Financial Markets and Institutions.pdf

Financial Markets and Institutions The Need to Study Financial Markets stages of use of money as a medium of exchange. What is Financial Market?...

Financial Markets and Institutions The Need to Study Financial Markets stages of use of money as a medium of exchange. What is Financial Market? Like Commodity money, Metallic money, - All institutions and procedures for bringing Paper money, Credit money, Electronic buyers and sellers of financial instruments money etc. together is called financial market. All such stages of money are used as a medium of exchange to solve the ❖ Financial Markets are the markets in which difficulties of barter economic system. funds are transferred from people who have an excess of available funds to EVOLUTION OF MONEY people who have a shortage. 1. Barter ❖ Financial Markets are important in 2. Gold channeling funds from people who do not 3. Metal coins have a productive use for them to those 4. Paper money who do. 5. Plastic cards 6. Electronic money Why Study Financial Markets? 7. Crypto currency - Financial markets, such as bond and stock markets, are crucial in our economy. The Key Functions of Money 1. These markets channel funds from savers 1. Medium of exchange: money allows goods to investors, thereby promoting economic and services to be traded without the need for a efficiency. barter system. Barter systems rely on there being a 2. Market activity affects personal wealth, double coincidence of wants between the two the behavior of business firms, and people involved in an exchange economy as a whole. 2. Store of value: this can refer to any asset whose WHY STUDY FINANCIAL INSTITUTIONS? "value" can be used now or used in the future i.e. Financial Institutions are the institutions that its value can be retrieved at a later date. This make financial markets work means that people can save now to fund "Financial Institutions are the spending at a later date. intermediaries, that take funds from the people who save and lend it to people 3. Unit of account: this refers to anything that who have productive investment allows the value of something to be expressed in opportunities". an understandable way, and in a way that allows the value of items to be compared. Chapter 1: Money and Interest Rates 4. Standard of deferred payment: this refers to the expressing of the value of a debt i.e. if people Money - A system of value that facilitates the borrow today, then they can pay back their loan exchange of goods in an economy. in the future in a way that is acceptable to the person who made the loan. Evolution of Money In the earlier stages of human civilization, History of Philippine Money to satisfy man needs, barter system took place. 1. Pre-Spanish Regime - Philippine was already After that with the passage of time man trading with neighboring countries such as China, used so many other ways of satisfying its Java and Macau by the use of barter. needs and wants which led to various Commodity money such as gold, gold dust, silver wires, coffee, sugar rice, spices, carabao were V = Velocity of circulation of money used as money. P = General price level in the economy T = Total index of physical volume of transactions 2. Spanish Regime - The Spanish introduced Quantity Theory of Money: coins. The concept of the quantity theory of money (QTM) began in the 16th century. 3. American Regime - The Philippine Peso was As gold and silver inflows from the introduced replacing Spanish-Filipino Peso. Americas into Europe were being minted into coins, there was a resulting rise in 4. Japanese Regime - The Japanese issued War inflation. Notes and introduced mickey mouse money. The idea is that the money supply will directly impact both prices and inflation 5. Post-War Period - in 2010, the Central bank rates. launched the New Generation Currency. The quantity theory of money states that there is a direct relationship between the Money Supply - All the currency and other quantity of money in an economy and the liquid instruments in a country's economy on the level of prices of goods and services sold. date measured. According to QTM, if the amount of money in an economy doubles, price levels also MEASUREMENTS OF MONEY SUPPLY double, causing inflation (the percentage ★ M0: currency (notes and coins) in rate at which the level of prices is rising in circulation and in bank vaults. MO is an economy). The consumer therefore usually called the monetary base - the pays twice as much for the same amount base from which other forms of money are of the good or service. created and is traditionally the most liquid measure of the money supply INTEREST RATES ★ M1: currency in circulation + demand - The interest rate is the price charged by a lender deposits + traveler's cheques. M1 to a borrower in order for the borrower to obtain represents the assets that can be used to a loan. This is usually expressed as a percentage pay for a good or service or to repay debt. of the total amount loaned. Interest rates, both ★ M2: The sum of M1 + savings deposits, nominal and real, have impacts on the economy small denomination deposits & retirement as they impact the saving, spending and accounts. investment decisions made by households and ★ M3: The sum of M2 + large deposits, firms. Euro-dollar deposits & dollars held in foreign offices of banks. Time Value of Money The time value of money (TVM) is the concept that money available at the The Demand For Money present time is worth more than the identical sum 1. Transaction demand - money demanded for in the future due to its potential earning capacity. day-to-day payment through balances held by This core principle of finance holds that provided households and firms. it varies with gdp and not money can earn interest, any amount of money is depend on the rate of interest worth more the sooner it is received. 2. Precautionary demand - money demanded as Reason for Time value of Money a result of anticipated payments. varies with gdp There are certain reason which determine that money has time value following are the reason; 3. Speculative demand - money demanded because of expectations about interest rates in 1. Risk and Uncertainty - As we know future is the future never certain and we can't determines the risk involved in future because outflow of cash is in Quantity Theory of Money ( Formula: MV = PT ) our hand as payment where as there is no certainty for future cash inflows. M = Total amount of money in the economy 2. Inflation - In an inflationary economy, the - A cheque is a document that orders a money received today, has more purchasing bank to pay a specific amount of money power than the money to be received in future. from a person's account to the person in In other words, a rupee today represents a whose name the cheque has been issued greater real purchasing power than a rupee in What Does Payment System Mean? future. ★ A payment system is any system used to settle financial transactions through the Present Value Formula transfer of monetary value. Present Value Formula: The Present Value Formula ★ The term electronic payment refers to a determines how much a sum of money to be payment made from one bank account to received in the future would be worth today. another using electronic methods. ★ Narrowly defined electronic payment The Future Value of money is discounted using an refers to e-commerce, a payment for interest rate. buying and selling goods or services offered through the Internet. ★ One of the examples of modern payments is an instant transfer when you can't wait for the next clearing session and need to. PV = Present Value of the $ FV = Future Value of the $ BSP has listed what is believed to be the five most I = interest rate that can be earned desirable outcome for a payments system: n = number of interest periods 1. Security 2. Efficiency 3. Speed Smooth International transactions 4. Effective collaboration among participants in the systems PV = Present value (amount of money today) FV = Future Value E- MONEY PROS & CONS i = Interest paid by the investment PROS: N = Number of periods the investment will be held ❖ E-Money Is Secure: Service providers must adhere to elaborate KYC and AML processes. ❖ E-Money Is Fast: E-money transactions take Chapter 2: Payment System only an instant or at most several minutes. Commodity monies ❖ E-Money Is Convenient: You enter your - are items used as money that also have payment data once and can pay intrinsic value in some other use. E.g.- Gold, everywhere. candy bars, cigarettes, etc. - has a market value as a good that equals CONS: its value as money (i.e. Gold) ❖ E-Money Requires High Security: Fiat, or token money Compliance to KYC/AML is effortful. - is money that is intrinsically worthless. ❖ E-Money Is Not Available Everywhere: It - government-backed money that we depends on infrastructure power. currently use for payment. Legal tender Cryptocurrency Defined - is money that a government has required Bitcoin Production Facts: to be accepted in settlement of debts -it How Bitcoin Works: Bitcoin is digital does this by fiat. currency Bitcoin Values & Regulations: Bitcoin will be Traditional Payment Systems capped at 21 Billion 1. Cash Public Blockchain Ledger File: How bitcoin 2. Cheques are tracked Bitcoin Security: Backups are essential  A single computer 'earns' 50¢- 75¢ per day - and usually created by or related to the lending of money. - Petty Cash, Deposits, Undeposited checks, The Pros and Cons of Moving to a Cashless Bank Drafts, Receivables, Derivatives Society Various types of bank deposits PROS: 1. Savings deposit ❖ Lower crime rates, as there is no tangible 2. Current deposit money to steal 3. Fixed deposit ❖ Decrease in money laundering ❖ Less time and costs associated with Financial Liabilities handling. storing, and depositing paper Financial liability is any liability that is a money contractual obligation to either: ❖ Easier currency exchange 1. deliver cash or other financial assets to another party, or CONS: 2. to exchange financial instruments ❖ Potential data breach may expose with another party under conditions personal info that are potentially unfavorable to ❖ Hacking risks; no alternative source of the entity money Measurement rules are significantly ❖ Technological issues could impact access different based on whether the liability is to funds considered financial or non-financial ❖ Temptation to overspend may increase Payables, Derivatives, Advances from Customers Chapter 3: What is a Financial Examples of Debt Securities Instrument and types of Financial 1. Corporate bonds - A bond issued by a corporation in order to obtain financing. Instrument 2. Redeemable preferred stock - A type of FINANCIAL INSTRUMENT - Any contract that gives preferred stock that enables the issuer to rise to a financial asset of one entity and a repurchase the stock at specified price financial liability or equity instrument of another points. and thereby converting the stock entity. into treasury stock. Ex: Bonds, Shares, Futures, Options Contracts, Bills 3. Commercial paper - Short-term unsecured of Exchange, Checks, Securities promissory notes that have been issued by either private or publicly traded companies. 4. Convertible debt - A type of debt security that can be converted into a predetermined amount of the underlying company's equity at certain times throughout the bond's life. 5. Government securities - Bonds or other types of promissory certificates that have been issued by the government. The Creation of Financial Assets A financial asset is… GOVERNMENT SECURITIES - a claim against the income or wealth of a ★ Treasury bills (T-bills) - short-term business firm, household, or unit of ★ Govt Treasury Bond Market at DSE government, (GST-bonds) - long-term - represented usually by a certificate, receipt, computer record file, or other legal What is equity instrument? document, ➔ An equity instrument refers to a document which serves as a legally applicable  evidence of the ownership right in a firm, Investors can trade warrants if he expects like a share certificate. Equity instruments the prices of the underlying security to go are, generally, issued to company up in future. shareholders and are used to fund the business. It is, however, not necessary that the issued equity must return a dividend for Derivatives it is based on profits and the terms of Forward contract business. Futures contract Option contract Ordinary Shares Swap contract Owned by the common shareholders of the company What are Derivatives? Entitled to voting rights A derivative is a financial instrument whose Entitled to dividends and capital gains value is derived from the value of another Incorporated with higher risk as will be asset, which is known as the underlying. settled after the preference shares When the price of the underlying changes, the value of the derivative also changes. Preference shares A Derivative is not a product. It is a Not entitled to voting rights contract that derives its value from Entitled to dividends and capital gains changes in the price of the underlying. Incorporated with lower risk as will be Example: The value of a gold futures settled before the preference shares contract is derived from the value of the underlying asset i.e. Gold. STOCK WARRANTS STOCK WARRANTS are the options that give investors the right to buy a company's stock at a specific price until the expiration date. FEATURES Rise in total outstanding shares Fixed prices No voting & dividend Not usually listed on stock exchanges Options Contract TYPES ➔ An options contract is an agreement 1. CALL WARRANT: Represents the right to buy between a buyer and seller that gives the a certain no. of stocks purchaser of the option a right but not an 2. PUT WARRANT: Represents amount of stock obligation to buy or sell a particular asset that is sold to issuer at a later date at an agreed upon price. The two most common types of options USEFULNESS TO ISSUER contracts are put and call options. Increase in company's capital Attaching warrants with bonds makes the shares more attractive. Finances during bankruptcy Future source of capital Investors will to buy the shares easily. USEFULNESS TO INVESTOR SWAP Lower purchase price when there is a ➔ A swap is a contract in which two parties lower price of warrant price than the stock agree to exchange their respective cash price. flows. This is a private agreement between  the parties to exchange cash flow according to some prearranged formula. ➔ The parties to the swap contract are known as counter parties. The Financial System: The Big Questions What is a financial instrument and what is their role in the economy? Conclusions Financial instruments ❖ Well-tested, efficient and effective way of supporting growth, jobs and innovation. ❖ Can attract private funding for public policy objectives. Needed in times of limited public resources. ❖ Will play an important role in achieving the Europe 2020 objectives. ❖ Promote best practices.