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• Focuses on Capital Market Theory, efficiency, implications, and coherence with financial institutions.
• It analyzes financial market relationships with the government, emphasizing its powerful role.
• Aims to enhance students' analytical skills through financial case presentations.

Introduction to the Financial System

• Financial System includes banking institutions, non-banking financial intermediaries, investments, and loan associations.
• The Financial System is necessary for economic growth.
• It facilitates fund transfers from savers to individuals, firms, and government via financial institutions.
• Investors rely on financial institutions for advice and transaction services.

Financial Assets: Tangible vs. Intangible

• Tangible assets have physical properties (e.g., buildings, land, machinery)
• Intangible assets represent claims to future cash flows.
• Issuers agree to future cash payments, owners of financial assets are referred to as investors.
• Examples include government and corporate bonds, loans, and stocks.
• Bonds involve issuers paying interest until maturity and repaying the borrowed amount.
• Japanese government bonds involve cash payments in yen.
• Automobile and home mortgage loans have individuals as issuers, banks as investors.
• Loan agreements specify repayment schedules and interest.
• Common stock entitles investors to dividends and a pro rata share of the company's net asset value in liquidation.

Debt vs. Equity Claims

• Debt instruments involve claims to a fixed or varying dollar amount.
• Equity claims, obligate issuers to pay an amount based on earnings.
• Convertible bonds allow debt conversion into equity.
• Both debt and preferred stock that pay a fixed dollar amount are income instruments.

Valuation of Financial Assets

• Valuation determines the fair value or price of a financial asset.
• Present value: Money today is worth more than the same amount in the future.
• Money received in the future is worth less than an equal amount received today.
• Cash flow represents the cash expected from investing in a financial asset.
• Financial assets (debt or equity) determine the certainty of cash flow.
• Government-issued bonds generally ensure certain cash flow.
• Inflation introduces uncertainty in the purchasing power of cash flow.

Targeting Inflation

• Aims to reduce inflation to the BSP's 2-4% target range by early 2024.
• Inflation is projected to average 3.7% in 2024 and 3.2% in 2025.
• Positive influence on consumer spending and investments is anticipated.

Determining Appropriate Interest Rates

• Investors need to consider the minimum acceptable interest rate and the required premium.
• The Central Bank of the Philippines maintained a 6.50% benchmark interest rate as of December 2023.
• Inflation slowed to 4.1% in November, and inflation forecasts were revised.

Role of Financial Assets in Fund Transfer and Risk Redistribution

• Transfers funds from surplus to deficit entities.
• Financial assets redistribute the risk from tangible asset cash flows.
• Provides examples of how financial assets are used to facilitate business activities and investments and to illustrate economic functions.

Properties of Financial Assets

• Moneyness: Acts as a medium of exchange; near money instruments.
• Divisibility and Denomination: Minimum size for liquidation and exchange.
• Reversibility (Round-Trip Cost): Costs of investing and reverting to cash (bid-ask spread is relevant).
• Maturity: Term until final payment or liquidation demand.
• Liquidity: Ease of selling without significant losses
• Convertibility: Conversion terms to other financial assets.
• Currency: Denomination in one currency; dual currency securities exist.
• Cash Flow and Return Predictability: Riskiness is predictability of return
• Complexity: Decompose and price parts separately.
• Tax Status: Varies by government and location.

Role of Financial Markets

• Prices of traded assets or required returns are determined through buyer-seller interactions.
• A mechanism for investors to sell, enhancing liquidity.
• Financial markets reduce explicit (search) and implicit (information) costs.

Classification of Financial Markets

• By Type of Financial Claims: Debt and stock markets.
• By Maturity: Money (short-term) and capital (long-term) markets.
• By Issuance and Trade: Primary (new issues) and secondary (trading between investors) markets.
• By Organizational Structure: Auction, over-the-counter, intermediate markets.
• Derivative Markets: Derives value from underlying assets (options, futures, forwards, swaps).

Strong Financial System Attributes

• Efficiently allocates resources, manages risks, achieves employment levels, and maintains price stability.
• Has complete markets with effective intermediaries, allowing capital movement and risk hedging.

Employment Level

• Discusses types of risks in the capital market.

Types of Risk in the Capital Market

• Market Risk: Investments decline due to economic events.
• Equity Risk: Risk in shares due to market price fluctuations.
• Interest Rate Risk: Risk of losing money due to interest rate changes.
• Currency Risk: Applies when you hold foreign investments due to the exchange rate.
• Liquidity Risk: Inability to sell at a fair price due to low trading volume.
• Concentration Risk: Loss from concentrating money in one investment.
• Credit Risk: Issuer defaults on interest or principal payments.
• Reinvestment Risk: Loss from reinvesting principal or income at a lower rate.
• Inflation Risk: Loss in purchasing power due to inflation.
• Horizon Risk: Risk that your investment horizon shortens unexpectedly.
• Longevity Risk: Outliving your savings.
• Foreign Investment Risk: Investing in foreign countries with risk.

Cost of Financial System Factors

• Increased Capital Requirement: Banks borrow more leading to leverage.
• Increased capital minimums can reduce lending, affecting GDP.
• Increased Liquidity Requirements: Banks must set aside cash, reducing lending.
• Increased Compliance: Reporting costs reflected on bank's financial statements.

Finance Defined

• It is the management of cash or funds
• Finance views transactions as cash management unlike accounting which follows the accrual method.

Functions of Finance

• Treasury Group: Manages company funds, financial planning, investments, foreign exchange, and credit collection.
• Accounting Group: Prepares financial statements, handles tax planning, and manages cost accounting.

Activities of a Finance Manager

• Investing, financing, financial statement analysis, and planning.
• The Finance manager decides how the company's investment will be distributed.
• Investment is equal to the financing side.
• Review Analog Devices cases and compare and contrast the differences.

Goal of Finance

• Maximizing the value of the firm.
• Under normal circumstances, the company will first take the option of finance its long-term projects with the profits it has generated.

Finance Market and Institutions

• Financial intermediaries facilitate fund transfers from providers to users.
• Loanable funds carry interest, benefiting both the bank and depositors.

Financial Markets

• Facilitating company listings for public fundraising via stock offerings.
• Governed by supply and demand of buyers or sellers.
• Includes money and capital markets.
• Money markets are short-term financial transactions (treasury bills, commercial papers).
• Capital markets deal with long-term transactions like stocks and bonds.

Arbitrage Pricing Theory (APT)

• APT predicts asset returns using a linear relationship with macroeconomic variables.
• Simultaneous purchase and sale of an asset to profit from price differences.
• Formula outlines expected asset return based on risk-free rate, asset price sensitivity, and risk premium.

Capital Asset Pricing Model (CAPM)

• CAPM shows the relationship between the risk and expected return for assets.
• CAPM is used for pricing securities and assessing risks The formula evaluates if a stock is fairly valued when its risk is compared to its return.

Overview of Market Participants

• Long-term capital financing involves expansion expenditures and higher investment in fixed assets.
• Short-term capital financing provides working capital for day-to-day expenses within one year.
• Aseca Enterprises example is given.

Procuring Funds

• Funds should be obtained at the lower amount in cost (capital cost).
• Aggregate expenses are included in obtaining such as interest, service costs.

Capital Market

• Trades mostly in bonds, stocks, with the intention of individuals etc..
• Households are the largest net suppliers of funds.
• Examples of capital markets are New York Stocks.
• In Economics the household sector is savings surplus.

Functions of Capital Market

• Comprises capital and money market.
• It involves the sale of securities to savers and money loaned to borrowers.