ALGARME, FRANZ KAYL V.

CRISTUTA, ARRIANE AYESSA A.

FINANCIAL MARKET
- where people and companies come to buy and sell assets like shares, bonds
(debt), commodities and other products.
- type of marketplace that provides an avenue for the sale and purchase of assets
such as bonds, stocks, foreign exchange, and derivatives.
- businesses and investors can go to financial markets to raise money to grow their
business and to make more money, respectively.
- market where buyers and sellers trade commodities, financial securities, foreign
exchange, and other freely exchangeable items (fungible items) and derivatives of
value at low transaction costs and at prices that are determined by market forces
- where traders buy and sell assets. These include stocks, bonds, derivatives,
foreign exchange, and commodities.
- where companies reduce risks and investors make money.
- marketplace, where creation and trading of financial assets, such as shares,
debentures, bonds, derivatives, currencies, etc. take place.
- acts as an intermediary between the savers and investors by mobilizing funds
between them.
- aggregate of possible buyers and sellers of financial securities, commodities, and
other fungible items, as well as the transactions between them.
- arena in which prices form to enable the exchange of financial assets to be
executed.
- Alternatively put, financial markets are places where the savings from several
sources are mobilized towards those who need funds. They are intermediaries
which direct money from savers or lenders to sellers or borrowers.

MONEY MARKET
- where large-scale, short-term debts are arranged
- organized exchange market where participants can lend and borrow short-term,
high-quality debt securities with average maturities of one year or less.
- enables governments, banks, and other large institutions to sell short-term
securities to fund their short-term cash flow needs.
- Some of the instruments traded in the money market include Treasury bills,
certificates of deposit, commercial paper, federal funds, bills of exchange, and
short-term mortgage-backed securities and asset-backed securities.
- The money market contributes to the economic stability and development of a
country by providing short-term liquidity to governments, commercial banks, and
other large organizations.
- section of the financial market where financial instruments with high liquidity and
short-term maturities are traded.
- buying and selling of securities of short-term maturities, of one year or less, such
as treasury bills and commercial papers.
- Over-the-counter trading is done in the money market and it is a wholesale
process. It is used by the participants as a way of borrowing and lending for the
short term.
- Money market consists of negotiable instruments such as treasury bills,
commercial papers. and certificates of deposit.
- Money market is considered a safe place to invest due to the high liquidity of
securities.
- Money market gives lesser return to investors but also lesser risk
- trading in very short-term debt investments.
- characterized by a high degree of safety and relatively low rates of return.
CAPITAL MARKET
STOCK MARKET
- series of exchanges where successful corporations go to raise large amounts of
cash to expand.
- The investors profit when companies increase their earnings.
- collection of markets and exchanges where regular activities of buying, selling, and
issuance of shares of publicly-held companies take place.
- a similar designated market for trading various kinds of securities in a controlled,
secure and managed environment.
- brings together hundreds of thousands of market participants who wish to buy and
sell shares
- One of the primary benefits of investing in the stock market is the chance to grow
your money. Over time, the stock market tends to rise in value, though the prices
of individual stocks rise and fall daily. Investments in stable companies that are
able to grow tend to make profits for investors.
- Minority Ownership, when you put your money in a reputed company’s stocks, you
become a part-owner of the company, irrespective of however smaller your share
may be. Minority ownership gives you the right to vote and voice your opinions at
the corporate level
DISADVANTAGES
- Volatile Investments
- Investment is subjected to many risks since the market is volatile. The shares of a
company go up and come down so many times in just a single day. These price
fluctuations are unpredictable most of the times and the investor sometimes have
to face severe loss due to such uncertainty.
BOND MARKET
- When organizations need to obtain very large loans, they go to the bond market
- When stock prices go up, bond prices go down.
- trades and issues of debt securities.
o Governments typically issue bonds in order to raise capital to pay down
debts or fund infrastructural improvements.
o Publicly-traded companies issue bonds when they need to finance business
expansion projects or maintain ongoing operations.
- marketplace where investors buy debt securities that are brought to the market by
either governmental entities or publicly-traded corporations.
- where investors go to trade (buy and sell) debt securities, prominently bonds,
which may be issued by corporations or governments.
- The biggest advantage of investing in the bond market is security. Bonds are
generally a less risky option than investing in stocks.
DISADVANTAGES:
- Although bonds provide diversification, holding too much of your portfolio in this
type of investment might be too conservative an approach. The trade-off you get
with the stability of bonds is you will likely receive lower returns overall, historically,
than stocks. Hence, the percentage of bonds in your investment strategy depends
on how much growth potential you’re seeking over time.

FOREIGN EXCHANGE MARKET

- decentralized global market in which currencies are bought and sold.
- This market affects exchange rates and, thus, the value of the dollar and other
currencies
- an over-the-counter (OTC) global marketplace that determines the exchange rate
for currencies around the world
- 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.
- largest financial market in the world and comprises a global network of financial
centers that transact 24 hours a day, closing only on the weekends.
- 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.
- global online network where traders buy and sell currencies.
- has no physical location and operates 24 hours a day from 5 p.m.
- It sets the exchange rates for currencies with floating rates.

COMMODITY MARKET - (e.g FUTURES INVESTMENT)

- physical or virtual marketplace for buying, selling, and trading raw or primary
products.
- Commodities are split into two types: hard and soft commodities.
o Hard commodities are typically natural resources that must be mined or
extracted—such as gold, rubber, and oil
o soft commodities are agricultural products or livestock—such as corn,
wheat, coffee, sugar, soybeans, and pork.
- where traders and investors buy and sell natural resources or commodities such
as corn, oil, meat, and gold.
- A specific market is created for such resources because their price is unpredictable
- There is a commodities futures market wherein the price of items that are to be
delivered at a given future time is already identified and sealed today.
- What Is a Commodity Investing?
- Commodity trading links different cultures and people together. From spices and
silks in the early days to the exchanges where these assets are now traded,
commodities are still a popular investment vehicle.
- Investors hoping to get into the commodity market, there are several different ways
to do so. Commodity-hungry investors can consider investing directly in the
physical commodity, or indirectly by purchasing shares in commodity companies,
mutual funds, or exchange traded funds (ETFs).
Benefits
- they tend to protect investors against the effects of inflation. Generally, demand
for commodities tends to be high during periods of high inflation, which pushes up
prices. It's also a good bet against the U.S. dollar, so when the greenback declines,
commodity prices rise.
- potential to maximize returns with commodity investing.
Risks
- tend to be much more volatile than other kinds of investments—especially funds
that track a single commodity or a specific sector of the economy.
- Investors who trade futures should remember that it involves speculation. Futures
contracts involve tracking an underlying commodity or index. This could have an
impact on the performance of the contract and, thus, give the investor a negative
(or positive) difference. Futures also come with their own set of unique risks that
must be managed independent of the underlying commodity.

DERIVATIVES MARKET
- Such a market involves derivatives or contracts whose value is based on the
market value of the asset being traded.
- financial market for financial instruments such as underlying assets and financial
derivatives.
 - Derivatives are also traded in stock exchanges. Derivatives are a type of security,
whose value is derived from an underlying asset.
o These underlying assets can be stocks, bonds, commodities or currency.
- financial marketplace for financial instruments like future contracts or options which
are borrowed from other asset forms.
- provide for price discovery and risk transfer for securities, commodities, and
currencies.

INSURANCE MARKET
- simply the "buying and selling of insurance."
- Consumers or groups buy insurance for risk management from insurers offering
coverage for specific risks.
- Individual consumers purchase insurance coverage to protect against risk.
- Common insurance market products including homeowner's, auto, life and health
insurance.
- The insurance sector is made up of companies that offer risk management in the
form of insurance contracts
- The basic concept of insurance is that one party, the insurer, will guarantee
payment for an uncertain future event. Meanwhile, another party, the insured or
the policyholder, pays a smaller premium to the insurer in exchange for that
protection on that uncertain future occurrence.
- provide many products with different levels of complexity that were designed for
different groups of people and businesses and other organizations.

WHAT AFFECTS THE MARKET?

NEWS
- Many market participants keep tabs on news in real-time; bad news affecting a
company or a country will drive prices down, for example. Even political news can
have a wide-reaching effect on markets
- Negative news will normally cause people to sell stocks.
- Positive news will normally cause individuals to buy stocks.
CENTRAL BANK POLICY
- Central banks make decisions such as setting interest rates, and these can have
a profound effect on the flow of money around the world, and will have a big impact
on markets
- A key role of central banks is to conduct monetary policy to achieve price stability
(low and stable inflation) and to help manage economic fluctuations.
COMPANY RESULTS
- Companies listed on stock exchanges will release regular results which will
encourage investors to buy or sell their shares
GOVERNMENT DATA
- Government data is a critical resource that can be used to improve operations,
drive innovation, deliver better services to citizens and improve civic democracy.

MARKET PARTICIPANTS
INSTITUTIONAL INVESTORS
- Pension funds, asset managers and mutual fund providers participate in financial
markets to make profits for themselves and their customers
- company or organization that invests money on behalf of other people.
- Mutual funds, pensions, and insurance companies are examples.
 - buys, sells, and manages stocks, bonds, and other investment securities on behalf
of its clients, customers, members, or shareholders.
- do not use their own money, but rather invest other people's money on their behalf.
BANKS
- Banks act like brokers for other companies, like fund managers. They used to do
plenty of trading themselves, but new regulations mean they have less scope to
trade their own book.
- licensed to receive deposits and make loans.
- may also provide financial services such as wealth management, currency
exchange, and safe deposit boxes.
BROKERS
- Specialists placing trades for their clients
- individual or firm that acts as an intermediary between an investor and a securities
exchange.
- provide that service and are compensated in various ways, either through
commissions, fees or through being paid by the exchange itself.
- regulated professional who buys and sells financial instruments on the behalf of a
client and charges a fee for doing so.
RETAIL INVESTORS
- Everyday investors can participate in financial markets through investing in funds,
buying shares, or actively trading the markets through spread bets and CFDs
- individual or non-professional investor who buys and sells securities through
brokerage firms or savings accounts like 401(k)s.
- investing for themselves, often in brokerage or retirement accounts.

HOW ARE FINANCIAL MARKET TRADED?

ON-EXCHANGE
- In the past, these were actual buildings where brokers met to buy and sale shares
in companies, or other assets, like corn or livestock
- Now most trading on exchanges takes place online, with orders being placed from
all over the world
- Trading on exchange means that contracts are standardised with a clear guidance
on the quality, quantity and when you will receive the goods.
- refers to the formally established stock exchange wherein securities are traded
and they have a defined set of rules for the participants.
- When the trading is performed through the exchange, it is under the supervision
of the exchange and so it ensures that all the rules and regulations are duly
complied with.
OVER-THE-COUNTER
- This is where two parties agree to buy/sell to each other directly, without trading
on an exchange.
- decentralized market in which market participants trade stocks, commodities,
currencies, or other instruments directly between two parties and without a central
exchange or broker.
- do not have physical locations; instead, trading is conducted electronically
- trading of securities between two counterparties executed outside of formal
exchanges and without the supervision of an exchange regulator
- dealer oriented market of securities, which is a decentralized and unorganized
market where trading happens by way of phone, emails, etc

FUNCTIONS OF FINANCIAL MARKET

1. mobilizes savings
- a financial market helps in connecting those with money with those who require
money.
 - puts it to the most productive uses
2. facilitating price discovery
- The frequent interaction between investors helps in fixing the price of securities,
on the basis of their demand and supply in the market.
- Demand and supply of an asset in a financial market help to determine their price
- The interaction between the investors and the industries and other market forces
helps to determine the price.
3. providing liquidity to financial assets
- The investors can readily sell their securities and convert assets into cash.
- Assets that buyers and sellers trade in the financial market have high liquidity. It
means that investors can easily sell those assets and convert them into cash
whenever they want.
4. reducing cost of transactions
- don’t have to waste resources to find probable buyers or sellers of securities.
Further, it reduces cost by providing valuable information, regarding the securities
traded in the financial market.
FINANCIAL INSTITUTIONS
- exists to provide a wide variety of deposit, lending and investment products to
individuals, businesses or both
- company engaged in the business of dealing with financial and monetary
transactions such as deposits, loans, investments, and currency exchange.
- companies in the financial sector that provide a broad range of business and
services, including banking, insurance, and investment management.
- Governments of the country consider it essential to oversee and to regulate these
institutions as they play an integral part in the economy of the country.
- describes an establishment that completes and facilitates monetary transactions,
such as loans, mortgages, and deposits
- place where consumers can effectively manage earnings and develop financial
footing.

TYPES OF FINANCIAL INSTITUTION:

CENTRAL BANKS
- responsible for the oversight and management of all other banks
- responsible for conducting monetary policy and supervision and regulation of
financial institutions
- given privileged control over the production and distribution of money and credit
for a nation or a group of nations
- usually responsible for the formulation of monetary policy and the regulation of
member banks.
- inherently non-market-based or even anti-competitive institutions.
o Although some are nationalized, many central banks are not government
agencies, and so are often touted as being politically independent.
o even if a central bank is not legally owned by the government, its privileges
are established and protected by law.

RETAIL AND COMMERCIAL BANKS

- retail banks offered products to individual consumers
- division of a bank that deals directly with retail customers.
- bring in customer deposits that largely enable banks to make loans to their retail
and business customers.
- provides financial services to the general public
- allows consumers to manage their money by giving them access to basic banking
services, credit, and financial advice.
- Commercial banks worked directly with businesses.
 - make loans that enable businesses to grow and hire people, contributing to the
expansion of the economy
- accepts deposits, offers checking account services, makes business, personal,
and mortgage loans, and offers basic financial products like certificates of deposit
(CDs) and savings accounts to individuals and small businesses.
- where most people do their banking, as opposed to an investment bank.
- accept deposits from the public and offer security to their customers.
- due to commercial banks, it is no longer required to keep huge large currency on
hand.
- Using commercial bank facilities, transactions can be done through checks or
credit/debit cards

INTERNET BANKS
- which work similarly to retail banks.
- offer the same products and services as conventional banks, but they do so
through online platforms instead of brick and mortar locations.
- lacks any physical branch locations and exists only on the internet.
- accessed via web browsers and mobile apps, providing customers with banking
services from any place with access to the internet.
- The biggest strength of an internet bank is also its greatest weakness: If internet
access is spotty or lacking, customers cannot access their accounts.
- In addition, there are security issues to keep in mind.
- Accessing one’s internet bank account via an unfamiliar or unsecured public Wi-Fi
hotspot carries a certain level of risk, and there is the ever-present threat of
hackers taking down an internet bank’s website.
- offer you access to your account online, and the ability to transfer money or
perform other tasks with a few clicks of your cursor or taps on your phone screen.

CREDIT UNIONS
- serve a specific demographic per their field of membership, such as teachers or
members of the military.
- While products offered resemble retail bank offerings, credit unions are owned by
their members and operate for their benefit.
- type of financial cooperative that provides traditional banking services.
- Ranging in size from small, volunteer-only operations to large entities with
thousands of participants spanning the country, credit unions can be formed by
large corporations, organizations, and other entities for their employees and
members.
- created, owned, and operated by their participants. As such, they are not-for-profit
enterprises that enjoy tax-exempt status.
- The members of the credit union pool their deposits and provide loans and other
financial services to each other.

SAVINGS AND LOAN ASSOCIATIONS

- mutually held and provide no more than 20% of total lending to businesses fall
under the category of savings and loan associations.
- Individual consumers use savings and loan associations for deposit accounts,
personal loans, and mortgage lending.
- makes loans for the purchase of private housing, home improvements, and new
construction.
- Formerly cooperative institutions in which savers were shareholders in the
association and received dividends in proportion to the organization’s profits
- similar to a bank that specializes in helping people get residential mortgages.
INVESTMENT BANKS AND COMPANIES
- Investment banks help individuals, businesses and governments raise capital
through the issuance of securities.
- acts as an intermediary in large and complex financial transactions.
- also has a role as a broker or financial adviser for large institutional clients such as
pension funds.
- Investment companies, more commonly known as mutual fund companies, pool
funds from individual and institutional investors to provide them access to the
broader securities market.
- corporation or trust engaged in the business of investing the pooled capital of
investors in financial securities.
- both privately and publicly owned, that manage, sell and market funds to the public.
- The main business of an investment company is to hold and manage securities for
investment purposes, but they typically offer investors a variety of funds and
investment services, which include portfolio management, recordkeeping,
custodial, legal, accounting and tax management services.

BROKERAGE FIRMS
- assist individuals and institutions in buying and selling securities among available
investors
- Customers of brokerage firms can place trades of stocks, bonds, mutual funds,
exchange-traded funds (ETFs), and some alternative investments
- main duty is to act as a middleman that connects buyers and sellers to facilitate a
transaction
- typically receive compensation by means of commissions or fees that are charged
once the transaction has successfully completed
- help you buy and sell securities.
- act as the middle man between the buyer and the seller.
- Depending on the brokerage firm type you choose, you can either make your buys
and sales via telephone, internet, or smartphone
- generally charge per buy or sell order with assisted telephone orders being more
expensive

INSURANCE COMPANIES
- help individuals transfer risk of loss are known as insurance companies.
- Individuals and businesses use insurance companies to protect against financial
loss due to death, disability, accidents, property damage, and other misfortunes.
- which may be for-profit, non-profit or government-owned, that sells the promise to
pay for certain expenses in exchange for a regular fee, called a premium.
- The insurance company covers its expenses and/or makes a profit by spreading
the risk of any one client over the pool of premiums from many clients.
- issue insurance policies to cover a variety of contingencies (fire, flooding,
breakage, theft, death, etc.), involving potential financial loss to policy holders or
their dependants in return for regular payments of a premium
- operates by pooling risk among a large number of policy holders; premiums are
based on the probability of a particular event occurring and the average financial
loss associated with each.

MORTGAGE COMPANIES
- originate or fund mortgage loans
- While most mortgage companies serve the individual consumer market, some
specialize in lending options for commercial real estate only
- firm engaged in the business of originating and/or funding mortgages for residential
or commercial property.
- often just the originator of a loan; it markets itself to potential borrowers and seeks
funding from one of several client financial institutions that provide the capital for
the mortgage itself
-
- DETERMINANTS OF INTEREST RATES (Revilla & Sanchez)
- A. Time Value of Money and Interest Rates
-
- Interest Rates
- The interest rate is the amount charged on top of the principal by a lender to a
borrower for the use of assets.
- Interest rates apply to most lending or borrowing transactions. The borrowed
money is repaid either in a lump sum by a pre-determined date or in periodic
installments.
-
- As we all know, the money to be repaid is usually more than the borrowed amount
since lenders require compensation for the loss of use of the money during the loan
period. So yung increase doon sa original amount ng loan is what we called the
interest charged.
- Time Value of Money
- The time value of money (TVM) is the idea that money available at the present
time is worth more than the same amount in the future due to its potential earning
capacity.
-
- This is because a dollar received today can be invested and it’s value enhanced by
an interest rate or return such that an investor receives more than a dollar in the
future. The concept of Time value of money provides that contractual agreements to
receive cash (or to pay cash) in the future will earn (or incur) interest due to passage
of time.
- This core principle of finance holds that, provided money can earn interest, any
amount of money is worth more the sooner it is received.
-
- Significance of Time Value of Money
- In Investment Decision
- Small businesses often have limited resources to invest in business operations,
activities and expansion. One of the factors we have to look at is how to invest, is the
time value of money.
- In Capital Budgeting Decisions
- When a business chooses to invest money in a project, it may be years before that
project begins producing a positive cash flow. The business needs to know whether
those future cash flows are worth the upfront.
- Two types of Interest Rates:
- Simple Interest- It is the interest that is calculated only on the original amount
(principal), and thus, no compounding of interest takes place.
- Compound Interest- It is the interest on a loan or deposit calculated based on both
the initial principal and the accumulated interest from previous periods.
- Under simple interest, interest is earned only on the principal while under the
compound interest, interest is earned on both principal and the interest
- TERMS RELATED TO TIME VALUE OF MONEY:
- Present Value- Is a series of future payment or future value discounted at a rate of
interest up to the current date to reflect the time value of money.
- The present value answers the question “How much do I have to deposit today to
receive a a certain amount in the future?
- Formula:
- Sample Problem
- You would like to have $3,000 in 2 years so that you can move into a new apartment
when you graduate. How much must you deposit today if you think you can earn an
interest rate of 7% per year?
- Future Value- Is the amount that is calculated by increasing present value or series
of payment at the given rate of interest.
- The future value answers the question: “If I deposit 100,000 today in the bank (or in
some other investment), how much will it be worth in the future?
- Formula:
- Sue now has P125. How much would she have after 8 years if she leaves it invested
at 8.5% with annual compounding?
- FV = C x [(1+i)^n] = 125 x [(1+8.5%)^8] = 240.08
- Ordinary Annuity- An ordinary annuity is a series of equal payments made at the
end of consecutive periods over a fixed length of time.
- Formulas:
- Present Value (Ordinary Annuity)
- What is the PV of an ordinary annuity with 10 payments of P2,700 if the appropriate
interest rate is 5.5%?
- PV of OA = 2700 x [ 1-(1+5.5%)^-10] 5.5% = 20,352
- Future Value (Ordinary Annuity)
- You want to go to Europe 5 years from now, and you can save P3,100 per year,
beginning one year from today. You plan to deposit the funds in a mutual fund that
you think will return 8.5% per year. Under these conditions, how much would you
have just after you make the 5th deposit, 5 years from now?
- FV of OA = 3100 x [(1+8.5%)^5 - 1] 8.5% = 18, 369
- Annuity Due - it is an annuity whose payment is due immediately at the beginning of
each period.
- Formulas:
- Present Value (Annuity Due)
- You have a chance to buy an annuity that pays P5,000 at the beginning of each year
for 5 years. You could earn 4.5% on your money in other investments with equal
risk. What is the most you should pay for the annuity?
- PV of AD = 5000 x [1-(1+4.5%)^-5] x (1+4.5%) 4.5% = 22,938
- Future Value (Annuity Due)
- You want to quit your job and return to school for an MBA degree 3 years from now,
and you plan to save P7,000 per year, beginning immediately. You will make 3
deposits in an account that pays 5.2% interest. Under these assumptions, how much
will you have 3 years from today?
- FV of AD = 7000 x [(1+5.2%)^3 -1] x (1+5.2%) 5.2% = 23,261
- DIFFERENT PERSPECTIVES AND COMPUTATIONS IN RELATION TO TIME
VALUE OF MONEY
- The Rule of 72 (Discovered by Albert Einstein)
- The Rule of 72 is a quick, useful formula that is popularly used to estimate the
number of years required to double the invested money at a given annual rate of
return.)
- the unit does not necessarily have to be invested or loaned money. The
Rule of 72 could apply to anything that grows at a compounded rate, such
as population, macroeconomic numbers, charges or loans. (i.e. GDP
growth)
- Formula: 72 / (periodic interest rate) = number of years to double principal
- The Rule of 70 and 69
- In some instances, the rule of 72 or the rule of 69 is used. The function is the same
as the rule of 70 but uses the number 72 or 69, respectively, in place of 70 in the
calculations. While the rule of 69 is often considered more accurate when
addressing continuous compounding processes, 72 may be more accurate for less
frequent compounding intervals. Often, the rule of 70 is used because it's easier to
remember.
- The Rule of 114 and 144
- Rule of 114 can be used to determine how long it will take an investment to triple
and the rule of 144 is used to determine how long will it take for an investment to
quadruple.
- Formulas:
- 114 / (periodic interest rate) = number of years to triple principal
- 144 / (periodic interest rate) = # of years to quadruple principal
- The 10, 5, 3 Rule
- This is the expected long-term return from equities, bonds and cash. It can be
combined with the rule of 72 so you can see how long it takes for each asset class to
approximately double in value.
- Pay Yourself First Rule
- Paying yourself first has been called “the golden rule of personal finance.” Before
you do anything else with your paycheck like paying bills, buying groceries, or
shopping you allocate a percentage of it to a specified savings or investment
account.
- One common mistake is that people wait and only save what’s left and that is paying
yourself last. Basically, paying yourself first means you’re making preparations for
your future finances like emergency fund, retirement fund and much more as a part
of your regular financial routine.
- The Emergency Fund Rule
- An emergency fund is a separate savings or bank account used to cover or offset
the expense of an unforeseen situation, the rule of thumb is to set aside at least
three to six months’ worth of expenses.
- Important Lesson – Investing does not necessarily mean big amount, it can also be
done in small amounts just like what Maam Van told us the last time about the 10
pesos
- per day savings that could grow 3,650 in a year then that’s the time na you will lend
it sa bank.
- APPLICATION OF INTEREST RATES (TVM)
- For Pag-IBIG: https://www.pagibigfund.gov.ph/FAQ_MP2.html
- PIFA: In order to know what the best performing fund is, we are going to consider
the type of the fund and the time period.
- https://pifa.com.ph/factsfignavps.asp?fbclid=IwAR0s0rtSTkmNh5e3z5PlAb
f0W4CMMVMpvpjI-Z1VfVL2pQfH6DWRFAetBTI
- Mutual Funds – is a type of financial vehicle made up of a pool of money collected
from many investors to invest in securities like stocks, bonds, money market
instruments, and other assets.
- Stock Fund – a type of mutual fund that focuses on the investment of stocks.
- Balanced Funds - Balanced funds are mutual funds that invest money across asset
classes, including a mix of low- to medium-risk stocks, bonds, and other securities.
- Bond Fund – type of mutual fund that focuses on the investment of bonds.
- Money Market Fund – a type of mutual fund that invests in highly liquid, near-term
instruments. These instruments include cash, cash equivalent securities, and high-
credit-rating, debt-based securities with a short-term maturity
- Feeder Fund – a feeder fund is a type of investment fund that invests its capital into
a larger master fund similar to an overarching umbrella fund.
- TOP MUTUAL FUNDS: https://pesolab.com/top-philippine-mutual-
funds/?fbclid=IwAR2hXP1BIfwcclXFCUFjej6RIoRLaIBOdnqNy1Th1eoPEpAc9-
B5wt6v22c
- TOP SAVING ACCOUNT: https://grit.ph/savings-
account/?fbclid=IwAR2DitKyvpC9Bd8BPPBBr8Qwp65YumIBbo4lrRqzs7BdjCJLr0uS
5tD3qp0
- B. Loanable Funds Theory
-
- Loanable Funds Theory
- This theory states that the rate of interest is determined by demand for loans
(investments) and supply of loanable funds (savings) in the economy at that level in
which supply and demand are equated.
-
- ● The supply for loanable funds comes from the people and organizations such as
government and businesses that have decided not to spend some of their money but
instead save it for investment purposes.
-
- The supply of loanable funds represents the behavior of all of the savers in an
economy. The higher interest rate that a saver can earn, the more likely they are to
save money. As such, the supply of loanable funds shows that the quantity of
savings available will increase as the interest rate increases.
- ● The demand for loanable funds comes from the people who desire to finance
investment through borrowing.
-
- The demand for loanable funds represents the behavior of borrowers and the
quantity of loans demanded. The lower the interest rate, the less expensive it is to
borrow.
- The equilibrium in the market for loanable funds is achieved when the quantities of
loans that borrowers want are the same as the quantity of savings that savers
provide. The interest rate adjusts to make these equal.
- C. Movements of Interest Rates
-
- The Loanable Funds Market follows the general rule of Demand and Supply:
- The increase in supply (savings) will lower the interest rates if the demand
remains unchanged.
-
- This is so that the lenders can attract more borrowers to invest because of lower
interest rate.. Kasi nga, the lower the interest rate, the less expensive it is to borrow.
- On the other hand, the increase in demand will also tend to increase the interest
rates if the supply remains unchanged.
-
- so that the number of borrowers will be lessen due to higher interest rates for
borrowings and also , As the interest rate rises, consumers will reduce the quantity
that they borrow. Kasi nga, The market price for interest rates will reach equilibrium
and stabilize where supply of loanable funds equals the demand for them.
-
- D. Determinants of Interest Rates for Individual Securities
-
- Inflation Rates
- It is the continual increase in the price level of a basket of goods and services.
- As actual or expected inflation rate increases, interest rate increases.
-
- The intuition behind the positive relationship between interest rates and
inflation rates is that an investor who buys a financial asset demands a
higher interest rate when inflation increases to compensate for the
increased cost of forgoing consumption of real goods and services today
and buying these more highly priced goods and services in the future.
- Real Risk-Free Rate
- It is the rate on a security if no inflation is expected over the holding period
-
- If consumers have a high preference to consume and invest today, the real interest
rate is also high because people tend to spend their money for current good rather
than in the future.
- The Fisher Effect
- The Fisher Effect is an economic theory created by economist Irving Fisher that
describes the relationship between inflation and both real and nominal interest rates.
- Formula: i = Expected (IP) + RIR
- Default Risk
- This premium reflects the possibility that the issuer will not pay the promised
interest at the stated time.
- As default risk increases, interest rate increases.
- DRP (Default Risk Premiums) = ijt-iTt
-
- Where:
- ijt = interest rate on a security issued by an non- Treasury issuer (Issuer j) of maturity
m at time t.
- iTt = interest rate on a security issued by the US Treasury of maturity m at time t
- Liquidity Risk
-
- This is the risk that a security cannot be sold at a predictable price with low
transaction costs at short notice.
- Liquidity Risk occurs when an individual investor, business, or financial institution
cannot meet its short-term debt obligations.
- The liquidity premium is added to return on investment (ROI) on securities that are
not liquid.
-
- In the US, liquid markets exist for most government securities and the stocks and
some bonds issued by large corporations. Many bonds, however, do not trade on a
regular basis or on organized exchanges such as the NYSE. As a result, if investors
wish to sell these bonds quickly, they may get a lower price than they could have
received if they had waited to sell the bonds.
- Term to Maturity
- It is the length of time a security has until maturity.
- It is term structure of interest rates compares interest rates on securities,
assuming that all characteristics (i,e. default risk, liquidity risk) except maturity are
the same.
- The change in the required interest rates as the maturity of a security changes is
called the maturity premium (MP).
-
- İJ=f(IP, RIR, DRPJ, LRPJ, SCPJ, MPJ)
-
- Where:
- IP= Inflation Premium
- RIR= Real Risk-Free Rate
- DRPJ= Default Risk Premium in the jth security
- LRPJ= Liquidity Risk Premium on the jth security
- SCPJ = Special feature premium on the jth security
- MPJ = Maturity Premium on the jth security
- E. Term Structure of Interest Rates
-
- Unbiased Expectations Theory
- • According to this theory, yield curve reflects the market’ s current expectations of
future S-T rates.
-
 - What expectation theory really attempts to do is to predict what short-term interest
rates will be in the future based on current long-term interest rates and what this
theory suggest is that (suppose an investor has a 4-year horizon).. if we have two
investors, one who invests in a single 4-year bond and one who invests in four
consecutive one-year bonds, their return will be equal.. So in other words according
to this theory investors have two choices, they can purchase a current bond and if
they hold it to maturity they can earn the current of spot yield every year until
maturity or they can can purchase a series of one-year bonds .. thing here is the only
rate that is known is the current yield or the spot yield but they can expect or predict
to know what the unknown yields will be in the future..
- Liquidity Preference Theory
- It is based on the idea that investors will hold Long-Term maturities only if they are
offered at a premium to compensate for future uncertainty with security’s value.
- It states that L-T rates are equal to geometric average of current and expected S-T
rates and liquidity risk premium.
-
-Based on the title Liquidity Preference, investors prefer to hold liquid securities or
short-term securities because of its greater marketability and it has lesser price risk
(because of smaller price fluctuations for a given change in interest). Investors prefer
to hold this kind of securities because they can be converted into cash with little risk
of a capital loss.
SECURITY VALUATION
• SECURITY
- defined as financial instruments that hold value and can be traded between
parties
- Used to raise capital in public and private markets.
- There are two types of securities: debt (bonds) and equity (stocks).
• SECURITY VALUATION
- The process of determining how much a security is worth.
• VARIOUS INTEREST RATES MEASURES
- Coupon rate
- Required rate of return
- Expected rate of return
- Realized rate of return
• COUPON RATE
- The annual cash flow that the bond issuer contractually promises to pay the bond
holder.
SAMPLE PROBLEM:
Gika Poi Company issues a $1000 bond which pays $40 annual coupon payments. Find
the coupon rate of the bond?
Given:
Par Value= $1000
Total annual payment= $40
𝑇𝑜𝑡𝑎𝑙 𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
Coupon rate=
𝑃𝑎𝑟 𝑉𝑎𝑙𝑢𝑒

Coupon rate= $40/$1000

= 4%
• Required Rate of Return
- The interest rate the investor should receive on the security, given its risk.
 SAMPLE PROBLEM:

Find the required return on a stock with beta 1.7 if the expected market return is
10% and the risk free rate is 2%.

Given:
Rf= 2%
Rm= 10%
Beta= 1.7

Formula: RE= Rf + (Rm-Rf) * Beta

RE= 2% + (10%-2%) * 1.7

RE= 2% + 8%*1.7
RE= 2% +13.6%
RE= 15.6%
• EXPECTED RATE OF RETURN
- The expected return is the amount of profit or loss an investor can anticipate
receiving on an investment.
SAMPLE PROBLEM:
Kerri Khoto thinks about investing her money in the stock market. She has the
following two stocks in mind: stock A and B. She knows that the economy is expected
to behave according to the following table.
States of Probability Return A Return B
the
economy
Good 45% 15% 16%
Average 40% 8% 9%
Bad 15% -11% -13%

Return A:
= 0.45* 0.15+0.4*0.08+0.15*-0.11
= 0.083
= 8.3%
Return B:
= 0.45*0.16+0.4*0.09+0.15*-0.13
=0.0885
= 8.85%
Standard deviation:

𝑆𝑈𝑀√𝑃𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 ∗ (𝑅𝑒𝑡𝑢𝑟𝑛 − 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛)^2

Return A
SD= 0.45(0.15-0.083) ^2+0.40(0.08-0.083) ^2+0.15(-0.11-0.083) ^2

SD= √0.07611
 SD= 0.087 or 8.7%
Return B
SD= 0.45(0.16-0.0885) ^2+0.40(0.09-0.0885) ^2+0.15(-0.13-0.0885) ^2

SD= √0.0946
SD= 0.097 or 9.7%
Conclusion: The higher the risk, the higher the return
• REALIZED RATE OF RETURN
- Interest rate actually earned on an investment in a financial security.
SAMPLE PROBLEM:
Sukho Nakow invested in 1 share of share apple (APPL) for $95 and sold a year later for $200.
The company did not pay any dividend during that period. What will be the rate of return on this
investment?
𝐷𝑖𝑣𝑡+1 +𝑃𝑡+1 − 𝑃𝑡 𝐷𝑖𝑣𝑡+1 𝑃𝑡+1 −𝑃𝑡
𝑅𝑡+1 = = +
𝑃𝑡 𝑃𝑡 𝑃𝑡

$0+($200−$95) $200 0−$95

𝑅𝑡+1 = = + =110.53%
$95 $95 $95

• BOND VALUATION
- Long term debt obligation issued by corporations and government units.
• TO DETERMINE THE VALUE OF THE BOND
- Number of periods remaining
- Face Value
- Coupon Rate
- Market Rate– yield to maturity (YTM)

PREMIUM BONDS
A bond in which the Present Value of the bond is greater than its Face Value.
DISCOUNT BONDS
A bond in which the Present Value of the bond is less than its face Value.
PAR BOND
A bond in which the present value of the bond is equal to its face value.
SAMPLE PROBLEM:

Suppose Bakon Na Co. were to issue a bond with 10 years to maturity. The Bakon Na
bond has as annual coupon of $80. Similar bonds have a yield to maturity of 8%. Bakon
Na bond will pay $80 per year for the next 10 years in coupon interest. In 10 years, Bakon
Na will pay $1000 to the owner of the bond. What would this bond sell for?

Given:
r= 8%, n = 10
Present Value of face amount = F/(1 + 𝑟)𝑛
PV of face amount = $1,000/1.0810
= $1000/2.1589
=$463.19
Alternative way:
PV of face amount =1,000 x .46319
= $463.19
Present Value of Annuity =
C x [1 − 1/(1 + 𝑟)𝑛 ]/r

PV of Annuity = $80x (1-1/ 1.0810 )/.08

 = $80x (1-1/2.1589)/.08
= $80 x 6.7101
= $536.81
Alternative Way:
PV of Annuity = 80 x 6.71008
= $536.81
Bond value =
C x [𝟏 − 𝟏/(𝟏 + 𝒓)𝒏 ]/r + F/(𝟏 + 𝒓)𝒏
= $463.19 + 536.81
= $1,000 (Par Bond)
This bond sells for exactly its face value. The going interest rate in the market is 8%. This bond
pays exactly 8% interest only when it sells for $1000.

• IMPACT OF INTEREST RATE CHANGES ON SECURITY VALUES

- Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall,
driving up demand and the price of the bond. Conversely, if interest rates rise, investors
will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in
its price.
• IMPACT OF MATURITY ON SECURITY VALUES
- As the bond nears maturity, the only cash flow left is the principal value which is
the par value, therefore, it will trade near that value.
- The longer the bond’s maturity, the greater the risk that the bond’s value could be
impacted by changing interest rates prior to maturity which may have negative
effect on the price of the bond. This is because longer term bonds have a greater
duration. Therefore, the bonds with longer maturities generally have higher interest
rate risk than similar bonds with shorter maturities.
• Duration
- Estimates how many years it will take for an investor to be repaid the bond’s price by its
total cash flows.
FORMULA:

𝐶 𝑀
D= ∑𝑛𝑡=1 𝑡 ( (1+𝑘)
𝑡
𝑡 ) + 𝑛 ( (1+𝑘)𝑛 )
𝐵0 𝐵0

n= Years to maturity
C= coupon payment
K= Market rate of Interest
M= Maturity (Par) Value
𝐵0 = Bond Price
SAMPLE PROBLEM:
Suppose that Sigei Phow have a bond that offers a coupon rate of 6% paid annually. The face
value of the bond is $1,000, it matures in four years and its current rate of return is 8%.

Year Cash PV of PV/𝐵0 Year*(PV/𝐵0 )

Flow CF
1 $60 $55.55 0.0595 0.0595

2 $60 $51.44 0.0551 0.1102

3 $60 $47.63 0.0510 0.1530
 4 $60 $44.10 0.0472 0.1889
4 $60 $735.03 0.7872 3.1487
Total $933.75 D= 3.660

MONEY MARKETS (REPORT)

• INTRODUCTION
o MONEY MARKETS
- The money market refers to trading in very short-term debt investments.
- Are you looking for a short-term investment with higher returns compared to a regular savings
account? Money market funds is a good option. It’s perfect for investors who have low to
moderate risk tolerance and prefer to keep the liquidity of their funds.
- The money market is a segment of the financial market where high-liquidity financial
instruments with short term (6-12 months) maturities are traded

• HOW MONEY MARKETS WORK

- Specifically, in money markets, short-term debt instruments (those with an original maturity of
one year or less) are issued by economic agents that require short-term funds and are
purchased by economic agents that have excess short-term funds. Once issued, money
market instruments trade in active secondary markets.
• WHY DO MONEY MARKETS EXIST?
- The need for money markets arises because the immediate cash needs of individuals,
corporations, and governments do not necessarily coincide with their receipts of cash
- Money markets exist to transfer funds from individuals, corporations, and government units
with short-term excess funds (suppliers of funds) to economic agents who have short-term
needs for funds (users of funds).
• ADVANTAGES OF INVESTING IN MONEY MARKETS
- A money market instrument provides an investment opportunity that generates a higher rate
of interest
- it is also very liquid and (because of its short maturity): cash funds in financial securities that
can be quickly and relatively costlessly converted back to cash when needed has relatively
low default risk
• CHARACTERISTICS OF MONEY MARKETS INSTRUMENTS
- money market instruments are generally sold in large denominations
➢ according to our research from 1 million to 10 million
- Second, money market instruments have low default risk
➢ The risk of late or nonpayment of principal and/or interest is generally small.
➢ Since cash lent in the money markets must be available for a quick return to the
lender, money market instruments can generally be issued only by high-quality
borrowers with little risk of default
- Finally, money market securities must have an original maturity of one year or less

• YIELDS ON MONEY MARKET SECURITIES/ INSTRUMENTS

1. BOND EQUIVALENT YIELDS
- the bond equivalent yield is the product of the periodic rate and the number of periods in a
year

- The
bond equivalent yield is a quoted nominal or stated rate earned on an investment over a one-
year period.
- TAKE NOTE: The bond equivalent yield does not consider the effects of compounding of
interest during a less than one year investment horizon
- The bond equivalent yield on money market securities with a maturity of less than one year
can be converted to an effective annual interest return ( EAR ) using the following equation

2. DISCOUNT YIELDS
- Some money market instruments (e.g., Treasury bills and commercial paper) are bought and
sold on a discount basis.
 - That is, instead of directly received interest payments over the investment horizon, the return
on these securities results from the purchase of the security at a discount from its face value
( P0 ) and the receipt of face value ( Pf ) at maturity
- Further, yields on these securities use a 360-day year rather than a 365-day year. Interest
rates on discount securities, or discount yields ( idy ), are quoted on a discount basis using
the following equation:

- An appropriate comparison of interest rates on discount securities versus non-discount

securities, adjusting for both the base price and days in the year differences, requires
converting a discount yield into a bond equivalent yield in the following manner:

3. SINGLE-PAYMENT YIELDS
- Some money market securities (e.g., jumbo CDs and fed funds) pay interest only once during
their lives: at maturity. Thus, the single-payment security holder receives a terminal payment
consisting of interest plus the face value of the security
- Further, quoted nominal interest rates on single-payment securities (or single-payment yield,
ispy ) normally assume a 360-day year.
- In order to compare interest rates on these securities with others, such as U.S. Treasury
bonds, that pay interest based on a 365-day year, the nominal interest rate must be converted
to a bond equivalent yield in the following manner:

- Further, allowing for interest rate compounding, the EAR for

single-payment securities must utilize the bond equivalent yield as follows:

NOTE: WHY DO WE NEED TO CONVERT?

- As we proceed with the discussion of the various money market instruments, pay particular
attention to the convention used to state returns in the various money markets.
- For example, Treasury bill rates are stated as discount yields and use a 360-day year.
Commercial paper and banker’s acceptance yields are also quoted as discount yields. Federal
funds, repurchase agreements and negotiable certificates of deposit are stated on a single
payment yield basis
- Differences in the convention used to calculate yields must be considered particularly when
comparing returns across various securities.

• MONEY MARKET SECURITIES

I. TREASURY BILLS
❖ WHAT ARE TREASURY BILLS
- The treasury bills or T-bills are a way for the government to borrow money in the short term.
- Treasury bills (T-bills) are short-term obligations of the government issued to cover current
government budget shortfalls (deficits) and to refinance maturing government debt.
- They’re called with that name because they’re issued by the Bureau of the Treasury
- They carry maturity of one year or less and can be traded in the secondary market before
maturity.
- Various tenors of T-bills exist: (1) 91 day, (2) 182 or (3) 364 days.
- Treasury Bills do not bear interest.
- They are issued and sold at a discount from face value and are redeemed at maturity for the
full face value of the instrument.

❖ NATURE OF TREASURY BILLS

- T-bills are virtually default risk free (they are backed by the government) In fact, T-bills are
often referred to as the risk-free asset in the United States.
- T-bills have little interest rate risk and liquidity risk (because of their short-term nature and
active secondary market)

❖ TRADING PROCESS FOR TREASURY BILLS

- Treasury bills are usually traded through auctions.
- Banks that comprise majority of the Government Security Eligible Dealers (GSED) bid for T-
bills in the weekly auctions held by the BTr.
- Bids may be submitted by government securities dealers, financial and nonfinancial
corporations, and individuals and must be received by a BTr.
- The banks then resell the T-bills to investors.

NOTE: What is government securities dealer?

- The person who is going to assist is a fixed income securities salesman licensed by the
Securities and Exchange Commission.
- Examples: BDO, Land Bank, China Bank, Citi bank, etc.

❖ TREASURY BILL YIELDS:

- As we discussed above, Treasury bills are sold on a discount basis.
- Rather than directly paying interest on T-bills (the coupon rate is zero), the government issues
T-bills at a discount from their par (or face) value
- The return comes from the difference between the purchase price paid for the T-bill and the
face value received at maturity.

REMEMBER:
- The discount yield differs from a true rate of return (or bond equivalent yield) for two
reasons: (1) the base price used is the face value of the T-bill and not the purchase price
of the T-bill, and (2) a 360-day year rather than a 365-day year is used.
- Conversion:

- Prices of treasury bills can be computed thru these formulas: (SEE SAMPLE PROB)
II. FEDERAL FUNDS (FED FUNDS)
- Federal funds (fed funds) are short-term funds transferred between financial institutions,
usually for a period of one day
- For example, commercial banks trade fed funds in the form of excess reserves held at
their local Federal Reserve Bank. That is, one commercial bank may be short of reserves,
requiring it to borrow excess reserves from another bank that has a surplus.
- The institution that borrows fed funds incurs a liability on its balance sheet, “federal funds
purchased,” while the institution that lends the fed funds records an asset, “federal funds
sold.”
- Federal Funds are overnight borrowings between banks and other entities to maintain
their bank reserves at the Federal Reserve.
- Banks keep reserves at Federal Reserve Banks to meet their reserve requirements and
to clear financial transactions.

❖ WHY DO BANKS BORROW MONEY

- By law, banks must maintain a reserve equal to a certain percentage of their deposits in
an account at a Federal Reserve Bank. (important because it helps in the conduct of
monetary policy)
- The amount of money a bank must keep in its Fed account is known as a reserve
requirement and is based on a percentage of the bank's total deposits
- They are required to maintain non-interest-bearing accounts at Federal Reserve banks to
ensure that they will have enough money to cover depositors' withdrawals and other
obligations.
- Any money in their reserve that exceeds the required level is available for lending to other
banks that might have a shortfall

❖ FEDERAL FUNDS YIELD

- Federal funds (fed funds) are single-payment loans—they pay interest only once, at
maturity.
- Further, fed funds transactions take the form of short-term (mostly overnight) unsecured
loans. Quoted interest rates on fed funds, assume a 360-day year.
- Therefore, to compare interest rates on fed funds with other securities such as Treasury
bills, the quoted fed funds interest rate must be converted into a bond equivalent rate or
yield.
 ❖ TRADING IN THE FEDERAL FUNDS MARKET
- The fed funds market is a highly liquid and flexible source of funding for commercial banks
and savings banks.
- Commercial banks, especially the largest commercial banks, conduct the vast majority of
transactions in the fed funds market.
- Fed funds transactions are created by banks borrowing and lending excess reserves held
at their Federal Reserve Bank, using Fedwire, the Federal Reserve’s wire transfer
network, to complete the transaction.
- Banks with excess reserves lend fed funds, while banks with deficient reserves borrow
fed funds.
- Federal funds transactions can be initiated by either the lending or the borrowing bank,
with negotiations between any pair of commercial banks taking place directly over the
telephone.
- Alternatively, trades can be arranged through fed funds brokers who charge a small fee
for bringing the two parties to the fed funds transaction together

III. REPURCHASE AGREEMENTS

❖ WHAT ARE REPURCHASE AGREMENTS?
- A repurchase agreement (repo or RP) is an agreement involving the sale of securities by
one party to another with a promise to repurchase the securities at a specified price and
on a specified date in the future
- A repurchase agreement (repo) is a form of short-term borrowing for dealers in
government securities. In the case of a repo, a dealer sells government securities to
investors, usually on an overnight basis, and buys them back the following day at a slightly
higher price. That small difference in price is the implicit overnight interest rate. Repos are
typically used to raise short-term capital. They are also a common tool of central bank
open market operations.
- Thus, a repurchase agreement is essentially a collateralized fed funds loan, with the
collateral (held by the repo seller) taking the form of securities
- The securities used most often in repos are U.S. Treasury securities (e.g., T-bills) and
government agency securities (e.g., Fannie Mae).

❖ WHAT ARE REVERSE REPURCHASE AGREEMENTS?

- A reverse repurchase agreement (reverse repo) is an agreement involving the purchase
(buying) of securities by one party from another with the promise to sell them back at a
given date in the future
- For the party selling the security and agreeing to repurchase it in the future, it is a repo;
for the party on the other end of the transaction, buying the security and agreeing to sell
in the future, it is a reverse repurchase agreement.

❖ REPURCHASE AGREEMENT YIELDS

- Because Treasury securities back most repurchase agreements, they are low credit risk
investments and have lower interest rates than uncollateralized fed funds.
- The yield on repurchase agreements is calculated as the annualized percentage
difference between the initial selling price of the securities and the contracted
(re)purchase price (the selling price plus interest paid on the repurchase agreement),
using a 360-day year.
COMMERCIAL PAPER

❖ WHAT IS A COMMERCIAL PAPER?

- Commercial paper is an unsecured short-term promissory note issued by a corporation
to raise short-term cash, often to finance working capital requirements.

- Commercial paper is one of the largest (in terms of dollar value outstanding) of the money
market instruments.
- One reason for such large amounts of commercial paper outstanding is that companies
with strong credit ratings can generally borrow money at a lower interest rate by issuing
commercial paper than by directly borrowing (via loans) from banks
- Maturities generally range from 1 to 270 days, the most common maturities are between
20 and 45 days
o This 270-day maximum is due to a Securities and Exchange Commission (SEC) rule
that securities with a maturity of more than 270 days must go through the time-
consuming and costly registration process to become a public debt offering (i.e., a
corporate bond)
- At maturity most commercial paper is rolled over into new issues of commercial paper, (to
avoid SEC registration process)
- Commercial paper is generally held by investors from the time of issue until maturity. there
is no active secondary market for commercial paper
- Commercial paper is not actively traded and because it is also unsecured debt, the credit
rating of the issuing company is of particular importance in determining the marketability
of a commercial paper issue.
- Credit ratings provide potential investors with information regarding the ability of the
issuing firm to repay the borrowed funds, as promised, and to compare the commercial
paper issues of different companies

❖ TRADING PROCESS OF COMMERCIAL PAPER

- Commercial paper is sold to investors either directly using the issuer’s own sales force
(e.g., GMAC), or indirectly through brokers and dealers, such as major bank subsidiaries
that specialize in investment banking activities and investment banks
- Commercial paper underwritten and issued through brokers and dealers is more
expensive to the issuer, usually increasing the cost of the issue by one-tenth to one-eighth
of a percent, reflecting an underwriting cost.
- When a company issues CP through a dealer, a request is made at the beginning of the
day by a potential investor for a particular maturity and is often completed by th end of the
day.
- When commercial paper is issued directly from an issuer to a buyer, the company saves
the cost of the dealer (and the underwriting services) but must find appropriate investors
and determine the discount rate on the paper that will place the complete issue.

❖ COMMERCIAL PAPER YIELDS:

 -

NEGOTIABLE CERTIFICATES OF DEPOSIT

❖ WHAT IS A NEGOTIABLE CERTIFICATE OF DEPOSIT?

- A negotiable certificate of deposit (CD) is a bank-issued time deposit that specifies an

interest rate and maturity date and is negotiable (i.e., salable) in the secondary market.
- A negotiable CD is a bearer instrument—whoever holds the CD when it matures receives
the principal and interest. A negotiable CD can be traded any number of times in
secondary market
o Therefore the original buyer is not necessarily the owner at maturity.
- However, negotiable CDs are often purchased by money market mutual funds, which pool
funds of individual investors and allow this group to indirectly purchase negotiable CDs.
- Negotiable CD maturities range from two weeks to one year, with most having a maturity
of one to four months.

❖ TRADING PROCESS FOR NEGOTIABLE CERTIFICATE OF DEPOSIT

- Banks issuing negotiable CDs post a daily set of rates for the most popular maturities of
their negotiable CDs, normally 1, 2, 3, 6, and 12 months
- the bank tries to sell as many CDs to investors who are likely to hold them as investments
rather than sell them to the secondary market.
- In some cases, the bank and the CD investor directly negotiate a rate, the maturity, and
the size of the CD.
o Once this is done, the issuing bank delivers the CD to a custodian bank specified by
the investor. The custodian bank verifies the CD, debits the amount to the investor’s
account, and credits the amount to the issuing bank.
- The secondary market for negotiable CDs allows investors to buy existing negotiable CDs
rather than new issues.
o While it is not a very active market, the secondary market for negotiable CDs is made
up of a linked network of approximately 15 brokers and dealers using telephones to
transact.

❖ NEGOTIABLE CD YIELDS:

- Negotiable CD rates are negotiated between the bank and the CD buyer. Large, well-
known banks can offer CDs at slightly lower rates than smaller, less well-known banks.
 This is due partly to the lower perceived default risk and greater marketability of well-
known banks and partly to the belief that larger banks are often “too big to fail”
- Interest rates on negotiable CDs are generally quoted on an interest-bearing basis using
a 360-day year.

BANKER’S ACCEPTANCE

❖ WHAT IS A BANKER’S ACCEPTANCE?

- A banker’s acceptance is a time draft payable to a seller of goods, with payment guar-
anteed by a bank. Bankers’ acceptances make up an increasingly small part of the money
markets.
- Time drafts issued by a bank are orders for the bank to pay a specified amount of money
to the bearer of the time draft on a given date.

❖ TRADING PROCESS FOR BANKER’S ACCEPTANCE

- Many banker’s acceptances arise from international trade transactions and the underlying
letters of credit (or time drafts) that are used to finance trade in goods that have yet to be
shipped from a foreign exporter (seller) to a domestic importer (buyer)
- If they have an immediate need for cash, they can sell the acceptance before that date at
a discount from the face value to a buyer in the money market (e.g., a bank). In this case,
the ultimate bearer will receive the face value of the banker’s acceptance on maturity.
- Because banker’s acceptances are payable to the bearer at maturity, they can and are
traded in secondary markets. Maturities on banker’s acceptances traded in secondary
markets range from 30 to 270 days.
- Denominations of banker’s acceptances are determined by the size of the original
transaction (between the domestic importer and the foreign exporter)
- Like T-bills and commercial paper, banker’s acceptances are sold on a discounted basis.

THE MART:

- Money Market Association of the Philippines, or MART

- The MART is a non-stock non-profit corporation organized to provide an institutional
medium by and through which the membership can collectively assist and cooperate with
one another, the National Government and its appropriate agencies and instrumentalities
in the promotion, development, expansion and regulation of a free and open market for
debt, debt-securities and debt-related instruments and products.
 - One of its mission: formulate, document and promote the use of standardized practices,
procedures and documentation that enhance the liquidity in conformity with internationally
accepted methods and practices;
IV. MONEY MARKET PARTICIPANTS
1. Bureau of Treasury
- The U.S. Treasury raises significant amounts of funds in the money market when it issues
T-bills.
- T-bills are the most actively traded of the money market securities.
- T-bills allow the U.S. government to raise money to meet unavoidable short-term
expenditure needs prior to the receipt of tax revenues.
- Tax receipts are generally concentrated around quarterly dates, but government
expenditures are more evenly distributed over the year.
2. The federal Reserve
- The Federal Reserve is a key (arguably the most important) participant in the money
markets.
- The Federal Reserve holds T-bills (as well as T-notes and T-bonds) to conduct open
market transactions—purchasing T-bills when it wants to increase the money supply and
selling T-bills when it wants to decrease the money supply.
- Moreover, the Fed targets the federal funds rate as part of its overall monetary policy
strategy, which can in turn affect other money market rates.
- Finally, the Fed operates the discount window, which it can use to influence the supply of
bank reserves to commercial banks and ultimately the demand for and supply of fed funds
and repos.
3. Commercial Banks
- Commercial banks are the most diverse group of participants in the money markets
- The importance of banks in the money markets is driven in part by their need to meet
reserve requirements imposed by regulation.
- For example, during periods of economic expansion, heavy loan demand can produce
reserve deficiencies for banks (i.e., their actual reserve holdings are pushed below the
minimums required by regulation). Additional reserves can be obtained by borrowing fed
funds from other banks, engaging in a repurchase agreement, selling negotiable CDs, or
selling commercial paper. Conversely, during contractionary periods, many banks have
excess reserves that they can use to purchase Treasury securities, trade fed funds,
engage in reverse repos, and so on.
4. Money Market Mutual Funds
- Money market mutual funds purchase large amounts of money market securities and sell
shares in these pools based on the value of their underlying (money market) securities
- Money market mutual funds provide an alternative investment opportunity to interest-
bearing deposits at commercial banks
5. Corporations
- Nonfinancial and financial corporations raise large amounts of funds in the money
markets, primarily in the form of commercial paper.
- Because corporate cash inflows rarely equal their cash outflows, they often invest their
excess cash funds in money market securities, especially T-bills, repos, commercial
paper, negotiable CDs, and banker’s acceptances.
6. Other Financial Institutions
- Because their liability payments are relatively unpredictable, property-casualty (PC)
insurance companies, and to a lesser extent life insurance companies, must maintain
large balances of liquid assets.
- To accomplish this, insurance companies invest heavily in highly liquid money market
securities, especially T-bills, repos, commercial paper, and negotiable CDs.
- Since finance companies are not banks and cannot issue deposits, they raise large
amounts of funds in the money markets, through issuing commercial papers.
7. Individuals
- Individual investors participate in the money markets through direct investments in these
securities (e.g., negotiable CDs) or through investments in money market mutual funds,
which contain a mix of all types of money market securities.

Group 5
(Hinlo and Jimenez)
Bond Market
Capital Markets
- Markets that trade debt (bonds and mortgages) and equity (stocks) instruments with
maturities of more than one year.

Bonds
- long-term debt obligations issued by corporations and government units.
- Proceeds from a bond issue are used to raise funds to support long-term operations of the
issuer

Bond markets
- markets in which bonds are issued and traded

- used to assist in the transfer of funds from individuals, corporations, and government units
with excess funds to corporations and government units in need of long-term debt funding

Why do people buy bonds?

Investors buy bonds because:
- They provide a predictable income stream. Typically, bonds pay interest twice a year.
- If the bonds are held to maturity, bondholders get back the entire principal, so bonds are a
way to preserve capital while investing.
- Bonds can help offset exposure to more volatile stock holdings.

Companies, governments and municipalities issue bonds to get money for various things,
which may include:
- Providing operating cash flow
- Financing debt
- Funding capital investments in schools, highways, hospitals, and other projects

Bond Characteristics
a. Face Value – (also known as the par value) of a bond is the price at which the bond is
sold to investors when first issued; it is also the price at which the bond is redeemed at
maturity.
b. Coupon Rate – The periodic interest payments promised to bond holders are computed
as a fixed percentage of the bond’s face value; this percentage is known as the coupon
rate.
c. Coupon – dollar value of the periodic interest payment promised to bondholders; this
equals the coupon rate times the face value of the bond.

Example: if a bond issuer promises to pay an annual coupon rate of 5% to bond holders
and the face value of the bond is $1,000, the bond holders are being promised a coupon
payment of (0.05) ($1,000) = $50 per year.
d. Maturity – the length of time until the principal is scheduled to be repaid. In the U.S., a
bond’s maturity usually does not exceed 30 years. Occasionally a bond is issued with a
much longer maturity.

Example: the Walt Disney Company issued a 100-year bond in 1993. There have also
been a few instances of bonds with an infinite maturity; these bonds are known as consols.
With a consol, interest is paid forever, but the principal is never repaid.
e. Call Provisions – Many bonds contain a provision that enables the issuer to buy the
bond back from the bondholder at a pre-specified price prior to maturity. This price is known
as the call price. A bond containing a call provision is said to be callable. This provision
enables issuers to reduce their interest costs if rates fall after a bond is issued, since
existing bonds can then be replaced with lower yielding bonds. Since a call provision is
disadvantageous to the bond holder, the bond will offer a higher yield than an otherwise
identical bond with no call provision. A call provision is known as an embedded option,
since it can’t be bought or sold separately from the bond.
f. Put Provisions – enables the buyer to sell the bond back to the issuer at a pre-specified
price prior to maturity. This price is known as the put price. A bond containing such a
provision is said to be putable. This provision enables bond holders to benefit from rising
interest rates since the bond can be sold and the proceeds reinvested at a higher yield than
the original bond. Since a put provision is advantageous to the bond holder, the bond will
offer a lower yield than an otherwise identical bond with no put provision.
g. Sinking Fund Provisions – requires the issuer to repurchase a fixed percentage of the
outstanding bonds each year, regardless of the level of interest rates. A sinking fund
reduces the possibility of default; default occurs when a bond issuer is unable to make
promised payments in a timely manner. Since a sinking fund reduces credit risk to bond
holders, these bonds can be offered with a lower yield than an otherwise identical bond with
no sinking fund.
Pricing Bonds (source https://www.graduatetutor.com/corporate-finance-tutoring/yields-bond-
valuation-pricing/)
Bond’s Price = the present value of its expected future cash flows
Rate of Interest used to discount the bond’s cash flows is known as the yield to maturity
a. Pricing Coupon Bonds
Where,
C = the periodic coupon payment
y = the yield to maturity (YTM)
F = the bond’s par or face value
t = time
T = the number of periods until the bond’s maturity date

Example: bond has a face value of $1,000, a coupon rate of 4% and a maturity of four
years. The bond makes annual coupon payments. If the yield to maturity is 4%,
These results show the following important relationship:
• • if y > coupon rate, P < face value
• • if y = coupon rate, P = face value
• • if y < coupon rate, P > face value

These results also demonstrate that there is an inverse relationship between yields and
bond prices:
• • when yields rise, bond prices fall

• • when yields fall, bond prices rise

• b. Adjusting for Semi-Annual Coupons - bond that makes semi-annual coupon

payments

Adjustments made to the pricing formula:

• • the coupon payment is cut in half
• • the yield is cut in half
• • the number of periods is doubled

Example: A bond has a face value of $1,000, a coupon rate of 8% and a maturity of two
years. The bond makes semi-annual coupon payments, and the yield to maturity is 6%. The
semi-annual coupon is $40, the semi-annual yield is 3%, and the number of semi-annual
periods is four.
The bond’s price = = 38.83 + 37.70 + 36.61 + 924.03 = $1,037.17
• c. Pricing Zero Coupon Bonds

Zero Coupon Bonds – does not make any coupon payments; instead, it is sold to investors
at a discount from face value.
Pricing formula for a zero-coupon bond
Example: A one-year zero-coupon bond is issued with a face value of $1,000. The discount
rate for this bond is 8%. What is the market price of this bond?
Three Common Types of Bonds
1. Treasury notes, bills and bonds,
2. Municipal bonds, and
3. Corporate bonds.

Bond Market Securities

In this section, we look at the bond market securities issued by each of these groups:
Treasury notes and bonds, municipal bonds, and corporate bonds.
Treasury notes and bonds (T-notes and T-bonds)
- Long-term securities issued by the U.S. Treasury to finance the national debt and other
federal government expenditures.
- considered to be risk-free because the “full faith and credit” of the U.S. government backs
them.

Full Faith and Credit

- The Full Faith and Credit Clause ensures that states honor the court judgments of other
states.
- For example, I'm involved in a car accident in America. As a result, America’s court grants
me $1,000 in damages. But the defendant or the person who ran into me lives in Florida
and refuses to pay me.

• a. What are Treasury Bills?

• - a short-term debt obligation backed by the U.S. Treasury Department with a

maturity of one year or less.
• - T-Bills are peso-denominated short-term fixed income securities issued by the
Republic of the Philippines through its Bureau of Treasury

• - Original tenors are 91, 182 and 364 days. All maturity dates traditionally fall on a
Wednesday (unless said day is a holiday). Computation of selling price is based on number
of days remaining till the maturity of a series.

Example:
Suppose you could buy a 91-day T-bill at an asked price of $98 per $100 face value and
you could sell to the dealer at a bid price of $97.95 per $100 face value. What are the
quotation conventions on this bill and how is the yield calculated? What is the best measure
of the yield on a T-bill?
Answer:
Bond Yield Equivalent = (𝐹−𝑃)𝑃𝑡 𝑤ℎ𝑒𝑟𝑒 𝐹=𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒 𝑃=𝑃𝑟𝑖𝑐𝑒 𝑃𝑎𝑖𝑑 𝑡=𝐹𝑟𝑎𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑦𝑒𝑎𝑟
Bond Yield Equivalent = (100−98)9891365 = 0.8186 =8.186% Discount Rate = (𝐹−𝑃)𝐹𝑥360
𝑤ℎ𝑒𝑟𝑒 𝐹=𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒 𝑃=𝑃𝑟𝑖𝑐𝑒 𝑃𝑎𝑖𝑑 𝑡=𝐹𝑟𝑎𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑦𝑒𝑎𝑟 x= days of maturity
Discount Rate = (100−98)10091360 = 0.8111 =8.11% Effective Annual Rate =( 1+ 𝑞𝑢𝑜𝑡𝑒𝑑
𝑟𝑎𝑡𝑒𝑛)𝑛−1 =( 1+ 0.08186365/91)365/91−1 = .0844 𝑜𝑟 8.44%
Note: Discount rate will always be lower than the ask yield based on the B.Y.E formula
because F appears in the denominator of the discount rate formula while P is in the
denominator of the B.Y.E. formula (and F>P as long as yields are positive). In addition,
360<365 in the year part of the formulas and those numbers wind up in the numerator the
best measure of yield earned when buying a T-bill is the B.Y.E since it uses P as the base
rather than F (and because 365 is correct).
Why does the discount rate calculation exist?
- it is a shorthand calculation that was easier beforehand calculators existed. It allowed
people to translate price into yield quickly.

Source: https://www.pnb.com.ph/index.php/investment-opportunities/treasury-bill
https://pesolab.com/how-to-start-investing-in-philippine-treasury-bills/
b. What are Notes? https://www.youtube.com/watch?v=1Ipz95Vqd8Q
- debt security that offers a fixed interest rate and a maturity date that ranges between one
and 10 years
- the government sells treasury notes to help fund its debt.

Example:
Wang Yibo deposit Php 1000 into a savings account paying 2.5% annual interest that
matures in 5 years. How much money will you have (principal plus interest) at the end of the
5-year term?
A = is the amount of money in the account at the end of the year (the account balance including
principal plus interest)
𝑃0= is the principal (starting amount)
r= is the annual interest yield in decimal form
k=is the number of periods over which the interest is paid during the year
t=is the number of years the principal remains invested in the account
Note that when the interest is paid once at the end of the year, the formula is A=P0(1+r)
Simple Interest Over Time 𝐴= 𝑃0 ( 1+(𝑟𝑘)𝑘𝑡) 𝐴= 1000 ( 1+(0.0251)1∗5) 𝐴= 1000 (
1+0.25∗5) 𝐴= 1125
c. What are Bonds?
· Long-term securities that typically mature in 30 years and pay interest every six months
Example:
Park Seo Joon invests Php 20,000 at 6% simple interest for 8 year. How much is in the
account at the end of the 8 years period?
Simple Interest Over Time 𝐴= 𝑃0 ( 1+(𝑟𝑘)𝑘𝑡) 𝐴= 20,000 ( 1+(0.061)1∗8) 𝐴= 20,000 (
1+0.6∗8) 𝐴= 29,600
Municipal Bonds
- called “munis,” are debt securities issued by states, cities, counties and other government
entities

Type of Minus
1. General obligation bonds.

- These bonds are not secured by any assets; instead, they are backed by the “full faith and
credit” of the issuer, which has the power to tax residents to pay bondholders.
- municipal debt issue that is secured by a broad government pledge to use its tax revenues
to repay the bond holders.

- GO bonds are considered safe

investments. It is common that such bonds receive strong ratings from credit rating
agencies.

Example: A municipality decides to launch a new project, but it lacks sufficient capital to
finance the initiative. In such a case, the municipality can issue general obligation bonds.
Investors who purchase the bonds provide capital to the municipality. In return, the
investors are entitled to a portion of the municipality’s revenues generated from the project,
as well as tax revenues. The revenue streams allow the municipality to honor both the
interest and principal payments of the bonds.
Source: https://investinganswers.com/dictionary/g/general-obligation-bond
2. Revenue bonds

- class of municipal bond issued to fund public projects which then repay investors from the
income created by that project

For example, a revenue bond may be issued to finance an extension of a state highway. To
help pay off the interest and principal on that bond, tolls collected from the use of the
highway may be pledged as collateral.
Note: If revenue from the project is insufficient to pay interest and retire the bonds on
maturity as promised maybe because motorists are reluctant to use the highway and pay
the tolls general tax revenues may not be used to meet these payments. Instead, the
revenue bond goes into default and bond holders are not paid. Thus, revenue bonds are
generally riskier than GO bonds and Revenue bonds are project-specific and are not funded
by taxpayers
Corporate Bonds
- Long-term bonds issued by corporations
- debt securities issued by private and public corporations.
- offer higher yields than government bonds because they usually come with a higher
probability of default, making them riskier.

Corporate Bonds Valuation

- it is dependent on the present value of future expected cash flows, discounted at a risk-
adjusted rate

How to Value a Corporate Bond?

- A common way to visualize the valuation of corporate bonds is through a probability tree.
(Probability Tree Method)

Example of a corporate bond:

 ⧫◆⧫
  ❖⚫◆
 ◆◼ ⧫  ◆◼ ◼⧫⬧  
◼◼◆⚫⚫
 ◆⧫ ⧫  ◆⚫⧫ ◆⧫
 ⚫⧫  ◆⚫⧫
5% risk-adjusted discount rate
First Step: Find the expected value at each period.
How to Compute?
- Done by Adding the product of the default payout and the probability of default (P) with the
product of the promised payment (coupon payments and repayment of principal) and the
probability of not defaulting (1-P)

See the Illustration for more easier interpretation:

Second Step: Calculate the bond’s price
d = risk-adjusted discount rate
How to Calculate a Corporate Bond’s Yield?
based on Problem
source: https://corporatefinanceinstitute.com/resources/knowledge/valuation/corporate-
bond-valuation/
-

BOND MARKET PARTICIPANTS

1. Bond Issuers
- The issuers sell bonds or other debt instruments in the bond market to fund the operations
of their organizations. This area of the market is mostly made up of governments, banks,
and corporations. The biggest of these issuers is the government, which uses the bond
market to fund a country's operations, such as social programs and other necessary
expenses. Banks are also key issuers in the bond market and they can range from local
banks
up to supranational banks such as the European Investment Bank, which issues debt in the
bond market. The final major issuer in the bond market is the corporate bond market, which
issues debt to finance corporate operations.

2. Bond Underwriters
- The underwriting segment of the bond market is traditionally made up of investment banks
and other financial institutions that help the issuer to sell the bonds in the market. In
general, selling debt is not as easy as just taking it to the market. In most cases, millions (if
not billions) of dollars are being transacted in one offering. As a result, a lot of work needs
to be done—such as creating a prospectus and other legal documents—in order to sell the
issue.
- In general, the need for underwriters is greatest for the corporate debt market because
there are more risks associated with this type of debt.

3. Bond Purchasers
- The final players in the market are those who buy the debt that is being issued in the
market. They basically include every group mentioned as well as any other type of investor,
including the individual. Governments play one of the largest roles in the market because
they borrow and lend money to other governments and banks.
- Furthermore, governments often purchase debt from other countries if they have excess
reserves of that country's money as a result of trade between countries. For example, China
and Japan are major holders of U.S. government debt.

COMPARISON OF BOND MARKET SECURITIES

US Treasury and Municipal Bonds
- Treasury bonds and municipal bonds are low-risk types of securities. The federal
government issues treasury bonds, while local and state governments issue municipal
bonds. When you purchase a treasury or municipal bond, you are lending money to the
government for a set period of time. In return, you receive income, typically with some tax
benefits.
- The Bureau of the Public Debt, a federal department, issues treasury bonds to provide
funds to operate the federal government and to cover the federal debt. Meanwhile,
municipal bonds are used to fund local and state public projects, such as roads, schools
and other infrastructure.
US Treasury and Corporate Bonds
- The most attractive aspect of a corporate bond is the yield. Because few corporations
have the credibility of the U.S. government, their bonds are considered riskier.
- the U.S. government continues to operate through good times and bad. To compensate
for the added risk, corporations offer higher rates of return on their bonds.
- Corporate bond investors can benefit from ratings upgrades on these bonds that can
positively affect the interest rate and return on their investments. Treasury bonds can be
attractive to those who want to have a guaranteed return on their investment and avoid
default risk. The interest earned on Treasury bonds is also tax-free at the local and state
levels.

Municipal Bonds and Corporate Bonds

- Corporate bonds are those issued by large companies to raise capital for things like
market research, development, and expansion. As an investor, you can make money by
collecting those interest payments for as long as you hold your bonds. However, those
interest payments will be subject to taxes. This means that if you buy corporate bonds
paying $800 in interest annually and your effective tax rate is 25%, you'll lose $200 of that
income to taxes.
- Municipal bonds are those issued by localities to fund public projects like roadways,
hospital systems, and schools. Municipal bonds come in two varieties: general obligation
and revenue.Example, If you buy bonds issued by your home state, you won't pay state or
local taxes, either. This means that if you buy municipal bonds issued by your home state
paying $800 interest annually, you'll get to keep that $800 in full.

INTERNATIONAL ASPECTS OF BOND MARKETS

International bond markets are those markets that trade bonds that are underwritten by an
international syndicate, offer bonds to investors in different countries, issue bonds outside
the jurisdiction of any single country, and offer bonds in unregistered form.
International bonds classified into three main groups:
1. Eurobonds,
2. Foreign bonds, and
3. Domestic bonds.
Eurobonds
- debt issued and traded in countries other than the country in which the bond’s currency or
value is denominated in. These bonds are often issued in a currency that is not the
domestic currency of the issuer.
- Issued by companies on the European continent, or in the European Union, but they can
trade in non-European countries, too.
- Euromarkets is the trading place of Eurobonds, Eurocurrency, Euro notes, Euro
commercial Papers, and Euro equity. It is commonly an offshore market.

Example: Company XYZ is headquartered in the United States. Company XYZ decides to
go to Australia to issue bonds denominated in Canadian dollars. In many cases, an issuer
sells its Eurobonds in a number of international markets. Company XYZ might sell its
Canadian dollar-denominated bonds in Japan and Canada too.
Foreign Bonds
- Bonds are issued by foreign borrowers

Special characteristics of the foreign bond markets are

• • Issuers of bonds are usually governments and private sector utilities.
• • It is a standard practice to underwrite and organize underwriting the risks.
• • Issues are generally pledged by the retail and the institutional investors.

Example: Foreign bonds issued in the United States are called Yankee bonds, foreign
bonds issued in Japan are called Samurai bonds, and foreign bonds issued in the United
Kingdom are called Bulldog bonds.
Domestic bonds
- dealt in local basis and domestic borrowers issue the local bonds. Domestic bonds are
bought and sold in local currency

Example: A British company issues debt in the United Kingdom with the principal and
interest payments based or denominated in British pounds.

What is Mortgage?
A mortgage is a method of using property as security for the performance of an obligation,
usually the payment of a debt. It is a type of loan you can use to buy or refinance a home.
It is also referred to as “Mortgage Loans”. Mortgages are a way to buy a home without
having all the cash up front.
MORTGAGE MARKETS?
The mortgage market is a collection of markets, which includes a primary(or origination)
and a secondary market where mortgages trade. A mortgage is a pledge of property to
secure payment of a debt.
The mortgage obliges the borrower (mortgagor) to make predetermined series of
payments.
The lender (mortgagee) has the right of foreclosure (can seize the property) if the
mortgagor defaults.
The Main operation of the Mortgage Market
• To provide people or families with the money to purchase a home.
Two Markets
• Primary market: where mortgage origination takes place. Lenders creating mortgages
in this market include banks and other financial institutions.
• Secondary market: where mortgages are resold. Mortgages in this market are often
grouped together into tranches based on risk, size, and structure and are then sold as a
collateralized debt obligation, mortgage- backed security, or other type of derivative.
How does the primary mortgage market work?
Primary lenders generally offer adjustable rate mortgage loans (ARM). This means that
your rate is fixed for a set period, normally five years, and then adjusts on a yearly basis
based on a pre-determined index. With ARM loans, payments are subject to change, for
better and worse. It all depends on the interest rate.
Participants in Primary Market
1. Lender( Mortgagee)
A mortgage lender is a financial institution or mortgage bank that offers and underwrites
home loans. Lenders have specific borrowing guidelines to verify your creditworthiness
and ability to repay a loan. They set the terms, interest rate, repayment schedule and
other key aspects of your mortgage
Who are the lenders?
- Commercial banks
- Savings and loans
- Credit unions
- Mortgage banking companies
- Pension funds
- Insurance companies
2. Borrower (Mortgagor)
Person or organization borrows something, especially money from a bank: Banks are
encouraging new borrowers. The borrower is charged interest from the time the
loan is disbursed until it is paid back in full
Advantages of the primary mortgage market
As you can tell by now, the primary mortgage market is the most viable option for
consumers. Here are its main advantages.
• Flexibility. Even if your financial situation doesn't fit the norm, most primary
lenders are flexible enough to consider other solutions.
• Convenience. Primary lenders are locally-based, which makes it easy for you to
deal with them directly. This also means they are in touch with the local market
and can make decisions quickly based on its conditions.
• Low cost. Primary lenders usually do all the underwriting and loan documentation
in-house. This minimizes the costs that are associated with closing a loan.
• Smaller down payments. Primary lenders don’t usually require a huge down
payment

How does the secondary mortgage market work?

The secondary mortgage market is where these investors buy mortgages that have been
originated by some of the larger national and regional banks, as well as through mortgage
brokers. A large percentage of newly originated mortgages are sold by the lenders who
issue them into this secondary market, where they are packaged into mortgage-backed
securities and sold to investors such as pension funds, insurance companies, and hedge
funds
Advantages of the secondary mortgage market
If your situation calls for the secondary mortgage market, here are the main advantages
you can look forward to.
• Fixed rates. Secondary lenders usually offer long-term fixed rates up to thirty
years. This means that the principal and interest remain constant over time even
when there are changes with taxes and insurance.
• Little or no down payment. Unlike the primary mortgage market, it is possible to
obtain a mortgage from the secondary mortgage market with little or no down
payment.

There are four main participants in this market: the mortgage originator, the
aggregator, the securities dealer, and the investor.
1. The Mortgage Originator
The mortgage originator is the first company involved in the secondary mortgage market.
Mortgage originators consist of retail banks, mortgage bankers and mortgage brokers.
The original lender is called mortgage originator. Principal originators of residential
mortgage loans are:
- Thrifts - Commercial banks - Mortgage banks Other private mortgage originators - Life
insurance companies - Pension funds
Types of Mortgage Originators
1. Mortgage broker
A mortgage broker can be defined as a middleman who manages the process of applying
for a mortgage loan for businesses or people. Basically, they connect mortgage lenders
and borrowers without making use of their own funds to establish the connection.

2. Mortgage banker
In contrast, a mortgage banker can be defined as an individual who is employed by a
lending agency or institution, credit union, or bank that carries out mortgages with their
own funds.

2. The Aggregator
Aggregators are the next company in the line of secondary mortgage market participants.
An aggregator is an entity that purchases mortgages from financial institutions and then
securitizes them into mortgage-backed securities (MBSs). Aggregators are large
mortgage originators with ties to Wall Street firms and government-sponsored enterprises
(GSEs), like Fannie Mae and Freddie Mac.
3. Securities Dealers
After an MBS has been formed (and sometimes before it is formed, depending upon the
type of the MBS), it is sold to a securities dealer. Most Wall Street brokerage firms have
MBS trading desks. Dealers on these desks do all kinds of creative things with MBS and
mortgage whole loans; the end goal is to sell them as securities to investors. Dealers
frequently use MBSs to structure CMO, ABS, and CDOs. These deals can be structured
to have different and somewhat definite prepayment characteristics and enhanced credit
ratings compared to the underlying MBS or whole loans.

4. Investors
Investors are the end-users of mortgages. Foreign governments, pension funds,
insurance companies, banks, GSEs and hedge funds are all big investors in mortgages.
MBS, CMOs, ABS, and CDOs offer investors a wide range of potential yields based on
varying credit quality and interest rate risks.

Foreign governments, pension funds, insurance companies and banks typically invest in
highly rated mortgage products. Certain tranches of the various structured mortgage
deals are sought after by these investors for their prepayment and interest rate risk
profiles. Hedge funds are typically big investors in mortgage products with low credit
ratings and structured mortgage products that have greater interest rate risk.
What are these Mortgage Backed Securities (MBS)?
A Mortgage-backed Security (MBS) is a debt security that is collateralized by a
mortgage or a collection of mortgages. An MBS is an asset-backed security that is traded
on the secondary market, and that enables investors to profit from the mortgage business
without the need to directly buy or sell home loans.
How a Mortgage-Backed Security Works?
Important:
Mortgage-backed securities loaded up with subprime loans played a central role
in the financial crisis that began in 2007 and wiped out trillions of dollars in wealth.
How Secondary Market Helps Banks to Release More Funds?
The secondary mortgage market emerged with the aim of providing a new source
of funds for home loans.
Are There Benefits To The Secondary Mortgage Market?
It encourages the movement of money, which helps borrowers gain access to
funding their home buying needs. The secondary mortgage market also keeps rates lower
and more consistent.
For lenders, being able to sell mortgages means they can fund more loans. It relieves
them of the risk of the loan, and they can still make money on fees.
What Are The Risks Of The Secondary Mortgage Market?
▹ The most notable risk of the secondary mortgage market is what occurred in the
2008 – 2009 mortgage crisis.
 ▹ In this situation, Fannie Mae and Freddie Mac held nearly $5 trillion in mortgages
on the edge of defaulting. Other large financial institutions, like Lehman Brothers
and Bear Stearns also had large amounts tied up in mortgages.
“Following the crisis in 2008, it wasn’t until 2013 that banks started to return to the
secondary mortgage market. This came with many changes. They made fewer loans
and adhered to stricter lending requirements.”
Financial crisis changed the market
On Sep 2008, there was an air of tension and panic around the globe, both among
the public and the governments, with an alarm triggered by the US market on the
upcoming Global Financial Crisis.
The recession, over the period of next 2 years resulted in several business and banks
closures, job loses, pay cuts to an extent that the national governments had to step in
to rescue some of the world’s top-most functioning banks and business firms (notably
Bear and Stearns, and AIG respectively) in order to dilute the effect of crisis on the
public, yet the havoc caused was a complete disastrous and an out of control market
reaction.
The losses piled up as institutional investors and banks tried and failed to unload bad
MBS investments. Credit tightened, causing many banks and financial institutions to
teeter on the brink of insolvency. Lending was disrupted to the point that the entire
economy was at risk of collapse.
“What caused such a scale of meltdown?”
It was the US Housing Market which acted as the core of the disaster with other
associated elements adding fuel to the wild fire. This makes understanding the
fundamental functioning of housing market a pre-requisite in process of gaining insights
into how 2008 Financial crisis was built up.
Essentially, the mortgage-backed security turns the bank into a middleman between the
homebuyer and the investment industry. A bank can grant mortgages to its customers
and then sell them on at a discount for inclusion in an MBS. The bank records the sale
as a plus on its balance sheet and loses nothing if the homebuyer defaults sometime
down the road.
Philippine Setting
Severe stress in the Philippine real estate sector is likely to result in material capital
impairment for the banking sector.
Fitch Ratings believes the pandemic-induced economic shock will lead to correction
in the Philippines' property market, which was buoyant prior to the coronavirus pandemic
with price increases significantly outpacing regional peers over the last decade.
We expect the property market to be weak in the near term as remittance inflows drop
and job losses mount, consequently reducing demand and raising the default risks of
household borrowers and weaker developers.
Fitch’s analysis shows that the major Philippine private banks have earnings and
capital buffers that are sufficient to withstand a moderate degree of shock in real estate
prices and market activity.
Securitization
▹ Securitization is the process of turning assets into securities. More specifically,
specific assets are pooled together and repackaged as interest-bearing securities.
 Securities are financial or investment vehicles that are bought and sold in financial
markets
Process of Securitization

Mortgages in the Philippines: What types of mortgages are available?

BDO bank, for example, offers fixed rate mortgages of varied lengths, with the rate rising
as the duration does. After the term ends, you’ll revert to the bank’s basic interest rate,
which is often not the best rate available overall.
The step-by-step process
To get a mortgage in the Philippines, you’ll generally need to follow these steps:
▹ Find a broker who can help you explore your options for a mortgage
▹ Choose a bank who offers a mortgage that suits your needs
▹ Provide the paperwork requested and get an offer in principle. In some cases,
you’ll be able to submit your application and supporting materials online
▹ Find a home you love and agree a purchase price with the seller
▹ Finalize your mortgage through your chosen broker
▹ A deposit of 20% is usually required to secure your purchase
▹ Your notary will guide you through the steps required to transfer ownership of the
property legally
▹ Your broker will help you finalise the remaining 80% payment, and you'll be
responsible for servicing the mortgage and paying any outstanding fees
- Market Segmentation Theory
- Individual investors and FIs have specific maturity preferences, and to get them to
hold maturities other than their prefered requires a higher interest rate (maturity
premium).
-
- The segmented markets theory also says that long-term fixed income securities and
short-term fixed income securities are fundamentally different and should not be put
in the same class of assets.
- For example, banks might prefer to hold short-term T-Bonds because of short-
term nature of their deposits. Insurance companies might prefer to hold long-term T-
Bonds because of the long-term nature of their liabilities (such as life insurance
policies)
-
- F. Forecasting Interest Rates
-
- Upward sloping yield curve suggests that the market expects future S-T interest
rate to increase. So that this theory can be used to forecast interest rates.
-
- For example, if interest rates rise, the value of investment portfolios of FIs and
individuals will fall, resulting in a loss of wealth. Thus, interest rate forecasts are
extremely important for the financial wealth of both FIs and individuals.
- “Forward rate” is the expected or implied rate on a S-T security. The market’s
expectations of forward rates can be derived directly from existing or actual rates on
securities currently traded in the spot market.
-
- 1R2=[(1+ 1R1)(1+ 2f1)]1/2-1
Where: 2f1 = Expected one-year for Year 2, or the implied
forward one-year rate for next year. 2f1=[(1+ 1R2)2/(1+ 1R1)]-1
- Example
- The existing (current) one-year, two-year, three-year and four-year zero coupon
Treasury security rates;
- 1R1= 4.32%,
- 1R2= 4.31%,
- 1R3= 4.29%,
- 1R4= 4.34%
- Using the unbiased expectation theory, forward rates on zero coupon T-Bonds
for years 2, 3 and 4 are;
- 2f1=[(1.0431)2/(1.0432)1]-1= 4.30%
- 3f1=[(1.0429)3/(1.0431)2]-1= 4.25%
- 4f1=[(1.0434)4/(1.0429)3]-1= 4.49%