UNIT I.

FINANCIAL MARKETS
A market is a place where two parties The financial system plays the key role in
can gather to facilitate the exchange the economy by stimulating economic
of goods and services. The parties growth, influencing economic
involved are usually buyers and sellers. performance of the actors, affecting
The market may be physical like a retail economic welfare.
outlet, where people meet face-to-
This is achieved by financial
face, or virtual like an online market,
infrastructure, in which entities with funds
where there is no direct physical allocate those funds to those who have
contact between buyers and sellers. potentially more productive ways to
TYPES OF MARKETS invest those funds. A financial system
makes it possible a more efficient
A black market refers to an illegal transfer of funds. As one party of the
market where transactions occur transaction may possess superior
without the knowledge of the information than the other party, it can
government or other regulatory lead to the information asymmetry
agencies. Many black markets exist to problem and inefficient allocation of
circumvent existing tax laws. Therefore, financial resources. By overcoming the
many involve cash-only transactions or information asymmetry problem, the
other forms of currency, making them financial system facilitates balance
harder to track. between those with funds to invest and
those needing funds.
An auction market brings many people
together for the sale and purchase of THREE MAIN COMPONENTS
specific lots of goods. The buyers or
bidders try to top each other for the • Financial Markets -facilitate the
purchase price. The items up for sale flow of funds to finance
end up going to the highest bidder. investments by corporations,
The most common auction markets governments, and individuals.
involve livestock and homes, or websites • Financial Intermediaries
like eBay where bidders may bid (Institutions) - are the key players
anonymously to win auctions. in the financial markets as they
perform the function of
The blanket term financial market refers intermediation and thus
to any place where securities, determine the flow of funds
currencies, bonds, and other securities ➢ Firms – bridge between
borrower and seller
are traded between two parties. These
- Easier to find borrowers
markets are the basis of capitalist
and sellers
societies, and they provide capital - firms are banks
formation and liquidity for businesses. • Financial Regulators - perform
They can be physical or virtual. the role of monitoring and
regulating the participants in the
• Stock Market
financial system.
• Bond Market
➢ Banking Sector & Government
• Short-term Fixed – where buying
and selling happens
FINANCIAL MARKETS AND THEIR
ECONOMIC FUNCTIONS Frequency of occurrence plays an
Price discovery function means that important role in determining if a
transactions between buyers and sellers transaction should take place within the
of financial instruments in a financial market or within the firm. A one-time
market determine the price of the transaction may reduce costs when it is
traded asset
executed in the market. Conversely,
frequent transactions require detailed
• Asking Price – Seller
• Bidding Price – Buyer contracting and should take place
• Buyers – Liquidity Providers within a firm to reduce the costs.
- Fulfilled by financial markets TRANSACTION COSTS CLASSIFIED
Liquidity function provides an Costs of search and information -
opportunity for investors to sell a explicit costs include expenses that may
financial instrument, since it is referred to be needed to advertise one’s intention
as a measure of the ability to sell an to sell or purchase a financial
asset at its fair market value at any instrument. Implicit costs include the
time. value of time spent in locating
• Fulfilled because buyers are counterparty to the transaction. The
willing to buy the instruments presence of an organized financial
(bidding price) market reduces search costs.

The function of reduction of transaction Costs of contracting and monitoring are

costs is performed, when financial related to the costs necessary to resolve
market participants are charged and/or information asymmetry problems, when
bear the costs of trading a financial the two parties entering the transaction
instrument possess limited information on each
other and seek to ensure that the
• Reduction is fulfilled by being transaction obligations are fulfilled
able to see price among various
markets Costs of incentive problems between
buyers and sellers arise, when there are
KEY ATTRIBUTES DETERMINING
conflicts of interest between the two
TRANSACTION COSTS
parties, having different incentives for
Asset specificity is related to the way the transactions involving financial
transaction is organized and executed.
It is lower when an asset can be easily
assets .
put to alternative use, can be deployed FINANCIAL INTERMEDIARIES AND THEIR
for different tasks without significant FUNCTIONS
costs. Financial intermediary is a special
financial entity, which performs the role
Transactions are also related to of efficient allocation of funds, when
uncertainty, which has (1) external there are conditions that make it difficult
sources (when events change beyond for lenders or investors of funds to deal
control of the contracting parties), and directly with borrowers of funds in
(2) depends on opportunistic behavior financial markets. Financial
of the contracting parties intermediaries include depository
institutions, insurance companies,
regulated investment companies, FINANCIAL MARKET’S STRUCTURE
investment banks, pension funds.
Financial Instruments
The role of financial intermediaries is to There is a great variety of financial
create more favorable transaction instrument in the financial marketplace.
terms than could be realized by The use of these instruments by major
lenders/investors and borrowers dealing market participants depends upon their
directly with each other in the financial offered risk and return characteristics, as
market well as availability in retail or wholesale
markets
The financial intermediaries are FINANCIAL INSTRUMENT CATEGORIES
engaged in:
• obtaining funds from lenders or
investors, and

• lending or investing the funds that

they borrow to those who need
funds
The funds that a financial intermediary
acquires become, depending on the
financial claim, either the liability of the
financial intermediary or equity
participants of the financial
intermediary. The funds that a financial A financial instrument can be classified
intermediary lends or invests become by the type of claims that the investor
the asset of the financial intermediary. has on the issuer.
A financial instrument in which the issuer
Asset transformation provides at least agrees to pay the investor interest plus
one of three economic functions repay the amount borrowed is a debt
• Maturity intermediation. instrument. A debt instrument also
• Risk reduction via diversification. referred to as an instrument of
• Cost reduction for contracting and indebtedness, can be in the form of a
information processing. note, bond, or loan. The interest
payments that must be made by the
Comparison of Roles Among Financial issuer are fixed contractually. For
Institutions example, in the case of a debt
instrument that is required to make
payments in Peso, the amount can be a
fixed in peso or it can vary depending
upon some benchmark. The investor in a
debt instrument can realize no more
than the contractual amount. For this
reason, debt instruments are often
called fixed income instruments.
FIXED-INCOME MARKET

FINANCIAL MARKET CLASSIFICATION

In contrast to a debt obligation, an

equity instrument specifies that the
issuer pays the investor an amount
based on earnings, if any, after the
obligations that the issuer is required to
make to investors of the firm’s debt
instruments have been paid.
Common stock is an example of equity
instruments. Some financial instruments
due to their characteristics can be
viewed as a mix of debt and equity.
From the perspective of country origin,
Preferred stock is a financial instrument, its financial market can be broken down
which has the attribute of a debt into an internal market and an external
because typically the investor is only market.
entitled to receive a fixed contractual The internal market, also called the
amount. However, it is like an equity national market, consists of two parts:
instrument because the payment is only the domestic market and the foreign
made after payments to the investors in market. The domestic market is where
the firm’s debt instruments are satisfied issuers domiciled in the country issue
Another “combination” instrument is a securities and where those securities are
convertible bond, which allows the subsequently traded. The foreign market
investor to convert debt into equity is where securities are sold and traded
under certain circumstances. Because outside the country of issuers.
preferred stockholders typically are
entitled to a fixed contractual amount, External market is the market where
preferred stock is referred to as a fixed securities with the following two
income instrument. Hence, fixed income distinguishing features are trading: 1) at
instruments include debt instruments issuance they are offered simultaneously
and preferred stock. to investors in a number of countries;
and 2) they are issued outside the
DEBT VERSUS EQUITY jurisdiction of any single country. The
external market is also referred to as the
international market, offshore market, derivative instruments and the market
and the Euromarkets (despite the fact where they are traded is called the
that this market is not limited to Europe). derivatives market.

FINANCIAL MARKET REGULATION

Money market is the sector of the In general, financial market regulation is
financial market that includes financial aimed to ensure the fair treatment of
instruments that have a maturity or participants. Many regulations have
redemption date that is one year or less been enacted in response to fraudulent
at the time of issuance. These are mainly practices. One of the key aims of
wholesale markets regulation is to ensure business
disclosure of accurate information for
The capital market is the sector of the investment decision making. When
financial market where long-term information is disclosed only to limited
financial instruments issued by set of investors, those have major
corporations and governments trade. advantages over other groups of
Here “long-term” refers to a financial investors. Thus, regulatory framework
instrument with an original maturity must provide the equal access to
greater than one year and perpetual disclosures by companies. The recent
securities (those with no maturity). There regulations were passed in response to
are two types of capital market large bankruptcies, overhauled
securities: those that represent shares of corporate governance, to strengthen
ownership interest, also called equity, the role of auditors in overseeing
issued by corporations, and those that accounting procedures. The Sarbanes-
represent indebtedness, or debt issued Oxley Act of 2002 in US was designed
by corporations and by the state and particularly to tighten companies’
local governments. governance after dotcom bust and
Enron’s Bankruptcy. It had direct
FINANCIAL MARKETS consequences internationally, first
CLASSIFIED through global companies. The US Wall
The cash market, also referred to as the Street Reform and Consumer Protection
spot market, is the market for the Act (Dodd-Frank) of 2010 aims at
immediate purchase and sale of a imposing tighter financial regulation for
financial instrument. the financial markets and financial
intermediaries in US, to ensure consumer
In contrast, some financial instruments protection. This is in tune with major
are contracts that specify that the financial regulation system
contract holder has either the obligation development in EU and other parts of
or the choice to buy or sell another the world.
something at or by some future date.
The “something” that is the subject of
the contract is called the underlying
(asset). The underlying asset is a stock, a
bond, a financial index, an interest rate,
a currency, or a commodity. Because
the price of such contracts derives their
value from the value of the underlying
assets, these contracts are called
A Ponzi scheme is an investment fraud following a massive accounting
that pays existing investors with funds fraud.
collected from new investors. Ponzi ➢ WorldCom remains the biggest
scheme organizers often promise to accounting scandal in U.S. history
invest your money and generate high as well as one of the largest
returns with little or no risk. But in many bankruptcies.
Ponzi schemes, the fraudsters do not ➢ As a result of the scandal, former
invest the money. Instead, they use it to CEO Bernard Ebbers was
pay those who invested earlier and may sentenced to 25 years in prison,
keep some for themselves. and former CFO Scott Sullivan
was sentenced to five years.
With little or no legitimate earnings, Ponzi
schemes require a constant flow of new
money to survive. When it becomes
hard to recruit new investors, or when Spread - The forex spread is the
large numbers of existing investors cash difference between a forex broker’s sell
out, these schemes tend to collapse. rate and buy rate when exchanging or
trading currencies.
Ponzi schemes are named after Charles
Ponzi, who duped investors in the 1920s
with a postage stamp speculation
scheme.

Enron Scandal

➢ Enron’s leadership fooled

regulators with fake holdings and
off-the-books accounting
practices.
➢ Enron used special purpose
vehicles (SPVs), or special
purpose entities (SPEs), to hide its
mountains of debt and toxic
assets from investors and
creditors.
➢ The price of Enron’s shares went
from $90.75 at its peak to $0.26 at
bankruptcy.
➢ The company paid its creditors
more than $21.7 billion from 2004
to 2011.

WorldCom

➢ WorldCom was a
telecommunications company
that went bankrupt in 2002
UNIT II. THE PHILIPPINE FINANCIAL
MARKETS

licensed by the securities and exchange

FINANCIAL MARKET commission foe sale to the public are
only available in the so-called over the
Are classified into the money market
counter (OTC) market.
and the capital market
ADVANTAGES IF THE STOCK MARKET
Money market – is where short term
funds are raised through the buying and • Most accessible market
selling of short-term debt securities such • Ready market
as commercial papers • Liquidity of the market
• Operates in full public view
Capital Market – is where long-term
funds are raised through bond market,
which deals with long term debt
securities such as bonds, the stock PLAYERS IN THE STOCK MARKET
market which deals with equity Stockbroker
securities or stocks.
Acts as an agent or middleman
Under Capital Market: between the investor and other
buyers/sellers
Primary market – new shares are issued
and sold to the investing public for the Stock exchange
first time, the capital is raised by the
company selling stock directly to The organization that oversees the
investors through an initial public transactions of the buyers and sellers
offering. placed through the member-brokers.

Secondary market - where securities Transfer agent

can be bought and sold after they have Maintains the ledgers for each issuer
been issued to the public in the primary company showing the name and
market. Secondary markets include the address of, and the number of shares
stock exchange and the over the held by each registered stockholder.
counter (OTC) market.
Clearing house
STOCK MARKET VS STOCK EXCHANGE
To facilitate transactions and make the
A stock market is an organized activity market more orderly, all payments by all
involving the buying and/or selling of stockbrokers are done to centralized
securities done within a stock exchange. institution called the clearinghouse.
It is an organization whose function is to Listed company
facilitate the purchase and sale of
stocks and other securities where brings Known as a publicly owned company
buyers and sellers together. that offers and lists its shares in the stock
exchange in view of the fact that its
OVER THE COUNTER MARKET shares were sold to the investing public.
Stocks not listed and not traded in the
stock exchange but registers and
UNIT III. BANKING INDUSTRY AND
OTHER FINANCIAL INSTITUTIONS

OTHER FINANCIAL INSTITUTIONS

Banking Industry and Nonbanking It mainly includes insurance companies,
Financial security investment companies, fund
management companies, pension
BANKING INDUSTRY funds, asset management companies,
A network of financial institutions security companies, futures companies,
licensed by the state to supply banking stock exchange and future exchange,
services etc.

NONBANKING FINANCIAL INSTITUTIONS

A non-bank financial institution is a
company that offers financial services
but does not hold banking licenses and
therefore cannot accept deposits.

DEPOSITORY INSTITUTIONS
A place or entity that holds financial
securities in a dematerialized form which
could be a bank, organization, or any
institution holding and assisting in
security trading.

Functions of a Depository Institutions

➢ A place or entity that holds
financial securities in a
dematerialized form which could
be a bank, organization, or any
institution holding and assisting in
security trading.
➢ Serves as a link between public
companies and
investors/shareholders
➢ Eliminates risk related to owning
physical financial securities
➢ Allows the provision of loans of
mortgages to interested parties
➢ Reduced paperwork and
accelerates the process of
transferring securities

Types of Depository Institutions

• Commercial banks
• Credit Unions
• Savings Institutions