FINANCIAL

MARKETS
AND
INSTITUTIONS
(BOOK ACTIVITIES: Chapters 5-9)
 CHAPTER 5

1. To have an efficient and strong financial system is to have a well-

developed and smoothly operating financial markets. It would create a

growing and prosperous economy in our country. A developed financial

system will channel funds from people who save to people who have

productive investment opportunities.

2. Financial system comprises many different types of private sector

financial institution, including banks, insurance companies, finance

companies, mutual funds, and investment banks.

3. The financial system consists of two; the financial intermediaries and

financial markets. They have relations to the flow of funds to and from

the households, governments, private sectors and even to foreigners that

gives us well functioning financial system. The financial infrastructure

also gives economic development in our country.

4. In the left, the lender or lending funds while on the right part of the flow

of funds are the borrowers who need funds to finance their spending.

The principal lender-savers are households, business firms, government

and foreigners, sometimes they lend some funds when they have excess

fund. They also borrow money to finance their purchases for their

business needs or necessity. They also directly borrow funds from

lenders in financial markets by selling them financial instruments.

5. The key components of financial system are; Financial Instruments,

Financial Markets and Financial Institutions, and The Central Bank and

Other Financial Regulators.

6. Describe the three important functions of the financial system, namely:

a) Risk Sharing – it allows a server to hold many assets to different

companies. They split their wealth into many assets to reduce the

risk they take it also known as diversification.

b) Liquidity – cash is the most liquid asset that which savers view

as a benefit. The bonds, stocks and checking accounts are also

liquid asset that investors can easily sell.

c) Information – it is the collection of facts about borrower’s

expectations of returns on financial assets. Through information

to both savers and borrowers determined the prices of stocks,

bonds and other securities.

7. Asymmetric information is the situation where one party in the

economic transaction has better information than the other party. For

instance, the borrower digs so much information to his lender before he

asks for funds unlike the lender who doesn’t dig more information to his

borrower.

8. Describe the two problems arising from asymmetric information,

namely:
 a) Adverse selection – the savers has a problem to distinguish the

low-risk and high-risk borrower because they may not have the

time to dig more information.

b) Moral hazard – if ever the lender digs more information about

his borrower he still doesn’t guarantee that the borrower uses the

funds as intended. The borrower may manipulate or conceal his

information.

9. The transaction cost is the cost of a trade or a financial transaction that

includes the commission fees and the cost of physically moving the

asset from seller to buyer. Meanwhile, the information costs are a fee to

servers who make time to get the information and the creditworthiness

of a borrower and monitor how they use their funds. These two create

profit opportunity for individuals and firms.

10. Explain how financial intermediaries

a) Reduce “Adverse Selection” – it can be minimized by requiring

borrowers to disclose material information. They can collect

information on firms and selling that information to investors.

Last, is to convince lenders to require borrowers to pledge some

of their assets as collateral which the lender can claim of the

borrower defaults.

b) Moral “Hazard Problem” – monitor their borrower on how they

can use their funds effectively. They can also impose restrictive
 covenants that will place limitations on the uses of funds and

when the borrower’s net worth drops they should pay off their

debt to the lender.

c) Reduce “Transaction and Information Costs” – the financial

intermediaries take advantage of economies of scale that reduces

average cost when the volume of goods and services increased.

They also take advantage of technology to provide financial

services.

CHAPTER 6

1. A commercial bank is a financial institution that accepts deposits and

lending funds. They generally finance trade and commerce with short-

term loans. Meanwhile, the universal bank is financial service that

provide all the facilities that both a commercial bank and an investment

bank. It has limited facility and offers loan and investment products.

2. The three (3) government banks are:

a) Development Bank of the Philippines (DBP)

b) Land Bank of the Philippines (LBP)

c) Philippine Al-Amanah Islamic Investment Bank.

3. Which is not a thrift bank?

d. Cooperative banks

4. A bank which caters to farmers businessman and cottage industries in

the rural areas.

a. Rural bank

5. Which is not a government bank?

C. Philippine National Bank

6. Which is not a government agency that regulates financial institutions?

D. Bureau of Internal Revenue

7. Explain briefly how the following regulatory agencies intend to align

their policies, roles and practices with global standards

a) BSP – they released Circular no. 975 in October 2017 for the

requirements on the issuance of bonds and commercial papers by

banks and quasi-banks. Additionally, the Circular nos. 984 and

985 in December 2017 in furtherance of liberalizing the foreign

exchange (FX). As a result, they became a BIS-reporting country

as they completed the requirements that will allow them to access

in detailed information on cross-border exposures of other

countries to the Philippines.

b) SEC – they propose the creation of a unit for handling rules,

regulations, guidelines and policies concerning the anti-money

 laundering and counter terrorist financing for covered entities.

Considering the crypto-currency and virtual currencies is rising.

c) Insurance Commission – they priority is the adoption of

international reporting practices. They also keeping reserves to

pay policyholders in case of solvency. As they prepare for the

implementation of PFRS by the FRSC that will be applied to

insurance company.

8. Discuss briefly the following current risks in the Philippine Financial

system

a) Repricing, refinancing and repayment risks – domestic

economies are affected by the global developments. By

normalization of US monetary policy, slowdown in global growth

and international trade, and the higher debt levels across

countries. The most affected are the small and open economy

such as the Philippines which is price taker than price setter.

b) Developments in the credit market – the loan portfolio of

banking system increased significantly over the years and funded

by peso deposits. It would be having to borrow in Philippine peso

and to invest these in US dollar instruments.

c) Increasing demand for credit by corporate business and

households – it is for local economic activity. This is need to get

 a better handle of household debt outside the formal sector. This

is a debt service burden issue and is at the core of 3Rs or

repricing, refinancing and repayment risks.

CHAPTER 7

1. Financial Markets is the meeting place for people, corporations and

institutions that either need money or have money to lend or invest. It is

also an organized institutional structure or mechanism for creating and

exchanging financial assets.

2. The public financial market where the stocks or financial instruments

are traded in stock exchange and has held an initial public offering.

These are available for the public. Meanwhile, the corporate financial

market their financial instruments were being traded privately or it does

not being traded in public. Only the shareholders can buy their financial

instruments.

3. Primary market, the original sale of securities by government and

corporations. It is not well-known to public because the selling of

securities to initial buyers often takes place behind closed doors. The

public offerings and private placements are the types of primary market.

Meanwhile, the secondary market is also known as Stock Market or

Exchange. It is place where securities are being sold to the public. The
 prices in secondary market are continually changing based on

corporation’s prospects.

4. The basic function of financial market is to become the vast global

network of individuals and financial institutions together by moving

funds from those who have a surplus of funds to those who have

shortage of funds. It serves as the source of funds for households,

business, government, and foreigners.

5. The two principle sources of funds in the financial market are the debt

instrument and equity instrument. The debt instrument is a contractual

agreement by the borrower to pay the holder. It may be bond or a

mortgage. It comprises of interest and principal payment and maturity

date. However, the equity instrument is the share in the net income or

asset of a company. It may be common or preferred stocks.

6. The organized stock exchange has a place of physical location where

buying of stocks and selling of transactions takes place. For examples,

Philippine Stock Exchange, Japan Nikkei and other largest corporations

usually use this. Then, the over the counter (OTC) exchange the shares,

bonds and other financial transaction takes place using the system of

computer or phone. Common stocks usually using over the counter like

NASDAQ.

7. Attributes of financial markets that investors as well as creditors are

looking for:
  Liquidity, trading is easier and spreads are narrower in more

liquid markets because it benefits almost everyone.

 Transparency, availability and complete information about

trades and prices.

 Reliability, ensures the traders are transparent and according to

the terms agreed.

 Legal procedures, authorized to settle query and enforce

contracts.

 Suitable investors protection and regulation, for investor be

confident in the available information about securities they may

wish to trade.

 Low transaction costs, for investor to seek low cost as for the

trading cost can attract them.

8. Forces of changes in the financial markets for the last two to three

decades:

 Technology

 Deregulation

 Liberalization
  Consolidation

 Globalization

9. The code of ethics is a guide of principles that participants conduct

business honestly and with integrity. it is also benefited by both parties

because maintaining the public trust in the fairness of financial markets

allows it to function efficiently.

10. Stock Exchange is a place where stocks are being traded systematically.

It brings the buyer and seller of stocks and securities together. Its

purpose is to facilitate the exchange of securities between the buyer and

the seller either virtual or real market place.

11. Listing of securities means admission of securities to provide liquidity

and marketability to ensure effective monitoring of trading for the

benefits of all participants in the market.

12. The Philippine Stock Exchange can implement its own rules and

penalties on giving inaccuracy to the trading participants and listed

companies. The self-regulatory organization is for the safety and

integrity for both participants and bourse.

CHAPTER 8
Money Markets
1. Money market refers to the network of corporations, financial
institutions, investors and governments that deal with the flow of short-
term capital. It also for borrowing and lending money for three years or
less therefore their rates are lower than funds.
2. Money markets exists to provide loans that need to carry in day-to-day
operations for the financial institution and governments. They bring the
borrowers and investors together without the comparatively costly
intermediation of banks. They also make it possible for the borrower to
meet short-run liquidity needs.
3. Banks, they issue certificate with interest rate and fixed-term maturity of
up to five years if the deposits from savings account do not cover the
long-term loans and mortgages. Companies, they issue commercial
paper if they need to raise their money to cover they payroll or running
costs. Investors, financial instrument where they can invest if they seek
to invest large sums of money with low risk.
4. Types of money market instruments:
a) Commercial paper – short-term date obligation of a private
sector maturity is about nine months. Generally, with low default
risk as businesses have good credit standing.
b) Banker’s acceptances – promissory note by a non-financial firm
is their acceptance. Usually have a maturity of less than six
months.
c) Treasury bills – issued by national government that matures
within one year or less and known as T-bills. It is generally
default-free as government will exert all effort to pay.
d) Government agency notes – they are heavy borrowers in the
money markets. These includes development banks, education
lending agencies and agricultural finance agencies.
 e) Local government notes – they issue money market securities
varies greatly from country to country. There are also local
agencies are allowed to borrow only from banks and cannot enter
to money market.
f) Interbank loans – these loans are across international
boundaries and used by borrowing institution to re-lend to its
own customers.
g) Time deposits – interest bearing deposit at a savings institution
that has a specific maturity.

Capital Markets
5. Capital markets are financial market for trading long-term debt and
equity instruments are being traded. It includes bonds, stocks, and
mortgages that mature more than one year.
6. The primary issuers of capital market securities are the national and
local government and corporation.
7. Capital market trading occurs either in primary or secondary market.
The primary market where the original sale of securities by government
and corporations. Meanwhile, the secondary market where the sale of
previously issued securities takes place. It is also a place where
securities are being sold to the public.
8. Bonds is any long-term promissory note issued by the firm. A security
that represent the debt of a government or business promising to pay a
fixed interest to the holder of the bond for a definite period of time. The
issues of bond usually occur through public offering using an investment
bank serving as a security underwriter. The bonds can generally be sold
in a national market.
9. Advantages of issuing bonds:
a) Long-term debt is generally less expensive than other forms of
financing.
 b) Bondholders do not participate in extraordinary profit; the
payments are limited to interest.
c) Bondholders are no voting rights.
d) Cost of bonds are lower than those of ordinary equity shares.

Disadvantages:
a) Debt results in interest payments that can be force the firm into
bankruptcy, if not met.
b) Debt produces fixed charges, increasing the firm’s financial
leverage.
c) Debt must be repaid at maturity and thus at some point involves a
major cash outflow.
d) The typically restrictive nature of indenture covenants may limit
the firm’s future financial flexibility.
10. Bond’s internal rate of return or yield to maturity determined:
Approximate = Annual interest Payment + Principal payment – Price
of the bond
Yield No. of years to maturity
.6 (Price of the bond) + .4 (Principal payment)
11. Credit quality risk is the chance that the timely payment may not be
made by the bond issuer. The corporation may minimize it by
thoroughly check a new customer’s credit record, establish credit limits
and the borrower require to take out appropriate insurance.
12. The relationship between bond rating and expected rate of return is
indirect relationship. The poorer the bond rating, the higher the interest
rate demanded by investor.
13. Describe the following types of bonds:
a) Unsecured long-term bonds, is not a secured by a specific asset
wherein the issuer promise to repay but has no claim on specific
 collateral. Unsecured bond is a debentures, subordinated
debentures and income bonds.
b) Secured long-term bonds, it collateralized by assets such as
property, plant equipment or another income or asset. some types
are mortgage bonds.
c) Junk or low-rated bonds, rated BB or below. This bond offers
investors higher yields than bonds of financially sound
companies.
d) Floating rate or variable rate bonds, the interest payment
changes with market conditions. It becomes appealing to
investors and issuers when interest rates are unstable.
14. Ordinary or common stocks are securities that represent equity
ownership in a company. common stocks also have a voting right such
as the election of directors. Meanwhile, the preferred stocks have
preference over common stocks. It also shows ownership in a
corporation gives the holder a claim and has a fixed dividend.
15. Compare the features of bonds, ordinary equity shares and preferred
shares in terms of:
a) Ownership and control of the firm; Ordinary equity shares, has
voting rights and residual claim to income; preferred shares,
limited rights when dividends are missed; bonds, limited rights
under default in interest payments.
b) Obligation to provide return; ordinary shares don’t have one
(none); preferred shares received first before ordinary
shareholders; bonds contractual obligation.
c) Claim to assets in bankruptcy; ordinary shares have the lowest
claim of any security holder; preferred shares the first must be
satisfied are the bondholders and creditors; bonds have the
highest claim.
 d) Cost of distribution; ordinary share has the highest; preferred
share has the moderate; and bonds are the lowest.
e) Risk return trade off; ordinary share has the highest return and
risk; preferred shares are moderate in risk and return; and the
bonds are the lowest.
f) Tax status of payment by corporation; the ordinary and
preferred shares are not deductible and the bonds is Tax
Deductible Cost= interest payment x (1 - tax rate).
g) Tax status of payment to recipient; ordinary share, a portion of
dividend paid to another corporation is tax exempt; preferred
shares has the same in ordinary; bonds, where government bond
interest is exempted in tax.

CHAPTER 9
1. Factors that affect the value of a currency in foreign exchange markets
are:

 Inflation

 Interest rates

 Balance of payments

 Government intervention

 Other factors

2. Import and export has a great impact and influence into the Gross
Domestic Product (GDP), its exchange rate and its level of inflation and
interest rate. The more export that a country has the high in demand in
goods and thus, for its currency. in contrast, the more the import that a
country has the less the demand in goods and its currency. it also
depreciates or losses its value in terms of currency.
3. Spot exchange rate is an exchange rate on currency for immediate
delivery and the forward exchange rate is an exchange rate fixed today
for exchanging currency at some future date.
4. The translation exposure in term of foreign exchange risk is the changes
that may trigger losses on business transactions. It also known as
translation risk that gives impact to foreign exchange transaction’s cash
flow.
5. To study in the exposure of political risk of a multinational company is
to research the riskiness of a country to be more informed to not set up
in a country considered political risk. Then, buy political risk insurance.
To guard against risk is to manage credit risk. Ensure your supply chain
can withstand unplanned disruptions. And use risk management dollars
wisely.
6. LIBOR stands for London Interbank Offer Rate. LIBOR and U.S prime
rate are both interest rate that used as reference rated for various lending
and borrowing transactions. LIBOR is a floating rate that fluctuates
continually however, the U.S. prime rate is a fixed rate.