

• Price-earnings (PE) ratio – is the ratio of stock price to

earnings per share
Bond Market
• Bond Market is the market where bonds are issued and
traded. It is generally classified into:
1. Treasury Notes and Bonds Market
- Treasury bonds and notes are issued by the government’s
treasury. Like T-bills, T-notes and T-bonds are backed by the full
faith and credit of the government and are therefore free from risks.
2. Municipal Bonds Market
- Municipal bond (LGU) is an important financial instrument
for development.
3. Corporate Bonds Market
- Corporate Bonds are long-term bonds issued by private
corporations. Bond indenture is the legal contract that specifies the
rights and obligations of bond issuer and bondholders (investors),
term of the bond, interest rate, and interest payment dates.
Derivative Securities Market
• Derivative Securities Market refers to market where
derivative securities are traded.

• Derivative Securities – are financial instruments which payoffs

are linked to another, previously issued securities. They
represent agreement between two parties to exchange a
quantity of an asset or cash flow at a predetermined price at a
specified date in the future.

• Options, futures and swaps are forward-contracts are

examples of derivatives as well as stock warrants, swap
agreements, mortgage-backed securities and other more
exotic variations.
2. Negotiated/Non-Securities Market
• Negotiated Market or Non-Securities Market does not
involve securities, thus called non-securities market. It results
from negotiation between a borrower and a lender. It includes
a direct loan by a company or a person from a lending
institution, like a bank.
• Term of Loan Agreement – is an agreement between a
borrower and a lender for a definite period of time, hence the
word “term”.
• Term of the Loan – is the length of period from the date the
loan is taken to its maturity date, the date the loan is to be
repaid.
• If the amount of financing or funds needed is large, instead of
borrowing from a single bank, a syndicated loan can be
obtained from a group of banks called a syndicate.
2. Negotiated/Non-Securities Market
The negotiated or non-securities market includes, but is not
limited to, the following:
1. Loan Market – is where one-on-one transaction takes place
between a borrower and a lender.
2. Mortgage Market – is where real property and big
machineries, among others are used to guarantee or secure
big loans. The mortgage market also includes the market for
foreclosed properties, properties that are taken by lenders
because the borrowers were unable to pay their loan and
since the property is used as the collateral for loan, the
property is taken over by the lender.
3. Lease Market – is where equipment, building or other
property is being leased/rented out to another party. The
one who owns and is renting out the property is the lessor
and the party who is to use the property in exchange of the
rent is the lessee.
Other Markets
Consumer Credit Market
• It involves parties and transactions related to loans
granted to households who desire to buy properties such
as cars or appliances, travel, obtain education for
themselves or their loved ones, or other similar needs.
• Consumer Credit usually takes the form of character loan
(short-term), car loan (usually five years), appliance loan
(usually three years), educational loan, and among
others. These can also include pawnshops, SSS pension
lending companies, and other small consumer loan
companies.
Other Markets
Organized Market
• Organized markets are the exchanges. Exchanges, whether stock
markets or derivative exchanges, started as physical places where
trading took place.
Over-the-Counter (OTC) Market
• OTC markets have never been a “place.” They are less formal,
although often well-organized networks of trading relationships
centered on one or more dealers.
Auction Market
• Auction market is where the trading is done by an independent third
party matching prices on orders received to buy and sell a particular
security.
• The highest bidder is the one who offered the highest price for a
particular security.
• Bids and offers stipulate both prices and volume and are handled by
the third party, called the trader, an agent of the auction market.
Other Markets
Foreign Exchange Market
• Foreign exchange market provides the physical and institutional
structure through which the money of one country is exchanged for
that of another country, the rate of exchange between currencies is
determined, and foreign exchange transactions are physically
completed.
• A foreign exchange transaction is an agreement between a buyer
and a seller that a given amount of one currency is to be delivered at
a specified rate for some other currency.
• The foreign exchange market consists of two tiers:
• interbank or wholesale market – individual transactions in the
interbank market usually involve large sums that are multiples of a
million USD or the equivalent value in other currencies.
• Client or retail market – contracts between a bank and its client are
usually for specific amounts, sometimes down to the last penny
Other Markets
Spot Market
• Spot markets are called such because buying and selling
is done “on the spot”, that is, for immediate delivery and
payment.
• Spot foreign exchange transactions involve the exchange
rate at the date of the transaction that is why it is called
spot exchange transactions.

Forward Market
• Forward contracts are contractual agreements between
a buyer and seller at time zero to exchange a pre-
specified, non-standardized asset for cash at some later
date.
Other Markets
Futures Market
• Futures market is where contracts are originated and traded that
give the holder right to buy something in the future at a price
specified in the contract.
• In futures contract, the contract’s price is adjusted each day as the
price of the asset underlying futures contract changes and as the
contract approaches expiration.
• In a forward market, the price is fixed at the time of entering into a
forward contract.
• There are two participants in a futures market:
• Speculators – who establish anticipation of a price change
• Hedgers – who employ futures to reduce the risk from price changes
• Hedging involves taking an offsetting position in a derivative in order
to balance any gains and losses to the underlying asset.
Other Markets
• Trading pit consists of circular steps leading down to the center of
the pit, where traders for each delivery date on a futures contract
informally group together.
• Professional traders are also:
• Position Traders – take a position in the futures market based on their
expectations about the future direction of prices underlying assets.
• Day Traders - generally take a position within a day and liquidate it
before the day’s end
• Scalpers – take positions for very short period of time, sometimes only
minutes, in an attempt to profit from this active trading.
• Futures trades may be placed as market orders (instructing the floor
broker to transact at the best price available) or limit orders
(instructing the floor broker to transact at a specified price)
• Clearing Houses break up every trade into a buy and sell transaction
and take the opposite side of the transaction, that is, become the
buyer for every futures contract seller, and the seller for every
futures contract buyer.
Other Markets
Options Market
• Options market is where stock options are traded. This is where the
formal market where the options are bought and sold, and not when
a stockholder is given the option or pre-emptive right to buy
additional shares of stock to maintain his proportionate share or
ownership in a corporation.
• Options are called warrants if they are issued by corporations, and
calls if they are issued by individuals.
• An option contract is defined by the following elements:
• Type (put or call)
• Underlying security
• Unit of trade (number of shares)
• Strike price
• Expiration date
Other Markets
• All option contracts that are of the same type and style and cover
the same underlying security are referred to as a class of options.
• All options of the same class that also have the same unit of trade at
the same strike price and expiration date are referred to as an
option series.
• Call option gives the buyer the right to buy an underlying security or
futures contract at a strike price.
• The following shows the difference between the parties in a call
option and a put option:
CALL OPTION PUT OPTION

Writer of the option Seller (of underlying security) Investor (buyer of underlying
security)
Buyer of the option Investor (buyer of underlying security) Seller (of underlying security)

• A market is bullish when stock prices are rising and bearish when
stock prices are going down.
Other Markets
Swap Market
• Swaps are agreements between two parties (counterparties)
in exchanging specific periodic cash flows in the future based
on an underlying instrument or price.
• There are five general types of swaps:
• Interest Rate Swaps – two parties independently borrow
the same amount of money from two different lenders,
and then exchange interest payments with each other for a
stipulated period of time.
• Currency Swaps
• Credit Risk Swaps
• Commodity Swaps
• Equity Swaps
Other Markets
Third and Fourth Markets
• Third Markets refers to transactions between broker-dealers
and large institutions
• Fourth Markets refers to transactions that take place between
securities firms and large institutional investors like pension
funds and investment companies.

Third and fourth market transactions occur to avoid placing the

orders through the main exchange and do away with the
commissions that are paid to floor brokers, which can greatly
affect the price of the security.
Types of Investors
1. Risk-averse Investors (bulls and chicken). They are the type
of investors who, when faced with two investment
alternatives with equal returns but one is riskier than the
other, will choose the less risky investment.

2. Risk-taker investors (bears and pigs). They are the investors

who are ready to pay a higher price for an investment
regardless of the risks involved.

3. Risk-neutral investors. They are investors who do not take

into account the risks involved in the investment and who are
focused only on the expected returns.
Financial Instruments
By : JAY-AR C. DIMACULANGAN
Differentiate money market instruments and capital market
instruments

Identify and explain the different government-issued money

market instruments and capital market instruments

Compare MMDAs and MMMFs; certificate of assignments and

certificate of participation

Discuss how a letter of credit operates

Explain the difference among the different non-negotiable

capital market instruments

Understand the differences among the different marketable

capital market instruments
Capital Market Institute of the
Philippines (CMIP)

CMIP is committed to promote, develop, and

advance awareness and knowledge of capital market and its
role in the development of the national economy through
developing, organizing, and conducting programs, projects,
researches and other activities to upgrade competencies of
members, practitioners, entrepreneres, professionals,
teachers, and students in dealing with the Philippine capital
market.
Money Market Instruments
Money Market Instruments are short-term securities
(maturing one year or less). They are paper or electronic
evidences of debt dealt in the money markets.
• Cash Management Bills are government-issued securities
with maturities of less than 911 days, specifically 35 days or 42
days.
• Treasury Bills (T-Bills) are issued by the Bureau of Treasury
with 91-day, 182-day, and 364-day maturities. They are zero-
coupon securities because they have no coupon payments and
only have face values.
• Banker’s Acceptance is a time draft issued by a bank payable
to a seller of goods. A time draft issued by a bank is an order
to pay a specified amount of money to the bearer of the time
draft on a given date. It is different from a sight draft, which is
an order to pay immediately (i.e. bank check).
Money Market Instruments
• Letters of Credit are a contractual agreement between a bank,
known as issuing bank, on behalf of the buyer (drawer),
authorizing another bank, the correspondent bank known as
the advising or confirming bank, to make payment to the
beneficiary, the seller.
• Negotiable Certificate of Deposit is a bank-issued time
deposit that specifies an interest rate and maturity date and is
negotiable. Certificate of Deposit is a receipt issued by a
commercial bank for the deposit of money.
• Repurchase Agreements are legal contracts that involve the
actual sale of securities by a borrower to a lender with a
commitment on the part of the borrower to repurchase the
securities at the contract price plus a stated interest charge at
a later date. Reverse Repurchase Agreement or Reverse Repo
is an agreement involving the purchase of securities by one
party to another with the promise to sell them back at a given
date in the future.
Money Market Instruments
• Money Market Deposit Accounts (MMDAs) are PDIC-insured
deposit accounts that are usually managed by banks or
brokerages and can be a convenient place to store money that
is to be used for upcoming investments or has been received
from the sale of recent investments. They are also called as
money market accounts.
• Certificate of Assignment is an agreement that transfers the
right of the seller over a security in favor of the buyer.
• Certificate of Participation is an instrument that entitles the
holder to a proportionate equitable interest in the securities
held by the issuing firm or an entitlement to a pro rata share
in a pledged revenue stream, usually lease payments.
• Eurodollar CDs and Eurocommercial Papers are dollar-
denominated, negotiable, large time deposits in banks outside
the United States.
 Money Market Instruments
• Money Market Mutual Funds (MMMFs) are investment funds that pool funds
from numerous investors and invest in money market instruments offered by
investment companies. A mutual fund is an investment company that pools the
funds. It has four basic types:
• Stock Funds/Equity Funds – invest primarily in shares of stock
• Balanced Funds – invest in both shares of stock and debt instruments
• Bond Funds – invest in long-term debt instruments of governments and
corporations
• Money Market Funds – invest purely in short-term debt instruments
• It can be classified as:
• Growth Funds – invest in assets that are expected to reap large capital gains
• Income Funds – invest in stocks that regularly pay dividends and in notes and
bonds that regularly pay interest
• Balanced Funds – combine the features of both growth and income funds
• Sector Funds – invest in specific industries
• Index Funds – invest in a basket of securities
• Global Funds – invest in securities issued in may countries
Capital Market Instruments
Capital market instruments are long-term
instruments either equity securities or debt securities.
Capital market instruments include corporate stocks,
mortgages, corporate bonds, treasury securities, state and
local government bonds, US government agency securities,
and non-negotiable bank, and consumer loans and leases.

Capital market instruments can be classified as:

1. non-negotiable/non-marketable instruments
2. negotiable/marketable instruments.
Capital Market Instruments
Non-Negotiable/Non-Marketable Securities
1. Loans – are direct borrowings of deficit units from surplus units like
banks.
2. Leases – are rent agreements. The owner of the property is the
lessor and the one who is renting is the lessee. The lease can be an
operating lease, where the lessor shoulders all expenses including
insurance and taxes related to the property leased out and the
lessee pays a fixed regular amount usually on a monthly basis. It
can also be a financing or capital lease, where the lessee shoulders
all expenses of the property as insurance taxes.
3. Mortgages are agreements where a property owner borrows
money from a financial institution using the property as security or
collateral for the loan.
4. Line of Credit is a bank’s commitment to make loans to regular
depositors up to a specific amount. Personal Lines of Credit are for
households. Commercial Lines of Credit are for businesses.
Capital Market Instruments
Negotiable/Marketable Securities

1. Corporate Stocks are evidences of ownership in a

corporation. The holders are called shareholders or
stockholders. Shares of stock may be classified as:
1. Par Value Shares are shares where the specific money
value is shown on the face of the stock certificate and fixed
in the Articles of Corporation
2. No Par Value Shares are shares without any money value
appearing on the face of the stock certificate.
a. With Stated Value
b. Without Stated Value
Capital Market Instruments
3. Common Shares are only one class of stock and each share has
equal rights.
4. Preferred Shares are shares with preferential rights
a. As to Assets means that the shares shall be given preference
over common shares in the distribution of the assets of the
corporation in case liquidation.
b. As to Dividends means that owners are entitled to receive
dividends before payment of any dividend to the common
stock is made.
I. Cumulative preferred shares are entitled to receive all
passed dividend in arrears (unpaid passed dividends)
II. Non-cumulative are not entitled to passed dividends or
which are called dividends in arrears for cumulative shares
III. Participating are entitled not only to the stipulated
dividend, but also to the share of common stock
IV. Non-Participating are entitled to a fixed amount or rate of
dividend
Capital Market Instruments
• Stocks are entitled to dividends. Dividends can be:
1. Dividends out of earnings (share of stockholders in the profit of
company)
2. Dividends representing return of capital in case of extractive industries
or mining companies
• Dividends out of earnings can be in the form of:
1. Cash Dividends are dividends distributed in the form of cash
2. Stock Dividends are dividends given out to stockholders in the form of
the company’s own shares. Unissued Common Stock refers to that part
of the authorized capital stock that has not been fully paid. Retained
Earnings refer to the profits of the company that have not been declare
as dividends and retained by the business to help in its operations.
3. Property Dividends are in the form of non-cash assets of the company
distributed as dividends to stockholders.
4. Scrip Dividends are deferred cash dividends. Scrips are promissory notes
that will be paid by the company in cash at a certain future date.
Capital Market Instruments
2. Bonds are debt instruments issued by private companies and
government entities to borrow large sums of money that no
single financial institution may be willing or able to lend.
• Sovereign Bonds refers to bonds issued by national
governments in foreign currencies.
• Corporate Bonds are certificates of indebtedness issued by
corporations who need large amount of cash. Bond
agreements are called bond indentures.
• Bonds can be classified as follows:
1. As to security:
a. Secured Bonds are collateralized either by mortgages or
other assets.
b. Unsecured Bonds also called debenture bonds, do not
have any sort of guarantee.
Capital Market Instruments
2. As to interest rate:
a. Variable rate bonds are bonds whose interest fluctuates
and changes when the market rates change
b. Fixed rate bonds have rates that are fixed as stated in
the bond indenture
3. As to retirement:
a. Putable Bonds are bonds that can be turned in and
exchanged for cash at the holder’s option.
b. Callable/Redeemable Bonds are bonds in which the
issuer has the right to call the bond for retirement for a
price determined at the time the bond is issued.
c. Convertible Bonds can be exchanged for common
stocks.
Capital Market Instruments

4. Other Classification
a. Income Bonds are bonds that pay interest only when
the interest is earned by the issuing company.
b. Indexed or Purchasing Power Bond. The interest rate
paid on these bonds is based on an inflation index such
as the consumer price index (CPI).
c. Junk Bonds are speculative, below-investment grade,
high-yielding bonds.
Capital Market Instruments

• Treasury Bonds are government securities that mature

beyond one year. The tenor of bonds are: 2, 3, 4, 5, 7, 10, 15,
20, and 25 years.
1. Retail Treasury Bonds (RTBs) are like T-notes, but are
usually longer in maturity (10 years and above).
2. Floating Rate Notes (FRNs) in which interest payments rise
and fall are based on discount rates for 13-week T-Bills
3. Fixed Rate Treasury Notes (FXTNs) are direct and
unconditional obligations of the national government.
Capital Market Instruments

• Municipal Bonds or local government unit (LGU) bonds

are issued by municipalities or local government units. It
comes in two varieties:
1. General Obligation Bonds (GO) are issued to raise
immediate capital to cover expenses and are
supported by the taxing power of the issuer.
2. Revenue Bonds are issued to fund infrastructure
projects and are supported by the income generated
by those projects.
Capital Market Instruments
3. Long-Term Negotiable Certificates of Deposit (LTNCDs)
are negotiable certificates of deposit with a designated
maturity or tenor beyond 1 year, representing a bank’s
obligation to pay the face value upon maturity, as well
as periodic coupon or interest payments during the life
of deposit.

4. Mortgage-Backed Securities are instruments that came

as a result of mortgage companies and banks grouping
mortgages into a standard million block group and
issuing securities backed up by these mortgages.
Financial Intermediation
By : JAY-AR C. DIMACULANGAN
Define financial intermediation

Discuss the difference between the old and new financial

environment

Differentiate depository financial institutions and non-

depository financial institutions

Explain the roles of different depository financial institutions

and non-depository financial institutions

Elaborate the CAMELS rating for bank supervision and

regulation

Discuss the different risks faced by financial intermediaries and

investors

Explain the role played by financial intermediaries in the socio-

economic development of a country

Discuss in detail the economic bases for financial

intermediation
Financial Intermediaries

Financial Intermediaries are the financial

institutions that act as a bridge between investors or savers
and borrowers or security issuers.

The securities issued by original issuers/borrowers are

called primary securities. The securities issued by financial
intermediaries are called secondary securities.
Direct and Indirect Finance

A borrower-lender relationship is the typical direct

finance relationship or transaction. A direct
security/primary security flows directly from the
borrowing unit to the lending or investing unit.

The relationship between the depositors, from

whom funds came, and the borrowers who borrowed from
the bank is indirect, thus indirect finance.
Changing Nature of Financial
Intermediaries

The Old Financial Environment (OFE) was a highly

specialized financial system where banks were set up to
take in deposits and grant only short-term loans.

The New Financial Environment (NFE) was

characterized by market-determined or deregulated sales
on assets and liabilities of financial intermediaries and by
greater homogeneity among financial institutions.
Classification of Financial
Intermediaries

Financial intermediaries varied but they have one

common characteristic. All of them issue secondary
securities to be able to purchase primary securities issued
by deficit units. They can however be grouped into two
basic categories:
1. Depository Institutions
2. Non-depository Institutions issue contracts that are
not deposits.
Depository Institutions
This refers to financial institutions that accept
deposits from surplus units. They issue:

• Current or Checking Accounts can be withdrawn by

issuing checks.
• Savings Accounts can be withdrawn by using the
passbooks given by the bank to depositors when they
initially make their deposits.
• Time Deposits refer to deposits that have maturity, like
30 days, 60 days, 180 days, or one year.
Depository Institutions
Depository institutions include:

1. Commercial Banks are perhaps the biggest of the

depository institutions.
• Ordinary Commercial Banks perform the most simple function of
accepting deposits and granting loans.
• Expanded Commercial or Universal Banks are a combination of
commercial banks and an investment house. They perform
expanded commercial banking functions (domestic and
international) and underwriting functions of an investment
house.
Depository Institutions
• Mismatching of Securities means that they can turn short-term
instruments like deposits into long-term securities like bonds or
long-term loans.
• Nationwide Branching is common among commercial banks and
this has helped not only the country, in general but also the
communities where these branches are located, in particular.
• Bank Supervision deals with ensuring the soundness and safety of
banks.
• Bank Regulation consists of the administration of laws in the form
of rules and regulations that govern the conduct of banking and the
structure of banking industry.
• Philippine Deposit Insurance Corporation insures the deposits in
depository institutions, including commercial banks to help
depositors have peace of mind knowing that their deposits are
insured and therefore, safe in the banks.
Depository Institutions
• Regulatory agencies in the Philippines include the Bangko Sentral ng
Pilipinas, Securities and Exchange Commission, Bureau of Internal Revenue,
and the provincial, city, or local governments.
• Prior to 1994, the MACRO rating was used by regulatory agencies to gauge
credit standing of banks:
• M – Management
• A – Asset Quality
• C – Capital Adequacy
• R – Risk Management
• O – Operating Results
• In 1995, the Hadjimichalakised (1995) identified the CAMELS rating:
• C – Capital Adequacy
• A – Asset Quality The CAMELS rating aims to determine
a bank’s overall condition and identify
• M – Management
its strengths and weaknesses
• E – Earnings financially, operationally, and
• L – Liquidity managerially.
• S – Sensitivity to Risk
Depository Institutions
2. Thrift Banks
The thrift banking system is composed of savings and
mortgage banks, stock savings and loan associations, private
development banks, microfinance thrift banks, and credit unions. Thrift
Banks are engaged in accumulating savings of depositors and investing
them.

• Savings and Mortgage Banks are banks specializing in granting

mortgage loans other than the basic function of accepting deposits.
• Mortgage Banks are usually private owned corporations willing to
take risks that other banks reject.
• Stock Savings and Loan Associations (S&Ls) accumulate savings of
their depositors/stockholders and use these accumulated savings,
together with their capital for the loans that they grant and for
investments in government and private securities.
Depository Institutions
• Private Development Banks cater to the needs of agriculture and industry
providing them with reasonable rate loans for medium- and long-term
purposes.
• Microfinance Thrift Banks are small thrift banks that cater to small, micro,
and cottage industries, hence the term “micro”. They grant small loans to
small businesses like sari-sari stores, small bakeries, and cottage industries,
among others.
• Credit Unions are cooperatives organized by people from the same
organization (whether formally or informally organized) like farmers,
fishermen, teachers, sailors, employees, and so on. Credit unions grant
loans to these people, who became members of the credit union, and get
deposits from the.

3. Rural and Cooperative Banks promote and expand the rural economy in
an orderly and effective manner by providing the people in rural
communities with basic financial services.
Non-Depository Institutions

1. Life Insurance Companies are financial intermediaries that

sell life insurance policies.
• Loan Value of a policy is the amount that can be borrowed
against the policy during the term of the policy.
• Cash Surrender Value is the amount that will be given to the
insured or beneficiary if the insured or the beneficiary decides
to surrender the policy before the term ends.
• A special type of insurance is the accident insurance that
insures against death or disability caused by accidents.
Non-Depository Institutions
2. Property/Casualty Insurance Companies offer protection
against pure risk.
• Homeowners Insurance insures one’s house and its
contents.
• Auto Insurance is “package protection” which provides
coverage for both physical injury and property damage
liability, as well as physical damage to the vehicle.
• Flood Insurance is a special type of insurance that covers
damage to any structure or the contents therein caused by
flood.
• Windstorm Insurance protects homeowners and business
establishments from devastations caused by windstorms
and hurricanes.
Non-Depository Institutions
• Umbrella Liability Policy provides coverage over and above
one’s automobile or homeowner’s policy.
• Health Insurance covers the cost of an insured individual’s
medical and surgical expenses during an illness.
• Long-term Care (LTC) is defined as a need for assistance with
some of the activities of daily living (often called ADLs).
• Professional Liability Insurance protects professionals, such as
doctors, financial advisors, nursing home administrators,
lawyers, etc. against financial losses from lawsuits filed against
them by their clients or patients.
• Credit Insurance is an optional protection purchased from
lenders and often associated with mortgages, loans, or credit
cards.
Non-Depository Institutions
3. Fund Managers include pension fund companies and mutual
fund companies.
• Pension Fund Companies sell contracts to provide income to
policyholders during their retirement years.
• Mutual Fund Companies allow investors to purchase mutual
funds that buy different securities in the securities market like
stocks, long-term bonds, or short-term debt instruments issued
by businesses or government units.

4. Investment Banks/Houses/Companies are financial

intermediaries that pool relatively small amounts of investors’
money to finance large portfolios of investments that justify the
cost of professional management.
Non-Depository Institutions
5. Finance Companies are profit-oriented financial institutions that
borrow and lend funds to households and businesses.
• Sales Finance Companies provide installment credit to buyers of
big-ticket items like cars and household appliances.
• Consumer Finance Companies grant credit to consumers.
• Commercial Finance Companies, also known as business
finance companies, grant credit to businesses.

6. Securities Dealers and Brokers are financial intermediaries that

look for investors or savings units for the benefit of the
borrowers or deficit units and are compensated by means of
commission.
Non-Depository Institutions

7. Pawnshops are the agencies where people and some small

businesses “pawn” their assets as collateral in exchange of an
amount much smaller than the value of the asset.

8. Trust Companies/Departments are corporations organized for

the purpose of accepting and executing trusts and acting as
trustee under wills, as executor, or as guardian.

9. Lending Investors are individuals or companies who loan funds

to borrowers, generally consumers or households.
Risks of Financial Intermediation
Risk is the possibility that actual returns will deviate or
differ from what is expected.

• Interest Rate/Market Price Risk is the risk that the market value
of an asset will decline, resulting in a capital loss when sold.
• Reinvestment Risk is the risk that earnings from a financial asset
need to be reinvested in lower-yielding assets or investment
because interest rates have fallen or decreased.
• Refinancing Risk is the risk that the cost of rolling over or re-
borrowing funds could be more than the return earned on asset
investments.
• Default/Credit Risk is the risk that the borrower will be unable to
pay interest on a loan or principal of a loan or both.
Risks of Financial Intermediation
• Inflation/Purchasing Power Risk is the risk of increase in
value of goods and services reducing the purchasing power of
money to purchase goods or services.
• Political Risk is the risk that government laws or regulations
will affect the investor’s expected return on investment and
recovery of investment adversely or negatively.
• Off-Balance-Sheet Risk are those transactions that do not
appear in the financial institution’s balance sheet but
represent transactions that pose contingent assets or
contingent liabilities on the financial institution.
• Technology and Operation Risks are related because
technological innovations generally involve and affect
operations.
Risks of Financial Intermediation

• Liquidity Risk results from withdrawal of funds by investors or

exercise of loan rights or credit lines of clients.
• Currency or Foreign Exchange Risk is the possible loss
resulting from an unfavorable change in the value of foreign
currencies,
• Country or Sovereign Risk overrides credit risk from a foreign
borrower because even if the borrower is in good credit
standing, the government of that foreign country can set up
regulations that prohibit debt repayments to outside or
foreign creditors.
Economic Bases of Financial
Intermediation
The economic bases for financial intermediation deal
with the spread of risk made possible by the pooling funds
through diversification through economies of scale by bearing a
large part of the cost that individuals and small borrowers should
have shouldered if they themselves had done what the financial
intermediaries are doing, absorbing transaction costs and
gathering information.
• Transaction Costs refers to all fees, commissions, and other
charges paid whether buying or selling securities.
• Information Gathering
• Asymmetric Information occurs when buyers and sellers
do not have access to the same information.