MABINI COLLEGES, INC.

Daet, Camarines Norte

COLLEGE OF BUSINESS ADMINISTRATION

And ACCOUNTANCY
1st Sem., S.Y.2022-2023

GEC Elect 2 – Business Finance

MODULE 4
Title: FINANCIAL MARKETS

Name of Student:
Course/ year:
Class Schedule:
Date Submitted:

In Module 4, you will learn about the Financial Markets. Awareness of the environment
where the business operates provides a better perspective to the one making decisions relating to
the finance function. An important concern refers to financial markets which perform a vital role in
the operation of the overall financial system including business finance.

After completing this module, students must have:

● Know what are financial markets and its benefits
● Learn why firms invest and borrow
● Determine the methods by which financial market transfer funds
● Know the classification of financial markets

FINANCIAL MARKETS

A. WHAT ARE FINANCIAL MARKETS

There are lots of individual and firms with surplus funds. This actually means that their
current expenditures are smaller than their current incomes. To many of them, the surplus funds
need to be invested.

At the same time, there are people and firm whose needs for funds are greater than their
current incomes. They need a reliable source of loanable funds.

Individuals and firms who want to borrow money are brought together with those who want
to lend in the financial markets. These markets provide a permanent venue for savers and borrowers,
and which render financial services whenever required by their customers. These services are made
possible by the financial markets through expediting the creation and trading of financial
instruments.
 Figure 4 shows an illustration of how funds and financial instruments are channeled to and
from the surplus spending units (SSUs) and the deficit spending units (DSUs) in the financial markets .

B. BENEFITS OF FINANCIAL MARKETS

The operation of financial markets offer advantages which covers the following:

1. funds are directed to DSUs which can use them most efficiently; and 2. liquidity is provided to
savers.

DIRECT FINANCING

Private placements
Direct Credit Market Brokers

Dealers
Investment bankers Primary Securities
Funds

Funds

SURPLUS SPENDING Primary Securities DEFICIT SPENDING

UNITS UNITS
Households Households, Govt.

Business Firms

Government Secondary Securities Business Firms

Funds INDIRECT FINANCING BY

FINANCIAL INTERMEDIARIES Primary Securities
Commercial banks
Funds
Savings and loans Associations
Mutual savings banks
Credit unions
Insurance companies
Pension funds
Finance companies
Mutual funds
Money market funds

Intermediation Market Indirect Credit Market

Figure 4. Channels for Funds and Financial

Instruments in the Financial Market
 Financial markets, just like any market, operate under the influence of the demand and
supply of funds. DSUs that can use borrowed funds in the most productive manner can afford to pay
higher interest rates. Because of this, they have an edge in the bidding for loanable funds. As such,
business firms, big and small, compete for the use of the funds made available by the financial
market. The competition will push interest rates higher and this will motivate savers to save more so
they will have more funds for lending.

An additional benefit provided by financial markets is liquidity. Without the intervention of

financial markets, savers will directly lend to borrowers. This arrangement forces the lender to wait
for the maturity date of the loan before he gets his money back. The lender will be at a great
disadvantage if he finds out later that he needs the loaned amount before maturity. This problem is
eliminated when financial markets are tapped. This happens because financial instruments are issued
to lenders, which in turn, can be converted to cash even before maturity, by endorsement or sale.

C. WHY FIRMS INVEST AND BORROW

Firms, at one time or another, are confronted by capital deficiency. This happens when
opportunities for investment come by. Additional investment may bring additional income or
economies in operation. An electronics-retailing firm, for instance, may expand by opening branches
in various places. The immediate advantages that may be derived are as follows:

1. quantity discounts for bulk purchases granted by suppliers; and

2. additional revenues from sales

When the owners of the firm cannot provide additional capital, they will resort to borrowing.
This situation happens not only to small firms but to big firms as well.

A system must be able to address that particular economic need. The answer lies in the
operation and maintenance of a financial system, which includes financial markets.

D. METHODS BY WHICH FINANCIAL MARKETS TRANSFER FUNDS

When firms need funds, the financial markets provide two methods by which funds could be
transferred to them. The methods consist of direct and indirect finance.

1. Direct Finance

Direct finance refers to lending by ultimate borrowers with no intermediary. Under this method,
the SSU gives money to the DSU in exchange for financial claims on the DSU. The claims issued by the
DSU are called direct claims and are typically sold in direct credit markets such as money or capital
markets.

Direct financing provides SSUs with a venue for savings with expected returns. The DSUs as a
result, are provided with a source of funds for consumption or investment. This arrangement
increases the efficiency of the financial market.

Direct financing however, has some disadvantages. These are as follows:

1. There are few DSUs which can transact in the direct market because the denominations of
securities sold are very large (usually millions of pesos).
 2. It is difficult to match the requirements of SSUs and DSUs in terms of denomination,
maturity, and other factors.

Methods of Direct Financing. There are various means used in direct financing. These are as follows:

1. private placements;

2. brokers and dealers; and

3. investment brokers.

Private placement refers to the selling of securities by private negotiation directly to

insurance companies, commercial banks, pension funds, large-scale corporate investors, and wealthy
individual investors.

A broker is one who acts as an intermediary between buyers and sellers but does not take
title to the securities traded.

INDIRECT FINANCE

FINANCIAL INTERMEDIARIES

Funds Funds Funds

Lenders-savers Borrowers- Spenders

1. Households 1. Business Firms

2. Business Firms FINANCIAL 2. Government

3. Government MARKETS 3. Households

4. Foreigners Funds Funds 4. Foreigners

DIRECT FINANCE

Figure 5. Transfer of Funds from Lenders to Borrowers

A dealer is one who is in the security business acting as a principal rather than an agent. The
dealer buys for his account and sells to costumers from inventory. He makes profits by selling his
inventory of securities at a price higher than acquisition cost.

The investment banker is a person who provides financial advice and who underwrites and
distributes new investment securities.

2. Indirect Finance

Indirect finance (also called financial intermediation) refers to lending by an ultimate lender
to a financial intermediary that then relends to ultimate borrowers. Financial intermediaries include
commercial banks, mutual savings banks, credit unions, life insurance companies, and pension funds.

The beneficiaries of direct financing brought to the fore the services of financial
intermediaries. Direct claims with one set of characteristics are purchased from borrowers, then
transformed into indirect claims with a different set of characteristics and then sold to lenders.
E. CLASSIFICATION OF FINANCIAL MARKETS

Financial markets may be classified as follows:

1. primary market

2. secondary market

3. money market

4. capital market

5. bond market

6. stock market

7. mortgage market

8. consumer credit market

9. auction market

10. negotiation market

11. organized market

12. over-the-counter market

13. spot market

14. futures market

15. options market

16. foreign exchange market

1. Primary Market. A financial market in which newly issued primary and secondary securities are
traded for the first time is called primary market. Investors who buy these new issues are supplying
funds to DSUs which issue the securities.

Large corporations needing large amount of funds usually tap the primary market through
bond issuance.

2. Secondary Market. A secondary market is that financial market through which existing financial
securities are traded. SSUs which bought new securities from the primary market may sell the same
to the secondary market anytime they wish to change their portfolios before maturity dates. As such,
the secondary market provides liquidity to the SSUs with securities held.

When banks buy Treasury bills (T-bills) from the Bangko Sentral, they do so in consideration
of their clients who buy the T-bills from them and which forms a solid secondary market. Figure 6
shows the flow of funds and securities in the primary and secondary markets.

3. Money Market. The money market is that financial market on which debt securities with an
original maturity of one year or less are traded. Long- term securities may also be traded in the
money market if they have six months or less left to maturity.

Banks like the Land Bank of the Philippines perform money market functions.
 PRIMARY MARKET: New Issues

Investment Bankers and

Money Invested Private Placement New Funds

New Common Stock New Stock

and Bond Certificates and Bond Certificates

Household Business
Sector Money Sector
Common Stock and

Bond Certificates

Common Stock and

Bond Certificates

Stock Exchanges and

Money Over-the-counter

Market

SECONDARY MARKETS: Seasoned or Existing Issues

Figure 6: The Flow of Funds and Securities in

Primary and Secondary Markets

4. Capital Market. The capital market is that portion of the financial market where trading is
undertaken for securities with maturity of more than one year. Banks that bid for two-year Treasury
bonds are considered part of the capital market.

The capital market is subdivided into three parts:

1. the bond market;

2. the stock market; and

3. the mortgage market.

5. Bond Market. The market for debt instruments of any kind is called the bond market. It operates
through a system of dealers using a telecommunications network, rather than in a single physical
location for trading. Dealers include giant banking firms located around the world.
6. Stock Market. The stock market is that financial market where the common and preferred stocks
issued by corporations are traded. It has two components: (1) the organized exchanges; and (2) the
less formal over-the-counter markets.

There are many organized exchanges throughout the world like the New York and the
London Stock Exchanges. In the Philippines, stocks are openly traded in the Philippines Stock
Exchange. The companies whose stocks are traded in the Philippine Stock Exchange are classified into
the following categories:

1. banks

2. financial service

3. communication

4. power and energy

5. transportation services

6. construction and other related products

7. food, beverages, and tobacco

8. holding firms

9. manufacturing, distribution and trading

10. hotel, recreation, and other services

11. bonds, preferred stocks, and warrants

12. others

7. Mortgage Market. The mortgage market is that portion of the financial market which deals with
loans on residential, commercial, and industrial real estate, and on farmland.

Various financial institutions comprise the mortgage market. This may be derived from a
review of advertisements in newspapers where financial institutions are inviting interested parties to
buy foreclosed properties. Aside from banks, the National Home Mortgage Finance Corporation
(NHMFC), the Government Service Insurance System (GSIS), and the Social Security System (SSS)
grant mortgage loans, secured by house and lot as collaterals.

8. Consumer Credit Market. The market involved in loans on autos, appliances, education, travel is
referred to as the consumer credit market. As there are millions of consumers tapping the credit
market, it is expected that there will be a number of financing institutions extending auto, salary and
various personal loans to consumers.

9. Auction Market. The auction market is one where trading is conducted by an independent third
party according to a matching of prices on orders received to buy and sell a particular security. Stocks
are sold to the highest bidder on the trading floors.
 At the Philippine Stock Exchange, buyers of securities make their bids and prospective sellers
make their offer. Bids and offers stipulate both price and volume and are handled by the trader, an
agent of the auction market.

Offers are ranked from the lowest price up; bids from the highest price down. Bids and offers
are matched with one another. If there is a match, trade is consummated. Buyers and sellers do not
directly trade with one another, but through the trader.

The Philippine Stock Exchange is an example of an auction market.

10. Negotiation Market. When buyers and sellers of securities negotiate with each other regarding
price and volume, either directly or through a broker or dealer, they are engaged in the financial
market called negotiation market.

Securities that are not frequently traded and which are in large volumes may not be readily
accommodated in the auction market for lack of time to receive sufficient orders. This situation is
remedied by the negotiation market where the buyers and sellers are given sufficient time to locate
one another and to revise either price or volume in order to clear the market.

Once in a while, the Philippine government negotiates with institutions like the World Bank
for loans intended for various projects.

11. Organized Market. The organized market is that financial market with fixed trading rules. It is
situated in central location in the financial district in which trading is generally conducted by auction.
Another name for organized markets are exchanges like the Philippine Stock Exchange and the
Australian Stock Exchange. Common and preferred stocks, bonds, and warrants are sold at the
Philippine Stock Exchange.

Stock exchanges have specifically designated members, and have an elected governing body
– the board. Members have seats in the exchange, which are bought and sold. The seat gives the
holder the right to trade on exchange. The board of governors of the Philippine Stock Exchange is
composed of 15 members.

12. Over-the-counter Market. The over-the-counter market is that market consisting of large
collection of brokers and dealers, connected electronically by telephones and computers that provide
for trading in unlisted securities. All securities not traded in the stock exchange, for one reason or
another, are traded over the counter.

The over-the-counter market consists of facilities, namely;

1. relatively few dealers who hold inventories or over-the-counter securities and act as a
securities market;

2. the many brokers who act as agents in bringing these dealers together with investors; and

3. the computers, terminals, and electronic networks that provide a communications link
between dealers and brokers.

13. Spot Market. When securities are traded for immediate delivery and payment, the market type
referred to is the spot market. The spot price is the feature of the spot market and which is actually
the price paid for a security that will be delivered on the spot immediately. The term immediately
may actually mean one or two days to one week depending on the facilities used or the tradition in
the area.

The spot market is an alternative to the futures market.

14. Futures Market. The futures market is that markets where contracts are originated and traded
that give the holder the right to buy something in the future at a price specified by the contract.

For some time in the past, there was a futures market operating in the Philippines, but it was
dissolved because of some difficulties. As its importance cannot be discounted, the Bankers
Association of the Philippines has recommended key reforms in government regulations that will
pave the way for the resumption of futures trading in the country.

15. Options Market. The options market is one where stock options are traded. A stock option is a
contract giving the owner the right to either buy or sell a fixed number of shares of a stock (usually
100) at any time before the expiration date at a price specified in the option.

Option contracts may cover items like gold and Treasury bonds. Options are traded in
organized securities exchanges like the Philippine Stock Exchange.

One purpose of the options market is to make possible for investors who wish to reduce the
risk of losing money due to price changes in the future. For instance, an importer purchasing goods
to be paid in foreign currency may avoid the risk of a sharp rise in the foreign exchange rate by
buying an options contract.

16. Foreign Exchange Market. The foreign exchange market is the market where people buy and
sell foreign currencies. This market is composed of the following:

1. banks located throughout the world buying and selling foreign monies, in the form of foreign
currencies and deposits in foreign banks;

2. foreign exchange dealers; and

3. currency exchanges catering mostly to tourists and are found in the downtown areas, airports, and
railroad stations in major tourist centers.

Discuss your answers on the following questions briefly:

(If means of learning and teaching is done online, the following questions will be asked to students
during video conference or be posted by the teacher in the Google Class Stream/ Wall as a discussion
point.)

1. Why is knowledge of financial markets an important requirement in business finance?

2. What methods do financial markets use to transfer funds?

3. What is traded in the money market?

4. How does funds and securities flow in primary and secondary markets?
 5. What situation is remedied by the negotiation market?

Prepare a list of financial intermediaries in your area providing indirect financing.

(In Google Classroom, this will be posted as a written task. There will be a deadline to be set for the
submission of answers)

True or False. Write I like to if the statement is True and Move it if the statement is False.

_____________ 1. Financial markets transfer funds directly or indirectly.

_____________ 2. Financial markets are useful in two aspects: (1) funds are directed to DSUs which
can use them most efficiently; and (2) liquidity is provided to savers.

_____________ 3. The options market is that financial market with fixed trading rules.
_____________ 4. The mortgage market is that portion of the financial market which deals with
loans on residential, commercial, and industrial real estate, and on farmland.

_____________ 5. Direct finance refers to lending by an ultimate lender to a financial intermediary

that then relends to ultimate borrowers.
_____________ 6. Direct finance refers to lending by ultimate borrowers with no intermediary.
_____________ 7. The foreign exchange market is the market where people buy and sell foreign
currencies.
_____________ 8. The options market is that market consisting of large collection of brokers and
dealers, connected electronically by telephones and computers that provide for trading in unlisted
securities.

_____________ 9. When buyers and sellers of securities negotiate with each other regarding price
and volume, either directly or through a broker or dealer, they are engaged in the financial market
called negotiation market.

_____________ 10. The market for debt instruments of any kind is called the stock market.