LESSON 2.

Financial Institutions, Instruments, and Markets

Time frame: Second Week

Performance Standard:

The learners describe the role of financial institutions and markets.

Specific Objectives:

At the end of the lesson, learners are expected to:

1. Describe a business environment;

2. Discuss the financial system;
3. Identify the elements of a financial system; and
4. Differentiate bonds from stocks.

Our life revolves in spending and earning money to sustain our needs.
In the morning, we drink milk or coffee, we take our breakfast, and we
go to school by attending online classes or modular learning due to the
pandemic.
With this, the business sector plays an important role in providing our
needs and wants. It is the business sector that creates the goods and
services for us.

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 LET’S TRY THIS!

Identify the logos of the following financial institutions and give their
complete name.

1. __________________________________

2. _________________________________

3. _________________________________

Questions:

1. Which bank have you visited? If you have not visited any of these
banks, you may identify which bank you have visited instead.

2. What services have you availed?

3. What experience have you encountered upon entering in that bank?

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 This lesson is all about financial
institutions, instruments, and markets. In Let’s
Try This, you have recognized the banks that
you have visited and came across a specific
service that benefits you through a particular
financial service or instrument. As we go along
in this topic, we will learn about the business
environment and the different players in the
financial system of the country.

The Business Environment

The business does not work in a vacuum but in an environment

affected by a range of forces, variables, and systems. In marketing or
entrepreneurship, the environment where the business operates is
generally classified as either macro or micro environment. In finance, the
business environment is divided into international, national, regional, and
local levels. Regardless of the classification on the business environmental
layers, business is affected by different outside forces (Aduana, 2017).

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 One of the environmental layers of the macro environment is the
societal environment. This environment is composed of the following
systems:

SOCIETAL
ENVIRONMENT

POLITICAL
SYSTEMS
LEGAL
SYSTEMS

FINANCIAL
SYSTEMS
TECHNOLOGICAL
SYSTEM

ECONOMIC
SYSTEM SOCIO-CULTURAL
SYSTEM

A system is composed of several parts with interrelated functions. If

one part of the system is dysfunctional, the operation of the whole system
is expected to be negatively affected (Aduana, 2017).

The Financial System

The financial system at the societal environment or regional level is

principally responsible for the flow of money or funds from the lender to
the borrower. The financial system controls, regulates, and facilitates the
saving, borrowing, lending, and investing activities happening among the
different players in the system (Aduana, 2017).

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 In the Philippine financial system, the government plays an active
role in the flow of money in the economy through the Bangko Sentral ng
Pilipinas (BSP). The BSP regulates the operations of financial institutions and
financial intermediaries (Aduana, 2017).

The fundamental elements of a financial system are as follows:

1. Financial institutions

2. Financial markets

3. Financial instruments

4. Lenders and borrowers

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 I. FINANCIAL INSTITUTIONS

Financial Institutions are institutions or organizations that offer

financial services, among others, in the structure of a loan, credit, fund
administration, financing, depository, and safekeeping. Financial
Institutions, therefore, is a broad word that encompasses every
organization that provide the aforesaid financial services.

Financial institutions, based on the financial services provided, are

normally classified as follows:

A. Depository institutions

B. Financial intermediaries

C. Investment institutions

A. DEPOSITORY INSTITUTIONS

Depository institutions are financial institutions that accept deposits

(saving, current, and time deposits) from individual and corporate
entities, extend loans to borrowers, transfer funds, and manage funds
for investment purposes (Aduana, 2017).

Depository institutions include the following:

1. Banks

2. Savings and loan associations

3. Trust companies

4. Credit unions

1. Banks

Banks are institutions authorized to operate and regulated by

the BSP under the General Banking Law of 2000. They accept
deposits and bills payment, provide loans, and facilitate the
transfer of funds domestically or abroad (Aduana, N. 2017).

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 Under BSP Circular No. 271, the major classifications of banks
operating are as follows:

a. universal bank

b. commercial bank

c. thrift bank

d. rural bank

e. cooperative bank

f. Islamic bank

•considered the largest

UNIVERSAL bank in terms of
BANK assets, loan portfolio,
and revenue.
•provides commercial loans and offers
COMMRCIAL investment products in addition to
BANK regular banking service of accepting
deposits
•includes savings and mortgage banks, private
development banks, and stock savings, loan
THRIFT BANK associations and microfinance thrift banks that are
organized under existing laws for the following
purposes

RURAL
BANK

•Rural banks and Cooperative banksthey

are intended to encourage and increase
the rural economy by providing the COOPERATIVE
BANK
public with essential financial services.

ISLAMIC
•aims to support and hasten BANK
the socio-economic expansion
of the Autonomous Region of
Muslin Mindanao

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A. Universal Bank. A universal bank is considered the largest bank in terms
of assets, loan portfolio, and revenue. It has the widest scope of
banking activities authorized by the BSP and usually has the most
number of branches nationwide and abroad. In addition to ordinary
banking services, a universal bank may perform the following (Aduana,
2017):

a) involves in underwriting services

b) engages in financial activities of investment houses
c) invests in equities of non-banking institutions

Less than 50 universal banks are operating in the Philippines as of this

writing. The minimum capital requirement of a universal bank with more
than 100 branches is set by the BSP at P20 billion in compliance with
BASEL III requirements. The raise in the capital requirement may persist
in the future as the BSP moves to fortify the Philippine financial system.

B. Commercial Bank is a type of bank that provides commercial loans

and offers investment products in addition to regular banking service
of accepting deposits. Compared to a universal bank, it has more
limited banking services (Aduana, 2017).

Commercial Banks are ranked next to universal banks in terms of

assets, revenue, general loan portfolio, and number of branches
operating across the country. The minimum requirement of a
commercial bank is also lower compared to that of a universal bank.

C. Thrift bank as defined in Republic Act No. 7906, includes savings and
mortgage banks, private development banks, and stock savings, loan
associations, and microfinance thrift banks that are organized under
existing laws for the following purposes (Aduana, 2017):

a) accumulating and investing the savings of depositors

b) providing working capital to businesses engaged in
agriculture, service, and housing
c) providing diversified financial services to individuals and small
and medium enterprises.

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D. Rural bank and Cooperative bank are structured and operate in rural
areas. They are intended to encourage and increase the rural
economy by providing the public with essential financial services.

Rural banks and Cooperative banks vary from each other through
ownership. Rural banks are privately owned and managed. On the
other hand, cooperative banks are structured and owned by the
cooperatives or a federation of cooperatives.

E. Islamic Bank which has been fashioned and structured under R.A. No.
6848, aims to support and hasten the socio-economic expansion of the
Autonomous Region of Muslin Mindanao by performing banking,
financing, and investment operations and to found and contribute in
agricultural, commercial, and industrial ventures based on the Islamic
notion of banking.

2. Saving and Loan Association

Savings and Loan Association, sometimes referred to as a financing
and mortgage loan company, is a financial institution that is engaged
in the business of accumulating the savings of its members and
stockholders, and using such accumulations for loans or investments in
securities of productive enterprises (Aduana, 2017).

The exceptional characteristic of the financing and mortgage Loan

Company is that the depositors are also the member-borrowers of the
association. The members are vested with the rights to point the
managerial and financial goals of the organization. If the financing
and mortgage loan company is a stock corporation, the members
have voting rights and may manage the association’s function.

3. Trust Company
Trust company is a legal business entity, usually a major division of a
universal or commercial bank that acts as fiduciary agent or trustee on
behalf of an individual person or corporate entity for the purpose of
management, administration and final transfer of property to the
beneficiary (Aduana, 2017).

A trust company could also be selected as the administrator of

properties of a decedent when specified in the last will and testament.
In this case, the trust company is in charge for the allocation of the net

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 estate to the recipient after accounting and paying all debts and
taxes.

4. Credit Union

Credit Union is a financial depository institution that is mainly

controlled and operated by its members for the following purposes:
a) extending credit to members
b) offering competitive interest rates
c) promoting the concept of thrift
d) providing other types of financial services

B. FINANCIAL INTERMEDIARIES

A financial intermediary is a type of a financial institution that acts as the

middleperson between two parties – the investors and the borrowers. Financial
Intermediaries raise and accumulate money from the investors and offer
accumulated money to the individuals or corporate entities in need of financial
assistance (Aduana, 2017).

The idea of financial intermediaries is broad. It includes every category of

financial institutions that obtain money from one party and present it to another
as financial aid. They include banks, insurance companies, brokerage and
investment houses, broker-dealer, mutual funds, and pension funds.

Financial intermediaries do not comprise depository and investment

institutions. Hence, financial intermediaries refer to the following:
•Mutual funds collect money by selling shares of stocks or bonds of publicly-
listed corporations to individuals or corporate investors.
MUTUAL •The funds from the proceeds of the sale are pooled together and directed to
FUNDS the borrowers.

• Pension fund is put up for the reason of paying the pension

needs of all private-sector employees who retire from the
PENSION
FUNDS business organization leading their retirement age.

•Insurance Company acts as a financial intermediary by pooling together the

proceeds of insurance policies sold to the public and investing the
accumulated funds in high yield maturing securities from investment houses
(Aduana, N. 2017).
•Generally of the money accumulated by insurance companies from insurance
INSURANCE premiums is borrowed in either medium – or long-term loan to companies
COMPANIES employed in commercial real estate.
•Insurance companies may offer the following products to the public: (a)life
insurance, (b)health insurance, (c)car insurance, (d)fire insurance, (e)crop
10 & (g)other insurance products
insurance, (f)marine insurance
C. INVESTMENT INSTITUTIONS

Investment Institution is a company engaged in buying securities of

other companies which are listed in the stock exchange for investment
purposes only. Hence, the buying and selling of financial securities are not
the primary business activities of an investment institution (Aduana, 2017).

II. FINANCIAL MARKETS

Market refers to the place where the sellers and the buyers of goods
and services meet. In the market, the major business happening is the
selling-buying activity, in which exchange occurs. The exchange process
indicates that the seller and the buyer agree on the exchange price.

Financial market refers to the place where the selling-buying activity

occurs to trade equity securities such as bonds and stocks, currencies,
derivatives, securities, notes, and mortgages. The selling-buying
transaction happening in the financial market is called trading activity.
The kinds of financial transactions and financial securities traded
determine the types of financial market (Aduana, N. 2017).

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 The financial market includes the following:
Capital market is a financial
market where stocks and bonds
are issued for medium- and
long-term periods. Stocks are
traded as equity securities while
bonds are technically
considered debt securities.
Investors who hold stocks
receive return from their
investments in the form of
dividends while those who hold
bonds earn income in the form
of interest. (Aduana, N. 2017).
In the Philippines, the capital
market is the Philippine Stock
Exchange (PSE) created in 1994
from the two non-operational
capital markets- the Manila
Stock Exchange and the Makati
Stock Exchange.
Money market. The financial
market is classified as money
The primary market is a The
market when the financial
financial market where
securities being traded have a secondary market A public market is a
a corporation can issue
period of less than one year. This is the financial market in which the
type of security is called short- new shares of stocks.
market where the financial securities of
term security. Since short-term Stock corporation that
securities are not intended to be financial securities publicly-listed
needs fresh capital can
held for more than one year, they raise the required are traded corporation are
are also referred to as trading between and traded following a
funds by issuing new
securities. (Aduana, N. 2017). The
shares of stock. The among investors. standardized
money market therefore, trades
financial securities that are highly primary market In the secondary contract agreement
facilitates the raising of market, there is no
liquid or readily marketable. The and procedures. A
the required amount
term highly liquid or readily issuance of new corporation is
marketable implies that there are when the investors shares from the classified as publicly-
available sellers and buyers of directly buy the new
the financial securities. (Aduana, corporation. listed when its
shares from the issuing
N. 2017). (Aduana, N. 2017). shares are available
corporation. (Aduana,
N. 2017). for sale to the public.
Basically, a public
market is an
organized financial
market. (Aduana, N.
2017).
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 III. FINANCIAL INSTRUMENTS

Financial Instruments refer to contracts that give rise to the formation of

financial assets of one entity and at the same time the creation of a financial
liability or an equity instrument in another entity (Aduana, 2017).

In all financial instruments, two parties are concerned. One party has the
contractual right to collect the financial assets, and the other party has the
contractual obligations to give or deliver the financial assets.

The most familiar forms of financial instruments are as follows:

1. Cash- On the part of the holder, cash is a financial asset. However, on

the part of the government such as the Bangko Sentral ng Pilipinas, cash is
a financial liability.

2. Check – It is a financial asset of the payer, but is considered a financial

liability of the drawer or the issuer.

3. Loan – It is the financial asset of the lender or creditor and a financial

liability of the borrower or the debtor.

4. Bond – It is a financial asset of the holder or investor but considered a

financial liability of the issuing company.

5. Stock – It is a financial asset of the investor or shareholder but an equity

of the issuing company.

1. Bonds

A Bond is a financial instrument that represents a contractual debt of the

party issuing the bond. The issuing party may either be a private business
entity or a government. This type of financial instrument is evidenced by a
certificate called bond indenture. (Aduana, 2017).

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The most common types of bonds are as follows:

•is a bond that has a single maturity date. The bond

can be a single lone bond, or can be composed of
TERM BOND
several bonds with the same maturity date. (Aduana,
N. 2017)

•is a kind of bond that has a series of several maturity

SERIAL BOND dates instead of a single maturity date. (Aduana, N.
2017).

•is a kind of bond that is secured by the issuing company.

The security is issued in the form of real property which
SECURED BOND
serves as a collateral in the event of default on the part
of the bond issuer. (Aduana, N. 2017).

•A bond is considered debenture bond when it is not

DEBENTURE BOND supported by any collateral or security as assurance in
times of non-payment or default. (Aduana, N. 2017).

•is a bond which can be converted into a share of stock

in a later date. The option to convert must be vested in
CONVERTIBLE BOND
the bondholder and not on the issuing company.
(Aduana, N. 2017).

•The bond is callable when the issuing company has the

option to redeem the bond prior to its maturity date. In
most instances, the company pays a higher amount, or
CALLABLE BOND
technically called at a premium, when the bond is
redeemed prior to its maturity period. (Aduana, N.
2017).

2. Stocks

Stock is a financial security that signifies ownership of the assets of

the corporation. Only stock corporations are authorized by the Securities
and Exchange Commission (SEC) to issue stocks, hence, sole
proprietorships and partnerships can never issue shares of stock. (Aduana,
2017).
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 The holders of the share of stock as evidenced by the stock
certificate are called shareholders or stockholders. The shareholder has
claim on the net assets of the business as owners of the corporation
(Aduana, 2017).

The two main types of stocks are as follows:

•The common stock or ordinary share is a financial

instrument whose holders do not have preferences
over each other. The common stockholders have the
same rights and privileges in terms of dividend or
asset distribution or other stockholders. (Aduana, N.
COMMON STOCK 2017)
OR •.A common stock is a voting stock. One share of stock
ORDINARY SHARES corresponds to one vote. A common stockholder with
500 shares has 500 votes. A common stockholder
who aspires to practically control the operation of the
business should have more than 50% of the total
common stock issued and outstanding. (Aduana, N.
2017).

•Preference stock is a kind of stock that is preferred

over common stock. The preferences are in terms of
the following: (Aduana, N. 2017). (a)distribution of
PREFERRED STOCK earnings or dividend distribution (b)net assets at the
time of liquidation.
OR
•The privileges of the preference shares outline the
PREFERENCE SHARES distinct difference between common stockholders
and preference stockholders. However, preference
shareholders do not have voting rights. (Aduana, N.
2017).

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 LET’S APPLY THIS!

Read the article below about BDO Unibank, Inc. Then submit a written
report on the space provided about BDO outlining the following details.
a. type of bank
b. competitors
c. services offered
d. scope of operation
e. number of branches

Start here:

From this activity, you will learn that even a single bank can have a variety
of services offered to their clients. The scope of their operations also differs from
different banks particularly if you compare one type of bank from another. You
also learn that one bank can have numerous branches in a city or region.

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 BDO Unibank, Inc., commonly known as Banco de Oro (BDO), is a Philippine
banking company based in Makati. In terms of total assets, the firm is the largest bank in
the Philippines, fifteenth largest in Southeast Asia, 116th largest in Asia, and the 234th
largest bank globally as of March 31, 2016. BDO Unibank is also a member of SM Group. It
is also the largest bank in the country by market capitalization. The firm is a full-
service universal bank. It provides products and services to the retail and corporate
markets including lending (corporate, middle market, SME, and consumer), deposit-
taking, foreign exchange, brokering, trust and investments, credit cards, corporate cash
management and remittances. Through its subsidiaries, the Bank offers Leasing and
Financing, Investment Banking, Private Banking, Bancassurance, Insurance
brokerage and stockbrokerage services.[9] BDO has the largest distribution network with
over 1,300 operating branches and more than 4,000 ATMs nationwide

BDO Unibank was established on January 2, 1968, as Acme Savings Bank, a thrift
bank with just two branches in Metro Manila. In November 1976, Acme was acquired by
the SM Group, the group of companies owned by retail magnate Henry Sy, and renamed
Banco de Oro Savings and Mortgage Bank.

In December 1994, BDO became a commercial bank and was renamed Banco de
Oro Commercial Bank. In September 1996, BDO became a universal bank, which led to
the bank's name being changed to the current Banco de Oro Universal Bank (BDO
Unibank). It is one of the many banks owned by a Chinese-Filipino in the Philippines (others
include Metrobank and Chinabank).

BDO Unibank eventually became involved in insurance services in 1997 (it is

a bancassurance firm) by establishing a subsidiary called BDO Insurance Brokers. In 1999,
BDO Unibank expanded its insurance services through partnerships with Zamora Assurance
and Assicurazoni Generali s.p.a. (Generali), one of the world's largest insurance firms, and
Jerneh Asia Berhad, a member of Malaysia's Kuok Group. Later, BDO Unibank partnered
up with its insurance affiliates, which are Generali Pilipinas Life Assurance Company and
Generali Pilipinas Insurance Company, in March 2000.

BDO Unibank, Inc's main competitors are major Philippine banks

like Metrobank and BPI.

As of 2018, BDO has the largest distribution network in the country, with more than
1,200 operating branches and over 4,000 ATMs nationwide. It has a branch in Hong Kong
as well as 24 overseas remittance and representative offices in Asia, Europe, North
America and the Middle East.

Source: https://en.wikipedia.org/wiki/Banco_de_Oro Retrieved July 18, 2020

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 LET’S DO THIS!

Fill in the blanks to complete the story.

Once upon a time, there was a (1) _________________ that does not
function in a vacuum but in an environment affected by a range of

(2) _________________, (3) ______________________ and (4) ___________________. This

is owned by a beautiful tycoon, in the name of Bernadetha Reyes of Iloilo City.
Her company is divided into (5) ________________ level, located in the United
States, (6) ____________________ level, in Metro Manila, and local levels in Iloilo
City.

Ms. Reyes is planning to expand her company so she needs additional

fund. She visited a (7)________________ which is considered the largest bank in
terms of assets, loan portfolio, and revenue. She needs P100 million loans from
such financial institution for her business expansion.

She also visited several financial markets to gain more funds. First she went
to (8) ______________which is a financial market where stocks and bonds are
issued for medium- and long-term periods. Then she proceeded to (9) __________
where the financial securities being traded have a period of less than one year.

She went also to a (10) _________________ which is a financial market where a

corporation can issue new shares of stocks. After having visited several financial
markets, Ms. Reyes analyzed what particular source of fund she would avail to
finance her business expansion.

Then with the advice of her finance officer she decided what particular
financial institution she would secure a loan.

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 LET’S REMEMBER!

These are the important points you need to remember:

 Business is an environment influenced by different forces, variables, and

systems.
 Societal environment consists of political system, financial system,
economic system, socio-cultural system, technological system, and
legal system.

 The financial system at the societal environment or regional level is

responsible for the flow of money or funds from the lender to the
borrower.
 The basic elements of a financial system are financial institutions,
financial markets, financial instruments, and lenders and borrowers
 Financial institutions, based on the financial services provided, are
generally classified as depository institutions, financial intermediaries,
and investment institutions
 Depository institutions consists of banks, savings and loan association,
trust companies, and credit unions
 Under BSP Circular No. 271, the major classifications of banks operating
in the Philippines are universal banks, commercial banks, thrift banks,
rural banks, cooperative banks, and Islamic banks.
 A financial intermediary is a type of a financial institution that acts as
the middleperson between two parties – the investors and the
borrowers
 The typical financial market includes capital market, money market,
primary market, secondary market, and public market.
 A bond is a financial instrument that represents a contractual debt of
the party issuing the bond.
 Stock is a financial security that signifies ownership of the assets of the
corporation. Only stock corporations are authorized by the Securities
and Exchange Commission (SEC) to issue stocks, hence, sole
proprietorships and partnerships can never issue shares of stock.
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 LET’S SEE WHAT YOU HAVE LEARNED

Instruction: Write in the space provided what you have learned in Lesson 2.

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