Philippine Financial Market Overview

• The lesson provides an overview of the Philippine Financial Market, including its importance and classification.

The Financial Market

• A market is any place where two or more parties meet to engage in an economic transaction.
• Every trade requires a buyer and a seller.
• Transactions can occur virtually, not limited to physical locations.
• People or agents who need money, agents willing to invest, and intermediaries bringing them together make a market.
• Investment products, such as stocks, bonds, mutual funds, and derivatives, are traded in the market.
• These products are traded on investment platforms, like capital markets.
• Stock exchanges are organized markets with specific trading rules.
• Over-the-counter (OTC) markets are informal networks of brokers and dealers negotiating securities sales.
• OTC markets have no membership or listing requirements, and trade thousands of securities.
• OTC stocks are riskier due to the companies not being large or stable enough for major exchanges.
• Markets facilitate price discovery and asset valuation by bringing buyers and sellers together.
• Price discovery is when a buyer and seller agree on a price and transaction.
• Asset valuation is determining an asset's fair market value.
• The financial market enables firms to invest in projects, acquire assets, and raise capital.
• Investment opportunities, like bonds and stocks, offer potential gains.
• Short-term financing involves taking out a loan for a purchase with a term of less than one year.
• Financial risk management involves identifying, measuring, and reducing financial risks.
• The Financial Risk Management process includes: (a) identifying risks, (b) measuring risks, (c) evaluating remedies, (d) developing a strategy, (e) implementing the strategy.
• Financial markets allow corporations and governments to raise new funds.
• They also allow investors to execute buying and selling orders.
• Funds are channeled from surplus entities (buyers) to shortage entities (issuers).
• Determination of asset prices, liquidity, and reduced transaction costs are all benefits of well-run financial markets.
• Explicit costs include advertising the desire to buy or sell a financial asset.
• Market classifications include the sequence of transactions, term of circulation, nature of securities, and perspective of a country.

Classification of Financial Markets

• Financial markets are divided into capital markets and money markets.

Capital Market

• Includes institutions and instruments providing medium and long-term funds (more than one year).
• Companies access money through equity or preference share capital.
• Investors access to invest in the company's equity share capital and be a party to the profits earned by the company.
• Capital markets allow firms and governments to finance spending beyond current incomes.
• Primary markets are where securities are sold for the first time.
• Issuers in the primary market are companies, governments, and entities seeking capital.
• Securities could be stocks, bonds, options, warrants, etc.
• Investment banks originate and trade equity and debt in the primary market.
• They serve as intermediaries between issuers and investors.
• Investors provide funds in the primary market for future returns.
• Initial Public Offering (IPO) marks a private company issuing stocks to the public for the first time.
• Secondary markets involve the sale and purchase of newly issued and second-hand securities.
• Companies do not directly issue securities to investors in the secondary market.
• Existing investors sell securities to other investors.
• Brokers facilitate the exchange of securities and cash between buyers and sellers.
• Brokers and dealers provide market access and execution services.
• Brokers find trading partners and negotiate prices for a fee.
• Dealers act as principals and trade securities.
• Full-service brokers charge higher fees for additional services and personal relationships.
• Discount brokers give low-cost market access to many self-directed clients.
• Asset Investment Managers manage retail and institutional assets for clients for a fee.
• They develop investment strategies and make investment decisions.
• Their services are typically referred to in the context of investment institutional investors.
• Market infrastructure includes the systems and entities involved in clearing, settlement, and recording transactions.
• A market infrastructure is administered by public or private entities and provides services for trading, clearing, matching, and depository functions.

Functions and Examples

• Exchange Example: The Philippine Stock Exchange (PSE)
• Clearing House/Clearer Example: Securities Clearing Corporation of the Philippines (SCCP)
• Depository Example: The Philippine Depository and Trust Corporation (PDTC)
• Custodian Example: Central Bank of the Philippines - Bangko Sentral ng Pilipinas (BSP)
• Integration includes Investors, Issuers, Investment Banks, Brokers/Dealers, Asset Investment Managers, Exchanges, Clearing Agencies, and Depositories.

Money Market

• A market for short-term funds (up to one year).
• Primarily for working capital.
• Involves short-term lending and borrowing of cash.
• Also involves the sale and purchase of securities with a term of one year or less.

Features

• Market for the short term.
• No fixed geographical location.
• Common instruments include Call Money, Commercial Bills, and Certificates of Deposits.

Money Market Instruments

• Call Money are amounts borrowed or lent on demand for a short period, typically one day.
• Treasury Bills (T-Bills) are issued by the Reserve Bank of India (RBI) on behalf of the government
• They allow the government to get short-term borrowings.
• Commercial Bills are bills drawn by one organization on another, used for credit sales and purchases.
• Commercial Paper are unsecured promissory notes issued by creditworthy companies with maturities from 15 days to one year.
• Certificate of Deposits (CDs) are time deposits that can be sold in the secondary market and are issued by banks.

Financial Instruments in the Capital Market

• Financial instruments are assets that can be traded or exchanged, such as stock shares, exchange-traded funds (ETFs), bonds, certificates of deposit (CDs), mutual funds, loans, and derivatives contracts.
• They facilitate efficient flow and transfer of capital, taking the form of cash, contractual rights, or evidence of ownership.

Debt-Based Instruments

• Debt-based instruments are mechanisms used to raise capital.
• Involves a binding contract where an entity borrows funds and promises to repay them.
• Debt instruments are loans from investors to issuers in return for interest payments.
• The conditions are a predetermined schedule for rate and frequency of interest, repayment of principal.
• Debt instruments are more secured than equities since returns are definite.

Types of Bonds

• Government Bonds: Issued by central governments and highly secured.
• Corporate Bonds: Issued by corporations and carry higher interest rates.
• Municipal Bonds: Issued by local governments for development purposes and have tax-free returns.
• Zero Coupon Bonds: Issued at a considerable discount to par value and make no coupon payments.

Features of Bonds

• Principal: The amount the issuer borrows and repays on the maturity date.
• Also referred as par value, face value or maturity value.
• Coupon: Interest rate paid by the issuer to the bondholder, often in regular installments.
• Payments can be made semi-annually or annually.
• Coupon Rate (I): Interest rate priced on the bond determining annual coupon payments, expressed as a percentage.
• Price: Depends on factors like current rates, credit quality, maturity, and supply/demand.
• Newly issued bonds generally sell at or near par value.
• Bonds trading above par value trade at a premium.
• Bonds trading below par value trade at a discount.
• Maturity: Length of time before a bond expires.
• Debt securities with terms under one year are Money Market instruments.
• Bonds usually have a maturity of up to 10 years.
• Bonds with maturities less than 10 years are referred to as "notes" in some markets.
• Longer maturities require greater yields from investors due to price risk.
• Current Yield: The expected annual return of a bond if the security is held for the next year. Current Yield = Annual Coupon / Bond Price
• Yield-The yield is the rate or return received from invesing in the bond
• The calculation can be seen in Bond Yield Metrics, including Rates, Current Yield, Yield to Maturity, Yield to Call, and Yield to Worst

Equity-Based Instruments

• Equity-based instruments give legal ownership of an entity.
• Represent ownership of an asset.
• An equity instrument offers the opportunity of owning an asset and also receiving income off of it.
• Investors receive shares or certificates for that ownership.
• Companies gather capital by issuing these shares to investors to fund their business.
• Equity financing is the process of gaining capital by selling shares.
• Investors in equity instruments may or may not get a monthly dividend.

Types

• Common Stock are the the most "common" type of equity security.
• Common Stockholders are behind preferred stockholders in the rights to receive dividends and both preferred stock holders and creditors in payment liquidations.
• Preferred Stock refers to the commonly used investment vehicle due to its flexibility.
• Preferred stock can offer characteristics of equity and debt in financial and non-financial terms.

Characteristics of Common Stock

• In liquidation, common shareholders have an unsecured interest.
• Dividends may vary and are not guaranteed.
• Usually, shareholders can control the voting power.
• Most have either no or minimal par value.

Characteristics of Preferred Stock

• Holder has a claim on an issuer's assets senior to common shareholders.
• Holders generally receive dividends before common shareholders.
• May be entitled to receive additional dividends.
• Voting rights may be voting or nonvoting.
• Preferred stock may be perpetual, mandatorily redeemable, or contingently redeemable.
• Convertible preferred stock converts the instrument into equity securities.