LESSON 1

Financial Markets Derivative Market (DM)

 involves buying and selling of financial assets such Trading of Financial Risk
as Securities, Bonds, Stocks Most Risky or Very Aggressive risk
 The main goal is to combat inflation(decrease of the Greater Return
value of money)
F – Futures: Agreed price and date
 To alleviate the risk corresponding to inflation
F – Forwards: Similar but traded OTC
 An asset can easily grow in the financial market
O – Option: Specific date and rate
 It is a highly liquid environment
S – Swap: Exchange of Financial Obligations
Purpose of Financial Markets
ETD (Exchange Traded Derivatives) – contracts that are
P – Puts savings into more productive use managed and regulated
D – Determines the price of securities OTCD (Over The Counter Derivatives) – private
M – Makes financial assets liquid agreements between the investor and investee
L – Lowers cost of transaction
Financial Institutions
BSP (Bank Sentral ng Pilipinas) – They regulate the
These are institutions that participate in the sale of
Financial Markets
financial assets
PSE (Philippine Stock Exchange) – Place of trade
These institutions help individuals and companies to
Primary Market – it is where stocks and securities are fulfill their requirement, for their purposes.
issued first time
Banks, Credit Unions, Community Development
IPO (Initial Public Offering) - is referred to products sold
Financial Institutions, Utilities, Government Lenders,
in this market
Specialized Lenders
Secondary Market – it is where stocks and securities
Insurance Co.: AXA, Pru, Manu, Sun life
previously issued/bought are sold
Banks: BDO, BPI, Security Bank, PNB, ChinaBank
Examples:
NYSE – New York Stock Exchange LESSON 2
NESDAQ – National Association of Securities Dealer
Interest
Automatic Quotation System(US based)
PSE – Philippine Stock Exchange The borrowing cost of money
Return of Investment
Money Market (MM)
Nominal Rate – most common interest rate from the
 Short term newly issued securities
banks. Adjustments for individual securities is due to
 It has a low risk or Conservative
the different demand for each security.
 Only large players can trade it
 Debt Securities Opportunity Cost – cost of giving up a thing in exchange
for another
Capital Market (CM)
Nominal Rate vs Real Rate
 Long term previously issued securities
 It has a high risk or Aggressive Nominal Rate Real Rate
 Can be traded by anybody Fair Value/Market Value Real Cost
 Equity Securities Not Adjusted to Inflation Adjusted to inflation

FOREX (Foreign Exchange) Side notes:

Conducts direct currency exchange Nominal Rates are often hidden due to the inflation of
Philippines do not have FOREX except banks money. The banks adjust on inflation to secure benefit
from interest. Using real rate help them to safely
traverse inflation.
The financial crisis in US was caused by banks using
nominal rates. When debtors/mortgagor left their
mortgages, the banks were faced with extreme money
deficit as they got less money, dropping the price of
debt in the market. Cancelled mortgage is referred to as
Default
Loanable Funds Theory
The movement of interest rate as it changes with the
demand supply of loans.
Demand is directly affecting the inflation. When there is
an increase in demand of loans, interest on such also
increase
Demand is inversely affecting the inflation. When there
is an increase in supply of loans, interest on such
decreases.
These changes serve as regulation on
borrowing/lending economy. If BSP increases the
purchasing power of peso through an increase in
interest rate and decrease it to lower the purchasing
power. BSP can also increase the amount of money in
circulation to decrease the purchasing power of peso
Banks also increases interest rate to combat inflation,
specifically by combating the decrease of Purchasing
power of money.
When supply of loan is high, interest decrease to
encourage to borrowings. It therefore increases
demand
When supply of loan is low, interest rate is increase to
discourage borrowings. It therefore decreases demand
RATES FOR INDIVIDUAL SECURITIES
Default Risk Premium – When it is lower, it means that
the company has a higher capacity to pay of its debt
Unbiased expectation theory -
Liquidity Premium theory – long term interest rate are
geometric ave
Market Segmentation theory – intereset rates are
determined by distinct supply and demand conditions
within many maturitie
Forward Rate
Expected rate on a short term security that is to be
originated at some point.
Time value of money and interest rate
A money received today is not worth the same in the
future.
Simple intereset – is not reinvested
Compound interest – is reinvested

One of a Kind – Special items Present Value of a Lump Some

When mortgagors fail to pay their mortgage, the banks PV = FVtI(1+r)t

will be selling the property for a lower price and lower
Future Value
interest rate.

Determinants of Household saving:

Present Value of Annuity
Interest rates and tax policy
Future value of Annuity
Greater wealth or income means that there is a greater
savings. N = number of compounding periods

If credit is always available then interest is low then

need for savings will lower

National Debt

The government need international loans because they

need fund for their projects

The also do this to so thea