Module 1: The Investment Setting and Portfolio Management PDF

Module 1: The Investment Setting and Portfolio Management Module Overview: Dear students, welcome to College Education. You have entered another phase of your life, the college level, and this is very exciting. You are in a new school, where you will form new friendships, meet your teachers...

Module 1: The Investment Setting and Portfolio Management Module Overview: Dear students, welcome to College Education. You have entered another phase of your life, the college level, and this is very exciting. You are in a new school, where you will form new friendships, meet your teachers and learn new things. This module is designed for students to explores the dynamic landscape of investment environments and the strategic management of investment portfolios. It delves into the factors influencing investment decisions, including economic indicators, market trends, and risk assessment. Students will gain insights into various asset classes, investment vehicles, and portfolio construction techniques. The module emphasizes the development of skills for creating and managing diverse investment portfolios, considering both short-term and long-term financial goals. By integrating theoretical knowledge with practical applications, participants will be equipped to navigate the complexities of the investment world and optimize their portfolio strategies. Module Objectives/Outcomes: At the end of Module 1, you will be able to:  gain a foundational knowledge of various types of investments, the structure and function of financial markets, and the roles of different market participants.  analyze the factors influencing investment environments, including economic indicators, market trends, and regulatory frameworks, to better grasp how they impact investment decisions and portfolio performance.  design and implement diverse investment strategies with varying risk tolerances and financial goals, utilizing a range of asset classes and investment vehicles to build and manage effective portfolios. Lessons in the Module: Lesson 1: Introduction to Investments and Portfolio Management Lesson 2: Risk and Return Lesson 3: The Role of Financial Markets Module 1 1  Lesson 1: Lesson Introduction 1: ThetoSelf Investments and Philosophical from Various Portfolio Management Perspectives Learning Outcomes: At the end of this lesson, you will be able to: a) distinguish between various investment options, such as stocks, bonds, mutual funds, and real estate, understanding the basic characteristics and potential returns of each. b) become familiar with essential investment concepts, such as risk, return, diversification, and liquidity, and how these factors influence investment decisions. c) gain a basic understanding of how financial markets operate, including the roles of major participants like investors, brokers, and regulatory bodies. Time Frame: Week 2 Introduction: In this lesson, you will explore the foundational concepts of investing and the structure of financial markets. Understanding the variety of investment options available, from stocks and bonds to mutual funds and real estate, is crucial for making informed financial decisions. It will also be discussed how financial markets function, including the roles of key participants such as investors, brokers, and regulators. And by the end of this lesson, you will have a clearer understanding of basic investment principles, including risk, return, diversification, and liquidity, setting the stage for more advanced topics in investment management. Activity: Investment Preferences Survey Instruction: Reflect on your personal views and experiences with investing by answering the following questions: 1. Have you ever made an investment (e.g., stocks, bonds, real estate)? If so, what was it, and why did you choose it? _______________________________________________________________ _______________________________________________________________ 2. What factors do you believe are most important when choosing an investment (e.g., risk, return, liquidity)? Module 1 2  _______________________________________________________________ _______________________________________________________________ 3. Rank the following investment types from what you perceive to offer the highest to lowest potential return: stocks, bonds, real estate, savings accounts, mutual funds. 1. 2. 3. 4 5. Analysis The investment survey activity aimed to gauge your initial understanding and perceptions of various investment types, factors influencing investment choices, and the basic functioning of financial markets. By analyzing responses, students' prior knowledge can be identified, common misconceptions, and areas for further learning. This analysis will help inform the direction of the course and ensure that foundational concepts are thoroughly addressed. Please consider the following questions: 1) What factors do you consider most important when choosing an investment? _______________________________________________________________ _______________________________________________________________ 2) How do you perceive the risk and return of different investments? _______________________________________________________________ _______________________________________________________________ 3) How well do you understand the roles of key financial market participants? _______________________________________________________________ _______________________________________________________________ The analysis of these questions will provide insights into your current knowledge base and misconceptions. By addressing these findings in subsequent lessons, the course can ensure that students develop a strong, accurate understanding of fundamental investment concepts and the functioning of financial markets. Module 1 3 Abstraction What is an Investment?  encompasses a wide range of financial instruments and strategies that individuals and institutions use to allocate capital with the goal of generating returns. Investments Objectives Classification The objectives can be classified on the basis of the investors approach as follows: a) Short term high priority objectives: Investors have a high priority towards achieving certain objectives in a short time. For example, a young couple will give high priority to buy a house. Thus, investors will go for high priority objectives and invest their money accordingly. b) Long term high priority objectives: Some investors look forward and invest on the basis of objectives of long term needs. For example, investing for post retirement period or education of a child. c) Low priority objectives: These objectives have low priority in investing. These objectives are not painful. After investing in high priority assets, investors can invest in these low priority assets. For example, provision for tour and aesthetic preferences. d) Money making objectives: Investors put their surplus money in these kinds of investment. Their objective is to maximize wealth. Usually, the investors invest in shares of companies which provide capital appreciation apart from regular income from dividend. Module 1 4 Common Objectives for Investments: 1. Capital Appreciation (Growth) Increase the value of the initial investment over time. This is typically the primary goal for investors looking to build wealth. 2. Income Generation Generate regular income from investments, which can be used to cover living expenses or reinvested for further growth. 3. Preservation of Capital Protect the initial investment from loss. Investors with a low-risk tolerance prioritize preserving their capital, even if it means accepting lower returns. 4. Diversification Spread investments across various asset classes to reduce risk. Diversification helps protect against losses in any single investment or sector. 5. Retirement Planning Build a sufficient retirement fund to maintain a desired lifestyle after leaving the workforce. This often involves long-term investment strategies that balance growth and income. 6. Tax Efficiency Minimize tax liabilities on investment returns, maximizing the amount of money that stays with the investor. 7. Inflation Protection Ensure that investment returns outpace inflation, preserving purchasing power over time. 8. Wealth Transfer or Estate Planning Preserve and grow wealth to pass on to future generations or charitable causes. 9. Liquidity Ensure access to cash when needed, without significant penalties or losses. 10. Education or Major Life Goals Save and invest for specific life goals, such as funding education, purchasing a home, or starting a business. Module 1 5 Comparison of Different Types of Investments Stocks Definition: Ownership shares in a company, representing a claim on part of the company's assets and earnings. Advantages: High return potential, Liquidity, Ownership in a company Disadvantages: High volatility, Market risk, Potential loss of principal Examples: Apple, Microsoft, Amazon, Tesla Bonds Definition: Debt securities issued by entities (governments, corporations) to raise capital, with a promise to pay back the principal along with interest. Advantages: Regular interest income, Lower risk than stocks, Capital preservation Disadvantages: Lower returns, Interest rate risk, Credit risk Examples: U.S. Treasury bonds, corporate bonds Mutual Funds Definition: Investment funds pooling money from investors to invest in a diversified portfolio of securities, managed by professionals. Advantages: Professional management, diversification Disadvantages: Higher fees, potential capital gains taxes Module 1 6  Examples: Sun Life, PhilEquity and Alyansa ng Lahing Pilipino (ALMF) Exchange Trade Funds (ETFs) Definition: Investment funds traded on stock exchanges, holding a basket of assets, often tracking an index. Advantages: Low cost, trading flexibility, tax efficiency, diversification Disadvantages: Trading fees, Market price deviations from NAV, Some ETFs are less liquid Example: First Metro Philippine Equity Exchange Traded Fund (FMETF) Real Estate Definition: Investment in physical property, either residential or commercial. Advantages: Income potential, Property value appreciation, Tangible asset Disadvantages: Low liquidity, high transaction costs, market fluctuations Examples: Rental properties, commercial buildings, REITs Commodities Definition: Physical assets like gold, oil, and agricultural products. Advantages: Inflation hedge, diversification, tangible asset ownership Disadvantages: High volatility, Storage costs, lack of income generation Examples: Gold, crude oil, agricultural products Two Concepts of Investment Module 1 7  VS ECONOMIC INVESTMENT FINANCIAL INVESTMENT Economic Investment Financial Investment Definition: Investments that contribute to the overall growth and development Definition: Investments made with the goal of the economy, often in the form of of generating financial returns or income, infrastructure, education, or technology typically through asset acquisition or trading. advancements. Focus: Enhancing productivity and Focus: Achieving capital appreciation, efficiency in the economy; improving income generation, or both; often through public goods and services. stocks, bonds, real estate, etc. Examples: Building highways, funding Examples: Purchasing stocks, bonds, mutual public education, investing in research funds, real estate properties, or investing in and development, and improving startups. healthcare systems. Impact: Affects individual or institutional Impact: Affects the broader economy, financial performance, with direct leading to potential long-term economic implications for personal or organizational growth and social benefits. wealth. Funding Sources: Typically financed by Funding Sources: Financed by individual government spending, public-private investors, institutions, or financial markets. partnerships, or philanthropic Module 1 8 contributions. Time Horizon: Often involves long- Time Horizon: Can vary widely, from short- term investments with benefits that term trading to long-term buy-and-hold accrue over extended periods. strategies. Risk Considerations: Risks are related Risks are related to market fluctuations, asset to economic policy changes, regulatory performance, interest rates, and investment impacts, and long-term economic shifts. decisions. Objective: To drive economic Objective: To generate returns, manage risk, development, enhance social welfare, and grow wealth. and improve the quality of life. Key Participants in the Investment Industry Individual Investors Private individuals who invest their own money in various assets based on personal financial goals, risk tolerance, and knowledge. Example: Small savers, high-net- worth individuals Institutional Investors Large organizations that invest significant funds on behalf of others, often having a substantial impact on financial markets due to their trading volume. Pension Funds, Mutual Funds, Insurance Companies, Hedge Funds, Sovereign Wealth Funds, and Foundations Module 1 9  Financial Advisors Professionals who provide financial and investment advice, offering services ranging from investment management to comprehensive financial planning. Independent Advisors, Financial Planning Firms, Wealth Management Services What is a Portfolio Management?  is the process of selecting, managing, and overseeing a collection of investments (known as a portfolio) in order to achieve specific financial objectives. It involves making strategic decisions about asset allocation, risk management, and investment selection to optimize returns while managing the level of risk. THE PORTFOLIO MANAGEMENT PROCESS  process of managing an investment portfolio never stops. Once the funds are initially invested according to the plan, the emphasis changes to evaluating the portfolio’s performance and updating the portfolio based on changes in the economic environment and the investor’s needs. Module 1 10 The first step in the portfolio management process, as shown in Exhibit 2.3, is for the investor to construct a: 1. Policy statement that specifies the types of risks the investor is willing to take and his or her investment goals and constraints. 2. Assessing the future and deriving strategies that meet the policy statement guidelines. 3. Construct the portfolio 4. Continual monitoring Types of Portfolio: 1. Growth Portfolio aim is to promote growth by taking greater risks, including investing in growing industries. typically offer both higher potential rewards and concurrent higher potential risk. involves investments in younger companies that have more potential for growth as compared to larger, well-established firms. 2. Income portfolio is more focused on securing regular income from investments as opposed to focusing on potential capital gains. An example is buying stocks based on dividends interest, or other cash distributions. Module 1 11  Examples are dividend- paying stocks and corporate bonds that pay regular interests. 3. Value portfolio when investor takes advantage of buying cheap assets by valuation especially useful during difficult economic times when many businesses and investments struggle to survive and stay afloat. Example are those companies with profit potential but that are currently priced below what analysis deems their fair market value to be. In short, value investing focuses on finding bargains in the market. Portfolio Investment Strategies: 1.Aggressive  Focuses on higher-risk investments with the potential for higher returns. This can lead to significant fluctuations in value. 2. Conservative  Prioritizes stability and preservation of capital, with minimal fluctuation in value. 3. Balanced  Seeks a middle ground between risk and return by blending high-risk and low-risk investments. Module 1 12  Investment Policy Statement (IPS) Objective: The primary objective of this portfolio is to achieve long-term capital growth while maintaining a moderate level of risk. The portfolio aims to outpace inflation and generate returns that support the investor’s retirement goals over a 20-year horizon. Investment Goals: 1. Capital Growth: Achieve an annualized return of 7% over the long term. 2. Income Generation: Provide a moderate level of income through dividends and interest to supplement other sources of retirement income. Risk Tolerance:  Moderate Risk: The portfolio will accept a moderate level of volatility in exchange for higher potential returns. The investor is willing to experience short-term fluctuations in value for the potential of long-term growth. Asset Allocation: 1. Equities (Stocks): 60% o Domestic Stocks: 40% o International Stocks: 20% 2. Fixed Income (Bonds): 30% o Government Bonds: 15% o Corporate Bonds: 15% 3. Cash and Cash Equivalents: 10% Investment Restrictions:  No investment in speculative or highly volatile assets.  Limited exposure to individual stocks exceeding 5% of the portfolio value.  No investments in companies or industries that do not align with personal ethical standards (e.g., tobacco, firearms). Rebalancing Policy:  The portfolio will be reviewed and rebalanced annually to ensure it remains aligned with the target asset allocation.  If any asset class deviates by more than 5% from its target allocation, rebalancing will be executed. Performance Measurement:  Performance will be evaluated on a rolling 5-year basis to assess alignment with long-term goals. Liquidity Needs:  Maintain sufficient cash reserves to cover anticipated expenses and emergencies, estimated at 2% of the portfolio value annually. Review and Amendments: Module 1 13 Application Think about what you learned from creating portfolio and how it helped you understand investments better. Note: Submit a brief report or presentation with the details of your investment portfolio and your reflections on the process. Be prepared to discuss your choices in class. Closure Dear students, thank you for seriously doing the activities in Lesson 1. Congratulations for a job well done. For your next lesson, please have an advance reading on “Risks and Returns”. Lesson Lesson 1: The 2: Risks Self from and Philosophical Various Returns Perspectives Learning Outcomes At the end of this lesson, you will be able to: a) explain the relationship between risk and return, and how they influence investment decisions. b) identify and describe various types of investment risks, including market risk, credit risk, liquidity risk, and interest rate risk. c) evaluate and apply different strategies to manage and mitigate risks in an investment portfolio, such as diversification and hedging. d) calculate different measures of returns, such as absolute return, annualized return, and risk-adjusted return, and interpret their implications for investment performance. Time Frame: Week 3 Introduction In your previous lesson, you are taught on the basics of investing, including different types of investments and how investment portfolio are managed to put the investor in greater advantage. Module 1 14  In this lesson, "Risks and Return" you will have an understanding of the relationship between risks and returns in making sound financial decisions. Risk represents the possibility of losing part or all of the investment, while return indicates the profit or loss generated by the investment over time. These two concepts are inherently linked, with higher potential returns generally requiring a greater acceptance of risk. For instance, investing in stocks may offer substantial returns but comes with higher volatility and uncertainty compared to more conservative options like bonds or savings accounts, which provide lower returns but with less risk. This lesson will also delve into various types of investment risks, such as market risk, which involves the potential for losses due to overall market fluctuations, and credit risk, which is the danger of a borrower failing to repay a loan. We'll also cover how to measure and interpret different types of returns, enabling you to assess the profitability of your investments. Activity: Scenario Creation:  Prepare three different hypothetical investment scenarios with varying levels of risk and return. o Investment A: A low-risk, low-return bond with an average annual return of 3%.. _________________________________________________________________ _________________________________________________________________ o Investment B: A moderate-risk stock with an average annual return of 8%. _________________________________________________________________ _________________________________________________________________ o Investment C: A high-risk, high-return venture capital investment with an average annual return of 15%. ____________________________________________________________ ____________________________________________________________ Module 1 15 Analysis : In a given figure below, explain vividly the relationship bettween risks and return in making investments. ____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _ Abstraction The Concept of Risks, Returns and Diversification Concept Description Key Points Market Risk: Losses due to market fluctuations. The possibility of losing Credit Risk: Risk of default by borrowers. Risk some or all of an Liquidity Risk: Difficulty in selling assets investment's value. without loss Inflation Risk: Erosion of purchasing power. Capital Gains: Increase in the value of an The gain or loss made on asset. Return an investment over a Dividends: Payments to shareholders from period. company profits. Interest: Earnings from bonds or savings. Diversification An investment strategy to Asset Allocation: Mixing different types of reduce risk by spreading investments (stocks, bonds, etc.). Module 1 16  Sector Diversification: Investing in different investments across various industries. assets or sectors. Geographic Diversification: Investing in different regions or countries. COMMON TYPES OF RISKS: Business risk The risk associated with the unique circumstances of a particular company as they might affect the price of the company’s securities. It can be affected by a number of issues such as changes in share prices, employee layoffs, gains or losses of contracts and changes in management. Market/systemic risk The day-to-day fluctuation in a stock’s price (also known as volatility). Market risk applies mainly to stocks and options. In general, stocks tend to perform well during a bull market and poorly during a bear market. Foreign exchange or currency risk Currency exchange rates can change the price of an investment. Foreign exchange risk applies to all financial instruments that are in a currency other than your domestic currency. There is a possibility that a profit may be negated once a profit from a foreign investment is converted to domestic currency, especially if exchange rates have changed since the investment was made. Inflation risk The possibility that the value of assets or income will decrease as inflation shrinks the purchasing power of a currency. Inflation causes money to decrease in value over time, and does so whether the money is invested or not. Interest rate risk Investments such as bonds, Guaranteed Investment Certificates and mortgage-based investments will fluctuate in value when interest rates change. When interest rates go up, the value of fixed-rate investments drop. When interest rates go down, the value of fixed-rate investments increase. Liquidity risk The risk coming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss.To sell the investment, you may need to accept a lower price. Mortgage risk Module 1 17 The risk that the individual or company that borrows the money will fail to make timely principal and interest payments in accordance with the terms of the mortgage. Political risk Return on an investment could suffer as a result of instability or political changes in a country. For example, the action of the United Kingdom voting to withdraw from the European Union caused the British pound to drop in value. Opportunity risk The risk that a better opportunity may present itself after an irreversible decision has been made. Managing Investment Risks: Asset allocation & Diversification  refers to the way you weigh the investments in your portfolio to meet your financial goals. It's the act of investing in different asset classes — such as stocks, bonds, alternative investments and cash — that should also take your risk tolerance, tax situation and time horizon into account.  Example: Allocating 60% of a portfolio to stocks, 30% to bonds, and 10% to cash. This allocation reflects an investor’s preference for higher growth potential (stocks) while maintaining some stability (bonds and cash).  is the process of selecting a variety of investments within each asset class, which can help those looking to learn how to mitigate investment risk. Module 1 18  Diversification across asset classes may also help lessen the impact of major market swings on your portfolio.  Example: Within a stock allocation, investing in different sectors (technology, healthcare, finance) and different companies (large-cap, mid-cap, small-cap) to spread risk. What Are the Different Types of Returns? How Are They Measured? Nominal Return  is the net change in value of an investment over a time period, excluding any taxes or fees paid for the investment or cash flows (like dividends) received as a result of the investment. It is calculated by subtracting the purchase price of an investment from its current value. Formula: Nominal Return = Ending Value – Initial Investment X 100 Initial Investment Total Return  unlike nominal return, total return includes both the capital gains (or losses) and any income generated from the investment, such as dividends or interest payments. Module 1 19 Formula: Total Return = (Ending Value – Initial Investment + Income) X 100 Initial Investment Real Return  tells you how much your investment has actually increased in value after considering the effects of inflation. Inflation reduces the purchasing power of your money over time, so you need to account for it to understand the true growth of your investment. Formula: Real Return = 1 + Nominal Return - 1 1 + Inflation Rate Module 1 20 Return on Investment (ROI)  is a measure of the return generated by each dollar invested in an asset. It means the same thing as rate of return and is calculated the same way—by subtracting the purchase price of an investment from its current value, then dividing the result by the purchase price to yield a percentage return. ROI Formula ROI = (Current Value – Cost of Investment) X 100 Cost of Investment Module 1 21 Return on Equity (ROE)  is a metric that expresses a company’s net income over a certain period (usually a year) as a percentage of its total shareholders’ equity. The result is the amount of income generated per dollar of invested capital. ROE Formula ROE = Net Income / Shareholders’ Equity x 100 Return on Assets (ROA)  is a metric that expresses a company’s net income over a certain period (usually a year) as a percentage of its total assets. The result is the amount of income generated per dollar of assets. ROA Formula ROA = Net Income / Total Assets x 100 Module 1 22 Application Investment Choice Comparison Average Annual Investment Risk Return Stock 8% 15% Bond 4% 5% Savings Account 1% 1% In this activity, use this data to compare the investments and make recommendations based on your hypothetical risk tolerance. Closure Thank you for seriously doing the activities in Lesson 2. Congratulations for a job well done. For your next lesson please have an advance reading on “The Role of Financial Markets Lesson Lesson 1: 3: The The Self Role from of Financial Various Markets Perspectives Philosophical Learning Outcomes: At the end of this lesson, you will be able to: 1) explain the primary functions of financial markets, including how they facilitate the allocation of resources, enable price discovery, and provide liquidity. 2) identify and describe the different types of financial markets (e.g., stock markets, bond markets, derivatives markets) and the key participants (e.g., investors, brokers, regulators) within each market. 3) assess how financial markets influence economic growth, stability, and the allocation of capital, including the impact of market fluctuations on businesses and consumers. Time Frame: Week 4 Module 1 23 Introduction: As discussed in the previous lessons, you are taught of understanding the relationship between risks and returns in making sound financial decisions.This succeeding lesson provides an overview of the functions of financial markets, its contributions to our economy as a whole. Financial markets are vital components of a modern economy, functioning as platforms where individuals, businesses, and governments can buy and sell financial assets such as stocks, bonds, and commodities. They play a crucial role in the efficient allocation of resources by facilitating the transfer of capital from those who have excess funds to those who need funding. By providing a mechanism for price discovery, financial markets help determine the value of assets based on supply and demand dynamics, enabling investors to make informed decisions. This process ensures that capital flows to the most productive uses, fostering economic growth and innovation. Moreover, financial markets contribute to economic stability and liquidity by offering a means for investors to convert their assets into cash relatively easily. They also help in managing and distributing risk through various financial instruments and derivatives. By allowing risk-sharing and providing access to a range of investment opportunities, financial markets help both individuals and institutions to diversify their portfolios and mitigate potential losses. In essence, financial markets are central to the functioning of the economy, influencing everything from interest rates to investment strategies and overall economic health. Activity: "Financial Market Research" Choose one financial market to research (e.g., stock market, bond market, forex market, etc.). and gather information on the following aspects: a.Market structure : ___________________________________________________________________________ ___________________________________________________________________________ b. Key participants: ___________________________________________________________________________ ___________________________________________________________________________ c. Market role: ___________________________________________________________________________ ___________________________________________________________________________ Module 1 24 Analysis: Instruction: Analyze the impact of a specific event on the markets and grasp how external factors influence their key functions. In 2023, the Philippine government announced a significant increase in infrastructure spending as part of its “Build, Build, Build” program to stimulate economic growth and improve public services. This move aimed to boost the economy and create jobs but had notable effects on financial markets. Write your analysis in space provided. _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ Abstraction: What is a Financial Market? It is a place where buyers and sellers trade financial assets, such as stocks, bonds, currencies, and derivatives. These markets facilitate the raising of capital, transfer of risk, and international trade. They are crucial for the functioning of an economy by providing a platform for investors to invest their funds and for businesses and governments to raise capital. Difference between Investment and Financial Market Module 1 25  Financial Market (Facilitates transactions) Individual Investors Institution Investors Financial Advisors Investments (Stocks, (Stocks, bonds, bonds, real real estate, estate, etc). etc). Functions of Financial Market Financial markets play a critical role in the functioning of modern economies by performing several key functions: 1. Price Discovery Financial markets help determine the prices of financial assets through the interaction of buyers and sellers. The prices reflect the supply and demand for assets, which in turn provide information about the value of securities and help investors make informed decisions. 2. Liquidity Provision Financial markets provide liquidity, which means they allow investors to buy and sell assets quickly and with minimal transaction costs. This ease of trading is crucial for investors who may need to convert assets into cash without significant loss of value. 3. Capital Formation Financial markets facilitate the raising of capital by businesses and governments. Companies issue stocks or bonds to raise funds for expansion, operations, or other activities. Governments may issue bonds to finance public projects or manage national debt. 4. Risk Management and Diversification Financial markets offer various financial instruments,that allow investors and companies to manage and hedge against risks. For example, options and futures can Module 1 26 be used to protect against price fluctuations in commodities, currencies, or interest rates. 5. Efficient Allocation of Resources By providing a platform for the exchange of funds between savers (investors) and users (businesses and governments), financial markets help allocate resources to the most productive uses. This efficient allocation supports economic growth and innovation. 6. Information Dissemination Financial markets serve as a medium for disseminating information. The prices and trading volumes of securities reflect market participants' expectations and information about the economy, industries, and companies. This information is vital for investors, analysts, and policymakers. 7. Facilitating International Trade and Investment Financial markets enable the exchange of currencies and international investment, facilitating global trade and capital flows. This contributes to the globalization of the economy and allows countries to benefit from foreign investment. 8. Credit Allocation Financial markets play a role in the distribution of credit within the economy. They channel funds from those with surplus savings to those in need of capital, such as businesses looking to expand or individuals seeking loans for large purchases. 9. Encouraging Savings and Investments By providing a range of investment options and returns, financial markets encourage individuals and institutions to save and invest their funds. This accumulation of capital is essential for long-term economic growth. Common Types of Financial Market A. Stock Markets  These are venues where companies list their shares, which are bought and sold by traders and investors. Stock markets, or equities markets, are used by companies to raise capital and by investors to search for returns.  play a crucial role in the global financial system by providing a platform for raising capital, investing, and managing financial risks.  Examples are: New York Stock Exchange (NYSE), London Stock Exchange (LSE) and Philippine Stock Exchange (PSE) Module 1 27 B. Over-the-Counter Markets (OTC)  is a decentralized market—meaning it does not have physical locations, and trading is conducted electronically—in which market participants trade securities directly (meaning without a broker).  Flexible in trading and customizing financial instruments but of higher risk due to less regulatory oversight.  play a crucial role in providing access to financial instruments not available on formal exchanges, catering to specific needs and providing greater flexibility for sophisticated financial transactions.  Examples: Pink Sheets (now known as OTC Markets Group) and Philippine Dealing & Exchange Corp. (PDEx) C. Bond Markets  is a debt security in which an investor loans money for a defined period at a pre- established interest rate. You may think of a bond as an agreement between the lender and borrower containing the loan's details and its payments.  Investors who buy bonds are essentially lending money to the issuer in exchange for periodic interest payments and the return of the bond's face value when it matures.  bond markets could either be:  Government Bonds: Issued by national governments (e.g., U.S. Treasury bonds, Philippine Government Securities). They are generally considered low-risk.  Corporate Bonds: Issued by companies to raise capital. These bonds typically offer higher yields compared to government bonds but come with higher risk.  Municipal Bonds: Issued by states, cities, or other local government entities. They often come with tax advantages. D. Derivatives Market  is a financial market where derivatives are traded. Derivatives are financial contracts whose value is derived from the value of an underlying asset, such as stocks, bonds, commodities, currencies, or interest rates. These contracts are used for various purposes, including hedging risk, speculating on price movements, and arbitrage.  examples are:  Futures Contracts: Agreements to buy or sell an underlying asset at a specified future date for a price agreed upon today. Futures are standardized and traded on exchanges.  Options Contracts: Provide the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a predetermined price before or at the expiration date. Options can be traded on exchanges or over-the-counter (OTC). E. Cryptocurrency Markets Module 1 28  is a financial marketplace where digital currencies (cryptocurrencies) are bought, sold, and traded. Cryptocurrencies are digital or virtual currencies that use cryptographic techniques for security and operate on decentralized networks based on blockchain technology.  Among them are: Bitcoin (BTC): The first and most well-known cryptocurrency, created by an anonymous person or group known as Satoshi Nakamoto. It operates as a decentralized digital currency without a central bank or single administrator. Ethereum (ETH): A decentralized platform that enables the creation of smart contracts and decentralized applications (dApps). Ether is the native cryptocurrency of the Ethereum network. F. Commodities Markets  are venues where producers and consumers meet to exchange physical commodities such as agricultural products (e.g., corn, livestock, soybeans), energy products (oil, gas, carbon credits), precious metals (gold, silver, platinum), or "soft" commodities (such as cotton, coffee, and sugar). These are known as spot commodity markets, where physical goods are exchanged for money. INFLUENCES OF FINANCIAL MARKET Economic Growth: Financial markets promote economic growth by efficiently allocating capital to businesses and projects with high potential returns. This capital facilitates investment in infrastructure, technology, and startups, driving innovation and productivity improvements. By channeling funds from savers to productive uses, financial markets support business expansion and economic development. Economic Stability: Financial markets contribute to economic stability by providing accurate price discovery and liquidity. They enable businesses and investors to manage risks through derivatives, helping stabilize financial positions and prevent crises. Transparent and liquid markets ensure smooth adjustments to economic changes, reducing the likelihood of severe disruptions. Allocation of Capital: Financial markets play a crucial role in the efficient allocation of capital by directing funds from investors to businesses and government projects. Market signals, such as stock prices and interest rates, guide resource distribution, Module 1 29 ensuring that capital flows to the most productive and promising opportunities, thus supporting overall economic efficiency. Impact on Businesses: Financial markets affect businesses by influencing their cost of capital and valuation. Fluctuations in interest rates and market conditions impact borrowing costs and the ability to raise funds. Market stability or volatility also influences business confidence and investment decisions, affecting growth and operational strategies. Impact on Consumers: Financial markets impact consumers by affecting their wealth and borrowing costs. Changes in stock prices and interest rates influence consumer spending and financial well-being. Rising interest rates can reduce disposable income and spending, while falling rates can increase consumer confidence and expenditure. Influence on Government Policy: Financial markets impact government policy by influencing fiscal and monetary decisions. Central banks may adjust interest rates in response to market conditions, and government debt issuance is affected by market demand. Market conditions also shape public financing strategies and broader economic policies. International Trade and Investment: Financial markets determine exchange rates and facilitate global capital flows, influencing international trade and investment. Currency fluctuations impact trade competitiveness, while cross-border investments affect global economic dynamics and international economic relationships. ETHICAL CONSIDERATIONS IN FACILITATING FINANCIAL MARKETS Transparency and Disclosure: Financial professionals must provide accurate and complete information to investors, avoiding misleading or deceptive practices. This includes clear disclosure of risks, fees, and conflicts of interest. Conflict of Interest: Individuals and firms should avoid situations where personal or financial interests conflict with their duties to clients or the market. Proper management and disclosure of such conflicts are essential. Market Manipulation: Ethical practice involves refraining from manipulating market prices or engaging in fraudulent activities, such as insider trading, which can undermine market integrity and investor trust. Module 1 30 Responsible Advice and Suitability: Financial advisors must provide advice that aligns with clients' best interests and financial goals, rather than pursuing transactions that primarily benefit themselves or their firms. Regulatory Compliance: Adhering to laws and regulations designed to protect investors and maintain market stability is crucial. This includes following guidelines set by regulatory bodies and upholding high standards of professional conduct. Confidentiality: Respecting the confidentiality of client information and using it only for the intended purposes is a fundamental ethical obligation in the financial industry. Sustainability and Social Responsibility: Increasingly, ethical considerations include evaluating the social and environmental impacts of investment decisions, promoting sustainability, and aligning investments with broader societal values. Application: Case Study Analysis You are a financial analyst for a Philippine-based company, Philippine EcoTech Inc., which specializes in renewable energy solutions. The company is planning to expand its operations to Southeast Asia and is considering investing in new markets in Thailand and Vietnam. Recent news has shown fluctuations in global oil prices, changes in interest rates, and fluctuations in local stock markets. In a 1000-word report, analyze the scenario and its impact to Economic Growth, Economic Stability and Capital Allocation. Prepare to discuss it in front of class. Closure: Congratulations on doing the activities well. Keep up the good work. For your next lesson, please make an advance reading on Module 2, “The Asset Allocation Decision” Module 1 31 Module Summary This module introduces you the fundamentals of investment settings and portfolio management, covering essential concepts and practices. You have explored various asset classes, including stocks, bonds, and real estate, and understand how they contribute to an investment strategy. Key topics include the basics of investment types and risk-return trade-offs, the structure of financial markets and economic factors affecting investments, and principles of portfolio theory such as diversification and asset allocation. The module also addresses risk management techniques and common investment strategies, along with ethical considerations and regulatory compliance. By the end, students will be equipped to analyze investment opportunities, build and manage portfolios, and make informed financial decisions. References Module 1 32