MAS 2

FINANCIAL MARKETS,
INSTITUTIONS, AND
INSTRUMENTS
THINGS TO DISCUSS
KEY TAKEAWAYS:
Financial System
FINANCIAL MARKETS,
Financial Markets INSTITUTIONS & INSTRUMENTS
Financial Institutions
Financial Instruments
FINANCIAL SYSTEM
The financial system plays the key role in
the economy by stimulating economic
growth, influencing economic performance
of the actors, affecting economic welfare.

This is achieved by financial infrastructure,

in which entities with funds allocate those
funds to those who have potentially more
productive ways to invest those funds.
STRUCTURAL APPROACH

The financial system of an economy

consists of three main components:

Financial Markets

Financial Institutions

Financial Regulators
FUNCTIONAL APPROACH

Financial markets facilitate

the flow of funds in order to
finance investments by
corporations, governments
and individuals.
Figure 1. The structure of financial system
FINANCIAL
MARKETS
 FINANCIAL MARKETS
A market in which financial assets (securities) such as stocks
and bonds can be purchased or sold.

Funds are transferred in financial markets when one party

purchases financial assets previously held by another party.

Financial markets facilitate the flow of funds and thereby allow

financing and investing by households, firms, and government
agencies.
SURPLUS UNITS OR INVESTORS
Those participants who receive more money than they spend

DEFICIT UNITS
Those participants who spend more money than they receive

E X A M P L E

College students are typically deficit units, as they often borrow from financial
markets to support their education. After they obtain their degree, they earn more
income than they spend and thus become surplus units by investing their excess funds.
A few years later, they may become deficit units again by purchasing a home. At this
stage, they may provide funds to and access funds from financial markets
simultaneously. That is, they may periodically deposit savings in a financial institution
while also borrowing a large amount of money from a financial institution to buy a
home.
 THREE ROLES OF
FINANCIAL MARKETS

1. Accommodating Corporate Finance Needs

2. Accommodating Investment Needs

3. Primary versus Secondary Markets

ACCOMMODATING
CORPORATE
FINANCE NEEDS
Key role of financial markets

Corporate finance (also called financial

management) involves corporate decisions
such as how much funding to obtain and
what types of securities to issue when
financing operations.
ACCOMMODATING
INVESTMENT NEEDS
Key role of financial markets

Accommodating surplus units who want to

invest in either debt or equity securities.

Investment management involves decisions by

investors regarding how to invest their funds.
PRIMARY VS. SECONDARY
NEEDS
Primary markets - facilitate the issuance
of new securities.

Secondary markets - facilitate the

trading of existing securities, which
allows for a change in the ownership of
the securities.
THREE
ECONOMIC
FUNCTIONS
1. Price Discovery

2. Liquidity

3. Reduction of Transaction Costs

PRICE DISCOVERY

It signals how the funds available from

those who want to lend or invest funds
will be allocated among those needing
funds and raise those funds by issuing
financial instruments.
LIQUIDITY
It provides an opportunity for investors to sell a financial
instrument, since it is referred to as a measure of the
ability to sell an asset at its fair market value at any time.

All financial markets provide some form of liquidity.

However, different financial markets are characterized by
the degree of liquidity.
REDUCTION OF
TRANSACTION COSTS
The function of reduction of transaction costs is performed,
when financial market participants are charged and/or bear
the costs of trading a financial instrument.

In market economies, the economic rationale for the

existence of institutions and instruments is related to
transaction costs, thus the surviving institutions and
instruments are those that have the lowest transaction costs.
TYPES & STRUCTURE
OF FINANCIAL
MARKET
 INTERNAL EXTERNAL
VS.
MARKET MARKET

Domestic Market International Market

Foreign Market Offshore Market

Euromarket
 MONEY CAPITAL
VS.
MARKET MARKET
SHORT-TERM LONG-TERM

Examples: Examples:
•Savings •Debt Market
•Demand Deposit •Corporate bonds
•Treasury Bill •Equity Market
•Commercial Paper •Preferred stocks
 PRIMARY SECONDARY
VS.
MARKET MARKET

Initial Public Offering Stock Exchange

Bureau of Treasury Philippine Dealing

and Exchange
Corporation (PDex)
 OVER-THE-
STOCK
VS. COUNTER
EXCHANGE
MARKET
Method of Method of trading Method of trading for companies
commodities and derivatives for well- that are not listed formally.
established companies in organized
manner.
Decentralized and informal
setting for trading which is
Absolute formal setting of trading
done by well-established companies usually used by small companies

to keep constant supervision on the and businessmen.

action.
 CASH DERIVATIVE
VS.
MARKET MARKET
Spot Market Future Market

The market for Some financial instrument are

contracts that specify that the
immediate purchase
contract holder has either
and sale of financial obligation or the choice to buy

instrument. or sell another something at or

by some future dates.
 FINANCIAL
INSTITUTIONS
WHAT IS FINANCIAL
INSTITUTION?
Financial institutions serve as
intermediaries by channeling
the savings of individuals,
businesses, and governments
into loans or investments.
 KEY CUSTOMERS OF
FINANCIAL INSTITUTIONS
For financial institutions, the key
suppliers of funds and the key
demanders of funds are individuals,
businesses, and governments.

Individuals as a group are the net

suppliers for financial institutions
and firms are net demanders of
funds.
 ROLE OF FINANCIAL
INSTITUTION
Create more favorable transaction terms than could
be realized by lenders/investors and borrowers
dealing directly with each other in the financial
market.

They have more expertise than individual surplus

units in evaluating the creditworthiness of deficit
units.
 DEPOSITORY NON-DEPOSITORY
VS.
INSTITUTION INSTITUTION

Accepts deposits from Generates funds

surplus units and from sources other
provide credit to
than deposits .
deficit units through
loans and purchases
of securities .
.
THE FINANCIAL INSTITUTIONS ENGAGED IN:
Obtaining funds from lenders or investors
and
Lending or investing the funds that they
borrow to those who need funds.

FUNCTION OF FINANCIAL INSTITUTIONS

Maturity intermediation.
Risk reduction via diversification.
Cost reduction for contracting and
information processing.
 CLASSIFICATION OF
FINANCIAL INSTITUTIONS

1. Depository Institutions
2. Non-Depository Institutions
 DEPOSITORY
INSTITUTIONS
Accept deposits from surplus units
and provide credit to deficit units
through loans and purchases of
securities
TYPES OF DEPOSITORY
INSTITUTIONS
1. Commercial Banks

2. Savings Institutions

3. Credit Unions
COMMERCIAL
BANKS
Serve surplus units by offering a
wide variety of deposit
accounts, and they transfer
deposited funds to deficit units
by providing direct loans or
purchasing debt securities
SAVINGS
INSTITUTIONS
Also knows as “thrift
institution”

Offer deposit accounts to

surplus units and then channel
these deposits to deficit units
CREDIT UNIONS
They are non-profit
and they restrict their
business to credit
union members, who
share a common bond
 NON-DEPOSITORY
INSTITUTIONS
Generate funds from sources other
than deposits but also play a major
role in financial intermediation
TYPES OF NON-DEPOSITORY
INSTITUTIONS
1. Finance Companies
2. Mutual Funds
3. Securities Firms
4. Insurance Companies
5. Pension Funds
 FINANCE MUTUAL
COMPANIES FUNDS

Obtain funds by Sell shares to surplus

issuing securities and units and use the
then lend the funds to funds received to
individuals and small purchase a portfolio
businesses of securities
 SECURITIES INSURANCE
FIRMS COMPANIES

Some securities firms Provide individuals and firms

with insurance policies that
act as a broker and
reduce the financial burden
often act as dealers associated with death,
illness, and damage to
property
 PENSION FUNDS

Provide an efficient way for individuals

to save for their retirement
EXHIBIT 1.3 COMPARISON OF ROLES AMONG FINANCIAL INSTITUTIONS
 FINANCIAL
INSTRUMENTS
 WHAT IS A FINANCIAL
INSTRUMENTS?

A contract between
individuals/parties that
holds a monetary
value.
 TYPES OF
FINANCIAL INSTRUMENTS

1. Cash Instruments

2. Derivative Instruments

3. Foreign Exchange Instruments

CASH INSTRUMENTS

Instruments with values

directly influenced by
the condition of the
market
TYPES OF CASH
INSTRUMENTS

Securities

Deposits and Loans

DERIVATIVE INSTRUMENTS

Instruments that have

values determined
from underlying
assets
Examples of Derivative
Instruments

Forward
Future
Interest Rate Swap
 FOREIGN EXCHANGE
INSTRUMENTS
Instruments that are
represented on the foreign
market and primarily consist of
currency agreements and
derivatives.
THREE
CATEGORIES Spot
OF FOREIGN Outright Forward

EXCHANGE Currency Swap

INSTRUMENTS
ASSET CLASSES
OF FINANCIAL
INSTRUMENTS
DEBT-BASED EQUITY-BASED

Categorized as Categorized as
mechanisms that an mechanisms that
entity can use to serve as legal
increase the amount ownership of an
of capital in a entity.
business.
 ROLES OF
FINANCIAL
INSTRUMENTS
ROLES OF FINANCIAL
INSTRUMENTS
Meet the economic objectives of
mobilizing funds.

Allocating the funds efficiently.

Monitoring the use of the funds.

FINANCIAL
INSTRUMENTS ARE
USED FOR:

Hedging Purposes
Trading Purposes
Investment Purposes
FUNCTIONS OF
FINANCIAL
INSTRUMENTS
 FUNCTIONS OF
FINANCIAL INSTRUMENTS
1 PROVIDES EFFICIENT FLOW

2 PROVIDES TRANSFER OF CAPITAL

3 PROVIDES FUTURE BUSINESS

BENEFITS REDUCE EXPOSURES TO
CERTAIN BUSINESS RISKS
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TIME WITH US!
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