Financial Markets and Systems

Financial Markets Overview

• Financial markets are taught by Ms. Rodelyn M. Alianza, MBA.

Topics Covered

• Nature and Importance of the Financial System
• Elements of Financial System
• Nature and Importance of the Financial Market
• Money Market vs. Capital Market
• Primary Market vs. Secondary Market

Nature and Importance of the Financial System

• Prasanna Chandra defined the financial system as institutions, markets, and instruments systematically transforming savings into investments.
• Financial systems facilitate the transfer of money between savers and borrowers.
• Van Horne defined a financial system as one that allocates savings efficiently in an economy to ultimate users for investment or consumption.
• Financial system is a complex, integrated set of subsystems including Financial Institutions, Markets, and Instruments.
• A financial system is complex, includes institutions, markets, instruments, and services.
• The financial system helps in the formation of capital.
• It can meet the short-term and long-term capital needs of households, corporations, governments, and foreigners.
• A key responsibility is to mobilize savings into productive investments.

Financial System

• A financial system allows the exchange of funds between lenders, investors, and borrowers.
• Financial systems operate at national, global, and firm-specific levels.
• They provide an efficient linkage between investors and depositors.

Functions of the Financial System

• Savings Mobilization
• Liquidity Function
• Payment Function
• Capital Formation
• Risk Protection
• Information Function
• Transfer Function
• Reformatory Functions
• Other Functions

Role and Importance in Economic Development

• Links savers and investors.
• Helps monitor corporate performance.
• Manages uncertainty and controls risk.
• Transfers resources across geographical boundaries.
• Offers portfolio adjustment facilities via financial markets and intermediaries.
• Lowers transaction costs and increases returns.
• Promotes capital formation and financial deepening/broadening.
• Financial deepening increases financial assets as a percentage of GDP.
• Financial broadening increases the number of participants and instruments.
• Provides a payment system and gives money time value.
• Offers products and services to reduce financial risk and compensate risk-taking.
• Financial systems are vital for efficient allocation of resources and economic stability.

Financial Concept

• This includes financial assets, instruments, intermediaries, markets, rates of return, and the concept itself.

Financial Assets

• Financial assets are used for production, consumption, or further creation of assets and are non-physical.
• Examples are securities, certificates, and bank balances, unlike physical assets.
• Equity shares are financial assets because they earn income.
• Important conditions:
  • Something you can own.
  • Something of monetary value.
  • That monetary value is derived from a contractual claim.

Types of Financial Assets

• Marketable Assets: Can be easily transferred (e.g., Shares of listed companies, Government securities).
• Non-marketable Assets: Cannot be easily transferred (e.g., provident funds, pension funds, National Savings Certificate).

Financial Intermediaries

• Financial intermediaries facilitate financial transactions for individuals and corporations.
• These include all kinds of financial and investing institutions.

Types of Financial Intermediaries

• Intermediaries mainly provide funds to individuals and corporate customers. Example LIC
• Money Market Intermediaries: Supply short-term funds to individuals and corporate customers (e.g., commercial banks, cooperative banks).

Financial Market

• Financial markets trade securities and commodities at low transaction costs.
• Prices reflect supply and demand.
• It transfers funds from surplus units to deficit units.
• It links savers and investors, not the source of the finance.
• Corporations, financial institutions, individuals, and governments trade in this market.
• Financial instruments are traded at low transaction costs, reflecting supply and demand.
• Securities include stocks and bonds.
• Commodities include precious metals and agricultural goods.
• Financial markets encompass any marketplace for trading securities.
• These include the stock market, bond market, forex market, and derivatives market.

Functions of Financial Market

• Facilitates creation and allocation of credit and liquidity.
• Intermediaries for mobilization of savings.
• Helps in balanced economic growth.
• Provides financial convenience.
• Provides information and facilitates transactions at low cost.
• caters to credit needs of business organizations.

Classifications of Financial Market

• On the basis of maturity claims, money market and capital market are part of the classification.
• Primary Market and Secondary Market form part of the seasoning claim.
• Organized and unorganized markets can also classify this market.
• Dept Market and Equity Market are part of financial type of claim.
• The timing of delivery includes cash/spot market and forward/future market.
• Other Types of financial markets, including Foreign Exchange Market and Derivatives Market.

Financial Market Definition

• A financial market is part of a country's financial system.
• It directs savings and investments, facilitating capital accumulation and production.
• Financial markets allocate resources, support the economy and create returns for funds.

Financial System Definition

• Creates financial instruments and services.
• Efficiently transfers funds between savers, investors, intermediaries, lenders, and users.
• Channels funds from entities with excess money to those who want to borrow.
• Savers supply funds and receive returns like interest, dividends, or capital gains.
• Borrowers use funds for consumer goods or business investments expecting future returns.

Basic functions of the Financial System

• Promote Savings functions
• Provides Payment functions
• Risk Protection functions
• provides Means to wealth function
• Provide Liquidity function
• Provides a Credit Facility function

Philippine Financial System

• Financial activities by economic units related to money, credit, and instruments.
• Key units are banks, non-banks, business organizations, and individuals.

Classification of the Financial system in the Philippines: Banking Institutions

• Private Banking Institutions includes Commercial Banks like Universal Banks and Commercial Banks.
• Thrift Banks have Savings and Mortgage Banks.
• Stocks savings and loan associations including Private Development Banks.
• Rural Banks
• Cooperative Banks
• Islamic Banks
• Other classifications as determined by the Monetary Board of the Bangko Sentral ng Pilipinas
• Government Banks includes Development Bank of the Philippines and Land Bank of the Philippines.

Classification of the Financial system in the Philippines: Non-Bank Financial Institutions

• Private Non-Bank Financial Institutions includes Investment Bank, investment companies, Securities Dealers/Brokers, Insurance Companies, Credit Unions and Pawnshops
• Government Non-Banks Financial Institutions includes Government Service Insurance System and Social Security System.

Banking Institutions: Universal Banks

• Combines investment, commercial, development banking, and insurance.
• These banks exercises powers of commercial bank, investment house, and investing in non-allied enterprises.

Banking Institutions: Commercial Banks

• Commercial banks are second to universal banks in capitalization.
• Examples include Bank of Commerce, Citibank, and Maybank Philippines.

Banking Institutions: Thrift Banks

• Thrift Banks mobilize savings and loans.
• They provide short-term working capital, medium, and long-term financing.
• They diversify services for small and medium enterprises.
• Examples include Allied Savings Bank, Bataan Development Bank.

Banking Institutions: Cooperative Banks

• Organized on a cooperative basis.
• Cooperative banking accepts deposits and provides loans to individuals for ventures.
• Examples of Cooperative Banks include One Network Bank, CARD Bank, Inc., GM Bank, and Metro South Cooperative Bank.

Banking Institutions: Islamic Banks

• Functions similarly to conventional banking without lending money for interest.
• Based on risk-sharing.
• Introduces concepts such as profit-sharing, safekeeping, joint venture, cost plus, and leasing.

Types of Banks: Government Banks

• Controlled by the government, playing a role in economic development.

Types of Banks: Investment Banks

• Underwrite securities, provides planning, consultancy, and fund management.
• Raises funds through equity financing and borrowings.

Non-Banking Financial Institutions: Investment Companies

• Engaged in buying& selling securities through closed-end or open-end funds (mutual funds).
• They issue redeemable shares with the ability to buy back shares anytime required.

Non-Banking Financial Institutions: Securities Dealers/Brokers

• Dealers buy stocks to resell for profit without commissions.
• Brokers engage in buying/selling stocks with commissions

Non-Banking Financial Institutions: Insurance Companies

• Provide insurance for loss to insured parties and transfer risk for a premium which mitigates liability with life, health, real estate, fire, accident, and credit cards.
• Investors use them for hedging risks of loss.

Non-Banking Financial Institutions: Credit Unions

• Member-owned producers and consumers promoting short term credit
• They provide financial services and community or international development support.

Non-Banking Financial Institutions: Pawnshops

• cater to financing low-income individuals requiring guarantee payment on the form of valuable items.
• Individuals use them for small gadgets and items.

Financial Intermediary definition

• A Financial intermediary brings together fund users and providers.
• It makes fund channeling more indirect.

Advantages of Financial Intermediary

• Financial intermediaries have access to assess risky investments
• The are professionals diversifying your investment protfolio
• Cost effective due to scale
• Reconciles investors and lenders
• Provides Savers with liquidity

Role of Financial Market

• Markets for trading financial assets like bonds, stocks, currencies, and derivatives.
• A forum for suppliers and demanders of funds
• Financial markets know where their money is being lent or invested.
• This includes money markets and capital markets are the types of financial markets.

Money Market

• This the market for short-term 1 year of less placements
• Firms and organizations with excessive funding can temporary investments in order to get income.

Money Market Instruments

• These are instruments used to traded in money markets such Negotiable Certificate of Deposit, Commercial Paper, Repurchase Agreement (Repo), Treasury Bills (T-bills), Banker's Acceptance.

Money Market Instruments explanation

• Negotiable Certificate of Deposit has banks ad investors agree on terms and placements.
• Commercial Paper is an unsecured promissory note with a fixed maturity of 1 to 270 days.
• Repurchase Agreement (Repo) has financial instrument sells financial assets to another, to then repurchase at a specific date with an agreed price.
• Treasury Bills (T-bills) has its obligations by the National Government.
• Banker's Acceptance is paid when it meets specified date.

Capital Markets

• Longer term financial instruments and obligations related to government and business agencies.
• This Market involved organized Security Exchanges and Over-the-counter markets (OTC). One example is Philippine Stock Exchange, Inc

Capital Market: organized Security Exchanges

• securities exchange operates under trading rules and regulations that are formulated by an exchange and are followed by investors

Capital Market: Over-the-counter markets (OTC)

• Registered Corporations that are selling stocks, with registered Licensed from Securities and Exchange Commission
• Relationship between sellers and purchasers of securities link up via telecommunication network

Types of Capital Markets

• Primary and secondary market forms part of capital market
• Primary Market, where firms and government agencies raise money, using stocks or bonds for the first time with dealers who receive commissions.
• The IPO or Initial Public Offering takes after this stage.

Players in the Primary Market

• Issuers, public or private corporations who can raise money by way of private or public placement,
• The Financial Instruments are purchased by investors (bonds, equity, and warrants). Financial Intermediaries, such as universal banks and investment funds.
• Investors including individuals and firms, who invest their available funds.

Other Examples of Markets

• Bond market, to raise money
• Commodity Market where trades raw commodities
• Stock Market, trade of publicly listed stocks
• Derivatives Market, Instrument to manage financial risk
• Foreign Exchange Market, most Banks have this

Structure of Interest Rates

• Money given to savers by buying equity is called dividents
• If funds are used to invest in fixed income, it is known as securities like Corporate Bonds, and Governments earn interests as a return.

Term and Maturity Date of interest rates

• Interest Rates can categorized: Short-term - which lasts less than 1 year, Medium term that spans more than 1 year, but 5 years Long-term are more than five years.

Loanable Funds Theory

• Assumes access,integration along easy accessibility The market views perfect competition and there are consistent levels of competition
• Lender and borrower are part of the pricetakers.

Supply of Loanable Funds

• Providers and households,government agencies, private are part its elements Households, governments agencies, private and foreign Investors element for the supply chain

Factors That AFFECT Supply of Loanable Funds

• these factors include interest rate, risk of securities, investment needs, economical position, Monetary Policies involved
• Influence include economic elements and foreign investors.

Definition of Supply and Demand on Household loanable funds

• Total demand for excess funds and resources
• The funds are to purchase household equipment and goods.

Definition of Supply and Demand on Loanable funds

• Businesses demand funds for either short or long term goals.
• There may also be influence due to government investment or supporting government projects. This also include interest from other countries.

Factors That AFFECT Demand of Loanable Funds

• Interest Rate that AFFECT demands
• Demand for funds is a factor
• Economic condition
• Spending Needs
• The Influence includes other countries.

The definition of EQUILIBRIUM INTEREST RATE

• supply is == demands then it indicates rate that borrowers want to borrow == interest rate No surplus, Nor Shortage.

The Characteristics Of EQUILIBRIUM INTEREST RATE

• In a simple model, the equilibrium rate determined from demand curve intersects with supply chain savings to see rates.

Factors That CAUSE the SUPPLY to shift

• The shift in the supply fund is related to Economic Condition, Spending, Risk level, Monetary Policy.

shift in the FACTORS That CAUSE the DEMAND

• Needs for cash for fund and Economic Condition, change of environment, perception can drive prices. The government spends.

CONCEPT for the COST OF MONEY

• The price associated amount

Factors AFFECTING the COST OF MONEY

• Money has limited amount
• time
• risk
• opportunity.