FUTURES EXCHANGE MARKET 3.
Options Contracts – the right (but not the obligation)
Futures Market – is a market in which traders purchase and
sell futures contracts. They also buy and sell commodities. We
also call it a futures exchange.
Participants trade, i.e., buy and sell their future delivery contracts
and commodities in a futures market. The market provides a
medium for the complementary activities of speculation and
hedging.
Futures Contract – is a contract to exchange a specific
security for a specific price. The price, which is determined on
the day of the contract, is created for payment and delivery
on a future date.
The futures contracts are for delivery on a specific future
date.
FUNCTIONS OF FUTURES MARKET
The futures exchange is an organized marketplace that:
 Provides and operates the facilities for trading.
 Establishes, monitors, and enforces the rules for
trading.
 Keeps and disseminates trading data.
Derivative – a security whose value depends on the values of
other “underlying” securities (also known as “contingent
claims”).
Spot Price – rate or price quoted for delivery in one or two
business days from the date of the transaction.
DERIVATIVE SECURITIES
1. Forward Contracts – a forward market is a market in
which a commodity/exchange rate for a future
exchange of commodities or financial contracts is
fixed today.
2. Futures Contracts – an agreement reached at one
point in time calling for the delivery of some
commodity at a specified later date at a price
established at the time of contracting.
to buy or sell a particular good at a specified price.
4. Swap Contract – an agreement where two parties
agree to exchange periodic cash flows.
WHY DO WE NEED FUTURES MARKET? OR WHY DO
COMPANIES ENTER THIS MARKET?
Futures offer a fast, cost-effective way to trade financial and
commodity markets.
They are standardized contracts to buy or sell a particular
asset at a set price, on a set date in the future, in predefined
quantity and quality. Traders worldwide use futures to easily
reduce risk or seek profits on changing markets.
Different types of companies may enter futures contracts for
different purposes. The most common reason is to hedge
against a certain type of risk. Companies may also trade
futures for speculative purposes.
Futures markets allow commodities producers and
consumers to engage in “hedging” in order to limit the risk of
losing money as commodity prices change.
Hedging – is typically defined as utilizing financial instruments
or contracts to reduce or eliminate the risk from future
changes in rates or prices. The purpose of hedging a
transaction is to replace an uncertain future cash flow, rate,
or price, with a fixed and certain cash flow, rate, or price.
Speculation – is to profit from a change in a future rate or
price. Speculating involves the assumption of additional risk.
Stock Futures – are financial contracts where the underlying
asset is an individual stock. Stock Future contract is an
agreement to buy or sell a specified quantity of underlying
equity share for a future date at a price agreed upon between
the buyer and seller.
The contracts have standardized specifications like market lot, expiry
day, unit of price quotation, tick size and method of settlement.
HOW ARE STOCK FUTURES PRICED?
Futures Price = Spot Price + Cost of Carry
The theoretical price of a future contract is sum of the current
spot price and cost of carry. However, the actual price of
futures contract very much depends upon the demand and
supply of the underlying stock. Generally, the futures prices
are higher than the spot prices of the underlying stocks.
Cost of carry – is the interest cost of a similar position in cash
market and carried to maturity of the futures contract less
any dividend expected till the expiry of the contract.
FINMAR – CA
 FOREIGN EXCHANGE DERIVATIVES MARKET
Foreign Exchange Market – is a financial derivative whose
payoff depends on the foreign exchange rates of two or more
currencies. These instruments are commonly used for currency
speculation and arbitrage or for hedging foreign exchange risk.
FINANCIAL INSTITUTION PARTICIPATION IN FOREIGN
EXCHANGE MARKET
Commercial Banks
 Serve as financial intermediaries in the foreign exchange
market by buying or selling currencies.
 Speculate on foreign currency movements by taking long
positions in some currencies and short positions in others.
 Provide forward contracts to customers.
 Offer currency options to customers, which can be tailored
to a customer’s specific needs.
International Mutual Funds
 Use foreign exchange markets to exchange currencies
when reconstructing their portfolios.
 Use foreign exchange derivatives to hedge a portion of
their exposure.
Brokerage Firms and Investment Banking Firms
 Engage in foreign security transactions for their customers
or for their own accounts
Insurance Companies
 Use foreign exchange markets when exchanging currencies
for their international operations.
 Use foreign exchange markets when purchasing foreign
securities for their investment portfolios or when selling
foreign securities.
 Use foreign exchange derivatives to hedge a portion of
their exposure.
Pension Funds
 Require foreign exchange of currencies when investing in
foreign securities for their stock or bond portfolios.
 Use foreign exchange derivatives to hedge a portion of
their exposure.
INSTRUMENTS OF FOREIGN EXCHANGE DERIVATIVE
MARKET
Basis Swap – is an interest rate swap which involves the
exchange of two floating rate financial instruments. A basis
swap functions as a floating-floating interest rate swap.
Currency Future – a.k.a FX  future or a foreign exchange
future, is a futures contract to exchange one currency for
another at a specified date in the future at a price (exchange
rate) that is fixed on the purchase date. Typically, one of
the currencies is the US dollar.
Currency Swap – an agreement in which two parties
exchange the principal amount of a loan and the interest in
one currency for the principal and interest in another
currency.
Foreign Exchange Binary Option – a binary option is a
financial exotic option in which the payoff is either some fixed
monetary amount or nothing at all. Also called all-or-nothing
options.
Forward Foreign Exchange – a contract to purchase or sell a
set amount of a foreign currency at a specified price for
settlement at a predetermined future date (closed forward)
or within a range of dates in the future (open forward).
Foreign Exchange Option – or FX option is a derivative
financial instrument that gives the right but not the obligation
to exchange money denominated in one currency into
another currency at a pre-agreed exchange rate on a
specified date.
Foreign Exchange Swap – a forex swap or FX swap is a
simultaneous purchase and sale of identical amounts of one
currency for another with two different value dates (normally
spot to forward) and may use foreign exchange derivatives.
Forward Exchange Rate – the exchange rate at which a bank
agrees to exchange one currency for another at a future date
when it enters into a forward contract with an investor.
Non-deliverable Forward – is an outright forward or futures
contract in which counterparties settle the difference
between the contracted NDF price or rate and the prevailing
spot price or rate on an agreed notional amount.
Dual-currency Note – a reverse dual-currency note is a note
which pays a foreign interest rate in the investor's domestic
currency.
Margin Trading – which means you could pay part of margin
but make full transaction without the practically transferring
of your principal. The end of contract mostly adopts the
settlement for differences. At the same time, the buyers need
not present full payment only when the physical delivery gets
performed on the maturity date.
FUNCTIONS OF FOREIGN EXCHANGE DERIVATIVE MARKET
 Avoiding and managing systemically financial risk.
 Increasing financial systems’ ability to resist risk.
FINMAR – CA
 Improving economic efficiency. It mainly refers to
raise the efficiency of business running and financial
market.

FINMAR – CA
 COMMERCIAL BANK
Commercial Bank – is a type of financial institution that
accepts deposits, offers checking account services, makes
various loans, and offers basic financial products like
certificate of deposits (CDs) and savings accounts to
individuals and small businesses.
Provides loans and earning interest income from those loans. The
types of loans a commercial bank can issue vary and may include
mortgages, auto loans, business loans, and personal loans. A
commercial bank may specialize in just one or a few types of loans.
HOW A COMMERCIAL BANK WORKS
A. Deposits – referred to as "core deposits", these are
typically the checking and savings accounts that so many
people currently have.
Largest source by far of funds for banks is deposits; money
that account holders entrust to the bank for safekeeping and
use in future transactions, as well as modest amounts of
interest.
In case the bank cannot attract customer through core deposits they offer:
1. Wholesale Deposits – higher cost of wholesale funding
means that a bank either has to settle for a narrower interest
spread, and lower profits, or pursue higher yields from its
lending and investing, which usually means taking on greater risk.
2. Current Account Deposits – such deposits are payable on
demand and are, therefore, called demand deposits. These
can be withdrawn by the depositors any number of times
depending upon the balance in the account.
3. Fixed Deposits (Time Deposits) – fixed deposits have a
fixed period of maturity and are referred to as time deposits.
These are deposits for a fixed term, i.e., period of time
ranging from a few days to a few years. They can be
withdrawn only after the maturity of the specified fixed
period. They carry higher rate of interest.  Lending Rate – the rate at which banks lend out.
4. Savings Account Deposits – These are depositing whose
main objective is to save. Savings account is most suitable for
individual households. They combine the features of both
current account and fixed deposits. Interest paid on savings
account deposits in lesser than that of fixed deposit.
B. Loans – are the primary use of their funds and the principal
way in which they earn income. Loans are typically made for
fixed terms, at fixed rates and are typically secured with real
property; often the property that the loan is going to be used
to purchase.
Bank loan officers decide which projects, and/or businesses,
are worth pursuing and are deserving of capital.
C. Consumer Lending
1. Mortgage Lending – mortgages are used to buy residences
and the homes themselves are often the security that
collateralizes the loan. These are typically written for 30-year
repayment periods and interest rates may be fixed,
adjustable, or variable.
2. Automobile Lending – is another significant category of
secured lending for many banks. Compared to mortgage
lending, auto loans are typically for shorter terms and higher
rates. 
3. Credit Cards – are another significant lending type and an
interesting case. Credit cards are, in essence, personal lines of
credit that can be drawn down at any time.
4. Home Equity Lending – a fast growing segment of
consumer lending for many banks. Home equity lending
basically involves lending money to consumers, for whatever
purposes they wish, with the equity in their home, that is, the
difference between the appraised value of the home and any
outstanding mortgage, as the collateral.
FEATURES OF COMMERCIAL BANKS:
1. Borrowing
2. Lending
All financial institutions are not commercial banks because
only those which perform dual functions of (1) accepting
deposits and (2) giving loans are termed as commercial
banks.
“Banks borrow to lend.”
Borrowing Rate – the rate of interest offered by the banks to
depositors.
The difference between the rates is called ‘spread’ which is
appropriated by the banks. 
 FUNCTIONS OF COMMERCIAL BANKS
1. Primary Functions
 It accepts deposits.
 Advancing Loans
2. Secondary Functions
 Transfer of funds
 General Utility Services
FINMAR – CA
  Agency Services
 Credit Creation
OPTIONS MARKET

Options Market – are financial instruments that are

derivatives based on the value of underlying securities such as
stocks.

These are financial derivatives that give buyers the right, but
not the obligation, to buy or sell an underlying asset at an
agreed-upon price and date.

Options Contract – offers the buyer the opportunity to buy or

sell—depending on the type of contract they hold—the
underlying asset.
HOW OPTIONS WORK:
Options are a versatile financial product. These contracts
involve a buyer and a seller, where the buyer pays an options
premium for the rights granted by the contract. Each call
option has a bullish buyer and a bearish seller, while put
options have a bearish buyer and a bullish seller.
Options Premium – is the current market price of an option
contract.
2 KINDS OF OPTIONS
1. Call Options – allow the holder to buy the asset at a stated
price within a specific time frame. Investors buy calls when
they believe the price of the underlying asset will increase
and sell calls if they believe it will decrease.
2. Put Options – allow the holder to sell the asset at a stated
price within a specific timeframe. Investors buy puts when
they believe the price of the underlying asset will decrease
and sell puts if they believe it will increase.
Each option contract will have a specific expiration date by
which the holder must exercise their option.
Strike Price – the stated price on an option.
Options are typically bought and sold through online or retail
brokers.
ARE OPTIONS BETTER THAN STOCKS?
 Options Are Cheaper Than Stocks
it is a fact that options are significantly less expensive than
the securities on which they are based. Each option contract
gives you control of 100 shares of the equity, yet the cost to
purchase an option contract is nowhere near the expense of
buying an equivalent chunk of stock.
Options can be less risky for investors because they require
less financial commitment than equities, and they can also be
less risky due to their relative imperviousness to the
potentially catastrophic effects of gap openings.
Options are the most dependable form of hedge, and this
also makes them safer than stocks.

Key points:
Although there are many opportunities to profit with options,
investors should carefully weigh the risks.

MONEY MARKET
FINMAR – CA
It is a money market for short terms financial assets that are
close substitute for money, facilitates the exchange of money
in primary and secondary market. The money market is a
mechanism that deals with the lending and borrowing of
short-term funds.
A segment of the financial market in which financial instruments
with high liquidity and very short maturities are traded. It doesn’t
actually deal in cash or money but deals with substitute of cash like
trade bills, promissory notes and government papers which can be
converted into cash without any loss at low transaction cost.
FEATURES OF MONEY MARKET
 It is a market for short-term funds or financial assets
called near money.
 It deals with financial assets having a maturity period
of less than one year only.
 Money market transaction is done through oral
communication and writing communication
transaction.
 It is not homogeneous market, it comprises of
several submarket like called money market,
acceptance and bill market.
 The component of money market are commercial
banks and non-bank financial companies.
Kinds of Commercial papers
OBJECTIVES OF MONEY MARKET
 To provide a parking place to employ short-term
surplus funds
 To provide room for overcoming short-term deficits.
 To enable the central bank to influence and regulate
liquidity in the economy
 To provide a reasonable access to users of short-
term funds to meet their requirement quickly,
adequately at reasonable cost.
Certificate of Deposit
IMPORTANCE OF MONEY MARKET
 Development of trade and industry
 Development of capital market
 Smooth functioning of commercial banks
 Effective central bank control
 Formulation of suitable monetary policy
 Source of finance to government
INSTRUMENTS OF MONEY MARKET
1. Treasury bills
 The most marketable money market security.
 Issued with three-months, six-months, and one-year
maturities.
 Purchased for a price that is less than their par value;
when they mature, the government pays the holder
the full par value.
2. Certificate of deposit
 It is a time deposit with a bank
 It has specific maturity date, interest rate and it can
be issued in any denomination
 The main advantage of CD is their safety
3. Commercial Paper
 It is a short-term unsecured loan issued by a
corporation typically financing day to day operation.
It is a very safe investment because the financial
situation of a company can easily be predicted over a
few months Only company with high credit rating
issues CP’s
 It is not meant for the general public and hence,
there is a restriction on the advertisement to market
the securities.
 It is issued at a discount to the face value and upon
maturity; the face value becomes the redemption
value. The maturity ranges from 1 to 270 days (9
months) but usually, it is issued for 30 days or less.
1. Draft – a written instruction by a person to another
to pay the specified amount to a third party
2. Check – a special form of draft where the drawee is a
bank
3. Note – in this instrument, a promise is made by one
person to pay another certain sum of money to
another
4. Repurchase Agreement (Repos)
 It is a form of government borrowing and is used by
those who deal in government securities. They are
usually very short term repurchases agreement,
from overnight to 30 days or more.
 The short-term maturity and government backing
usually mean that Repos provide lenders with
extremely low risk.
 Repos are safe collateral loans.
5. Banker’s acceptance
 It is a short-term credit investment by a non-financial
firm
FINMAR – CA
 It is guaranteed by a bank to make payment
 Acceptances are traded at discounts from face value
in the secondary market
 BA acts as a negotiable time draft for financing
imports, exports or other transactions in goods

FINMAR – CA
 BOND MARKET
It is a debt financing contract that allows investors to lend
money to a borrower.
The borrowers are typically the government or corporations
who need additional capital or financing. The amount issued
by the investors are paid with interest at a given term, usually
at a fixed interest rate.
Features of Bonds
 Par value – the value stated on the face of the bond
which the company or government body promises to pay
at the time of maturity.
 Coupon rate – the rate of interest payable to the
bondholder
 Maturity date – the date at which the bond gets
matured, the principal amount is paid to the bondholder
 Redemption value – the value paid to the bondholder, at
the time of expiry of the term for which bond is issued.
Features of Debt Market
 Efficient mobilization and allocation of resources in the
economy.
 Financing development activities of the Government
 Transmitting signals for implementation of monetary
policy.
 Facilitating liquidity management in tune with overall
short-term and long-term objectives.
Monetary Policy
It is the monitoring and control of money supply by a central
bank, such as the Federal Reserve Board in the United States
of America, and the Bangko Sentral ng Pilipinas in the
Philippines. This is used by the government to be able to
control inflation and stabilize currency. Monetary policy is
generally the process by which the central bank, or
government controls the supply and availability of money,
the cost of money, and the rate of interest.
Monetary Policy Instruments
1./ Open Market Operations – consist of repurchase and
reverse repurchase transactions, outright transactions, and
foreign exchange swaps. “In Purchase transactions, the Bangko
Sentral buys government securities with a dedication to sell it back
at a specified future date, and at a predetermined interest rate.”
The BSP’s payment increases reserve balances and expands
the monetary supply in the Philippines:
Reverse Repurchase – the government acts as the seller and
works to decrease the liquidity of money. These transactions
usually have maturities ranging from overnight to one month.
Outright Transactions – when the BSP buys securities, it pays
for them by directly crediting its counterparty’s Demand
Deposit Account with the BSP. The reverse is done upon the
selling of securities.
Foreign Exchange Swaps – This refers to the actual exchange
of two currencies at a specific date and the reverse exchange
of the currencies at a farther date in the future, also at an
interest rate agreed on deal date.
2./ Standing Facilities – To increase the volume of credit in
the financial system, the BSP extends loans, discounts, and
advances to banking institutions. Rediscounting is a standing
credit facility provided by the BSP help banks meet temporary
liquidity needs by refinancing the loans.
3./ Reserve Requirements – In banking institutions, there
are required amounts that banks cannot lend out to people.
They always need to maintain a certain balance of money,
which are called “reserves”. Once these reserve
requirements are changed and are varied, changes in the
monetary supply will be observed greatly.
Types of Bonds
Corporate Bonds – bonds issued by corporations, limited
liability companies, and other commercial enterprises.
Corporate bonds often offer higher yields than other types of
bonds, but the tax code is not favorable to them.
Municipal Bonds – bonds issued by state and local
governments.
Government Bonds – Issued by government agencies, e.g.
Pag-ibig or the Home Development Mutual Fund. It is a type
of debt-based investment where you loan money to
government in return for an agreed rate of interest. It is used
to raise funds that can be spent on new projects or
infrastructure.
Treasury Bonds – Debt investments with long term maturity
of more than one year. According to the Bureau of Treasury,
there are currently fie maturities of Treasury Bonds: 2, 5, 7,
10 , 20 year
Treasury Bills (T-Bills) – Debt investments with short term
maturity of less than a year.
FINMAR – CA
 MORTGAGE MARKET
A long-term loan secured by real estate and an amortized
loan whereby a fixed payment pays both principal and
interest.
A mortgage in a form of debt that finances investments in
property.
Types of Mortgages:
1. Residential Mortgage
2. Commercial Mortgage
Acceptable Collateral for Mortgages
The real estate properties that can be mortgage can be
divided into two broad categories:
1. Single family (one-to-four-family) residential
 House
 Condominiums
 Cooperatives
 Apartments
2. Commercial properties
 Multifamily Properties e.g., apartment buildings
 Office buildings, industrial properties, warehouse,
shopping centers, hotels, etc.
Types of Mortgage Loans
1. Insured vs. Conventional Mortgages – If the down
payment is less than 20%, insurance is usually
required.
2. Fixed-Rate Mortgages – The interest is fixed for the
life of the mortgage.
3. Adjustable-Rate Mortgages – The interest rate can
fluctuate within certain parameters.
Repayment of Term Loans
1. Equal Principal Payment – the loan is repaid in equal
amounts of principal.
2. Equal Amortization – the loan is repaid in equal
installments.
3. Balloon Payment – the loan is repaid in equal
installments for a number of years, then, a large and
final payment is made at maturity date.
4. Deferred Payment with grace period – the payment
of principal under this program is deferred, although
payments on interest are made. A variation of the
deferred payment plan allows the borrower a grace
period during which the payment of principal is
deferred.
VALUATION OF LONG-TERM SECURITIES
Value – Liquidation value represents the amount of money
that could be realized if an asset or group of assets is sold
separately from its operating organization.
Liquidation value – the price of an asset when it is allowed
insufficient time to sell on the open market, thereby reducing
its exposure to potential buyers. It is the total worth of a
company’s assets when it goes out of business or if it were to
go out of business.
Generally, there are four levels of valuation for business
assets:
1. Market value
2. Book value
3. Liquidation value
4. Salvage value
“Liquidation is the difference between some value of
tangible assets and liabilities.”
Assume that ALVIN Corporation had Php550,000
liabilities. The book value of assets found on the balance
sheet is Php1,000,000.00, the salvage value is Php 50,000.00
and the estimated value of selling all assets at auction is Php
750,000.00
The liquidation value is calculated by subtracting liabilities
from the auction value.
Php 750,000.00
(Php 550,000.00)
Php 200,000.00 (liquidation value)
Going-concern value – represents the amount a firm could be
sold for as a continuing operating business; the value of a
company under the assumption that it will continue to
operate for the foreseeable future; this is in contrast to
liquidation value, which assumes the company is going out of
business.
Book Value represents either:
(1) an asset: the accounting value of an asset (the asset’s cost
minus its accumulated depreciation)
(2) a firm: (total assets minus liabilities and preferred stock as
listed on the balance sheet.)
FINMAR – CA
Market value – represents the market price at which an asset
trades and the highest estimated price that a buyer would
pay, and a seller would accept for an item in an open and
competitive market.
Intrinsic Value – represents the price a security “ought to
have” based on all factors bearing on valuation. It is the
actual value of a company, or an asset based on an underlying
perception of its true value including all aspects of the
business, in terms of both tangible and intangible factors.
Is the value the same as the current market value? – No.
Salvage Value – the estimated resale value of an asset at the
end of its useful life. And it is used as a component of the
depreciation value.
Important Bond Terms
Bond – a long-term debt instrument issued by a corporation
or government; it is issued with a stated value, known as the
par, or face value; is the value at which the bond will be
bought back by the issuer upon its maturity and bonds are
issued with a 1,000-par value.
The maturity value (MV) [or face value] of a bond is the
stated value.
Most individual bonds have five features when they are
issued:
 issue size
 issue date
 maturity date
 maturity value
 coupon
Issue size – reflects both the borrowing needs of the entity
issuing the bonds, as well as the market’s demand for the
bond at a yield that’s acceptable to the issuer.
Maturity value – the amount payable to an investor at the
end of a debt instrument’s holding period (maturity date)
Why is a bond issued?
 To raise money for some purpose
 Corporations issue bonds to raise money to run the
business.
 Government entities may issue bond to pay for a
project.
 Every bond is issued with a specific face amount.
 The face amount of the bond is the amount an
investor receives at maturity.
 The maturity date of a bond is the date that the
issuer must repay the face amount.
 All of the details of the bond are listed on a bond
certificate.
 If you buy Php 10,000, 6% IBM Corporate bond due
in 10 years, all of those details will be listed on the
electronic bond certificate. 10,000 x 6% x 10 = 6000
The formula to calculate interest earned is (principal amount
multiplied by interest rate multiplied by time period)
Bond’s coupon rate – the stated rate of interest; the annual
interest payment divided by the bond’s face value.
Coupon Rate
 The yield paid by a fixed income security.
 A fixed-income security’s coupon rate is simply just
the annual coupon payments paid by the issuer
relative to bond’s face or par value.
 Coupon rate is the yield the bond paid on its issue
date.
Discount Rate (Capitalization Rate)
 is dependent on the risk of the bond and is
composed of the risk-free rate plus a premium for
risk.
 It is the interest used to price bonds via present
valuation calculations.
 It is also referred to as the bond’s yield to maturity
and is the return required to entice an investor to
invest in the bond.
Different Types of Bonds
1. Perpetual bond
 is a bond that never matures. It has an infinite life.
 it may be treated as equity, not as debt.
 Issuers pay coupons on perpetual bonds forever, and
they do not have to redeem the principal.
2. Zero-coupon bond
 is a bond that pays no interest but sells at a deep
discount from its face value; it provides
compensation to investors in the form of price
appreciation.
 Since the entire payment is at maturity zero coupon
bonds tend to fluctuate in price much more than
coupon bonds.
FINMAR – CA
FINMAR – CA