Financial Markets: An Introduction

Introduction to Financial Markets

• Introductory courses teach the basics, structures, and functions of financial markets.
• Understanding financial markets is essential to understanding fund flow between savers and borrowers.
• Financial markets are critical to the global economy.

Fundamental Financial Market Concepts

• Financial markets involve buying and selling financial instruments: stocks, bonds, commodities, derivatives, etc.
• These markets facilitate fund transfers between individuals, businesses, and governments.

Types of Financial Markets

• Capital markets trade long-term securities such as stocks and bonds.
• Money markets trade short-term debt instruments like T-bills and commercial paper.
• Commodity markets trade commodities such as oil, gold, and agricultural products.
• Foreign Exchange (Forex) markets facilitate currency trading.
• Derivatives markets trade contracts whose value depends on an underlying asset's value; examples are options, futures, and swaps.

Key Participants in Markets

• Investors and traders include individuals and institutions that buy and sell financial instruments.
• Issuers are entities like companies and governments that issue securities to raise capital.
• Brokers and dealers act as intermediaries to facilitate transactions between buyers and sellers.
• Regulators, such as the SEC in the U.S., enforce rules and ensure market transparency.

Traded Financial Instruments

• Stocks represent ownership in a company.
• Bonds are debt securities issued by corporations or governments.
• Derivatives are financial contracts with values linked to the price of an underlying asset.
• Mutual Funds and ETFs are pooled investment vehicles for diversified portfolios.

Market Mechanics in Action

• Primary Markets involve new securities being issued via IPOs
• Secondary Markets involve previously issued securities traded among investors
• Market orders are trades done immediately at the best available price
• Limit Orders are trades that will execute only at a specified price
• Market liquidity is the measure of how easily assets can be bought or sold without significantly impacting their price.

Pricing of Assets

• Supply and demand drive financial market prices.
• The interaction between buyers and sellers establishes the price of financial instruments.
• Valuation models like the Dividend Discount Model (DDM) and Discounted Cash Flow (DCF) are used to estimate the value of stocks and bonds.

The Broader Economic Role

• Capital Formation: Markets enable businesses to raise funds for expansion.
• Price Discovery: Buying and selling helps determine the fair market value of securities.
• Risk Management: Markets allow diversification and risk management through derivatives.

Examining Market Efficiency

• The Efficient Market Hypothesis (EMH) suggests asset prices reflect all available information.
• EMH implies it's impossible to consistently outperform the market.
• Weak Form Efficiency: Past prices and trading volumes do not predict future prices.
• Semi-Strong Form Efficiency: Public information is reflected in stock prices.
• Strong Form Efficiency: All information, public and private, is reflected in stock prices.

Understanding Risk and Return

• Risk types include market risk, credit risk, and liquidity risk.
• A risk-return tradeoff dictates that higher returns usually come with higher risk.
• Investors must understand and consider their risk tolerance.
• Diversification is the act of spreading investments across different assets to reduce risk.

Rules and Ethics

• Regulatory Frameworks: Oversight is performed by bodies like the SEC.
• Ethical Considerations include avoiding insider trading, preventing market manipulation, and encouraging transparency.

The Global Nature

• Markets are interconnected worldwide.
• Exchange rate fluctuations impact international trade and investment.
• Global financial crises, like the 2008 event, have broad market impacts.

How Markets Aid the Economy

• Capital Allocation involves directing funds from savers to borrowers, boosting economic growth.
• Economic Indicators include stock prices and bond yields serve as barometers of economic health and indicate recessions, inflation, or booms.
• Markets offer avenues for investing in stocks, bonds, and real estate.
• Risk diversification and derivatives help manage investment risks.

Career Paths

• Understanding financial markets is a foundation for investment banking and advising on mergers and acquisitions.
• Proficiency in financial markets is essential for portfolio managers in asset management roles to optimize capital allocation and returns.
• Sophisticated investment strategies in hedge funds and private equity rely on a strong grasp of market analysis.
• Expertise in financial markets is valuable in consulting roles for financial planning and wealth management by providing advice and guidance to clients.
• Knowledge of financial markets is vital for regulatory roles in ensuring efficient, fair, and transparent market operations.

A Global View

• Global markets offer investment diversification and access to foreign capital.
• International trade and investment requires financial market knowledge such as, understanding currency risks and market regulations.

Impact of Crises

• Financial crises can stem from mismanagement or breakdowns in financial markets.
• Systemic Risk is when problems in one market can spread globally.

Company Financing

• Companies raise operating funds by issuing equity or debt in financial markets.
• Assessing business financials includes understanding how they use markets to access capital.

Valuation Matters

• Real-time pricing data aids accurate valuations during mergers and acquisitions.

Personal Finance

• Wealth Building: Taking part in financial markets allows individuals to save, invest, and prepare for retirement.
• Planning Financial Goals: Knowledge is empowerment to align goals that could include buying a home, education and retirement with effective investment strategies.

Necessary Regulation

• Regulation ensures fairness, transparency, and ethical conduct, preventing unethical behavior.
• Legal/Regulatory Knowledge is vital for compliance roles in the finance industry.

Predicting Trends

• Market Analysis is necessary for informed trading and investment decisions.
• Market psychology and its effect on decision-making are covered in behavioral finance.

Why Study Financial Markets

• Decision-Making: Studying financial markets allows you to analyze data and make informed decisions.
• Problem-Solving: Critical thinking is important in handling complex financial issues.

Financial Markets of the Philippines

• Financial markets in the Philippines, including the PSE, help the local businesses raise capital.
• Financial institutions, insurance companies, and mutual funds are important to the Philippine financial system.
• Investment Portfolio Management: Financial markets can provide more insightful advice regarding investment strategies.
• Risk and Return Assessment assist in assessing investment risks and rewards for clients or businesses.

Career Opportunities in the Philippines

• Knowing local stock market performance is integral to corporate finance roles; which also requires managing capital structure and issuing stocks/bonds.
• Auditing and Financial Reporting: Stock market knowledge helps assess listed company health.
• Regulatory Bodies: Solid financial market knowledge is needed when ensuring regulatory compliance and market transparency working for the SEC or BIR.

Local and Global Economics

• Philippine market volatility is sensitive to local and global events.
• Global Economic Trends in the Philippine markets are influenced by economic activity of other countries such as that of the United States and China.
• Tax Implications are important when understanding the tax efficiency of potential Investment Decisions.
• Capital Gains and Dividends is a part of accountants' roles to counsel on taxation of investments for sound tax strategies.
• Valuing Companies in financial markets helps in analyzing stocks, bonds, and financial statements.

Ethical Considerations

• Regulatory Framework: Adhering to good governance and ethical compliance through Philippine SEC regulations helps the risks of fraud and unethical practices be reduced.
• Market Manipulation and Insider Trading is important to promote financial integrity with roles in regulatory roles.

Transactions

• Foreign Exchange and Currency Risk needs examination on accountancy when working in international commerce due to its influence on value of Philippine peso.
• multinational Corporations must know how markets in other countries affect local and global operations.
• FinTech and digital trading transforms financial market functions using online platforms and blockchain. These changes offer accountants the ability to provide more advice on adapting to novel technologies.
• Cryptocurrency and Digital Assets have a larger, emerging presence on a global scale and in the Philippines which accountants must prepare to handle.

Financial System

• The financial system directs money and capital flow.
• Savers and borrowers are connected.
• Efficient exchange, risk management, and economic growth facilitation is enhanced.
• Financial stability and economic development support is enhanced.
• Banks, stock market, insurance companies, and pension funds are all supported.
• Economic growth is impacted, capital formation occurs, greater stability is achieved, cross border investments and trade are all supported.
• Financial institutions serve as intermediaries between savers and borrowers: like Commercial banks or credit unions
• They can also serve as investment banks or mutual funds.
• Financial markets permit selling and buying a wide array of financial assets like currencies or commodities, used for raising capital and assessing value.
• Regulators ensure that markets function transparently, efficiently, establishing rules to reduce risks and safeguard investors.

Money Market vs Capital Market

• Capital markets tackle long-term securities like stocks and bonds for extensive development.
• Money markets handle short-term instruments like Repos or T-bills for short term funding needs.
• Instruments are traded in markets: Equity/Stocks, Bonds, and Derivatives (options, swaps)
• Stock markets give ownership through equities
• Bond markets offer bonds, which are loans to corporations/government
• Derivatives come in the form of options and are derived from underlying assets.
• Fair operations through monitors and regulators are maintained.

What is Financial Market?

• Platforms where financial assets are exchanged i.e stocks, bonds
• Assets are priced based on supply/demand: price discovery
• Provide Liquidity, ease of converting to cash.
• Two types - Capital which raises funds for long term use ie: development and Money which raises funds for short term use ie: managing expenses.
• Derivatives function through contracts

Philippine context

• Helps individuals know more about taxes with investments
• Understanding the market aids in statement analysis/valuation
• Corporate governance and ethics help align business governance.
• Frameworks like SEC help to achieve fraud reduction and compliance.
• Also important - Market manipulation knowledge, insider trading rules, globalization/cross border regulations.

The Basics of BSP

• Economic stability and regulatory practices of financial markets are all key. These tools are the most essential part of the country’s financial security. To protect citizens and all involved.
• Has history during Pre-colonial era (bartering) to now after the arrival of the Spanish. The Philippines has continued to undergo currency evolution.
• PFRS ensures all financial statements and reporting are up to global standards as well as integrity.
• Tools comprise money supply/regulation to keep economy balanced through means that offer global balance and standards.

Managing Credit Risk

• Regulations/credit/solvency exist through these types: ratings from agencies that provide data/assessments based not he ability to pay/debts.
• Rating models blend different models that may not always be quantitative
• Financial info systems/CIS: a databased system that protects consumers thru credit reports in order to encourage fair lending.
• Cost of Debt, interest rate a borrower pays which impacts risk: rate formulas = credit ratings/maturity all factor
• Ratios such as solvency must be handled so as to not encourage significant loss

Instruments

• Liquidity for short term/agreements in markets is established. To do so - maintaining proper valuations & managing collateral are essential in case of a loan default/securing.
• As such, instruments and collateral management = important.
• Tools in finance such as instruments with examples: certificates/short term debt instruments.
• Short/Long term commercial papers are essential instruments: with risk management and other strategies to protect against said risks.
• Bankers acceptances: draft/used in trade/credit
• Trading is risky based on factors:
• market factors
• defaults
• liquidity
• Accounting for all of this is achieved under various models i.e GAAP