WEEK 6

FINANCIAL SYSTEM AND ITS COMPONENTS

Financial Instrument
 Any contract that gives to a financial asset of one entity and a financial liability or equity instrument of another
entity.
Contract
 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.

Contracts and thus financial instruments may take a variety of forms and need not be in writing.

Financial Instruments
 Primary Instruments
 Derivative Financial Instruments

Financial Instruments

 A real or virtual document representing a legal agreement.

Two types:

1. Cash instruments
2. Derivatives instrument

 Financial assets
 Financial liabilities
 Equity Instrument
 Derivatives

Financial assets

Any asset that is

 Cash
 Equity instrument of another entity (investment in ordinary share of corporation)
 Receivable (accounts, notes and loans receivable)

FINANCIAL ASSETS

(a) Cash on Hand (most liquid) and in Banks

1. Petty cash
 Small amount of money to pay for minor expenditure. Such as postage, other small out of pocket cost or
expenditures.
 Certain funds na nandyaan lang or nakatago.
2. Demand, savings and time deposits.
 Represent amount on deposit checking, savings, time deposit accounts.
 Time deposits: maturity of 5 years (long period)
3. Undeposited checks
 Hindi pa sya pinipresent sa bank
 Payable to the enterprise or sa payor ng check but not yet presented in bank for payment. Ex. Post-
dated check.
 4. Foreign currencies

5. Money orders
 Similar to bank drafts
 Hindi sa banko galing.
 From authorized cost offices or other financial institution.
 Sure na may pera pero hindi bank ang naggaguarantee kundi ang ibang financial institution.
6. Bank drafts
 Commitment by banking institution to advance funds on demand by the party to whom the drafts are
directed.
 Guaranteed by bank as document. (Sure na may pera then si banko ang magbabayad na galling sa
account mo.)
 Example. Manager’s checks – sure na may laman. Considered as cash pero nakacheke. Guarantee na
may laman.

(b) Accounts, notes and loans receivable and investment in bonds and other debt instrument issued by other
entities.

1. Trade-receivables (signed delivery receipts and sales invoice)

2. Promissory notes
3. Bond certificates

(c) Interest in shares or other equity instruments issued by other entities

1. Stock certificates
2. Publicly listed securities

(d) Derivative Financial Assets

1. Futures contract
2. Forward contracts
3. Call options
4. Foreign Currency Futures
5. Interest Rate Swaps

Financial Liabilities

(a) Contractual obligation

 To deliver cash or another financial asset to another entity; or

 To exchange financial assets or financial liabilities with another entity under conditions that are potentially
unfavorable to the entity; or
 Contract that will or maybe settled in the entity’s owned equity instrument.

(b) A contract that will or may be settled in the entity’s own equity instruments and is:

 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
 A derivative that will or may be settled other than by the exchange of a fixed amount of cash or another
financial asset 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 instruments.
  Derivative financial liabilities.
 Obligations to deliver own shares worth a fixed amount of cash.
 Some derivatives on own equity instruments.

Equity Instruments
Any contract that evidence a residual interest in the assets of an entity after deducting all of its liabilities.
 Ordinary Shares
 Preference Shares
 Warrants
 Or written call option.
 It allows the holder of the warrants to subscribe or purchase ordinary shares in exchange for a fix
amount of each or other financial assets.

Derivative Financial Instruments

 Financial Instruments that “derive” their value on contractually required cash flows from some other security or
index.
 Securities that derive their value from underlying assets. This can be commodity, stocks, or bonds.
 Types: over the counter and exchange traded
 Most are not traded on exchanges and are used by institution to hedge risk or speculate at price.
 Can be traded but most of derivatives are not traded.
 Usually leverage instrument which increases their potential risk and rewards.
 You can either have gain or loss.
 To protect my assets sa risk na papasukin ko in the future.
 Purposes are hedging and the act of preventing an investment against unforeseen price changes.
 Vitality of changes in prices every month or years.

PURPOSE OF DERIVATIVES

1. Hedging
 The act of preventing an investment against unforeseen price changes. 
 Managing the risk of assets

2. Speculative
 Involves trying to make a profit from a security's price change.
 To earn or make profit

TYPES OF DERIVATIVES
1. Futures Contract
 Almost the same as forward contract in terms of price of assets and when. (nakalagay both sa contract)
 Purpose is to speculate.
 Example: 1 range of delivery date.
 Oil industry. Gusto ko mabili ko at the lower price then, mabenta ko at a higher price.
(Near 2007, when the oil price went from less than 60 dollars per barrel. A year after it went to 140
dollar so more than double ang inincrease ny, so tumaas ang cost ng gasoline. This increase really hits
the airline industry so this time, I need a large amout of oil. So nung tumaas yung presyo ng gas/oil. For
so long the prices simple paying the airports for fuel thus the prices of gas went up quickly. A year after,
the profit of the airline company dropped dramatically.
One company si southwest, had be gone a practice a decade earlier of buying oil futures so the delivery
date of about 1 year out with the price that was just little higher than the current price.
Eample: the current price is 60 dollars 2007, southwest was buying oil futures for the same month in
2018 for about 65 dollars, so nagenter sya into future contracts na ang expiry ay next year which is 2018
the following year na bibili sya ng oil at 65 dollars. So, mas mataas konti dun sa current na market price
 nung 2007 na 60. Then a year later when the oil price went 140 dollar, southwest was making money on
their 65 dollars oil futures contracts.)

 The company (southwest) enter into future contracts, the amount in contract was decided by
both parties. The buyer and seller must both agree on the price of the future contracts.
 Case 1: the current price is 60 then the market price is 140 and the buyer bought 65 dollars
future contracts. Because of that, the buyer or the company gained a profit of 75 dollars.
(kumita)
 Case 2: the current price is 60 then the market price is 63 and the buyer bought 65 dollars future
contracts, the company losses 2 dollars. (nalugi)

2. Forward Contract
 Cash basis and one delivery
 Spot price- kung magkano yung price nya.
Example of a Forward Contract
Assume that an agricultural producer has two million bushels of corn to sell six months from now and is
concerned about a potential decline in the price of corn. It thus enters into a forward contract with its financial
institution to sell two million bushels of corn at a price of $4.30 per bushel in six months, with settlement on
a cash basis.
In six months, the spot price of corn has three possibilities:
 It is exactly $4.30 per bushel. In this case, no monies are owed by the producer or financial institution to each
other and the contract is closed.
 It is higher than the contract price, say $5 per bushel. The producer owes the institution $1.4 million, or the
difference between the current spot price and the contracted rate of $4.30. (5 - 4.3 x 2M = 1.4M) GAIN
 It is lower than the contract price, say $3.50 per bushel. The financial institution will pay the producer $1.6
million, or the difference between the contracted rate of $4.30 and the current spot price. (3.5 – 4.3 X 2M =
1.6M) LOSS

3. Call Options
 Financial contract that gives the option buyer the right (option buyer)
 Have a right but no obligation to buy a stock, bonds or commodities or other assets or instrument at
specified price within a specific time period.
 Nakaindicate sa contract kung kalian ko bibilhin pero hindi ako obligado bilhin yon pero meron lang
akong right to buy. Nakalagay yung time and price.
 The stock, bonds and commodities are called underlying assets
 A call buyer will have a profit when the underlying increases in price.
 Advantage if the underlying asset increases the price but if not, I’m not obligated to buy that underlying
assets.
 Strike price – price of underlying assets. Certain price that is indicated in the contract.
 A call option is a security that gives the owner the right to buy a share of stocks or an index at a certain
price by a certain date.
 Expiration date/ maturity date – certain date na nakaindicate sa contract
 Maybe purchase for speculation not for hedging purposes.
 Purpose is to secure the unforeseen increase of price kaya for speculation only.
 Can be compare.
 Example: House and lot – down payment of 20k
 I have the right or option to buy the property and the seller has the obligation to sell the property to me.
 Loss is the downpayment if hindi tinuloy.
 Premium – downpayment kaya nagkaron ng right para bilhin or hindi yung property.
 Example: Stock of apple – right to buy 100 shares of apple stocks at 100 dollars until the expiring date in
3 months. In 3 months, I can buy the stocks at 100 dollars. There are many expiration dates and strike
prices for the trader to choose from. As the value of the apple stocks goes up, the price of the option
contract goes up and vice versa. The call option buyer may hold the contract until the expiration date (3
 months). At which point, they can take deliveries of the 100 shares of stocks or sells the option contract
at the any point before the expiration date at a market price of the contract at that time. But if hindi
ituloy because the current market price is mababa. So ibebenta na sya before the expiration date.
Pinakalugi ron is yung premium.
 The market price of the call option is called the premium. The price paid for the rights that the call
option provides. If at expiry, the underlying assets is below the strike price the call buyer uses the
premium base. Because of that, hindi na itutuloy kasi mas mababa pa sa strike price yung value ng
assets na yon.
 If the underlying asset is above the strike price at expiry
 Gain = strike price – premium x number of shares
 Enter into call option because of speculation; you want to grab the opportunity in case na magincrease
and prices ng stocks.

4. Foreign Currency Features

 Purpose is to hedge (protect) the assets from the depreciation of foreign currency.
 Involves currency like dollars, peso or euro
 Example: XYZ Company that is based on US (foreigh company), exposed on foreign exchange risk went
to hedge against projected receipts of 125M Euros. Dahil sa nature ng business nya ang narereceived
nyang pera is in euro hindi in dollars. Bayad sakanya is in euro. So, meron syang foreign exchange risk
kasi baka mamaya kapag that time na nagbayad na sakanya yung in euro baka maliit ang value ng euro
compared sa US dollar so kaya gusto nya ihedge.
 The company wants to manage the risk. Kaya papasok sya into foreign currency contract. The company
expected to receive the euro on December, so dapat before dec papasok na sya sa isang contract,
magbebenta sya, the company will sell features contract on the euros they will be receiving. Wala pa
sakanya yung euro, dec pa darating pero pumasok na sya ng contract na magbebenta sya ng euro.
 Ibebenta nya na agad yung hindi nya pa narereceive. Para pagdating nang decemeber, mabebenta nya
na agad kasi hindi nya naman kailangan ng euro kasi US based sya.
 Since they know that they will receive euro (xyz company), they can sell them now and lock in at a rate
at which euros can be exchange for US dollars. There’s a lock in rate. So whatever kung magkano man
yung exchange rate ng euro pagdating ng December na mareceive nila yon, ibebenta nila yon at
ganitong rate.
 Then, the company sells the features contract on euro to hedge (protect or minimize the risk) its
projected receipts.
 Case 1: Consequently, if the euro depreciate against the US dollars then, the contract is effective. They
protected the unforeseen depreciation of currency. (advantage/ gain)
 Case 2: unfortunately, if the euro appreciates against the US dollars then, they will not be benefited in
the appreciation of euro because they enter into a contract. (disadvantage/ loss)
 Lock in rate – they get to sell the euro kung magkano yung nalock in nila. If bumaba or depreciate yung
value ng euro it means protected nga sila.
5. Interest Rate Swaps
 A contract that will happen in future
 More on hedging but can be speculation.
 There’s a one stream of interest payment then, iniexchange mo yun sa isang klase ng interest payment.
 One stream of future interest payment is exchange for another based on specified principal amount in
the contract.
 Can be fixed or floating in order to reduce or increase exposure to fluctuation in interest rate.
Kalian ginagamit ang interest rate swap?
 To reduce or off set the risk of floating interest rate
 To lock into a future fix rate
 To leverage rate differentials between currencies and to speculate on anticipated risk rate fluctuation.
 Example: Fixed then, you will exchange it in floating (fluctuating rate).
 ABC Company, may utang na 1M. In the interest rate swap contract nakaindicate don yung principal
amount. Si ABC binabayaran nya yung loan nya ng fix interest rate na 5% yearly. Because the company,
napredict nila na magdadrop ang interest rate, therefore, they want to switch into a floating rate
 XYZ also have a 1M loan, binabayaran nya yung loan na may floating rate pero gusto nya ang fix rate.
 Yung gusto ng dalawang company wala sa kanila therefore, they decided to use the interest rate swap
so ABC swap into floating rate while, XYZ swap into fix rate.
 After they swap their interest rate, the loan and lender are not affected.
 The contract is between ABC and XYZ. The bank is not involved.
 The contact indicate the notional principal (principal amount), the rate of the company will pay the due
date for the payment and date swap mature (based on their loan maturity). Both companies continue
making the usual interest payment to their lenders. The parties will only pay the difference between the
fixed and variable interest amount.
 Results:
 Case 1: fixed 5%. The interest increases at 6%. So the difference is 1%. Therefore, the ABC should pay
XYZ a 1% of the increase in the interest.
 Case 2: fixed 5%. The interest decreases at 6%. Therefore, XYZ should pay 1% of the decrease in the
interest.
 Important: should have the same principal amount in order to enter into interest rate swap.
WEEK 7

MONEY MARKET

 Network of corporation, financial institutions, investors and governments which deal with the flow of short-term
capital.

 Unregulated and informal market and not structured like the capital markets

- Informal siya kasi unlike capital market hindi na siya dumadaan sa Philippine stock exchange.
- Do not exist in particular place or operate into a single set of rules or do they offer a single set of posted
prices with one current interest rate for money.

 High liquidity and short-term maturitie s are traded. (one year or less)

- Low risk = lesser term, lesser return

- high liquidity = easily convertible to cash

 Provide loans for day-to-day operations.

- Operating expenses

 Withdrawing money from the money market is easier.

- Mabilis kasi yung term, short period lang walang additional cost and penalty kapag winidraw.
- Unline capital market na maturity is 5yrs. Mahirap or matagal kunin

 Gives lesser return to investors who invest in it but provides a variety of products.

- Conservative type of investment because of lower risk

- Ex. Savings, emergency funds, life insurance

 It is a wholesale market, as the transaction volume is large.

- Users: large companies, banks, private sectors, government thru wholesales

- Transaction are in bulk / wholesale then eventually offered by banks to individuals or investors
- Retailed na ang money markets pag dating sating mga individual
- For as low as 5,000 we can invest in money market

 Web of borrowers and lenders, all linked by telephone and computers.

- The product and transaction can be settled electronically

- Done thru online, computers
- No need to go to branch of banks
- At the center of each web is a central bank.
- Central bank – policy that determines the short interest rate for that currency

 Low risk, high liquidity

- Short term period (1yr)

- Easily convertible into cash
- Lesser the term, lower the risk
 - High risk, low return
- Low interest

Common misconception:

- Hindi nakikipagexchange ng currency or peso or cash, it is done thru financial instrument. Sinasabi na money
kasi high liquid (easily convertible into cash) good as cash but not literally money yung tinitrade.

Who uses the Money Market?

 Primary function of money market is for banks and other investors with liquid assets to gain a return
on their cash or loan
 They provide borrowers such other banks brokerages and hedge funds with quick access to short term
funding
 Money market is dominated with professional investors also retail investors (50k can be invest pero
now kahit may 5k kalang pede ka ng maginvest ng money market)

Mutual funds

- Pool of funds and diversified; may option ka na hindi pillin ang money market. Stocks or bonds

Money market funds

- Limited to short term fund unlike mutual fund may option kana na ang piliin mo ay hindi money market,
stocks or bond na longer term.

Money market mutual fund

- pool of funds and diversified pero limited to short term funds lang. Selected na sya na ang mga funds na
nadoon ay galing sa mga short term lang like bank deposits, time deposits,commercial papers, treasury bills,
etc. ito yung mga usually invested into mutual fund na money market.

Companies

- Meron silang mga urgent means

- Mga dapat naiprovide ng company:
o Kailangan nila magpasweldo
- So kapag naubusan sila meron sila shortage sa fund they may issue commercial paper (para makakuha sila
ng pera) – mga naissue non ay ang mga private companies. Unsecured instrument (CP).
- Ex. Ang investor kapag bumili ng commercial paper, at discount so mas mura don kung ano man yung
nakalagay na price sa principal amount or face value dun sa commercial paper.
- Thru issue commercial paper, si company makakaipon sya ng fund para pampasahod sa mga employees nya.
- (CP) 1 to 9 months pero meron din na up to 12 months

 For payroll

 “Park” money for a time in short-term, debt-based financial instruments

 May extra na fund - cash surplus

 Park – temporarily dun muna yung pera mo para kahit papaano kumikita naman sya
  Debt based FI – such as treasury bills, commercial papers, certificate of deposits

 Kasi ang lumalabas dun ay nangungutang yung issuer (example yung sa commercial
paper (magbibigay ng pera then babayaran at maturity date))

Banks

Demand for long term loans and mortgages is not covered by deposits from savings account

- Meaning, yung bangko na yon madaming customer na nagloloan pero hindi nila kayang iprovide yung loan
na kailangan ng mga customers thru the use of savings account kasi umiikot lang naman yung pera galling
lang din naman yun sa mga deniposito ng mga tao sakanila. So hindi enough yung savings account para
ipautang so, ginagawa nila nagiissue sila ngayon ng certificate of deposits with a set interest rate and fixed-
term.
- Meaning, the bank cannot provide all the customers who wants to make a loan by using only the savings
account

 Issues certificate of deposits with a set interest rate and fixed-term of up to 5 years.

Investors

IndividualS seeking to invest large sum of money at relatively low risk na iinvest at financial instrument. Pero pede
naman din 5k lang ang iinvest. We can invest for as low as 5k to 50k.

 Investing large sums of money at relatively low risk. Sums of less than 50,000 can also be invested in money
market funds.

The money market does not exist in particular place to operate according to a single set of rules.

- Informal, unregulated, not structure

- Walang specific place na dun mangyayari ang buy and sell ng securities and walang rin syang isang set of
rules. Iba iba ang offer na price, depende kung anong type ng instrument ang inuooffer.
- How to effectively manage ang pera ng company.
- Pang matagalan – capital market.
- Concern with the cash management or financing their portfolio with the money market.

Participants in the money market

 Bureau of Treasury

 They sell government securities to raise funds.

 Issued treasury bills, short term issuances of government securities, allowance of the government to
obtain cash until cash revenue are collected

 So meron silang mga panghangailangan na hindi napoprovide agad dahil scheduled lang naman yung
pagcollect ng tax, hindi nman every day yon. Regular but not in a daily basis but yung expenses lagi.
Kapag nagshort ang government nagiisue sya ng treasury bills.
  Commercial banks

 Issued treasury security, sell certificate of the proceeds, offers individual investor accounts that can be
used to invest in money market.

 Offers certificate of deposits, time deposits, bankers acceptances in repurchase agreement.

 Private Individual

 Ordinary person that can invest in money market mutual funds.

 Commercial Non-financial Institutions

 They buy and sell money market securities to manage their cash.

 They temporarily store excess funds or park their cash surplus in exchange of high return and obtain
shorter funds.

 Investment Companies

 Finance/Commercial leasing companies

 They raise money market instrument.

 Example: They used commercial paper to lend funds to individual borrowers.

 Insurance companies

 They also need money market in case magklano ng unexpected demands most especially for property
and casualty insurance companies.

 Pension funds

 To maintain funds in preparation for long term investing in stocks and bonds market.

 Money market mutual funds

 This funds permits small investors to invest in money market by accumulating funds from numerous
small investors to buy large denomination money market securities

TYPES OF MONEY-MARKET INSTRUMENTS

Commercial paper

 Short-term debt obligation of a private sector firm or a government-sponsored corporation.

 Typically issued for the financing of payroll, accounts payable, inventories, and meeting other short-term
liabilities.

 Only companies with good credit ratings issue CPs

 Unsecured, no collateral (hindi pedeng habulin ni company kapag may nangyare sa market or economy)

 Can issue commercial paper called credit worthiness or companies with good credit ratings. SEC knows kung
sino lang pedeng magissue ng Commercial paper.
  Maturity is greater than 90 days but less than nine months.

 Denis Uy – Business man, based In Davao. Issued CP na worth 10.10B in Phoenix Petroleum (oil company)

 Usually unsecured although a particular commercial paper issue may be secured by a specific asset of the issuer
or may be guaranteed by a bank.

 Usually issued at a discount from face value and reflects prevailing market interest rates.

 Should be registered in SEC but there are some cases na pedeng hindi na basta mameet yung mga certain
requirements.

 Requirements: (w/o SEC)

 Payable to a specific person

 Neither negotiable nor assignable in held on to maturity in the amount not exceeding 50M

Banker’s acceptances (BA)

 Form of payment that is guaranteed by a bank rather than an individual account holder.

 Typically 90 days from the date of issue, but can range from 1 to 180 days.

 Most frequently used in international trade (import and export) to finalize transactions with relatively little risk
to either party.

  Traded at a discount in the secondary money markets.

 BA used as a means of insuring payments

 Example: an importer and exporter – mostly thru banks hindi company to company para segurado sa bayad.

 So an importer wants to import a product from a foreign country (kukuha sya ng letter of credit from his banks
and send it to the exporter)

 Letter of credit- a document issued by a bank (importer) that guarantees the payment of importers draft for
specified amount in time. The exporter can rely on the banks credit rather than the importers.

 The exporter will present the shipping document and the letter of credit to his domestic banks which pays for
the letter of credit at a discount because the exporter’s bank won’t receive the money from the importers bank
until later. The exporter’s bank then, sends a time draft to importer’s banks which then stump as accepted. And
thus, converting the time draft into banker’s acceptance.

 This negotiable instrument is back up by importer’s promise to pay together with the imported goods, the banks
guarantee of payment.

 BP has low credit risk because they are back up by the importer and the importer banks and the imported
goods.

 Bank Charges – it does not only depend on its own fees or commission for creating. It also commensurate the
general market bills of other from money market instrument
Treasury Bills (T-bills)

 With a maturity of one year or less, issued by national governments.

 The government can create money to pay you. So, it’s impossible na hindi ka nila bayaran.

 Low interest, low return.

 Considered the safest of all possible investments in that currency.

Three tenors of T-bills

 91 day (Cash Management Bills)

 182 day
 364-day

 Virtually zero default risk since the government can always print more money that they can use redeems these
securities at maturity. (advantage)

 Market for Treasury bills is both deep and liquid.

 Safest investment instrument in the market.

 T-bills are issued at a discount (meaning lower price than the par value at maturity)

Can be sold via two methods:

1. Auctions or Competitive bidding

 Magpapabid si bureau of auction, magiissue ng securities so, kung sino makapagbid sakanya iohonor ang
securities (sa highest bidder). Not secured kasi iohonor lang yun sa pinakamataas na bidder.

2. Noncompetitive bidding

 No bidding so, si investors ang magseset kung magkano yung gusto nyang bilhin na securities. Secured
kasi ikaw ang naseset ng amount.

Government agency notes

Local government notes

 Issued by provincial or local governments

 Debt issued by state and local governments to finance capital expenditures, such as construction projects.
Municipal notes are appealing to investors because they mature in one year or less

Interbank loans

 Loans extended from one bank to another

 Used by the borrowing institution to re-lend to its own customers

 Overnight loans are short-term unsecured loans from one bank to another. Used to help borrowing banks
finance loans to customers.
  To maintain reserve of banks for regulatory purposes

 Interbank loans may be made to ensure that banks meet their capital requirements at the end of each day.

Certificates of Deposit or Time Deposit

 Securities issued by banks which records a deposit made.

 Cannot be withdrawn without penalty before a specified date.

 Usual term is 5 years, but there are CDs with terms as brief as 30 days

 If kinuha mo sya in less than 5 year may certain penalties

 Interest rates depend on length of maturity, with longer terms getting better rate.

 The shorter the term, the lower the return pero kapag mas mahaba o mas mataas yung time deposit mo, mas
mataas yung interest rate na iooffer ng bank.

Repurchase agreements or Repos (Binenta mo tas bibilhin mo ulit)

 A short-term agreement to sell securities in order to buy them back at a slightly higher price. (government
securities)

 Usually on an overnight basis.

 Term repurchase agreements, on the other hand, can be as long as one year with a majority of term repos
having duration of three months or less.

 A combination of two transactions.

 In the first the securities dealer, such as a bank, sells securities it owns to an investor, agreeing to repurchase
the securities at a specified higher price at a future date.

 In the second transaction, days or months later, the repo is unwound as the dealer buys back the securities from
the investor.

 The amount the investor lends is less than the market value of the securities, a difference is called the spread or
haircut, to ensure that it still has sufficient collateral if the value of the securities should fall before the dealer
repurchases them.

 Typically used to raise short-term capital.

 Used as a short-term financing solution or cash-investment alternative with a fixed term lasting from overnight
to a few weeks to several months.

 It sell fixed income securities like bonds

 If dumating yung future date na yon at hindi yun binili, the buyer can sell the assets to the third party to offset
his loss.
 Example:
si seller nagbenta ng government securities ng November 1 in the amount of 10,167,671 euros. agreement is
bibihin niya ulit (buyback) ng November 8 at a slightly higher price.the difference in the amount is the reurn or
gain ni buyer. If sa agreed date hindi binuyback ni seller, pwede ibenta ni buyer yun sa 3 rd party to offset his loss.
WEEK 8

CAPITAL MARKETS

 Financial market in which longer-term debt and equity instruments are traded.

 Include bonds, stocks, and mortgages

 Often held by financial intermediaries such as insurance companies and pension funds

Two Primary Issuers

1. National - fund national debts

2. local government - finance capital projects

3. Corporations - finance capital investments and expenditures, to fund future investment opportunities

CAPITAL MARKET TRADING

• Primary Market
o new issues of stock and bonds are introduced
o investment funds, corporations, individual investors can all purchase securities offered in primary
market
o issuer ng securities ang nakakareceive ng proceeds ng sale
o issuing for the first time (IPO)
• Secondary market
o subsequent sale by individual investors (who purchased previously issued stocks) to other investors
o 2 types of exchanges:
o Over the counter
o Organized – governing bodies who oversees if operation exchanges are legal and review the rules.

1. Bonds

• Long-term promissory notes issued by the firm.

• Bond certificate is a tangible evidence of debt issued by a corporation or a governmental body and represents a
loan made by investors to the issuer.
Two Sets of cash flows

1. Periodic interest payments – fixed interest payments we receive as an investors until maturity of bonds

2. The Principal (par value or face value) returned at maturity

Trading process for Corporate Bonds

Initial sale of corporate bond issues occurs either thourgh:

• Public Offering

o merong investment bank serving as a security underwriter

• Private Placement –

o small group of investors na pinapadaan sa mga financial institutions (banks)

*generally when a firm issues bonds to the public many investments banks are interested in underwriting the bonds

*corporate bonds are offered publicly through investment banking firms as underwriter

*investment bank guarantees the firm or corporation a price for newly issued bonds by buying the whole issue at a fixed
price (bid price) The underwriter (investment bank) will eventually find individuals who wil sell these at a higher price
(offer price)

As a result the investment bank will have the risk or possibility na hindi niya mabenta lahat ng securities at a higher
price.

Bid price – price selected by a buyer to buy a stock

Offer price – price at which the seller is offering to sell the stock

Other arrangements can be as follows: (paano pa mabibili ni investement bank ang mga bonds)

1. Competitive Sale / bidding – different investment banks can participate ; highest bidder wins

2. Negotiated Sale – single investment banks obtains the exclusive right to originate, underwrite, distribute the
new bonds through 1 on 1 negotiation process

3. Best Efforts Underwriting Basis - the underwriter does not guarantee a firm price to re-issuer ; walang fixed
prices (bid price) but instead ibebenta niya yung securities at the best price na kaya niya makuha.

Advantages of Issuing Bonds

• Long term debt is generally less expensive than other forms of financing.

o Investors view debt as relatively safe investments alternative and demand a lower rate of return
o Instead na stock dapat bonds kasi longer term, fixed interest na mas mataas compare sa other bank
products

• The payments are limited to interest.

• Bondholders do not have voting rights.

 • Flotation costs of bonds are generally lower than those of ordinary (common) equity shares.

* Flotation costs – are costs incurred in issuing the securities

Disadvantages of Issuing Bonds

• Debt resulted in payments that, if not met, can force the firm into bankruptcy.

o Ang mga issuer firms ay required magbayad ng mga interest payments sa mga bond holders kapag
nagkaron ng financial difficulties

• Debt produces fixed charges, increasing the firm’s financial leverage.

o Financial leverage – is the presence of debt in the capital structure (san nanggagaling capital nila)
o Pag mataas ang financial leverage magkakarong ng conclusion ng karamihan sa kapital nila ay galling sa
utang which is pangit sa reputation ng entity.

• Debt must be repaid at maturity, involves a major cash outflow.

• May limit firm’s future financial flexibility.

o Indenture covenants – an agreement between the bond issuer and bond holder.

Bond Features and Prices

1. Par Value

o (Face value) the amount return to the bond holder at maturity.

2. Coupon Interest Rate

o Percentage of the par value of the bond that will taken out on a regular basis.

3. Maturity

o Term ng bonds

4. Indenture

o Agreement between the bond issuer at trustees who represents the holder; specific terms, loan
agreements, description, rights of bond holders and issuing firms and responsibilities of trustees.

5. Current Yield

o Ratio of annual interest payment to the bond’s market price ; annual coupon payment / bond price
o Helps investors drill down on bonds that generates the greatest return on investment each year. Para
macompute mo kung saang bonds maganda maginvest.

6% – coupon interest

1,000 – face / par value

 900 - price

6. Yield to Maturity
o Bonds internal rate of return; discount rate that equates the present value of the interest and principal
payments with the current market price of the bonds.
o Useful for investors looking to maximize the profits by holding a bond until maturity.

Determination of Bond Yield to Maturity

 Par value of bond: P1,000

 Interest rate : 10%
 Term: 10 years
 Current price: P900
 What is the bond’s approximate yield to maturity?

Approximate Yield to Maturity

Credit Quality Risk

• The chance that the bond issuer will not make timely payments.

Bond Ratings

• Involve a judgment about the future risk potential of the bond provided by rating agencies such as Moody’s,
Standard and Poor’s and Fitch IBCA, Inc. Dominion Bond Rating Services.

• Investment grade:

• AAA – highest quality investment issuer has the capacity to meets its financial commitments on the
obligation is extremely strong. (mataas ang capacity ng firm na mabayaran ka on maturily) (stable
companie)

• BBB – bond issuer exhibits adequate protection pero if may mga unexpected events pwedeng hindi
mabayaran.
 • CCC – currently vulnerable to nonpayment; dependent upon favorable business

• D – default ; payments are jeopardized, on the verge of filing bankruptcy

Types of Bonds

A. Unsecured Long-term Bonds

o no collateral
o financial stability
o Parang commercial paper w/ no collateral
o Regulated by SEC
o Limited yung pagissue ng long term debt
o To protect, they may be prohibited

 Debentures

 To the issuing firm, they allowed it

 Long term debts and backed only by the reputation and financial stability of the corporation

 To protect the bond holders the issuing firm is prohibited from issuing future secured long term debt
that would create additional income runs of the assets.

 To the issuing firm debentures will allow it to incur indebtedness and still preserve some future
borrowing power

 Subordinated Debentures

 May hierarchy, honor only after claim ng secured debt and unsubordinated
 These are claims of bond holders subordinate the debentures honoured only after claims of secured
debts and unsubordinated debentures

 Income Bonds

 Requires interest payment only if earned and non-payment of interest does not lead to bankruptcy
 During reorganization or facing financial difficulties
 Have longer maturity
 Unpaid interest is generally allowed to accumulate (must be paid prior to the payment of dividends to
stockholders)
 they are not required to pay interest on a regular basis

B. Secured Long-term Bonds

Mortgage Bonds

 secured by lien or real property; incase na hindi makabayad si issuing firm during maturity
 Trusty can foreclose or sell the mortgage property
  Use the proceed to pay the bond holders.

1. First Mortgage Bonds

 Senior claims in secured assets

2. Second Mortgage Bonds

 Claim only after the first MB

 Second claim and paid only after the first mortgage bonds has been satisfied

3. Blanket or General Mortgage Bonds

 All the assets of the firm are use as securities

4. Close-end Mortgage Bonds

 Forbids the further use of pledge asset securities for other bonds
 This protects the bond holders from delusion of their claims on the assets by any future mortgage bonds

5. Open-end Mortgage Bonds

 This bond allows the issuance of additional mortgage bond using the same secured assets as security.
 Allow to use the assets na nagamit na.
 Restrictions: requiring the additional assets should be added to the secured property

6. Limited Open-end Mortgage Bonds

 Allow to use same assets as security but limited to the amount of bonds.

Other Types of Bonds

1. Floating Rate or Variable Rate Bonds

 Fluctuating
 Unstable interest rate

2. Junk or Low-Rated Bonds

 BB rating or below – faces major ongoing uncertainty or exposure to adverse

 There’s an investment rates

3. Eurobonds

 Payable or denominated in the borrowers currency but sold outside used by international syndicate

4. Treasury Bonds

 issued by the government full faith and credit

EQUITY INSTRUMENTS
 • A type of financial instruments wherein the issuer agrees to pay an amount to the investor in the future based
on the future earning of the company.

• The earnings used as basis of the amount to be paid to equity instrument holder is determined after settling all
the required payments.

• Shares – most common example of equity instruments. Stocks that represent ownership in a company of the
total outstanding shares or authorized shares.

• Stock certificates – legal document which certifies the ownership of specific number of shares of a corporation.

• Company is the issuing party and the shareholders who purchase the shares are the investors

Why invest in equity instruments?

You have two methods in earning:

1. Capital appreciation

• it refers to the rise of the value of an assets in relation to the increase in its market price

• buy low and sell high

2. Dividends

• Payment made by corporations to shareholders representing excess earnings of the company; usually
paid out quarterly but some companies pay it annually or semi-annually.

• Distributed to shareholders based on discretion and approval of the BOD in some cases management
can recommend amount to be declared but still subject to final approval of BOD

• It can be in the Form of cash, property usually share investment in another company and owned shares
of the company.

• It is based on the current performance of the business and is NOT DEPENDENT on the capital
appreciation of the company.

ORDINARY (COMMON) EQUITY SHARES

• Long-term equity that represents ownership interest of the firm.

Features of Ordinary Equity Shares

1. Par Value/No par value

• The par value is stated value attached to a single share at issuance.

2. Authorized, issued, and outstanding

• Authorized - Maximum a number of shares that a corporation may issue without amending its charter.

• Issued – number of authorized shares that have been sold.

• Outstanding – those shares held by the public.

 3. No maturity

4. Voting rights

Two common systems of voting

a. Majority Voting – entitles each shareholder to cast 1 vote for each shares owned, majority wins

b. Cumulative Voting – that permits the shareholder to cast multiple votes for a single director

5. Book value pe share

• ordinary share +paid in capital +retained earnings / total number of outstanding shares

6. Numerous rights of stockholders

 Right to vote on specific issues

 Right to receive dividends if declared by the firm’s board of directors.

 Right to share in he residual asset in the event of liquidation.

 Right to transfer their ownership in the firm to another party.

 Right to examine the corporate banks.

 Pre-emptive right.

PREFERRED SHARE

• Class of equity shares which has preference over ordinary shares in the payment of dividends and in the
distribution of corporation’s assets in the event of liquidation.
• Preference means only that the holder of the preferred share must receive dividend before holder of ordinary
equity share are entitled to anything.
• No voting rights but it is a form of equity from a legal and tax stand point.
• Issuance of this share favoured when the following conditions are met:
1. Control problems exist when the issuance of ordinary shares
2. Profit margins are adequate to make of additional leverage attractive. additional debt imposes
substantial risk.
3. Interest rates are low, lowering the cost of preferred shares
4. The firm has a high debt ratio

PREFERRED SHARE FEATURES

1. Par Value – the face value that appears on the stock certificate

2. Dividends – percentage of the par value commonly fixed and paid quarterly

3. Cumulative and Noncumulative dividends

• Cumulative – past and current preferred dividends must be paid before the ordinary equity
shareholders receive anything

• Noncumulative – dividends declared in past are lost forever

 4. No definite maturity date

• Call feature – it gives the issuing firm the option of purchasing the share directly from its owners usually
at a premium.

• Sink fund provision – it requires the issuer to repurchase and retire the share on a scheduled time basis.

5. Convertible preferred share – icoconvert into common shares

6. Voting rights

• Ordinarily walang voting rights si preferred shareholder

• Special voting to procedure that may take effect if the issuing firm omits its preferred dividends for a
specific time period

7. Participating features

• entitled its holder to share in profits which is above and beyond the declared dividends

• Most preferred share issued are non-participating

8. Protective features

• Preferred share issued contains Covenants that assures the regular payment of preferred share
dividends and to improve the quality of the preferred share.

9. Call provision – Right to call in the preferred share for redemption

10. Maturity

Comparative Features of Ordinary Equity Shares, Preferred Shares and Bonds

Ordinary Equity Shares Preferred Shares Bonds

(a) Ownership and control
of the firm
Belongs to ordinary Limited rights when Limited rights under
equity shareholders dividends are missed default interest
through voting right payments
and residual claim to
income

(b) Obligation to provide None Must receive before Contractual obligation

return ordinary shareholder

© Claim to assets in Lowest claim of any Bondholders and Highest claim

bankrutpcy security holder creditors must be
satisfied first

(d) Cost of distribution Highest Moderate Lowest

 (e) Risk-return trade off Highest risk, highest Moderate risk, Lowest risk, moderate
return moderate return return

(f) Tax status of payment Not deductible Not deductible Tax deductible cost =
by corporation Interest payment x (1-
Tax rate)

(g) Tax status of payment A portion of Dividend Same as ordinary Government bond
to recipient paid to another shares interest is tax exempt
corporation is tax
exempt

WEEK 9

TIMELINE OF FOREIGN EXCHANGE

1. 1944 Bretton Woods Accord is established to help stabilize the global economy after World War II.

• Established the pegging (fixing) of currencies in the international monetary fund in hope of the purpose
is to stabilize global economic situation because of the world war

• Major currencies were pegged to the US dollars

• These currencies were allowed to fluctuate by 1% on either side of set standard.

2. 1971 Smithsonian Agreement established to allow for greater fluctuation band for currencies.

• To stabilize the global economic situation

• Similar to Bretton but greater fluctuation bond for the currencies

3. 1972 European Joint Float established as the European community tried to move away from its dependency on
the U.S. dollar.

• European community tries to move away from its dependency on the dollar

• Established by west Germany, France, Italy, Netherlands and Luxemburg.

• Also similar to Bretton woods accord but allows greater range of fluctuation in the currency values.

4. 1973  Smithsonian Agreement and European Joint Float failed and signified the official switch to a free-floating
system.

• Both agreements made mistake

• Free-floating system - These occurred by default as they were no new agreements to take their place.

• Governments were now free to peg their currencies or allow them to freely float.
 5. 1978 The European Monetary System was introduced so other countries could try to gain independence from
the U.S. dollar. Free-floating system officially mandated by the IMF.

6. 1993 European Monetary System fails making way for a world-wide free-floating system.

FOREIGN EXCHANGE (FOREX) MARKET

 Network of buyers and sellers, who transfer currency between each other at an agreed price. 

 It is the means by which individuals, companies and central banks convert one currency into another.

 A 24-hour over-the-counter (OTC) and dealers’ market, meaning that transactions are completed between two
participants via telecommunications technology.

  Participants are able to buy, sell, exchange and speculate on currencies.

  Foreign exchange markets are made up of banks, forex dealers, commercial companies, central banks,
investment management firms, hedge funds, retail forex dealers and investors.

 The largest financial market in the world.

 Trading in foreign exchange markets averaged $6.6 trillion per day in April 2019.

 Currencies are always traded in pairs, so the "value" of one of the currencies in that pair is relative to the value
of the other. 

Free float currency

 Those whose relative value is determined by free market forces, such as supply / demand relationships. (U.S.
Dollar, Japanese Yen and British Pound)

Fixed float currency

 Where a country's governing body sets its currency's relative value to other currencies, often by pegging it to
some standard. ( Chinese Yuan and the Indian Rupee)

How it Works?

 The forex market is run by a global network of banks, spread across four major forex trading centres in different
time zones: London, New York, Sydney and Tokyo. Because there is no central location, you can trade forex 24
hours a day.

1. Spot Market:  (sale and purchase) of currency are settled within two days of the deal

 Spot exchange rate – settlement rate

2. Forward Market:  sale and purchase of foreign exchange at some specified date in the future, usually after 90
days of the deal. 

 forward exchange rate – buyers and sellers agreed to settle the transaction

Main players of the forex market

1. Central bank
 • Each country has its own central bank

• Apex body in the organization of the exchange market, they work as the lender of the last resort and the
custodian of the foreign exchange of the country.

• Has the power to regulate and control the foreign exchange market to assure that it works in an orderly
manner

• Prevent aggressive fluctuations; magkakaron si central bank ng direct intervention meaning pwede niya
gawin is to sell currency when it is overvalue and buying it when it tends to be undervalue

2. Brokers

• Constitutes the foreign exchange brokers

• Links (central-commercial) (commercial-actual buyers)

• Major source of market information

• These are the person who do not themselves buy the foreign currency but rather strike a deal between
the buyer and the seller on a commission basis.

• Hindi actual na bumibili nagaact lang as a middle man.

3. Commercial banks

• Second most important organ of the FOREX market

• Market makers

• Clearing houses – helping in wiping out the difference between the demand and supply of currencies

4. Exporters, importers, tourists, investors, immigrants

• Actual buyers, users and seller of the foreign currencies

What moves the forex market

1. Central banks

• Supply is controlled by the central banks who can announce measures that will have significant effect on
their currency’s price

• Quantitative easing for instance involves injecting more money into an economy and can cause its
currency’s price to drop.

2. News reports

• May effect siya sa pagpili natin sa company kung saan tayo magiinvest.

• If a positive piece of news hits the market about a certain region it will encourage investments and
increase demand for that regions currency.

3. Market sentiment
 • result of news report.

• Plays a major role in driving the currency prices.

FUNCTION OF THE FOREIGN EXCHANGE MARKET

1. Transfer

• Basic and most visible function of the forex market

• Conversion of one currency to another wherein the role of the forex is to transfer the purchasing power
from one country to another

2. Credit

• Typically used or applied to international trade

• The transfer function is performed through a use of credit instruments.

• Forex provide a short term credit to the importers to facilitate the smooth flow of goods and services
from country to country.

• Importers can use credit to finance the foreign purchases.

3. Hedging

• Managing the risk due to foreign exchange rate

• Players are often afraid to fluctuations ; exchange rate may result in a gain or loss to parties concerned.

SPECULATION

 Act of buying and selling the foreign currency under the conditions of uncertainty with a view to earning huge
gains.

ARBITRAGE

 The process of a simultaneous sale and purchase of currencies in two or more foreign exchange markets with an
objective to make profits by capitalizing on the exchange-rate differentials in various markets.

DIRECT AND INDIRECT QUOTES

 Direct quote indicates the number of units of the home currency required to buy one unit of the foreign
currency.

o Peso / Foreign Currency Rate

 Indirect quote indicates the number of units of foreign currency that can be bought for one unit of the home
currency.

o Foreign Currency Rate / Peso

Indirect quote = 1

Direct quote
 US Dollars = 1/52.3260 = .01911 (dollar/P1)

CROSS RATES

 Indirect computation of the exchange rate of one currency from the exchange rates of two other currencies.

Example:

P63.9424 = 1 pound

P48.1028 = 1 euro

P63.9424 / P48.1028 = 1.1005 euro per 1 pound

Pound/euro exchange rate is:

P58.1028 / P63.9424 = .90867 pound per 1 euro

Factors that affect exchange rates in the long run

1. Relative Price Levels

• Rise – it will depreciate
• Decrease / fall – appreciate
• Inversely proportional
2. Trade Barriers
• Increase – appreciate in the long run
• Decrease – depreciate
• Directly proportional
3. Preferences for Domestic Versus Foreign Goods
• Increase in demands of country’s exports – appreciate
• Increase in country’s imports – depreciate
4. Productivity
• Country become more productive relative to other countries – appreciate

Forex Trading in the Philippines: Complete Guide for Newbie Traders

Below is a list of online forex brokers in the Philippines:

• AvaTrade

• eToro

• XM Global Limited

• Vantage FX

• OctaFX

• Tickmill

• Alpari International

• IG
 • Pepperstone

• FXPro

• IQ Option

MORTGAGE MARKETS

 Long-term loan secured by real estate. (last to 15 to 30 yrs.)

o Collateralized (kapag di nakapagbayad ng loan kukunin yung property nyo)
 Usually house and lot
 Sub category of capital markets pero nagkaiba sa borrowers
 Made of borrowing amounts and maturities depending on the borrower’s needs and features that cause
problems for developing a secondary market. (Maraming variation kasi depende sya sa kung ano yung need ng
borrowerso, magkakaiba yung interest rate, terms kaya nagkakaroon ng problem sa pagdevelop ng secondary
market.)
 Both individuals and businesses obtain mortgages loans to finance real estate purchases.
o Si business for example, yung mga developer ng villages, umuutang din sila thru mortgages for the
construction nung building and also yung iba for the construction of an office.
o Most of the individuals, kumukuha ng mortgage loan, nagaaply sila para ifinance naman yung purchase
ng bahay.
 The loan is amortized.
o Meron kang binabayaran on a monthly basis regularly for 15 to 30 years so, at the end of the term fully
paid na yung loan mo or yung property.
 The borrower pays it off over time in some combination of principal and interest payments that result in full
payment of the debt by maturity.
o Combination ng principal and interest payment.
 It is a subcategory of capital markets because it involves long term funds.

DIFFERENCE NG MORTGAGE MARKET SA CAPITAL MARKET

Capital markets Mortgage markets

borrowers Businesses and

individuals
government entities

HISTORY

The Great Depression

• Happened during later part of 1929 lasted for 10 years. Worldwide effect of Depression.

• It stated with the bonds market in US. Before 1920’s meron ng mga home mortgages.

• Home mortgages were 5- to 10-year loans for only about 50% of the value of the property in the years before
the Great Depression. The principal was due as a balloon payment (a large, single, one-time payment (isang
bagsakang bayad) at the end of the term).
 • Then housing prices fell by about 25% during the Depression, and homeowners couldn't afford their balloon
payments. The banks wouldn't allow refinancing (it is an option kapag di mo na kayang bayaran ng gantong
amount monthly so, irereconstruct yung loan mo so, kung magkano lang yung kaya mong bayaran yun nalang
yung babayaran mo pero maeextend yung term kasi nga syempre kung initially 15 years yan more than 50 years
kasi mas mababa na yung monthly mo). Approximately 1,000 homes were foreclosed upon every day in 1933.
(nagpull out yung 1k homes nung time na yon everyday in 1933.)

PRIMARY AND SECONDARY MORTGAGE MARKET

• The primary lender is the one who deals directly with the public.

o Kumikita sila thru processing fees.

• They are the ones who originate the mortgage loans.

• They do not lend the money themselves.

• They make money from the loan processing fees rather than interest rates (secondary markets).

o Kumikita thru interest rates.

The institution that initially lends the money more than likely will sell your mortgage note to another company on the
secondary market.

o Si banks and other financial institution kung saan tayo nagloloan, yan yung mga secondary markets. So,
incase na di mo mabayaran yung loan mo, ifoforeclose nila yung property mo and then, ibebenta nila
yan ulit sa iba.

CHARACTERISTICS OF THE RESIDENTIAL MORTGAGE

• The modern mortgage lender has continued to refine the long term loan to make it more desirable to
borrowers. In the past 30 years both the nature of lenders and the instruments have undergone substantial
change.

• The biggest change is the development of an active secondary market for mortgage contracts.

o Nagkakaroon ng problem in secorndary market because of many variations of mortgage so, mahirap
magbenta, magtrade, magtransact in retail or wholesale kasi iba iba yung variations nya.

• The mortgage markets became very competitive in recent years.

• 20 years ago in savings and loan institutions and mortgage departments of large banks where mortgage loans
originates but in today’s time there are many loan production offices that compete in real estate financing ,
some of these offices are subsidiaries of banks and others are independently own.

• As a result of the competition for mortgage loans borrowers can choose from a variety of terms and options.

o Mas malawag na yung options or pagpipilian ni borrowers.

3 IMPOTATNT FACTORS THAT AFFECTS THE INTEREST RATES OF LOAN

1. Mortgage Interest Rates

 a. Current long-term market rates

 Determined by the law of supply and demand of the long term funds. Hindi sya controlled.
 Affected and determined by the number of global, national and regional factors. Rates tend to stay
above the less risky treasury bonds most of the time but tend to track along with them.
 Treasury bonds rate- most of the time mortgage rate stays above the treasury bonds.

b. Term or Life of the mortgage

• Interest differs base on its term (the longer the term, high risk, high interest rate)
• Yung 30 years na loan mas mataas ang interest non kaysa sa 15 yrs loan. Kapag mas matagal yung
term ng loan, mas mataas yung chances na yung borrower hindi sya makapagbayad kasi andaming
pedeng mangyari sa 30 years. Kaya baka dumating sa point na mabankrupt sya or magka default
kaya mas mataas yung interest rate kapag mas mahaba yung term.

c. Number of Discount Points Paid

• Simple called Points.

• Are interest payments made at the beginning of the loan, a loan with one discount point means that
the borrower pays 1%. (1 discount point = 1% of loan amount).

• The moment the borrower signed the loan paper and received proceeds from its loan and interest
payments are already paid that moment is considered discount points.

• In exchange dun sa points the lender reduces the interest rates of the loan. Advantage is bababaan
ang interest rates.

• Considering whether to pay points the borrower must determine whether the reduced interest rates
over the life of the loan fully compensates for the increase upfront expensed.

• Discounts are not allowed on loans that is less than five years

• It is only allowed to those 6 years loan.

2. Loan Terms

• What is included in the clause, mortgage contract, legal financial terms and usually the terms
protect the lenders form financial loss. (So, incase na si borrower hindi makabayad ano yung pedeng
maging proteksyon ni lender don.)
• Example: Lloyd Cadena, bought a house and lot, nakamortgage yon. So when the time na namatay
sya, considering na sya yung borrower, yung protection nung lender is may insurance yung loan. So
yung insurance yung nagbayad sa lender na nagfully paid nung property na yon. It also protect the
lender kasi kahit nawala yung lender na fully paid parin yung bahay thru insurance.

3. Collateral

4. Down Payment

 To obtain the mortgage loan the lender, also requires the borrower to make a down payment on the
property. Meaning, a portion of the purchase price. And the balance of the purchase price will be loan.
  This is required by banks. Usually the required down payment ng mga banks is 5% to 20% from your own
money or pocket. Then the remaining percentage, yung yung ipapautang sayo.
 The borrowers who does not make a down payment could walk away from the house and the loan and
lose nothing. (kasi yung DP proteksyon din sya sa lender. Kasi if walang DP, pedeng di nya na bayaran
kasi wala naming nawala sa kanya kasi hindi naman sya naglabas ng pera. Pero kapag may DP,
manghihinayang sya dun sa nilabas nyang DP.)
 The DP reduces moral hazard for the borrowers. So, the amount of the DP depends on the type of the
mortgage loan.

5. Private Mortgage Insurance (PMI)

• Insurance policy that guarantees makeup. To make up any discrepancy between the value of the
property and the loan amount should a default occurs.
• Required when down payment is less than 20%
• PMI usually cost between 200 to 300 pesos per 100,000 loan. Monthly payment of 200 to 300 pesos.

6. Borrower Qualifications

• Before granting a mortgage loan the lender will determine whether the borrower qualifies for it.
• May mga qualification si lender and other bankls. and hindi sila agad agad nagpapautang, meron
silang mga tinitignan and chinicheck thru back ground check if you have previous debt kaya
importante na may maganda kang record. Example: Credit cards. (if may hindi ka nabayarang credit
cards) kasi if you hafve bad records hindi kayo maaprove sa loan.
• Maintain the credibility as a buyer.
• Qualifying for a mortgage loan is different for qualifying for a bank loan because most lenders sell
their mortgage loan to one of a few government agencies in the secondary mortgage market. These
agencies established very precise guidelines that must be following before they accept the loans. If
the lender gives a mortgage loan to a borrower who does not fit these guidelines, the lender may
not be able to resell the loan.
• The banks may be more flexible with loans that we kept on the banks own books.

TYPES OF MORTGAGE LOANS

1. Conventional Mortgages
• Most common, originated by banks or other mortgages lenders.
• Not guaranteed by government or government controlled entity.
• Most lenders though now ensure many conventional loan against default or they require the borrower
to obtain private mortgage insurance on loans.
• They required to have an insurance.
• Loan is not guaranteed; usually requires private mortgage insurance; 5% to 20% down payment
2. Insured Mortgages
• Also originated by banks or other mortgage lenders but;
• Loan is guaranteed by either the government or government controlled entities; low or zero down
payment
• Loan is guaranteed by Federal Housing Administrative (FHA) or Veterans Administrative (VA); low or zero
down payment. These are government entities.
3. Fixed rate Mortgages
• Hindi nagvavary ang payment ng borrower over the life of mortgage.
 • Kung ano yung payment mo from first month hanggang sa maend yung loan, yun lang yung fix na
babayaran mo over the life of the mortgage.

4. Adjustable Rate Mortgages (ARMs)

• Interest rateon adjustable rate mortgage is tied to some market interest rate (may sinusunod na interest
therefore, it changes overtime) from other security and is adjusted periodically (changes overtime) ; size
of adjustment is subject to annual limits
• Example: treasure bill rate
• Caps- limits (kung gano kataas or kababa yung interest rate.)
• Interest rate is tied to some other security and is adjusted periodically; size of adjustment is subject to
annual limits
5. Graduated-Payment Mortgages (GPMs) (means tumataas)
• Expect to increase their income
• Initial low payment increases each year, loan usually amortizes in 30 years.
• Borrowers in this type usually expects increase in income.
• Early payments may not be sufficient to cover the interest dues in which case the principal balance
increases.
• As time passes, the borrowers expect income to increase so that higher payment will not be too much of
a burden.
6. Growing Equity Mortgages (GEMs)
• The mortgage will initially be the same as on the conventional mortgage but over time the payment will
increase. These increase, mababawasan yung principal than the conventional payment mortgage.
• Initial payment increases each year , mabilis mababawasan yung principal balance
• Loan amortizes in less than 30 years.
7. Shared Application Mortgages (SAMs)
• In exchange for providing a low interest rate, the lender shares in any appreciation in value of the real
estate.
• Si lender yung nakikihati dun sa mismong increase ng value ng property.
• Si lender mayroon syang share dun sa property in case of appreciation of value ng property.
8. Equity Participating Mortgages (EPMs)
• In exchange for paying a portion of the down payment (purchase price) or for supplementing the
monthly payments, an outside investor shares in any appreciation in value of the real estate.
9. Second Mortgages
• Loan is secured by a second lien against the real estate; often used for line of credit or home
improvement loans.
• These are loans that are secured by the same real estate that is used to secure the first mortgage. (isang
mortgage lang yung ginamit as collateral.)
• The second mortgage is a junior to the original loan which means the default occur, the second
mortgage holder will be paid only after the original loan has been paid off if sufficient fund remain.
10. Reverse Annuity Mortgages (RAMs)
• The bank advances funds to the owner on a monthly schedule to enable him to meet needing expenses,
either by increasing the balance of the loan which in secured by the real estate.
• When the borrower dies, the estate sells the property to pay the debt. (so, meaning secured yun ng
property nya)
 • Lender disburses a monthly payment to the borrower on an increasing-balance loan; loan comes due
when the real estate is sold.

MORTGAGE LENDING INSTITUTIONS (Players in mortgage market)

The institutions that provide mortgage loans to familiar and business that they share the mortgage market are as
follows:

 Mortgage tools and trusts 49%

 Commercial banks 24%
 Government agencies and others 15%
 Life insurance companies 9%
 Savings and loans associates 9%

SECURITIZATION OF MORTGAGES (protection)

Intermediaries face several problems when trying to sell mortgages to the secondary market, the lenders selling the
loans to another investor. (Pagbenta ulit sa iba pang investor)

Problems that are usually encountered by the intermediaries:

A. Mortgages are usually too small to be wholesale instruments.

B. Mortgages are not standardized.

o No definite term or rate, there are different terms to maturity, interest rate and contract term. It is
difficult to bundle a large mortgages together.

C. Mortgage loans are relatively costly to service.

o Lenders must collect monthly payment often advances payment of property taxes, insurance premium
and service reserve accounts.

D. Mortgages have unknown default risk.

o The investors do not want to spend a lot of time and effort in evaluating the credit of the borrowers.

 Mortgage-backed security
o Created because of the problems.
o A security that is collateralized by a pool of mortgage loans.
o Also known as securitized mortgage. Process of transforming an assets into marketable capital market
instrument.
o In recent years, as institutional investors look for appreciative investment opportunities that compete for funds
with government notes, bonds , corporate bonds and stocks. Can be considered instead of investing in
government bonds.
o Securitized mortgage lower the risk of the securities and have higher than comparable compared to government
bond and attract funds around the world.
 Securitization
o Is the process of transforming illiquid financial assets into marketable capital market instruments.

The most common type of mortgage-backed security is the mortgage pass through, a security that has the borrower’s
mortgages pass through the trustee before being disbursed to the investors in the mortgage-pass through. If borrowers
pre-pay their loans, investors received more principal than expected

What benefits are derives from Securitized Mortgage (SM)

A. SM has reduced the problems and risks caused by regional lending institutions’ sensitivity to local economic
fluctuations.

B. Borrowers now have access to a national capital market.

C. Investors can enjoy the low risk and long term nature of investing in mortgages without having to service the
loan

D. Mortgage rates are now more open to national and international influences. As a consequence, mortgage rates
are more volatile that they were in the past.

INTERNATIONALIZATION OF FINANCIAL MARKETS

FINANCIAL MARKETS AROUND THE WORLD

 New York, US

The New York Stock Exchange (NYSE) is the largest in the world.

Market Capitalization – the market value of its outstanding shares: $21.04 trillion followed by NASDAQ, which is also
based in New York ($20.66 B)
  Toronto, Canada

Established in 1852 and owned and operated as a subsidiary of the TMX Group, the Toronto Stock Exchange (TSX) is the
most significant stock exchange in Canada. Until 2001, the Toronto Stock Exchange was known as the TSE. The TSX is the
third-largest stock exchange in North America by capitalization, after the New York Stock Exchange (NYSE) and
the Nasdaq.

Toronto Stock Exchange (TSE) in Canada is run by the TMX Group ($2.26 Trillion)

 Tokyo, Japan

The Tokyo Stock Exchange was established on May 15, 1878.

The TSE is run by the Japan Exchange Group and is home to the largest and best-known Japanese giants with a global
presence—including Toyota, Honda, and Mitsubishi.

Japan Exchange Group (JPX), based in Tokyo, is the largest exchange in Asia $5.6 trillion (as of June 2020)

 China - Shanghai, Shenzhen, and Hong Kong

There are two exchanges on the mainland. The Shanghai and Shenzhen exchanges were opened by the Chinese
government in 1990 as a way of modernizing China's economy. The Hong Kong stock exchange is being integrated into
the other Chinese exchanges. That makes the HKEx loosely part of China's stock market.
Shanghai Stock Exchange (SSE), ($ $6.09 Trillion); Shenzhen Stock Exchange (SZSE) ($4.53 Trillion); and the Stock
Exchange of Hong Kong (SEHK) ($5.37 Trillion)

1. Shanghai stock exchange

 Most of the companies listed are the large, state-owned companies responsible for China's economic
growth. Most investors are pension funds and banks. The SSE is located in Shanghai, China's financial capital.
2. Shenzhen stock exchange 
 The SZ is in Shenzhen, Guangdong, one of China's most modern cities. It’s a two-hour drive from Hong Kong.
Most investors are individuals. Most investors are individuals.
 The Shenzhen trades the shares of smaller, more entrepreneurial companies. 11 1 Their growth is a critical
component of China's economic reform. These privately-owned businesses are more innovative and more
profitable than the state-owned companies. A lot of tech companies are listed there, making this exchange
similar to the NASDAQ.
3. Hong Kong Exchanges and Clearing Limited or HKEx
 A stock market and derivatives market.

 London, UK

The London Stock Exchange (LSE) is the primary stock exchange in the United Kingdom and the largest in Europe.

The stock exchange is physically located in the city of London. In 2007, the London Stock Exchange merged with
the Milan Stock Exchange, the Borsa Italiana, to form the London Stock Exchange Group.

The "Big Bang" refers to the government's deregulation of the London stock market on Oct. 27, 1986, an event that led
to a modernized electronic trading system and opened up the LSE to capital markets worldwide.

Stock Exchange (LSE) is Europe’s largest ($3.3 Trillion)

 European Union

Euronext is the largest stock exchange in Europe and sixth largest in the world. It was originally created by the mergers
of the Amsterdam, Paris, and Brussels stock exchanges.

Over the years, it merged with several other exchanges, most notably the New York Stock Exchange, before being
acquired itself by the Intercontinental Exchange. In 2014, Euronext was spun off to become an independent entity once
again.

Euronext has headquarters in Amsterdam, Brussels, Lisbon, and Paris

Euronext Amsterdam ($4.43 Trillion)

 Frankfurt, Germany

The Frankfurt Stock Exchange, known in German as FWB Frankfurter Wertpapierbörse, is the largest German stock
exchange based in Frankfurt.

Owned by Deutsche Börse AG, it had a market capitalisation of around $1.99 trillion as of March 2019, making it the
world's 12th largest stock exchange. 

Börse Frankfurt is a trading venue mainly for private investors. It provides access to thousands of securities of German
and international issuers.
Latest Market Cap - $2.1 Trillion

SIZE OF THE MARKETS

Table 11-1 The world’s financial markets

2015 2016 2017 2018

International bank loans 13.6 22.6 20.4 27.0

International debt securities 11.5 18.9 21.9 21.3
Domestic debt securities 44.1 59.8 62.5 68.7
Equities 37.2 32.6 54.6 67.2
Other 5.2 8.0 8.4 8.8
Total value outstanding 111.60 141.9 167.8 193.0

CROSS BOARDING FINANCING

 Also known as import and export financing.

 Helps business to participate in international trade by providing a source of funding that enables them to compete
globally and conduct business beyond their domestic borders.
 Usually used by the companies who has global subsidiaries.
 Example: Canadian based company.

ADVANTAGES

o Opting in for cross-border financing solutions can allow corporations to maximize their borrowing capacity.
o Cross-border factoring (selling off receivables) is a type of cross-border financing that provides businesses
with immediate cash flow that can be used to support growth and operations. 
 The third company collects payments from customers and transfers the payment to original
business owner less the charges in providing the service.
o The advantage to the business owners is that they receive their money upfront rather than waiting
anywhere from 30 to 120-days for payment from their customers.

DISADVANTAGES

o Currency Risk - Refers to the possibility companies may lose money due to changes in currency rates that
occur from conducting international trade.
o Political Risk – Refers to the risk a company faces when doing business in a foreign country that experiences
political instability. It can affect cross boarder financing.

INTERNATIONAL BOND MARKET

 Foreign Bonds
 A bond issued in a domestic market by a foreign entity in the domestic market's currency as a means of raising
capital. For foreign firms doing a large amount of business in the domestic market, issuing foreign bonds, such
as bulldog bonds, Matilda bonds, and samurai bonds, is a common practice.
 Issued by the international company or foreign entity in a country different from their own using that country’s
currency to denominate those bonds. So, domestic investors can diversify internationally by owning foreign bonds
since they are traded on local exchanges they are easier to acquire. Still, the foreign bonds have certain implicit and
explicit risk associated with them including the impact of two interest rates: the currency exchange rate and the geo
political factors.

Example:

Bulldog Bond – this bond is issued in UK, in British Pound by a foreign bank or corporation. Foreign corporation raising
funds in UK, typically issue this bond when interest rate and the UK are lower than those in the corporation’s country.

Matilda Bond – this is a bond issued in Australian market, (issued by the foreign bank using the currency of Austria.)

Samurai Bonds – corporate bond issued in Japan by a non-Japanese company.

 Eurobonds
 A Eurobond is a debt instrument that's denominated in a currency other than the home currency of the country or
market in which it is issued.
 Frequently group together by the currency which they are denominated, such as euro dollar or euro yen bonds.
 Since euro bond issued in an external currency they often called external bond.
 Eurobonds are important because they help organizations raise capital while having the flexibility to issue them in
another currency.
 Issuance of the euro bonds usually handle by an international syndicate of financial institution on behalf of the
borrower. One of which they underwrite the bond does guarantee in the purchase of the entire issue.
 Eurobond refers only to the fact the bond is issued outside of the borders of the currency's home country; it doesn't
mean the bond was issued in Europe.
 Also called external bond. Not necessarily in Europe only.

FACTORS AFFECTING THE LONG-RUN TRENDS OF INCREASED FINANCIAL MARKET ACTIVITY

A. LOWER INFLATION

 The inflation rate around the world had fallen markly since 1990’s.
 Effects: It erodes the value or gradually decreases the value of the financial assets and increases the
value of physical assets (houses and machines) which will cause far more to replace than they are worth.
 When the inflation is high, (like the cases in US in 1970’s also in Latin America during the 1980’s) avoid
raising term capital because investors require a high return on an investment.
 In a long inflation environment, the financial market investors require less on an inflation premium and
they do not expect general increase in prices to revalue their assets.

B. PENSIONS

 There are significant changes in pension policies occurred in many countries starting in the 1990’s.
 Changes in demography working patterns have made pay as you goes, increasing the costly to support,
so pension became very expensive as there are fewer young workers relative to the number of
pensioners.
 This has stimulated interest in the pre funded individual pension. Meaning, each worker may have an
account in which the money will be save and also invested.
  This personal investment account to some extent sa planted firms private pension plans. They have also
led to huge increase in financial assets in countries where private pension where previously uncommon.

C. STOCK AND BOND MARKET PERFORMANCE

 They performed during most of 1990’s and in the period before 2008 (Global financial crisis).
 The global bond market boom, continuing until interest rate begun to rise in 2020.
 Stock markets after several difficulties rouse deeply in many countries in 2012 and 2013 and again in
2016 and 2017.
 The rapid increase in financial wealth paid on itself, so, investors whose portfolio appreciated are willing
to reinvest some of their profit in the financial market and appreciation in the value of their financial
assets gives investors the collateral to borrow additional money which can be invested.

D. RISK MANAGEMENT

 The result of the innovation in financial product. Before, the purpose of the financial product is to raise
fund or capital that’s why you are entering the financial market but because of derivatives and other
securities which the basic purpose is to redistribute the risk or hedging.
 Firms and investors can choose which risk they wish to bare and use financial instrument to shed the risk
they did not want or alternatively to take additional risk in the expectation of earning a higher returns.
 Risk management revolution resulted in an enormous expansion of the financial market activity.
 The credit crisis that begun in 2007 however revealed that the pricy of many these risk management
products did not properly reflect the risk involve.

E. THE INVESTORS

 The driving force of why do we need to invest or entering into financial market.
 The main purpose behind the financial market is the desire to earn profit and the return in assets.
 There are two distinct component in return;
o Yield – this is the income the investor’s receives while owning an investment.
o Capital gains – there are increase in value in the investment itself and often available if you sell
your investment. You’ll only have a capital gain if you sell your investment.
 So, the investor’s preferences vary which type of return they prefer. This will affect their investment
decisions. Some financial market products are deliberately designed to offer only capital gains and no yield
but there are some who are offering yield only without capital gains. These are made to satisfy the
preferences of the investors.

CATEGORIES OF INVESTORS

 INDIVIDUALS
 Collectively, owned a small proportion of the financial assets.
 Most household in the wealthier country, own some financial assets in the form of retirement savings or
shares in the employer of a household member.
 So, many holdings however are quite small, their composition varies greatly from one country to another.

 INSTITUTIONAL INVESTORS
 Have a larger portion of investment.
 Insurance company and other institutional investors including high frequency traders are responsible for
most of the trading in the financial markets.
 The size of the institutional investors varies greatly from country to country depending on the development
of collective investment vehicles.
 Investment practices vary considerably as well.

TYPES

1. Mutual Funds

 Fastest growing institutional investors company. They combined the investment of number of
individuals called pulling of funds.
 Combination of the investment of number of the individuals with the aim of achieving particular
financial goals in an efficient way.
 Typically accepts an unlimited number of an individual investment.
 Then, the funds declare the strategy; it will pursue and as additional money invested in a fund
manager. The fund manager purchase financial instrument appropriate to that strategy.
 In some cases the trusts acquires security as its exemption and never sells them in other cases
the fund changes its portfolio from time to time. So, the investors wishing to enter or leave the
unit trust must buy or sell trust share from stockholder.

2. Hedge Funds

 The opposite of mutual funds.

 They are focusing on an investment on one or another type of asset rather than versifying.
 No diversification.
 Able to employ aggressive investment strategies such as using borrowed money to increase the
amount invested in focusing investment on one or another type of asset. If successful, such
strategy can be too very large returns, but if unsuccessful, they can result in sizable losses and
closure of the fund.
 All investment company earns a profit by charging investors a fee for their services.
 They also take a portion of any gain in a value of the fund.
 Have come under particular criticism because their fee structure may give managers undesirable
incentives to take large risk with investors’ money. As fund managers may share in their funds,
gains, but not its losses.

3. Insurance Companies

 The most important type of the institutional investors.

 1/3 of the financial assets owned by the insurance company.
 In the past, most of these holdings were needed to back life insurance policies. In recent years,
growing shares of insurers business has consisted of annuities which guarantee policy holders as
some of money each years as long as they live rather than merely paying their heirs upon death.
 The growth of free funded individual pension has benefited insurance company because on
retirement many worker used the money on their accounts to purchase annuity.

4. Pension Funds

 Aggregate the retirement savings of large number of workers.

  Sponsored by the employer or labored union.
 There are organization like SSS, GSIS and government organization which represent the large
investors of pension funds. It is automatically deducted in your salary.
 Unlike individual accounts, pension fund do not give individual control over the how their
savings invested. They do typically offer a guaranteed benefit once the individual reaches the
retirement age. Depends on your total contribution in the SSS.

5. Algorithmic traders

 Also known as high frequency trading.

 Expanded in recent years as a result of increase computing power and availability of low cost
high speed communication.
 Investors specializing in this type of trading program computers to enter buy and sell orders
automatically in an effort to exploit tiny price differences in securities and currency markets.
 Control only tiny proportion of the whole financial assets but they account for the large
proportion of the trading in some markets.
 Usually used by the institutional investors. Process of executing order, utilizing automated free
program trading instruction to account for variable such as price, timing and volume.
 Set of directions for solving a problem. Computer algorithm sends small portion of the full order
to the market over time.
 Used in variety of situation in order execution, arbitrage and trend trading strategies.

Disadvantage:

 It can give the market negative tendencies by causing flash trashes in immediate loss of liquidity.

Advantage

 Faster execution and reduced the cost.

 It can exacerbates the market negativity by causing flash trashes in immediate loss of liquidity

INTERNATIONAL CREDIT MARKETS

 Eurocredits
 Market for free floating-rate bank loans whose rates are tied to LIBOR (London Interbank Offer Rate).
 Usually issued for a fixed term with no early repayment.
 Currently, eurocredit exist for major trader currency
 Example: Euro dollar deposit which is US dollar deposited in a bank outside the US.
 Eurobond Market
 International bond underwritten by international syndicate of banks
 Issued in other currency. Kung sino yung issuer ng currency.
 Can be issued under the floating rate depending on the preference on the issuer for long term maturity.
 Not necessarily in Europe.
 External bonds

 Foreign Bond Market

  Issued by the country in whose currency the bond is denominated and they are underwritten by investment
bank in that country.
 Called the bond that is issued in the USA is the Yangki Bonds.
 They can have a floating rate coupon or a fixed rate coupon. They have the same maturity that purely
domestic bond which they must compete for funds.

INTERNATIONAL CREDIT MARKETS

ICMA (International Capital Markets Associations)

 Leading dealers created the ICMA.

 They established standard practices. Followed all over the world.
 Such as in settlement procedure and then, all international bond traders among its member’s money and
securities (can be settle in the 3rd business day after the transaction).
 Based in Switzerland and recognized a self-regulatory organization by British authorities and all major dealers
adhere to its rules.
 Other procedures that they established are; trading transaction, including reporting system so, the firms can
identify and reconcile errors that may have occur in writing down the name and quantity of a security.
 Over the years, the distinctive features of the international market have been eroded. The international
government liberalized their rules for issuing trading securities in east restriction in cross boarder capital flows.
 The advantages of international issue have seen to lun
 Global bond issues in the creation of cross boarder issue have blur the distinction between euro bond and other
international bond issue.
 Some securities traditionally considered to be domestic, so the changes have blurred the difference between the
euro bond and foreign bonds.
 Nung wala pang euro bond and foreign bond, and ang inaapply the international market ay tinatawag na Euro
market.
 But the international bond markets are flourishing and likely to grow rapidly.