Unit 1 Foundaton of Financial Market and Institution

The World of Financial markets and Institutions
Unit 1 – Foundation of Financial Markets and Institution
Financial institutions are what make financial market work. Without them,
financial markets would not be able to move funds from people who save to
people who have productive investment opportunities, thus they also have
important effects on the performance of the economy as a whole.
Financial institutions are financial intermediaries that acquire funds by
issuing liabilities and in turn use those funds to acquire assets by
purchasing securities or making loan.
They play on important role in the financial system because they reduce
transaction costs, allow sharing and solve problems created by adverse
relation and moral hazard. As a result, financial institutions allow small
savers and borrows to benefit from the existence of financial markets
thereby increasing the efficiency of the economy.
-Ma. Elinita Balatbat Cabrera

Financial Markets and Institutions 2020 Edition
Learning Outcomes
 At the end of this unit, you will able to:

Identify the approaches in studying financial market and institution at the same
time to highlight the role of money and its evolution in the economy and the nature of
financial instruments.
Pretest
Directions: Read the following sentences. Write the letter “T” if the statement is True and
“F” if the statement is False. Write your answer on the space before the number. You may
view this test at our google class.
_______1. Financial institutions are financial intermediaries that acquire funds by issuing
assets and in turn use those funds to acquire liabilities by purchasing securities or making
loan.
_______2. Financial institutions are what make financial market work.
_______3. Financial institutions allow small savers and borrows to benefit from the
existence of financial markets thereby decreasing the efficiency of the economy.
_______4. Direct funds transfer are common among individuals and small businesses and
in economies where financial markets and institutions are more developed.
“Not intended for publication. For classroom instruction purposes only”.

_______5. Financial markets have been around ever since mankind settled down to growing
crops and trading them with others.
_______6. In a market system, businesses of all types face risk, and many businesses fail.
_______7. Economists and policy makers are particularly concerned about the risk and
potential failure that financial institutions (bank or non-bank) face because they play a vital
role in the financial system.
_______8.The study of financial markets and institutions will reward you with an
understanding of many exciting issues such as how funds are transferred from people who
have an excess of available funds to people who have a surplus
_______9. Understanding how financial institutions are managed is important because there
will be many times in one’s life, as an individual, an employee, or the owner of a business,
when you will interact with them.
_______10. With financial institution, financial markets would be able to move funds from
people who save to people who have productive investment opportunities, thus they also
have important effects on the performance of the economy as a whole.
Thank you for answering the test. Please see the back
content for the answer key or you may view it in the google
class.
The next section is the content of this unit. It contains
vital information. Please read the content.
Content
CHAPTER 1 RATIONALE IN STUDYING FINANCIAL MARKETS AND INSTITUTIONS
THE NEED TO STUDY FINANCIAL MARKETS
In a market system, businesses of all types face risk, and many businesses fail. Economists
and policy makers are particularly concerned about the risk and potential failure that
financial institutions (bank or non-bank) face because they play a vital role in the financial
system.
Financial markets and institutions not only influence your everyday life but also involve huge
flows of funds- trillions of dollars-throughout the world economy which is turn affect business
profits, the production of goods and services and the economic well-being of the countries
around the world.
The study of financial markets and institutions will reward you with an understanding of
many exciting issues such as how funds are transferred from people who have an excess of
available funds to people who have a shortage. Indeed, well-functioning financial markets
are a key factor in producing high economic growth and poorly performing financial markets

are one reason that many countries in the world remain desperately poor. Activities in
financial markets also have direct effects on personal wealth, the behavior of business and
consumer and the cyclical performance of the economy.
On the evening television news, you have just heard that the bond market has been
booming. In the business section of a local newspaper, you read that the Euro is slightly
higher against the yen. A European airline loses millions of dollars with derivatives. The Dow
Jones Industrial Average is off 18 points in active trading. Another local newspaper reported
that "with inflation slowing again in June, 2019, the Bangko Sentral ng Pilipinas (BSP)
Governor has sounded off on potential rate cuts in the near term. There was even a hint that
the overnight borrowing rate cut will likely come before the last installment of the latest
reserve requirement reduction scheduled at the end of July, 2019 which was implemented
by the BSP in early May, 2019, will occur
All these events are examples of Financial Markets at work. That markets exercise
enormous influence over modern life comes is not news. But although people around the
word speaks glibly of “Wall Street: the “stock market” and the “currency marks”, the meaning
they attach to these times-worn phrases are often unclear and out –of- date.
It also explains the purpose that different financial markets serve and clarifies the way they
work. It cannot tell you whether your investment portfolio is likely to rise or fail in value. But it
may help you understand how its value is determined and how the different securities or
financial instrument in it are created and traded.
The word “market” usually conjures up an image of the bustling, paper-strewn floor of the
New York Stock Exchange and Philippines Stock Exchange and of traders motioning
frantically in the “future” cubicles of Chicago. These images are out-of-date as almost all the
dealings are now handled computer to computer, often with minimal human intervention.
Financial markets have been around ever since mankind settled down to growing crops and
trading them with others. The independent decisions of all of those farmers constituted a
basic financial markets, and the market fulfilled may be the same purposes as financial
market do today.
THE NEED TO STUDY FINANCIAL INSTITUTION
Direct funds transfer are common among individuals and small businesses and in
economies where financial markets and institutions are less developed. But large
businesses in developed economies generally find it more efficient to enlist the services of a
financial institutions when the time comes to raise capital.
Financial institutions are what make financial market work. Without them, financial markets
would not be able to move funds from people who save to people who have productive
investment opportunities, thus they also have important effects on the performance of the
economy as a whole.
Financial institutions are financial intermediaries that acquire funds by issuing liabilities and
in turn use those funds to acquire assets by purchasing securities or making loan.
They play on important role in the financial system because they reduce transaction costs,
allow sharing and solve problems created by adverse relation and moral hazard. As a result,

financial institutions allow small savers and borrows to benefit from the existence of financial
markets thereby increasing the efficiency of the economy.
The field of financial markets and institutions is indeed an exciting one. Not only will one
learn materials that affect the life of the individual directly but also gain a clearer
understanding of events in financial markets and institutions that we hear about in the news
media. Understanding how financial institutions are managed is important because there will
be many times in one’s life, as an individual, an employee, or the owner of a business, when
you will interact with them.
Another reason for studying financial institutions is that they are among the largest
employers in the country and frequently pay very high salaries. Hence some of you have a
very practical reason for studying financial institutions. It may help you get a job in the
financial sector. Even if your interest lie elsewhere, you should still care about how financial
institution are run because there will be many times in your life, as an individual, an
employee, or the owner of a business, when you will interact with these institutions.
APPROACHES IN STUDYING FINANCIAL MARKETS AND INSTITUTIONS
The framework underlying all discussions in this text has three levels namely:
a. Understanding
Students learn to understand economic analysis, that is, students develop the
economic intuition they need to organize concepts and facts
b. Evaluating
Students learn to evaluate current developments and he financial news.
Students learn to use financial data and economic analysis to think critically
about how they interpret current events
c. Predicting
Students learn to use economic analysis to predict likely changes in the
economy and the financial statements.
This framework uses a few basic concepts to keep organize your thinking about the
determination of asset prices, the structure of financial markets, bank management and the
role of monetary policy in the economy. The basic concept are equilibrium, basic supply
and demand analysis to explain behavior in the financial market, the search for profits, and
the approach to financial structure based on transaction costs and asymmetric information.
The framework also provides the tools needed to understand trends in the financial market
place and in variables such as interest rates and exchange rates. It also emphasizes he
interaction of theoretical analysis and empirical data in order to expose the reader to real-life
events and data.
This chapter offers a preliminary overview of the fascinating study of financial markets and
institutions. We will return to a more detailed treatment of the regulation, structure and
evaluation of financial markets and institutions in the succeeding chapters.

CHHAPTER 2 INTRODUCING MONEY AND INTEREST RATES
ROLE OF MONEY IN THE ECONOMY
Money is any item commodity that is generally accepted as a means of payment for goods
and services or for payment of debt, and that serves as an asset to its holder. On the
simplest level, money is composed of the bills and coins which have been printed or minted
by the National Government (these are called currency). But money also includes the funds
stored as electronic entries in one’s checking account and saving account.
Because money in a modern economy is not directly backed by intrinsic value (e.g., coin’s
weight in gold or silver), the financial system works on an entirely fiduciary basis, relying on
the public’s confidence in the established forms of monetary exchange.
Money is the oil that keeps the machinery of our world turning. By giving goods and services
an easily measured value, money facilitates the billions of transactions that take place every
day. Without it, the industry and trade that form the basis of modern economies would grind
to a halt and the flow of wealth around the world would cease.
Money has fulfilled this vital role for thousands of year. Before its invention, people
bartered, swapping goods they produced themselves for things they needed from others.
Barter is sufficient for simple transactions, but not when the things traded are of differing
values, or not available at the same time. Money, by contrast, has a recognized uniform
value and is widely accepted. At heart a simple concept, over many thousands of years, it
has become very complex indeed.
At the start of the modern age, individuals and governments began to establish banks, and
other financial institutions were formed. Eventually, ordinary people could deposit their
money in a bank account and earn interest, borrow money and buy property, invest their
wages in business or start companies themselves. Banks could also insure against the sorts
of calamities that might devastate families or traders, encouraging risk in the pursuit of profit.
Today it is the nation’s government and the central bank that control a country’s economy.
The Federal Reserve (known as “The Fed”) is the central bank in the US. The Fed issues
currency, determines ow much of it is in circulation and decides ow much interest it will
charge banks to borrow its money.
In the Philippines, the central bank that controls the country’s economy is the “Bangko
Sentral ng Pilipinas”. While government still print and guarantee money, in today’s world it
no longer needs to exist as physical coins or notes, but can be found solely in digital form.
CHARACTERISTICS AND KEY FUNCTIONS OF MONEY
Money is not money unless it has all of the following defining characteristics: Money must
have value, be durable, portable, uniform, divisible, in limited supply, and be usable as a
means of exchange. Underlying all of these characteristics is trust- people must be confident
that if they accept money, they can use it to pay for goods.

Store of value
Money acts as a means by which people can store their wealth for future use. It must not,
therefore, be perishable, and it helps if it is of a practical size that can be stored and
transported easily.
Item of worth
Most money originally has an intrinsic value, such as that of the precious metal that was
used to make the coin. This in itself acted as some guarantee the coin would be accepted.
Means of exchange
It must be possible to exchange money freely and widely for goods, and its value should
be as stable as possible. It helps if that value is easily divisible and if there are sufficient
denominations so change can be given.
Unit of account
Money can be used to record wealth possessed, trade or spent- personally and nationally.
It helps if only one recognized authority issues money. If anybody could issue it, then trust
in its value would disappear.
Standard of Deferred Payment
Money is also useful because of its ability to serve as a standard of deferred payment.
Money can facilitate exchange at a given point by providing a medium of exchange and
unit of account.
THE EVOLUTION OF MONEY
People originally traded surplus commodities with each other in a process known as bartering.
The value of each good traded could be debated, however, and money evolved as a practical
solution to the complexities of bartering hundreds of different things. Over the centuries, money
has appeared in many forms, but, whatever shape it takes, whether as a coin, a note, or stored
on a digital server, money always provides a fixed value against which any item can be
compared.
Barter (10,000-3000 BCE)

In early forms of trading, specific items were exchanged for others agreed by the negotiating
parties to be of similar value.
Barer-the direct exchange of goods- formed the basis of trade for thousands of years. Adam
Smith, 18th- century author of The Wealth of Nations, was one of the first to identify it as a
precursor to money.
Barter in practice

Essentially, barter involves the exchange of an item (such as a cow) for one or more of a
perceived equal “value” (for example a load o wheat). For the most part of the wo parties
bring the goods with them and hand them over at the time of a transactions. Sometimes,
one of the parties will accept an “I owe you,” or IOU, or even a token, that it is agreed
can be exchanged for the same goods or something else at a later date.
Advantages and Disadvantages of Barter
Advantages
 Trading relationship- Foster strong links between partners.
 Physical goods are exchanged- barter does not rely on trust that money will
retain its value.
Disadvantages
 Market needed both parties must want what the other offers.
 Hard to establish a set value on items- two goats may have a certain value to
one party one day, but less a week later.
 Goods may not be easily divisible- for example, a living animal cannot be divided.
 Large scale transactions can be difficult- transporting one goat is easy, moving
1,000 is not.
Evidence of trade records (700 BCE)
Pictures of items were used to record trade exchange, becoming more complex as values were
established and documented.
Coinage (600BCE-1100CE)
Defined weights of precious metals used by some merchants were later formalized as coins that
were usually issued by states.
Bank notes (1100-2000)

States began to use bank notes, issuing paper IOU’s that were traded as currency and could be
exchanged for coins at any time.

Digital money (2000 onwards)
Money can now exists “virtually” on computers, and large transaction can take place without any
physical cash changing hands.
ARTIFACTS OF MONEY
Since the early attempts at setting values for barter goods, “money” has come in many forms
from IOU’s to tokens. Cows, shells and precious metals have all been used.

Barter (5000 BCE)
Early trade in wot directly change items often reachable one such as cow
Sumerian cuneiform tablets (4000BCE)

Scribes recorded transactions on clay tablets which could also act as receipt
Cowry shells (1000BCE)
Used as currency across India and the South Pacific, they appeared in many colors and sizes
Lydian gold coins (600BCE)
In Lydia, a mixture of gold and silver was formed into disks, or coins, stamped with inscriptions
Athenian drachma (600BCE)
The Athenians used silver from Lauri to mint the currency used right across the Greek world.
Han dynasty coins (200BCE)
Often made of bronze or copper, early Chinese coins had holes punch in their center
Roman coin (27BCE)
Bearing the head of the emperor, these coins circulated throughout the Roman Empire.
Byzantine coin (700CE)
Early Byzantine coins where pure gold; later ones also contained metals such as copper.
Anglo-Saxon coin (900CE)
This 10th century silver penny has an inscription stating that Offa is King (“rex”) of Mercia
Arabic dirham (900CE)
Many silver coins from the Islamic empire were carried to Scandinavia by Vikings
THE ECONOMICS OF MONEY
From the 16th century understanding of the nature of money became more sophisticated.
Economics as a discipline emerged, in part to help explain the inflation caused in Europe by the
large-scale importation of silver from the newly discovered American. National Bank were
establish in the late 17th century with the duty of regulating the country's money supplies.
By the early 20th century, money became separated from its direct relationship to precious
metals. The gold standard collapse all together in the 1930s by the mid-20th century, new ways
of trading with money appeared such as credit cards digital transactions and even forms of

money such as cryptocurrency and financial derivatives. As a result the amount of money in
existence and in circulation increased enormously
Potosi inflation (15401640)

The Spanish discovered silver in Potosi, Bolivia, and caused a century of inflation by shipping
350 tons of the metal back to Europe annually.
The great debasement (1542-1551)
England’s Henry VIII debased the silver penny, making it three-quarter copper. Inflation
increased as trust dropped.
Early joint-stock companies (1553)
Merchants in England began to form companies in which investors bought shares (stock) and
shared its rewards.
Bank of England (1694)
The Bank of England was created as a body that could raise funds at a low interest rate and
manage national debt.
The Royal Mint (1696)
Isaac newton became Warden and argued that debasing undermined confidence. All coins were
recalled and new silver ones were minted.
US Dollar (1775)
The Continental Congress authorized the issue of United States dollars in 1775, but the first
national currency was not minted by the US Treasury until 1794.
Gold Standard (From 1844)
The British pound was tied to a defined equivalent amount of gold. Other countries adopted a
similar Gold Standard.
Credit cards (1970s)
The creation of credit cards enabled consumers to access short-term credit to make smaller
purchases. This resulted in the growth of personal depth.
Digital Money (1990s)
The easy transfer of funds and convenience of electronic payments became increasingly
popular as internet use increased.
Euro (1999)
Twelve EU countries joined together and replaced their national currencies with the Euro. Bank
notes and coins were issued three years later.

Bitcoin (2008)
Bitcoin- a form of electronic money that exists solely as encrypted data on servers-is
announced. The first transaction took place in January 2009.
HIGHLIGHHTS IN THE HISTORY OF MONEY IN THE PHILIPPINES
Pre Spanish Regime
Prior to the coming the Spanish 1521, the Philippines was already trading with neighboring
countries such as China, Java and Macao. Through the prevailing medium of exchange was
barter, some coins were circulating in the Philippines as early as the 8th century
Commodity money such as gold, gold dust, silver wire, coffee, sugar rice, spices are both were
used as money. Between the 18th and 14th century the penniform gold barter rings were
predominantly used by foreign merchants. Piloncitos and other commodities in circulation.
Spanish Regime
The Spanish introduced coin in the Philippines when they colonized country in 1521. Silver
coins minted in Mexico were predominantly used in 1861, the first meet was established order
to standardize coinage
American Regime
After gaining independence in 1898 Spain ceded the Philippines to the united states the
country's first local currency the Philippine peso was introduced replacing the Spanish Filipino
peso the Philippine national bank was authorized to issue Philippine banknotes later the bank of
the Philippine islands was authorized issued its own banknotes this notes were redeemable by
the issuer but not made legal tender.
Japanese Regime
When the Philippines was occupied by japan during world war ii the Japanese issue that
Japanese worn out their bills had no reserves nor back up by any government assets and were
called mickey mouse money.
Post war period
In 1944 when the American forces defeated Japanese imperial army the Philippine
commonwealth established under president Sergio Osmeña old Japanese currency circulating
in the Philippines where declared illegal all bombs were closed and all Philippine national bank
notes or withdrawn from circulation
The new treasury certificate (called Victory Money) were printed in P500, P200, P100,
P20,P10, P5, P2 and P1 denominations with the establishment of the Central Bank in 1949, a
new currency called “Central Bank Notes” was issued
In 2010 the Central Bank launch the “New Generation Currency” which is uniform in size were
significant event in the Philippine history, iconic buildings and heritage sites were featured.

In 2018, the New Generation Currency coins series were put in circulation.
THE SUPPLY AND DEMAND FOR MONEY
Money facilitate the flow of resources in the circular model of macro economy. Not enough
money will slow down the economy, and too much money can cause inflation because of higher
price levels. Either way monitoring the supply and demand for money is vital for the economy’s
central bank's monetary policy, which case a stabilized price levels and support economic
growth.
THE MONEY SUPPLY
Although the general description of money is relatively straightforward, the precise definition of
the overall supply of money is complex because of the wide variety of forms of money in
modern economies.
The key issues for the money supply are:
 M1. The narrowest measure of the money supply. Includes currency in circulation
held by the non-bank public, demand deposits, other checkable deposit, and traveler’s
checks. M1 refers primarily to money used as a medium of exchange
 M2. In addition to M1, this measure includes money held in savings deposit, money
market deposit accounts noninstitutional money market mutual funds and other short-
term money market asset. M2 refers primarily to money used as a store of value.
 M3. In addition to M2, this measures includes the financial institutions. M3 refers
primarily to money used as unit of account.
 L. In addition to M3, this measure includes liquid and near-liquid assets.
The deposits of the public at dancing have a depository institutions are considered money and
are therefore included in the m1 money supply if the public withdraw money from bank deposit
to hold money as personal currency under the mattress this increase in inactive money will
affect the bank ability to extend loan and will influence the supply of money
The Bangko Sentral ng Pilipinas is responsible for determining the supplying of manning
agencies daily open market operations influence the creation of managed by banks and to guide
availability of money and iconic BSP also has an impact on the creation of money by the
reserve requirements and a discount rate that is the interest rate at which bank can borrow from
BSP as a lender of last resort changes in the supply of money but affect the interest rates and
therefore the cost of borrowing money is will happen impactful consumption and investment can
help in the economy
THE DEMAND FOR MONEY

The Source of the Demand for Money are:
 Transaction demand. Money demanded for day-to-day payments through balances

held by households and firms this kind of demand varies with GDP it does not depend
on the rate of interest
 Precautionary demand. Money demanded as a result of an anticipated payments this

kind of them and carries with GDP.
 Speculative demand. Money demanded because of expectations about interest rates in

the future that means that people will decide to expand their money balances and power
bank offices if they expect interest rates rise this kind of demand has a negative
relationship with the interest rate.
The rate of interest is the price paid in the money market for the use of money or knows the rate
is percentage of the amount borrowed
If a person holds P1,000 in currency, opportunity cost of holding the money is the interest that
could be heard on the P1,000 in an interest-bearing account. The opportunity cost of holding
money goes up if the interest rate increases which may lead to decreased consumption and
increase savings. Conversely, if the interest rate is low, it is relatively cheap to borrow money
and the quantity of money demanded goes up. Therefore the demand for currency has a
negative relationship with the interest rate
Changes in other factors will lead to ship in the demand curve for money. Increase in the
economy's price level with increasing demand for money (note that the demand for money is
tide to the interest rate, not the price level). If the real GDP increases, the demand for money
increases because of the higher demand for products. Also, when the banks develop new
money products that allow for easier, low-cost withdraw, the demand for money will decrease,
such as, bank offering savings accounts with shorter (or less stringent) time deposit
requirements and lower penalties for withdrawal.
THE IMPACT OF MONEY
The macroeconomic street from some prices (e.g. wages rate affected by labor contract) will be
inflexible. This causes economic fluctuations real GDP either the low potential GDP
(recessionary gap) or above potential GDP (inflationary gap).
The BSP monetary policy has an immediate short-term impact on the economy. In particular
higher interest rates will decrease investments because it becomes more expensive to borrow
money, and will also decrease consumption because consumer will tend to save more as
interest rates returns increase. In addition, as higher Philippine interest rate increase the
demand for pesos on the foreign exchange market (because the higher returns on Philippines
deposits), the higher pesos will decreased exports by making them increasingly expensive. This
means that the real GDP growth and the inflation rates slow when the BSP raise the interest
rate. The reverse of course when the interest rate is lowered.
Monetary policy can be applied in the short run when the economy faces an inflationary gap
(real GDP exceeds potential GDP). The BSP may then pursue a policy to avoid inflation by
decreasing the quantity of money and raising the interest rate. The higher interest rate
decreases investment, consumption and net export. This decrease in aggregate demand will

decrease real GDP and lower the price level. In the macroeconomics long-run prices are
assumed to be fully flexible and this will move real GDP towards potential GDP.
If the economy is at its long run to equilibrium and the BS increases the money supply, it will
increase aggregate demand. Consequently, the price level goes up, as well as the real GDP.
This means that an intentionally gap exists with the actual unemployment rate being below the
natural rate. The tightness in the labor market will lead to a rise in the money wage rate.
Because of higher labor costs, the short run aggregate supply will increase returning real GDP
to the level of potential GDP.
THE QUANTITY THEORY OF MONEY
The quantity theory of money holds that changes in the money supply MS directly influences the
economy's price level, but nothing else. This theory follows from the equation of exchange:
MxV=PxY
Where M= quantity of money

V= velocity of money (i.e., the average number of times a unit of money is
used during a year to purchase GDP's goods and services)
P= price level
Y= real GDP
The equation of exchange essentially states that the economy's nominal GDP or expenditures
(P x Y) equal the money actually used in the economy (M x V). According to the quantity theory
of money, velocity V is not affected by the quantity of money M and is considered constant: V=V
Constant. Also, potential real GDP (i.e., long-run equilibrium) is not affected by M and is considered
constant : Y=Y constant. It not follows directly from the equation of exchange (M x V constant) = ( P x Y
constant) that changes in M are equal to the changes in P, in the long-run. This view of the equation
of exchange expresses the (neo) classical neutrality of money, that is, money affects only
nominal values but not real values. In other words, the money supply leaves real output
unaffected.
Historical evidence suggests that the money growth rate and the inflation rate are positively
related in the long-run. However, the year-to-year relationship is weaker.
The equation of exchange does not hold in the short-run, as the economy does not immediately
adjust because of price inflexibility. Although, the relationship between M and P may not be
casual, as suggested by quantity money theorists, it appears that there is a correlation between
M and P in the long-term. Therefore, growth in M can be used as a statistical estimate for the
rate of inflation, that is, the Central bank can be effective in stabilizing prices. It is less clear
what the Central bank's impact on short-term real GDP and real interest rates is.
THE TIME VALUE OF MONEY
Investor interest is defined as the cost of using money over time this definition is in close
agreement with the definition to use by columnist who preferred to say that interest represent
the time value of money

PRESENT VALUE
The concept of present value (or present discounted value) is based on the common sense
notion that peso cash to flow paid to you one year from now is less valuable to you than a peso
paid to you today. This notion is rue because you can deposit a peso in a saving account that
earns interest and have more than peso in one year. Economists use a more formal definition,
as explained in this section.
Let's do this kind of debt instrument which we will call a simple loan. In this loan, the lender
provides the borrower with an amount of funds (called the principle) that must be repaid to the
lender at the maturity date, along with an additional payment for the interest. For example, if you
made your friend Jane a simple loan of P100 for one year, you would require her to repay the
principal of P100 in one year's time along with additional payment for interest: say. P10. In the
case of simple loan like this one, the interest payment divided by the amount of loan is a natural
and sensible way to measure the interest rate. This measure of the so-called simple interest
rate,i,is:
If you make tis P100 loan, at the end of the year toy would have P110, which can be written as:
P100 x (1+ 0.10) = P110
If you then lent out the P110, at the end of the second year you would have:
P110 x (1+ 0.10) = P121

Or, equivalently,
P100 x (1+ 0.10) x (1+ 0.10) = P100 x (1+ 0.10)2 = P121
Continuing with the loan again, you would have at the end of the third year:
P121 x (1+ 0.10) = P100 x (1+ 0.10)3 = P133
Generalizing, we can see that at the end of n years, your P100 would turn into:
P100 x (1 + i)n
The amounts you would have at the end of each year by making the P100 loan today can be
seen in the following timeline:
Today Year 1 Year 2 Year 3 Year n

n
P100 P110 P121 P133 P100 X (1+0.10)n
INTEREST RATES
The interest rates link the future to the present. It allows individuals to evaluate the present
value (the value today) of future income and cost. In essence, it is the market price of earlier
availability.

From the view point of a potential borrower, the interest rate is the premium that must be paid in
order to acquire goods sooner and pay for them later. From the lender’s viewpoint, it is a reward
for waiting- a payment for supplying others with current purchasing power. The interest rates
allows the lender to calculate the future benefit (future payments earned) of extending a loan or
saving funds today.
In a modern economy, people often borrow funds to finance current investment and
consumption. Because of this, the interest rate is often defined as the price of the label funds.
This definition is correct but we should remember that, it is the earlier availability of goods and
services purchase, not the money itself that is desired by the borrower.
HOW INTEREST RATES ARE DETERMINED
Interest rates are determined by the demand for and supply of loanable funds. Investors
demand funds in order to finance capital assets that they believe will increase output and
generate profit. Simultaneously, consumers demand loanable funds because they have a
positive rate of time preference. They prefer earlier availability.
The demand of investors for loanable funds stems from the productivity of capital. Investors are
willing to borrow in order to finance the use of capital production because they expect that
standing future output to provide them with more than enough resources to repay the amount
borrowed (the principal) and the interest on the loan.
Figure 2-1 illustrates, the interest-rate brings the choices of investors and consumers wanting to
borrow funds into harmony with the choices of lenders willing to supply funds. Higher interest
rates makes it more costly for investor to undertake capital spending projects and for consumers
to buy now rather than later. Both investors and consumers will therefore, curtail their borrowing
as the interest rate rises. Investors will borrow less because some investment projects that
would be profitable at a low interest rate will be unprofitable at higher rates. Some consumers
will reduce their current consumption rather than pay the high interest premium when the
interest rate increases. therefore the amount of funds demanded by borrowers is inversely
related to the interest rate.
The interest rate also rewards people (lenders) willing to reduce their current consumption in
order to provide a loanable funds to others. If some people are going to borrow in order to
undertake an investment project (or consume more than their current income) other must curtail
their current consumption by an equal amount. In essence, the interest rate provides lenders
with the incentive to reduce their current consumption so that, borrowers can either invest or
consume beyond their present income. Higher interest rates gives people willing to save (willing
to supply loanable funds) the ability to purchase more good in the future in exchange for
sacrificing current consumption. Even though people have a positive rate of time preference,
they will give up current consumption to supply funds to the loanable funds market if a price is
right. Higher interest rates will induce people to save more. Therefore, as the interest rate rises,
the quantity of funds supplied to the loanable funds market will increase
Figure 2-1: Determining the Interest Rate
Supply
“Not intended
Interestfor
ratepublication. For classroom instruction purposes only”.
Demand
Q Loanable Loans
Figure 2-1 illustrates, the interest rate will bring the quantity of fund demanded into balance with
the quantity supplied. At the equilibrium interest rate, the quantity of funds borrows demand for
investment and consumption now (rather than later) will just equal to the quantity of funds
lenders save. So, the interest rate brings the choices of borrowers and lenders into harmony
The rate of interest function as the price in the money market money. Money has a time value,
and its use is bought and sold in the money market in return for the payment of interest. The
financial institutions that deal in government securities and loans, gold and foreign exchange
make up the money market. The money market is not as a specific physical location but
consists of transactions made electronically or by phone. Equilibrium in the money market
occurs when MD and MS curves intersect at the equilibrium interest rate, as shown in figure 2-2.
If the BSP where to decide to increase the quantity of money from MS to MS 1 to supply of
money curve would shift to the right, resulting in a decrease in equilibrium interest rate. The
lower cost of borrowing could spur higher consumption and investment.
The equilibrium interest rate goes down from r to r1 as the money supply curve shifts to the right
from MS to MS1 (e.g., when the BSP increases the quantity of money).
Figure 2-2: Money Market Equilibrium
MS MS1
MS
I
Interest
Rate
r
r1 MD
M M1
According to Keynesian theory the rate of interest is determined as a price in two markets:
 Investment funds. The rate of interest balances the demand for funds (required for
investment) and the supply of funds (from savings). If such investors can earn a 10%
return on a capital investment project, they will be willing to pay a rate of interest of up to
10% . Household delay consumption by saving (and are rewarded by earning interest)
depending on their time preference and the rate of interest. Savings percentages can
differ significantly from one nation to another.
 Liquid assets. Households and businesses may have reasons to hold assets in liquid
form. Because borrowers required cash in the long term (that doesn't need to be paid to

the lender immediately), they are willing to compensate lenders for giving up liquidity.
Keynes introduced the influence of the liquidity preference on the interest rate. The
classical economies, who consider investment funds as a critical market for the interest
rate disregarded the topic of liquidity preference.
Although intermediaries can achieve equality between the rates of interest in two markets the
potential lack of balance between the investment and money markets was essential to
Keynesians, who claim that it cause unemployment in the short run.
THE NOMINAL OR MONEY RATE VERSUS THE REAL RATE OF INTEREST
We have emphasized that the interest rate is a premium paid by borrowers for earlier availability
and a reward received by lenders for delaying consumptions. However, during a period of
inflation (a general increase in prices), than nominal interest rate for money rate of interest is
misleading indicator of how much borrowers are paying and lenders are receiving. Inflation
reduces the purchasing power of a loan’s principal. Rising prices means that, when the
borrower repays the principal in the future, it will not produce as much as it would have when
the funds were initially loaned.
When inflation is common, lenders will recognize they are being repaid with castle of less
purchasing power. Unless they are compensated for the anticipated inflation by an upward
adjustments in the interest rate, they will supply fewer funds to the loanable funds market. At the
same time, when borrowers anticipate inflation, they will want to purchase goods and services
now before they become even more expensive in the future. Thus, they are willing to pay an
inflationary premium, an additional amount of interest that reflects the expected rate of future
price increases. For example, if borrowers and lenders fully anticipate a 5% rate of inflation,
they will be just as willing to agree on a 9% interest rate as they were earlier to agree on a 4%
interest rate when both anticipated price stability
Unlike when a general price level is stable, the supply of loanable funds will decline (the supply
curve will shift to the left) and the demand will increase (the demand curve will shift to the right)
one's decision-maker anticipate future inflation. The money interest rate thus, rises overstating
the “true” cost of borrowing and the yield from lending. This true cost is the real rate interest,
which is equal to the money rate of interest minus that inflationary premium. It reflects the real
burden to borrowers and pay off to lenders in terms of their being able to buy goods and
services.
Our analysis indicates that, high rates of inflation will lead to a high money rate of interest. The
real world is consistent with this view.
INTEREST RATES AND RISK
So far, we have assumed there is only a single interest rate present in the loanable funds
market. In the real world, of course, there are many interest rates. There is the mortgage rate,
the prime interest rate (the rate charge to business firm with strong credit rating), the consumer
loan rate and a credit card rate, to name but a few.
Interest rates in the loanable funds market will differ mainly because of the differences in the
risk associated with the loans. It is riskier, for example, to loan money to unemployed worker
than to a well-established business with substantial assets. Similarly, credit cards loans are
riskier than those secured by an assets. An example of a secured loan would be a mortgage

loan on house if the borrower defaults the lender can repossess the house. The risk also
increases with the duration of the loan. The longer the time period of the loan, the more likely it
is that the borrower's ability to repay the loan will deteriorate or market condition changes in a
highly unfavorable manner.
The money rate of interest on the loan has three components:
Pure-interest Component Inflammatory Premium Risk Premium Components

Components
Is the real price one must Reflects the expectation that Reflects the probability of
pay for earlier availability the long will be repaid with default (the risk imposed on
pesos of less purchasing the lenders by the possibility
power as the result of that the borrower may be
inflation unable to repay the loan.)
THE IMPACT OF CHANGING INTEREST RATES
Control over short-term interest rate is one of the main tools of the BSP to achieve its main
goals of controlling inflation, smoothing out the business cycle and ensuring financial stability.
Short-term interest rates are relevant for loans with a relatively short length for repayment while
long-term interest rates on the other hand, are relevant for loans such as long-term corporate
borrowing and 10-20-30 year fixed rate mortgages.
If the BSP pushes short-term interest rates up or down, the effects of its actions are felt most
directly by interest rate sensitive sectors of the economy. When it is more expensive to borrow,
people make fewer purchases that require borrowing. But when the BSP cuts the short-term
interest rates, that encourages borrowing and spending in the economy and puts upward
pressure on prices.
If interest rates fluctuated all the time the economy would become volatile. This is why the
government and central bank work together to keep inflation and interest at stables rates. Every
time the interest rate is changed, it sends a signal to society to either spend or save- and may
also increase or decrease confidence in the state of the economy. A rise interest rates
encourages savings since higher interest will be paid on money in savings accounts, and
investment can grow. Meanwhile, borrowing becomes less attractive as interest repayments are
steeper, and bank or selective about whom they lend to. This impact the affordability of
obtaining or repaying an existing loan, such as mortgage.
By contrast a drop in interest rate is intended to cause an increase in spending since borrowers
are able to take out loans more cheaply. For those with mortgages tracking the base rate,
interest repayments will drop. At the same time savers will tend to spend invest deposits that
are attracting little interest. While discouraging savings through very low interest rates might
stimulate economy, this can ultimately negatively impact long-term savings plans, such as
pension.
WHEN INTEREST RATES ARE RAISED

Higher interest rates makes loan as affordable, while high interest on savings accounts
encourage savings rather than spending. As spending slow, so that the economy, with demand
for goods and services decreasing. This eventually affect business and employment levels.
WHEN INTEREST RATE ARE ALLOWED
Lower interest rates make it cheaper to take out loans, and hence to spend more money.
Saving becomes less attractive as interest rates are low. With more money in circulation,
demand for products and services rise, stimulating businesses and increasing employment.
CHAPTER 3 THE PAYMENTS SYSTEM: AN OVERVIEW

INTRODUCTION
Money facilitates transactions in the economy. The mechanism for conducting such transactions
is called a payments system. The payments system has evolved over time from relying on
payments made in gold and silver coins, to payments made with paper currency and checks
written on deposits in banks, to payments made by electronic funds transfers.
The Transition from Commodity Money to Fiat Money
Commodity money refers to a good used as money that has value independent of its use as
money. Fiat money refers to money, such as paper currency that has no value apart from its
use as money. People accept paper currency in exchange for goods and services partly
because the government has designed it to be legal tender, which means the government
accepts paper currency in payment of taxes and requires that individuals and firms accept it in
payment of debts.
Money is also useful because of its ability to serve as a standard of deferred payment. Money
can facilitate exchange at a given point in time by providing a medium of exchange and unit of
account.
Historians disagree about precisely when people began using metallic coins. Evidence suggests
that people in China were using metallic coins in the year 100 BC and people in Greece were
using them in 700 BC. For centuries, buyers and sellers used coins minted from precious metals,
such as gold, silver, and copper as money. Gold and silver coins suffer from some drawbacks,
however. An economy's reliance on gold and silver coins alone makes for a cumbersome
payments system. People had difficulty transporting large number of gold coins to settle
transactions and also ran the risk of being robbed. To get around this problem, beginning
around the year AD. 500 in Europe, governments and private firms- early banks- began to store
gold coins in safe places and issue paper certificates. Anyone receiving a paper certificate could
claim the equivalent amount of gold. As long as people had confidence that the gold was
available if they demanded it, the paper certificates would circulate as a medium of exchange. In
effect, paper currency had been invented.
In modern economies, the central bank (Bangko Sentral ng Pilipinas), issues paper currency.
The modern BSP payments system is a fiat money system because the BSP does not
exchange paper currency for gold or any other commodity money. The BSP issues paper
currency and holds deposits from banks and the national government. Banks can use these
deposits to settle transactions with one another. Today, the BSP has a legal monopoly on the

right to issue currency. Although in the nineteenth century private banks issued their own
currency, they can no longer do so.
In fact, it is not the government's designation of currency as legal tender that explains why
paper currency circulates as a medium of exchange. Rather, paper currency circulates because
of the confidence of consumers and firms that if they accept paper currency, they will be able to
pass it along to someone else when they need to buy goods and services. Basically, it is a case
of self-fulfilling expectations: You value something as money only if you believe that others will
accept it from you as payment. Our society's willingness to use pieces of paper issued by the
BSP as money makes them an acceptable medium of exchange.
The Importance of Checks
Paper money has drawbacks. Another major innovation in the payments system came in the
early twentieth century, with the increasing use of checks. Checks are promises to pay on
demand money deposited with a bank or other financial institution. They can be written for any
amount, and using them is a convenient way to settle transactions.
Settling transactions with checks does, however, requires more steps than settling transactions
with currency. Processing the enormous flow of checks worldwide costs the economy several
billion dollars each year. There are also information costs to using checks-the time and effort
required for the seller to verify whether the check writer (the buyer) has sufficient amount of
money in her checking account to cover the amount of the check. Accepting checks requires
more trust on the part of the seller than does accepting peso bills.
New Technology and the Payments System
The Bangko Sentral ng Pilipinas supervise the payments system but doesn’t directly control it
because many payments are processed by banks and other private firms. The BSP has listed
what it believes to be the five most desirable outcomes for payments system:
o Security. Episodes in which criminals have hacked into retail credit card systems and
other parts of the payments system have raised concerns about security. Better security
increases consumers and businesses confidence that funds will not be stolen
electronically.
o Efficiency. Resources devoted to processing paper checks or other aspects of
processing payments are diverted from producing other goods and services. Increasing
the efficiency of the payments system allows it to function using fewer workers and
computers, or other capital, which to function using fewer workers and computers, or
other capital, which benefits the economy.
o Speed. Fast settlement of payments facilitates transactions by bot households and
business.
o Smooth international transactions. The increasing amount of business that takes place
across borders can be facilitated if payments can be made quickly and conveniently.
o Effective collaboration among participants in the system. The payments system needs to
efficiently involve governments, financial firms such as banks, and other business
around the world. Such involvement ensures smooth transfers of funds in transactions.
Debit cards can be used like checks: cash registers in supermarkets and retail stores are linked to
bank computers, so when you use a debit card to buy groceries or other products, your bank

instantly credits the store’s account with the amount and deducts it from your account. Such a
system eliminates the problem of trust between the buyer and seller that is associated with checks
because the bank computer authorizes the transaction. In recent years, many consumers have
begun using apps on their smart-phones or smart-watches that are linked to credit or debit cards.
For example, Apple Pay and Android Pay allow consumers to buy goods at any store with a
compatible register at checkout counter by waving their phone or watch. Apple Pay and Android
Pay are examples of proximity mobile payments. While the total volume transactions using such
payments is relatively small, it has been increasing rapidly.
Automated Clearing House (ACH) transactions include direct deposits of payroll checks into the
checking accounts of workers and electronic payments on car loans and mortgages, where the
payments are sent electronically from the borrower s account and deposited in the lender's account.
ACH transactions reduce the transactions costs associated with processing checks, reduce the
likelihood of missed payments, and reduce the costs lenders incur in notifying borrowers of missed
payments.
Forty years ago, Automated Teller Machines (ATMs) did not exist. To deposit or withdraw money
from your checking account, you needed to fill out a deposit or withdrawal slip and wait in line a
bank teller's window. Adding to the inconvenience was the fact that many banks were open only
between the hours of 10 AM and 4 PM (which were called bankers' hours). Today, ATMs allow you to
carry out the same transactions at your bank whenever it is most convenient for you. Moreover,
ATMs are connected to networks (such as BANCNET, Megalink, so you can withdraw cash from
the ATMs of banks other than your own.
E-Money, Bitcoins, and Blockchain
The boundaries of electronic funds transfers have expanded to include e-money or electronic
money, which is digital cash people use to buy goods and services. One of the best-known forms of
e-money is the PayPal service. An individual or a firm can set up a Pay Pal account by linking to a
checking account or credit card. As long as sellers are willing to accept funds transferred from a
buyer's PayPal (or other e-money) account e-money functions as if it were conventional,
government-issued money. The central bank does not control e-money, though, so it is essentially a
private payments system.
Recently, journalists, economists, and policymakers have been debating the merits of bitcoin, a new
form of e-money. Unlike Pay Pal, bitcoin is not owned by a firm is instead the product of a
decentralized system of linked computers. Bitcoins are produced by people performing the
complicated calculations necessary to ensure that online purchases made with bitcoins are
legitimate-that is, that someone doesn't try to spend the same bitcoin multiple times. People who
successfully complete these calculations are awarded a fixed number of bitcoins typically- 25. This
process of bitcoin "mining" will continue until a maximum of 21 million bitcoins has been produced-a
total expected to be reached in 2030.
Because people can buy and sell bitcoins in exchange for dollars and other currencies on web
sites, some people refer to it as a "cryptocurrency. You can buy bitcoins and store them in a "digital
wallet" on a smartphone. You can then buy something in a store that accepts bitcoins by scanning a
bar code with your phone. A number of web sites, such as BitPay, which is based in Atlanta, allow
merchants to process purchases made with bitcoins in a way similar to how they process credit
card payments.

Despite these possible benefits to using bitcoin, it has not yet been widely adopted. The
introduction of Apple Pay and Android Pay provided consumers with a way to use their
smartphones linked to a credit card to make payments, which undercut one of bitcoins advantages.
Some firms also question whether the software underlying bitcoin is capable of dealing with a large
number of transactions. The most popular online bitcoin exchange, Japan-based Mt. Gox, closed in
2015, further reducing confidence in the cryptocurrency.
Despite the problems with bitcoin, the underlying technology behind it, known as blockchain, has
attracted interest from both firms and governments as they attempt to increase the speed,
efficiency, and security of the payments system. Blockchain is technically a distributed ledger, or an
online network that registers ownership of funds, securities, or any other good, including movies
and songs. Blockchain allows individuals and businesses around the world to settle transactions
instantly and securely on encrypted sites. The ability to direct transactions through blockchain could
eliminate banks and other intermediaries, potentially greatly reducing costs. The greatest stumbling
block to businesses adopting blockchain is the complexity if the technology and its resulting high
cost. If the cost declines over time, blockchain may become a key part of the payments system.
CASHLESS SOCIETY
Blockchain and other new payment technologies are exciting and lead some commentators to
predict a “cashless society.” A Federal Reserve study found that noncash payments continue to
increase as a fraction of all payments, and electronic payments now make up more than two thirds
of all noncash payments, and electronic payments. Not surprisingly, the number of checks written
has been dropping by more than 2 billion per year. In reality, though, an entirely cashless (or
checkless) society may be difficult to attain in the near future for two key reasons.
(1) As we noted with respect to blockchain, the infrastructure for an e-payment system is
expensive to build.
(2) Many households and firms worry about protecting their privacy in an electronic system that
is subject to computer hackers, although supporters of blockchain believe its encryption
technology can overcome this problem. While the flow of paper in the payments system is likely
to continue to shrink, it is unlikely to disappear.
CHAPTER 4 FINANCIAL INSTRUMENT
NATURE OF FINANCIAL INSTRUMENTS
A financial instrument is any contract that gives rise to a financial assets of one entity and a
financial liability or equity instrument of another entity.
The contract in the definition refers to an agreement between two or more parties that has clear
economic consequences that the parties have little, if any, discretion to avoid, usually because the
agreement is enforceable by law. Contract, and thus financial instruments, may make a variety of
forms and need not be in writing.
Financial instrument include primary instruments and derivative financial instruments.

Based on the definition, financial instruments include financial assets, financial liabilities, equity
instrument and derivatives. Derivatives include financial options, futures and forward, interest rate
swaps and currency swaps.
Financial Assets
A Financial Assets is any assets that is

 Cash
 Equity instrument of another entity (e.g. investment in ordinary share of a
corporation)
 Receivable (accounts, notes and loan receivables)
Some of the most commonly encountered Financial Instrument representing Financial Assets
are the following
(a) Cash on Hand and in Banks
o Petty cash fund. Refers to cash balances kept on hand at various locations to pay for
minor expenditures such as postage and other small out-of-pocket expenditures.
o Demand, saving and time deposits. Represent amounts on deposit in checking, savings
and time deposit accounts respectively. Time deposits are placements covering a
relatively long period of time.
o Undeposited checks. Are checks payable to the enterprise or bearer but not yet
presented to the bank for payment.
o Foreign currencies
o Money orders are financial instruments similar to bank drafts but are drawn generally
from authorized post offices or other financial institutions.
o Bank drafts are commitments by banking institutions to advance funds on demand by
the party to whom the draft was directed.
(b) Accounts, notes and loan receivable and investment in bonds and other debt instrument
issued by other entities.
o Trade-receivable (signed delivery receipts and sales invoice)
o Promissory notes
o Bond certificates
(c) Interest in shares or other equity instruments issued by other entities

o Stock certificates
o Publicly listed securities
(d) Derivative Financial Assets

o Future contracts
o Forward contracts
o Call options
o Foreign Currency Futures
o Interest rate Swaps

Financial Liabilities
A financial liability is any liability that is
(a) A contractual obligation
i. To deliver cash or another financial assets to another entity; or
ii. To exchange financial assets or financial liabilities with another entity under
conditions that are potentially unfavorable to the entity; or
(b) A contract that will or may be settled in the entity’s own equity instruments and is:
i. A non-derivative for which the entity is or may be obligated to deliver a variable
number of the entity’s own equity instruments; or
ii. A derivative that will or may be settled other than by the exchange of a fixed amount
of cash or another financial assets for a fixed number of the entity’s own equity
instruments.
Examples of Financial Liabilities are the following:
 Accounts and notes payable, loans from other entities and bonds and other debt
instrument issued by the entity.
 Derivative financial liabilities
 Obligations to deliver own shares worth a fixed amount of cash.
 Some derivatives on own equity instruments.
Equity Instruments
An equity instrument is any contract that evidence a residual interest in the assets of an entity
after deducting all of its liabilities.
Example of Equity Instruments are:
 Ordinary shares
 Preference Shares
 Warrants or written call option that allow the holder to subscribe or purchase ordinary
shares in exchange for a fixed amount of each or another financial assets.
Derivatives Financial Instruments
Derivatives are financial instruments that “derive” their value on contractually required cash
flows from some other security or index. For instance, a contract allowing a company to
purchase a particular assets (say gold, flour, or coffee bean) a designated future date, at a
predetermined price is a financial instrument that derives its value from expected and actual
changes in the price of the underlying assets.
Examples of Derivatives
1. Future Contracts
A future contract is an agreement between a seller and a buyer that requires that seller to
deliver particular commodity at a designated future date, at a predetermined price. These
contracts are actively treated on regulated future exchanges and are generally referred to as

“commodity future contracts”. When the “commodity” is a financial instrument such as

Treasury bill or commercial paper, the agreement is referred to as a financial futures
contract. Futures contracts are purchased either as an investment or as a hedge against the
risks of future price changes.
2. Forward Contract
A forward contract is similar to a future contract but differs in three ways:
a. A forward contract calls for delivery on a specific date, whereas a futures contract
permits he seller to decide later which specific day within the specified month will be the
delivery date (if it gets as far as actual delivery before it is closed out.)
b. Unlike a future contracts, a forward usually is not traded on a market exchange.
c. Unlike a future contract, a forward contract does not call for a daily cash settlement for
price changes in the underlying contract. Gains and losses on forward contracts are paid
only when they are closed out.
3. Call Options
Options give its holder the right either to buy or sell an instrument, say a Treasury bill, at a
specified price and within a given time period. Options frequently are purchased to hedge
exposure to the effects of changing interest rates. Options serve the same purpose as
futures in that respect but are fundamentally different. Importantly, though, the option holder
has no obligation to exercise the option. On the other hand, the holder of the futures
contract must buy or sell within a specified period unless the contract is closed out before
delivery comes due.
4. Foreign Currency Futures
Foreign loans frequently are denominated in the currency of the ender. When loans must be
repaid in foreign currencies, a new element of risk is introduced. This is because if
exchange rate exchange rates change, the peso equivalent of the foreign currency that must
be rapid differs from the peso equivalent of the foreign currency borrowed.
5. Interest Rate Swaps

There are contracts to exchange cash flows as of a specified date or a series of specified
dates based on a notional amount and fixed and floating rates.


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Unit 1 Foundaton of Financial Market and Institution

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The World of Financial markets and Institutions

Unit 1 – Foundation of Financial Markets and Institution

-Ma. Elinita Balatbat Cabrera

 At the end of this unit, you will able to:

“Not intended for publication. For classroom instruction purposes only”.

“Not intended for publication. For classroom instruction purposes only”.

“Not intended for publication. For classroom instruction purposes only”.

“Not intended for publication. For classroom instruction purposes only”.

CHHAPTER 2 INTRODUCING MONEY AND INTEREST RATES

ROLE OF MONEY IN THE ECONOMY

CHARACTERISTICS AND KEY FUNCTIONS OF MONEY

“Not intended for publication. For classroom instruction purposes only”.

Standard of Deferred Payment

THE EVOLUTION OF MONEY

Barter (10,000-3000 BCE)

“Not intended for publication. For classroom instruction purposes only”.

Advantages and Disadvantages of Barter

Evidence of trade records (700 BCE)

Bank notes (1100-2000)

“Not intended for publication. For classroom instruction purposes only”.

Barter (5000 BCE)

Sumerian cuneiform tablets (4000BCE)

Cowry shells (1000BCE)

Lydian gold coins (600BCE)

Athenian drachma (600BCE)

Han dynasty coins (200BCE)

Roman coin (27BCE)

Byzantine coin (700CE)

Anglo-Saxon coin (900CE)

Arabic dirham (900CE)

THE ECONOMICS OF MONEY

“Not intended for publication. For classroom instruction purposes only”.

Potosi inflation (15401640)

The great debasement (1542-1551)

Early joint-stock companies (1553)

Bank of England (1694)

The Royal Mint (1696)

Gold Standard (From 1844)

Credit cards (1970s)

Digital Money (1990s)

“Not intended for publication. For classroom instruction purposes only”.

HIGHLIGHHTS IN THE HISTORY OF MONEY IN THE PHILIPPINES

Pre Spanish Regime

Post war period

“Not intended for publication. For classroom instruction purposes only”.

THE SUPPLY AND DEMAND FOR MONEY

THE MONEY SUPPLY

The key issues for the money supply are:

 L. In addition to M3, this measure includes liquid and near-liquid assets.

THE DEMAND FOR MONEY

“Not intended for publication. For classroom instruction purposes only”.

The Source of the Demand for Money are:

 Transaction demand. Money demanded for day-to-day payments through balances

 Precautionary demand. Money demanded as a result of an anticipated payments this

 Speculative demand. Money demanded because of expectations about interest rates in

THE IMPACT OF MONEY

“Not intended for publication. For classroom instruction purposes only”.

THE QUANTITY THEORY OF MONEY

Where M= quantity of money

“Not intended for publication. For classroom instruction purposes only”.

P100 x (1+ 0.10) = P110

P110 x (1+ 0.10) = P121

P100 x (1+ 0.10) x (1+ 0.10) = P100 x (1+ 0.10)2 = P121