Financial Markets - Marvin Lascano - OCR - 1

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Fundamentals of
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- Financial Markets -
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Marvin V. Lascano, CPA, CFC,.MBA

Dr. Herbert C. Baron, CPA '
Andrew Timothy L. Cachero, CPA
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FUNDAMENTALS OF FINANCIALMARKET
Fundamentals of Financial Market
by
Marvin V. Lascano, CPA, CFC, MBA

Herbert C. Baron, CPA, DBA
Andrew Timothy L. Cachero, CPA
2019
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Financial Resource is vital in every company. This is c

company's life-blood. These resources can be generated in different
andcompany
the system. Financial management
to improve its monetary a key branch
is resources of manaa
in different for ° thatenable
broad goals:an
understand profit maximization
important and wealth
venue where thesemaximization It is '
types of wealth POrtant ât we
the Financial market. 3 were 9®nerated i,e
This book will discuss how financial resources flow to the business through
financial markets. It will also enable the readers of this book to have a grasp on
howfinancial markets play a role in economicdevelopment. The approach adopted
by this book is an integration to accountancy discipline and giving readers,
particularly B.S. Accountancy, B.S. Management Accounting, B.S. Finandal
Management and other related discipline an idea on how they can maximize the
opportunity as wellas understanding theirrole in thefinancial market environment,
particularly in the Philippine Setting and how it integrates to international markets.
The discussions of this book are designed to accommodate the different discipline
and integrate the thoughts for better appreciation. Add-on information in the form
of trivia were injected in Point of Information! boxes, new approach for exercises
and new case studies were included for better appreciation and learning of the
subject.
The Authors
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FUNDAMENTALS OF FINANCIAL MARKET
The Authors
MARVIN V. LASCANO, CPA, CFC, MBA
Marvin V. Lascano is a Certified Public Accountant and Certified Financial Consultant by

profession. He earned his degrees in Bachelor of Science in Accountancy and Master in Business
Administration major in Financial Management in Polytechnic University of the Philippines. He is
the Financial Regulation Department Head of the only public listed water and used water enterprise
in the Philippines, Manila Water Company. He has extensive experience and exposure on financial
modelling, corporate valuation, financial statement preparation and analysis, and business process
reengineering. He also undergo Financial Modelling Masterclass from the Institute of Financial
Consultants in the Philippines; and Euromoney Asia in Singapore. He is one of the Founding
Members of the Academy of Regulatory Professionals of the University of Florida, USA. He is an
alumnus of the International Regulation Leadership program of the Public Utility Research Center
of University of Florida where he eventually became a guest lecturer of the said program. He also
earned a certification as Certified Scrum Master in Las Vegas, USA. He is also a faculty member
of the College of Accountancy and Finance of the Polytechnic University of the Philippines handling
subjects on Financial Management, Management Accounting, Financial Markets, Management
Consultancy, and Thesis Writing. He published papers on business process reengineering and
innovation in international journals and international conferences.
DR. HERBERT C. BARON, CPA
Dr. Herbert C. Baron is an adjunct professor of Polytechnic University of the Philippines, Manila
since 2013 teaching Financial Management, Management Accounting and Accountancy Research
subjects. He has more than 10 years' experience in Corporate Finance, Project Management and
Accounting. He is currently heading the Finance Department of the Property Group of Sterling
Paper Group of Companies. His experience in corporate finance includes his involvement in debt
and equity financing activities for the expansion programs of the companies where he was and is
connected, dealing with banks, investment companies, market makers, brokers, underwriters,
insurance companies and government agencies. He graduated from Technological Institute of the
Philippines, Manila in 2004 and has passed the Certified Public Accountant Licensure Examination
the same year. He earned his Master in Business Administrationf rom Philippine School of Business
Administration, Manila in 2007. He has a Doctorate degree in Business Administration conferred
by Polytechnic University of the Philippines in 2017.
ANDREW TIMOTHY L. CACHERO, CPA
Andrew Timothy L. Cachero is a part-time professor in the Polytechnic University of the Philippines
- Manila since 2014 handling Management Accounting and Financial Management subjects. He
has more than 8 years’ experience in Corporate Finance and Internal Controls. His corporate
finance experience includes performing financial due diligence for buy side transactions,
commercial due diligence, financial modeling, capital investment evaluations, value chain analyses
and commercial finance. He also engages with banks, insurance companies, mutual fund
companies and underwriters to explore investment opportunities. He graduated from Polytechnic
University of Philippines - Manila in 2011 with a degree in BS Accountancy and has passed the
Certified Public Accountant Licensure Examination the same year. He is currently taking up his
Master in Business Administration from the Polytechnic University of the Philippines - Manila.
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FUNDAMENTALS OF PtNANClALMAa.^
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Table of Contents
systems and the financial market 5

financial
The Financial System
Elements of the Financial System
The Financial markets .. 12
Types of Financial Markets - i*
FINANCIAL INTERMEDIARIES AND OTHER PARTICIPANTS
Financial Intermediaries and Other participants.............................................................. 37
Benefits from Financial Intermediaries 37
Classification of Financial Intermediaries 43
Other Participants .
FINANCIAL REGULATION AND THE CENTRAL BANK
Financial Regulation
Regulators of Financial Activities
Money Supply and Payment System 52
Effective Risk Management ................................... 39
MONEY MARKETS RELATED FINANCIAL INSTRUMENTS 102
Financial Instruments KB
Money Market 104
Types of Money Market Financial Instruments 106
Evaluating Money Market Securities

MANAGING THE CREDIT RISK OF THE FINANCIAL INSTRUMENT
Credit Risk and Interest Rates
Determination of Interest Rate................................................................................................ 127
Mitigating the Interest Rate Risks 131
Credit Ratings 233
DEBT SECURITIES MARKETS 145

Debt Instrument 25G
Debt Security .........................................

Debt Security vs. Debt Instrument
Safety of Debt Securities
The Bond Market
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Characteristics of Bonds
Bond Valuation............................................................................................................. 155
EQUITY SECURfflES MARKET......................................................................................170
171
Equity Security Market................................................................................................
17c
Types of Shares.............................................................................................................
Stock Market................................................................................................................... 178
Philippine Stock Exchange........................................................................................... 181
Platforms for Capital Market......................................................................................... 188
Market Capitalization..................................................................................................... 189
Limitations of Share Valuation..................................................................................... 198
Relevance of Share Valuation to Investors.................................................................199
Hybrid and Derivative Securities.................................................................................. 200
INTERNATIONAL FINANCIAL MARKETS........................................................................ 214
International Financial Markets.................................................................................... 215
Motives for Using International Financial Market..................................................... 216
History of Foreign Exchange........................................................................................ 219
Foreign Exchange Transactions.................................................................................. 220
Foreign Direct Investments........................................................................................... 232
Country Risk Premium.................................................................................................. 233
Cryptocurrency................................................................................................................ 238
Offshore banking Unit (OBU)........................................................................................ 240
The World Bank............................................................................................................... 241
Comparison of International Financial Markets........................................................ 243
AMENDED IRR ON REPUBLIC ACT NO. 9160.............................................................. 259
INFLATION TARGETING.................................................................................................... 296
REFERENCES.......................................................................................................................298
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Chapter 1
FINANCIAL SYSTEMSAND THE
_____ FINANCIAL MARKET
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The Financial System
In the world ol commerce finance is a key player in ensuring continuity d

operations As they say. it is the life-blood of the company Being the life-blood, tne
management must ensure that its continuous flow is maximize Hence, financia
management is an important process to ensure that profit and wealth is maximized.
Sources of Wealth
Money or wealth can be generated in different ways. In economics, there are
different sources of wealth Figure 1 illustrates the sources of wealth and the type of wealth
that can be generated Let’s call this as the Origin of Wealth.
Every person always started with their own baby steps. Of course, we can t
discount the fact that we are heavily dependent on our families, parents in particular, who
provide us with our needs. Normally, a person completes his education then after a while
they will either work or do their own business but the basic of it is primarily labor since
what they acquired from their education are the fundamentals. Labor through hard work
will allow them to earn salary or wage. As the person
continuously earns, they can save and eventually acquire Point of Information!
their own land which maybe used in their business or be
Wages are earned on a
leased by somebody else. Either way, it will generate
wealth in the form of rent Moving on, as their land and daily or weekly basis more
labor become profitable, people starts venturing to higher than that is called Salary
risk thus aiming for higher returns.
They start infusing capital either financial or industrial. Now the person is an
investor. As the venture is realizing good returns the capital will earn interest. In later
chapters, we will discuss how to manage the interest earned in capital markets.
Optimistically, businesses that matures and grow need more focus. The investors
eventually take active participation in the business/venture. Thus, from investors they
become the entrepreneur of their own which requires entrepreneurial skills, managing
the commercial affairsand ensuring that their company continuously grow and generate
more profit. Profit will eventually be accumulated, and investment will be diversified as it
grows employing new breed of individuals and labor force and the cycle goes on. Here
you will see how finance plays in the system called business.
The word finance is well known and defined in different ways. Finance is the
application of economic principles to decision-making that involves the allocation of money
under conditions of uncertainty. In the field of commerce, investors allocate their funds
among financial assets to accomplish their objectives i.e. to maximize profit and wealth in
the long run. Businesses and governments, on the other hand, raise funds by issuing
claims against themselves that are invested.
Finance provides the framework for making decisions as to how those funds
should be obtained and then invested. It is the financial system that provides the platform
by which funds are transferred from those entities that have funds to invest to those entities
that need funds to invest.
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The theoretical foundations for finance draw from the field of economics and, for
this reason, finance is often referred to as financial economics. The tools used in financial
decision-making, however, draw from many areas outside of economics: mathematics,
statistics, psychology, and accountancy.
Since accountancy deals in providing quantitative information, primarily financial
in nature, it is a necessity for these disciplines will have an integration. Accountancy
requires in depth analysis of the transaction and even financial results to enable them to
provide reasonable opinion which among the courses of action should be considered.
The study of capital markets focuses on three key areas: the financial system,
structure of interest rates and pricing of assets. These will be further discussed in the later
chapters.
Financial system allows households, companies and the government who have
available funds to invest these funds in more potentially productive vehicles that can result
in faster growth in the economy. The financial system encourages fund savings from its
stakeholders and transform these savings efficiently into investment vehicles that help the
economy grow faster.
To cite another good definition of financial system:
“Financial system is a set of arrangements or conventions embracing the

lending and borrowing of funds by non - financial economic units and the
intermediation of this function by financial intermediaries in order to
facilitate the transfer of funds, to create additional money when required,
and to create markets in debt and equity instruments (and their derivatives)
so that the price and allocation of funds are determined efficiently. ” - Faure,
AP.
Financial system is composed of network of inter-related systems of financial markets,

intermediaries and services. The financial system of a country carries out the essential
economic function that transfers funds from parties that have available funds to parties
that need funds.
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FUNDAMENTALS PDFelement
FINANCIALMARKET
In a country, there are households, companies

Point of Information! and government agencies who have available funds
Finance came from the because they spend less than their income. Essentially,
French word "finer" which these are the fund providers. On the other hand, there are
also households, companies and government agencies
means "to end and settle that have fund shortage because of deciding to spend
a debt" more than their income. These are the fund demanders.
Matching the difference in spending (excess funds from
one party to the fund gap of another party) is the main reason for the existence of a
financial system.
The financial system permits an efficient method to move funds between entities
who have funds and entities who need funds. Financial systems serve as a regular, time
efficient and cost-effective link between fund providers and fund demanders. Within the
financial system, funds are efficiently transferred from one party to another through
innovative schemes on savings and investments that investors are willing to partake in.
A basic overview of how a financial system works as illustrated by (Mishkin, 2004)
in Figure 2. As Mischkin illustrated, the primary fund provider I lender-savers in the
financial system are households but business firms, government and foreigners with spare
funds can also lend out. On the other end, the main fund demanders or borrower-spenders
are business firms and government. Businesses use the borrowed fund to support growth
and expansion projects while government use the money to finance infrastructure and
other community welfare projects. Households also become borrower-spenders when
they borrow money to buy their cars and houses. Market participants will be further
discussed in the later chapters.
Funds can flow from lender-savers to the borrower-spenders in two routes: via
direct financing or indirect financing:
• Direct Financing. In this route, the borrower-spenders borrow and deal directly
with lenders through selling financial instruments (or securities). Financial
instruments represent claims on the future income or assets of the borrower.
Borrowers recognize financial instruments as liabilities while lenders recognize
these as an asset. Buying stocks directly from a company is also considered as
direct financing.
• Indirect financing. In this route, the borrowing activity between both parties still
happens though indirectly through the intervention of a financial intermediary.
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FUNDAMENTALS OF FINANCIALM ap^
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INDIRECT FINANCE
F Financial 1
FUNDS
c FUNDS
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Lenders ~ Savers
1. Household
2. Business FUNDS
<^FUNDS
Borrowecs-Spenders
1.
2.
Business
Government
3. Government 3. Households
4. Foreigners 4, Foreigners
DIRECT FINANCE
Figure 1.2. Financial Systems
People who save frequently are not the same people who have access to profitable
investment opportunities (i.e. entrepreneurs). The transfer of funds from providers to
demanders allows both parties to gain some return. For example, fund providers can
charge interest on the fund they are willing to loan out while fund demanders can earn
from the investment they are going to pursue using the funds obtained from the provider.
Without the financial system, fund providers will not earn interest and fund demanders
cannot pursue their investment because of lack of funds. The existence of financial system
is important for the growth of the economy because of this reason.
Financial markets help in creating more efficient allocation of capital which results
in higher production and efficient that ultimately leads to economic growth. Capital can be
physical or financial, either of which are used to produce more wealth. Efficient allocation
of capital occurs when funds are invested in productive investments that yield return for
the fund providers and fund demanders.
A properly functioning financial system also enhances welfare of individual

consumers as they have immediate access to funds allowing them to purchase things as
they prefer. Funds are made available to young people to purchase what they want without
making them wait to save for the entire purchase price. As a result, funds flow back much
faster to business enterprises (through profit), government (through taxes) and investors
(through interest or dividends). Efficient financial markets enhance the economic well
being of all members of the society.
To become more efficient, the financial system of a country commonly addresses

the problem of information asymmetry. Information asymmetry occurs when one
stakeholder to a transaction holds superior information than the other party. Information
asymmetry causes inefficient allocation of financial resources as one party may be in a
etter negotiating position because of the lacking information of the other party.
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Elements of the Financial System
There are seven essential elements that make up a country s financial syste
These seven elements are the following:
T Lenders and borrowers (Who are the players?)
Lenders and Borrowers are also known as fund providers and fund
demanders, respectively. These are the most essential stakeholders that makeup me
foundation of a transaction in the financial system. Without these two parties, the
financial system will not exist.
Lenders are parties that have excess funds that they can lend out to other
entities for a required return. Borrowers are parties who are willing to pay the
required return to obtain additional funds to finance their investment initiatives.
2. Financial intermediaries (How will the exchange occur?)

Financial Intermediaries are special type of financial entity that acts as a
third party to facilitate the borrowing activity between lenders and borrowers. Often,
potential borrowers do not have an idea which parties or entities are willing to lend
out money to them and vice-versa. This gap in awareness makes it difficult for
financial transactions to occur. This is where financial intermediaries come into the
picture. They gather funds from lenders and redistribute it to borrowers through an
investment vehicle like loans. Potential lenders and borrowers then just need to visit
a financial intermediary to participate in the financial transaction. The lenders and
borrowers do not even know who the ultimate individual or firm is who provided or
demanded for the funds. They only need to have access to the financial intermediary
to enjoy the benefits of the financial transaction.
3. Financial instruments (What will be used?)
Financial instruments are medium of exchange of contractual obligation cf

a party, where such contract can be traded. These can be tangible or intangible.
There are two types of financial instruments, it could be cash or derivative financial
instruments. International Financial Reporting Standards defined Financial
Instruments as a contract where a party recognize it as an asset and another is a
liability. This will be extensively discussed in later chapters.
4. Financial markets (Where will it be traded?)
Financial Markets is same with the other economic markets where

suppliers and buyers of financial instruments meet. There are two types of financial
markets depending on the instrument that were being traded. For cash financial
instruments, these are exchanged in the money market. For derivative financial
instrument, it will be traded in the capital markets.
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Regulatory environment (How it is controlled?)

5.
Risk is inherent in every business operation. Moreover, for financial systems
<;ince it involves different business and financial risks, government should intervene
in the system Regulatory environment is the governance body to ensure that the
transactions that occur within the financial systems complies with the laws and
Anulations imposed to the actors as well as the elements that plays within the system
Fâncial systems are normally regulated by Central banks.
6. Money creation (What is the value it creates?)

With the flow of financial instruments, money is created. Money is used to
either be reinvested or earned out from the system flows. In economics, the money
as it was given value out of the financial transactions because of the exchange that
occurred in the system may be converted into another form.
7 Price discovery (How much is created?)

As the financial systems continuously flows and operates, the financial
instruments create value. Price discovery is the process of determining or valuing
the financial instrument in the market. The price is normally driven by the level of risk
on how the issuer of the financial instruments.
The Financial markets
Financial market refers to channels or places where funds and financial

instruments such as stocks, bonds and other securities are exchanged between willing
individuals and/or entities. This also includes the existing mechanisms and conventions to
facilitate transfer of funds and/or financial instruments between market participants.
Financial markets intend to establish a consistent, efficient and cost-effective bridge
between fund providers and fund demanders.
Participants in the financial markets include ultimate lenders and borrowers such
as household, government and businesses, financial intermediaries, broker and dealers,
regulators, fund managers and financial exchanges.
The main economic function of the financial markets is to serve as a channel to

transfer excess funds from fund providers to fund demanders. As a result, financial
markets become the mechanism that bridges surplus and deficit economic units through
providing ways to fund deficit units directly or indirectly via financial intermediaries.
.. hfînai?cial marl<ets also provide additional options to lenders and borrowers on
fund*? irTT want thejr transaction to be in. For example, fund providers may deposit
Durrha«ino a2 -S’*- buy Pr|mary or secondary securities or lessen their debt through
securities9r>r qIh1'119 securities- On the other hand, fund demanders may issue new
funds. The existinn14*^^0?y_owned financial instruments in the financial market to obtain
different options tha°sut ^ctlon'ng financial market allows market participants to avail of
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Exchanging of financial instruments is also more commonly known as "trading”.

Popular examples of financial markets are the New York Stock Exchange and Philippine
Stock Exchange or PSE.
There are three major economic functions of the financial market: price discovery,
liquidity and reduced transaction costs.
• Price Discovery
Price discovery refers to the interaction between buyers and sellers in the
financial market in order to come up with price of the traded financial instrument.
Price is set at the level wherein the buyers are willing to buy, and sellers are willing
to sell. The agreement between the two parties is important in determining the
price of the financial instrument. Usually, the providers of fund in the financial
market determines the required return for a financial instrument. This is the
minimum rate of return that they are willing to accept to purchase a financial
instrument. This function of the financial market determines how the available
funds from the fund providers are allocated towards the fund demanders based on
the fund demanders’ willingness to accept the return required by the fund
providers.
• Liquidity
The second function of the financial market is liquidity. Financial markets

serve as a forum where buyers and sellers can meet to facilitate transactions. As
a result, holders can sell their own financial instruments to other investors to earn
cash. Easy access to a venue where investors can sell financial instruments for
cash is an appealing feature when circumstances may occur that push investors
to sell a financial instrument. This reality offers liquidity to the investors.
Without liquidity, an investor is forced to hold to financial instrument up until

such time that conditions in the agreement happen that will permit the disposal of
the instrument (e.g. conversion) or the issuer is contractually obligated to pay for
the instrument. For debt instruments, this pertains to the maturity date; for equity
instruments, this refers to voluntary or involuntary liquidation. All types of financial
markets offer different degrees of liquidity.
• Reduction in transaction costs
Reduction in transaction costs is the last function of a financial market

Transaction costs are the costs incurred of parties’ transaction to trade a financial
instrument. Transaction costs can be classified into two types: search costs and
information costs.
Search costs are costs incurred to look for financial instruments that can
be purchased or sold by a party. Explicit search costs are expenses needed to
advertise intent to purchase or sell a financial instrument. Implicit search costs
include value of time consumed to look fora counterparty for the transaction.
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FUNDAMENTALS Wondershare
OF FINANCIALMARk-c-r
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, arp costs related in evaluating investment characteristics

in^^t'on costs are c oftep spend informat.on costs to gather
of a financial instrum®nt |iquidity, stability and market value of a financial
information about Probability, Znvestment ,n a price efficient market, prices
instrument to justify worth nes ref|ectthe combined information gathered by
of the financial instrument propeny uy
the market participants.
Types of Financial Markets

n that financial markets are classified depending on the transactions
AS 11 'Sh Pêd or the exchange that is done, to whom t is traded or the market
where ^sTrade^ê manner how it is traded, and the perspective of the country.
Based on Instruments Traded

Financial Markets may be classified according to the type of financial instrument it
traded Whethe the Xment is a short-term security or long term. Short term securities
are normally traded in money market, while long term secunt.es were classified under
capital market.
Money market is the sector of the financial system where financial instruments that will
mature or be redeemed in one year or less from issuance date are traded. Specifically,
money markets cater to fund demanders who need short-term funds from fund providers
who have excess short-term funds. Short-term is defined as one year or less. Once money
market securities are issued, they are traded in the secondary market. Money markets are
not exclusive for short-term investors. Long-term investors also need the money market
as they tend to invest in this market to meet their short-term liquidity needs.
Money market is very important for fund demanders since immediate cash requirements
of individuals, government and corporations do not necessarily coincide on the timing of
their cash receipts. For example, cash receipts from sales of a corporation do not take
place at the same pattern of their expenses (e.g. wages, supplies and other expenses).
Seasonal or temporary financing requirements like peak seasons also creates the
necessity for short-term fund requirements.
cessiveholdin9S ofcash by fund providers also generates opportunity

Xta,n on?v mrnlC:^9One;n eSt As a result'fund Polders with excess cash tend to
invest the excess cash in rtnon?<,|,lr^?entS aS needed for its day-to-day operations and
•o cash when needed XlS'SkT^
fund providers to fund demandersfor ,ransfer lar9e amounts of money from

the parties involved. maturity term quickly and at a cheap cost from
Money market instruments off^r •
areveZV0?09 of cash (which general ™zX-n°PtPOrtUnity that yields a higher return than
associated short^ easily convertible to cash andh^’ A|S°’ money market instruments
in the? money °ArTa!Urity term- Com m on ex am ot . ^Îitt,e default risk because of the
Deposits, RenuS 6 the following: Treas^ r 11 ânCial instmments that are traded
■ Repurchase agreement, Banked SeptanceT”116'0131 PaPers’ Certifica,es
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FUN DA M ENTALSOF FINANCIAL-MARKET
Capital market is the sector of the financial markets where financial

by governments and corporations that will mature beyond one year from issuanceaaxe
(long-term) are traded. Long-term financial instruments encompass financi maturrtvl
that have maturity dates longer than one year and perpetual securities ( market which
The foundation of the capital market is made up by the dealers and broker
creates a venue for bond and stock transactions.
Capital market securities are classified into two. equity (w/ i represent ownership
interest) and debt. Further discussion in the later chapters.
Capital markets are expected to be a liquid market where fund demanders can interact
with potential investors to acquire external financing resources. Investors believe that
capital market should be an efficient market to ensure that available funds are allocated
to its most productive use. The efficient allocation stems from competition between wealth
maximizing investors who determine prices of securities believed to be close to their real
value. In an efficient market, the price of securities, which is a product of interaction
between buyers and sellers in the market, is believed to be a fair estimate of its real value.
Any new information that investors will learn will eventually move its price upwards or
downwards.
Based on Market Type
Another categorization of financial market is to what type of market it is being

traded. This may be categorized into primary and secondary market. Figure 1.3
illustrates the difference of the two types of financial market in terms of the market type.
It can be noted that in primary market the supplier of funds is called lenders while they
are buyers in the secondary market. Borrowers are the demanders of fund in primary
market while sellers are what we call forthose demanders in the secondary market.
primary matfcei
the difference
secorxiary market
money
the difference HIM R S SELLERS
Marita
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Figure 1.3. Primary vs Secondary Markets
Primary market is a type of financial market wherein fund demanders such as corporation
or a government agency raise funds through new issuances of financial instruments e.g.
bonds and stocks. Normally, when internally generated funds (e.g. retained earnings) are
not enough, demanders need to raise additional funds in primary markets to fully finance
new projects or production expansion requirements.
F UNDAMENTALS OF FINANCIALMARK
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ft
New issuances of financial instruments are sold to original fund, Pro^lders (usually
households) in exchange for money that the fund demander needs. Primary market
securities also include issuance of additional debt or equity securities of an already
publicly traded company. Non-negotiable instruments like mortgage loans, savings
deposits and life policies are issued only in primary markets and are not traded in
secondary markets.
Usually, primary markets transactions are coursed through investment banks which are
financial institutions that act as intermediaries between issuing companies (fund
demanders) and potential investors (fund providers).
Investment banks provides advice to issuers on matters related to prices of the securities,
transaction costs and number of securities to be issued based on their fund needs. They
also provide advice on how to present information to attract potential investors to the
securities issuance. Once the securities issuance is settled with the issuer, the investment
banks markets the securities to the initial purchasers for the issuer. Through the
assistance of an investment bank, the issuer reduces the risk and cost of establishing a
market for the securities on its own. Investment banks is responsible to all aspects to
ensure proper execution of the issuance: legal and financial exchange requirements,
appointments of lawyers and auditors, due diligence, etc. Investment banks also
underwrite securities. Underwriting means that investment banks guarantee the price for
the securities of the issuing company and then sells these to the general public.
Transactions in the primary market can be classified based on the intended purchasers of
the securities. There are four types of issue methods that can be done in the primary
markets:
• Public Offering. This occurs when securities are offered for sale to the general
public. Offering to the general public is done through issuing a prospectus or
placing document which contains an offer to the general public to subscribe or
purchase securities ata stated price. Private companies who will sell shares to the
general public for the very first time is said to undergo an initial public offering or
IPO. IPOs are usually done through the help of investment banks
Public offering can either be an offerfor subscription or an offerfor sale. In an offer

for subscription, the general public is invited to subscribe to unissued shares of the
company. Proceeds received from this offer are enjoyed by the company and can
be used to finance their investment objectives. In an offer for sale, existing
shareholders invites potential subscribers to buy portion of the shares they own.
Proceeds from this offer is enjoyed by the existing shareholders, not by the
company.
Most of the time, an underwriter is appointed for public offerings. An underwriter

provides an undertaking to purchase the remaining securities if the offer will not be
fully subscribed by the public. In exchange of the undertaking, a fee is paid by the
issuing company to the underwriters. Securities coursed through underwriters
gives comfort to potential investors since underwriters are willing to take the risk
of guaranteeing these securities.
iûZte\^Cetment (a,so caUed as limited public offer). This occurs when the
s or a single investor, an institutional buyer or group of buyers to
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purchase the whole securities issuance instead of offering it to the general public.
Traditionally, securities sold through private placements tend to be illiquid and are
not easily converted into cash because of the very limited parties it was sold to. As
a result, it is common that only established financial institutions or firms are able
to buy and hold on to them.
One variation of a private placement is that an underwriter subscribes to all

securities at a certain price and consequently, sells these same securities to a
group of investors at a higher price. The difference between these two prices is
termed as underwriting spread.
• Auction. Another way to offer securities to the general public is through an auction
process. Auction is usually used for issuance of treasury bills, bonds and other
securities issued by the government and are commonly executed exclusively with
market makers. Auction can be done in three methods:
o Dutch auction — Type of auction where seller begins the sale at a high price.
From that point, the price of the securities is continuously lowered down at
specific intervals until the potential buyer agrees to purchase at that price,
o English auction — Type of auction where the prospective buyers commence
the auction by submitting an initial bid price. Other buyers interested to
purchase the securities submit a new bid to top the previous one. The
process continuous as price of the securities increases as more interested
buyers bid on it. The bidding stops when no other bidders want to top the
last bid. The last, highest bid price becomes the price of the securities that
the highest bidder should pay.
o Descending price sealed auction (or first-price sealed auction) — Type of
auction where bidders submit sealed bids to the sellers. The sealed bids
are ranked from highest to lowest price. The number of securities is
allocated first to highest priced bid and follows a descending order. Highest
priced bids receive full allocation while lower bids receive allocations
distributed pro rata.
• Tap Issue. This method occurs when issuers are open to receive bids for their
securities at all times. Issuers maintain the right to accept or reject the bid prices
based on their how much fund they need, when they need the fund and what is
their outlook of the market.
Secondary market refers to the market wherein the securities issued in primary market
are subsequently traded i.e. resold and repurchased (secondhand). Buyers in the
secondary market include households, businesses and governments who have excess
funds while the sellers are the household, businesses and governments who are need
funds. Secondary market become a centralized marketplace wherein buyers and sellers
can quickly and efficiently transact with each other. As a result, the secondary market
allows the buyers and sellers to save on search and information costs as they do not need
look for transactions on their own.
When the buyer purchases a financial instrument in the secondary market, funds are
transferred to the seller. Transactions in the secondary market usually occurs through the
help of securities brokers which acts as the facilitator between the seller and the buyer of
the security. The original issuer of the financial instrument is not involved in the
OF FINANCIALlV)
Remove Watermark Ark-r-j-
PDFelement
new securities in the primary market.

. Liquidity and reduction in borrowing costs -secondary market allows activetrading
which improves liquidity and marketability of the securities. A liquid market means
that parties who want to buy and sell are equally matched, thus, price of securities
becomes stable. A liquid market also reduces interest rates as liquidity premium
can be removed. Increased liquidity of a security also improves its desirability in
the eyes of investors helping issuing firms to sell new instruments in the primary
market.
• Support to the primary market - Price discovery helps in giving information that
can be helpful in (a) setting prices for new issuances executed in the primary
market and (b) assessing receptiveness of the market for new issuances.
• Implementation of monetary policy - Secondary market allows regulators such as
the BSP to trade securities to influence liquidity and interest rates set in the
financial system.
For investors, secondary markets are beneficial as it gives them the opportunity to
sell securities at fair market value if they need cash or purchase additional securities that
have differing risk and return characteristics to diversify their portfolio. Secondary markets
provide liquidity to the investors who hold the securities as they are able to convert the
securities to cash quickly by selling to other participants in the secondary market
Secondary market also provides information to investors on the market value of the
investments. Transactions costs are also kept at a low level since the securities are traded
in a centralized market.
Although issuers are not involved, they also benefit from the transactions in the
secondary market. Securities traded in the secondarv markAtnivAc thA iccninn nnmnam/
- ---------- —' ***^WK4| lUÔ.

^®^0nda,V markets can be classified based on the market structure. Market structure
rstothe
---------- mechanisms how buyers
u ic niecnanismshow
- --- __ ..***•
buvers and sellers interact *^«-;**^**■*****•
to arrive *-**4u^
at ****j***^ a structure
,vi
the prices , nusntity
mian v-
of the securities to be traded. There are two classifications based on ma
order — driven and quote-driven.
18
PDFelement
C| I Ki hamentals of financial market
• Order-Driven Market Structure „ _ir

In an order-driven market structure, the buyers and sellers prop .<-
through their brokers who conveys the bid in a centralized location. p
then matched (securities will be awarded to the buyer with same of er price as
selling price of the seller) and the transaction is consummated. Also called as
auction market.
Types of orders that go into an order-driven market structure include the following.
• Market orders (or at-best orders) — orders placed with broker — dealers with the
instruction to execute transaction at the prevailing best market price. Client
relies on the expertise and the integrity of the broker-dealer to execute deals
when the latter perceives that the current price is considered best.
• Limit orders — orders placed where clients set a price or price range that may
be below/above the existing price. Depending whether it is a sale or purchase
transaction, the broker executes the transaction when prices go higher (sell) or
lower (buy) than the limit price or range.
• Day orders - orders placed that only valid until the end of the business day. All
orders not executed at the end of day are cancelled and removed from the
system.
• Good-until-cancelled orders - orders placed that remains valid for a sustained
period up until the client voluntarily cancels and removethese from the system.
• Quote-Driven Market Structure

This is also called as primary dealer markets, professional markets or market-
made markets. In a quote-driven market structure, the market makers establish a
price quote at which the market participants should trade with. The market makers
set a bid quote (to buy) and offer quote (to sell). Bid quote is generally lower than
the offer quote. The difference between the bid quote and offer quote, called a
spread, inures to the benefit of the market makers as profit. Spread is important as
it represents the transactional costs of trading and reflects liquidity. Narrow spread
signals liquidity while a wide spread indicates that securities are illiquid. The higher
turnover of securities sold, the better prof it earned by market makers. Trading of
bonds and currency are usually done in a quote-driven structure.
Primary and secondary markets can also be classified based on where the financial
instruments are traded. There are two classifications: exchange and over-the-counter
market. Figure 1.4 illustrates how financial instruments in primary and secondary market
were traded.
• Exchange (or formalized)
Exchanges are centralized trading locations where financial instruments are

purchased or sold between market participants. In order to be traded, all financial
instruments should be listed by the organized exchange. All financial instruments
should comply with the regulations set forth by the exchange prior to being listed.
Most exchanges are order-driven. Most popular exchanges are the New York
Stock Exchange, Philippine Stock Exchange and Chicago Board of Trade for
commodities (wheat, com, silver and other raw materials).
19 I
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PDFelement
-------------------------------- ~^Ji5KET
r market (or informal)

. Over-the-Coun er unlisted financial instruments
Over-the-cou t roTC) market

tradedi in is inc n securities financial instruments.
on hand stay Dealers
ready to sell and
ar6t nned at various locations who ha who approaches them and is willing
stationed at the counter to any P y ica, advancements, transacton in
buy securities Because of the tec _ornDUters. OTC markets are very
to accept their Prê’a®o be done through^cor
'prices are set for each available
OTC markets ca rtjes are aware o h P market and vegetable market
competitive since a"îve, the labor market, risn
security. To 9'^ o-|-c market.
isconsidere formalized mechanisms to regulate
or markets do not nav~ cu<-tems bonds, loans, spot money
Over-the-coui .er exchanges. For fl"an y traded in an OTC market
^'^"ptancesand foreign exchange. ne9otiab,e ce“s*
market
nature
market
■i
type 1^^
market
form
issue
method
trading
driver
trading
system
Figure 1.4. Trade Segregation for Primary and Secondary Markets

Based on Country’s Perspective
Financial markets can be also categorized depending on the interest or
perspective of the country. It can be internal or national and external.
Internal or National market refers to the financial market operating in a certain country
It is made up of two parts: domestic market and foreign market.
resident^ irârket reêfs to the market where issuers who are considered
afterwards 3 country issue the securities and where these securities are traded
PDFelement
----------------------------------------------------------------------------------------------- FUNDAMENTALS OF FINANCIALMARKET
• Foreign Market — refers to the market where issuers who are not residents of a
country can sell or issue securities and subsequently traded. The rules of the
regulatory authority where the security is issued will prevail regarding issuance of
foreign securities. For example, a US company wanting to issue financial
instruments in the Philippines shall comply with Philippine securities law.
External market refers to the financial market where securities that have two unique
characteristics are being traded:
a. Upon issuance, these securities are offered simultaneously to investors in different
countries
b. Securities are issued outside the regulatory jurisdiction of any single country.
Examples of external market includes international market, offshore market and

Euromarkets.
Based on Manner of Financial Intermediaries

In a broker market, the buyer and the seller of the securities are brought together by a
broker and the trade occurs at that point. Ownership of the securities effectively changes
on the floor of the exchange through the help of a broker. Broker market is usually
composed of national and regional securities exchanges. The Philippine Stock Exchange
is the sole broker market in the Philippines.
In a dealer market, the buyer and seller are not brought directly together by a third party.
Instead, market makers (dealers who create market by offering to sell/buy securities at
stated ask/bid prices, respectively) execute the sell or buy orders. In a dealer market, there
are two distinct trades that occur: Seller sells his securities to a dealer and Buyer buys his
securities from a dealer (can be the same dealer of Seller A).
The ask price refers to the lowest price of a security offered for sale while the bid price is
the highest proposed price in order for investors to buy a security. In essence, investors
pay the ask price when purchasing securities and receives the bid price when selling them.
Dealers earn prof it from these transactions though the spread between bid and ask prices.
Dealer markets do not have centralized trading floors as compared with exchanges.
Instead, dealer markets consist of many market makers that are connected through a
mass telecommunications network.
21 I
FUNDAMENTALS OF FINANCIAL
PDFelement
SUMMARY
• Finance or wealth can be generated from different sources. What is important is fOr
the finance managers to find ways on how to maximize them.
• Financial Systems is a network of interrelated factors. The elements of financial
systems are: (1) lenders and borrowers; (2) financial intermediaries; (3) financial
instruments; (4) financial markets; (5) regulatory environment; (6) money creation;
and (7) price discovery.
• Financial market refers to channels or places where funds and financial instruments
such as stocks, bonds and other securities are exchanged between willing individuals
and/or entities. The economic functions that affect the market are as follows: (1) price
discovery; (2) liquidity and reduction in borrowing costs; (3) support to the primary
market; and (4) implementation of monetary policy.
• Financial market are classified in terms of instruments traded - money market and
capital market; or in terms of market types - primary and secondary market; in terms
of country’s perspective - internal or national market and external market; in terms
of financial intermediaries - broker market and dealer market.
22 |
PDFelement
NAME:
Date:
1. True or False. Write the word TRUE if the statement is true and FALSE if the
ent is false before the number of each statement. If FALSE, encircle the word/s
made it incorrect and replace with the correct word that will make the statement/s
true.
1. Financial system is a set of arrangements or conventions embracing the

lending and borrowing of funds by non-financial economic units and the
intermediation of this function by financial intermediaries in order to
facilitate the transfer of funds, to create additional money when required,
and to create markets in debt and equity instruments including their
derivatives so that the price and allocation of funds are determined
efficiently.
2. Financial system is composed of network of inter-related systems of
financial markets, intermediaries and services.
3. Finance came from the French word “finens” which means “to end and
settle a debt”
4. Funds can flow from lender-savers to the borrower-spenders in two routes:

via direct financing or indirect financing
5. In direct financing, the borrowing activity between both parties still

happens though indirectly through the intervention of a financial
intermediary.
6. In indirect financing, the borrower-spenders borrow and deal directly with

lenders through selling financial instruments (or securities).
7. Information symmetry occurs when one stakeholder to a transaction holds

superior information than the other party.
8. Lenders and Borrowers are also known as fund demanders and fund
providers, respectively
PDFelement
9. Financial intermediary are special type of financial entity that acts as a

third party to facilitate the borrowing activity between lenders and
borrowers
10. Financial instruments are medium of exchange of contractual obligation

of a party, where such contract can be traded
11. Financial Markets is same with the other economic markets where
suppliers and buyers of financial instruments meet.
12. Regulatory environment is the governance body to ensure that the

transactions that occur within the financial systems complies with the
laws and regulations imposed to the actors as well as the elements that
plays within the system.
13. With the flow of financial instruments, price is created. Price is used to
either be reinvested or earned out from the system flows.
14. The price is normally driven by the level of risk on how the issuer of the
financial instruments.
15. Financial market refers to channels or places where funds and financial
instruments such as stocks, bonds and other securities are exchanged
between willing individuals and/or entities.
16. Price Valuation refers to the interaction between buyers and sellers in the
financial market in order to come up with price of the traded financial
instrument.
17. All types of financial markets offer the similar degrees of liquidity.
18. Transaction costs in the financial market can be classified into two types:
Finder’s fee and information costs.
19. Finders fee are costs incurred to look for financial instruments that can
be purchased or sold by a party.
20. Information costs are costs related in evaluating investment

characteristics of a financial instrument.
PDFelement
21. Capital market is the sector of the financial system where financial
instruments that will mature or be redeemed in one year or less from
issuance date are traded.
22. Money market is the sector of the financial markets where financial
instruments issued by governments and corporations that will mature
beyond one year from issuance date (long-term) are traded.
23. Capital market securities are classified into two: equity (which represent
ownership interest) and debt.
24. Primary market is a type of financial market wherein fund demanders

such as corporation or a government agency raise funds through new
issuances of financial instruments e.g. bonds and stocks.
25. Public Offering occurs when securities are offered for sale to the general
public.
26. Private placement occurs when the issuer looks for a single investor, an
institutional buyer or group of buyers to purchase the whole securities
issuance instead of offering it to the general public
27. Tap Issue is usually used for issuance of treasury bills, bonds and other
securities issued by the government and are commonly executed
exclusively with market makers. Auction is a method that occurs when
issuers are open to receive bids fortheir securities at all times.
28. Primary market refers to the market wherein the securities issued in
primary market are subsequently traded i.e. resold and repurchased
(secondhand).
29. Internal or National market refers to the financial market operating in a

certain country.
30. In a dealer market, the buyer and the seller of the securities are brought
together by a broker and the trade occurs at that point. In a broker market,
the buyer and seller are not brought directly together by a third party.
25
PDFelement
FUNDAMENTALS OF FINANCIAL m
^ket
NAME:________________________________ __________ Date:-------------------------

E1-2. Crossword. Fill up the crossword puzzle based on the description or definite
given.
1 2 3
4 5
□
6
1
7
9 10
12
11
1
13
14
■"
Across Down
4. Selling the capital ownership into the public 1. Where sellers and buyers of financial instruments meet
6. Wealth generated by the use of land 2. Life-blood of the company
8. Philippine Stock Exchange 3. Fund Providers
11. over the counter 5. Fund Demanding Party
14. Middle man of transactions 7. Medium of Exchange
15. centralized trading locations 9. Ability to meet currently maturing obligation
10. Ability to meet long term obligation
12. price offering
13. form of intermediary that facilitates the exchange
26
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FUNDAMENTALS OF Watermark PDFelement
FINANCIAL MARKET
NAME:
E1-3. Multiple Choices. Encircle the letter of the best answer to the following
statements/questions below.
1. Which if the following is not a source of wealth

a. labor
b. capital
c. wages
d. entrepreneurship
2. Which of the following is not correct about Financial System?

a. Financial system is a set of arrangements embracing the lending and borrowing of
funds by non-financial economic units and the intermediation of this function by
financial intermediaries in order to facilitate the transfer of funds, to create additional
money when required, and to create markets in debt and equity instruments so that
the price and valuation of funds are determined effectively.
b. Financial system allows households, companies and the government who have
available funds to invest these funds in more potentially productive vehicles that can
result in faster growth in the economy.
c. A properly functioning financial system also enhances welfare of individual
consumers as they have immediate access to funds allowing them to purchase things
as they prefer.
d. The financial system encourages fund savings from its stakeholders and transform
these savings efficiently into investment vehicles that help the economy grow faster.
3. In this route of fund flows, the borrower-spenders borrow and deal directly with lenders
through selling financial instruments (or securities).
a. Indirect Financing
b. Direct Financing
c. Indirect Funding
d. Direct Funding
4. In this route of fund flows, the borrowing activity between both parties still happens
though indirectly through the intervention of a financial intermediary.
a. Indirect Financing
b. Direct Financing
c. Indirect Funding
d. Direct Funding
5. Which of the following is not an element of the Financial System

a. Financial Market
b. Financial Intermediaries
c. Financial Instruments
d. Regulatory Compliance
27 |
PDFelement
instruments suun &=> ~------------ LL 7.7 _. , - - ---------ueiween

willing individuals and/or entities e.g. Philippine Stocks Exchange and Philippine
Dealings and Exchange.
c Participants in the financial markets include ultimate lenders and borrowers such
household, government and businesses, financial intermediaries, broker and dealer^
regulators, fund managers and financial exchanges.
d. The main economic function of the financial markets is to serve as a channel to
transfer excess funds from fund providers to fund demanders.
7. Which of the following is not an economic function of financial market?

a. Price
b. Liquidity
c. Reduced Transaction Costs
d. All of the above are economic functions of financial market
8. Which of the following is not a classification of financial market

a. Based on Instrument traded: Stock and Debt Market
b. Based on Market type: Primary and Secondary Market
c. Based on Country's Perspective: National and External Market
d. Based on Manner of Financial Intermediaries: Broker and Dealer Market
9. The sector of the financial system where financial instruments that will mature or be
redeemed in one year or less from issuance date are traded
a. Current or Short-term Market
b. Debt Market
c. Money Market
d. Long term Market
a. Long term Market

b. Stock Market
c. Debt Market
d. Capital Market
Wondershare
Remove Watermark
PDFelement
____________________________________________ FUNDAMENTAlSOfHNftNCIALMA —
c. Initial Public Offering Market

d. Primary Market
12. Private companies who will sell shares to the genera Pu blic for the very first time is
said to undergo an
a. Public Market Offering
b. Initial Public Offering
c. New Market Issuance
d. Primary Market Offering
13. Public offering can be----------- -------------- ---------------------

Which is not correct?
a. offer for subscription
b. offer for sale .
c. acceptance of subscription and acceptance of s
d. both a and b
14. Securities coursed through gives comfort to potential investors since

------------------- are willing to take the risk of guaranteeing these securities.
a. market maker
b. underwriter
c. financial intermediary
d. guarantor
15. This is also known as limited public offer

a. private placement
b. money market placement
c. capital market placement
d. public placement
16. is usually used for issuance of treasury bills, bonds and other
securities issued by the government and are commonly executed exclusively with
market makers. This can be done in 3 methods.
a. money market placement
b. government bidding
c. auction
d. Tap issue
17. This method occurs when issuers are open to receive bids fortheir securities at all
times.
a. Tap issue
b. government bidding
c. auction
d. money market placement
29 I
T

PDFelement
18. This refers to the market wherein the securities issued in primary market are
subsequently traded
a. Primary market
b. Secondary market
c. Consequent Market
d. Trading Market
19. Which of the following is not an economic function of Secondary Market

a. Price discovery
b. Liquidity and reduction in borrowing costs
c. Support to Primary market
d. Implementation of fiscal policy
20. The market structure where the buyers and sellers propose their price through their
brokers who conveys the bid in a centralized location.
a. Secondary market
b. Order Driven market
c. Quote Driven market
d. Auction
21. Also called as primary dealer markets, professional markets or market-made

markets.
a. Secondary market
d. Auction
22- The market structure (secondary market) where the market makers establish a price
quote at which the market participants should trade with.
a. Secondary market
d. Auction
23. Primary and secondary markets can also be classified based on where the financial
instruments are traded.
a. Exchange and Over the Counter market
b. Formalized and Informal
c. Primary and Secondary
d. either of a and b
24. This refers to the market where issuers who are considered residents in a country
that issues securities and where these securities are traded afterwards.
30 |
PDFelement
a. Internal/National Market
b. Domestic Market
c. Foreign Market
d. Resident Market
25. This refers to the market where issuers who are not residents of a country c
issue securities and subsequently traded.
a. Internal/National Market
b. Domestic Market
c. Foreign Market
d. Non-Resident Market
26. Examples of __ includes international market, offshore market and

Euromarkets
a. Internal Market
b. External Market
c. Foreign Market
d. Non-Resident Market
27. in a , the buyer and the seller of the securities are brought
together by a broker and the trade occurs at that point.
a. broker market
b. dealer market
c. trading market
d. Secondary market
28. in a , the buyer and seller are not brought directly together by a
third party.
a. broker market
b. dealer market
c. trading market
d. Secondary market
29. Money Market and Capital Market are classification of Financial Market based on
a. Instrument traded
b. Market type
c. Country's Perspective
d. financial intermediaries
30. Primary Market and Secondary Market are classification of Financial Market based
on .
b. Market type
Remove
FUNDAMENTALS OF Watermark Wondershare
FINANCIALMARKFT
PDFelement
31. Internal Market and External Market are classification of Financial Market based on
b. Market type
32. Broker Market and Dealer Market are classification of Financial Market based on
b. Market type
32. Financial Systems is a network of interrelated factors. Which of the following is not an
element of financial system?
a. Value Creation
b. Regulatory Environment
c. Financial Intermediary
d. Financial Instruments
33. Which of the following statements is not correct?

a. Financial system allows households, companies and the government who have
available funds to invest these funds in more potentially productive vehicles that can
result in faster growth in the economy.
b. The financial system mandates fund savings from its stakeholders and transform
these savings efficiently into investment vehicles that help the economy grow faster.
c. Financial systems serve as a regular, time-efficient and cost-effective link between
fund providers and fund demanders
d. Efficient allocation of capital occurs when funds are invested in productive
investments that yield return for the fund providers and fund demanders.

a. A properly functioning financial system also enhances welfare of individual
consumers as they have immediate access to funds allowing them to purchase things
as they prefer.
information thanthe other°partyS WhGn °n6 stakeholder to a transaction holds superior
c. Lenders and borrowers am u

respectively. e also known as fund demanders and fund providers,
d- Financial instruments am mc-r

where such contract can be traded ^®xchan9e of contractual obligation of a party
• nese can be tangible or intangible.
PDFelement

a. There are two types of financial instruments, it could be cash or derivative financial
instruments.
b. Regulatory compliance is the governance body to ensure that the transactions that
occur within the financial systems complies with the laws and regulations imposed to
the actors as well as the elements that plays within the system.
c. Financial systems are normally regulated by Central banks.
d. Price discovery is the process of determining or valuing the financial instrument in
the market.
I
OF FINANriA.Wondershare
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FUNDAMENTALS
----------------------
PDFelement
NAME: _ Date:
E1-4. Case Study. Discuss thoroughly the following cases.
1. The Directors of Hybrid Rice Corporation want to modernize its plant and .
nachinery
by making a public issue of shares. They wish to approach the stock exchange wh'i
the finance manager prefers to approach a consultant for the new public iss
gf
shares.
a. Would it be better to approach directly the stock exchange or approach

consultant for the new public shares? Why?
b. What are the different methods which the company may adopt for the new
public issue of shares? Discuss each.
2. Specialty Paper Corporation is a large credit worthy company operating in a Philippine

Valley. It is an export-oriented unit, dealing in exclusive embroidered paper. The floods
in the valley have created many problems for the company. Many craftsmen and
workers have been dislocated and raw material has been destroyed. The firm is
therefore, unable to get an uninterrupted supply of raw materials, and the duration of
the production cycle has also increased. To add to the problems of the organization,
the supplier of raw materials who were earlier selling on credit are asking the company,
for advance paymentor cash payment on delivery. The company is facing a liquidity
crisis. The CEO of the company feels that taking a bank loan is the only option with
the company to meet its short-term shortage of cash.
a. As a finance manager of the company, name and explain the alternative to

bank borrowing that the company can use to resolve the crisis.
b. Would you consider Commercial Paper as one of your alternatives? Why?
3. Property Corporation requires funds for its inventory, payment of salaries and wages,
payment of utilities and other monthly operating costs.
34 I
PDFelement
8- You are to suggest which financial market; the company may approach and
why?
b. Discuss the financial instruments to raise in this requirement.
4. Incorporated in 2000, Dairy Corporation is one of the leading manufacturers and

marketers of dairy-based branded foods in India. In the initial years, its operation was
restricted only to collection restricted only to collection and distribution of milk. But,
over the years it has gained a reasonable market share by offering a diverse range of
dairy based products including fresh milk, flavored yogurt, ice creams, butter milk,
cheese, ghee, milk powders etc. In order to raise capital to finance its expansion plans.
Dairy Corporation has decided to approach capital market through a mix of Offer for
sale and a public issue of shares.
a. Name and explain the types of financial market being approached by the
company.
b. Identify the possible financial instruments to be raised for this.
5. Juana Dela Cruz’ grandmother who was unwell, called her and gave her a gift packet.
Juana opened the packet and saw many crumpled share certificates inside. Her
grandmother told her that they had been left behind by her late grandfather. As no
trading is now done in physical form, Juana wants to know the process by adopting
which she is in a position to deal with these certificates.
a. Identify and state the process mentioned above.
b. Give at least two reasons why dealing with shares in physical form had been
stopped.
35 |
PDFelement
Chapter 2
FINANCIAL INTERMEDIARIES
AND OTHER PARTICIPANTS
PDFelement
___________________ ______________________________ FUNDAMENTALS OF FINANCIALMARKET
ancial Intermediaries and Other participants
expenditurAÔrhmOnthat 'ncome received by a party or entity does not match required

transferrins f ri®nce’ resulting in deficits. These deficits may be resolved through
deficits^ Th- Unas ^rom ûnd providers (with excess funds) to fund demanders (with
)■ is can be done either through direct financing or indirect financing.
Despite Presence of a financial market, its role to provide efficient allocation of
bridn between fund Providers and fund demanders may not work as expected. To
tn f Tt i 9aP,a special type of financial entity called financial intermediaries were formed
51' a*e 'ndirect financing. Financial intermediaries were formed during the time when
rxet conditions make it hard for lenders of funds to transact directly with borrowers cf
unds. Financial intermediation is the process of indirect financing using financial
in ermediaries as the main route to transfer funds from lenders to borrowers. Examples cf
financial intermediaries are depository institutions, insurance companies, asset
management firms, regulated investment companies and investment banks.
Most financial intermediaries provide services to suppliers and demanders of
funds. The assets these financial intermediaries are not limited to the portfolio they are
managing but the information they gain to facilitate and support their clients.
Financial intermediaries generally provide the following services:

• Enable trading of financial assets for the customers of the financial intermediary
through brokering arrangements
• Enable trading of financial assets through its own capital by buying a stake in a
financial asset that its customers want to transact in
• Assist in forming financial assets needed by its customers and distribute these to
its customers and other market participants as well.
• Provide investment advice and consultation services to customers
• Manage financial assets of customers
• Facilitate payment mechanism between merchantsand customers.
Benefits from Financial Intermediaries
The existence of financial intermediaries is also beneficial for the economy.

Services provided by financial intermediaries creates opportunities to financial savvy
people. Not to mention other economic benefits that this will help as well as managing the
risk on the part of the investors.
Acceleration of flow of funds between entities

Fund providers use financial intermediaries to transfer funds to fund demanders.
In the absence of financial intermediaries, most savings of fund providers may not be
easily available to fund demanders. Fund providers may opt to keep their money at home
rather than in banks disrupting the flow of money. Financial intermediaries also serve a
savings and wealth storage function, allowing parties with excessfunds to store their funds
in risk-free/low-risk financial instruments.
37 |
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FUNDAMENTALS OF FINANCIALMARK ft
Efficient allocation of funds

Financial intermediaries possess the expertise to make sure that fundswill flow in
the economy in the most efficient manner. To ensure efficient aHocatooixTinancial
intermediaries manage asymmetric information to a certain deg “ operations.
Asymmetric information occurswhen potential borrowers have more informat.on about the
transaction compared to the bank. Asymmetric information may lead to two further
problems: adverse selection and moral hazard.
Adverse selection means that high risk borrowers Point of Information!
that would tend to default is more likely to be more active in
borrowing funds than low risk borrowers who pay on time. New York Stock
Since high risk borrowers are more eager to look for loans, Exchange (NYSE) is the
they have a higher chance of being chosen. Adverse largest in the world. NYSE
selection usually occurs before a transaction takes Pjace was established in 1792
Since adverse selection is a known fact, potential direct and accounts for about
lenders may opt not to extend loans despite good payers in 40% of the world market
the market. capitalization.
Moral hazard occurs when borrowers have the
tendency to take undesirable or immoral risks (for the lender) with the money, once they
receive it, not disclosed during the loan granting process. Engaging in these undesirable
activities may lower the chance that the loan will be paid back. Moral hazard happens after
the loan is granted. As a result, lenders may also refrain from extending loans since moral
hazards reduces the probability of the loan to be repaid.
Through financial intermediaries, individuals and firms may put their money in
trustworthy banks financial intermediaries rather than directly to borrowers. Financial
intermediaries are also better equipped at screening out bad borrowers from good
borrowers which may reduce risk of adverse selection. Financial intermediaries also have
the mechanism to monitor action of their borrowers, potentially reducing losses related to
moral hazard. Knowing this allows bank to put controls in place to ensure that these risks
are consistently mitigated, ensuring efficient allocation of funds.
Creation of money
Through its depositary function, financial intermediaries, specifically banks, allow

creation of money through its bank loan services. This allows existing and new funds to
be allocated efficiently. Banks acts as the conduit that lessen the constraint of limited
income over spending, permitting consumers to spend while expecting future income and
businesses to get physical capital. This results in more output for the economy and
employment growth. Through the financial intermediaries the state may recognize whether
the need to create stronger monetary policy is imperative.
Support in price discovery

Price Discovery is a process of setting a price which is acceptable for the buyer
and the seller. Since financial intermediaries actively engage in trading financial securities,
they play a significant role in price discovery. They play the role as experts and facilitators
to enable to assign values to financial instruments based on different factors. The financial
rafimrnn!f'f'Ca th.® banking sector, also significantly influences discovery of interest
instrument Û ty’ th'S ,nterest rates are factored in fair market valuation of financial
38 I
PDFelement
Improved liquidity for lenders
interm utl™ate lenders is enhanced through the presence of financial

throiinh rieJ F°r examPle> a borrower receives money from an ultimate lender
and th venicle like loan, the lender’s liquidity is zero up until the loan matures
f e ender receives the payment. Financial intermediaries can manage cash
om different lenders (i.e. depositors) through immediately encashable products
such as current and savings deposit accounts and at the same time and offer non-
marketable financial products such as mortgages, leases and credit contracts. As
a result, the ultimate lenders have better liquidity compared to directly lending
funds to providers.
Reduced price risk for lenders
Price risk means that prices of financial instruments may vary overtime. Financial
intermediaries offer very low-risk financial products such as deposits to ultimate
lenders and at the same time offer financial products with high price risk such as
shares, bonds and property financing to borrowers. As a result, lenders enjoy
mitigated price risks as they course the transfer of funds with very low risk to
financial intermediaries which in turn bear the bigger risk when lending to other
entities. This process can be called as risk sharing. Risk sharing happens when
financial intermediaries create and sell financial assets with risk profile that their
clients are comfortable to invest on. Through the proceeds they can collect,
financial intermediaries may then sell these financial assets to purchase other
assets that may have higher risk and return. Risk sharing can also be called as
asset transformation, since in essence, risky assets are converted into safer assets
for the investors.
■ Diversification of lenders
Typically, members of household only have smaller wealth compared to financial

intermediaries. As a result, they do not have as much investment opportunities for
their funds. This becomes a problem as lenders may not be able to efficiently
maximize returns from their funds because of the limited investment opportunities.
Putting their funds through financial intermediaries, which have wider access to
investment possibilities, allows these household members to diversify their
portfolio better. Diversification is the process of investing funds in a portfolio of
assets that have individual returns that do not move at the same direction together.
For example, if return of Asset A goes up, return of Asset B usually goes down.
Diversification usually results in an overall portfolio risk that may be lower than risk
of each individual asset. Diversification also allows lenders to share risk from their
investments. Looking at a finance perspective, risk refers to the uncertainty
regarding the return an investor will earn on their invested assets. Low transaction
costs allow financial intermediaries to offer diversification opportunities by
organizing a collection of assets into a new product and then selling it to interested
investors.
■ Economies of scale
Economies of scale occurs when fixed costs are optimized per unit as a result of
sheer volume of transactions. Cost per transaction is reduced as the number of
transactions increases. Since financial intermediaries are experts in executing
39 |
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— ______________________ FUNOAMLNTALSOFFINANCIALMARKET
financial transactions, they can get and perform large numbers of transactions.
There are two main economies of scale that are optimized by financial
intermediaries transaction costs and research costs Transaction costs pertain to
cost associated with trading or managing funds and investment transactions.
Research costs refer to costs incurred to monitor performance of potential
companies to be invested in through economic, industry and financial analysis and
look for other investment opportunities that will pay off in the long run. Financial
intermediaries allow funds to be concentrated to them and they will incur
transaction and research costs in behalf of all of its depositors. As a result,
transaction and research costs are spread over all depositors of the bank, thus,
enabling economies of scale.
• Payments System
The financial system serves as the main structure for making payments for any
goods, service or securities that are purchased. Certain financial assets become
the medium of payment and are settled efficiently (assuming efficient clearing and
settlement system) Most common financial assets that are accepted as payment
are bank notes, coins and bank deposits (through checks, straight credit card
purchases, debit cards).
■ Risk mitigation
On a general perspective, risk may also pertain to the uncertainty that something
untoward or damaging may occur to a person or entity. Some types of financial
intermediaries offer protection to individuals and organizations against adverse
incidents that may occur. Consequently, the financial system allows people and
companies to protect and build their wealth through having insurance against
threats to their life, income and properties.
• Implementation of monetary policy function
The financial system provides the best mechanism to allow the government to
implement its monetary policies to manage economic growth, steady employment
rate, equilibrium of balance of payments and inflation. Through the regulatory
authorities, the government is also able to greatly influence interest rates which
consequently affect consumption and investments and the demand for loans.
Financial intermediaries exist to foster a more favorable transaction terms between
fund providers and fund demanders compared if the two parties directly deal with
each other. Figure 2.1 presents the two-step process observed by financial
inform/ariirarioc J
40 |
PDFelement
Obtaining of Lending or
funds from investing fund
fund providers obtained to
lenders or the fund
investors) demanders
Figure 2.1 Two Step Process
Funds that the financial intermediaries obtain can become either a liability of the
financial intermediary or equity owners of the financial intermediary. The funds that
they invest or lend out to other market players are recognized as assets of the
financial intermediary. In exchange facilitating indirect financing, financial
intermediaries receive a fee as cost of providing the service. Fees of financial
intermediaries usually pertains to the difference between cost of issuing financial
securities (dividends, interest, capital gains) and revenues earned from primary
securities (dividends, interest, capital gains) bought.
Let’s take a look at a universal bank, a depositary institution, as an example.
Universal banks accept cash deposits from persons, companies and the
government. Bank depositors are the fund providers. Funds received from the
depositors are treated as liability of the bank. Consequently, the same funds are
used by the bank either to lend to parties who need funds through a loan
agreement or buy securities for capital appreciation. The loan receivables and
securities acquired becomes assets of the universal bank.
The process mentioned above permits financial intermediaries to convert financial
assets that are not attractive to most investors (money of an individual) into another
financial asset - as a liability of the financial intermediary - that are more favored
by the general public. This transformation has three economic functions:
• Maturity intermediation
Normally, money deposited in banks are payable on demand or at a specific

maturity date (e.g. time deposits). Usually, banks can only hold deposits that
cannot be withdrawn by depositors for a maximum term of three years. Based on
this premise, maturity of deposits made by fund providers are usually short-term.
On the other hand, banks usually extend loans to its borrowers for more than three
years. This mismatch between fund providers and fund demanders can become a
problem if financial intermediaries did not exist.
If financial intermediaries did not exist, long-borrowers would have to borrow

money for shorter term to match short duration at which fund providers are willing
41 I
FUNDAMENTALS OF FINANCIALPDFelement
Market
to lend funds. This may also result in difficulties for borrowers in looking for lenders
who are willing to provide funds for the length of time it is needed.
By using its own liabilities, banks essentially convert long-term assets into short
term assets by extending loans to borrowers based on the time they need it and
giving financial assets to depositors for their desired investment prospect. This
economic function of financial intermediaries is called maturity intermediation.
Maturity intermediation gives fund providers / investors more alternatives in terms

of how long they want to invest in financial instruments and borrowers have more
choices on the length of maturity of their debts. Maturity intermediation also allows
financial intermediaries to charge lower interest rate for borrowers. Normally,
individual investors require higher interest rate from borrowers for long-term loans
compared to short-term loans. Since financial intermediaries can depend on
successive fund sources over a long period of time, they can offer lower interest
rates on long-term loans compared to individual investors. Thus, cost of long-term
borrowing can be lessened in an economy that has financial intermediaries.
• Risk reduction through diversification

Diversification is the economic function exercised by financial intermediaries which
converts more risky assets to less risky assets through sharing of risks. One good
example of diversification is the activities performed by mutual funds.
Mutual funds normally solicit and accept fund from investors in exchange fa-
shares in the mutual fund. Consequently, the mutual funds then invest the funds
obtained in portfolio of financial instruments. The shares in the mutual fund
represent the ownership in the portfolio of financial instruments while the financial
instruments are considered as assets of the mutual fund.
Investing in many companies (and not only in one or two firms) allows the mutual
fund to diversify and reduce the overall risk of the investment. This is
advantageous for individuals who have limited capital as they will face difficulty in
buying shares in many companies on their own because of the high cost involved.
Investing in mutual funds help these individuals to enjoy the same level of
diversification even at a limited capital.
Even though individuals may diversify their portfolio on their own, they may not be
able to lower down the risk as cost-effective as financial intermediaries. The cost-
effective diversification that financial intermediaries can do is an essential
advantage of financial systems to the economy.
• Cost reduction for contracting and information processing
Information processing costs refers to the cost of acquiring and processing
information needed to evaluate purchase or subsequent sale of a financial
instrument. Information processing costs also include opportunity cost of time
associated with information processing. In order to maximize return from their
available funds, investors should be able to develop skills essential to assess risk
and return characteristics of their financial instrument alternatives. Once they
develop these skills, investors can use these to evaluate whether to buy or sell a
financial instrument.
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FUN DAM ENTALS PDFelement
OF FINANCIALMARKET
Contracting costs refers to the cost incurred for writing loan agreements and
enforcing terms of agreements to the concerned parties. Contracting costs are
usually incurred by investors who are willing to extend loans to a consumer or
business. In order to protect their self-interest, investors should develop skills to
draft a legally enforceable contract to be signed by both parties. Once loan
agreement is signed, investors should also devote time to monitor financial status
of the borrower and pursue legal actions for any violation in the legal agreement.
Both information processing and contracting costs require time before they can be
done. However, most investors do not have the luxury of time to do both activities
and are willing to pay compensation to other parties to do these forthem.
With these points, financial intermediaries employ personnel that possess both
skills that they can act in behalf of investors. Banking staffs and investment
professionals are knowledgeable in analyzing and managing financial assets.
Standardized loan agreements are available in banks that can be easily used. For
more complex transactions, the legal counsel of banks can also help in
customizing the agreement. Investment professionals can also monitor
compliance to loan stipulations and initiate actions for any violations noted.
As a result, it is cost-effective for financial intermediaries to employ these people
since their main business is managing and investing funds. Financial
intermediaries enjoy economies of scale associated with information processing
and contracting costs due to the large sum of funds that they manager. The
reduced costs of financial intermediaries, compared to costs of each individual
investor if incurred separately, ultimately benefit the investors who has financial
claim on the financial intermediary and the issuers (reduction in funding costs).
Most financial intermediaries are exposed to high levels of liquidity risk. Liquidity
risk refers to the risk that liability holders (e.g. depositors for banks) may require
cash in exchange of the financial claims they have from the institution. As a result,
financial intermediaries always maintain high level of cash and marketable
securities to make sure that they can meet the demand from depositors when the
latter requires them to pay.
Classification of Financial Intermediaries
Given the diverse role of the financial intermediaries in the financial system.
Commonly, financial intermediaries may opt to be a financial institution which is primarily
extending financial support to demanders, while most are going into the exchange of this
instruments. With the emergence of technology and innovative ways on how the funds
were channeled, financial intermediaries can already make combination to mitigate the
risk and generate greater returns.
There are three classifications of Financial Intermediaries: Depository Institutions
and Investment Intermediaries. These three intermediaries find ways on how the
suppliers of fund will be able to maximize the funds they put into the financial system
and at the same time address the needs of the demander of fund.
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FUNDA.MENTALSOF FINANCIALMARKET
Depository Institutions
Depository institutions are firms that accept cash deposits from individuals,
companies and entities. Once the deposit is received, this becomes liability of the
depositary institution to the depositor. Through the funds accumulated throu9h deposit
and non-deposit sources (obtained via issuance of debt instruments), depository
institutions extend loans to different entities. Interest earned from these loans are the main
source of revenue for depository institutions.
A simple illustration to distinguish the differenceon how depository institutions and
nonfinancial companies recognize assets and liabilities is shown in Figure 2.2.
Commercial Banks Nonfinancial Firms
Uabtltttes and Equity Assets Liabilities and Equity

Assets
Loans Deposits Dopostls Loans
Other Other
financial financial
assets assets
other Other Other Other

nonfinancial Rabtiraos nonmanclal RabflltJes
assets and equity assets and equity
Figure 2.2 Commercial Bank vs Nonfinancial Firms
The biggest portion of the asset base of a depositary institution is loans. Loans can be
divided into four categories: business, commercial or industrial loan; commercial or
residential real estate loans; individual loans for vehicle or credit card purchases and all
other loans. Loans are the main revenue-generating assets for banks.
Depositary institutions also keep a significant investment on securities such as
interest-bearing deposits purchased from other financial institutions, repurchase
agreements, treasury bills, mortgage-backed securities and other equity and debt
instruments. Banks earn interest income from these and trade these regularly tomanage
liquidity. Banks usually invest on securities that are highly liquid, can be traded in
secondary markets and have low default risk. Investment on securities offers liquidity to
banks.
On the other hand, deposits comprise the biggest portion of a bank’s liabilities.
Deposits may be transaction accounts (checkable deposits that may bear interest or not),
household savings, large time deposits and passbook savings accounts.
. . fh K pf"hPP5es- depository institutions are further subdivided to commercial
banks, thrift banks and savings banks.
PDFelement
° ommercial Banks. These banks authorized to accept drafts/checks and

issue letters of credit; discount and negotiate promissory notes, drafts, bills
of exchange, and other evidences of debts; receive deposits; buy and sell
foreign exchange and gold or silver bullion; and lend money against
securities consisting of personal property or first mortgages on improved
real estates and the insured improvement thereon. Basically, commercial
banks raise their funds through offering checking deposit accounts
(deposits on which drafts/checks can be written
Point of Information! against), savings deposit accounts (deposits that
Top 5 Commercial Banks in the are payable on demand, but checks cannot be
Philippines written against) and time deposits (deposits that
have maturity in fixed terms). Based on how much
(As of December 31, 2018)
BDO Unibank Inc. is raised from these deposits, commercial banks
Metropolitan Bank and Trust use these funds to extend consumer, mortgage
Company and commercial loans to borrowers and purchase
Land Bank of the Philippines government securities and corporate bonds.
Bank of the Philippine Islands Banks who operate as a commercial bank and
Philippine National Bank also offer investment banking services are known
as universal banks.
o Thrift Banks. These banks are primarily mobilized small savings and
provide loans at generally longer and easier terms than do commercial
banks as they cater to the lower income groups. Loans are usually for basic
economic needs, such as housing. Small producers such as farmers,
cottage industry entrepreneurs, and consumers rely on these banks for the
financing of their production and consumption requirements.
o Savings Banks, organized for the purpose of accumulating savings

deposits, and investing them for specified purposes, such as readily
marketable bonds and securities, commercial papers and accounts
receivables, drafts, bills of exchange, acceptance or notes arising from
loans, whether secured or unsecured, mortgages on real financing for
home building or home development, such other investments and loans as
allowed by the Monetary Board of the BSP in pursuit of national economic
objectives.
Banks offer variety of services to their clientele which can be grouped into
individual banking, institutional banking and global banking. Individual banking primarily
focuses on financial requirements of individuals and included services such as consumer
lending, consumer installment loans, automobile financing, brokerage services, mortgage
lending, credit card financing, individual-oriented financial investment services.
Institutional banking often caters to needs of financial and non-financial corporations and
government entities in activities such as commercial real estate financing and leasing.
Lastly, global banking is the sector wherein commercial banks contend with investment
banks by offering broad range of service offerings revolving around corporate financing
(sourcing of funds that goes beyond traditional bank loans to include letters of credit and
underwriting of securities), providing financial advice on strategic initiatives such as
financing sources, corporate restructuring, acquisitions and divestitures, and facilitating
transactions involving the capital market and foreign exchange products / services.
Banks play a significant role in transmitting the impact of monetary policy set by a
country’s central bank to the rest of the economy. Banks also contributes to the efficiency
45 |
PDFelement
of the financial system by offering payment services that directly benefits the economy
and by offering maturity intermediation services. Because of the crucial nature of the
services offered by banks, the government closely regulates its operation to prevent any
huge disruption in providing financial services that may eventually result in massive losses
for the economy.
Banks often issue four types of deposit accounts (liabilities in their point of view):
demand deposits, savings deposits, money market demand accounts and time deposits.
Depositors are insured by the Philippine Deposit Insurance Corporation up to maximum
amount of Php500,000.
• Demand deposits or checking accounts - Deposits that can be withdrawn upon

demand through checks and offer very minimal interest since this can be
withdrawn easily.
• Savings deposits - Deposits that earn interest at a level below market interest
rates, can be withdrawn upon demand and do not have a specific maturity.
• Money market demand account - Deposits that are placed on money markets that
have slightly higher interest rates (money market rates) compared to savings
deposits but can be withdrawn only after a short period of time
• Time deposits (or certificates of deposits) - Deposits that have a fixed maturity
date and depositors may earn interest at a fixed or floating interest rate.
Aside from deposits, banks can procure funds from non-depository sources. Non
depository sources include borrowing through issuing financial instrument in the money
and/or bond market and borrowing reserves from the BSP.
Rediscounting is a standing credit facility offered by the BSP to aid banks to meet
temporary liquidity needs through refinancing the loans that banks extend to their clients.
Through this facility, the BSP enables timely delivery of credit to all productive sectors of
the economy. Rediscounting is one of the various monetary tools use by the BSP to
regulate the liquidity level in the Philippine financial system. The BSP’s rediscounting is
administered by the Department of Loans and Credit.
For banks participating in the clearing operations of the Philippine Clearing House
Corporation, BSP offersan overdraft credit line (OCL) facility to cover for any shortfall
demand deposit accounts of the banks with the BSP resulting from clearing operations.
Overdraft refers to the deficit in a deposit account resulting from withdrawing more money
than what is deposited in the account. Usually, the BSP sets a ceiling on the overdraft
amount that a bank may incur to cover for clearing losses from interbank borrowings and
repurchase agreements with BSP.
For solvent banks experiencing liquidity problems resulting from causes beyond
their control, BSP offers fully secured emergency loans to serve as financial assistance to
help in resolving liquidity woes. This is pursuant to Section 84 of RA No. 7653. The
emergency loan shall be only up to the amount of needed by the bank to resolve the
liquidity predicament but shall not exceed 50% of its deposits and provided that any
emergency advance should be collateralized by government securities and
unencumbered first-class collateral (primarily real estate).
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OF FINANCIALMARKET
PDFelement
. Contractual savings institutions are financial intermediaries that obtain funds at

periodic intervals based on an existing contract. Unlike depository institutions, contractual
savings institutions can project more accurately how much money they need to pay in the
future (in the form of benefits promised). Usually, contractual savings institutions need to
pay their contractual obligations after several years. As such, asset liquidity is not the
prime importance and they focus more in investing in long-term securities like stocks,
mortgages and corporate bonds. Examples of contractual savings institutions are
insurance companies and pension funds.
Insurance Companies
Insurance companies offer a unique service to the individuals, corporations and
other entities in a country. Insurance companies offer services to assume risk or become
underwriters of the risk associated with various insurable occurrences. In addition to their
role as risk bearers, insurance companies also invest in the financial markets. A contract
of insurance is an agreement whereby one undertakes for a consideration to indemnify
another against loss, damage or liability arising from an unknown or contingent event.
Insurance companies is an example of a contractual savings institutions.
The business of insurance companies works like this. Insurance companies collect
premiums (payment made by parties who want to be insured) in exchange for selling
nmtcK'tinn anain^t nntAntial future risks. Premiums can be paid lump sum prior to the
include:
• Pure life insurance coverage

Life Insurance
- premium is cheaper vs
VUL; insured amount is
guaranteed
• Variable unit linked (VUL)
insurance - insurance with
investment component;
portion of the premiumsis
invested, and any return will
be in added to the insured
amount. Insured amount in
the contract is the minimum
guaranteed amount.
47 |
PDFelement
FUNDAMENTALS OF FINANCIALMARKE7
Product I Proceeds will be paid to I Other Notes

| beneficiary if... ]
Health J he insured person gets • Hospitals will have receivables

Insurance hospitalized or undergoes a to these firms
covered medical treatment
Property and Financial losses occur resulting • Commonly covers residential
Casualty from damage, destruction or houses and vehicles
Insurance loss of insured property
properly attributable to a
sudden event.
Liability The insured party gets involved • Some companies also call this
Insurance in a litigation resulting from his as Directors’ Action Insurance
or other’s actions
Disability The insured party becomes • Same with health insurance
Insurance unable to earn income due to a however this will be for partial
disability or full disability
Long-term care The insured party requires

insurance long-term care coverage if they
are no longer able to take care
of themselves.
Structured The insured event occurs
settlements Fixed guaranteed periodic
payments are given over a long
period of time.
Financial Issuer of an insured bond fails • Used to manage credit risks
guarantee to pay principal and interest
insurance timely.
Investment Intermediaries
Investment intermediaries are organizations whose primary objective is to
maximize return from investments in various financial instruments to add value for the
investors.
• Asset Management Firms
Asset management firms are companies that manage funds owned by
individuals, companies or the government through buying and selling of financial
instruments. Asset management firms are compensated for the management
service through fees that they their clients. Mostly, the fee charged is based on the
amount of fund being managed. In some cases, fee charged cans be based on the
performance of assets being managed. Looking at the trend nowadays, asset
management firms are usually subsidiaries of commercial banks, investment
48 I
PDFelement
hv'swMsa/101 insurance companies. The types of accounts I funds usually handled

Dy asset management firms are:
Regulated investment companies (RIC)
Financial intermediaries that sells shares to the general public in

exchange of cash. Once they receive the proceeds, they then invest the money
in a diversified portfolio of financial instruments. Normally, asset management
firms are contracted to manage the investment portfolio of regulated
investment companies.
Different RICs have varying investment objectives and can engage in

trading in different asset classes — whether money market funds, stock funds
or bond funds. Asset management strategies in portfolios can be further
subdivided into two: passive funds and active funds. Passive funds (or indexed
funds) are managed to mimic movements in the market index such as the PSE
Index. Activefunds are managed by asset management firms with the intention
to outperform the index fund via actively trading securities in the fund portfolio.
Each share stands for proportional interest in the portfolio of financial

instruments managed by the RIC. Each share in the portfolio is valued at Net
Asset Value (or NAV). NAV is interpreted to be a per share metric. Eq. 2.1
presents the NAV computation.
number of shares
Pm Market Value of the Portfolio
L Liability
For example, a RIC has currently 10 million shares outstanding in its

portfolio with market value of Php520 million and liabilities of Php20 million.
The NAV is computed as follows:
Php 520 - Php 20

AMI/ = = Php50 per share
10
Asset management firms may manage two types of RICs: open-end
funds and closed-end funds. Open-end funds, or more commonly known as
mutual funds, do not have fixed number of shares. As long as investors are
willing to invest, open-end funds can offer additional shares. Looking at the
point of view of investors, new investments to the fund are purchased at net
asset value at time of purchase while redemptions or sale of shares are also
priced at net asset value. Total number of shares of the fund increases if there
more investments made to the fund than withdrawals and vice-versa.
For example, at the beginning of the trading day, the mutual fund
portfolio has 10 million shares and is valued at Php150 million without any
liabilities. The NAV at the beginning of the trading day is P15. During the
trading day, investors paid Php2.5 million to the fund and redeemed Php1
million from the fund. Assume that prices of the securities remain constant. The
net investment of Php1.5 million signifies that 100,000 shares (Php1.5 million
49 |
PDFelement
FUNDAMENTALS OF FINANCIALMARkc-r
/ P15) were issued to investors. At the end of the day, the fund has 10.1 million
shares valued at Php151.5 million.
More commonly, the market value of the portfolio and the number of
shares changes. This ultimately leads to a change in NAV. However, once the
trading day ends, NAV will be the same for all regardless of the net shares
added to or deducted from the fund. This is because new investments and
withdrawals on the fund are valued at the end-of-day NAV.
On the other hand, closed-end funds have a fixed number of shares

upon its inception and do not issue additional or redeem shares. Investors who
intends to buy or sell shares should bring it to the secondary market for trading.
Prices of the shares in closed-end funds are associates with demand and
supply in the secondary marketwhere the funds are being traded. Unlike open-
end funds, market price of the fund’s shares may be higher or lower than NAV.
Shares that are priced higher than NAV are dubbed as trading at a premium
while shares value lower than NAV is known to be trading at a discount. A
brokerage commission fee is paid by investors in closed-end funds to brokers
who will transact the purchase or sale on their behalf.
Costs associated with investing in RICs include;

• Shareholder fee or sales charge — one-time charges imposed to
investors
• Annual fund operating expense known as expense ratio - covers
operating expenses of the fund. Large component of the expense
ratio is management fee, the fees paid to asset management firms
in exchange of its services.
RICs allow individual shareholders to combine their resources to take
advantage of lower transactions costs when purchasing large number of stocks
or bonds. These funds let investors to have access on more diversified
portfolios than they otherwise would invest individually. Since mutual fund
shares are traded in the market, investments in mutual fundscan be regarded
as risky.
• Exchange Traded Funds (ETF)
Exchange traded funds are like mutual funds, but the shares of the portfolio
funds trade in an exchange like a regular share offered by a company.
Exchange traded funds possess characteristics of both open-ended and
closed-ended funds. They are open-end funds, but the share pricing has small
premiums/discounts from the NAV, like a closed-end fund. Investment advisors
assume responsibility for managing the portfolio that it moves at the same way
mfiuAnro^h P"cin9 mi’9ht be slightly different from the NAV as the pricing is
market d interactlon of the suPP'y and demand in the secondary
orTZSamllrS^r.all0Wed t0 place ,imit orders, stop orders and orders to sell short
unlike open-end^nds^ Shar6S directly traded in the secondary market
50 |
PDFelement
• Hedge Funds
Hedge funds are developed to cater to sophisticated investors and are usually
not subject to the same regulations covering mutual funds. Investor base
usually consists of affluent individuals and organizations with a relatively high
minimum investment limit.
Hedge funds are usually organized as a private investment partnership or

offshore investment corporation which uses various trading strategies to gain
better position in different markets. Hedge usually employ the following
strategies when executing its investments: leverage (use of borrowed money
to invest), short selling (sale of a security not owned with the expectation that
price of the security will eventually decline), derivatives and simultaneous
selling and buying of securities to take advantage of profit from temporary
mismatching of prices.
Normally, investors of hedge funds are more inclined to evaluate performance

of the asset manager through absolute return rather than relative return.
Absolute return refers to peso amount realized from the investment while
relative return refers to the difference between realized return and the return
shown in a benchmark index.
Compensation for the services of hedge fund managers are a mix of fixed fee
computed based on the value of portfolio being managed plus an incentive fee,
a performance- based compensation that is computed through a % share in
the positive return realized from the investment.
• Separately managed accounts
Separately managed accounts or individually managed accounts are distinct

funds solely dedicated to an individual or institutional investor. Instead of
investing in a shared fund like a mutual fund, a fund can be made that will be
based on the specific necessities of a sole investor. Investments done through
the fund will suit the specific objectives required by the sole investor. Since
these are like “specialized” funds, fees charged for separately managed
accounts are typically higher than RICs.
• Investment Banks
Investment banks are highly leveraged institutions that have significant influence
on how primary and secondary markets work. Investment banks assist entities
(individual, corporate, government) in raising money to fund their initiatives.
Investment banks also assist potential investors by serving as the dealer or broker
of transactions in the secondary market. Investment banks may be affiliated with
leading financial services holding companies such as Banc of America Securities
and JPMorgan Securities or be an independent investment bank without any
affiliation such as Goldman Sachs and Merrill Lynch.
Investment banks can also be grouped based on activities that they can offer to
investors. Full-service investment banks offer wide range of activities while
51 I
PDFelement
FUN DAM ENTALS OF FINANCIAL MARKET
t t cnpriaiiê in one or two activities that they offer to
a. Public offering of securities

Investment banks often assist firms to offer securities to the general public in
order to raise funds for varying business objectives. Investment banks give
recommendation to the issuing company on what securities are attractive to
investors to allow easier raising of funds. Investment banks also take into
consideration how the issuing company want to treat the securities (whether
equity, debt or mix of both) when advising. Investment banks possess
information regarding the current willingness of investors to buy various kinds
of securities and on the prices, investors are willing to pay. Investment banks
participate in initial public offering and subsequent public offerings (also called
secondary or seasoned offering). Initial public offering refers to the first time
that a corporation offers stock to the general public.
Once the issuing company chose the investment bank that would underwrite
its securities, the investment bank then performs a due diligence process to
look at the value of the firm. The results of the due diligence process will be
documented via prospectus which is a requirement of the SEC for public
offerings. The prospectus contains all information regarding the firm that a
potential investor finds relevant in deciding whether to buy the firm’s securities
or not. The prospectus also shows the firm’s profitability, net worth and risks
that the firm is facing such as pending lawsuits and competition. A preliminary
prospectus shared to potential investors is called a red herring because of the
notice printed in red included in the front cover signifying the tentative nature
of the information in the document. Once the SEC approves the registration
statement, the investment banks conducts a road show to visit institutional
investors like pension funds and mutual funds that might be interested in the
securities. The investors then check the prospectus and the securities offer. A
quiet time is observed which restricts what the company officials can say
regarding the company. The quiet time is important to ensure that all potential
investors will have access to the same information and no unpublished data
will give them an unfair advantage. Once all available information is shared
with the investors, the investment banks then assign price for the security
based on its estimate on how many securities will the investors demand.
Next, the investment bank underwrites the shares. Underwriting occurs when
an investment bank purchases the securities from the issuing company and
then offers these securities in the market on behalf of the latter. Investment
bank earns in underwriting through the gross spread ie the difference
investment banksKuX
zs; has misjudged ex ‘
condition ?o t
Tthe market ^mav that £ T'r
J hZ
secunt.es at a lower price than what was guaranteed to the issuing company.
The underwriting arrangement can be firm commitment nr . f-

commitment, the investment bank buys the secXfro°X iJ^Xs^
52 |
FUNDAMENTALS OF FINANCIAL PDFelement
MARKET
diJrXed ^r'Ce and then resells t0 the general public at a higher price as
ussea in the last paragraph. A single investment bank may perform
un erwriting for small issues. However, for large issues, a single investment
ank may face problems in exhausting all securities to be sold. Since this type
o arrangement entails a high level of risk, the primary investment bank often
form a group of investment banks, called as an underwriting syndicate, to buy
and sell the securities. Once the securities are reoffered to the public, the gross
spread will be shared between all investment banks in the underwriting
syndicate. Distributing the securities to the general public is critical to ensure
realization of the gross spread. All the securities should be sold to the public
based on the reoffering price and usually entails a huge marketing effort
especially if the issue size is huge. Each member of the underwriting syndicate
will offer the securities to their own client base.
If the member investment banks included in the syndicate is not able to exhaust
and sell all securities, the lead investment bank can also engage other
institutions not included in the underwriting syndicate to form a selling group to
extend their investor reach. Once sold, the gross spread shall be distributed
between the lead underwriter (which serves as the manager), members of the
underwriting syndicate and members of the selling group.
In a best effort arrangement, investment banks do not buy the securities from
the issuing company. In its place, investment banks only use their connections
and expertise to offer the securities to the general public and earn based on
the gross spread of the securities it can sell.
Underwriting help reduce information costs between borrowers and lenders

since investment banks place their reputation on the line for the firms that they
are underwrite for. Investors have greater confidence if securities are
underwritten by investment banks as they believe that the latter has performed
due diligence on the issuing firm to ensure that investors can buy the securities
without incurring excessive risk.
b. Private Placement of Securities

Instead of selling securities to the general public, investment banks can also
offer private placement of securities. In private placement, securities are
offered only to a select number of firms like insurance companies, pension
funds and investment companies.
c. Trading of securities
Investment banks can also trade securities on behalf of their clients.

Investment banks earn from this service through commissions when they act
as a broker or dealer for a transaction. When they act as a broker or dealer,
investment banks do not take any position in the trade, thus, not putting their
own capital at risk. In some instances, investment banks can become market
makers in behalf of clients, thus, using their own capital to trade the securities.
When investment banks are market makers, they earn through the difference
between selling price of the security and the price paid by the investment bank
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FU N DAM ENTALS OF FINANCIALMARKET
for the security (i.e. bid-ask spread) and through price appreciation of any
security still on hand.
Investment banks can also use their capital on their own volition to trade
securities based on how they forecast potential movements in pnces, interest
rates and foreign currency. This is called proprietary or prop trading. However,
proprietary trading exposes the investment banks to two major risks, interest
rate risk and credit risk. Interest rate risk pertains to the risk that if investment
banks hold long-term securities, they are exposed to the risk that if market
interest rates went up, the prices of their long-term securities will go down.
Credit risk refers to the risk that the borrower might not pay or default on their
loans.
d. Advisory services for mergers, acquisitions and financial restructuring
Investment banks perform advisory engagements for mergers and

acquisitions, leveraged buyouts, capital restructuring and reorganization for
financially distressed corporations. Investment banks usually help in looking
for potential M&A candidates based on the requirements of the client, perform
due diligence and give recommendation to acquiring or target companies
regarding valuation and non-valuation related aspects of the transaction,
provide support to firms that are in danger of a hostile takeover, assist
companies to raise funds for an acquisition and give a fair opinion regarding a
potential transaction to the board of directors. Investment banks can provide
advice for both buyers (buy side) and sellers (sell side). Since they have access
to their client information, investment banks may initiate contacting companies
regarding potential sales, purchases or mergers. For firms who wish to be
acquired, investment banks may look for companies that are willing to pay
significantly higher than the book value of the firm. Investment banks can
estimate the value of firms, lead negotiations, and prepare acquisition bids.
Investment banks also provide advices on f inancial restructuring of problematic

companies. Financial restructuring occurs when a corporation undergoes a
significant modification of its capital structure, operating structure, corporate
strategy and corporate tactical plans. Firms often resort to financial
restructuring to prevent bankruptcy, avoid potential problems with creditors or
undergo reorganization as permitted by the law. Investment banks earn from
providing advisory services through a fee based on the size of the transaction.
This service is particularly profitable as investment banks do not need invest
sizeable portion of its capital to perform. The only significant costs are the
salaries of personnel working on the engagement.
e. Merchant banking
In merchant banking, investment banks use it<? «wn ionH ™<->nAv as
54 |
PDFelement
The invect nance and Prime Brokerage Service

srment strategy of some investors requires them to borrow money to
y a security or borrow securities to sell a security short or cover a short sale,
se investors usually enter in a repurchase agreement (or repo) when
orrowing funds in the securities market rather than a bank borrowing. A
repurchase agreement is like a collateralized loan whose collateral is the
security bought. Investment banks can usually lend the securities for the
repurchase agreement and earn a fee for such service. This activity of
borrowing securities or borrowing funds is known as securities finance.
Prime brokerage is also offered by investment banks to hedge fund and large
institutional investors. Prime brokerage is considered as priority servicing for
very important clients. Services offered under prime brokerage include
securities finance, global custody, risk management system and prioritized
operational support.
g. Asset Management
Investment banks also have division that perform asset management services
to clients such as endowments, insurance companies, pension funds,
foundations and high net worth individuals. These asset management
departments can be mutual or hedge funds. Same with asset management
firms, investment banks earn through a percentage of the managed assets in
this service.
h. Research
Investment banks also conduct research on different industries or large market

players. Investment banks assign analysts that collect publicly available
information about the subject, visit the firm to do interview and inspect the
facilities. The investment bank then uses the results of the compiled research
as inputs to identify potential candidates as acquirer or acquiree. Some
research information is made public as research notes and can be used to
provide advice to investors whether to buy, sell or hold stocks. Opinions from
large investment banks sometime may affect market price of shares as they
can influence perception of investors.
Analysts may also engage in giving opinions regarding present state of the
financial markets, do economic researches, write reports on economic trends
and provide forecastmacroeconomicvariables like GDP, inflation, employment
and interest rates.
• Finance Companies
Finance companies raise their funds through issuing stocks and bonds or selling
commercial papers. Finance companies then lend out the funds to individual
consumers (to buy furniture, vehicles, home improvements) and small businesses.
Some non-financial corporations open their own finance companies to assist in
selling their main product. One example is Toyota Motor Philippines. Toyota Motor
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PDFelement
Philippines has a wholly owned finance company known as Toyota Financial

Services Philippines that offer car financing solutions for automobiles sold by
Toyota.
Other Participants
Aside from financial intermediaries, there is a significant number of participants who

interact with each other to buy or sell different kinds of financial instruments. Depending
on the circumstances, below market participants can either be a lender (fund provider) or
borrower (fund demander). These market participants can be divided into five sectors.
Household Sector
The household sector is composed of individuals and families, including families
serving charitable, religious and non-profit organizations. This sector also includes
unincorporated businesses such as retailers, farmersand professional partnerships since
the business transactions cannot be specifically segregated from the owner’s personal
transactions.
Government
Government role is focused more on regulating all participants and the market in
general. In the Philippines, the government sector includes the national government
agencies (NGAs), local government units (LGUs) and government-owned and controlled
corporations (GOCCs). Normally, the national government raises funds through the
Bureau of Treasury.
Corporate Sector / Non-financial Corporations
Corporations can be classified into two big segments: financial and non-financial
corporations. Financial corporations include depositary institutions, investments banks,
asset management companies and insurance companies. Most financial corporations act
as financial intermediaries and will be discussed in the next topic. All other companies not
classified as financial are known to be non-financial corporations.
Non-financial corporations issue financial instruments to raise funds for their
business requirements and trade financial instruments in the money market (for short
term) or capital market (for long-term) as investment in case they have excess funds. Also,
non-financial corporations that offer pension plans for their employees invest the funds
associated with the defined benefit plan to earn some return in preparation for payout in
the future. There are also some non-financial corporations with subsidiaries that engage
in activities same as financial corporations. These subsidiaries are called as captive
finance companies. Examples are Toyota Financial Services (subsidiary of Toyota Motor
Corporation) and Puregold Finance, Inc.
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PDFelement
Foreign Sector
f°re'9n sector consists of all entities,

f’ ♦»^SSetS and organizations that are situated Point of Information!
i o the jurisdiction of a certain country. Foreign World Bank Group is one of
centra banks (monetary authorities of a foreign country) the world’s largest sources
and foreign companies invest in other countries / markets of funding for developing
in order (a) to stabilize their local currency compared to countries. Members of the
foreign currencies and (b) to gain return from investing group are as follows:
excess funds in attractive countries / markets with huge International Bank for
growth potential. Reconstruction and
Development (IBRD),
Supranational institutions refer to an internationalInternational Development
entity formed by two or more central governments via Association (IDA),
International Finance
international treaties. An example of supranational
Corporation (IFC),
institution are multilateral development banks. Multilateral Multilateral Investment
development banks are mandated to give financial Guarantee Agency (MIGA),
assistance to developing countries using funds gathered and International Center for
from member countries. Through this activity, regional Settlement of Investment
integration is pursued in specific geographic territories. Disputes.
Examples of multilateral development banks are European
Investment Bank, World Bank (or International Bank for
Reconstruction and Development), Inter-American Development Bank and Asian
Development Bank. World bank will be further discussed in Chapter 8.
Non-profit organizations
Non-profit organizations are businesses that exist to respond to specific causes
like humanitarian aid, socio-civic causes, environment, arts and many more. These do not
necessarily operate to generate profit or monetary for its investors. Non-profit
organizations include foundations and endowments.
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PDFelement
FUNDAMENTALS OF FINANCIALMARKFT
SUMMARY
• Financial Intermediaries were formed during the time when market conditions
make it hard for lenders of funds to transact directly with borrowers of funds.
• Benefits of having financial intermediaries in the Financial System are: (1)

acceleration of flow of funds between entities; (2) efficient allocation of funds;
(3) creation of money; and (4) support in price discovery.
• Financial Intermediaries can be classified into: Depository Institutions and

Investment Intermediaries. The type on how they will manage the funds
whereby the suppliers will be able to realize maximum returns and address
the needs
• Other participants in the financial system are the household sector,

government, corporate sector or the non-financial corporations, and the
foreign sector
58 |
PDFelement
NAME:
Date:
E2-1. True or False. Write the word TRUE if the statement is true and FALSE if the
statement is false before the number of each statement. If FALSE, encircle the word/s
which made it incorrect and replace with the correct word that will make the statement/s
true.
1. One of the roles of financial market is to provide efficient allocation of

resources between fund providers and fund demanders.
2. It is not uncommon that income received by a party or entity does not match
required expenditures, hence, resulting in deficits.
3. Deficits may be resolved through transferring funds to fund providers (with

excess funds) from fund demanders (with deficits). This can be done either
through direct financing or indirect financing.
4. Financial intermediaries were formed during the time when market

conditions make it easy for lenders of funds to transact directly with
borrowers of funds.
5. Financial intermediation is the process of direct financing using financial

intermediaries as the main route to transfer funds from lenders to borrowers.
Examples of financial intermediaries are depository institutions, insurance
companies, asset management firms, regulated investment companies and
investment banks.
6. The existence of financial intermediaries is also beneficial for the economy.

Services provided by financial intermediaries creates opportunities to
financial savvy people. Not to mention other economic benefits that this will
help as well as managing the risk on the part of the investors.
7. Financial intermediaries also serve a savings and wealth storage function,

allowing parties with excess funds to store their funds in risk-free/low-risk
8. Financial intermediaries possess the expertise to make sure that funds will
flow in the economy in the most effective manner. To ensure efficient
59 I
FUNDAMENTALS OF FINANCIALM
PDFelement
arkft
allocation, financial intermediaries manage asymmetric information to a

certain degree in its operations.
9. Symmetric information occurs when potential borrowers have more

information about the transaction compared to the bank.
10. Problem on random selection means that high risk borrowers that would
tend to default is more likely to be more active in borrowing funds than low
risk borrowers who pay on time.
11. Moral hazard occurs when borrowers have the tendency to take
undesirable or immoral risks (for the lender) with the money, once they
receive it, not disclosed during the loan granting process.
12. Through financial intermediaries, individuals and firms may put their money
in trustworthy banks financial intermediaries rather than directly to
borrowers. Financial intermediaries are also better equipped at screening
out bad borrowers from good borrowers which may reduce risk of random
selection.
13. Financial Intermediaries play the role as experts and facilitators to enable
to assign values to financial instruments based on different factors.
14. Through its depositary function, financial intermediaries, specifically banks,

allow creation of money through its bank loan services. This allows existing
and new funds to be allocated efficiently.
15. Solvency of ultimate lenders is enhanced through the presence of financial

intermediaries. For example, a borrower receives money from an ultimate
lender through a vehicle like loan, the lender’s cash position is zero up until
the loan matures and the lender receives the payment.
16. Price risk means that prices of financial instruments may vary overtime.
17. Diversification is the process of investing funds in a portfolio of assets that

have individual returns that do not move at the same direction together.
18. There are two main economies of scale that are optimized by financial
intermediaries: transaction costs and research costs.
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PDFelement
19. The financial system serves as the main structure for making payments for
any goods, service or securities that are purchased.
20. All types of financial intermediaries offer protection to individuals and

organizations against adverse incidents that may occur.
21. The financial system provides the worst mechanism to allow the
government to implement its monetary policies to manage economic
growth, steady employment rate, equilibrium of balance of payments and
inflation.
22. Financial intermediaries exist to foster a more favorable transaction terms

between fund providers and fund demanders compared if the two parties
directly deal with each other.
23. Maturity intermediation gives fund providers / investors more alternatives

in terms of how long they want to invest in financial instruments and
borrowers have more choices on the length of maturity of their debts.
24. Diversification is the economic function exercised by financial

intermediaries which converts more risky assets to less risky assets through
sharing of risks. One good example of diversification is the activities
performed by mutual funds.
25. In order to maximize return from their available funds, investors should be
able to develop skills essential to assess risk and return characteristics of
their financial instrument alternatives. Once they develop these skills,
investors can use these to evaluate whether to buy or sell a financial
instrument.
26. Most financial intermediaries are exposed to low levels of liquidity risk.
Liquidity risk refers to the risk that liability holders (e.g. depositors for banks)
may require cash in exchange of the financial claims they have from the
institution.
27. Banks are firms that accept cash deposits from individuals, companies and
entities.
61
FUNDAMENTALS OF FINANCIALMarke-t
PDFelement
. hp divided into five categories: business, commercial or

28 Loans can be diviaea im .
industrial loan; commercial or residential real estate loans; ,nd.v,dual ioans
for vehicle or credit card purchases and all other loans. Loans are the main
revenue-generating assets for banks.
29. Commercial Banks are banks authorized to accept drafts/checksand issue

letters of credit; discount and negotiate promissory notes, drafts, bills of
exchange, and other evidences of debts; receive deposits; buy and sell
foreign exchange and gold or silver bullion; and lend money against
securities consisting of personal property or first mortgages on improved
real estates and the insured improvement thereon.
30. Savings Banks are banks are primarily mobilized small savings and provide
loans at generally longer and easier terms than do commercial banks as
they cater to the lower income groups.
31. Thrift Banks are organized for the purpose of accumulating savings
deposits, and investing them for specified purposes, such as readily
marketable bonds and securities, commercial papers and accounts
receivables, drafts, bills of exchange, acceptance or notes arising from
loans, whether secured or unsecured, mortgages on real financing for home
building or home development, such other investments and loans as
allowed by the Monetary Board of the BSP in pursuit of national economic
objectives.
32. Discounting is a standing credit facility offered by the BSP to aid banks to
meet temporary liquidity needs through refinancing the loans that banks
extend to their clients.
33. The BSP’s rediscounting

is administered by the Department of Loans,
Credit and Cooperative
House PartlC'Patin9 In the faring operations of the Philippine Clearing

iiouse Corporation, BSP offers
cover for any shortfall d^ underdraft credit line (UCL) facility to
resulting from clearing operations P°Slt aCC°UntS °f the banks with the BSP
PDFelement
35 For
or solvent banks experiencing liquidity problems resulting from causes
beyond their control, BSP offers fully secured emergency loans to serve as
financial assistance to help in resolving liquidity woes. This is pursuant to
Section 84 of RA No. 7563.
36. Contractual savings institutions are financial intermediaries that obtain

funds at periodic intervals based on an existing contract. Unlike depository
institutions, contractual savings institutions can project more accurately how
much money they need to pay in the future (in the form of benefits
promised).
37. Assurance companies offer services to assume risk or become

underwriters of the risk associated with various insurable occurrences.
38. Investment intermediaries are organizations whose primary objective is to

maximize return from investments in various financial instruments to add
value for the investors.
39. Exchange traded funds possess characteristics of both open-ended and

closed-ended funds. They are closed-end funds, but the share pricing has
small premiums/discounts from the NAV, like an open-ended fund.
40. RICs allow individual shareholders to combine their resources to take

advantage of lower transactions costs when purchasing large number of
stocks or bonds.
41. Hedge funds are usually organized as a public investment partnership or

offshore investment corporation which uses various trading strategies to
gain better position in different markets.
42. In Separately Managed Account, instead of investing in a shared fund like

a mutual fund, a fund can be made that will be based on the specific
necessities of a sole investor. Investments done through the fund will suit
the specific objectives required by the sole investor.
43. Investment banks are highly liquid institutions that have significant
influence on how primary and secondary markets work.
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FUNDAMENTALS OF FINANCIALMARKF
PDFelement
t
44. Finance companies raise their funds through issuing stocks and bonds or
selling commercial papers. Finance companies then lend out the funds to
individual consumers (to buy furniture, vehicles, home improvements) and
small businesses.
45. Aside from financial intermediaries, there is a significant number of

participants who interact with each other to buy or sell different kinds of
46. The family and community sector are composed of individuals and families,
including families serving charitable, religious and non-profit organizations.
47. In the Philippines, the government sector includes the national government
agencies (NGAs), local government units (LGUs) and government-owned
and controlled corporations (GOCCs). Normally, the national government
raises funds specifically through the Bureau of Internal Revenue.
48. Non-financial corporations issue financial instruments to raise funds for

their business requirements and trade financial instruments in the money
market (for short-term) or capital market (for long-term) as investment in
case they have excess funds.
49. The foreign sector consists of all entities, individuals, assets and
organizations that are situated outside of the jurisdiction of a certain country.
Supranational institutions refer to an international entity formed by two or
more central governments via international treaties.
50. Non-profit organizations are businesses that exist to respond to specific

causes like humanitarian aid, socio-civic causes, environment, arts and
many more. These operate to generate profit or monetary for its investors.
Non-profit organizations include foundations and endowments.
64 |
PDFelement
NAME:
E2-2. Crossword. Fill up the crossword puzzle based on the description or definition
given.
Across Down
1. Banks organize to accumulate saving deposits 2. 'S* institutions refer to international entity formed by 2 or more central
5. ETF or Exchange Funds governments
8. Consists of entities, individuals outside of the Jurisdiction of a country. 3. Banks for small savings and provide loans at generally longer terms
9. Strategy to better position by anticipating costs or prices in the future 4. Middlemen or agencies that act as a route for borrowers and lenders
10. 'V* for NAV means what 6. The 'E* of Scale that occurs when fixed costs are optimized per unit
as a result of sheer volume or transactions
7. T Companies offers services to help individuals and entities to
mitigate risks
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PDFelement
FUN DAMENTALSOFFINANCIALMARKET
NAME:_________________________ ____________ Date: - -----------------------

1. Which of the following is not a service provided by financial intermediaries?

a. Enable trading of financial assets for the customers of the financial intermediary
through brokering arrangements
b. Enable trading of financial assets through its own capital by buying a stake in a
financial asset that its customers want to transact in
c. Assist banks in forming financial assets needed by its customers and distribute
these to its customers and other market participants as well.
d. Provide investment advice and consultation services to customers; Manage
financial assets of customers; facilitate payment mechanism between merchants
and customers.
2. Which of the following is one of the benefits from financial intermediaries?

Acceleration of flow of funds between entities
a. Efficient allocation of funds
b. Support in price valuation
c. Reduced price risk for lenders
d. Economies of scale
3. This means that prices of financial instruments may vary overtime.

a. Price Risk
b. Volatility
c. Price Discovery
d. Valuation Risk
4. This happens when financial intermediaries create and sell financial assets with risk
profile that their clients are comfortable to invest on. Through the proceeds they can
collect, financial intermediaries may then sell these financial assets to purchase other
assets that may have higher risk and return. This can also be called as asset
transformation, since in essence, risky assets are converted into safer assets for the
investors.
a. Risk Management
b. Risk Pooling
c. Risk Sharing
d. Risk Balancing
5. This is the process of investing funds in a portfolio of assets that have individual
returns that do not move at the same direction together For examole if return of Asset
A goes up, return of Asset B usually goes down. This usuaVresuhs in an overa I
portfolio risk that may be lower than risk of each individual
lenders to share risk from their investments ,ndlv,dual aaset. This also allows
66 |
PDFelement
I UNUAMI NIAiÔI HNANCIAL MARKET
a. Diversification
b. Pooling
c. Portfolio Management
d. Investment Risk management
6. Economies of scale occurs when are optimized per unit as a

result of sheer volume of transactions
a. total cost
b. variable cost
c. fixed cost
d. uncontrollable
7. Which of the following is not a common financial asset that are accepted as payment?
a. bank notes such as demand drafts
b. coins
c. bank deposits
d. virtual currency such as bitcoins
9. Which of the following is not an economic function related to Financial Intermediary as

to implementation of monetary policy function of the government?
a. maturity intermediation
b. risk reduction through diversification
c. cost reduction for contracting and information processing
d. fiscal intermediation
10. refers to the cost of acquiring and processing information needed to evaluate
purchase or subsequent sale of a financial instrument
a. Contracting Cost
b. Information Processing Cost
c. Acquisition Process Cost
d. Data Processing Cost
11. refers to the cost incurred for writing loan agreements and enforcing terms of
agreements to the concerned parties
a. Contracting Cost
b. Information Processing Cost
c. Acquisition Process Cost
d. Data Processing Cost
12. Which of the following is not true about Depositoiy Institutions?

a. Depository Institutions are also known as banks
b The biggest portion of the asset base of a depository institution is deposits
c. Deposits comprise also the biggest portion of a hank s liaNlities
PDFelement
FU N DAM ENTALS OF FINANCIAL MARKET
d. Depository institutions are firms that accept cash deposits from individuals,
companies and entities.
13. Which of the following does not belong to Top 5 Commercial banks in the Philippines
as of December 31, 2018?
a. BDO Unibank Inc.
b. Development Bank of the Philippines
c. Land Bank of the Philippines
d. Philippine National Bank
14. raise their funds through offering checking deposit accounts

(deposits on which drafts/checkscan be written against), savings deposit accounts
(deposits that are payable on demand, but checks cannot be written against) and time
deposits (deposits that have maturity in fixed terms).
a. Commercial banks
b. Thrift banks
c. Savings banks
d. Universal banks
15. Small producers such as farmers, cottage industry entrepreneurs, and consumers
rely on these banks for the financing of their production and consumption
requirements.
a. Commercial banks
b. Thrift banks
c. Savings banks
d. Universal banks
16. Organized forthe purpose of accumulating savings deposits, and investing them for
specified purposes, such as readily marketable bonds and securities, commercial
papers and accounts receivables, drafts, bills of exchange, acceptance or notes
arising from loans, whether secured or unsecured, mortgages on real financing for
home building or home development, such other investments and loans as allowed by
the Monetary Board of the BSP in pursuit of national economic objectives.
a. Commercial banks
b. Thrift banks
c. Savings banks
d. Universal banks
17. Which of the following is not correct about banks?

a. Banks play a significant role in transmitting the impact of monetary policy set by a
country s central bank to the rest of the economy. Banks also contributes to the
efficiency of the financial system by offering payment services that directly benefits
the economy and by offering maturity intermediation services.
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b S ??n ISSUe five tyv*3 deposit accounts (liabilities in their point of view):
deposits depOSrtS’ savin9s deposits, money market demand accounts and time
c. Banks offer variety of services to their clientele which can be grouped into individual
banking, institutional banking and global banking.
d. Aside from deposits, banks can procure funds from non-depository sources. Non
depository sources include borrowing through issuing financial instrument in the
money and/or bond market and borrowing reserves from the BSP.
18. Which of the following is not a category of services provided by banks based on type
of clients?
a. individual banking
b. institutional banking
c. global banking
d. electronic banking
19. Which is not a type of deposit accounts?

a. security deposit
b. savings deposit
c. money market demand account
d. time deposits
20. Is a standing credit facility offered by the BSP to ad banks to meet temporary liquidity
needs through refinancing the loans that banks extend to their clients.
a. Liquidity fund
b. Rediscounting
c Bank Recovery fund
d Overdraft Credit Line
21. Which of the following is incorrect?

a. For banks participating in the clearing operations of the Philippine Clearing House
Corporation, BSP offers an overdraft credit line (OCL) facility to cover for any
shortfall demand deposit accounts of the banks with the BSP resulting from clearing
operations
b. For solvent banks experiencing liquidity problems resulting from causes beyond
their control, BSP offers fully secured emergency loans to serve as financial
assistance to help in resolving liquidity woes
c. Rediscounting is a standing credit facility offered by the BSP to aid banks to meet
temporary liquidity needs through refinancing the loans that banks extend to their
clients Through this facility, the BSP enables timely delivery of credit to all
productive sectors of the economy.
d. All of the above are correct.
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FUNDAMENTALS OF FINANCIALMARKft
22. Are financial intermediaries that obtain funds at periodic intervals based on an
existing contract. Unlike depository institutions, these institutions can project more
accurately how much money they need to pay in the future (in the form of benefits
promised).
a. Depositary Institutions
b. Contractual Savings Institutions
c. Projection Institutions
d. Forward Contract Institutions
23. companies offer a unique service to the individuals, corporations and

other entities in a country. companies offer services to assume risk or
become underwriters of the risk associated with various insurable occurrences.
a. Insurance
b. Assurance
c. Risk Management
d. Underwriting
24. are organizations whose primary objective is to maximize

return from investments in various financial instruments to add value for the investors.
a. Asset Management Firms
b. Investment Intermediaries
c. Regulated Investment Companies
d. Financial Intermediaries
25. Financial intermediaries that sells shares to the general public in exchange of cash.
Once they receive the proceeds, they then invest the money in a diversified portfolio of
financial instruments. Normally, asset management firms are contracted to manage
the investment portfolio of .
a. Asset Management Firms
b. Investment Intermediaries
c. Regulated Investment Companies
d. Financial Intermediaries
26. Asset management strategies in portfolios can be further subdivided into two.
funds (or indexed funds) are managed to mimic movements in the market
index such as the PSE Index. funds are managed by asset management
firms with the intention to outperform the index fund via actively trading securities in
the fund portfolio.
a. Active; Passive
b. Direct; Indirect
c. Passive; Active
d. Indirect; Direct
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. funds are like mutual funds, but the shares of the P0^0^?
in an exchange like a regular share offered by a company. It possesses ar
of both open-ended and closed-ended funds.
a. Exchange Traded Fund
b. Hedge Fund
c. Separately managed fund
d. Regulated Investment company account
28. Instead of investing in a shared fund like a mutual fund, a fund can be made that wS
be based on the specific necessities of a sole investor. This refers to:
b. Hedge Fund
29. This usually organized as a private investment partnership or offshore investment

corporation which uses various trading strategies to gain better position in different
markets.
b. Hedge Fund
30. Which of the following are activities an investment bank can offer?
a. Public Offering of Securities
b. Private Placement of Securities
c. Trading of Securities
d. Management Advisory Services
31. Which of the following are activities an investment bank can offer?
a. Merchant Banking
b. Securities Finance and Prime Brokerage Service
c. Liability Management
d. Research
32. Which of the following does not belong to sectors of market participants aside from
financial intermediary?
a. Family and Community
b. Government
c. Non-Profit Organizations
d. Corporation
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FUNDAMENTALS OF F1NANCIALMAP^ :
33 is one of the world’s largest sources of funding for developing

countries. Members of the group are as follows: International Bank for Reconstruction
and Development (IBRD), International Development Association (IDA), International
Finance Corporation (IFC), Multilateral Investment Guarantee Agency (MIGA), and
International Center for Settlement of Investment Disputes.
a. International Monetary Fund
b. World Bank Group
c. European Union
d. APEC

a. Financial Intermediaries were formed during the time when market conditions make
it hard for lenders of funds to transact directly with borrowers of funds
b. Benefits of having financial intermediaries in the Financial System are: (1)
acceleration of flow of funds between entities; (2) efficient allocation of funds; and
(3) support in price valuation.
c. Depository institutions, insurance companies, asset management firms, regulated
investment companies and investment banks are common types of Financial
Intermediaries.
d. Other participants in the financial system are the household sector, government,
corporate sector or the non-financial corporations, and the foreign sector
35. Which of the following statements are correct?

a. It is not uncommon that income received by a party or entity does not match
required expenditures, hence, resulting in deficits. These deficits may be resolved
through transferring funds from fund providers (with excess funds) to fund
demanders (with deficits). This can be done either through direct financing or
indirect financing.
b. Financial Institutions were formed during the time when market conditions make it
hard for lenders of funds to transact directly with borrowers of funds.
c. Financial intermediation is the process of direct financing using financial
intermediaries as the main route to transfer funds from lenders to borrowers.
Examples of financial intermediaries are depository institutions, insurance
companies, asset management firms, regulated investment companies and
investment banks.
d. Most financial intermediaries provide services to suppliers and demanders of funds.
The assets these financial intermediaries are limited to the portfolio they are
managing and the information they gain to facilitate and support their clients.
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NAME: __________ ______________________________ Date:
E2-4. Case Study. Discuss thoroughly the following cases.
1 oa*thiel W°n a cash prize of Php 20>000 in the National level Robotics Competition,
n he advice of his father, he visits a nearby bank to open a Fixed deposit account in
reaclY016 the prize money- His sister Heart accompanied him to the bank. On
. .In.9 the bank, he notices big banners which are placed within the premises
rai<sf»aifhn9 Informat'on about the various arrangements through which corporates may
GahriAi th ,c^pital throu9h the bank. Being a finance graduate, Heart explains to
of banks play the role of the financial intermediary by helping in the process
ventures ° 2109 the savir’9s of the households into the most profitable business
a. Aside from the bank, suggest other financial intermediaries that help in the
°' cpanne'’z’n9 savings of the households into the most productive
b. Identify the functions of those financial intermediaries that you will be

suggesting. 7
2. M ichael works as a waiter in a five-star hotel in Philippines. While serving the customer
e overhears him at the table saying that the he has made profits higher than expected
y investing in securities market. So, Michael also decides to make a nominal
investment from his savings in the stock market in pursuit of higher gains.
a. As a financial consultant, discuss with him the steps involved in investing in the
securities market.
b. Discuss also with him, other alternatives where he can invest his savings, the
process and which financial intermediaries they can go to.
3. Raphael finalizes a deal to buy a new house. So, he visits a nearby branch of a
commercial bank and withdraw from his account in order to pay the token money to
the seller. In the bank he observes that a large number of customers are present to
make cash withdrawals, probably because it is an auspicious time to make purchases.
After some time, he overhears one of the bank staff members telling his colleague that,
today the bank is likely to fall short of cash and to make up for the deficit and maintain
its cash reserve ratio it will have to approach another bank.
a. Identify the instrument that the bank will use to meet its short-term
requirements of funds.
b. State any feature of the instrument as per above.
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FUNDAMENTALS OF PDFelement
financialmarkft
Chapter 3
FINANCIAL REGULATION
AND THE CENTRAL BANK
PDFelement
FUN DAM ENTALS OF FINANCIAL-MARKET
Financial Regulation
Every country must implement its regulatory system to ensure controls and
governance. Regulation was designed to set rules and guidelines to be followed that is
designed to ensure balance among the individuals, firms and/or citizens as the case
maybe. Regulation is also designed to reconcile conflicting interests. Public Utility
Research Center in the University of Florida defined regulation is a process whereby the
designated government authority provides oversight and establishes rules for firms in an
industry. Normally a regulatory agency was identified by law or by order to execute the
regulatory framework and be an oversight of a certain industry or particular firm. Its
presence sets the boundaries to manage or control the behavior of the individuals, firms
and/or citizens.
World bank 1sets regulatory measures to address certain risks and social factors.
These are systemic risk, consumer protection, efficiency enhancement, and social
objectives. Systemic risk is the probability of a firm to fail its objective that will result to
ripple effect. Consumer protection on the other hand is a factor to consider that policies
enforced assumes the effecttothe consumers’ welfare. Efficiency enhancement is a factor
that is considered to ensure the dynamism and agility of the policy to adopt in a fast
changing environment. In broader scope, the policy should take into consideration the
alignment in the objectives of the society or what is factored as social objectives. Table
3.1 presents what regulatory measures address the risks identified.
Financial regulation is a type of regulation whereby rules and standards were set
to oversight the ability of the companies to establish and maintain appropriate level of
capital to sustain its operation. It also includes setting controls over the marketfactorsthat
will affect the financial sustainability of the firmsand players in the industry.
Table 3.1 Regulatory Measures and Risk Management Objective

Regulatory Measures Systemic Consumer Efficiency Social
Risk Protection Environment Objectives
Antithrust / competition policy Y Y Y
Disclosure standards Y Y Y
Conduct of business rules Y Y Y
Conflict of interest rules Y Y
Capital adequacy standards Y Y
Fit and Proper entry tests Y Y Y
Liquidity Requirements Y Y
Reporting Requirements Y
Restriction on services Y Y
Asset restriction Y Y
Deposit insurance Y Y
Reserve requirements Y Y
Customer suitability requirements Y
Interest Rate Ceiling-Deposits Y Y
Interest Rate Ceiling - Loans Y
Investment Requirements Y
Geographic Restrictions
Y
1 Carmichael, Jeffrey. The Development and Regulation ofNon-Bank Financial Institutions World Bank
2002
FUNDAMENTALS
OF FINANCIALMARKF t
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Market Drivers Regulated

In financial markets, some players or firms failed to survive even they comply wi1h
the regulation set. The reason being is that these firms respond to the following market
dnvers:
• Competitiveness • Consistency
• Market Behavior • Stability
Competitiveness
Government are duty bound to regulate competition in the environment, in this
case is the financial sector. Financial sector has an important role in shaping the overall
economy of a country hence it is a must that this must be regulated. Note that marketforln
the financial market the following are regulated: access to capital, credit and loan term
offerings, support to providers of financing, management of business risks, transaction
costs and tariffs. It must be noted that the main determinant of competition are the main
forces that drives the market i.e. buyers and sellers.
Firms in the financial market must be able to understand how to respond and
maximize their leverage in the industry and compete. Normally, investors explore forthose
which can offer with the less risk with favorable returns. The question is, how favorable is
favorable? This will be discussed in the later chapters. The challenge is for the firm on the
degree of risk it can assume to enable them to compete in the market. On the other hand,
connivance in the market may be probable and impose a high collaborative rate among
them, in this scenario government regulation will take place.
To illustrate, Company A, a brokerage company, imposes 1% brokerage fee to its
clients. Company B as a new player imposes a brokerage fee of 0.75% for every
transaction it closes. Company C another player enters the market offering brokerage fee
of 0.70% for every transaction. Company A kept its price policy.
In this case, assuming the provide same level of service, Company A is facing a
high risk of sustainability in the future if they will not adjust to the competition. In the given
scenario, probability that their clients will shift to the new players that offer a lower rate.
Government in this case may provide support to Company A to enable the company to
compete should there are internal consideration or risk that they assume that can be
passed on in other means. Note that pricing for services may be affected with the risks
assumed by a firm.
Market Behavior
The behavior of the firms in the industry can be regulated by their behavior. Their
behavior in the market can be demonstrated on their: (1) integrity on their activities; and
(2) integrity on their representation. Regulation will come into play to address failures in
the market by setting parameters to ensure that firmswill comply with certain standards
to ensure integrity of the firms and level the playing field. The government normally sets:
• full disclosure of information
• prohibition on insider trading
• control of new players
• setting minimum capital requirement
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minimum governance rules

Consistency
onncir>i^°nS,S,enCy same wrtb ,he f,e,d of Accountancy, is considered as an important
inform n ’he bus,n®ss Consistency in the market is normally demonstrated to their
a ’°2 disclosure and policies The firm must enable themselves to ensure that they
serv' 6 Sufflc,enl ,r*formation to their customers Given that financial market is heavily a
ice providing industry, information symmetry is a plus to all custom ers/cl tents that
ena e them to make sound decision. Information is a vital asset in financial markets,
oveinment role is to set standards to regulate and ensure that information provided in
e market are fair, consistent, and conservative. This will allow the investors to make
ecision In most of the times, the degree of risks assumed were based on the information
made available
The issue is that the company’s ability to provide a fair and consistent information.
Trust of the clients is dictated on how the firms was able to maintain its rapport in terms of
the information shared. In accounting parlance, information can be treated as an intangible
asset hence value should be tested overtime.
The principle of prudential regulation whereby the government impose rules or
standards that will govern the behavior of the financial institutions and financial markets
that grants commitments to minimize the risk of uncertainty and strengthen the integrity cf
the firms.
Stability
Market stability is an external and fatal factor to be considered by the firms in the
financial market. Given that market behavior is dependent on a lot of factors, the risk is
very high. Most of the players failed to survive because their ability to forecast and to
mitigate the market risk. In the financial market, the impact of financial risk is something
that the regulatory environment should consider. The regulation must be able to protect
the interest of the clients as well as the companies to enable their corporate sustainability.
Systemic instability is a challenge or threat whereby it arises where a segment or
firm was not able to meet its commitment because of their failure to address the risks of
the market. At the end of the day, the risk arises is the default risk of the company to
ascertain repayments thereby disrupting the continuous flow of finances in the industry.
Regulators of Financial Activities
Financial Activities has been referred to activities that deals on funding certain
transaction or expenditures. In the financial market, the financial activities are focused on
the trading of securities and financial instruments. Setting rules to set standards, control
and order on the financial activities, regardless of the source, is called as financial activity
regulation.
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OF FINANCIAL MARKET
in the Philippine setting, the financial regulation is observed by the following, but
not limited to the following:
Bangko Board of
Sentral ng Investment
and Exchange
Commission
Bangko Sentral ng Pilipinas (BSP) 2

The BSP is created under the New Central Bank Act or Republic Act 7653 and an
attached agency of the Department of Finance. Under the Philippine law, this will act as
the central monetary authority which will act as a corporate body that is responsible
concerning money, banking and credit BSP shall provide policy directions in these areas.
It is also responsible for the supervision of financial institutions and exercise regulatory
powers.
The function of BSP are following:
• Liquidity Management
The BSP formulates and issues monetary policy aimed at influencing
money supply in order to maintain price stability. Money supply will be further
discussed in the later part of this chapter.
• Currency Issue
The sole responsibility to issue notes and coins representing the national
currency for the Philippines. All issuances made by the BSP are with sovereign
guarantee and shall be considered legal tender in exchange for private and public
debts.
• Lender of last resort

BSP acts as the provider of discounts, advances and financial support to
financial institution forthem to maintain their liquidity.
2 https://www.bsp.gov.ph
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F U N DA M FNTALSOF FINANCIAL-MARKET
• Financial supervision
BSP regularly supervises the financial institutions and is empowere o
exercise regulatory powers over non-bank institutions conducting quasi-banking
functions.
• Management of foreign currency reserves

Manages the financial foreign currency requirement of the Republic by
ensuring sufficient international reserves will be made available on time. This is to
preserve the international stability and position of the Philippine Peso.
• Determination of exchange rate policy

BSP sets the policy that will determine the rate of exchange of Philippine
Peso over different currency. Currently, BSP subscribes to a market-oriented
foreign rate policy hence the rates are dependent in the behavior of the market.
• Other activities as banker, financial advisor and official depository of the

Government and its instrumentalities.
BSP shall be governed by the Monetary Board. The Monetary board is composed of
seven members. The board is chaired by the Governor of the BSP and composed of six
other members coming from: 1 member - member of the cabinet designated by the
President of the republic (that cabinet member can designate an undersecretary of his
department to attend on his behalf); 5 members-shall be
coming from the private sector (3 members shall serve for Point of Information!
a term of six months while 2 will serve for three months).
The BSP has its money
All members can only be re-appointed once.
museum within their
The Governor acts as the Chief Executive Officer of complex. It was constructed
the BSP. In order to carry its functions, it is supported by since January 3, 1999. It
serves are the repository of
four sectors I functions. (1) Financial Supervision Sector
all currencies and other
is responsible mainly for the supervision and regulation of historical financial resources.
banks and other financial institutions under the scope of
the BSP. (2) Monetary and Economics Sector aims to The Museo ng Bangko
conduct the formulation of monetary policy, ensure its
Sentral ng Pilipinas is open
implementation and assess its effectiveness. (3) Currency from Monday to Friday 9:00
Management Sector will be responsible in the production, a.m. to 4:00 p.m. Visiting the
distribution, disposal or retirement of currencies in the museum is subject for
Philippines including security documents, appointment
commemorative medals and medallions. Lastly, is the (4)
Corporate ServicesGroup which is the support group of the BSP that conducts the human
capital management, financial services, information technology support and other
corporate resource management. More specific information is available on the
Organization Primer of the BSP.
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FUNDAMENTALS OF FINANCIALMar.^
tnsurance Commission (IC)3

IC mandated by virtue of Executive Order No. 192 s. 2015 to ensure enforcement
of the provisions of the Insurance Code or Republic Act 10607, i.e. to regulate and
supervise the insurance, pre-need, and health maintenance organization industry, it js
governed by Department of Finance that supervises and regulates the operations
of life and non-life companies, mutual benefitassociations, and trusts for charitable
uses. IC issues licenses to insurance agents, general agents, resident agents
underwriters, brokers, adjusters and actuaries. It has also the authorityto suspend
or revoke such licenses.
The functions of IC are as follows:

1. Promulgation and implementation of policies, rules and regulations governing the
operations of entities engaged in insurance, pre-need, and HMO activities as well
as benevolent features.
2. Licensing of insurance, reinsurance companies, its intermediaries, mutual benefit

associations, trusts for charitable uses, pre-need companies, pre-need
intermediaries, and HMO companies
3. Conducting insurance agent’s examinations, as well as processing of

reinsurance treaties and request for investments of insurance companies
4. Examination/verificationof the financial condition and methods of doing business

of entities engaged in insurance business, pre-need, mutual benefit associations,
trusts for charitable uses, and HMO companies
5. Evaluation and preparation of statistical reports, studies, researches, annual

reports, and position papers relative to insurance, pre-need matters, and HMO
matters
6. Review of premium rates imposed by life and non-life companies, mutual benefit
associations; statistical reports of adjusters to determine compliance with
established standards.
7. Adjudication of claims and complaints involving loss, damage or liability incurred

by an insurer under any kind of policy or contract of insurance or suretyship;
8. Review and approval of all life and non-life policies, pre-need, and HMO plans
before sale to prospective clients.
Philippine Securities and Exchange Commission (SEC)

The SEC is the national government regulatory agency to administer oversight on
the corporate sector, capital market participants and securities and investment instrument
and promote corporate governance over these. It was created on October 26 1936 under
the Commonwealth Act No. 83.
3 https://www.insurance.gov.ph
PDFelement
FUNDAMENTALSOF FINANCIAL-MARKET
In the Republic Act 8799 or the Securities Regulation Code, widens the
responsibility and scope of the SEC to include the following:
1. Have jurisdiction and supervision over all corporations, partnerships or
associations who are the grantees of primary franchises and/or a license or permi
issued by the Government;
2. Formulate policies and recommendations on issues concerning the securities

market, advise Congress and other government agencies on all aspects of the
securities market and propose legislation and amendments thereto;
3. Approve, reject, suspend, revoke or require amendments to registration

statements, and registration and licensing applications;
4. Regulate, investigate or supervise the activities of persons to ensure compliance;
5. Supervise, monitor, suspend or take over the activities of exchanges, clearing

agencies and other SROs;
6. Impose sanctions for the violation of laws and the rules, regulations and orders
issued pursuant thereto;
7. Prepare, approve, amend or repeal rules, regulations and orders, and issue
opinions and provide guidance on and supervise compliance with such rules,
regulations and orders;
8. Enlist the aid and support of and/or deputize any and all enforcement agencies of
the Government, civil or military as well as any private institution, corporation, firm,
association or person in the implementation of its powers and functions under this
Code;
9. Issue cease and desist orders to prevent fraud or injury to the investing public;
10. Punish for contempt of the SEC, both direct and indirect, in accordance with the
pertinent provisions of and penalties prescribed by the Rules of Court;
11. Compel the officers of any registered corporation or association to call meetings
of stockholders or members thereof under its supervision;
12. Issue subpoena duces tecum and summon witnesses to appear in any
proceedings of the Commission and in appropriate cases, order the examination,
search and seizure of all documents, papers, files and records, tax returns, and
books of accounts of any entity or person under investigation as may be necessary
for the proper disposition of the cases before it, subject to the provisions of existina
laws;
13. Suspend, or revoke, after proper notice and hearing the franchise or certificate of
registration of corporations, partnerships or associations, upon any of the grounds
provided by law; and
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14 Exercise such other Powe;* mav be provided

o *s ™^cessary by law astowell
or incidental the as those out
carrying which
of,
' may be implied from, or which are achjeve the objectives and purposes of
the express powers grantee
these laws.
Board of Investments (BO!)
BOI is the lead agency to promote investment in country and thereby generate
local and foreign investment in the country. It is an attached an agency of the Department
of Trade and Industry. The agency provides advisory, actualization and post services to
the investors.
BOI provides the following services to encourage new investments:
• Providing information for the knowledge-based research.

• Incentivize the investors through the provision of tax holidays, tax and duty
exemption of imported capital equipment etc.
• Participate through policy advocacy initiatives to ensure that the laws and
regulation are investment friendly.
Money Supply and Payment System
The financial system is an interrelated financial process which is fueled by

money. Money supply is the availability of financial resources for deployment in the
financial system. It is making the money available for use or for trade or investment. This
is, of course, balanced with the monetary demand of the market.
This balance is managed by the central bank. For the case of the Philippines, it is
the Bangko Sentral ng Pilipinas. Money will take the form of the following:
• Cash (coins and bills)

• Demand deposits
• Other financial instruments
Money is expected to be regulated somehow to enable the sovereign to have control to

its economy. As mentioned in the earlier chapters, money is an essential factor in the
financial system. In order to do this, monetary policies must be enforced with the
objective of promoting sustainable output and employment at its peak and stabilize
prices. For a monetary policy to be appropriate or effective, the BSP must ensure the
following are present:
• Alignment to the target goals

• Access to information
• Responsiveness of the variable set
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Regulation of Circulation of Notes
The central bank, BSP for the case of the Philippines, is authorized by the
republic under R.A. 7653 that they have the sole power to issue currency, within the
territory of the Philippines. Given it is a sole authority, no one is allowed to issue or
reproduce any documentor object for general monetary circulation. Violators will be
facing with imprisonment of no less than five (5) years but not more than (10) years,
greater penalty may be imposed depending on the gravity pursuant to the Revised Penal
Code of the Philippines. In foreign countries, different manner of regulation was
imposed.
According to Chapter 4 of the BSP Circular No. 829 series 2014 amending the
consolidated rules and regulations on currency notes and coins issued in the Philippines,
for the banks, including their branches, if applicable, must observe the following for the
deposit of their notes:
• Banks shall classify their cash deposits and sorted by series and by
denomination. They should classify it according to:
1. clean or fit notes
2. dirty or unfit notes
• Banks shall provide securely sealed bags or containers separately for the clear
or fit notes, and for the dirty or unfit notes accompanied by a deposit slip for each
type/category. It must be labeled “UNFIT”.
• Handling of deposits, banks’ deposits shall be packed in sealed bags or
containers in standard quantity of twenty (20) full bundles per denomination.
Each bundle containing 1,000 notes in 10 equal straps. Each strap containing
100 notes.
• Banks located in the provinces may make direct deposits of currency notes, duly
identified and sorted, with the nearest BSP regional office/branch. Forthose
without regional offices available, they may arrange it with their respective head
offices to be shipped to BSP in Quezon City. The cost shall be borne by the bank
concerned.
• Banks shall incorporate measures on the implementation thereof in their
compliance program.
For the deposit of their coins the following were observed:
• Coins shall be free from adhesive tapes

• Coins shall be sorted into fit, unfit or mutilated per denomination and per series
• Each bag of coins shall contain the following standard number of pieces and
amount per denomination:
Denomination Pieces per Bag Amount per Bag
Php 10.00 1,200 Php 12,000

Php 5.00 1,500 Php 7,500
Php 1.00 2,000 Php 2,000
Php 0.25 3,000 Php 750
Php 0.10 4,500 Php 450
Php 0.05 5,000 Php 250
Php 0.01 5,000 Php 50
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fundamentals OF FINANCIALMa^
Personnel in charge for setting up the controls for

financial institutions, e.g. Accountants, Internal Auditors,
Point of Information!
Controllers, Comptrollers etc., must ensure that these As of 2019, there are 8
guidelines were properly observed. countries using Peso as a
currency. These are
Auditors may consider as part of their procedures Argentina, Chile, Colombia,
to validate the authenticity of the currencies, as Cuba, Dominican Republic,
Mexico, the Philippines, and
described by the BSP in its circulars, a currency note
Uruguay. There are other 14
shall be considered unfit for circulation when: countnes that used the
currency previously.
• It contains heavy crinkles which break the
fiber of the paper and indicate that
disintegration of the note has begun; or
• It is badly soiled/contaminated and/or with writings even if it has proper
life or sizing; or
• It presents a limp or rag-like appearance and/or it cannot sustain its
upright position when held at the mid-portion of one of the shorter
borders.
For currency coin shall be considered unfit for circulation when:
• It is bent or twisted out of shape or defaced or show signs of corrosion,

but its genuineness and/or denomination can still be readily and clearly
determ ined/identified; or
• It has been considerably reduced in weight by natural abrasions/wear and
tear.
For guidance, these currencies which are no longer allowed to be used for circulation but
may be presented forexchange to or deposited with any bank. The reason that the BSP
will not accept these currencies are as follows:
• The notes and coins can no longer be identified; or

• The coins have indications of filing, clipping or perforation; or
• Notes which have lost more than 2/5 of their surface or all of the signatures
inscribed thereon; or
• Notes which are split edgewise resulting in the loss of the whole of or part of,
either the face or back portion of the banknote paper; or
• Notes where the Embedded Security Thread or Windowed Security Thread
placed thereon is completely lost except when the damage appears to be
caused by wear and tear, accidental burning, action of water or chemical or
bites of insects etc.
Purchasing Power
The purchasing power is practically based on the consumer price index. In

economics, the consumer price index or CPI is the weighted average value of the basket
of prices of all commodities representing the market.
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FUNDAMENTALSOF FINANCIALMARKET
pie commodity group in the consumer price index are: food and non-
alcoholic beverages; alcoholic beverages and tobacco; clothing and footwear,
housing, utilities and otherfuels; furnishings and maintenance costs; health,
transport, communication; recreation and culture; education; restaurantand
miscellaneous.
The degree of movement of the CPI from a period to another is called the
inflation rate. Inflation is derived in EQ 3.1
Eq 3.1 Inflation = x 100%
CPh = Cunent price index

CPIo = Base price index
To illustrate, the CPI for years 1 and 2 are as follows: Year 1 = 112; Year 2 -
116. The inflation is computed as follows:
Inflation = — lj x 100%
Inflation = 0.0357 x 100%
Inflation = 3.57%
This means that the prices went up by 3.57%. In terms of the purchasing power
this signifies that P1.00 can buy lesser than the previous year to about 3.57%. Inflation is
an indication of the market risk. Hence, this also affects the ability of the people to make
new purchases or settle their obligation. In finance, inflation is a driver of the financing
costs. For regulatory purposes, BSP finds its way to control inflation and enable
continuous flow of funds in the market. Thus, BSP is one of the credible agencies that
targets the inflation. Philippine Statistics Authority, for the case of the Philippines, is the
body that determines the current inflation based on the current movement of the
commodities set as index in the market.
There are two types of inflation: the core inflation and headline inflation. Per the
BSP, core inflation is used for most of the economic estimates where it excludes in the
equation the movement of the commodities or incidents with very volatile movementor
outliers. Headline inflation on the other hand captures the changes of the cost of living
based on the movement of the basket of commodities as a whole.
In figure 3.1, you may note the trajectory of the headline and core inflation for the
years 2013 to 2018. You may observe that the relationship of the headline to core is not
consistent over the years where the headline is not always higher than the core inflation.
This is because the excluded incident or commodity may overstate or understate the
basket of prices, but that effect will not last for long term. It is important in those
engaging in financial markets to know which movement should be considered fortheir
long-term decision. For those in the capital market for example, this is a good input
whether to buy, sell or hold their securities. Strategies on how manage these securities
and even the financial instruments will be discussed in the later chapter of this book.
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FUNDAMENTALS OF FINANCIAL^
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Figure 3.1 Headline and Core Inflation from 2013 to 2018
Payment System
The business is not a business if without any trade or exchange. In civil law of
the Philippines there are different way to settle an obligation after the delivery of
products or render of service. One of the modes of settlement is through payment of the
products or services through a payment system. The payment system is a set of
interrelated processes of settlement of goods or services rendered in exchange fora set
of instruments that will undergo either a banking or non-banking procedures.
Characteristics for an Effective Payment System
There is no ideal or best methodology to administer a payment system. The

system is dependent on the best amenable, convenient and acceptable solution for both
parties i.e. the payee and the payor. The payment system will work on a certain network
or sub-systems that will link the parties grounded by certain rules and procedures.
According to BSP, a payment system normally requires the following:
• Standard methods of transmitting payment messages within the system

• Agreed means of settlement
• Common operating proceduresand rules e.g. admission, feesand operating
hours.
Standard Methods of Transmitting Payment
The conventional way of transmitting payment is the literal arm’s length

exchange of transaction whereby the seller or the obligor deliver the goods or
render service while the other party will deliver in the instance. However, this
PDFelement
became a challenge especially forthose located in a remote location or far from

each other. Nowadays, this is no longer a challenge. Banking system already
provides different ways to settle obligation or may payments. With the electronic
banking or e-banking system, it enables the settlement to be made through fund
transfer, online payment or special requests from the bank made virtually. Figure
3.2 presents an interface of a personal e-banking service.
t? *• Ww»>■«-> • •*r H
Welcome to an onk<* Beu?
wK»n new;
• frwnlri rnoncv Io hndy gul HcxK the wjy ty
t ng a QR
• I’.ty pbmv, uidibn j M cthet SBi
• Reload Io all tece netweskx Metako load
and
• CtKtanii* ymr dcM card senary with C*d Cotrtrc*
• Grt Ml xreu to vot i iimtment account* with
MJtanXHXY Kfcnvikiq and of «nk
CAM tmd YCRB L’vCUtfCV Mwe why
Figure 3.2 E-banking interface
The e-banking with the other features allows payment and money
transfers. This shows that payment system works within an infrastructure
providing efficient solution and real-time processing of payment with reduce risk.
Agreed Means of Settlement
Given that the exchange is a contract between the parties, it is essential

that they also agree on the manner on how the payment is to be rendered. Even
there is an available online infrastructure to make payments, some people are
still confident on doing it manual or the conventional way. Although the payment
made through cheques is not that warranted, except if it is a manager cheque,
some people still preferred this type of payment. What is important in a payment
system is that the parties will agree on the manner of payment.
In accounts payable processing or AP processing, all transactions for

purposes of controls are charged to accounts payable account. Now, the
settlement of these transactions varies depending on the manner on how it is
agreed for settlement. Well, at the end of the day it all boils down to a credit to
cash.
The normal means of settlement are as follows:
• Cash or cheque Payment

• Online payment (if the supplier of goods or service is an accredited
merchant of a bank)
• Automated Teller Machine
• Fund transfer
• Credit Cards
• Debt Cards and Stored Value Cards
• Electronic Money
• Manual Money transfer
• Paybox System
• Cash deposit
• Assignment
Common Operating Procedures and rules
Other than the agreement on the manner on how it will be settled, another
key requirement for an effective payment system is the operating procedures and
rules. Like any other contract these information or guidelines must mutually
accepted by both parties. These agreements are normally provided by the
payment system facility to provide guidelines and protection for both parties in
case of breach as well protection of the system that the transactions are cleared
from the settling party.
In an online banking system, these agreements are provided as a

template to all clients or users of the system. These provides a formal authority to
the facility to use information and the users agreed to subscribed to the banking
policies. These policies sent by the banks or financial institutions were regulated
by the BSP.
Importance of Payment System
Payment System as mentioned is an essential facility to enable the complete

course of the transaction. Based on the characteristics and features of payment system,
BSP identified the following importance of the system, among others
• Safe and Real Time Transactions;

• Effective risk management; and
• Facilitates Financial Market Transactions.
Safe and Real Time Transactions
The payment systems are designed to safeguard the identity and transaction as
a whole especially on electronic payment system facilities. Payment systems are
deemed safe given that the characteristics are mutually agreed by the parties
including the manner of payment which is convenient for both. Real time are
normally applicable for electronic I internet-based system. Real time can be
applicable to manual payment system. Essentially the transaction when the
exchange is made, and settlement is rendered completes the transaction already in
that point in time.
For e-banking payment system facilities, it is debited to the account of the pay^
real-time however most of the systems requires 3 banking days before it is credit
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FUNDAMENTALS OFWatermark Wondershare
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PDFelement
i th©
f-'v-'oiii iy to th© ------ •»«*•*** w »** m • ■**« «•••■— j-—j — ■------------- ------- v» iw
clearing process h Payee‘ _rê three banking day rules is required as part of the
time. ’ U mostof the time, particularly for fund transfer it is credited real
The Philippine Bureau of Internal Revenue adopts the use o personal

and Payment System. This allows you to file and pay the tax u® . to enCourage
and corporate. This payment system is a hybrid that is primarily nceto the
compliance in tax filing and facilitates the payment to provide con
tQV HOV/r.t-r'
taxpayers.
Effective Risk Management
Since the payment system facility, nowadays, involve well defined parties and
rules. The payment system facilities have verification process to allow the users to
validate the transaction before completing the authority to make payments. Also, one
advantage for established payment system is the absence of physical cash or
financial instrument, everything can be made virtually or if applicable electronically,
this minimizes the risk of loss, theft and misappropriation.
Although it is an effective risk mitigation methodology, there are still risk that
needs to be recognize upon using payment systems. These risks are enumerated in
Table 3.2
Table 3.2 Risks of Payment Systems
Credit Risk Ability of the payor to meet the full value of its
obligation due to unforeseen charges.
Liquidity Risk Timing difference on posting may affect the

visibility of the user or a party to determine that
full amount due and end up its ability to
calculate currently maturing obligation
Default Risk Risk that payment will be made on time.
Technological Risk System downtime and system “bugs” may

occur.
Legal Risk Changes in rules and regulations affecting the

payment system
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of financialmarket
Facilitates Financial Market Transactions p|atform of the
In the emergence of the e-banking may facilitate the settlement of the

payment system facilities. The paymen y a|SO Pe Used to make future analysis
financial market transaction. The databas pe used to validate the
or projections of the investors. The system f completed the trade,
personality or credit rating of certain instruments beror
• A vA/ith online brokerage companies to (1)
Currently, certain platforms are integr or of the transactions; and
facilitate opening an account; (2) fa^tat® P approach to manage financial
(3) reduce human intervention provides objective appi ua
market transactions.
\ ----------------------------------------------------------------------------- 71
SUMMARY
• Financial Regulation set rules and standards to oversight the ability of the
companies to establish and maintain appropriate level of capital to sustain in
the operation.
• Drivers in the market that led to failure for businesses are: competitiveness,
market behavior, consistency, and stability.
• Bangko Sentral ng Pilipinas is the top financial regulator in the Philippines.
Together with it are: Philippine Securities and Exchange Commission,
Insurance Commitments, and Board of Investments
• Money is the basic form of the financial system. Money supply is the
availability of financial resources for deployment in the system.
• Purchasing power is based on the consumer price index.
• Payment System is a set of interrelated processes of settlement of qoods or
rendering of service in exchange for set of instrument that will undergo either
a banking or non-banking procedures
’ C?aLaC?riSti?u L°r a2 Effective Payment System is that it should have
standard methods of transmitting payment message- (2) aqreed means of
settlement; (3) common operating procedures and’ rules
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NAME:
E3 1. True or False. Write the word TRUE if the statement is true and FALSE if the
true.
1 Every country must implement its regulatory system to ensure controls

and governance.
2. Regulation was designed to set rules and guidelines to be followed that is
designed to ensure balance among the individuals, firms and/or citizens
as the case maybe.
3. Public Utility Research Center in the University of Florida defined
regulation is a process whereby the designated government authority
provides oversight and establishes rules for firms in an industry.
4. Systematic risk is the probability of a firm to fail its objective that will result
to ripple effect.
5. Consumer protection on the other hand is a factor to consider that policies
enforced assumes the effect to the consumers’ welfare.
6. Efficiency enhancement is a factor that is considered to ensure the
dynamism and agility of the policy to adopt in a fast-changing
environment.
7. In broader scope, the policy should take into consideration the alignment
in the objectives of the society or what is factored as cultural objectives.
8. Financial regulation is a type of regulation whereby rules and standards
were set to oversight the ability of the companies to establish and
maintain appropriate level of capital to sustain its operation. It also
includes setting controls over the market factors that will affect the
financial sustainability of the firmsand players in the industry.
9. Financial sector has an important role in shaping the overall economy of a
country hence it is a must that this must not be regulated.
10. Firms in the financial market must be able to understand how to respond
and minimize their leverage in the industry and compete.
11. The behavior of the firms in the industry can be regulated by their
behavior. Their behavior in the market can be demonstrated on their: (1)
integrity on their activities; and (2) integrity on their representation.
12. Given that financial market is heavily a product providing industry,
information symmetry is a plus to all customers/clients that enable them
to make sound decision.
13. Government role is to set standards to regulate and ensure that
information provided in the market are fair, consistent, and conservative.
14 Market stability is an external and fatal factor to be considered by the
firms in the financial market.
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----------------------------------- threat whereby it arises where a
5*2* ,|,: "" °*,llal 1ft°r,!: r' ■

a a- ♦ioc has been referreu financial market, the financial
17. Setting rules to set "s called as financial activity

activities, regardless of the ’
regulation. D-i,v»ino is created under the New Central Bank
18. The Bangko Sentral ng ' ched agency of the Department of
Actor Republic Act 7653 ana an gg the centra| monetary
Finance. Under the Philippine > . . that is responsible concerning
authority which will act as a corporate oooy
money, banking and credit noverned by the Monetary Board.
19. Bangko Sentral ng Pilipinas shall begoverne
The Monetary board is composed of nine m
„ monHatpH bv virtue of Executive Order No. 192
20. Assurance Commission mandated oy insurance CoHa nr
s. 2015 to ensure enforcement of the provisions of the Insurance Code or
Republic Act 10607, i.e. to regulate and supervise the insurance, pre
need, and health maintenance organization industry. It is governed by
Department of Finance that supervises and regulates the operations of
life and non-life companies, mutual benefit associations, and trusts for
charitable uses.
21. The Securities and Exchange Commission is the national government
regulatory agency to administer oversight on the corporate sector, capital
market participants and securities and investment instrument and
promote corporate governance over these. It was created on October 26,
1936 under the Commonwealth Act No. 83.
22. Philippine Economic Zone Authority is the lead agency to promote
investment in country and thereby generate local and foreign investment
in the country. It is an attached an agency of the Department of Trade
and Industry. The agency provides advisory, actualization and post
services to the investors.
23th^°f?ne/nHJiPJy ? the.fvailabiil!ty of financial resources for deployment in
or investment^ *S makin9 the money available for use or for trade
^h^v^controrîtêconomy6^0*3^ somehow to enable the sovereign to
2^tlTe^republ|rc u^d^r R Philippines, is authorized by

currency, within thj P°Wer ‘° iSSUS
no one is allowed to issue or reared, m PP nes‘ Glven it is a sole authority,
general monetary circulation. 6 any document or object for
26. The purchasing power is practicall
In economics, the consumer oricp indc^Sed tPe consumer price index,
value of the basket of prices of all comm°H-P* IS *s tbe we'Qhted
'9hted average
27. There are two types of inflation- th ° ,tl6S representin9 the market.
S COre Nation and headline inflation.
92 I
PDFelement
AQfin-> n+e headline inflation is used for most of the economic

ates where it excludes in the equation the movement of the
ommodities or incidents with very volatile movementor outliers.
29'j.9ore inflation on the other hand captures the changes of the cost of
iving based on the movement of the basket of commodities as a whole.
30. The payment system is a set of interrelated processes of settlement of
goods or services rendered in exchange fora set of instruments that will
undergo either a banking or non-banking procedures.
31. The e-banking with the other features allows payment and money
transfers. This shows that payment system works within an infrastructure
providing efficient solution and real-time processing of payment with
reduce risk.
32. Since the payment system facility, nowadays, involve well defined
parties and rules. The payment system facilities have verification process
to allow the users to validate the transaction before completing the
authority to make payments. Also, one advantage for established
payment system is the absence of physical cash or financial instrument,
everything can be made virtually or if applicable electronically, this
minimizes the risk of loss, theft and misappropriation.
33. In the emergence of the e-banking system that serves as the platform of
the payment system facilities. The payment system may facilitate the
settlement of the financial market transaction.
34. Currently, certain platforms are integrated with online brokerage
companies to (1) facilitate opening an account; (2) facilitate purchase or
sale of the transactions; and (3) reduce human intervention provides
objective approach to manage financial market transactions.
35. Drivers in the market that led to failure for businesses are:
competitiveness, market behavior, consistency, and stability.
36. Money is the basic form of the financial system. Money demand is the
availability of financial resources for deployment in the system.
37. Bangko Sentral ng Pilipinas is the top financial regulator in the
Philippines. Together with it are: Philippine Securities and Exchange
Commission, Insurance Commitments, and Board of Investments
38. Characteristics for an Effective Payment System is that it should have
(1) standard methods of transmitting payment message; (2) agreed
means of settlement; (3) common operating procedures and rules.
39. Payment System is a set of interrelated processes of settlement of
goods or rendering of service in exchange for set of instruments that will
undergo either a banking or non-banking procedures.
40 Financial Regulation set rules and standards to oversight the ability of
the companies to establish and maintain appropriate level of capital to
sustain in the operation.
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FUNDAMENTALS OF FINANCIALMPDFelement
ap.^
NAME: —--------------- ________ Date: _
given.
Across Down
1. Risk of changing rules and regulations affecting the payment system 2. Risk that the timing difference on posting may affect the vistoiSty of
6. What ’P’ system which is a set of interrelated processes of settlement the user
of goods or services 3. Risk that payment will be made on time
7. a function of BSP to manage this by issuance of monetary policy in 4. Board of ‘I’ that promotes inflow of financial resources by attracting
order to allow firms meet currently maturing obligations investors in the country
9. process whereby the designated government authority provides 5. The ‘S’ in the SEC a government agency that is tasked to administer
oversight over a firm or industry oversight to corporate entities
10. a risk that is driven beyond the firm 8. This represents the purchasing power of a currency
FUNDAMENTALS OF FINANCIAL-MARKET
PDFelement
NAME:
1. Which of the following is not one of the risks and social factors being addressed by
regulatory measures set by World bank?
a. systematic risk
b. consumer protection
c. efficiency enhancement
d. social objectives
2. Is the probability of a firm to fail its objective that will result to ripple effect.
a. systemic risk
3. Is a factor to consider that policies enforced assumes the effect to the consumers’
welfare.
a. systemic risk
4. Is a factor that is considered to ensure the dynamism and agility of the policy to adopt
in a fast-changing environment
a. systemic risk
5. Is a factor that is taking into consideration the alignment in the objectives of the society
a. systemic risk
6. Which of the following is not addressed by Antithrust/competition policy?
a. systemic risk
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FUNDAMENTALS OF FINANCIALMARtftrr
7. Which of the following is not addressed by Disclosure of Standards?

a. systemic risk
8. Which of the following is addressed by Geographic Restrictions?

a. systemic risk
9. Drivers in the market that led to failure for businesses do not include .
a. competitiveness
b. market behavior
c. consistency
d. Integrity
10.1s a challenge or threat whereby it arises where a segment or firm was not able to
meet its commitment because of their failure to address the risks of the market.
a. Systemic instability
b. Consistency
c. Market Stability
d. Inefficiency
11. Which of the following is not a function of Bangko Sentral ng Pilipinas?

a. Liquidity Management
b. Currency Issue
c. Lender of Last Resort
d. Financial Intermediation
12. BSP shall be governed by the Monetary Board. The Monetary board is composed of
members.
a. six
b. seven
c. five
d. four
13. Which of the following is not a member of Monetary Board?

a. Secretary of Department of Finance or his designate
b. Private sector
c. BSP Governor
d. Head of the Bureau of Treasury
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FUNDAMENTALS OF F1NANCIALMARKET
14 Which of the
Governor? w’ng is not a sector/function supporting the function of the BSP
a- Financial Supervision
b. Monetary and Economics
c- Financial Management
• Corporate Services Group
a Incu iro°f flowing is not regulated by Insurance Commission?

a. Insurance Companies
b. Pre-need Companies
c. Health Maintenance Organization
d. Philhealth Insurance Corporation
16. Which of the following is not a function of Insurance Commission?

a. Promulgation and implementation of policies, rules and regulations governing the
operations of entities engaged in insurance, pre-need, and HMO activities as well
as benevolent features.
b. Licensing of insurance, reinsurance companies, its intermediaries, mutual benefit
associations, trusts for charitable uses, pre-need companies, pre-need
intermediaries, and HMO companies
c. Conducting insurance agent’s examinations, as well as processing of reinsurance
treaties and request for investments of insurance companies
d. Review, approval, selling and marketing of all life and non-life policies, pre-need,
and HMO plans to prospective clients.
17. National government regulatory agency to administer oversighton the corporate

sector, capital market participants and securities and investment instrument and
promote corporate governance over these.
a. Department of Trade and Industry
b. Securities and Exchange Commission
c. Department of Finance
d. Board of Investments
18 Issues licenses to insurance agents, general agents, resident agents, underwriters,

brokers, adjusters and actuaries. It has also the authority to suspend or revoke such
licenses.
d. Insurance Commission
19 It will act as a corporate body that is responsible concerning money, banking and
credit.
a. Bangko Sentral ng Pilipinas
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d. Insurance Commission
20. Which of the following is not within the scope and responsibilities of Securities and
Exchange Commission?
a. Have jurisdiction and supervision over all corporations, partnerships, sole
proprietorships or associations who are the grantees of primary franchises and/o
license or permit issued by the Government ra
b. Formulate policies and recommendations on issues concerning the securities

market, advise Congress and other government agencies on all aspects of the
securities market and propose legislation and amendments thereto
c. Approve, reject, suspend, revoke or require amendments to registration statement
and registration and licensing applications ls
d. Regulate, investigate or supervise the activities of persons to ensure compliance
21. Lead agency to promote investment in country and thereby generate local and
foreign investment in the country.
b. Board of Investments
c. Economic Processing Zone Authority
d. Philippine Economic Zone Authority
22. Which of the following is not a service provided by Board of Investments?

a. Providing information for the knowledge-based research.
b. Incentivize the investors through the provision of tax holidays, tax and duty
exemption of imported capital equipment etc.
c. Participate through policy advocacy initiatives to ensure that the laws and regulation
are investment friendly.
d. All of the above
23. The availability of financial resources for deployment in the financial system.
a. Money
b. Money Supply
c. Money Demand
d. Monetary Demand
24. Money will take the form of the following, except:

a. Coins and bills
b. Demand deposits
c. Security Deposits
d. Other Financial Instruments
25. For a monetary policy to be appropriate or effective, the BSP must ensure the
following are present, except:
a. Alignment to the target goals
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b. Access to information
d.AroPfZXSeSO,,heVa"abl6S6t
consolidated ml apte\ 4 of the Bsp Circular No. 829 series 2014 amending the
PhiliDDine<? for +rS ^nd ,re9ulations on currency notes and coins issued In the
following for+u Tj6 banks’ including their branches, if applicable, must observe the
snowing for the deposit of their notes, except:
3 S Sâl' 'ncorP°rate measures on the implementation thereof in their compliance
program.
b. Banks shall provide securely sealed bags or containers separately for the clear or fit
otes, and for the dirty or unfit notes accompanied by a deposit slip for each
type/category. It must be labeled “UNFIT”.
c. Handling of deposits, banks’ deposits shall be packed in sealed bags or containers
in standard quantity of ten (10) full bundles per denomination. Each bundle
containing 1,000 notes in 10 equal straps. Each strap containing 100 notes.
d. Banks located in the provinces may make direct deposits of currency notes, duly
identified and sorted, with the nearest BSP regional office/branch. Forthose without
regional offices available, they may arrange it with their respective head offices to
be shipped to BSP in Quezon City. The cost shall be borne by the bank concerned.
27. According to Chapter 4 of the BSP Circular No. 829 series 2014 amending the
consolidated rules and regulations on currency notes and coins issued in the
Philippines, for the banks, including their branches, if applicable, must observe the
following for the deposit of their coins, except:
a. Coins shall be free from adhesive tapes
b. Coins shall be sorted into fit, unfit or mutilated per denomination and per series
c. Each bag of coins shall contain the prescribed standard number of pieces and
amount per denomination
d. Banks shall classify their cash deposits and sorted by series and by denomination.
28. As of 2019, there are 8 countries using Peso as a currency. These include the
following, except:
a. Cuba
b. Chile
c. Columbia
d. Czech Republic
29 Auditors may consider as part of their procedures to validate the authenticity of the
currencies, as described by the BSP in its circulars, a currency note shall be
considered unfit for circulation when, except:
a it contains heavy crinkles which break the fiber of the paper and indicate that
disintegration of the note has begun; o
b It is badly soiled/contaminated and/or with writings even if it has proper life or sizing;
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FUNDAMENTALS OF FINANCIALMAR kpt
c. It is bent or twisted out of shape or defaced or show signs of corrosion, but its
genuineness and/or denomination can still be readily and clearly determined.
d. It presents a limp or rag-like appearance and/or it cannot sustain its upright position
when held at the mid-portion of one of the shorter borders.
29. Auditors may consider as part of their procedures to validate the authenticity of the
currencies, as described by the BSP in its circulars, a currency coin shall be
considered unfit for circulation when, except:
a. It contains heavy crinkles which break the fiber of the paper and indicate that
disintegration of the note has begun; or
b. It is bent or twisted out of shape or defaced or show signs of corrosion, but its
genuineness and/or denomination can still be readily and clearly
determ ined/identified
c. It has been considerably reduced in weight by natural abrasions/wear and tear.
d. All of the above
30. Practically based on the consumer price index. In economics, the consumer price
index or CPI is the weighted average value of the basket of prices of all commodities
representing the market.
a. Purchasing Power
b. Monetary Value
c. Per Capita Income
d. Inflation rate
31. The degree of movement of the Consumer Price Index from a period to another
a. Purchasing Power
b. Monetary Value
c. Per Capita Income
d. Inflation rate
32. a set of interrelated processes of settlement of goods or services rendered in

exchange fora set of instruments that will undergo either a banking or non-banking
procedures.
a. Exchange System
b. Payment System
c. Monetary System
d. Banking System
33. According to BSP, a payment system normally requires the followinq except
a. Standard methods of transmitting payment messages within the system
b. Agreed means of settlement y
c. Common operating procedures and rules e.g. admission, fees and operating hours.
d. All of the above
34. A Payment system is important due to the following features, except:
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a. Safe and Real Time Transactions;

b. Effective risk management
c. Facilitates Financial Market Transactions
d. All of the above
35. Risk referring to the ability of the payor to meet the full value of its obligation
unforeseen charges.
a. Liquidity Risk
b. Default Risk
c. Credit Risk
d. Technological Risk
36. Timing difference on posting may affect the visibility of the user or a party to
determine that full amount due and end up its ability to calculate currently maturing
obligation
a. Liquidity Risk
b. Default Risk
c. Credit Risk
37. Risk that payment will be made on time.

a. Liquidity Risk
b. Default Risk
c. Credit Risk
38. System downtime and system “bugs” may occur.

a. Liquidity Risk
b. Default Risk
c. Credit Risk
39. Changes in rules and regulations affecting the payment system

a. Legal Risk
b. Default Risk
c. Credit Risk
40. What is the inflation rate if the Consumer Price Indexes are 110 and 116 last year
and this year respectively?
a. 3.57%
b. 0.36%
c. 35.7%
d. Cannot be determined
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Chapter 4
MONEY MARKET &
RELATED FINANCIAL INSTRUMENTS
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Financial Instruments
According to Conceptual Framework for Financial Reporting (2018), an asset is a

resource controlled by the entity as a result of past events and from which future economic
benefits are expected to flow to the entity. Assets can be classified in terms of physicality,
tangible and intangible assets.
Tangible assets are assets that has physical properties and can be easily seen,
touched or perceived by the five senses. Value of tangible assets are based on its physical
properties. Examples of tangible assets include buildings, equipment, machinery, land and
supplies.
Intangible assets are identifiable assets that do not have physical substance and
usually represents a legal claim to some future economic benefit. Financial instruments
(also called as financial assets or securities) are basically intangible as future economic
benefit takes form of a claim to cash that will be received in the future. Financial
instruments are the main vehicle used for transactions in the financial market. For the
purposes of presentation in financial statements, financial instruments may be presented
under cash equivalents or investments. Securities that are maturing within 90 days or less
are classified under cash equivalents. Otherwise, they are classified under investments.
There is a minimum of two parties involved in a financial instrument:
• the issuer; and

• the investor.
The issuer is the party that issues the financial instrument and agrees to make future cash
payments to the investor. The issuing party usually needs additional funds for investment
to further grow their business. On the other hand, the investor is the party that receives
and owns the financial instrument and bears the right to receive payments to be made by
the issuer. The investors usually have surplus funds that are not earning anything and are
willing to bear some risk to earn something from their surplus funds. On an accounting
perspective, investors recognize financial instruments as an asset.
At the point of issuance of the financial instrument, the issuer usually receives
something of value (usually cash) from the investor. The financial instrument then
becomes the proof (hence, called as security) of the future claim of the investor from the
issuer.
Financial instruments have two main economic purposes:
• Allows transfer of fund from entities with excess funds (investors) to entities who
needs funds (issuer) for business purposes (e.g. to pay for tangible assets).
• Permit transfer of fund that allows sharing of inherent risk associated with the cash
flows coming from tangible asset investment between the issuer and investor.
Usually, the initial investor does not hold on to the instrument up until the time the
issuer can make the payment. In such cases, investors trade their financial securities to
other individuals or institutions who are willing to pay for their claim to future payment
Financial intermediaries also operate in the financial system demand funds from
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financial assets that the general public is willing

“investors" and convert these to various Haims of the final wealth holders generaii9
to buy. As a result of these interlinked.ac:tivi i. ( demanders of funds). Financial
differ from the liabilities recognized by tn discussed in this chapter while tho<=Q
instruments that are used in the money m subsequent chapters,
that are used in the capital markets are presented
Money Market
• nnontinn is that money or currency is the security being traded
One primary misconception jthyother markets, financial instruments are
in a money market. This ,s not true. Same th However, the financial instruments
the primary subject of trading in a money k g d (hat it can be considered
traded in the money market are short-term ariu my y u
close to being money.
Money market securities have three fundamental Point of
characteristics: Information!
• Usually sold in large denominations No exact account when
• Low default risk first currency is used. But
• Mature in one year or less from original issue date. as early as 5,000 B.C.
metals were believed to
Most money markets instruments mature in less than
be the first form of
4 months. currency in the West
Hemisphere. While shells
Transactions in the money market are not confined to
for the East.
one singular location. Instead, the traders organize the
purchasing and selling of the securities among participants
and closes the transactions electronically. As a result, money market securities commonly
have an active secondary market. An active secondary market enables individuals /
organizations to trade money market instruments to cater to short-term financial needs.
Money market instruments become a flexible tool as individuals / organizations may invest
in these for short-term gains and convert it back to cash quickly once liquidity need arises.
On an accounting perspective, most money market instruments are considered as cash
equivalents due to the fact that they mature (i.e. cash can be redeemed) within three
months or less from the date of purchase.
Most transactions in the money market are very large, hence, they are considered
as wholesale markets j;he required size of the transaction usually averts individual
investors in directly participating in the monw/ a ^^"y dvens> i iuiviu
execute transactions in the trading rooms of brokAran \ S 3 reSU dea,ers and brokers
customers (buyers to sellers) with each othor n ôuses and lar9e banks to match
nowadays can invest in the money market bv in 6Spi*e this limitation, individual investors
market instruments. V 1 by JO,n,n9 funds that trade mostly using money
A mature secondary market for mon^v i x-

market to be the preferred place for firms to t arket instruments allows the money
time they are needed again by the organization f?°ranly Store excess funds up until such
market do not intend earn high retun,s foMh^ S‘°rS who funds in the money
money. Instead, investors look at the
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money mar et as a temporary investment that will provide a slightly higher return than
° °n money or depositing it in banks. If investors believe that the prevailing
mar e con i ions do not justify a stock purchase or there might be a possible interest rate
i es impac ing bonds, then they can choose to invest on money market instruments in
e mean ime. Holding on to cash is a very expensive option for investors as this does not
genera e any return. Any idle cash becomes an opportunity cost to investors by means of
e in eres income not earned by holding on to the cash. To reduce opportunity costs,
money markets become a viable option to temporarily invest idle funds.
Investors also plan their strategy to incur the lowest opportunity costs. Investors
want to have an easy source of cash to be able to act quickly if there are available
investment opportunities that come but at the same time do not want to let go of potential
interest income. As a result, they invest on money market securities to achieve these
objectives. Financial intermediaries also use money market instruments to attain
investment requirements or deposit outflows.
On the other hand, money markets offer a least expensive alternative for fund
demanders such as the government and financial intermediaries when they have short
term fund requirements. Fund demanders need to have funds quickly because the timing
of cash inflows and outflows does not synchronize with each other. For businesses, timing
of cash collections from revenue may not match when the business needs to pay its
operating expenses. For government, collection of revenue only comes at certain points
of the year (tax payment deadlines) but expenses are incurred throughout the year. To
resolve the need for funds as a result of the mismatch, these entities turn to money
markets to obtain funds.
Participants in the money market include the following
• Bureau of Treasury. The bureau sells government securities to raise funds. Short
term issuances of government securities allow the government to obtain cash until
tax revenues are collected.
• Commercial banks. Issues treasury securities; sell certificates of deposits and

extends loans; offers individual investor accounts that can be used to invest in
money markets. Banks are the primary issuer negotiable certificates of deposits,
banker’s acceptances and repurchase agreements.
Private Individual. These private individuals made their investment through money
market mutual funds
mmmercial Non-Financial Institutions. These entities buy and sells money market
manaoe their cash i.e. to temporarily store excess funds in exchange
higher return and obtain short-term funds
moanies. Trade securities in behalf of their clients. Makes a market

Investment co p securities through maintaining an inventory of financial
for money mar bought or sold. Investment companies help maintain
instruments tha since they make sure that sellers can easily sell their
ScX"-ed arises. ....................... ......................................................
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These companies raise money market

Finance / commercial leasing coâ"'^ funds to individual borrowers
instruments i.e. commercial paper to lend r
nmcanies that invest on money market to
Insurance companies. These are prtec| demands most especially for property
maintain liquidity level in case o un
and casualty insurance companies.
f nHc in money market as preparation for long-term
Pension funds. Maintain funds Neecj to maintain liquidity to meet obligations
investing in stocksand bonds marke . huge money market investments
but since future obligations are likely expecieu,
are not necessary.
x tk«p funds permit small investors (e.g. individuals)
Money market mutual funds. accUmulating funds from numerous small
to invest in the money market by accum“T*1 y qpcuritjes
investors to buy large-denomination money market securities.
Types of Money Market Financial Instruments
Money market Instruments took the form of short-term deposits, government

securities, commercial papers and certificates of deposit which form part of the Philippine
interest rate market. Money market instruments are governed by Philippine regulations
and are influenced by market movements.
Treasury Bills
Treasury Bills are government securities issued by the Bureau of Treasury which
mature in less than a year. There are three tenors of Treasury Bills: (1) 91 day (2) 182-
day (3) 364-day Bills. The number of days is based on the universal practice around the
world of ensuring that the bills mature on a business day. Treasury Bills are quoted either
by the'r yield rate, which is the discount, or by their price based on 100 points per unit.
1^742 1W1R 'eSS 'han 91‘dayS are called Cash Management Bills (e.g.
35-day, 42-day). Being government securities the«?P aro «« i y x
scripless) same with the practice in other countrilTT k no longer certificated (i.e.
Banks that compose majority of the Government ch China. Canada and USA.
T-bills in the weekly auctions held by the Burea . „r t V 9 '® DealerS (GSED) bid fCT
T-bills to investors. * Treasury. The banks then resell the
Treasury bills have virtually zero default ricu •

more money that they can use redeem thesp Sll^ceê Government can always print
changes is also lower since the maturity term is eh!2tles at maturity. Risk of inflationary
deep and qund. Deep market means that thT mark Market^ Treasury bills is both
sellers while hqu.d market means that securities k S numerous different buyers and
n e quickly traded at low transactions
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•W K ’"terest rate is not explicitly stated in the Treasury bill; hence, Interest Is not actually
paid by the government when they sell this security. Instead, treasury bills are Issued at a
discount (meaning lower price than the par value at maturity). The return realized by
investors come from the increase in the value of the securities (purchase price to the price
upon maturity). This means that fora P1,000 Treasury bill sold at 99, the investor only
needs to pay P990 as their investment. Once they redeem the Treasury bill at maturity
date, they will be able to collect the P1,000. Simply put, they had a return of P10 from this
investment.
Treasury bills can be sold via two methods: auctions or competitive bidding and
noncompetitive bidding. In auctions, the Bureau of Treasury announces quantity and type
of securities that they will sell. Interested parties give bid offering and the Treasury accepts
the highest bids. The Treasury accepts the bids in ascending order of yield until the
accepted bids reach the offering amount. Each accepted bid is awarded at the highest
yield paid to any accepted bid.
In noncompetitive bidding, bidders only give the amount of securities that they want
to buy. The Treasury accepts all noncompetitive bids. The price for all the securities under
noncompetitive bids is set at the highest yield paid to any accepted competitive bid. In
essence, non-competitive bidders still pay the same price that are paid out by competitive
bidders The main difference between the two methods is that competitive bidders may or
may not receive allocation from the securities being sold while noncompetitive bidders are
guaranteed to receive the securities.
Bv — Bp 360
Eq. 4.1 Annualized Discount Rate — ----------- -x ——■
Bv Face Value or Market Value
Bp Purchase Price
D tenor or period in days

PDFelement
For example, a P1.000 Treasury bill with a 91-day tenor can be purchased at 995.
To compute for the discount rate, we just need to substitute above information in the
formula.
. P 1,000 -P 995 360

Annualized Discount Rate = ------------------------ x ——
P 1,000 91
, J P5.00 360
Annualized Discount Rate = • • x ——
P 1,000 91
Annualized Discount Rate = 1.98%

Another variation of the annualized discount rate is what we call the investment
rate. The investment rate address two weaknesses of the discount rate. The first one is
the use of face amount as the denominator. Since the investor will pay less than the face
amount and the security is sold as a discount instrument, the computed return is
understated. The second weakness is the use of 360 days to annualize the return which
also understates the return. To be more specific, investment rate uses 365 days (366 days
during leap year) to annualize the return. The investment rate portrays a more accurate
representation of how much investor will earn from the security since it uses the actual
number of days per year and the true initial investment in the computation. Eq. 4.2
presents the formula for the annualized investment rate.
Bv— Bp 365
Eq. 4.2 Annualized Investment Rate = ------------- x -------
Bp M
Bv = Face Value or Market Value

Bp = Purchase Price
M = number of days to maturity
Using the previous example, the annualized investment rate is

x ,• „ P 1,000-P 995 365
Annualized Investment Rate = ------------------------- x ------
P 995 91
„ ,-^r r. p 5.00 365
Annualized Investment Rate = ----------x
P 995 91
Annualized Invesment Rate — 2.02%
Treasury bills are also known to be very near to the definition of a risk-free asset
As a result, interest earned on Treasury bills are among the lowest in the market. Investors
may find that earnings from Treasury bills may not be sufficient to cover for changes in
purchasing power brought by higher inflation. Treasury bills are mostly meant as an
investment vehicle to temporarily store excess cash since it may hardly catch up with
inflation.
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Repurchase Agreement
transaction«PUJCha|S? a9reernent (repo) is a financial contract involving two securities

purc^^s^salp a<->fê/pUrChase Of a debt on a near date and a reversing
aareempnt<? ki e same or equivalent debt security on a future date. Repurchase
institutions no i|G sbort-terrn funds to be transferred between financial or non-financial
from one Ua y ran9'n9 from one-day to 3 to 14 days. Some repos can also range
Drodurps ch montbs' êP°s are a key component of the debt securities market that
income dealers 6rm C3Sh °r securities ,icluidity critical to price-making activity of fixed
. . h ea ers °f government securities commonly use repos to manage liquidity and

. 4^° a96 exPected changes in interest rates. Dealers sell their securities to a
an wi an accompanying repo agreement promising to buy the securities back at a
specified future date. Essentially, repos are collateralized loans.
In the Philippines, the government (through BSP) also uses repo to enforce
monetary policy. The BSP purchases government securities from a bank with a
commitment to sell it back at a specified future date at a predetermined rate. In effect, a
repo transaction expands the level of money supply as it increases the bank’s level of
reserves. Under a reverse repo, the BSP acts as the seller of government securities, thus,
the bank’s payment reduces its reserve account resulting in a contraction in the system’s
money supply. For both repos, the BSP can only affect the level of money supply
temporarily, given that the parties involved commit to reverse the transaction at an agreed
future date. At present, the BSP enters into repo agreements for a minimum of one (1)
day (overnight) for both repos and a maximum of 91 days and 364 days for repo and
reverse repo agreements, respectively.
Since repos are collateralized by the accompanying securities, these usually are
treated as low-risk investments with low interest rates.
Negotiable Certificates of Deposit
Negotiable certificates of deposit are securities issued by banks which records

a deposit made. The certificate indicates the interest rate and the maturity date of the
deoosit Since maturity date is stated in the certificate, negotiable certificates of deposit
e treated as a term security with a specific maturity date. It cannot be easily withdrawn
hth depositor since it is different from a demand deposit account wherein money can
h fthdrawn upon demand of depositor. A certificate of deposit essentially restricts
bG WIT m withdrawing funds on demand. The concept behind CDs is that investors are
h°||derStcaccept a higher return in exchange of having no access to liquidity.
f ble certificate of deposit is also classified as a bearer instrument. As a

Nego la whoever person or entity which possesses the instrument upon
bearer instrume principal and interest. This feature allows negotiable CDs to be
maturity will r®cei^ , between investors. Interest rates of CDs are based on the outcome
purchased and 30 the depositor and the bank. Both parties should agree on the
of the negotiation between m
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, ,hA CD The interest rates of CDs are usually at the same level with other
’*carrias a low level of risk-
Invpstors can buy or sell certificates of deposit up until the instrument s maturity.
, ,-JhiX CD?mav have maturity period between one to four months up to six months.
H^weveMhere am fesser demand for CDs with longer maturity. Upon matunty, the bank
shall pay the principal plus the interest to the investor who holds the CD.
In the Philippines, the BSP allows and regulates the issuance of long-term
negotiable certificates of deposits (LTNCD). LTNCD refers to interest bearing negotiable
certificates of deposit with a minimum maturity of five years. LTNCD offers a higher return
compared to regular time deposit account because of the long period that depositors will
be unable to withdraw the money.
Commercial Paper
Fundamentally, commercial papers are unsecured promissory notes.

Commercial paper may be short-term or long-term. Short term commercial paper means
an evidence of indebtedness of any person with a maturity of three hundred and sixty-five
(365) days or less. Long term commercial paper is an evidence of indebtedness of any
person with a maturity of more than three hundred sixty-five (365) days.
Since commercial papers are unsecured, only large and creditworthy corporations
can issue this security. Lenders will not accept commercial papers from small companies
since they are going to assume high level of risk since this security is not secured.
Commercial papers are issued directly to the buyer and usually, there is no secondary
market for commercial papers. Dealers may redeem commercial papers if the bearer
needs cash, but this seldom happens.
Nonbank corporations like financing companies usually issue commercial papers
and use the proceeds to fund loans that they extend to their clients. Issuers often maintain
line of credits with banks to serve as backup for a commercial paper. The line of credit is
primarily for the benefit of the issuer of the commercial paper. If the issuer is not able to
pay the maturing commercial paper, the bank will lend funds to the issuer to enable the
latter to pay for the commercial paper. The availability of line of credit reduces the risk
associated with commercial papers, hence, this reduces the interest rate. Banks usually
extends the line of credit and agrees to provide the loan in advance in case there is a need
to pay off the commercial paper. In exchange, the issuer pays of a service charge in
exchange of the line of credit. Issuers of commercial paper agrees to pay the line of credit
fee because this is lower versus paying interest on the commercial paper for an extended
period of time.
Commercial papers may either have a stated interest rate on its face or sold at a
discounted basis.
In the Philippines, commercial papers are not required to register with SEC if they
meet the following requirements:
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Pavahil0, n°* m°re ,han 19 "‘’"-institutional lenders

Hayable to a specific person
Am™?n(nÔtiable nor ass'9"abl® a"d Held on to maturity
Amount not exceeding P50 million.
Otherwise, companies need to
register with SEC first prior to issuing any commercial
paper.
Banker’s Acceptances
Banker s acceptances refer to an order to pay a specified amount of money to

the bearer on a specified date. Banker’s acceptances are often used to finance purchase
of goods that have not yet been transferred from the seller to the buyer. Banker’s
acceptance is usually offered to importersand exporters. An acceptance is formed when
a draft or a promise to pay is made by the bank’s client and the bank then ultimately
accepts, promising to pay in behalf of the client. The bank’s acceptance of the draft
translates to a promise to pay to whomever party presents it to the bank for payment. The
client then gives the draft (i.e. banker’s acceptance) to the vendor to finance the purchase.
For example, Company A wants to buy a large equipment from Company B for the
first time. Since Company B does not have any experience that will establish the
creditworthiness of Company A, it may be reluctant to ship the equipment immediately
because they might experience difficulty in collection afterwards. Company A may also be
reluctant to send money to Company B for the same reason that they may not receive the
equipment as promised. To help consummate the transaction, banks may intervene
through the issuance of banker’s acceptance wherein it will lend its name and
creditworthiness to the paying party, i.e. Company A.
Banker’s acceptances are usually payable to the bearer. Hence, this can be
subsequently purchased and sold until it matures. Banker’s acceptances are usually sold
at a discount, similar with Treasury bills. Market dealers also facilitate the trading of
banker’s acceptances by matching prospective sellers and buyers. Interest rates on
banker’s acceptances are usually low since default risk is very minimal.
Evaluating Money Market Securities
As a finance person, you should be able to understand and evaluate which money
t securities to invest on depending on the purpose of the business. Money market
purities may be evaluated based on the interest rates and liquidity.
rest rates are very relevant in deciding which money market securities to invest
. edictate the potential return that can be received from the investment. Interest
since this markettend to be relatively low as a result of the low risks associated with
them ancTthe short maturity period. Money market securities have a very deep market;
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most money market securities

thus, they are competitively priced. If y°t' instrument a close subsfrtute
carry the same risk profile and attributes, thus, 9 gn jnterest rate that deviates from
for each other. Hence, if a particular security may r f wou,d ultimately correct it and
the average rate, supply and demand forces in
force rt back to the average rate. . .
aD to convert a security into cash.
Liquidity refers to how quick, efficient an c e more liquid than commercial
treasury bills, that have a ready secondary mar e > Ho|ders of commercial papers
papers which do not have a developed secondary m brokers may charge a higher fee
tend to hold the security until it matures. For >h.s -eason brokersm J
for investors that would want to liquidate ' Pbi|£. that have buyers willing to
made to look for potential buyers compared to treasury twnicallv short-term
purchase at short notice. Since most money market securiti nrr>viriin«
money market is often preferred by investors who desire liquidity in erv p g
liquidity where it did not previously exist.
Valuation of Money Market Securities
Valuation of money market securities is important to determine at what amount an

investor is willing to pay in exchange of a security. In some cases, investors need to give
an amount as a bid to be able to buy securities. Money market securities can be valued
using the present value approach. The interest rate used in the valuation shall reflect the
required return from the instrument based on the investor’s perceived risk. Investors may
also use the prevailing interest rate in the market for the type of security being purchased.
Eq 4.3 presents the valuation formula which is practically present value formula.
Sb
Eq. 4.3 Market Security Value = --------------
(l + /)n
Sb = Face value of the security
I = Interest rate
n = Number of Periods
For example, face value of a one-year Treasury bill is at P1 000 with an annual
irrterest rate of 3%. To compute for the value of the Treasury bill, use the formula above.
The face value wh,ch will be received upon maturity is P1,000. The interest rate will be
3% and the number of periods is 1 (since it has a one-year maturity term)
Market Security Value = _P1»00Q

(1 + 3%)i
Market Security Value = P970.87
This means that an investor is willing to pay P970 87 for a pi non -r xn

based on the risks surrounding the instrument. In absolute tprmc tJ’000 Treasury blH
return of P29.13 from this investment. ‘e ,erms’,he 'êstor 9®'
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Assume that another P1.000 Treasury bill with maturity term of 90 days with an
annual interest rate of 4% is being evaluated. Assume 360 days. The value of said
Treasury bill is computed as follows:
Market Security Value = —----- ---------7

CL+1%)1
Market Security Value = P990.10
The annual interest rate should be converted to match the 90-day maturity term.
Hence, annual interest term of 4% shall be multiplied with 90 / 360 to get how much is
the interest rate for the tenor of the security. In this case, the interest rate to be used is
1 % which represents the interest cost associated with the 90 days that the money is held
by the government.
As a general rule, as the interest rate rises, the value of the security becomes
lower. This means that the market risk is increases thus the impacton the value of the
securities also reduces. Factors that drive the interest rate will be further discussed in
the succeeding chapter for this book.
X 7
SUMMARY
• Financial Instruments are the main vehicle used for transactions in the
financial market. There are two parties involved in the financial instruments -
issuer and investors.
• Money Market where the money and currency were traded. There are three
fundamental characteristics are: Sold in large denomination; low default risk;
and mature in one year or less from original issue date.
• Common types of financial instruments are treasury bills, repurchase
agreements or repo, negotiable certificates of deposits, commercial paper,
and banker’s acceptances.
• In evaluating money market securities, interest and tenor of the securities
before maturity are the large factors. As the interest increases the value of
the securities reduces. Investors must ensure apples-to-apples comparison
among the securities to determine.
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NAME:____________________ ________________ Date: - -----------------------

true.
1. According to Conceptual Framework for Financial Reporting (2018), a

property is a resource controlled by the entity as a result of past events and
from which future economic benefits are expected to flow to the entity.
2. Intangible assets are assets that has physical properties and can be easily
seen, touched or perceived by the five senses.
3. Tangible assets are identifiable assets that do not have physical substance
and usually represents a legal claim to some future economic benefit.
4. Financial instruments are the main vehicle used for transactions in the
financial market. For the purposes of presentation in financial statements,
financial instruments may be presented under cash equivalents or
investments.
The investor is the party that issues the financial instrument and agrees to
make future cash payments to the investor.
The issuer is the party that receives and owns the financial instrument and
bears the right to receive payments to be made by the issuer.
The investors usually have surplus funds that are not earning anything and
are willing to bear some risk to earn something from their surplus funds.
On an accounting perspective, investors recognize financial instruments as

a liability.
At the point of issuance of the financial instrument, the issuer usually gives
something of value (usually cash) to the investor. The financial instrument
then becomes the proof (hence, called as security) of the future claim of the
investor from the issuer.
. One primary misconception is that money or currency is the security being

traded in a money market.
1. Financial instruments are the primary subject of trading in a money market
. Financial instruments traded in the money market are short-term and

highly liquid, that it can be considered close to being money.
. Transactions in the money market are not confined to one singular
location. Instead, the traders organize the purchasing and selling of the
securities among participants and closes the transactions electronically.
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14. Most transactions in the money market are very large, hence, they are
considered as retail markets.
15. A mature secondary market for money market instruments allows the
money market to be the preferred place for firms to temporarily store
excess funds up until such time they are needed again by the organization.
16. Investors look at the money market as a permanent investment that will
provide a slightly higher return than holding on the money or depositing it in
banks.
17. If investors believe that the prevailing market conditions do not justify a
stock purchase or there might be a possible interest rate hikes impacting
bonds, then they can choose to invest on money market instruments in the
meantime.
18. Holding on to cash is a very viable option for investors as this does not
generate any return
19. Any idle cash becomes an opportunity to investors by means of the

interest income not earned by holding on to the cash. To reduce
opportunity costs, money markets become a viable option to temporarily
invest idle funds.
20. Money market Instruments took the form of short-term deposits,
government securities, commercial papers and certificates of deposit which
form part of the Philippine interest rate market.
21. Money market instruments are governed by Philippine regulations and are
influenced by market movements.
22. Treasury Bills are government securities issued by Bangko Sentral ng
Pilipinas which mature in less than a year.
23. There are three tenors of Treasury Bills: (1) 91 day (2) 182-day (3) 364-
day Bills.
24 Treasury bills have virtually zero default risk since the government can
always print more money that they can use redeem these securities at
maturity.
25 Market for Treasury bills is both deep and liquid. Deep market means that
the market has numerous different buyers and sellers while liquid market
means that securities can be quickly traded at low transactions costs.
26 Government securities, particularly treasury bills, are the safest investment
2 instrument in the market. Because they are backed by the full taxing power
of the government, they are practically default risk-free.
97 Treasury bills can be sold via two methods: auctions or competitive
2 bidding and noncompetitive bidding.
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- Treasury announces quantity and type of

28. In auctions, the Bureau of Trea y . gjVe bid offering and the
securities that they will sell. Interested parties g
Treasury accepts the highest bids.
, . . nive the amount of securities that
for all the securities under noncompetitive i s i

paid to any accepted competitive bid.
30. When a P1.000 Treasury bill with a 91-day tenor can be purchased at 995,
this means that its Annualized Investment rate is 1.98 /o
. When a P 1,000 Treasury bill with a 91-day tenor can be purchased at 995,
this means that its Annualized Discount rate is 2.02%
2. A repurchase agreement (repo) is a financial contract involving two

securities transactions, a sale/purchase of a debt security on a near date
and a reversing purchase/sale of the same or equivalent debt security on a
future date.
J. Repos are a key component of the debt securities market that produces
short-term cash or securities liquidity critical to price-making activity of fixed
income dealers.
k Dealers of government securities commonly use repos to manage liquidity

and take advantage of expected changes in interest rates.
>. The Bureau of Treasury purchases government securities from a bank

with a commitment to sell it back at a specified future date at a
predetermined rate. In effect, a repo transaction expands the level of
money supply as it increases the bank’s level of reserves.
i. Negotiable certificates of deposit are securities issued by banks which

records a deposit made.
- Negotiable certificate of deposit is also classified as a bearer instrument.

As a bearer instrument, whoever person or entity which possesses the
instrument upon maturity will receive the principal and interest.
'• Long term commercial paper means an evidence of indebtedness of any

person with a maturity of three hundred and sixty-five (365) days or less.
'• Short term commercial paper is an evidence of indebtedness of any
person with a maturity of more than three hundred sixty-five (365) days.
. Since commercial papers are unsecured, only large and creditworthy
corporations can issue this security. Lenders will not accept commercial
papers from small companies since they are going to assume high level of
risk since this security is not secured.
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41. Commercial papers are issued directly to the buyer and usually, there is
no primary market for commercial papers.
42. Commercial papers may either have a stated interest rate on its face or
sold at a discounted basis.
43. Bankers acceptances refer to an order to pay a specified amount of
money to the bearer on a specified date.
44. Banker’s acceptance are usually offered to importersand exporters.
45. Banker’s acceptances are usually payable to the order. Hence, this can be
subsequently purchased and sold until it matures.
46. Money market securities may be evaluated based on the interest rates
and liquidity.
47. Interest rates are very relevant in deciding which money market securities
to invest since this dictate the potential return that can be received from the
investment.
48. Liquidity refers to how quick, efficient and cheap to convert a security into
cash. Treasury bills, that have a ready secondary market, are considered to
be more liquid than commercial papers which do not have a developed
secondary market.
" 49. Valuation of money market securities is important to determine at what
amount an investor is willing to pay in exchange of a security
” 50. As a general rule, as the interest rate rises, the value of the security
becomes higher. This means that the market risk is increases thus the
impact on the value of the securities also reduces.
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Date:
NAME: _
crossword puzzle based on the description or definition
E4-2. Crossword. Fill up the
given.
Across Down
3. Financial are the main vehicle used for transacting 1. A place where financial instruments are traded
6. Negotiable of Deposits are securities issued by banks which 2- The party that issuers the financial instruments
records a deposit made 4. Government securities which mature less than a year
7. short term evidence of indebtedness 5. Funds in foe money market where invests elsewhere to maintain
8. Financial Instruments is also cafied as Financial what? liquidity
10. Repurchase Agreement 9. The party that receives and owns foe financial instruments
PDFelement
NAME: / Date:
1. Using the present value approach, what is the market security value of one-year
Treasury bill is at P 1,000 with an annual interest rate of 3%?
a. P 1,030.00
b. P 970.87
c. P 1,000.00
d. P942.60
2. Using the present value approach, what is the market security value of 90-day Treasury
bill is at P 1,000 with an annual interest rate of 4%?
a. P 990.10
b. P 961.54
c. P 1,000.00
d. P 1,040.00
3. Using the present value approach, what is the return of one-year Treasury bill is at
P1.000 with an annual interest rate of 3%?
a. P 30.00
b. P 29.13
c. P 0.00
d. P57.40
4. Using the present value approach, what is the return of 90-day Treasury bill is at
P 1,000 with an annual interest rate of4%?
a. P 9.90
b. P38.46
c. P 0.00
d. P 40.00
5. What is the Annualized Discount rate of a P1,000 Treasury bill with a 91 -day tenor that
can be purchased at 995?
a. 1.98%
b. 2.02%
c. 0.50%
d. 1.00
-x -nent rate of a P1,000 Treasury bill with a 91 -day tenor
6.
a. 1.98%
b. 2.02%
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c. 0.50%
d. 1.00
7. is a resource controlled by the entity as a result of past events and from

which future economic benefits are expected to flow to the enti y.
a. Assets
b. Property
c. Investment
d. Financial Instrument
8. Which of the following is not a tangible asset?

a. software
b. buildings
c. equipment
d. leased equipment
9- are the main vehicle used for transactions in the financial

market. For the purposes of presentation in financial statements, these may be
presented under cash equivalents or investments.
a. Financial Intermediary
b. Financial Instruments
c. Currency
d. Money
10. Which of the following is not correct about financial instruments?

a. The issuing party usually needs additional funds for investment to further grow
their business.
b. The investors usually have surplus funds that are not earning anything and are
willing to bear some risk to earn something from their surplus funds.
c. At the point of issuance of the financial instrument, the issuer usually receives
something of value (usually cash) from the investor.
d. The investor is the party that issues the financial instrument and agrees to make
future cash payments to the investor.
11. Which of the following is not an economic purpose of financial instruments?

a. Allows transfer of fund from entities with excess funds (investors) to entities who
needs funds (issuer) for business purposes (e.g. to pay for tangible assets).
b. Permit transfer of fund that allows sharing of inherent risk associated with the cash
flows coming from tangible asset investment between the issuer and investor.
c. Allows the money market to be the preferred place for firms to temporarily store
excess funds up until such time they are needed again by the organization.
d. All are economic purposes of financial instruments.
12. Money market securities have fundamental characteristics, except:

a. Usually sold in large denominations
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b. Low default risk

c. Mature in one year or less from original issue date.
d. Money market securities commonly have an active secondary market
13. Which of the following is not correct about money market and money market
instruments?
a. Transactions in the money market are not confined to one singular location.
Instead, the traders organize the purchasing and selling of the securities among
participants and closes the transactions electronically.
b. money market securities commonly have an active secondary market. An active
secondary market enables individuals I organizations to trade money market
instruments to cater to short-term financial needs.
c. Most transactions in the money market are very large, hence, they are considered
as retail markets.
d. A mature secondary market for money market instruments allows the money
market to be the preferred place for firms to temporarily store excess funds up until
such time they are needed again by the organization.
14. Holding on to cash is a very expensive option for investors as this does not generate
any return. Any idle cash becomes an to investors by means of the
interest income not earned by holding on to the cash.
a. opportunity
b. opportunity cost
c. sunk cost
d. interest cost
15. Which of the following is true about the participants in the money market?
a. Commercial banks issues treasury securities; sell certificates of deposits and
extends loans; offers individual investor accounts that can be used to invest in
money markets. Banks are the primary issuer negotiable certificates of deposits,
banker’s acceptancesand repurchase agreements.
b. Bangko Sentral ng Pilipinas sells government securities to raise funds. Short-term
issuances of government securities allow the government to obtain cash until tax
revenues are collected.
c. Private individuals made their investment through stock market.
d Insurance companies issues commercial paper on money market to maintain
liquidity level in case of unexpected demands most especially for property and
casualty insurance companies.
16 are government securities issued by the Bureau of Treasury

which mature in less Than a year.
a. Money market securities
b. Treasury bills
c Certificate of Deposits
d. Government Commercial Paper
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17. The following statements are correct about Treasury bills, except:
a. There are three tenors of Treasury Bills: (1) 91 day (2) 182-day (3) 364-day Bills.
The number of days is based on the universal practice around the world of
ensuring that the bills mature on a business day.
b. Treasury Bills are quoted either by their yield rate, which is the discount, or by their
price based on 100 points per unit.
c. Treasury Bills which mature in less than 91-days are called Cash Management
Bills (e.g. 35-day, 42-day).
d. Treasury bills are government issued securities evidenced by Certificate of
Treasury Bills.
18. Is a financial contract involving two securities transactions, a sale/purchase of a debt

security on a near date and a reversing purchase/sale of the same or equivalent debt
security on a future date.
a. Repurchase Agreement
b. Security Purchase Agreement
c. Buy back agreement
d. Forward Debt contract
19. are securities issued by banks which records a deposit made. The
certificate indicates the interest rate and the maturity date of the deposit.
a. Negotiable Certificates of Deposit
b. Treasury Bills
c. Negotiable Time Deposit
d. Commercial Paper
20. Which of the following are essentially unsecured?

a. Treasury Bills
b. Certificates of Deposit
c. Commercial Paper
d. Repurchase Agreement
21. refer to an order to pay a specified amount of money to the

bearer on a specified date.
a. Treasury Bills
b. Certificates of Deposit
c. Commercial Paper
d. Banker's Acceptance
22. Which of the following is not true about Repurchase Agreement?

a. Repurchase agreements enable short-term funds to be transferred between
financial or non-financial institutions, usually ranging from one-day to 3 to 14 days-
b. Dealers of government securities commonly use repos to manage liquidity and
take advantage of expected changes in interest rates.
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------------------------------------------------------------------------------------------FUNDAMENTALS OF FINANCIALMARKET
c- In the Philippines, the government (through BSP) also uses repo to enforce
monetary policy.
d. Since repos are collateralized by the accompanying securities, these usually are
treated as low-risk investments with high interest rates.
23. The following statements are true about Negotiable Certificates of Deposits, except.
a. The certificate indicates the interest rate and the maturity date of the deposit. Since
maturity date is stated in the certificate, negotiable certificates of deposit are
treated as a term security with a specific maturity date.
b. Negotiable certificate of deposit is also classified as an order instrument. As an
order instrument, whoever person or entity which possesses the instrument upon
maturity will receive the principal and interest
c. Investors can buy or sell certificates of deposit up until the instrument s maturity.
d. In the Philippines, the BSP allows and regulates the issuance of long-term
negotiable certificates of deposits (LTNCD).
4. Which of the following statements is correct about Commercial Paper?

a. Fundamentally, commercial papers are secured promissory notes.
b. Since commercial papers are secured, large and creditworthy corporations can
issue this security.
c. Nonbank corporations like financing companies usually invest in commercial
papers and use the proceeds to fund loans that they extend to their clients.
d. Commercial Paper can either be in money market and capital market
25. In the Philippines, commercial papers are not required to register with SEC if they
meet the following requirements, except:
a. Issued to not more than 19 non-institutional lenders
b. Payable to a specific person
c. Neither negotiable nor assignable and held on to maturity
d. Amount not exceeding P500 million.
26. Which of the following is not correct about Banker’s Acceptance?

a. Banker’s acceptances are often used to finance purchase of goods that have not
yet been transferred from the seller to the buyer.
b. Banker’s acceptances are usually payable to the order. Hence, this can be
subsequently purchased and sold until it matures.
c. Market dealers also facilitate the trading of banker's acceptances by matching
prospective sellers and buyers.
d An acceptance is formed when a draft or a promise to pay is made by the bank’s
client and the bank then ultimately accepts, promising to pay in behalf of the client
27 How much is Investor willing to pay for a P 25,000 Treasury bill with 10% interest rate
which will mature in 90 days?
a. P 24,390.24
b. P 22,500.00
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c P 24,375.00
d P 25,625.00
28 At a discount of 3% fora one-year Treasury bill, an Investor paid P 970.87. How much
will the Investor received at maturity?
a P 1,000.00
b. P 1.000.90
C. P 998 99
d P 900 00
29. At a discount of 4% for a 90-day Treasury bill, an Investor paid P 970.10. How much
will the Investor received at maturity?
a. P 1,000.00
b. P 1,000.90
c. P 998.99
d. P 900.00

a. Financial Instruments are the main vehicle used for transactions in the financial
market. There are two parties involved in the financial instruments — issuer and
investors.
b. Money Market where the money and currency were traded. There are three
fundamental characteristics are: Sold in large denomination; low default risk; and
mature in one year or less from original issue date.
c. Common types of financial instruments in Money Market are treasury bills,
repurchase agreements or repo, negotiable certificates of deposits, shortterm
commercial paper, long term commercial paper and banker’s acceptances.
d. In evaluating money market securities, interest and tenor of the securities before
maturity are the large factors. As the interest increases the value of the securities
reduces. Investors must ensure apples-to-apples comparison among the securities
to determine.
PDFelement
Chapter 5
MANAGING THE CREDIT RISK
OF THE FINANCIAL INSTRUMENT
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Credit Risk and Interest Rates

• risk This is the risk that the borrower was not
Credit risk is one type of business nsn. gs factor to determine the cost of
able to repay its obligation. Such risk is;vai affects the valuation of accounts
lending or financing using debt. Credi
receivable.
Theories related in Setting Interest Rates
According to Fabozzi and Drake, there are two economic theories that drives the
interest rates. These are loanable funds theory and liquidity!*,h 2^'®
funds theory assumes that it is ideal to supply funds when the interests are high and vice
versa. This theory was introduced by Knut Wicksell in 1900s.
On the other hand, liquidity preference theory was introduced by John Maynard
Keynes, that the interest rates are dependent on the preference of the household whether
they hold or use it for investment. There by that the longer the term the higher the rates
because investors preferred the short-term investment more.
BSP defined interest rates to be a type of price. Interest are set to compensate the
risk of allowing the finances to flow into the financial system. The interest as a price is
different on the perspective of the lender or borrower. For lenders, interest rate is called
as lending rate or return. For the borrowers, these will serve as cost of debt. Interest rates
were classified depending on the type of instrument they derived and the tenor of the
investment.
The tenor of the investment also defines the riskiness of the repayment of debt.
The longer the life of the debt the riskier the repayment hence the interest rate is higher.
There are two economic theories that affect the term structure of interest rate. These are
expectations theory and market segmentation theory.
• Expectation Theories
Expectation theories is that the interest rates are driven by the

expectation of the lender or borrowers in the risks of the market in the future.
These maybe a pure expectation theory and biased expectation theory. Both
theories understand how interest rate, or the term should be structured over
time.
Pure expectations theory is based on the current data and statistical

analysis to project the behavior of the market in the future. They all rely on the
forward rates or the future interest rates based on their projection on the future
prices. Of course, expectation on the interest rates varies depending on the
perspective and the maturity. For example, Company A needs to finance a
project that will be operated in perpetuity. Company A applied for a loan to
Company B payable for 20 years. The prevailing interest rate at present is
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Based on the current environment, the market seems to worsen in the future.
How will the interest rate behave in the future? With the given information,
Company B must assume a higher rate than 7% since the probability that
Company A may pay in the future is becoming low. The pure expectations shall
be based on the strong estimates based on the uncertainty of the future. The
rates to be agreed should be reasonable enough for both parties otherwise one
will not be fully compensated especially on the part of the lenders. Observed
that the pure expectations theory only relies on the term and not on other
factors.
Biased Expectation Theory includes that there are other factors that
affect the term structure of the loans as well as the interest to be perceived
moving forward. The forward rates will be affected or will be adjusted if the
liquidity of the borrower will be weaker or stronger in the future. The adjustment
or increase on the interest rate is called the liquidity premium. Liquidity
premium increases as the maturity lengthens. This theory is called the liquidity
theory. Another theory under the Biased Expectation Theory is the preferred
habitat theory. This theory does not only consider the liquidity but the risk
premium as well but disregarding the consensus of the market on the future
interest rates. The habitat being referred here is the biased estimate over the
market behavior in the future.
• Market Segmentation Theory
This theory assumes that the driver of the interest rates are the savings
and investment flows. The maturities are segmented depending on how the
assets and liabilities were managed as well as the lenders on how they extend
financing. It is the same with preferred habitat theory however it does not
assume that any of the players are willing to shift sector should opportunity to
arise for the asset or liabilities to be retired or lenders to offer higher rates
Determination of Interest Rate
To determine the appropriate interest rate or rates the following factors

should be considered assuming the cash flows are already been established-
interest rates in the industry

Risk exposure
Compensation on the market expectation.
In finance, interest can be determined by the function of the risk and th

compensation of the investor on the difference between the risk-free rate and the markX
fluctuations (Eq 5.1).
Eq 5.1 i — (Rf + Dm)
interest
Rf = risk free rate where (Real risk free rate = Rf - inflation^
Dm = debt margin or debt spread or the risk premium
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r,.MnAMENTALSOFFINANCIALMARKET
... -zero default in the market where

The risk-free rate should the rate that ^su™ sovereign.
this is more or less equivalent to the rates the republic. In the P i PP
of the risk-free rate is the Treasury bills issue y & pps Group.
also be referred in the Philippine Dealing System oraanized market that was
The PDS Group » stress in 1997. Using the
Point of Information! formed out of the full financial serviced from
PDS provides rates for technology, the group pr°v sett|ement The group is
government securities using trading to clear mg tjon; Philippine Dealing and
the BVAL Methodology for composed of f°ur . their trading services arm.
Government, Supranational, Exchange Corp. <PD^’ Trust corp. (PDTC) for the
Agency and Investment-
Philippine Deposrto^ an securities Settlement Corp,
Grade Corporate Bonds.
securities services, pDS Academy for Market
(PSSC) for their payments and transfer services;
Development Corp. (PDSA) as their training center.
The risk free rate can be real or excludes the effect of inflation. the exclusion of
the effect of the purchasing power of Philippine Peso. Since the rea ris
the inflation, the nominal which is the risk free adjusted for inflation rnay assume a
compounding effect in the future. Since the BSP is the main supplier o e u ’
it cannot set the real interest rates because it cannot set the inflation exP®c
it is more appropriate to say the real risk-free rate can be determine ye g
prevailing inflation.
Let’s illustrate, Morgana Corp, would like to borrow funds from Oberon Financing.
The risk free rate is 6% and the current inflation is 2%. In the following year, the inflation
is expected to grow to 3%. Oberon still finds that the 4% margin remains to be relevant.
How much is the interest rate that Oberon Financing should impose to Morgan Corp..
i — (Rf + Dm)
We know that the risk-free rate is nominal hence we have to recalculate to
incorporate the forecasted risk of purchasing power in the future. Hence, the real risk free
rate should be recalculated.

Rfr = (Rf- Inflation')
Rfr = 6% - 2%
Rfr = 4%
The real risk free rate is 4%, since the repayment will be made in the future,
Oberon should consider the forecasted inflation. Transposing the formula to determine
the risk free rate nominal in the future and incorporate the 3% inflation forecast:
Rf = (Rfr + Inflation)
Rf = 4% + 3%
Rf = 7%
PDFelement
applicable return that ntT rate applicable for the loan is 7%. We can calculate the
heron Financing need in order to kept them whole by
i = 7% + 4%
i = 11%
Therefore, the interest rate that Oberon Financing should charge Morgan is 11%. Now the
question is will this be acceptable to Morgana Corporation? The assessment then again
will be different to the borrower. Morgana should consider if their assessment in the future
that the interest will go worse in the long term then 11% is a good offer. Suppose, another
financing company is offering 9% then Morgana should reconsider. In addition, Morgana
Corporation in the long run should also consider that the interest cost on their end would
also result to tax benefits, if the interest cost is considered as a tax-deductible expense.
Another way on how to calculate the interest rate is by the function of the market value,
par value and the interest expense paid by debt securities or bonds. Eq 5.2 presents the
formula suggested to determine the interest rate on debt securities.
Eq 5.2 i =----- x 100%

2
i = interest rate
I = periodic interest payments
V = par value of bonds
M = market value of bonds
n = term of bonds
To illustrate, Merlin Corporation issued bonds with 10% nominal rate fora Phpl.OOO par
value bond payable for 20 years. The bonds were sold forPhp1,200. How much is the
interest rate of the Merlin bonds in the market?
Using the formula in Eq 5.2 the interest rate of Merlin bonds
(1,000 x 10%) + (-;0002^1,200)

‘= 1,000 + 1,200 x 100°/o
2
1 “ 2,200 x 100%
2
100 - 10
x 100%
1,100
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theâ^116 Mer>'n B?ndsnTê market is 8.18% which is lower than the nominal rate of
Premium^ aS CornPared Ia mear>s that the same bonds are perceived to be riskier in
on the Ph N°te that the m i, nominal rate. But what if the bonds were sold on a
c°rPoraf ’°°0 Par value of Ph Va,Ue Of the bond is Php1,200 hence there is a premium
than marl?0 tO earn 10% int hp20°- This is because the bonds are guaranteed by Merlin
et- res* while the market can only provide about 200 bps lower
Cornog0* °r bond of thetls^m°nd SO,d at a d,scount expects that the nominal rate of the
years u J°n ,ssu®d Phni non S c,ass is lower than the market. Assume that Merlin
market? &re their bor>ds were sold Va,â bonds paying PhplOO interest every year for 20
a Php950. How much is the rate of cost of debt in the
It b©
discou/n %h?sa,Ue iS Phpfôwer'thanethethatthT 'nterest is given at PhP100 and the
same problem can be cm the parvalue of Php1,000, therefore there is a
1 De solve using Eq 5.2
(100) + ( TPOO ~ 950^

i =--------------- L
,________ 20
20 J
1,000 + 950 — x 100%
2
loo + fÔ)
i = \ 207 „„
T950------ xl00%
2
. 100 + 2.50
i950 x 100%
i = 0.1051 x 100% = 10.51%

This time the interest rate is 10.51% hiaher than th~ ■
d'pehreQCeis about 51 bPs- the market value is discounted byTabout Ph^' Given that the
- Php950). You may observe that using this formula, interest rate^9 ° °n'y <PhP'’.000
depending on how the nominal or guaranteed interest rate fairs with th °an be determined
cost of debt. e ra,rs w,th the marketer effective
In commerce, risk is a very important factor to consider th=>t

business up or down. Risk relates to the volatility of return patterns in th h*ay drives the
the challenge on quantifying the risk is imperative for the investors to h e business- Thus,
e ab,e to determine
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financJna tra16^ <*an keeP themselves whole. There are risks that are inherent in every
among othersSaCt'°n These are default risk, liquidity risk, legal risks, and market risks,
Default risk arise on the inability to make payment consistently. Most of the
usinesses wasable to raisefinancingon theirdemands, howevertheircash flows
projected were not that guaranteed. Basically, the cash flows management
principle is to allow the business to self-liquidate or self-finance. While, the
company is made aware of theirperiodic obligation butthereare still chances that
they may fail to make sure that the funds were available upon servicing of debt or
paying the amortization including interest. This type of risk may be quantified by
determining the probability of the borrower to default in their payments in the
duration of the loan.
Liquidity Riskis identified by ensuring th ebusiness to be capable of meeting

all its currentlymaturing obligation.This is differentin default risk. Liquidity risk is
focusing on the entire liquidity of the company or its ability to service its current
portion of their debt as it comes due. In practice, this risk is quantified by
determining the opportunity cost of the lender on the period within which the
borrowers were able to recoupor worst the value th ere cannotbe salvage because
of the ability of the company to be liquid.
Legal risk is dependent on the covenants set and agreed in between the
lenders and the borrowers. The legal risk will arise only upon the ability of any of
the parties to comply with the covenants of the contract. Normally, the burden isto
the borrower to comply given that the party who is obliged to pay back is them.
The common defaults in the covenants are as follows: (1) maintaining the financial
ratios; (2) significant acquisition or disposal of assets; (3) repayment of other
obligation; or (4) declaration of dividends of any form withoutthe consent of the
lenders.
Market risk is the impact of the market drivers to the ability of the borrowers
to settle the obligation. Market risk is classified as a systematic risk because it
arises from external forces or based on the movement of the industry. Among the
risks that affects the interest, market risk is the most difficult to quantify. The
experts and analystscan just only set certain parameters to measure it.
Mitigating the Interest Rate Risks
re interest rate is dependent on the inflation, tenor and other market

Since the |d consjder and make reasonable estimates to mitigate these
risks. Companies are measures that the company may consider mitigating the
risks. Commercia y, movement of the yield maybe normal or increasing,
impact of the interest rate .
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inverted or declining or flat or constant over time. Figure 5.1 presen j ry or
possible yield curves.

Flat or Constant
Time
Figure 5.1 Possible Yield Curve
Spot Rates
The yield curves presented in Figure 5.1 was a set of points of rates on a
particular maturity date. In a normal yield curve, most theories expect that interest rates
increasing as the maturity lengthens. Although on the other hand, yield curve may
change or move differently as expected especially when the inflation is decreasing, or
the purchasing power is improving. Spot rate is the interest rate or yield available I
applicable for a particular time.
Spot rates are already actual rates and are not hedge. When the agreement is a
spot rate the applicable interest rate is based on the prevailing market rate at the
particular time. It is important to know the spot rates to be used for establishing market
expectation in the future. Spot rates will be used to mitigate the risk by referring to
historical yield vis-a-vis the forces that occur in those times. For example, a typhoon
occurred in the Metro Manila that causes the prices of the resources to rise because of
the scarcity of resources resulting to increase in interest rates. Upon noting the effect on
the spot rates of the external forces, we will expect in the future that when such incident
will recur the spot rates will increase. Thus, it is incumbent to the supplier of funds to
consider quantifying its effect so that the variability of rates will be managed.
Forward Rates
Given that spot rates are very hard to determine precisely, a way on how to
mitigate the impactto the lender of fund’s return and on the other hand, the borrower’s
cash flows to service the debt or loans in the future should the interest go beyond their
expectation, this is to have a forward rate or hedge rates.
Forward rates are normally contracted rates that fixed the rates and allow a
party to assume such risk on the difference between the contracted rate and the spot
rate. It is a challenge for the financial consultants and economic experts to determine
that most probable rates in the future. The clash will be that the lenders would like a
more conservative rate while borrowers are aggressive or lower as much as possible
versus the expected spot rate in the future.
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based on the mark’ ♦ •beron Financing offers loans fixed for the first 5 years at 8% and
9% for the next m S 10 tbe future- Morgana Corp, is capable of servicing the debt at only
ratios Morns r* ^SarS more than that they will fail to maintain their debt covenant
first 5 vparc Can enter ,nto agreement with Oberon to have the rates 8% for the
interest rata r . 0 for years 6 to 10. The risk on the part of Morgana Corp, if the
other hand if th13"?tO be 8% until year 10- the company will lose 1% per year. On the
contract ’ S resu'ts say ar°Lind 10% then Morgana gain for the forward rate
Swap Rate
Another way on how to mitigate the interest rate risk is enter into a swap rate,
wap rate is another contract rate where a fixed rate exchange for a certain market rate
at a certain maturity. Usually the one used as reference is the LIBOR. For the swap rate,
it is normally the fixed portion of a currency swap.
LIBOR or London Interbank Offered Rate is

used to benchmark interest rates which is used as
reference for international banks to borrow. It is
calculated using the Intercontinental Exchange or ICE or International
ICE. The rates issued short term from 1 day up to 1 Exchange was established in
2000 in Georgia, USA.
year and releasing more than 30 rates based on Although it is in US it is
about five currencies. This is the reason why this rate subject to European Union
is used as the referencefor consumer loans across regulators watch.
the world.
For better appreciation, with the illustration that Oberon Financing and Morgana
Corp, borrowed at the rate of 8% for years 1 to 5 and 9% for years 6 to 10 but with a
clause that Morgana Corp and Oberon Financing may use the prevailing LIBOR rate on
years 9 to 10. Thus, the risk for Morgana Corp, is when the LIBOR rate is higher than
the rate at the maturity.
The correlation of the swap rate and the maturity rate is called the swap rate
yield curve. The curve is useful for countries as reference for the credit risks and for
future decisions.
Credit Ratings
A«?ide from the purchasing power and factors initially identified, another driver of
♦ nr risk consideration are the credit ratings. Credit rating affects the
the interest rate or risk cons^ companjes The credjt ratjngs are
confidence level hat recognized globally that objectively assigns or
determined by comp cornpanies based on the riskiness of doing business with them,
evaluates countries a by thejr ability to manage their liquidity and solvency in
The riskiness is Prirr\ X ade the lower the default risk associated to the country or
the long run. The higher y
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company. Those three major rating companies are: Standard & Poor’s Corporation
(SAP); Moody’s Investors Service; and Fitch Ratings.
Although, the credit ratings provided by these companies are just

recommendatory opinion and will serve as reference only and is not an absolutely
provide default probability to the companies.
Standard & Poor’s Corporation
Standard and Poor’s Corporation or S&P is an American financial services

corporation was founded in 1941 by Henry Varnum Poor in New York, USA. The
company uses data gathered from 128 countries using more than 1,500 credit analysts
to assess the creditworthiness to the industry. The credit ratings provided by S&P were
categorized to Investment Grade and Non-lnvestment Grade and scaled from AAA to D
as presented in Table 5.1.
Table 5.1 S&P Credit Rating
AAA Extremely strong capacity to meetfinancial commitments
AA Very strong capacity to meetfinancial commitments

c/>
3
A Strong capacity to meetfinancial commitments but susceptible to adverse economic CD
3
conditions and changes in circumstances
o
0)
BBB Adequate capacity to meetfinancial commitments, butmore subjectto adverse economic Q.
CD
conditions
BB Less vulnerable in the near-term but faces major ongoing uncertainties to adverse
business, financial and econom ic conditions
B More vulnerable to adverse business, financial and economic conditions but currently has
the capacity to meetfinancial commitments cn
■U
CD
CCC Currently vulnerable and dependent on favorable business, financial and economic 2
conditions to meetfinancial commitments
<’
CD
CC Highly vulnerable, default has not yet occurred, but expected to be a virtual certainty Q
S
C Currently highly vulnerable to non-payment, and ultimate recovery is expected to be lower a.

CD
than thatof higher rated obligations
D Payment default on a financial commitmentor breach of an imputed promise; also used

when a bankruptcy petition has been filed or similar action taken.
Moody’s Investors Service
Moody’s Investors Services or Moody’s is credit rating company particularly on

debt securities established in 1909 in New York, USA. The company gathers information
from more than 130 countries, more than 4,000 non-financial corporate issues and more
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than 4,000 financial institution*. The company employs more than 13,000 across the
whole woild
Moody's classify the credit standing into the ratings in Table 5.2 for the Moody's
Rating Scale4
Table 5.2 Moody's Rating Scale
Aa»» Obligations luted Aaa aie judged to be of the highestquality, subject to the lowest level of credit
risk
Aa Obligations rated Aa are judged to be of high quality and are subject to very low credit risk.
A Obligations lated A are judged to be upper-medium grade and are subject to low credit risk.
Baa Obligations i ated Baa are judged to be medium -grade and subject to moderate credit risk and as
such may possess certain speculative characteristics.
Ba Obligations rated Ba are judged to be speculative and are subject to substantial credit risk.
B Obligations rated B are considered speculative and are subject to high credit risk.
Caa Obligations rated Caa are judged to be speculative of poor standing and are subject to very high
credit risk
Ca Obligations rated Ca are highly speculative and are likely in, or very near, default, with some
prospect of recovery of principal and interest.
c Obligations rated C are the lowest rated and are typically in default, with little prospect for recovery
ot principal or interest.
Fitch Ratings
The third credit rating agency is Fitch Ratings. It was founded in 1914 in New
York, USA. The company was owned by Hearst. Hearst is a global information and
services company. Fitch provides credit opinions based on the credit expectations based
on the certain quantitative and qualitative factors that drive a company, they assess
based on the credit analysis and intensive research. They conduct their assessment
over more than 8,000 entities around the globe with 25 different currencies.
Fitch same with the other rating agencies publishes its opinion based on a
certain scale of ratings to represents their opinion. Table 5.3 presents the rating
definition of Fitch Ratings5.
4 www.moQ.dvs.CQin
5 https://www.fitchratings.com/site/def.inltj.Qns
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Table 5.3 Fitch Rating Scale
AAA Highestcredit quality
AA Vers4 high credit quality
A High credit quality
BBB Good creditquality
BB Speculative
B Highly speculative
CCC Substantially credit risk
CC Very high levels of credit nsk
C Neardefault
RD Restricted Default
D Default
In 2019, Philippines was assessed by S&P at BBB with a stable outlook while
Fitch last evaluation was in 2017 at BBB also with stable outlook. Moody’s on the other
hand, rated the country in 2014 at Baa with stable rating.
United States were rated as AAA by Fitch in 2014 with stable outlook. Moody’s
rating is Aaa with stable outlook in 2013, while S&P s latest rating in 2013 with stable
rating at AA.
Other rating agencies
There are other credit rating agencies other than the three major like DBRS and
CARE Ratings. Unlike S&P, Moody's and Fitch, these credit rating agencies were not
located in the United States.
DBRS was established in 1976 in Toronto, Canada. The company was

considered as the fourth largest ratings agency. The company observe almost 50,000
securities worldwide. DBRS also has offices in New York, Chicago, London, Frankfurt
and Madrid in Spain6. The rating follows from AAA to C as the least.
CARE Ratings started its operation in 1993 based in India. The company is
based in Mumbai with partners in Brazil, Portugal, Malaysia and South Africa. Other than
Mumbai they also have about 10 regional officers that aims to provide information to
investors to serve as guide as they enter into new investment. They also use AAA as the
best instrument to D as the least.
6 https://www.dbrs.com/about/
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fun damentals of financialm a r k et
NAME:__________________________________________Date:---------------------------
E5-1. True or False. Write the word TRUE if the statemerit is true arid FALSE if the
*^+Qrrr»n+ If FALSE, encircle the word/s
statement is false before the number of, each statement.
. . . made
which . it incorrect and replace with the rnrrpct woiu that will make the statemenVs
correct word
true.
1. Credit risk is one type of business risk that the borrower was not able to
repay its obligation.
2. Credit risk also affects the valuation of accounts receivable.
3. According to Fabozzi and Drake, there are two economic theories that
drives the interest rates. These are loanable funds theory and liquidity
preference theory.
4. Loanable funds theory assumes that it is ideal to supply funds when the
interests are high and vice versa. This theory was introduced by Knut
Wicksell in 1900s.
5. Liquidity preference theory was introduced by John Maynard Keynes, that

the interest rates are dependent on the preference of the household
whether they hold or use it for investment.
6. BSP defined interest rates to be a type of price. Interest are set to

compensate the risk of allowing the finances to flow into the financial
system.
7. The interest as a price is different on the perspective of the lender or

borrower. For lenders, interest rate is called as lending rate or return.
8. The interest as a price is different on the perspective of the lender or

borrower. For the borrowers, these will serve as cost of debt.
9. The tenor of the investment also defines the riskiness of the repayment of
debt.
10. There are two economic theories that affect the term structure of interest
rate. These are expectations theory and market segmentation theory.
11. Expectation theories is that the interest rates are driven by the
expectation of the lender or borrowers in the risks of the market in the
future. These maybe a pure expectation theory and biased expectation
theory.
12. Pure expectations theory is based on the current data and statistical
analysis to project the behavior of the market in the future.
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ExP®ctati°n Theory Includes that there are other factors that affoct
mow. *S ,ucture of the loans as well as the Interest to be perceived
moving forward.
14. The adjustment or increase on the Interest rata Is called the liquidity
premium
15. Liquidity premium increases as the maturity lengthens. This theory Is
called the liquidity theory.
16. Preferred habitat theory does not only consider the liquidity but the risk
premium as well but disregarding the consensus of the market on the
future interest rates.
17. The risk-free rate should be the rate that assumes zero default In the
market where this is more or less equivalent to the rates offered by the
sovereign.
18. Market Segmentation Theory assumes that the driver of the interest rates
are the savings and investment flows.
19. The PDS Group is an organized market that was formed out of the
financial distress in 1997.
. In commerce, risk is a very important factor to consider that may drives

the business up or down. Risk relates to the volatility of return patterns in
the business.
. There are risks that are inherent in every financing transaction. These are
default risk, liquidity risk, legal risks, and market risks, among others.
. Default risk arise on the inability to make payment consistently.
. Liquidity Risk is identified by ensuring the business to be capable of

meeting all its currently maturing obligation.
. Legal risk is dependent on the covenants set and agreed in between the
lenders and the borrowers.
. Market risk is the impact of the market drivers to the ability of the
borrowers to settle the obligation.
. Since the interest rate is dependent on the inflation, tenor and other
market risks. Companies should consider and make reasonable estimates
to mitigate these risks.
When the agreement is a spot rate the applicable interest rate is based
on the prevailing market rate at the particular time.
Forward rates are normally contracted rates that fixed the rates and allow
a party to assume such risk on the difference between the contracted rate
and the spot rate.
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. Swap rate is another contract rate where a fixed rate exchange tor a
certain market rate at a certain maturity.
. LIBOR or London Interbank Offered Rate is used to benchmark interest
rates which is used as reference for international banks to borrow It is
calculated using the Intercontinental Exchange or ICE.
. The credit ratings are determined by companies that are recognized
globally that objectively assigns or evaluates countries and companies
based on the riskiness of doing business with them.
I. The credit ratings provided by S&P were categorized to Investment
Grade and Non-lnvestment Grade and scaled from AAA to D
. Standard and Poor’s Corporation or S&P is an American financial
services corporation was founded in 1941 by Henry Varnum Poor in New
York, USA.
. Moody’s Investors Services or Moody’s is credit rating company

particularly on debt securities established in 1909 in New York, USA.
. Moody’s classify the credit standing into the ratings Aaa to C

. Fitch Ratings was founded in 1914 in New York, USA. The company was
owned by Hearst. Hearst is a global information and services company,
. Fitch Ratings classify the credit standing into the ratings AAA to D
. In 2019, Philippines was assessed by S&P at BBB with a stable outlook

while Fitch last evaluation was in 2017 at BBB also with stable outlook.
Moody’s on the other hand, rated the country in 2014 at Baa with stable
rating.
. DBRS was established in 1976 in Toronto, Canada. The company was

considered as the fourth largest ratings agency.
.CARE Ratings started its operation in 1993 based in India. The company
is based in Mumbai with partners in Brazil, Portugal, Malaysia and South
Africa.
. One of the challenges in financing is to ensure the ability of the borrowers

to settle the obligation. The risk involve in financing are: default risk,
liquidity risk, and market risk among others.
42. It is theoretically assumed that the cost of financing is affected by the

availability of loanable funds which is the Loanable Funds Theory and the
maturity of the loans, where the longer the life of the loans the higher the
rate is Liquidity Preference Theory.
43. The three factors that affect the interest rates: (1) industry; (2) risk
exposure; and (3) compensation for the market expectation. Hence, the
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interest formula will require the function of default or risk-free rate, inflation
and debt premium for the compensation.
44. In order to mitigate the risk, most businesses hedge forward rates or
enter into a swap rate agreement. It is important for the borrowers and
lenders to know what the spot rate in the prevailing market is and employ
certain expectations in the future.
45. In finance, interest can be determined by the function of the risk and the
compensation of the investor on the difference between the risk-free rate
and the market fluctuations
46. Normal basis of the risk-free rate is the Treasury bills issued by the
Republic.
47. The PDS group is composed of four corporation: Philippine Dealing and
Exchange Corporate (PDEx) their trading services arm, Philippine
Depository and Trust Corp. (PDTC)forthe securities services, Philippine
Securities Settlement Corp. (PSSC) for their payments and transfer
services, and the PDS Academy for Market Development Corp. (PDSA) as
their training center.
48. Since the BSP is the main supplier of the bank reserves, it cannot set the
real interest rates because it cannot set the inflation expectations. Hence,
it is more appropriate to say the real risk free rate can be determined by
deducting the prevailing inflation.
49. Another way on how to calculate the interest rate is by the function of the
market value, par value and the interest expense paid by debt securities or
bonds.
50. The common defaults in the covenants are as follows: (1) maintaining the
financial ratios; (2) significant acquisition or disposal of assets; (3)
repayment of other obligation; or (4) declaration of dividends of any form
without the consent of the lenders.
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NAME: Date:
E5'2‘ Cr°ssword. Fill up the crossword puzzle based on the description
or definitiOn
given.
Across Down
2. It is the London Interbank Offered Rate 1. Liquidity theory assumes that the interest rates are
3. Drake and this author theorizes that interest is affected by the dependent on the preference of the household
availability of funds 4. S&P or and Poors
5. Risk Free Rate plus Debt Margin 6. Gathers credit information from more than 130 countries
7. Rates contracted to be fixed at a certain future date 9. Risk Rate
8. Indian credit rating company
10. risk is the probability that the borrower was not able to
repay the entire obligation.
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1. Which of the following is incorrect about credit risk?

a. Credit risk is one type of business risk.
b. This is the risk that the lender was not able to repay its obligation.
c. Credit risk also affects the valuation of accounts receivable.
d. Such risk is valuated as a factor to determine the cost of lending or financing using
debt.
2. This economic theory accordingly drives the interest rate assumes that it is ideal to
supply funds when the interests are high and vice versa.
a. Loanable funds
b. Liquidity preference
c. Expectation
d. Market Segmentation
3. This economic theory accordingly drives the interest rate assumes that the interest
rates are dependent on the preference of the household whether they hold or use it for
investment.
a. Loanable funds
c. Expectation
4. Which of the following is correct about interest rates?

a. BSP defined interest rates to be a type of price.
b. The interest as a price is similar on the perspective of the lender or borrower.
c. For borrowers, interest rate is called as lending rate or return.
d. For lenders, these will serve as cost of debt.
5. This economic theory accordingly affects the term structure of interest rate. Interest
rates are driven by the expectation of the lender or borrowers in the risks of the market
in the future.
a. Loanable funds
c. Expectation
6. This economic theory accordingly affects the terms structure of interest rate. This
theory assumes that the driver of the interest rates are the savings and investment
flows.
a. Loanable funds
c. Expectation
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7. This theory is based on the current data and statistical analysis to project the behavior
of the market in the future
a. Pure Expectation
b. Biased Expectation
c. Liquidity
d. Preferred Habitat
8. This theory includes that there are other factors that affect the term structure of the
loans as well as the interest to be perceived moving forward. The forward rates will be
affected or will be adjusted if the liquidity of the borrower will be weaker or stronger in
the future.
a. Pure Expectation
b. Biased Expectation
c. Liquidity preference
d. Market Expectation
9. The adjustment or increase in the interest rate described under Biased Expectation
theory is called .
a. liquidity premium
b. either discount or premium
c. interest delta
d. liquidity discount
10. Which of the following is not a type of Biased Expectation Theory?

a. liquidity
b. preferred habitat
c. liquidity preference
d. both a & b
11. This Biased Expectation theory does not only consider the liquidity but the risk
premium as well but disregarding the consensus of the market on the future interest
rates.
a. liquidity
b. preferred habitat
c. liquidity preference
d. market segmentation
12. Preferred habitat theory does not only consider the liquidity but the risk premium as
well but disregarding the consensus of the market on the future interest rates. The
habitat being referred here is the _ __________ _______
a. preferred estimate over the market behavior in the future.
b. preferred estimate over the present market behavior.
c. biased estimate over the market behavior in the future
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MAKKI I
c. biased estimate over the present market behavior.
13. To determine the appropriate interest rate or rates the following factors should bo
considered assuming the cash flows are already been established:
a. Interest rates in the industry
b. Risk exposure
c. Compensation on the market expectation.
d. All of the above
14. Related to the determination of interest rates, the following are true except:
a. In finance, interest can be determined by the function of the risk and the
compensation of the investor on the difference between the risk-free rate and the
market fluctuations
b. Another way on how to calculate the interest rate is by the function of the market
value, par value and the interest expense paid by debt securities or bonds
c. The risk-free rate should the rate that assumes zero default in the market where this
is more or less equivalent to the rates offered by the sovereign.
d. The low risk rate can be real or excludes the effect of inflation or the exclusion of
the effect of the purchasing power of Philippine Peso.
15. The PDS Group is an organized market that was formed out of the financial distress
in 1997. Using the technology the group provides full financial serviced from trading to
clearing and to settlement. Which of the following does not belong to PDS Group?
a. Philippine Dealing and Exchange Corporate
b. Philippine Deposit Insurance Corporation
c. Philippine Securities Settlement Corp.
d. PDS Academy
16. Which of the following is the trading services arm of PDS Group?
d. PDS Academy
17. Which of the following is for the payment and transfer services of PDS Group?
d. PDS Academy
18. Identify the risks described in each statement:
1st: Arise on the inability to make payment consistently. Most of the businesses was
able to raise financing on their demands, however their cash flows projected were
not that guaranteed.
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2nd: Identified by ensuring the business to be capable of meeting all its currently
maturing obligation.
a. Liquidity; Default
b. Default; Liquidity
c. Solvency; Default
d. Default; Solvency
19. Identify the risks described in each statement:
1 st: Dependent on the covenants set and agreed in between the lenders and the
borrowers.
2nd: Classified as a systematic risk because it arises from external forces or based on
the movement of the industry.
a. Legal; Market
b. Market; Legal
c. Contractual; Industry
d. Industry; Contractual
20. is the interest rate or yield available / applicable for a particular time.
a. Prevailing rate
b. Spot rate
c. Forward rate
d. Day rate
21. Normally contracted rates that fixed the rates and allow a party to assume such risk
on the difference between the contracted rate and the spot rate.
a. Prevailing rate
b. Spot rate
c. Forward rate
d. Future rate
22. Contract rate where a fixed rate exchange fora certain market rate at a certain
maturity. Usually the one used as reference is the LIBOR.
a. Swap rate
b. Exchange rate
c. Forward rate
d. Future rate
23. Which of the following statements is incorrect?

a LOBOR or London Interbank Offered Rate is used to benchmark interest rates
which is used as reference for international banks to borrow.
b. LIBOR is calculated using the Intercontinental Exchange or ICE.
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a ICI or International I xGhariue was eslal dial ie» I in 2000 in Ueorgte, UtjA II is
subjecjt tg | iircj|Union regulators watch
(I I lit* I liu )R mioer itsd short term horn I »lay up to 1 year and rateae»)rig more than
30 (uinti baâd on about five* currencies
24 1 *’* are determined by companies that are recognized globally that

objectively aabigna oi wvnhialee, countries and companies based on the riskiriees of
doing business wllh them I lie riskiness la primarily driven by their ability Io manage
their liquidity and solvency in the long run I Im higher the grade the lower the default
rink associated to Um country or company
n Credit Ratings
b Credit 8oore
c, Investment Rating
d Investment Scorn
25. The following statements are counci, nxr.npl

a Standard and I Poor's Corporation or t ;&l * is an American financial services
corporation wan founded in 194 I by I Innry Varnum Poor In New York, USA
b Moody's Investors Services oi Moody's Is credit rating company particularly on
equity securities established In 1909 in New York, USA
c. Fitch Ratings was founded in 1914 in New York, USA t lie company was owned by
11 ear st
d. DBR8 was established In 1976 in I oronto, Canada I he company was considered
as the fourth largest ratings agency
26. The following me major credit ratings company, except

a. S&P
b. Moody's
c. Fitch
d. MTRCB
27. Which of the following scaled Its ratings from AAA to D

a. Moody's and DBR8
b. S&P and Fitch
c. S&P and DBRS
d. Moody's and CARE
28. Which of the following is not correct?

a. One of the challenges In financing Is to ensure the ability of the borrowers to settle
the obligation, The risk involve In financing are default risk, liquidity risk, and
market risk among others.
b. It is theoretically assumed that the cost of financing is affected by the availability of
loanable funds which is the Loanable Funds Theory and the maturity of the loans,
where the longer the life of the loans the higher the rate Is Liquidity Premium
Theory
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c. The three factors that affect the interest rates: (1) industry, (2) risk exposure, and (3)
compensation for the market expectation. Hence, the interest formula will require
the function of default or risk-free rate, inflation and debt premium for the
compensation.
d. In order to mitigate the risk, most businesses hedge forward rates or enter into a
swap rate agreement. It is important for the borrowers and lenders to know what the
spot rate in the prevailing market is and employ certain expectations in the future.
29. The common unit of measure for interest rates and other percentage in finance is
called BPS. What does BPS stand for?
a. Basis points
b. Basic percentages
c. Basic point system
d. Basic percentage system
30. Oberon Financing offers loans fixed for the first 5 years at 8% and based on the
market in the future. Morgana Corp, is capable of servicing the debt at only 9% for the
next 10 years more than that they will fail to maintain their debt covenant ratios.
Morgana Corp can enter into agreement with Oberon to have the rates 8% for the first
5 years and 9% for years 6 to 10. Which of the following is correct?
a. If the interest rate remains to be 8% until year 10, the Morgana will lose 1% per
year.
b. If the rate results say around 10% then Morgana gain for the forward rate contract.
c. If the interest rate remains to be 8% until year 10, the Oberon will lose 1% per year.
d. Both a and b are correct
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Chapter 6
DEBT SECURITIES MARKETS
F U N DA MENTALS Wondershare
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Debt Securities Market
Financial market is a forum or market that enables suppliers and demanders of

funds to make transactions. This can be money market or capital market in the form of
debt or equity/stock transactions. Debt can be short term or long term that is why it can be
within money market definition if shortterm, while in capital market if long term. Equity or
stock is normally long term.
Debt market or Debt Securities Market is the financial market where the debt
instruments or securities are transacted by suppliers and demanders of funds. This
chapter shall focus on this type of financial market.
Debt Instrument
A debt instrument is a paper or electronic obligation that enables the issuing party
to raise funds by promising to repay a lender in accordancewith terms of a contract. Types
of debt instruments include notes, bonds, debentures, certificates, mortgages, leases or
other agreements between a lender and a borrower. These instruments provide a way for
market participants to easily transfer the ownership of debt obligations from one party to
another.
A debt instrument is legally enforceable evidence of a financial debt and the
promise of timely repayment of the principal, plus any interest. The importance of a debt
instrument is twofold. First, it makes the repayment of debt legally enforceable. Second, it
increases the transferability of the obligation, giving it increased liquidity and giving
creditors a means of trading these obligations on the market. Without debt instruments
acting as a means of facilitating trading, debt would only be an obligation from one party
to another. However, when a debt instrument is used as a trading means, debt obligations
can be moved from one party to another quickly and efficiently.
Types of Debt Instruments
Debt instruments can be either long-term obligations or short-term obligations.

Short-term debt instruments, both personal and corporate, come in the form of obligations
expected to be repaid within one calendar year. Long-term debt instruments are
obligations due in one year or more, normally repaid through periodic installment
payments.
• Short-Term Debt Instruments
From a personal finance perspective, short-term debt instruments come in the

form of credit card bills, payday loans, car title loans and other consumer loans that
have repayment terms of less than 12 months. If a person incurs a credit card bill of
Php 1,000, the debt instrument is the agreement that outlines the obligated payment
terms between the borrower and the lender.
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In corporate finance, short-term debt usually comes in the form of revolving

lines of credit, loans that cover networking capital needs and Treasury bills. If for
example, a corporation looks to cover six months of rent with a loan while it tries to
raise venture funding, the loan is considered a short-term debt instrument.
• Long-Term Debt Instruments
Long-term debt instruments in personal finance are usually mortgage

payments or car loans. For example, if an individual consumer takes out a 30-year
mortgage for Php 500,000, the mortgage agreement between the borrower and the
mortgage bank is the long-term debt instrument.
Debt Security
Debt security refers to a debt instrument, such as a government bond, corporate

bond, certificate of deposit (CD), municipal bond or preferred stock, that can be bought or
sold between two parties and has basic terms defined, such as notional amount (amount
borrowed), interest rate, and maturity and renewal date. It also includes collateralized
securities, such as collateralized debt obligations (CDOs), collateralized mortgage
obligations (CMOsj, mortgage-backed securities issued by the Government National
Mortgage Association (GNMAs)and zero-coupon securities.
The interest rate on a debt security is largely determined by the perceived
repayment ability of the borrower; higher risks of payment default almost always lead to
higher interest rates to borrow capital. Also known as fixed-income securities, most debt
securities are traded over the counter. The total dollar value of debt security trades
conducted daily is much larger than that of stocks, as debt securities are held by many
large institutional investors as well as governments and nonprofit organizations.
Types of Debt Securities

Debt securities, sometimes referred to as fixed-income securities, include
money market securities and capital market debt securities such as notes, bonds,
and mortgage backed securities. Like Debt instruments, debt security can be
classified into short term/money market debt securities or long term/capital market
securities.
• Money market debt securities
Money market securities are debt securities with maturities of less

than one year. Money market securities of most interest to individual
investors are treasury bills (T-bills) and certificates of deposit (CDs).
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• Capital market debt securities
Capital market debt securities are debt securities with maturities of

longer than one year. Examples are notes, bonds, and mortgage-backed
securities.
Debt Security vs. Debt Instrument
Usually Financial Instruments and Financial Securities are interchangeably used,

however technically these two are different. Not all financial instruments are securities. A
security is a fungible, negotiable financial instrument that holds some type of monetary
value. It represents an ownership position in a publicly-traded corporation (via stock), a
creditor relationship with a governmental body or a corporation (represented by owning
that entity’s bond), or rights to ownership as represented by an option.
Financial Instruments are called securities since securities carry some value on
them. When they are exchanged in the market, the realization will be in the form ofcash
and a benefit for the holder of the securities.
Alternately we can call financial instruments are called Securities, since they are
backed by Corporations or Government. Take for example Government Bonds, Money
market Instruments. Equities or Shares though have no formal backing, still they carry
value on them and when they are exchanged in the secondary market, the shareholder
will still be able to receive cash
With the above, debt securities therefore are negotiable and tradable debt
instruments which carry value on them. A credit card bills and payday loans for example
are just debt instrument but not debt securities. On the other hand. Government bonds
are debt instrument and also debt securities since they carry' value that is negotiable and
tradable in the financial market and that holder will still be able to receive cash.
Safety of Debt Securities
Debt securities have an implicit level of safety simply because they ensure that the
principal amount that is returned to the lender at the maturity date or upon the sale of the
security. They are typically classified by their level of default risk, the type of issuer and
income payment cycles. The riskier the bond, the higher its interest rate or return yield.
For example, Treasury bonds, issued by the U.S. Treasury Department, have
lower interest rates than bonds issued by corporations. Corporate and government bonds,
however, are both rated by agencies such as Standard & Poor’s and Moody's Investors
Service. These agencies assign a rating, similar to the credit scores assigned to
individuals, and bonds with high ratings tend to have lower interest rates than bonds with
low ratings. For example, historically, corporate AAA bonds have lower yields than
corporate BBB bonds.
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The Bond Market
Debt market or Debt securities market is also known as bond market is a financial
market in which the participants are provided with the issuance and trading of debt
securities. The bond market primarily includes government-issued securities and
corporate debt securities, facilitating the transfer of capital from savers to the issuers or
organizations requiring capital for government projects, business expansions and ongoing
operations. In the bond market, participants can issue new debt in the market called the
primary market or trade debt securities in the market called the secondary market. These
products are typically in the form of bonds, but they may also come in the form of bills and
notes. The goal of the bond market is to provide long-term financial aid and funding for
public and private projects and expenditures.
The participants of the bond market are nearly the same as the participants in other
financial markets. In bond markets, the participants are either buyers of funds (that is, debt
issuers) or sellers of funds (institutions). Participants include institutional investors,
traders, governments and individuals who purchase products provided by large
institutions. These projects may be in the form of pension funds, mutual funds and life
insurance, among many other product types.
Types of Bond Markets

The general bond market can be classified into corporate bonds, government
and agency bonds, municipal bonds, mortgage-backed bonds, asset-backed bonds, and
collateralized debt obligations.
Corporate Bond
Corporations provide corporate bonds to raise money for different
reasons, such as financing ongoing operations or expanding businesses. The
term "corporate bond" is usually used for longer-term debt instruments that
provide a maturity of at least one year.
Government Bonds
National governments issue government bonds and entice buyers by
providing the face value on the agreed maturity date with periodic interest
payments. This characteristic makes government bonds attractive for
conservative investors.
Municipal Bonds
Local governments and their agencies, states, cities, special-purpose
districts, public utility districts, school districts, publicly owned airports and
seaports, and other government-owned entities issue municipal bonds to fund
their projects.
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Mortgage Bonds
Pooled mortgages on real estate properties provide mortgage bonds.
Mortgage bonds are locked in by the pledge of particular assets. They pay
monthly, quarterly or semi-annual interest.
Asset-backed bonds
Also known as asset-backed security (ABS) is a financial security

collateralized by a pool of assets such as loans, leases, credit card debt,
royalties or receivables. For investors, asset-backed securities are an alternative
to investing in corporate debt. An ABS is similar to a mortgage-backed security,
except that the underlying securities are not mortgage-based.
Collateralized Debt Obligation (CDO)
CDO is a structured financial product that pools together cash flow

generating assets and repackages this asset pool into discrete tranches that can
be sold to investors. A collateralized debt obligation is named for the pooled
assets — such as mortgages, bonds and loans — that are essentially debt
obligations that serve as collateral for the CDO. The tranches in a CDO vary
substantially in their risk profiles. The senior tranches are generally safer
because they have first priority on payback from the collateral in the event of
default. As a result, the senior tranches of a CDO generally have a higher credit
rating and offer lower coupon rates than the junior tranches, which offer higher
coupon rates to compensate fortheir higher default risk.
Characteristics of Bonds
A bond is a debt instrument that provides a steady income stream to the investor
in the form of coupon payments. At maturity date, the full face value of the bond is repaid
to the bondholder. The characteristics of a regular bond include:
• Coupon rate
Some bonds have an interest rate, also known as the coupon rate, which is
paid to bondholders semi-annually. The coupon rate is the fixed return that an
investor earns periodically until it matures.
• Maturity date
All bonds have maturity dates, some short-term, others long-term. When the
bond matures, the bond issuer repays the investor the full face value of the
bond. For corporate bonds, the face value of a bond is usually Php 1,000 and
for government bonds, face value is Php 10,000. The face value is not
necessarily the invested principal or purchase price of the bond
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• Current or Market Price
Depending on the level of interest rate in the environment, the investor may
purchase a bond at par. below par, or above par. For example, if interest rates
increase, the value of a bond will decrease since the coupon rate will be lower
than the interest rate in the economy, When this occurs, the bond will trade at
a discount, that is, below par. However, the bondholder will be paid the full
face value of the bond at maturity even though he purchased it for less than
the par value.
Bond Valuation
Bond valuation is a technique for determining the theoretical fair value of a

particular bond. Bond valuation ncludes calculating the present value of the bond's future
interest payments, also known as its cash flow. and the bond's value upon maturity, also
known as its face value or par value. Because a bond's par value and interest payments
are fixed, an investor uses bond valuation to determine what rate of return is required for
a bond investment to be worthwhile. Eq 5,1 describe the formula to value a bond.
Eq 5.1
Bo = present value of the bond

I = annual interest paid in dollars
n = number of years to maturity
M = par value in dollars
rd = required return
To illustrate, suppose a 10-year 10% bond with a par value of Php1,000 is traded
in the market. The similar debt instrument is expecting 9% returns in the market. How
much is the value of the bonds?
Using Eq 5,1 the bond is valued at Php 1,064, The value is higher than par and
issued on a premium because the market offers a lower return as compared the
guaranteed returns of 10%.
Bo = Php1,000 x 10% x + Phpl.000 X [ ^*<^,0]

Bo = PhplOO x 6.4177 + Phpl.000 x 0.4244
Bo = Php641.77 + 422.41
Bq = Phpl,064.18
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This principle simply states that the bonds can be resold at Php1,064 since this is
perceived by the market to be better off that what is available to everyone else.
Since bonds are an essential part of the capital markets, investors and analysts
seek to understand how the different features of a bond interact in order to determine its
intrinsic value. Like a stock, the value of a bond determines whether it is a suitable
investment fora portfolio and hence, is an integral step in bond investing.
Bond valuation, in effect, is calculating the present value of a bond’s expected

future coupon payments. The theoretical fair value of a bond is calculated by discounting
the present value of its coupon payments by an appropriate discount rate. The discount
rate used is the yield to maturity, which is the rate of return that an investor will get if s/he
reinvested every coupon payment from the bond at a fixed interest rate until the bond
matures. It considers the price of a bond, par value, coupon rate, and time to maturity.
A zero-coupon bond makes no annual or semi-annual coupon payments for the
duration of the bond. Instead, it is sold at a deep discount to par when issued. The
difference between the purchase price and par value is the investor’s interest earned on
the bond. To calculate the value of a zero-coupon, we only need to find the present value
of the face value.
Following our example above, if the bond paid no coupons to investors, its value
will simply be the present value of the face value of the bonds i.e. Php422.41. Under both
calculations, a coupon paying bond is more valuable than a zero-coupon bond.
Valuation for a Non-Treasury bond (Adding Risk Premium)
The above valuation assumes a default free rate and thus for a non-Treasury bond,
a risk premium has to be added to the base interest rate (the Treasury rate). The risk
premium is the same regardless of when a cast) flow is to be received. This risk premium
is also called constant crodlt sproad So, for the above, assuming the appropriate risk
premium / credit spread is 100 bps equivalent to 1%, the discount rate to be used should
be 6% i.e. 5% the risk free Interest rate (the Treasury rate) + 1% risk premium.
In practice, the spot rate used to discount tho cash flow of a non-Treasury security
is the Treasury spot rate plus a constant crodlt spread. Tho drawback of this approach is
that there Is no reason to expect tho crodlt spread to bo the same regardless of when the
cash flow Is expected to bo received. Instead, it might be expected that the credit spread
increases with the maturity of the bond. That Is, there Is a term structure for credit spreads.
Dealer firms typically construct a term structure for crodlt spreads for a particular rating
based on the Input of traders. The term structure of Interost rates is the relationship
between Interest rates or bond yields and different terms or maturities. Whon graphed, the
term structure of Interest rates Is known as a yield curve discussed In the earlier chapter,
and It play* a central role In an economy. Tiro term structure inflects expectations of
market participants about future changes In Interest rates and their assessment of
monetary policy conditions,
Generally, the credit spread Increases with maturity. This Is a typical shape for the
term structure of crodlt spreads In addition, the shape of the term structure Is not the
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same for all credit ratings. The lower the credit rating, the steeper the term structure. When
the credit zero spreads for a given issuer are added to the Treasury spot rates, the
resulting term structure is used to value bonds of issuers of the same credit quality. This
term structure is referred to as the benchmark spot rate curve or benchmark zero
coupon rate curve.
Approaches in Valuation
The above formula can be adjusted based on the approaches in valuation. There
are at least 2 approaches in valuation of bonds. Below are approaches which assumed
option-free bonds.
• Traditional approach
The traditional approach to valuation has been to discount every cash

flow of a bond by the same interest rate (or discount rate). The cash flows are
viewed as default free / risk free, the traditional practice is to use the same
discount rate to calculate the present value of securities and use the same
discount rate for the cash flow for each period. So, suppose that the yield on a
10-year Treasury trading at par value is 5%. Then, the practice is to discount
each cash flow using a discount rate of 5%. In case of non-treasury securities,
the risk premium has to be added.
• Arbitrage Free Valuation approach
The fundamental flaw of the traditional approach is that it views each

security as the same package of cash flows. For example, consider a 10-year
Philippine Treasury bond with an 8% coupon rate. The cash flows per Php 100
of par value would be 19 payments of Php 4 every 6 months and Php 104 for
20 six month periods from now. The traditional practice is to discount every
cash flow using the same interest rate. The proper way to view the 10-year 8%
coupon bond is as a package of zero-coupon bonds. Each cash flow should
be considered a zero-coupon bond whose maturity value is the amount of the
cash flow and whose maturity date is the date that the cash flow is to be
received. Thus, the 10-year 8% coupon bond should be viewed as 20 zero
coupon bonds. The reason this is the proper way to value a bond is that it does
not allow a market participant to realize an arbitrage profit by taking apart or
“stripping” a security and selling off the stripped securities at a higher
aggregate value than it would cost to purchase the security in the market. This
approach to valuation is referred to as the arbitrage-free approach.
The arbitrage-free approach values a bond as a package of cash
flows, with each cash flow viewed as a zero-coupon bond and each cash
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flow discounted at its own unique discount rate. For better appreciation of
the difference of the traditional valuation approach and arbitrage free
valuation approach, traditional uses interest rate one time for 10 years
tenor of the securities while in arbitrage free, it uses different interest rates
published every period or near term since the securities are viewed as if
separate zero coupon bonds. With this, to implement the arbitrage-free
approach, it is necessary to determine the theoretical rate that the U.S.
Treasury would have to pay to issue a zero-coupon Treasury bond for each
maturity. Another name used for the zero-coupon Treasury rate is the
Treasury spot rate. Spot rates are available from vendors of financial
information such as Bloomberg and Reuters. The spot rate for a Treasury
security of some maturity is the base interest rate that should be used to
discount a default-free cash flow with the same maturity.
Valuation of Bonds with Embedded Options
The two approaches to valuation presented above have dealt with the valuation of
option-free bonds. Thus, a Treasury security and an option-free non-Treasury security can
be valued using the procedures described above. More general valuation models handle
bonds with embedded options. Practitioners commonly use two models in such cases:
The lattice model and Monte Carlo simulation model
• The lattice model is used to value callable bonds and putable bonds.
• The Monte Carlo simulation model is used to value mortgage-backed securities
and certain types of asset-backed securities.
This chapter will not to go into the details of these two models. What is critical to
understand is that these valuation models use the principles of valuation described earlier
in this chapter. Basically, these models look at possible paths that interest rates can take
in the future and what the bond’s value would be on a given interest rate path. A bond’s
value is then an average of these possible interest rate path values.
There are four features common to the binomial and Monte Carlo valuation
models.
1. Each model begins with the yield on Treasury securities and generates the
Treasury spot rates.
2. Each model assumes about the expected volatility of short-term interest rates. This
es?rnatedalahemPtlOn bOth m°dels since jt can significantly affect the bond’s
3. !aTta^XnSdaSSUmP‘iOn’ dWeren‘ the short-term interest rate
4.
°aei will produce the observed market price.
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SUMMARY
• Debt Securities Market is the type of financial market in the form of debt
transactions between demanders and suppliers of funds.
• Debt instrument is legally enforceable evidence of a financial debt and the promise
of timely repayment of principal, plus any interest.
• Debt security is a debt instrument however not all debt instruments are debt
securities.
• Debt securities are different from equity securities as equity securities represent
ciaims on earnings and assets of a corporation, while debt securities are
investment into debt instruments.
• ~ne characteristics of a regular bond are coupon rate, maturity date and current
price.
• Bond Valuation in Practice essentially is calculating the present value of a bond’s

expected future coupon payments.
• The theoretical fair value of a bond is calculated by discounting the present value
of its coupon payments by an appropriate discount rate.
• The discount rate used is the yield to maturity, which is the rate of return that an
investor will get if s/he reinvested every coupon payment from the bond at a fixed
interest rate until the bond matures. It takes into account the price of a bond, par
value, coupon rate, and time to maturity.
• Discount rate used normally is the risk free or default free rate plus the risk
premium, if applicable.
• There are 2 approaches in Bond Valuation for option-free bonds: traditional

approach and arbitrage free valuation approach.
• There are 2 approaches in Bond Valuation for bonds with embedded options:
lattice model and Monte Carlo Simulation
/ X
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NAME: __________________________________ Date: _
true.
1. Financial market is a forum or market that enables suppliers and

demanders of funds to make transactions.
2. Debt can be short term or long term that is why it can be within capital
market definition if short term, while in money market if long term.
3. Debt market or Debt Securities Market is the financial market where the
debt instruments or securities are transacted by suppliers and demanders
of funds.
4. A debt instrument is a paper or electronic obligation that enables the
issuing party to raise funds by promising to repay a lender in accordance
with terms of a contract.
5. Types of debt instruments include notes, bonds, debentures, certificates,
mortgages, leases or other agreements between a lender and a borrower.
6. The importance of a debt instrument is twofold. First, it makes the

repayment of debt legally enforceable. Second, it increases the
transferability of the obligation, giving it increased liquidity and giving
creditors a means of trading these obligations on the market.
7. Without debt instruments acting as a means of facilitating trading, debt

would only be an obligation from one party to another.
8. Long-term debt instruments are obligations due in one year or more,

normally repaid through periodic installment payments.
9. Short-term debt instruments, both personal and corporate, come in the
form of obligations expected to be repaid within one calendar year.
10. From a corporate finance perspective, short-term debt instruments come
in the form of credit card bills, payday loans, car title loans and other
consumer loans that have repayment terms of less than 12 months.
11. In corporate finance, short-term debt usually comes in the form of
revolving lines of credit, loans that cover networking capital needs and
Treasury bills.
12. Long-term debt instruments in personal finance are usually mortgage

payments or car loans.
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13. Debt security refers to a debt instrument, such as a government bond,

corporate bond, certificate of deposit (CD), municipal bond or preferred
stock, that can be bought or sold between two parties and has basic terms
defined, such as notional amount (amount borrowed), interest rate, and
maturity and renewal date.
14. The interest rate on a debt security is largely determined by the perceived
repayment ability of the borrower; higher risks of payment default almost
always lead to higher interest rates to borrow capital.
15. Also known as fixed-income securities, most debt securities are traded
over the counter.
16. Debt securities, sometimes referred to as fixed-income securities, include

money market securities and capital market debt securities such as notes,
bonds, and mortgage backed securities.
17. Money market securities are debt securities with maturities of less than
one year. Money market securities of most interest to individual investors
are treasury bills (T-bills) and certificates of deposit (CDs).
18. Capital market debt securities are debt securities with maturities of longer
than one year. Examples are notes, bonds, and mortgage-backed
securities.
19. Usually Financial Instruments and Financial Securities are
interchangeably used, and these are indeed similar.
20. All financial instruments are financial securities.
21. A security is a fungible, negotiable financial instrument that holds some

type of monetary value.
22. A security represents an ownership position in a publicly-traded
corporation (via bonds), a creditor relationship with a governmental body
or a corporation (represented by owning that entity's stock), or rights to
ownership as represented by an option.
23. Financial Instruments are called securities since securities carry some
value on them. When they are exchanged in the market, the realization will
be informed of cash and a benefit for the holder of the securities.
24. Alternately we can call financial instruments are called Securities, since
they are backed by Corporations or Government.
25. Debt securities are negotiable and tradable debt instruments which carry
value on them.
26. A credit card bills, and payday loans are examples of debt securities.
27. Debt securities represent a claim on the earnings and assets of a

corporation, while equity securities are investments into debt instruments.
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28. A stock is an equity security, while a bond is a debt security.

29. When an investor buys a stock, he is essentially loaning the corporation
money, and he has the right to be repaid the principal and interest on the
bond. In contrast, when someone buys a bond from a corporation, he
essentially buys a piece of the company.
30. While most people are more familiar with the market for equity securities,
the debt market is nearly twice its size, globally.
31. Debt securities have an implicit level of risk simply because they ensure
that the principal amount that is returned to the lender at the maturity date
or upon the sale of the security.
32. Debt market or Debt securities market is also known as bond market is a
financial market in which the participants are provided with the issuance
and trading of debt securities.
33. The bond market primarily includes government-issued securities and

corporate debt securities, facilitating the transfer of capital from savers to
the issuers or organizations requiring capital for government projects,
business expansions and ongoing operations.
34. In the bond market, participants can issue new debt in the market called
the primary market or trade debt securities in the market called the
secondary market.
35. In bond markets, the participants are either buyers of funds (that is, debt
issuers) or sellers of funds (institutions).
36. The general bond market can be classified into corporate bonds,
government and agency bonds, municipal bonds, mortgage-backed
bonds, asset-backed bonds, and collateralized debt obligations.
37. National government provides corporate bonds to raise money for

different reasons, such as financing ongoing operations or expanding
businesses.
38. Public Corporations issue government bonds and entice buyers by

providing the face value on the agreed maturity date with periodic interest
payments. This characteristic makes government bonds attractive for
conservative investors.
39. Local governments and their agencies, states, cities, special-purpose

districts, public utility districts, school districts, publicly owned airports and
seaports, and other government-owned entities issue municipal bonds to
fund their projects.
0. Pooled mortgages on real estate properties provide mortgage bonds.

Mortgage bonds are locked in by the pledge of particular assets.
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41. Asset-backed security (ABS) is a financial security collateralized by a

pool of assets such as loans, leases, credit card debt, royalties or
receivables.
42. An ABS is similar to a mortgage-backed security, except that the
underlying securities are not mortgage-based.
43. A collateralized debt obligation (CDO) is a structured financial product
that pools together cash flow-generating assets and repackages this asset
pool into discrete tranches that can be sold to investors.
44. Bond valuation is a technique for determining the true fair value of a
particular bond.
45. Because a bond's par value and interest payments are not fixed, an
investor uses bond valuation to determine what rate of return is required
for a bond investment to be worthwhile.
46. The coupon rate is the fixed return that an investor earns periodically until
it matures.
47. When the bond matures, the bond issuer repays the investor the full
discounted value of the bond.
48. If interest rates increase, the value of a bond will decrease since the
coupon rate will be lower than the interest rate in the economy. When this
occurs, the bond will trade at a premium, that is, above par.
49. The lattice model to valuation has been to discount every cash flow of a
bond by the same interest rate (or discount rate).
50. Practitioners commonly use two models in cases of bonds with
embedded options: The traditional model and Monte Carlo simulation
model.
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given.
Across Down
2. Popular long term debt instrument 1. a emutabon rrryiet used to Out twtofflpWulMrt securities
4. a kind of spread over the default rate 3. Model ^sed to tar caatte. ttM bonta,
8. approach that strps the security and se# M on a higher vaiue 5. pace or value <M tie searay other than par
9. coupon is a no interest security 8. type of bond used for rsa&xca projects
10. A date of expiration of the bond 7. type o? bond used fo fcr buaness ezpansrn
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NAME:
Date: .
1. Which of the following approaches is appropriate for bonds with embedded options?
a. Traditional valuation
b. Arbitrage free valuation
c. Risk free valuation
d. Lattice model
2. Risk premium is also called .

a. Credit Spread
b. Risk additive
c. Debt Spread
d. Risk Spread
3. The fixed return that an investor earns periodically until bond matures.
a. coupon rate
b. cost of capital
c. return of investment
d. coupon bond
4. The date when bond issuer repays or pays the investor the full face value of the bond.
a. payment date
b. repayment date
c. maturity date
d. bond amortization date
5 This is the prevailing value of bond based on the level of interest in the environment.
This maybe at par, premium or at discount.
a. Current Price
b. Premium Price
c. Discounted Price
d. Par Value
a This technique of determining the theoretical value of bond includes calculating the
resent value of the bond’s future interest payments, also known as its cash flow, and
the bond's value upon maturity, also known as its face value or par value.
a. Net Present Value
b. Capital Budgeting
c. Bond Valuation
d. Theoretical valuation
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7. Which of the following is not correct about the importance of a debt instrument?
a. It makes the repayment of debt legal.
b. It increases the transferability of the obligation, giving it increased liquidity and
giving creditors a means of trading these obligations on the market.
c. Without debt instruments acting as a means of facilitating trading, debt would only
be an obligation from one party to another.
d. When a debt instrument is used as a trading means, debt obligations can be moved
from one party to another quickly and efficiently.
8. A credit card bill is an example of

a. short term securities
b. money market securities
c. short term debt instruments
d. short term equity instruments
9. Which of the following is not a debt security?

a. pay day loans evidenced by loan agreement
b. government bond
c. preferred stock
d. collateralized debt obligations
10. Which of the following are money market debt securities?

a. Treasury bills and Certificate of Deposits
b. Treasury bills, notes and bonds
c. Certificate of Deposits and Preferred stocks
d. Credit Card bills and Pay Day Loans
11. Which of the following are capital market debt securities?

a. Treasury bills and Certificate of Deposits
b. Treasury bills, notes and bonds
c. Certificate of Deposits and Preferred stocks
d. Treasury notes and bonds
12. What is the difference between debt instrument and debt security?
a. They can be interchangeably used hence similar.
b. Not all debt instruments are debt securities, however debt securities are all debt
instruments.
c. Not all debt securities are debt instruments, however debt instruments are all debt
securities.
d. Debt instruments are negotiable and tradable debt securities.
13. What is the difference between debt securities and equity securities?
a. Equity securities represent a claim on the earnings and asset of the corporation
while debt securities are investments into debt instruments.
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b. Equity securities are in the form of stocks like preferred stock while debt securities
are in the form of bonds
c. Equity securities represents investment in debt instruments while debt securities are
investment in preferred stocks.
d. Both are negotiable and tradable securities, hence similar.
14. Which of the following is the safest (least risky) investment?

a. treasury bills
b. investment of common stock with voting rights
c. preferred stock non-cumulative
d. corporate bonds
15. Debt securities are typically classified by the following except:

a. level of default risk
b. type of issuer
c. income payment cycles
d. interest rate
16. Which of the following is incorrect about bond market?

a. Also known as debt securities or credit market
b. The bond market primarily includes government-issued securities and corporate
debt securities, facilitating the transfer of capital from savers to the issuers or
organizations requiring capital for government projects, business expansions and
ongoing operations.
c. In the bond market, participants can issue new debt in the market called the initiate
public offering or trade debt securities in the market called the secondary market.
d. The goal of the bond market is to provide long-term financial aid and funding for
public and private projects and expenditures.
17. Corporations provide to raise money for different reasons, such as

financing ongoing operations or expanding businesses.
a. corporate bonds
b. institutional bonds
c. private bonds
d. pubic bonds
18. National governments issue government bonds and entice buyers by providing the
face value on the agreed maturity date with periodic interest payments.
a. corporate bonds
b. institutional bonds
c. private bonds
d. government bonds
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19 .Local governments and their agencies, states, cities, special-purpose districts, public
utility districts, school districts, publicly owned airports and seaports, and other
government-owned entities issue _ to fund their projects.
a. corporate bonds
b. municipal bonds
c. private bonds
d. government bonds
20. are locked in by the pledge of particular assets.

a. corporate bonds
b. municipal bonds
c. mortgage bonds
d. government bonds
21. is similar to a mortgage-backed security, except that the underlying

securities are not mortgage-based.
a. Asset backed bonds
b. non-mortgage backed security
c. mortgage bonds
d. collateralized debt obligation
22. is a structured financial product that pools together cash flow-generating assets and
repackages this asset pool into discrete tranches that can be sold to investors.
a. Asset backed bonds
b. non-mortgage backed security
c. mortgage bonds
d. collateralized debt obligation
23. manage and measure bond portfolio performance. Many

are members of broader indices that may be used to provide and
measure the performances of global bond portfolios.
a. bond indices
b. debt security indices
c. consumer price indices
d. market indices
24. A corporate bond was issued by X Corporation to an Y Corporation. From this

investment, Y Corporation will earn 5% every year for 5 years. Y Corporation has paid
for this Php1,000.00 value bond for only Php990.00. What do you call the 5% that will
be earned by Y Corporation?
a. coupon rate
b. cost of capital
c. cost of debt
d. cost of bond
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25. Following above, the Php 990.00 referred is called

a. current price
b. face value
c. bond value
d. coupon value
26. Following above, the Php 1,000.00 referred is called -------- ------ •
a. current price
b. face value
c. bond value
d. coupon value
27. Find the value of Php 1,000.00 corporate bond with annual interest ratesof 5%
making semi-annual interest payments for 2 years, after which the on
the principal must be repaid. Yield to Maturity is 3%.
a. Php 981.42
b. Php 888.49
c. Php 92.93
d. Php 1,000.00
28. Following above, if the bond paid no coupons, how much will be its value.
a. Php 981.42
b. Php 888.49
c. Php 92.93
d. Php 1,000.00
29. Following the above, assuming again there are coupon payments, what is the present
value of the coupon payments.
a. Php 981.42
b. Php 888.49
c. Php 92.93
d. Php 1,000.00
30. Following the above, what is the present value of the face value of ttfe bond?
a. Php 981.42
b. Php 888.49
c. Php 92.93
d. Php 1,000.00
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Chapter 7
EQUITY SECURITIES MARKET
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FUNDAMENTALS OF FINANCIAL-MARKET
Equity Security Market
In accounting perspective, shareholder's equity, or more commonly known as

equity, refers to the difference between the assets and liabilities of a company,
fundamentally, equity represents ownership of a firm. Same with debt, investors can put
out k,ash to purchase equity and trade these in financial markets through equity
instruments.
Equity instrument is a type of financial instrument wherein the issuer (company)

agrees to pay an amount to the investor in the future based on the future earnings of the
company, if any. The earnings used as basis of the amount to be paid to equity instrument
holder is determined after settling all required payments (i.e. interest for debt security
holders) of the business. The most common example of equity instruments is shares.
Basically, shares (or stocks) represent ownership in a company. May it be one
share. 10% of total outstanding shares or all authorized shares, having shares means that
a party owns a portion of the business. An individual or a party who owns a share is called
a shareholder or stockholder. Shareholders own a percentage interest in a company in
relation to the total outstanding shares. Stock certificates, the legal document which
certifies the ownership of specific number of shares of a corporation, is given to
shareholders. In equity instruments, the company is the issuing party and the shareholders
who purchased the shares are the investors.
Authorized capital stock refers to the total maximum amount stated in the
Articles of Incorporation that can be subscribed to or paid by investors of a corporation if
the shares have a par value. Par value is the nominal value of the share that is indicated
in the face of the stock certificate. A company cannot issue additional shares in excess of
its authorized capital stock. Companies may increase its authorized capital stock by
amending its Articles of Incorporation and seeking approval from regulatory agencies.
If the shares do not have a par value, the corporation does not have an authorized
capital stock, but it has an authorized number of shares it may issue.
Outstanding shares refer to the total shares of stock issued under binding
subscription agreements to subscribers or stockholders, whether partially or fully paid.
Outstanding shares do not include treasury shares. Treasury shares are shares that are
repurchased or bought back by the company from its stockholders. Issued shares refer to
all shares that were issued by the company, whether outstanding or treasury shares.
In the Philippines, there are three major forms of business organizations:
• Sole proprietorship
Type of business organization which an individual personally owns a business.

The sole proprietorship has no distinct personality from the owner, thus, the owner
is responsible for all debts and obligations (unlimited liability). The owner has full
control regarding decision making of the business.
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• Partnership
Formed when two or more persons bind themselves to contribute money, property
or industry to a com mon fund with the intention of dividing the profits and ownership
among themselves. Though the partnership is a separate legal entity from the
partners, the partners are still personally obliged to pay for the debts of the
partnership. In case of bankruptcy, creditors can compel the partners to pay up to
the extent of their personal assets.
• Corporation
Legal entity has a personality separate and distinct from the owners/shareholders.
Limited liability, i.e. legal provision that protects shareholders from losing more
than they invested in the company, exists. Responsibility of shareholders to
creditors is only up to the extent of their capital contribution. This means that even
if the corporation goes bankrupt, shareholders will only lose up to the extent of the
amount they spent in buying shares. Ownership in corporations is evidenced
through shares.
Among the three, only corporations can issue shares. Investors prefer to put their money
on shares because of the concept of limited liability.
Why Invest in Equity Instruments?
Investors may earn from equity instruments through two methods: capital appreciation and
dividends.
Capital Appreciation
Capital appreciation refers to the rise in the value of an asset in relation to the
increase in its market price. Since shares can be traded in the secondary market, investors
may sell shares they originally bought to other investors who are interested to buy. As long
as the buyer and seller agree on the price, the trade can occur. The price at which they
can trade is based on the interaction of different market factors. As a result, market prices
of shares can be very volatile and may change from time to time. It is not 100% certain all
the time that market price of shares will go up. This uncertainty increases the risk
associated with shares.
For example, Investor A bought 1,000 shares from Company X at Php 10 per
share. After six months, share price increased to Php 12 per share. In this case, capital
appreciation occurred since share price increase by Php 2 per share; the total value of the
investment in equity securities increased by Php 2,000. If Investor A sells the shares at
Php 12, he will realize the Php 2,000 gain and receive the money. Otherwise, the Php
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atx* gain. Gain or loss will only be realized orfinalized when shares
thrs . '* '** . 9ains or losses are temporary and may still go up or down based on
"* market price of the shares at a given point in time.
d" ssumo that Investor A held on to the shares for another six months and the share
ri \C ? hTT tO H' As a result, total unrealized gain decreased from Php 2,000 to
h is still capital appreciation as the prevailing market price of Php 11 per
s mi v is ughoi than the original investment cost of Php 10 per share.
It Investor A still did not sell shares for another six months, and the share price
dipped to I 8 share, then Investor A now has an unrealized loss of P2 share or P2,000. In
this case, capital depreciation occurred, or the investment lost value because of lower
maiket puce of the share. The risk of capital depreciation also exists when it comes to
investment in equity securities. As long as Investor A does not sell these shares, the
uniealized loss is still temporary and can be recovered if the market price of the share
increases in the future.
Dividends
Dividends are payments made by corporations to shareholders representing

excess earnings of the company. Dividends are usually paid out quarterly, but some
companies pay it semi-annually or annually. Dividends are distributed to shareholders
based on discretion and approval of the board of directors. In some cases, management
can recommend amount to be declared as dividend still subject to final approval of board
of directors. Dividends can be in the form of cash, property (usually share investment in
another company) and own shares of the company. Cash is the most common type of
dividend. Dividends are only paid out once all claims from debt such as maturing interest
and principal repayments are settled.
Dividends are not dependent on capital appreciation of the share; instead, it is
based on the cunent performance of the business. Dividends may be declared even if
share price is going down as long as the company is allowed to declare dividends. The
ability to declare dividends may be restricted by covenants in loan agreements entered by
the corporation. The restrictive rule in dividend declaration is designed to make sure that
the company will have the money to pay the creditors first before distributing cash to
shareholders. In instances wherein, the company report successive losses, they may
temporarily suspend declaring dividends.
In the Philippines, corporations are encouraged to declare dividends when needed
through the imposition of improperly accumulated earnings tax (IAET). The IAET is a
penalty tax imposed on corporations who intend to accumulate excess earnings to enable
its shareholders to avoid paying the 10% final tax on dividends that they might have
received if these were declared.
Since declaration of dividends is based on the discretion of the board of directors,
companies may opt to delay declaring dividends. As a result, the government loses cash
that it should have earned from the tax on dividend. To prevent this, an IAET of 10% is
imposed on the improperly accumulated earnings if corporations are found to be guilty of
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improperly accumulating earnings. Improper accumulation means the unjustifiable

accumulation beyond the reasonable needs of the business.
According to Section 43 of the Corporation Code, stock corporations are not
allowed to maintain retained earnings more than 100% of its paid-up capitalization at par
(any additional paid-up capital or excess over par is excluded). Corporate taxpayers have
one year from the end of the taxable year to dispose excess retained earnings: whether
through appropriation of retained earnings for business expansion or redemption of long
term debt via board resolutions or dividend declaration. The 10% IAET is patterned to the
10% final tax on dividends which the government should have received if the dividends
were declared properly.
Comparison between Debt vs. Equity

In debt, creditors or lenders possess the legal right to receive payment on the
amount that they invested or lent out. This means that the payment is required, and the
issuing business is compelled to repay once the debt becomes due. For equity,
shareholders only have an expectation of being repaid in the future. There is no clear
certainty that the money they used to pay for the shares can be recovered in the future.
The value that shareholders may enjoy depends on the future performance of the
company. This distinction makes equity instruments riskier compared with debt
instruments.
Other distinctions between debt and equity is summarized below:
Debt Equity
Voice in management No Yes
Creditors do not have voting Since shareholders are

privileges on company owners of the company, they
matters. They only rely on the possess voting rights on
contractual obligation certain decisions that affect
inherent to the debt. the company such as election
of company directors and
other special issues.
Claim on Assets and Prioritized over Equity Subordinate to Debt
Income
Claims of the creditors, i.e. Claims of the creditors should
interest on debt and principal be satisfied first before board
repayment, shall be paid first of directors can distribute
before claims on income of dividends to shareholders.
shareholders are satisfied.
Upon liquidation,
If a company fails then shareholders only receive
liquidates, creditors also any remaining proceeds after
have a prioritized claim on satisfying principal ar»d
assets over equity holders. interest claims of creditors.
This means that once assets
are sold, proceeds will be
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used to settle the following in
order: secured creditors,
unsecured creditors and
shareholders.
Type of Financinq Temporary Permanent
Maturity Has a maturity date when the Has no maturity date.
issuing company needs to
repay the debt Although shares have a
ready secondary market,
prices at which the shares
can be sold at may fluctuate.
Risk Profile Lower risk relative to equity Higher risk relative to debt
Return of invested money High uncertainty of returns

(and interest) of creditors is associated with shares
more certain because of the (yearly earnings and
contractual obligation proceeds from asset
inherent to debt. liquidation).
Fluctuating price of shares in

secondary market
As a result, shareholders
expect higher return (i.e. high
interest rate) from shares vs.
debt.
Return Expectations Lower compared to equity Higher compared to debt
Return is only up to Return (dividends and capital

contracted interest. appreciation) may increase
infinitely as long as the
business keep on growing.
Tax Implication Can be used as tax Dividend payments to
deductible expense by the shareholders cannot be used
issuing company, thus, as tax deductible expense by
reduces their income tax the issuing company.
payable to the government.
Types of Shares
Investors should have an idea what type of shares they want to put their money on
based on their investment objectives. There are two types of shares that corporations can
issue: preference (or preferred) shares and ordinary (or common) shares. Both shares
represent ownership of the corporation but differ in several aspects.
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Preference shares
Preference shares give its holders distinct rights that enable them to be prioritized
over ordinary shares. A fixed periodic dividend, whether percentage or peso amount, is
promised to holders of preference shares. Par-value preference shares have stated face
values and the annual dividend is expressed as a percentage of the face value. On the
other hand, no-par preference shares do not have stated face value; its annual dividend
is usually stated in peso amount per share. Since dividends on preference shares are
fixed, its share price is usually stable.
Normally, preference shareholders do not have voting rights, but corporations can
opt to give them voting rights explicitly in the Articles of Incorporation. Companies often
choose to issue preference shares if they need additional financing, but they do not want
to dilute ownership of the corporation.
As mentioned, preference shares have senior rights over ordinary shares.
Preference shares are treated as quasi-debt, the required dividend associated with
preference shares is like the interest on debt. This should be settled first prior to settling
any claims by ordinary shareholders. However, unlike debt, preference shares do not have
a maturity date. Issuing preference shares commonly costs the firm more than if they issue
debt.
In instances of liquidation of the assets of the corporation, the claim of preference
shareholders is only up to the par value of the preference shares. Preference shareholders
will be paid before ordinary shareholders but only once liabilities to creditors and lenders
are fully settled.
When preference shares are issued, an agreement like a bond indenture is made
which contains relevant information such as par value of the share, amount of dividend,
date of payments and other restrictive covenants to ensure continued existence of the
business and consistent dividend payments. The restrictive provisions include omitting
payment of dividends, minimum liquidity requirements, mergers and acquisitions, sale of
assets and repurchases of ordinary shares. Violation of any of these provisions usually
allow preference shareholders to have representation in the board of directors or force the
corporation to redeem the preference shares held by the shareholders at an amount
higher than its par or stated value.
Other features that may be included with preference shares are the following:
• Cumulative. All dividends in arrears (i.e. dividends not paid in previous periods),
together with the current dividend, should be paid prior to paying dividends to
ordinary shareholders. If preference shares are non-cumulative, this means that
the corporation can pass on paying dividends on preference shares and will only
be required to pay the current dividend, not the dividend in arrears.
• Callable. Allows the issuing corporation to retire or repurchase outstanding
shares within a predetermined period of a time at a specified price. Usually, the
call price is established higher than the issuance price but may gradually decrease
over time. Callable preference shares permit the issuing corporation to end the
fixed-payment commitment associated with preference shares if market
conditions make it favorable to do so.
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numbar or ■ Allawi* »hwr«holdar» to convert the preference shares to a stated

that th ort’,nnry eheree after m certain date, The number of ordinary shares
Ik.m i or*nct* •hares earn be exchanged Into may also change over time
bated on a predetermine formula
Ordinary Shares
°'(lii»aiy shares represent the true owners of a corporation. They are called as
5 UU fownors “ince they will only receive what will remain after all claims of creditors
pro tirerrcij shareholders on the Income and assets are satisfied. It is possible that
AH|ir° K|1 °rS wou^ he multiples times richer If ttio business goes well in the future,
lough, if upon liquidation, the corporation has no leftover assets, ordinary shareholders
a so got nothing. Dividends ate also not guaranteed for ordinary shareholders unlike
preference shareholders. The only assurance that ordinary shareholders have relies on
the concept of limited liability - they can only lose up to the extent that they have invested
in the company. Because of the level of uncertainty associated with returns related with
ordinary shares, shareholders usually expect to have higher returns in the form of
dividends and capital gains
Ordinary shares can be
• Privately owned. Owned by private investors and shares are generally,

not publicly traded (if to bo traded, transactions are usually between private
investors only and consent of the organization is needed)
• Closely owned. Owned by an individual investor or a small group of private
investors like a family
• Publicly owned or publicly traded. Owned by mix of public and private investors
and shares are actively traded in stock market
• Widely owned. Owned by many unrelated individual or institutional parties
Ordinary shareholders generally possess the voting rights to decide on certain

corporate decisions like electing the board of directors, issuance of new shares or
change in fundamental corporate direction. As a result, ordinary shareholders are
granted preemptive rights. Preemptive right permits ordinary shareholders to retain
their proportionate ownership in the firm in case of new share issuances, hereby
protecting them against dilution of ownership. Dilution of ownership occurs when
fractional ownership of an existing shareholder is reduced as a result of the company
issuing additional shares. Preemptive rights allow existing shareholders to maintain their
current voting influence and protect them from dilution of earnings i.e. reduction of claim
on earnings as a result of lowering of its fractional ownership.
To exercise the preemptive right, companies give stock rights to the shareholders.
A stock right is a financial instrument which permits shareholders to buy additional shares
from the company at a price cheaper than the market price, in direct proportion of the
number of shares they own. Rights is very important for companies who need financing
but intend to protect the ownership percentage or proportionate control of the
shareholders in the company. Companies use rights as a better financing option as this
is cheaper compared with public offering of shares.
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Basically, each ordinary share grants one vote to the shareholder. Votes can be assigned
and cast during shareholders’ meeting. Since small shareholders often do not attend the
shareholder meeting to vote, they can opt to sign a proxy statement to transfer their votes
to another shareholder. Solicitation of proxies is controlled by the Securities and
Exchange Commission to make sure that the solicitation is not based on misleading
information.
In recent years, other types of ordinary shares were offered to shareholders to suit
different objectives.
• Supervoting shares. Shares that have multiple votes associated with one share.
This allows controlling shareholders to maintain control against any outside group
who may plan for a hostile takeover. Hostile takeover occurs when an outside
group tries to gain controlling ownership of a company without the support of the
management by buying more shares from existing shareholders.
• Nonvoting ordinary shares. Shares that have no voting rights. Offered by
companies that want to raise capital but does not want to give up any voting
control.
Stock Market
The stock market is composed of exchanges and over the counters where shares
are issued and traded publicly. The actual stock market is both physical and virtual as
electronic trading of stocks has been increasingly relevant due to the easy access to
technology. The stock market can be considered both a primary and secondary market.
However, since most of the transactions are buying and selling existing stocks of investors
(compared with new share issuances), the secondary market is considerably bigger than
the primary market.
The physical site where shares are purchased and sold face-to-face on a trading
floor is called a stock exchange. The most well-known organized exchange is the New
York Stock Exchange. Before, buyers and sellers who participate in organized exchanges
meet in a specified location and uses an open out-cry auction model to trade securities.
Since exchange is already transitioned to a more virtual mode of trading, this method is
less frequently used.
Organized exchanges, being auction markets, employ floor traders that oversee
and facilitate the trading of specific shares. The floor traders, who are representatives of
different brokerage firms, meet at the trading post on the exchange and gather the current
bid and ask prices. The quoted prices are called out loud. In around 90% of trades, the
floor traders match buy and sell orders from their clients. In the remaining 10%, the floor
traders buy the shares themselves or sell shares from their inventory. Floor traders are
responsible to maintain an orderly market for the share even if it requires buying shares
in a declining market.
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dealers^th;*f7er the COUnter marke^ refers to the market wherein shares can be traded by
makprcin arS connected electronically by computers. Dealers (also called as market
, perating in an OTC market try to “make a market* by matching the buy and sell
rece’ve from investors. Dealers keep an inventory of shares that they trade in
the OTC market to balance buy and sell orders
Dealers are usually responsible to set bid and ask prices. There can be multiple
market makers for a given stock and each shall provide their bid and ask quote in the
system. Once this is done, they are required to buy or sell a minimum of 1,000 securities
at the given price. Once trade is executed, they can enter a new bid or ask quote in the
system. Dealers earn through two means: through the spread between the bid price (price
to pay for shares) and ask price (price at which shares are sold at) and through
commissions on trades.
Dealers are very important in the

success of the OTC market. Dealers ensure that
there is continuous liquidity for each available The most popular OTC market in
stock in the market. Dealers allow small shares the world is the National
with liquidity that can help them get accepted in Association of Securities Dealers
the market. Without dealers who is always ready Automated Quotation System or
to buy/sell shares, investors would be reluctant NASDAQ. NASDAQ provides the
to purchase shares from unknown firms. This current bid and ask prices for
makes it difficult for start-up firms to gather about 3,000 actively traded
necessary funding. securities.
Aside from organized exchanges and
OTC markets, new modes to trade stocks have surfaced due to the advancement of
technology and changing appetites of investors. These are electronic communications
networks and exchange traded funds.
Electronic communications network (ECN) is a network which directly links
major brokerage firmsand traders and removes the need fora middleman. ECN has been
gaining ground lately because of the following reasons:
• Transparency. Traders in the ECN can easily view if there are unfilled orders
timely. This input allows them to understand supply and demand for the shares
and modify their strategy accordingly. Some exchanges also provide this
information but not as timely and complete as ECN can provide.
• Cost reduction. The removal of middleman and commission reduces the

transaction costs associated with the trade. Spread is also reduced and sometimes
removed.
• Faster execution. Trades are matched faster and confirmed quicker since the
ECN is fully automated. Individual trades are done with minimal human
intervention. This is very critical for investors who trade on small price fluctuations.
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• After-hours trading. Trading can continue at any time of the day because of the
availability of ECN. Traders can react accordingly based on news reports and
information that come out after trading hours of exchanges.
However, ECNs can only work well with shares that has a substantial amount of
trading volume. Since ECN also requires matching between seller and buyer, thinly traded
stocks may go for long periods without trading.
Exchange-traded funds (ETF) happens when a portfolio containing various
securities is purchased and a share is created based on this specific portfolio which can
be traded in the exchange. ETFs are listed and can be traded as individual shares in the
exchange. ETFs are often indexed instead of being actively managed. ETFs are valued
based on the underlying net asset value of the shares inside the index portfolio.
Information about the shares inside the ETF is publicly available so that intraday arbitrage
can help keep ETF price close to the implied value.
ETFs do not have minimum investment amount unlike mutual funds. Although they
are somewhat like stock index mutual funds, ETFs can be preferable since they can be
traded like a normal share — limit orders, short sales, stop-loss orders and ability to
purchase on margin. ETFs also have lower management fees than comparable index
mutual funds. However, since ETFs trade like stocks, they are subject to commission to
brokers when they are being traded.
In terms of value, the top 10 largest stock markets in the world are the following:
1. New York Stock Exchange
2. Tokyo SE Group
3. NASDAQ OMX
4. NYSE Euronext (Europe)
5. London Stock Exchange
6. Shanghai Stock Exchange
7. Hong Kong Exchanges
8. TSX Group (Canada)
9. BME Sapnish Exchanges
10. BM & FBOVESPA
The overall performance of a stock market is measured through stock market
indexes, which represents the average of stock prices currently being traded. The value
of a stock market index is usually set at 100 in a base year. Stock market indexes intend
to show movementsof price overtime instead of the actual stock value. It is for this reason
why the year selected as base year is not as relevant. If stock prices increase by more
than 20%, it is usually called bull market or bullish. On the other hand, the decline of more
than 20% of stock prices means it is a bear market or bearish.
Investors use stock market indexes to gain some insight on how a group of stocks
could have performed in the market. Different stock market indexes may contain different
mix of companies or group of stocks.
Understanding the performance of the stock market is important as it can have
further implications in other segments of the economy. Economists believe that changes
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in soc prices may affect the economy since it affects spending households and
usinesses. ncreasing share prices may influence higher spending while declining share
prices may lead to lower spending. Increased spending means higher production level
an employment and vice versa. Impact of changes in stock prices can be felt at the
following levels:
a. Large corporations treat the stock market as an essential fund source for
expansion projects. High share prices allow them to receive higher funds they can
use for capital investments such as machineries and plants and research &
developments when they issue new shares.
b. At a macro level, shares account for significant portion of household wealth. Share
prices and household wealth has a positive correlation. If share prices increase,
household wealth also increases and vice versa. Household tends to spend more
if they have higher wealth than spend less if their wealth declines. Consequently,
movements in share prices affect household spending.
c. Fluctuations in share prices affect expectations of consumers and business. This

is perhaps the most important consequence of movements in share prices.
Historically, significant declines in share prices are usually followed by economic
recessions. Asa result, consumers who observe significant decline in share prices
tend to have more uncertainty regarding the future of their jobs and income. This
uncertain outlook makes consumer more conscious on their spending. They spend
less on consumer durables like vehicles, appliances and furniture. The reduced
spending consequently leads to decline in production and employment. Lower
share prices also deter firms in spending on capital investments as the funds they
will receive if they issue new shares are lower.
Philippine Stock Exchange
The Philippine Stock Exchange or PSE is the national and sole stock exchange
of the Philippines. PSE is considered as one of the oldest stock exchanges in Asia starting
in 1927 when it was still Manila Stock Exchange. The trading floor of PSE is currently
situated in the PSE Tower in Bonifacio Global City, Taguig. The PSE is composed of a
15-man Board of Directors with Jose T. Pardo as Chairman.
The Philippine Stock Exchange was created in 1992 due to the merger of the
country’s two former stock exchanges: The Manila Stock Exchange (MSE), established
on August 8, 1927, and the Makati Stock Exchange (MkSE), which was established on
May 27, 1963.
PSE has been granted a “Self-Regulatory Organization” or SRO status by the SEC
' June 1998 This means the PSE can implement its own rules and set penalties on erring
trade^participants and listed companies.
p merlv PSE used to be an on-profit, non-stock, member-governed organization.

In 2001 °PSE was transformed to its current structure which is a shareholder-based,
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revenue-earning corporation headed by a president and a board of directors. PSE

eventually listed its own shares in the exchange under the ticker PSE.
The PSE through the Philippine Central Depository (PCD) uses the computerized
book-entry system to transfer ownership of securities from one investor to another, thus,
eliminating the need for physical exchange of scrip between the seller and buyer. Scripless
trading describes the system where settlement is carried out via book-entries, rather than
by the movement of physical certificates. However, investors may still request for an
upliftment of their shareholdings to get a physical certificate.
The PSE regulates trading activities through the Capital Markets Integrity
Corporation (CMIC),a spinoff of the Market Regulation Division of PSE, to monitor and
penalize trading participants that violate the Securities Regulation Code and its
implementing rules and regulations; the Anti-Money Laundering Law and its implementing
rules and regulations; the Code of Conduct and Professional Ethics for Traders and
Salesmen; CMIC Rules; and other relevant laws and regulations. The CMIC shall also
have the authority to investigate and resolve trading-related irregularities and unusual
trading activities involving issuers based on complaints received, findings and reports.
The CMIC oversees the market through a world-class and sophisticated
surveillance system called Total Market Surveillance (TMS), which was developed by the
Korea Exchange. TMS is equipped with the critical elements of the surveillance process
and provides a robust monitoring and warning mechanism. It is designed to safeguard the
integrity of the stock market from fraud, manipulation, and breaches of marketplace rules
of erring market players. The CMIC conducts investigation of unusual price and volume
movements to identify and sanction trading participants, issuers or investors who might
have committed unfair market practices.
CMIC, with the approval of the PSE President, shall have the power to restrict, halt
or suspend the trading of a listed security of an issuer or the trading by a trading participant
of a particular listed security in cases of unusual trading activities or possible trading-
related irregularities.
Other initiatives to safeguard interests of the investors include:
• Enforcement of static and dynamic thresholds to protect against unusual

share price fluctuations. The Static Threshold enforces a 50% trading band
within which the price of a stock is allowed to move. When the stock price increases
by 50% (price ceiling) or decreases by 50% (floor price) on a particular day, to be
determined from the last closing price or the last adjusted closing price, the trading
of the stock shall be automatically frozen by the PSE upon reaching said limit,
unless there is an official announcement from the listed company or the proper
government agency which would justify such price fluctuations. The Dynamic
Threshold is the maximum allowable price difference between an update in the
Last Traded Price (LTP) of a given stock or group of stocks and its preceding LTP
that is equal to a percentage set by the PSE, subject to the classification of a stock
or a group of stocks based on its trade frequency. The Dynamic Threshold of a
listed stock may vary from 10% , 15% and 20% depending on its trade frequency.
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' Disclosure requirement for publicly listed companies. The PSE requires that
material information, which may affect a listed company's stock price positively or
negatively, are disclosed within 10 minutes after its occurrence. Disclosures must
also be done first to the PSE so that it will cascade information to every investor
and general public through its communication channels and not to a selected group
of individuals only. This is very important to ensure the fairness and efficiency of
the trading happening in the market. The PSE ensures that listed companies
promptly disclose only factual and truthful information. Non-compliance with or
violations of the disclosure rules are heavily penalized with fines, trading
suspension, or even delisting from the PSE.
• Securities Investors Protection Fund, Inc. or SIPF. The SIPF, which is

comparable to the Philippine Deposit Insurance Corporation providing insurance
for bank deposits, seeks to build and enhance investors' confidence in the market
and is envisioned to protect the investing public from extraordinary losses, other
than the ordinary market fluctuations, arising as a result of fraud, failure of
business, or judicial insolvency of PSE-accredited stockbrokers. Protection to
investor's is automatic upon the opening of an account with a PSE-accredited
stockbroker and given by way of compensation for trade-related obligations of
stockbrokers to its customers.
Corporate Compliance
Companies who plant to list publicly in the Philippine Stock Exchange should:
a. Comply with the laws, regulations and full disclosure rules and policies of the
Philippine government
b. Have standards of quality, operations, and size under efficient and effective
management;
c. Conduct issuance, offering and marketing of securities in a fair and orderly
manner and ensure that securities are widely and equitably distributed to the
public
d. Give adequate, fair and accurate information about the company and its
securities to the general public to enable them to make informed investment
decisions
e. Ensure that directors and officers act in the interest of all security holders as a
whole, particularly where the public represents only a minority of the security
holders or where a director or security holder owning a substantial amount of
shares has a material interest in a transaction entered into by the company.
General Criteria for Admission to Listing in the PSE

a Track Record of Profitable Operations - The company must have cumulative
consolidated earnings before interest, taxes, depreciation, and amortization
(EBITDA), excluding nonrecurring items, of at least P50 Million for three (3) full fiscal
years immediately preceding the application for listing and a minimum EBITDA of
P10 Million for each of the three fiscal years. The applicant must further be engaged
in materially the same businesses and must have a proven track record of
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management throughout the last three (3) years prior to the filing of the application.
To show this, the company submits audited consolidated Financial Statements for
the last three (3) full fiscal years preceding the filing of the application to the PSE.
The Financial Statements must be accompanied by an unqualified external auditor’s
opinion
b. Exception to the 3-year Track Record Requirement — The following are the
exceptions to the three (3) year track record rule:
• The company has been operating for at least ten (10) years prior to the filing of
the application and has a cumulative EBITDA of at least P50 Million for at least
two (2) of the three (3) fiscal years immediately preceding the filing of the listing
application.
• The company is a newly formed holding company which uses the operational
track record of its subsidiary.
c. Positive Stockholders’ Equity — The company must have a positive stockholders’

equity in the fiscal year immediately preceding the filing of the listing application.
d. Market Capitalization — At listing, the market capitalization of the company must

be at least P500 Million.
e. Operating History — The company must have an operating history of at least three
(3) years prior to its application for listing.
f. Minimum Capital Requirement — The company must have a minimum authorized

capital stock of P500 Million, of which a minimum of twenty-five percent (25%)
must be subscribed and fully paid.
g. Minimum Offering to the Public — The minimum offering to the public for initial listing
shall be based on the following schedule:
1 Market Capitalization Public Offer
Not exceeding P500 M 33% or P50M whichever is higher
OverF500M to P1B 25% or P100M whichever is higher
Over P1B to P5B 20% or F250M whichever is higher
OverF5B to F10B 15% or P750M whichever is higher
Over P10B 10% or F1B whichever is higher
h. Minimum Number of Stockholders — Upon listing, the company shall have at least
one thousand (1,000) stockholders, each owning stocks equivalent to at least one
(1) board lot. The requirement to have at least one thousand (1,000) security
holders each owning securities equivalent to at least one (1) board lot is only
required upon listing. Once listed, companies shall, at all times, maintain a
minimum percentage of listed securities held by the public of ten percent (10°/o^
the listed companies issued and outstanding shares, exclusive of any treasury
shares, or as such percentage that may be prescribed by the Exchange.
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aluation of Assets — When required by the PSE, the company shall engage the
services of an independent appraiser duly accredited by PSE and SEC
determining the value of its assets.
j. Full Payment of Issued and Outstanding Shares — The company shall cause all its
subscribed shares of the same type and class applied for listing to be paid in full.
k. Investor Relation Program — The company shall have an investor relation program
to ensure that information affecting the company is communicated effectively to
investors. Such program shall include, at the minimum, a corporate website that
contains, at the minimum, the following information:
• Company information — organizational structure, board of directors,

and management team;
• Company news — analyst briefing report, latest news, press releases,
newsletter (if any);
• Financial report — annual and quarterly reports, at least for the past 2
years;
• Disclosures — recent disclosures to the Exchange and the
Commission for the past 2 years;
• Investor FAQs — commonly asked questions of stockholders;
• Investor Contact — email address forfeedback/comments,
shareholder assistance and service; and
• Stock Information — key figures, dividends, and stock information.
A company that incurs negative stockholders’ equity forthree (3) consecutive years shall
be subject to delisting, in accordance with the rules of the Exchange. The delisting of the
company’s securities shall take effect thirty (30) days from approval by the PSE Board of
Directors of the said delisting. The Exchange shall send notice of such delisting
immediately to the listed company and the Securities and Exchange Commission. The
Exchange shall likewise publish an announcement relative thereto on the Exchange
website.
Disclosure Rules
All companies listed in the PSE is required to comply with its disclosure rules. The basic
principle of the Exchange is to ensure full, fair, timely and accurate disclosure of material
information from all listed companies. This principle shall apply to all the required
disclosure requirements of listed companies.
Corporate disclosures are classified into two: the structured and the unstructured
corporate disclosures. Structured continuing disclosures are reportorial requirements
submitted within specific time frames such as annual, quarterly and monthly reports.
Unstructured continuing disclosures are communications of corporate developments as
they happen and are intended to update the investing public on the activities, operations
and business of the company.
Structured continuing disclosures include the following:
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• Annual report (SEC Form 17-A) - To be submitted within 105 days after end of
fiscal year
• Three Quarterly Reports (SEC Form 17-Q) - To be submitted within forty-five (45)
days from end of the first three (3) quarters of the fiscal year
• Reports on Beneficial Ownership
• Other periodical reports to update and keep current information on the operation
of the business and financial condition of the company.
On the other hand, the objective of requiring unstructured disclosures is for the company
to update the investing public with any material fact or event that occurs which would
reasonably be expected to affect investors’ decision in relation to the trading of its
securities. A material factor event is one which would reasonably be expected to affect
investors’ decisions in relation to those securities. This includes, but is not limited to, any
significant and relevant information relating to the business and operations of the Issuer
that, if and when disclosed, would result in or would reasonably be expected to cause a
significant change in the trading and/or market value of the company’s securities.
Disclosures must be made promptly by the issuing company if it meets any of the following
standards:
a. Where the information is necessary to enable the company and the public to appraise
their position or standing, such as, but not limited to, those relating to the company’s
financial condition, prospects, development projects, contracts entered into in the ordinary
course of business or otherwise, mergers and acquisitions, dealings with employees,
suppliers, customers and others, as well as information concerning a significant change
in ownership of the Issuer’s securities owned by insiders or those representing control of
the Issuer; or
b. Where such information is necessary to avoid the creation of a false market for its
securities; or
c. Where such information may reasonably be expected to materially affect market activity
and the price of its securities.
Events that prompt disclosure if required from listed companies include:

• Change in the control of the company
• Filing of legal proceeding against the company involving a claim amounting to
10% company’s assets
• Change in corporate purpose and material alterations in company’s activities or
operations
• Resignation or removal r/1 directors, officers or senior management and their
replacements and the reasons for such
• Any decision taken to carry out extraordinary investments or the entering into
financial or commercial transactions that might have a material impact on the
company's srfuatron
• Lome* oi potential Iomm, the nyqreyato of which amounts to at least ten percent
IW-/;) rj the IrM of lh„ company
• Dissolution
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Acts and facts of any nature that might seriously obstruct the development of
corporate activities and its implications
Any licensing or franchising agreement or its cancellation which may materially
affect the company’s operations
Any delay in the payment of debentures, negotiable obligations, bonds or any
other publicly traded security
Creation of mortgages or pledges on assets exceeding ten percent (10%) or more
of the company’s total assets
Any purchase or sale of stock or convertible debt securities of other companies
when the amount is ten percent (10%) or more of the company’s total assets;
Contracts of any nature that might limit the distribution of profits,
Facts of any nature that materially affect or might materially affect the economic,
financial or equity situation of those companies controlling, or controlled by the
Issuer including the sale of or the constitution of sureties/pledges on a substantial
part of its assets
Authorization, suspension, retirement or cancellation of the listing of the Issuer’s
securities on an exchange or electronic marketplace domestically or abroad
Fines of more than P5CLOOO.OO and/or other penalties on the company or on its
subsidiaries by regulatory authorities and the reasons
Merger, consolidation or spin-off of the company
Modification in the rights of the holders of any class of securities issued by the
company and the corresponding effect of such modification upon the rights of the
holders
Declaration of cash dividend, stock dividend and pre-emptive rights by the Board
of Directors
Any change in the company’s fiscal year and the reason(s) behind
All resolutions, approving material acts or transactions, taken up in meetings of
the Board of Directors and stockholders of the company
A joint venture, consolidation, acquisition, tender offer, take-over or reverse take
over and a merger;
Capitalization issues, options, directors/officers/employee stock, option plans,
warrants, stock splits and reverse splits;
All calls to be made on unpaid subscriptions to the capital stock of the company;
Any change of address and contact numbers of the registered office of the
company;
Any change in the auditors of the company and the corresponding reason for such
change;
Any proposed amendment to the Articles of Incorporation and By- Laws and its
subsequent approval by the Commission;
Any action filed in court, or any application filed with the Commission, to dissolve
or wind-up the company or any of its subsidiaries, or any amendment to the
Articles of Incorporation shortening its corporate term;
The appointment of a receiver or liquidator for the company or any of its
subsidiaries;
Any acquisition of shares of another corporation or any transaction resulting in
such corporation becoming a subsidiary of the Company;
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• Any acquisition by the company of shares resulting in its holding ten percent (10%)
or more of the issued and outstanding shares of another company or where the
total value of its holdings exceeds five percent (5%) of the net assets of an unlisted
corporation;
• Any sale made by the company of its shareholdings in another listed or unlisted
corporation: (1) resulting in such corporation ceasing to be its subsidiary; (2)
resulting in its shareholding falling below ten percent (10%) of the issued capital
stock;
• Firm evidence of significant improvement or deterioration in near-term earnings
prospects;
• The purchase or sale of significant assets amounting to ten percent (10%) or more
of the company’s total assets otherwise than in the ordinary course of business;
• A new product or discovery;
• The public or private sale of additional securities;
• A call for redemption of securities;
• The borrowing of a significant amount of funds not in the ordinary course of
business;
• Default of financing or sale agreements;
• Deviation from capital investment funds equivalent to twenty percent (20%) of the
original amount appropriated;
• Disputes with subcontractors, customers or suppliers or with any other parties;
• An increase or decrease by ten percent (10%) in the monthly, quarterly and annual
revenues on a year-on-year basis
Corresponding penalties are meted to listed companies that fail to comply with the
disclosure requirements of PSE.
Platforms for Capital Market
In trading or doing business in Capital Market, there are different ways on howto
conveniently facilitate the trading in the Capital Market.
Conventional Brokerage
In conventional brokerage, investors buy or sell shares by opening an account with
a stockbroker. The broker will buy and sell shares in behalf of the investor in exchange for
payment called commission. Commissions are normally percentage of the amount being
traded. Since brokers are exposed to the workings of the stock market, they can provide
sound investment advice to their client-investors on what stock trading decision to take.
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Online Trading
Due to the advent of technology, many investors are shifting towards digital
platforms to trade shares. Online brokers typically charge lower commission compared to
conventional brokers. However, they do not offer any investment advice and other
services that a traditional broker can give.
Mutual Funds
Instead of buying or selling individual stocks, investors can also opt to buy shares
in mutual funds. Mutual funds are an investment company that pools money from various
investors and invests them to different securities based on the investment objective of the
fund. Mutual funds allow investors to diversify their portfolio since mutual funds hold
shares in different companies.
Market Capitalization
Market capitalization refers to the total market value of all outstanding shares of
a company. This is calculated by multiplying the total outstanding shares by the prevailing
market price per share. Market capitalization is an important indicator used by investors
to determine the size of a company. For example, if a company has 25 million shares
outstanding and each is worth P100, then the company's market capitalization amounts
to P2.50 billion.
Market capitalization allows investors to benchmark the relative size of a company against
another. This measures the worth of the company in the open market and the perception
of the market regarding its future prospects. Market capitalization reflects how much
investors are willing to pay for the shares.
Several factor may impact the market capitalization of a company. Significant changes in
the share value — whether higher or lower —could impact market capitalization, same
with changes in the number of shares issued. Any exercise of warrants will increase the
number of outstanding shares, thereby diluting its existing value.
Share Valuation
It is important for investors to understand how to value shares to be able to assess
reasonableness of the price being offered to them. Knowing different share valuation
techniques equip investors with the right knowledge that will help them choose the best
stocks that fit their investment appetite. Share valuation techniques are commonly
grounded in identifying how much cash flow can be received in the future if the investor
purchases the share now. Even though investors can earn through capital appreciation,
they ultimately pay to earn the right to receive dividends.
The value of a share is equivalent to the present value of the future cash flows that can
be received from an investment. This approach is most commonly called as the discounted
h flow approach. To identify future cash flows, investors should be able to project items
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that they can receive from an investment. All discussion assumes that cash will be
received at the end of the year.
One-Period or Multiple Period Valuation Model
Most investors tend to hold shares only as investment for a couple of years.
Individual investors do not plan to buy shares to take over control in firm; they leave the
management and board of directors to do their work. Instead, investors look at share
purchases to receive a greater return. If the investor intends to sell the share after a fixed
number of years, he/she only needs to consider the dividend he/she expects to receive
during the time he/she holds the shares. For this type of investment wherein there is an
expected fixed holding time, it is helpful to use the below formula.
= CFr CF2 CFm
0 (1+r,)1 (l + rs)2T (l + roor
Where Po = value of stock today
CFt = expected cash flow (dividend or proceeds from sale) per

share at end of year t
rs = required return on ordinary share

The required return represents the discount rate which investors expect to receive
in exchange for assuming risk in an investment. On the viewpoint of the company, this
represents the rate of return that they need to pay to investors to make their shares an
attractive investment.
Illustration 1. Investor TBA want to buy shares of Flix Company. When he looked it up at
the stock exchange, Flix Company can be bought at P30 per share. Further research
showed that dividends are stable at P5 per year and it is expected to be resold at P40 per
share after a year. Investor TBA expects a 10% return on his investments and only expects
to hold Flix Company shares for a year. What is the value of the shares based on Investor
TBA’s computation?
Investor TBA expects two cash flows from this: first is from the dividend of P5 for the year
and the expected selling price of P40 after a year. The discount rate to be used is 10%.
We will only be using 1 year since both cash flows can be received after a year.
p = CF' ■ CF'
0 (l+rs)' + (l +rs)'
P = 5 . 40
0 (1+10%)'■r(l + 10%)'
p = 5 . 40
0 (1.10)'(1.10)'
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Po = 4.55 + 36.36
Po = 40.91
The value of the share currently is at P40.91. Investor TBA should consider buying this
pad S|thS current sellin9 Price of P30 is lower than the true value of the shares at
...' ’ Pves*or TBA may be able to receive return from the spread between the current
se ing price and the real value based on the share valuation technique.
Dividend-based valuation techniques

The most common share valuation technique is through dividends. Future dividends are
the most relevant input for share valuation. Dividends embody future cash flows which is
the usual return that investors receive in a stock investment. However, timing of dividends
might be a little tricky for investors as there is no assurance when a company will declare
dividends.
The basic dividend-based valuation model uses this basic formula:

P = Dl -+■ D 4- D°°
° (1+tD1 (l + rs)2_h (l + roo)°°
Dt = expected cash flow (dividend or proceeds from sale) per share at end of year
t
The basic dividend- based valuation model can be further interpreted by anticipating how
much dividend will grow in the future. There are three models that can be used: zero
growth model, constant growth and variable growth.
Zero-growth model
The zero-growth model assume that the dividend will be fixed and not change anymore in
the future. This is the simplest approach to share valuation. Zero-growth model is very
useful in valuing preferred shares since the dividend is already fixed upon issuance.
Dividends of preference shares are expected to be received as long as the shareholders
hold the stock. The formula for zero-growth model is:

Dt = expected dividend per share at end of year 1
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The equation above shows that the a zero-growth model assumes that the present value
of the share equates to the present value of perpetuity of the expected dividend discounted
at the required return.
Illustration 2. Investor CDE wants to buy 1,000 preference shares, P200 par value from
Korean Company. According to his sources, the preference shares come with a constant
dividend of P30 per share Investor CDE intends to hold the preference shares long-term
and has no plans on selling this in the near future. Investor CDE requires a 15% return on
all of his investment. What is the value of each preference share?
We can compute for the value of the preference share using the zero-growth model.
P30
15%
Po = P200 per share
The value of each preference share of Korean Company is P200. Assuming that Investor
CDE is also looking at the preference shares of Chinese Company that has par value of
P100 with 20% stated dividend rate. Same expectations on required return apply. What is
the value of each preference share of Chinese Company?
First, compute for the expected dividend of Chinese Company. Investor CDE expects to
receive P20 dividend per share (P100 x 20%). With this expected dividend as input,
calculate for the value of the preference share using the zero-growth model.
/J20
Po = P 133.33 per share

The value of each preference of Chinese Company is P133.33.
Constant Growth Model
The constant growth model or the Gordon growth model (named after Myron Gordon) is
the most widely known model used in share valuation. The constant growth model
operates under the following assumptions:
a. Dividends are assumed to grow at a constant rate forever (or at an extended period
of time). This will yield reasonable results since errors regarding far-off cash flows
are too small to be discounted to the present.
b. Growth rate is always assumed to be lower than the required return. This is a
reasonable assumption since if growth rates were higher than the required return,
the firm may grow impossibly large in the long run.
c. The first dividend is assumed to be received right away and the next dividend will
be received after a year.
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d. Reasonableness of expectations of investors regarding future profitability of the

firm and future dividends is important to determine right share valuation.
The constant growth model formula is shown below:
p°= tQr—
s - g^
Dt = expected dividend per share at end of year 1
g = expected dividend growth rate
Illustration 3. Investor TLC is looking at investing and buying shares from Nutela
Company, a publicly listed company. Based on publicly available information, Investor
TLC was able to compile the following dividend data for the last 6 years.
Year Dividend per
Share
2018 2.80
2017 2.58
2016 2.40
2015 2.24
2014 2.10
2013 2.00
Based on the available historical information, Investor TLC believed that the historical
annual growth rate of dividends is a good indicator of the future constant growth rate of
the dividends. This can be computed through the use of the compounded annual growth
rate (CAGR) formula. CAGR measures the compounded average growth for several
periods covered by the analysis.
Dividend, Current Period r 1
CAGR = (____________ ___________________ } _ 1
^Dividend, First Period AvailableJ
Where n = number of years considered in the analysis.
Using the CAGR formula above, the CAGR computed for the last 6 periods is at 7%.
,2.80 x
CAGR = ~ 1
k 2.00 7
CAGR = (1.40)^ - 1
CAGR = 7%
Assuming that growth rate will continue based on the historical trend, value of the common
stock can be computed as follows:
3
P° ~ (15% - 7%
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3
“ (8%)
Po « 37.50 per share

The dividend of P3 is used as the numerator since this is the expected dividend to be
received in the next period. This is computed by multiplying the previous dividend of P2.80
by the computed historical growth rate of dividends of 7% and addwig the result to the
previous dividend. Simply this is [Latest dividend x(1 * growth rate)].
Variable Growth Model
An inherent limitation associated with the zero-growth and constant growth model
is it does not allow flexibility in terms of growth rate expectations. Since future growth rates
may go up or down as a result of changes in economic conditions, a variable grow th model
was developed to incorporate changes in growth rate in the valuation.
There are four steps involved in the variable growth model:
1. Determine value of expected cash dividends at the end of each year using the
initial growth rate assumption/s. To compute for this, apply the growth rate
assumption on the current dividend and do this year on year.
2. Compute for the present value of the expected dividends during the initial growth
period.
3. At the end of the initial growth period, determine the value of the stock ^from that
point to infinity) using the constant growth model. The assumption ben? is that from
this point onwards, dividend will grow at a constant pace, hence, the use of the
constant growth model.
4. Lastly, add the computed present value of the expected dix dends during the initial
growth period and the computed value of the stock at the end of the initial growth
period.
Illustration 4. Vic Company is contemplating whether to buy shares in Vin Company. Vin
Company recently paid dividends of P3 per share. After carefully study ing the business cf
Vin Company, Vic came up with the estimate that dividends may grow at 5% annual rate
in the next 3 years. At the end of 3 years, Vic expected that the market win mature. and
organic growth will only lead to a constant 3% dividend growth in the foreseeable
future. Vic uses 12% required return in evaluating his investments.
Using the four steps mentioned above, we can compute for the value of the shares in Vin
Company.
1. Dividend from previous year x (1 + growth rate in the initial period) = Expected
Dividend
Year 1 P3 x 1.05 P3.15
Year 2 P3.15 x 1.05 P3.31
Year 3 P3.31 x 1.05 P3.47
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2. Present value of dividends expected to be received for each year using required
return of 12%
Year 1 P3.15 x 0.8928 P2.81
Year 2 P3.31 x 0.7972 P2.64
Year 3 P3.47 x 0.7118 P2.47
3. Value of the stock at the end of Year 3 (last year of initial growth period) using the
constant growth model
Expected Dividend in Year 4 = P3.47 x 1.03 = P3.57
Po = 7------
(rs - g)
P3.57
P°~ 12%-3%
P3.57
P° ~ 9%
Po = 39.67
The value of the stock at the end of the initial growth period is P39.67.
4. Combine the present value of the expected dividends during the initial growth
period and the value of the stock (which considered future expected dividends
growing at a constant rate) at the end of the initial growth period.
p0 = pv of Dividend in Y1 + PV of Dividend in Y2 + PV of Dividend in Y3 + Share

Value at end of Initial Growth Period
Po = 2.81 + 2.64 + 2.47 + 39.67
Po = 47.59
The value of each share of Vin Company is P47.59.
Other Approaches to Share Valuation
Free cash flow

An alternative to using dividend-based share valuation techniques is the use of free cash
flow Free cash flow refers to the cash flow that are available for debt creditors and
shareholders after satisfying all other operating obligations. Free cash valuation is useful
when computing the value of startup companies, companies without any dividend history
or the operating division of a large company.
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Free cash flow follows the same premise as the dividend-based valuation
techniques — computing for the present value of future cash flows that are expected to be
received from the company in an infinite time horizon. Instead of using dividends, the
model uses free cash flows which is the available cash to the providers of funds. The
present value is computed using the weighted average cost of capital (or WACC) of the
company. The WACC represents the average future cost of sourcing the funds.
The free cash flow valuation model estimates the value of the entire company as
a whole. Since it is the value of the entire company, it is necessary to isolate only the
value of ordinary shares. To do that, the market value of the debt and preference shares
should be deducted from the entire company value. This can be in the form of below
formula:
Market Value of Entire Company

—Market Value of Debt
—Market Value of Preference Shares
Value of Ordinary Shares
Free cash flow valuation also faces the same limitation as the dividend growth
model i.e. it is difficult to forecast cash flow for an extended period of time. Forthis reason,
methodologically, PV of free cash flow can be computed for the first five years and value
from Year 6 onwards will be computed using the constant dividend growth model. This is
the same method of computation as the variable growth model.
Book value per share
Book value per share refers to the amount per share that will be received if all of
the company’s assets are sold based on its exact book or accounting values and whose
proceeds will go to ordinary shareholders after satisfying claims from creditors and
preference shareholders. Book value per share is very easy to compute since book value
can easily be derived from the accounting records. However, the drawback of this method
is that it lacks sophistication and its reliance on historical balance sheet data. This method
does not consider expected earnings potential of the firm and does not have any link or
relationship to the true value of the firm in the market.
Book value of assets — Book value of liabilities —

Book value per share = ------------- —°k value Preferences shares
Total No. of Outstanding Shares
Illustration. At the end of 2018, the balance sheet of Jamar Company showed total assets
of P3 million pesos, total liabilities of P2 million pesos, preference shares of P250
thousand and 100,000 outstanding shares. Book value can be computed using above
formula.
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P3,000,000 - 2,000,000 - 500,000

Book value per share =
100,000
500,000
Book value per share —
100,000
Book value per share = PS per share
Liquidation value per share

Liquidation value per share pertains to the actual amount per share that will be
received if all assets are sold based on their current market value and all liabilities
(including preferred shares) are fully paid and the proceeds are divided between remaining
shareholders. Liquidation value is a more realistic approach compared to book value since
this approximates that assets will be sold based on its market value. However, this
approach still lacks any consideration on the future earning potential of the company.
Illustration: Upon further evaluation, JamarCompany found out that the assets can
only be realized for P2.7 million, lower than its book value of 3 million. Based on
this data, liquidation value per share will be at
P2,700,000 - 2,000,000 - 500,000
Liquidation value per share = ------------------ „ -------------------
K 100,000
200,000
Book value per share — ------------
K 100,000
Book value per share = P2 per share
Price Earnings (P/E) Multiples

The P/E multiples method uses the price-earnings ratio to compute for the share
price. The price/earnings ratio shows the amount that investors are willing to pay for each
peso of earnings. Investors can use the average P/E ratio of a particular industry as
reference point to determine a company’s value. This is under the assumption that
investors compute for the value of a firm through the same methodology assuming the
average firm in the industry is valued. The P/E multiples is a very popular approach in
estimating how much the shares of a firm are value. The P/E multiples is computed by
multiplying the expected EPS of the company by the average P/E ratio for the industry
where the company is similar. The average P/E ratios for the industry can be researched
from publicly available information.
One advantage of the P/E multiples approach is its simplicity. Share value can be easily
computed using this method once companies announce how much they earned for the
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historical year This led to an increase in demand for more frequent announcement
regarding future earnings of a company.
P/E multiples is very helpful in valuing non-publicly traded companies since not
much relevant information is available. Still, P/E multiples can i
publicly traded companies. The P/E multiples approach is treated as a better methodology
compared to book value per share and liquidation value share since it considers expected
earnings of the firm. Firms in the same industry are expected to have similar PE ratios in
the long run.
A high than average P/E ratio may mean two things:
• Market is expecting company earnings to increase in the future which will pull down
P/E to the normal level or
• Market feels that company earnings has low risk and investors are willing to pay
premium for them
Limitations of Share Valuation
Valuation models often measure share value at a specific point in time according to the
projected return and risk at that moment. Any decision that investors or the issuing
company may take can change the variables and ultimately, the value of the shares.
• Changes in Expected Dividends - Increase in expected dividends brought upon

by positive management actions will increase the firm’s value under the
assumption that associated risk is unchanged. This means that changes in
expected dividends has direct relationship with share value.
• Changes in Risks / Required Return - Actions taken by management that will
increase risk will cause share value to decline. Changes in risks is inversely
proportional to share value.
• Problems with Growth Estimations - Estimating future growth using historical data
may fail to account for present changes in the company or economy that might
influence the growth rate.
• Problems with Risk Estimations - Since share price is highly dependent on
required return, any minute error in risk estimations may result in a different share
price.
• Problems with Dividend Forecasting — Many factors can influence dividend payout
such as future growth opportunities and management’s concern regarding future
cash flows. Investors may find it difficult to accurately forecast dividends as
declaration is highly dependent on the decision of board of directors.
Decision making of investors do not consider risk, dividends or estimation problems
separately. Often, investors evaluate investments to ensure that it goes in the same
direction. As companies assume more risks, shareholders tend to expect higher dividends.
Investors should also be wary that all inputs in the valuation models are based on
estimates and careful consideration should still be employed before making any
investment decision.
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Relevance of Share Valuation to Investors
In the stock market, share prices are usually set by the buyer who are willing to
pay the highest price. This price doesn't necessarily mean that it Is true price of the asset
but is incrementally greater than prices from other buyers. Market prices are set by buyers
who can take advantage of the asset. If buyers think that they can do more with the
investment, they are willing to pay for it even if they push the price higher. Lastly,
information plays a significant role how securities are priced In the stock market. Superior
or more information regarding an asset may increase its value by mitigating associated
risks. Investors who do not have background knowledge will tend to put a higher discount
on securities because of the associated uncertainties. On the other hand, Investors who
have knowledge regarding events affecting the security may be able to place the right
discount rate and dictate the price accordingly.
Distinctively, prices computed in our share valuation techniques may or may not
approximate the price that is set for the share in the stock market. Nevertheless, share
valuation techniques are very important to investors since it gives them a sense whether
price being offered for a share is reasonable or not. Fundamentally, price derived through
share valuation techniques are considered fair since this considers expected cash flows
from the investment. If the market price is lower than price computed through the models,
the share is considered cheap or undervalued. Otherwise, if market price is higher than
the computed price, it is considered costly or overvalued. A share that is traded at a price
close to its computed price is considered as fairly valued. Investors tend to buy shares
when they are undervalued (to prof it off when price becomes higher) and sell shares they
feel are overvalued (to cut off loss in case of decline towards the fair price).
These valuation models only reveal the relative value of shares but does not
provide any information on when or how long the current market price will approximate its
fair value. This leads to investors holding on to shares that are perceived to be cheap for
an extended period.
Mispriced stocks give investors an opportunity to take appropriate actions to
generate higher returns. Investors should consider how mispriced a share is for them to
know what action to take — whether to buy undervalued shares or sell short overvalued
shares. This decision may depend upon how far the trading price is from its fair value and
its associated transaction costs. Investors should also take into consideration that shares
may look as mispriced due to inaccurate estimates.
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Market Efficiency
Setting of share prices in the market through the interactions of many buyers and sellers
can be further explained through market efficiency. The market price of shares signifies
the collective actions that sellers and buyers undertake based on currently available
information. As new information comes available, a new equilibrium price is set and
becomes the market price of shares. The phenomena wherein the flow of information is
constant which leads to fluctuations in share prices to reflect impact of the new information
received is generally known as the concept of market efficiency.
The efficient market hypothesis (EMH) theory — developed by John Muth — describes the
behavior of a perfect market. The EMH theory says that:
1. Securities are typically in equilibrium, which means that they are fairly priced and
that their expected returns equal their required returns.
2. At any point in time, security prices fully reflect all information available about the
firm and its securities, and these prices react swiftly to new information.
3. Because stocks are fully and fairly priced, investors need not waste their time trying
to find mispriced (undervalued or overvalued) securities.
However, not all investors believe in the EMH theory. Some investors still try to look for
overvalued and undervalued shares to take advantage of inefficiencies in the market.
The expectation of investors regarding future profitabilrty of companies significantly
influence determination of share price in the market Adaptive expectations, which
assumes that people forecast future values based on past values, became the norm
during the early studies of expectations However, in recent years, investors becamewary
of using adaptive expectations solely since this approach ignores other present
information that may be relevant.
One emerging trend regarding expectations is the rational expectations Rational
expectations assume that people make forecasts using all available information, thus, they
are acting rationally to achieve the goal of preparing a better forecast For example,
instead of looking at past prices of a product, investors can also look at the existing top
managements, channels participating in, new products, etc. If enough investors and
traders in the stock market have rational expectations, the market price of a stock should
equal the fair value derived from the share value techniques
Hybrid and Derivative Securities
Aside from shares, there are other securities that can be traded in the capital markets with
the intention of mitigating potential risks. Investors need to know what these securities are
and how these securities will be helpful in diversifying their portfolios to max.mize returns
At the same time, issuing companies should be able to know which secunty they should
offer to achieve their business objectives.
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Hybnd StK urrb»s
Hybnd secur4x>s are finance fn«rumectj mat carry characteristics of both debt (i e fixed
contractual payment) and equity (cwnenhp features) instruments Examples of hybrid
secunties, are Mock warrants ccrrverwte bonds and convertible preference shares.
• Stock purchase warrants
Stock rurc base warrants are nstruments that grant their holders right to buy a
spec * ic number of shares of the issuer at a specified price for a given period of
time This is somewhat similar to a stock nght Stock warrants are usually added
as sweeteners to bond issuances to lower risk, improve marketability and lessen
restnctrve covenants Lenders often ask warrants from new firms who are raising
funds to allow them to share in whatever success the firm will enjoy in the future
Warrants are detachable meaning they can be sold by bondholders without

selling the security or bond it is attached to. Detachable warrants are actively
traded in broker and dealer markets
Warrants vs Stock Rights

Warrants are exercisable for several years; rights can only be used within
a few months
Warrants are issued at an exercise price higher than the prevailing market
price nghts are issued below the prevailing market price
• Convertible securities
Convertible bonds are bonds that can be converted into specified number of
ordinary shares Most of the time, these are unsecured bonds that have a call
feature The conversion feature gives investors an opportunity to become a
shareholder if positive business conditions exist. Convertible bonds are a cheaper
form of financing than straight bonds. The conversion grants a speculative feature
to the bond though it maintains its value as a bond.
Same with bonds, convertible preference shares can be converted into specified
number of ordinary shares. These are sold at a lower price compared with straight
preference shares Advantages of convertible preference shares include the
guarantee of a fixed dividend payment and the opportunity to realize capital gains
from increases in the market price of underlying ordinary shares.
Motives for the use of convertible financing include:

o Deferred ordinary shares financing - Deferring the issuance of new
ordinary shares up until such time that the market price of the share has
increased means that fewer shares will have to be issued, which reduces
the dilution of both ownership and earnings.
o Sweetener for financing - Because of the conversion feature, convertible
securities can be sold at a lower interest rate benefitting issuing
companies. For investors, they will sacrifice portion of the interest in
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exchange of the opportunity to become part owner of the company In

future.
o Can be issued with lesser restrictive covenants
o Source of temporary, cheap funds - Through convertible bonds, firms
temporarily raise debt which is cheaper to fund projects As the project Is
being completed, companies may opt to shift to a less levered structure
which allows shareholders to convert their securities to ordinary shares
Derivative Securities
Derivative securities are securities that are not debt nor equity but derives Its value on an
underlying asset which is another security. The most popular type of derivative securities
is options.
• Options
Options are financial instruments that grants the holder a chance to sell or buy a
specific asset at a set price on or before an expiration date. Options are attached
to an underlying asset where it derives its value There are two types of options:
call and put options.
Call option is an option to buy a specified number of shares on or before a

specific date at a stated strike price. Call options usually expire in a few months,
although some call options have much longer expiration dates. Investors should
consider using their call option if the strike price (price at which the holder can
buy or sell shares using the option) is lower than the market price of the shares.
This means that the option is in the money.
Put option is an option to sell a specified number of shares on or before a specific

date at a stated strike price. Strike prices for both put and call options are set at
an amount close to the value of its underlying assets at issuance date. A put
option is in the money when the market price of the underlying asset is lower
than the strike price. This means that the option holder can sell the stock at an
above-market price.
Call options are being used by investors because of the expectation the market
price of underlying stock has the opportunity to increase by more than enough to
cover option cost which will result in profit for the holder.
Options can be traded through two channels: via stock brokers and through
organized option exchanges.
Options do not play a role in fund raising for companies. Instead, these are more
commonly used by investors and option exchanges since companies do not
receive money when they issue options. Options buyers do not vote nor influence
management. Options play well as part of employee compensation packages
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NAME: Date: ____
true.
1. Fundamentally, equity represents ownership of a firm. Same with debt,

investors can put out cash to purchase equity and trade these in financial
markets through equity instruments.
2. Equity instrument is a type of financial instrument wherein the issuer
(company) agrees to pay an amount to the investor in the future based on the
future earnings of the company, if any.
3. The most common example of equity instruments is shares.
4. Authorized capital stock refers to the total maximum amount stated in the
Articles of Incorporation that can be subscribed to or paid by investors of a
corporation if the shares have a par value.
5. A company can issue additional shares in excess of its authorized capital
stock.
6. If the shares do not have a par value, the corporation does not have an
authorized capital stock but it has an authorized number of shares it may
issue.
7. Outstanding shares refer to the total shares of stock issued under binding
subscription agreements to subscribers or stockholders, which are fully paid.
8. Outstanding shares include treasury shares. Treasury shares are shares
that are repurchased or bought back by the company from its stockholders.
Issued shares refer to all shares that were issued by the company, whether
outstanding or treasury shares.
9. Among the three forms of business organization, only corporations can
issue shares. Investors prefer to put their money on shares because of the
concept of unlimited liability.
10. The sole proprietorship has no distinct personality from the owner, thus,
the owner is responsible for all debts and obligations (unlimited liability).
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11. Since the partnership is a separate legal entity from the partners, the
partners are no longer personally obliged to pay for the debts of the
partnership.
12. Limited liability, i.e. legal provision that protects shareholders from losing
more than they invested in the company, exists. Responsibility of
shareholders to creditors is only up to the extent of their capital contribution.
13. Investors may earn from equity instruments through dividends only.
14. Capital appreciation refers to the rise in the value of an asset in relation
to the increase in its market price.
15. Dividends are payments made by corporations to shareholders
representing excess earnings of the company.
16. The IAET is a penalty tax imposed on corporations who intend to
accumulate excess earnings to enable its shareholders to avoid paying the
10% final tax on dividends that they might have received if these were
declared.
17. According to Section 43 of the Corporation Code, stock corporations are
not allowed to maintain retained earnings more than 200% of its paid-up
capitalization at par (any additional paid-up capital or excess over par is
excluded).
18. The 10% IAET is patterned to the 10% final tax on dividends which the
government should have received if the dividends were declared properly.
19. There are two types of shares that corporations can issue: preference (or
preferred) shares and ordinary (or common) shares. Both shares represent
ownership of the corporation but differ in several aspects.
20. Normally, preference shareholders do not have voting rights, but
corporations can opt to give them voting rights explicitly in the Articles of
Incorporation.
21. Preference shares are treated as debt; the required dividend associated
with preference shares is like the interest on debt.
22. Ordinary shares represent the true owners of a corporation.
23. ordinary shareholders generally possess the voting rights to decide on
certain corporate decisions like electing the board of directors, issuance of
new shares or change in fundamental corporate direction.
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24. Preemptive right permits ordinary shareholders to retain their

proportionate ownership in the firm in case of new share issuances, hereby
protecting them against dilution of ownership.
Zb. A preemptive right is a financial instrument which permits shareholders to
buy additional shares from the company at a price cheaper than the market
price, in direct proportion of the number of shares they own.
26. The actual stock market is both physical and virtual as electronic trading
of stocks has been increasingly relevant due to the easy access to
technology.
27. Dealers (also called as market makers) operating in an OTC market try to
“make a market” by matching the buy and sell orders they receive from
investors.
28. Electronic communications network (ECN) is a network which directly links
major brokerage firmsand traders and removes the need fora middleman.
29. Exchange-traded funds (ETF) happens when a portfolio containing
various securities is purchased and a share is created based on this specific
portfolio which can be traded in the exchange.
30. The overall performance of a stock market is measured through stock
market indexes, which represents the average of stock prices currently being
traded.
31. The Philippine Stock Exchange or PSE is the national and sole stock
exchange of the Philippines.
32. PSE has been granted a “Self-Regulatory Organization” or SRO status by
the SEC in June 1998. This means the PSE can implement its own rules and
set penalties on erring trade participants and listed companies.
33. The PSE regulates trading activities through the Financial Markets
Integrity Corporation (FMIC).
34. In conventional brokerage, investors buy or sell shares by opening an
account with a stockbroker. The broker will buy and sell shares in behalf of
the investor in exchange for payment called commission.
35. Online brokers typically charge lower commission compared to
conventional brokers and they offer investment advice and other services that
a traditional broker also gives.
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3t' Mutual funds is an investment company that pools money from various
m\ esters and invests them to different securities based on the investment
obpctiv e of the fund
37 Market capitalization refers to the total market value of all outstanding
shares of a company This is calculated by multiplying the total outstanding
shares by the prevailing par value per share.
38 Market capitalization allows investors to benchmark the relative size of a
company against another.
39 Know ing different share valuation techniques equip investors with the right
knowledge that will help them choose the best stocks that fit their investment
appetite.
40. Share valuation techniques are commonly grounded in identifying how
much cash flow can be received in the future if the investor purchases the
share now.
41. The constant growth model or the Gordon growth model (named after
Myron Gordon) is the most widely known model used in share valuation.
42. Since future growth rates may go up or down as a result of changes in
economic conditions, a variable growth model was developed to incorporate
changes in growth rate in the valuation.
43. The market price of shares signifies the collective actions that sellers and
buyers undertake based on currently available information.
44. The efficient market hypothesis (EMH) theory — developed by John Muth
— describes the behavior of a imperfect market.
45. Not all investors believe in the EMH theory. Some investors still try to look
for overvalued and undervalued shares to take advantage of efficiencies in
the market.
46. Aside from shares, there are other securities that can be traded in the
capital markets with the intention of mitigating potential risks.
47. Derivative securities are financial instruments that carry characteristics of
both debt (i.e. fixed contractual payment) and equity (ownership features)
instruments.
48. Hybrid securities are securities that are not debt nor equity but derives its
value on an underlying asset which is another security.
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49. Options are financial instruments that grants the holder a chance to sell
or buy a specific asset at a set price on or before an expiration date.
50. Put option is an option to buy a specified number of shares on or before
a specific date at a stated strike price.
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given.
Across Down
2. instrument used where the issuer agrees to pay the investor future 1. Dividends of these shares are in arrears when not paid
earnings 2. Exchange-traded funds
4. ft is the type of financing made by Equity Securities 3. Shares that gives its holders distinct rights that enable them to be
5. two or more persons bind themselves for a common purpose prioritizes
7. PhTsppine Stock Exchange S. type of capital stock that is maximum amount allowed to be issued
8. shares that was issued under binding agreements
3. Payments received by the stockholders
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NAME:
1. Which of the following is not a form of business organization in the Philippines?

a. corporation
b. private limited company
c. partnership
d. sole proprietorship
2. Capital Appreciation happens when there is .

a. increase in par value of stocks
b. increase in market value of stocks
c. Increase in market capitalization
d. Decrease in market capitalization
3. Capital Depreciation happens when there is .

a. decrease in par value of stocks
b. decrease in market value of stocks
c. Increase in market capitalization
d. Decrease in market capitalization
3. Dividends maybe in the form of the following except:

a. Cash
b. Stock
c. Property
d. Bonds
4. Improperly Accumualted Earnings Tax (IAET) is imposed for excess in Retained

Earning beyond ______________________ -
a. 100% of Capital Stock
b. 100% of Authorized Capital Stock
c. 100% of Paid up Capital Stock at par value
d. 100% of Outstanding Stocks less Treasury shares
5. The following are distinctions of equity and debt except:

a. voice in management
b. claims on asset and income
c. maturity
d. all of the above
6. Which of the following are 2 major types of shares?

a. Ordinary and Preferred shares
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FUNDAMENTALS OF FINANCIALM A R K ET
b. Callable and Convertible shares

c. Participating and Non Participating shares
d. Cumulative and Non Cumulative shares
7. is a financial instrument which permits shareholders to buy additional

shares from the company at a price cheaper than the market price, in direct
proportion of the number of shares they own.
a. Preemptive rights
b. Stock rights
c. Voting rights
d. Preferential rights
8. allow existing shareholders to maintain their current voting influence

and protect them from dilution of earnings i.e. reduction of claim on earnings as a
result of lowering of its fractional ownership.
a. Preemptive rights
b. Stock rights
c. Voting rights
d. Preferential rights
9. Which of the following is not correct about stock market?

a. The stock market is composed of exchanges and over the counters where shares
are issued and traded publicly.
b. The actual stock market is both physical and virtual as electronic trading of stocks
has been increasingly relevant due to the easy access to technology.
c. The stock market can be considered both a primary and secondary market.
d. However, since most of the transactions are buying and selling existing stocks of
investors (compared with new share issuances), the primary market is considerably
bigger than the secondary market.
10. Electronic communications network (ECN) is a network which directly links major
brokerage firmsand traders and removes the need for a middleman. ECN has been
gaining ground lately because of the following reasons, except:
a. transparency
b. cost reduction
c. faster execution
d. elegance
11. Which of the following does not belong top 10 largest stock markets in the world?
a. Philippine stock exchange
b. Tokyo SE Group
c. Shanghai Stock Exchange
d. Hong Kong Exchanges
12. Which of the following is correct about Philippine Stock Exchange?

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a. One of the largest stock markets in the world

b. One of the oldest stock exchanges in Asia
c. It is a merger of two stock exchanges: Manila Stock Exchange and Malabon Stock
Exchange.
d. It is unlisted company since it is the one implementing rules and set penalties on
erring trade participants and listed companies.
13. Companies who plan to be listed in PSE should, except:

a. Comply with the laws, regulations and full disclosure rules and policies of the
Philippine government
b. Ensure that directors and officers act in the interest of all security holders as a
whole, particularly where the public represents only a minority of the security holders
or where a director or security holder owning a substantial amount of shares has a
material interest in a transaction entered into by the company.
c. Give adequate, fair and accurate information about the company and its securities
to the general public to enable them to make informed investment decisions
d. Have to be ISO certified so to ensure company has standards of quality, operations,
and size under efficient and effective management.
14. To be admitted for admission to listing in PSE, the following are general criteria
except:
a. a. Track Record of Profitable Operations
b. The company has been operating for at least ten (10) years prior to the filing of the
application and has a cumulative EBITDA of at least F50 Million for at least two (2) of
the three (3) fiscal years immediately preceding the filing of the listing application
c. The company is a newly formed holding company which uses the operational track
record of its subsidiary.
d. At listing, the capitalization of the company must be at least F500 Million.
15. Which of the following is not correct about Disclosure rules?

a. All companies listed in the PSE is required to comply with its disclosure rules The
basic principle of the Exchange is to ensure full, fair, timely and accurate disclosure
of material information from all listed companies
b. Corporate disclosures are classified into two: the structured and the unstructured
corporate disclosures.
c. Structured continuing disclosures are reportonal requirements submitted within
specific time frames such as annual, quarterly and monthly reports Unstructured
continuing disclosures are communications of corporate developments as they
happen and are intended to update the investing public on the activities, operations
and business of the company.
d. Unstructured continuing disclosures include the Annual report (SEC Form 17-A) —
To be submitted within 105 days after end of fiscal year and Three Quarterly Reports
(SEC Form 17-Q) — To be submitted within forty-five (45) days from end of the first
three (3) quarters of the fiscal year.
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16. Which of the following is not a platform for Capital Market?

a. Conventional Brokerage
b. Online Trading
c. Mutual Funds
d. All of the above
17. Using one period or multiple period valuation model, what is the current value/true
value of the shares in the below problem?
Investor HAM want to buy shares of Flix Company. When he looked it up at the stock
exchange, Flix Company can be bought at P30 per share. Further research showed
that dividends are stable at P5 per year and it is expected to be resold at P40 per
share after a year. Investor HAM expects a 10% return on his investments and only
expects to hold Flix Company shares fora year. What is the value of the shares
based on Investor HAM’scomputation?
a. P40.91
b. P36.36
c. P4.55
d. P40.00
18. Using Dividend based valuation technique (zero growth model), what is the current
value/true value of the shares in the below problem?
Investor CDE wants to buy 1,000 preference shares, P200 par value from Korean
Company. According to his sources, the preference shares come with a constant
dividend of P30 per share Investor CDE intends to hold the preference shares long
term and has no plans on selling this in the near future. Investor CDE requires a 15%
return on all of his investment. What is the value of each preference share?
a. P200.00
b. P230.00
c. P215.00
d. P250.00
19. The following are Dividend based valuation technique model except:
a. Zero growth model
b. constant growth model
c. variable growth model
d. time value discounting model
20. Which is not correct about the limitation of Share Valuation?
212
PDFelement
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PDFelement
f UNDAMENTALSOF FINANCIAL MARKET
Chapter 8
INTERNATIONAL FINANCIAL MARKETS
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FIN ANCIALMARKET
International Financial Markets
It er^ • v>'e find ourselves in constant contact with internationally traded goods,
thr ■> k mUSiC*yOU may a U S manufactured DVD of music by a Polish composer
g a apanese amplifier and British speakers. You may be wearing clothing made in
. orea or eating fruit from China. As you drive to work, you will see cars manufactured in
cour,tries such as Korea. Japan, U.S. and Germany. Less visible in daily life is
*n ’^nat’ona' in financial assets, but its dollar volume is much greater. This trade
takes place in the international financial markets. When international trade in financial
assets is easy and reliable, due to low transactions costs in liquid markets, we say
international financial markets are characterized by high capital mobility.
Financial capital was highly mobile in the 19,h century. The early 20th century
brought two world wars and the Great Depression. Many governments implemented
controls on international capital flows, which fragmented the international financial markets
and reduced capital mobility. Post-war efforts to increase the stability and integration of
markets for goods and services included the creation of the General Agreement on Tariffs
and Trade (the GATT, the precursor to the World Trade Organization, or WTO). Until
recently, no equivalent efforts addressed international trade in securities. The low level of
capital mobility is reflected in the economic models of the 1950s and 1960s: economists
felt comfortable conducting international analyses under the assumption of capital
immobility.
Financial innovations, such as the Eurocurrency markets, undermined the

effectiveness of capital controls. Technological innovations lowered the costs of
international transactions. These factors, combined with the liberalizations of capital
controls in the 1970s and 1980s, led to the development of highly integrated world financial
markets. Economists have responded to this “globalization” of financial markets, and they
now usually adopt perfect capital mobility as a reasonable approximation of conditions in
the international financial markets.
International capital flows surged after the oil shock of 1973 to 1974, which spurred
financial intermediation on a global scale. Surpluses in the oil-exporting countries and
corresponding deficits among oil importers led to a recycling of “petrodollars” in the
growing Euromarkets. Many developing countries gained new access to international
capital markets, where they financed mounting external imbalances. Most of this
intermediation occurred in the form of bank lending, and large banks in the industrial
countries accepted huge exposures to developing country debt. The debt crisis of the
1980s led to a significant slowdown in capital flows to emerging markets. The waning of
the debt crisis led to new large-scale private capital inflows to emerging markets in the
1990s.3 Private capital responded to the efforts of many Latin American countries to
liberalize, privatize, open markets, and enhance macroeconomic stability. Countries in
Central and Eastern Europe began a transition toward market economies, and rapid
growth in a group of economies in East Asia had caught the attention of investors
worldwide. Net long-term private flows to developing countries increased from $42 billion
in 1990 to $256 billion in 1997. This time the largest share of these flows took the form of
foreign direct investment (investment by multinational corporations in overseas operations
215 |
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under their own control). These flows totaled $120 billion in 1997 (Council of Economic
Advisors, 1999, p.221). Bond and portfolio equity flows were 34 percent of the total in that
year, while commercial bank loans represented only 16 percent, compared with about two-
thirds in the 1970s Council of Economic Advisors (1999, p.222).
Net flows have been large and growing, but gross cross-border inflows and
outflows have grown even faster. The Mexican peso crisis of December 1994 led to a
modest slowdown in capital flows to emerging markets in 1995, they surged again
thereafter until the Asian crisis erupted in the summer of 1997.
Indeed, due to growth in international business over the last 30 years, various
international financial markets have been developed. Financial managers must
understand the various international financial markets that are available so that they can
use those markets to facilitate their international business transactions. The specific
objectives of this chapter are to describe the background and corporate use of the
following international financial markets: foreign exchange market; Eurocurrency market;
Eurocredit market; Eurobond market and international stock markets
Motives for Using International Financial Market
Several barriers prevent the markets for real or financial assets from becoming
completely integrated; these barriers include tax differentials, tariffs, quotas, labor
immobility, cultural differences, financial reporting differences, and significant costs of
communicating information across countries. Nevertheless, the barriers can also create
unique opportunities for specific geographic markets that will attract foreign creditors and
investors. For example, barriers such as tariffs, quotas, and labor immobility can cause a
given country’s economic conditions to be distinctly different from others. Investors and
creditors may want to do business in that country to capitalize on favorable conditions
unique to that country. The existence of imperfect markets has precipitated the
internationalization of financial markets.
Motives for Investing in Foreign Market
Investors invest in foreign markets for one or more of the following motives:
• Economic conditions.
Investors may expect firms in a particular foreign country to achieve more

favorable performance than those in the investor’s home country. For example, the
loosening of restrictions in Eastern European countries created favorable
economic conditions there. Such conditions attracted foreign investors and
creditors.
216 |
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Exchange rate expectations.
Some investors purchase financial securities denominated in a currency that is

is^6 *° aPPrec‘a*e against their own. The performance of such an investment
ls ig y dependent on the currency movement over the investment horizon.
• International diversification.
Investors may achieve benefits from internationally diversifying their asset

portfolio. When an investor’s entire portfolio does not depend solely on a single
country s economy, cross-border differences in economic conditions can allow for
risk-reduction benefits. A stock portfolio representing firms across European
countries is less risky than a stock portfolio representing firms in any single
European country. Furthermore, access to foreign markets allows investors to
spread their funds across a more diverse group of industries than may be available
domestically. This is especially true for investors residing in countries where firms
are concentrated in a relatively small number of industries.
Motives for Providing Credit in Foreign Markets
Creditors (including individual investors who purchase debt securities) have one or more
of the following motives for providing credit in foreign markets:
• High foreign interest rates.
Some countries experience a shortage of loanable funds, which can cause market
interest rates to be relatively high, even after considering default risk. Foreign
creditors may attempt to capitalize on the higher rates, thereby providing capital to
overseas markets. Yet, relatively high interest rates are often perceived to reflect
relatively high inflationary expectations in that country. To the extent that inflation
can cause depreciation of the local currency against others, high interest rates in
the country may be somewhat offset by a weakening of the local currency over the
time period of concern. The relation between a country’s expected inflation and its
local currency movements is not precise, however, because several other factors
can influence currency movements as well. Thus, some creditors may believe that
the interest rate advantage in a particular country will not be offset by a local
currency depreciation over the period of concern.
• Exchange rate expectations.
Creditors may consider supplying capital to countries whose currencies are

expected to appreciate against their own. Whether the form of the transaction is a
bond or a loan, the creditor benefits when the currency of denomination
appreciates against the creditor’s home currency.
217
FUNDAMENTALS OF FINANCIAPDFelement
L M A R K ET
♦ dwersihc-ation.
Cw ea' benef t from international diversification, which may reduce the

ovCvs-b X of s "tu'taneous bankruptcy across borrowers. The effectiveness of
s. v" a st- ategx depends on the correlation
VAneves V> cP -cmvi v *~o eon A4ank-efs

:X> -vwe s **a\ have o 'e or more of the following motivesfor borrowing in foreign markets:
♦ Lew interest rates.
So"e ox. 't es *x?ve a ■arge supply of funds available compared to the demand
\v\ x's w he*' ca" cause relatively lew interest rates. Borrowers may attempt to
bo—ow funds *"O"* cred tons in these countries because the interest rate charged
s ewe A CxX.'trv w th relatively low interest rates is often expected to have a
eatx e\ ew ate c* inflation. which can place upward pressure on the foreign
Cx. e x'\ s \ a and offset any advantage of lower interest rates. The relation
betwee" expected "*ation differentials and currency movements is not precise,
$ se so"e borrowers will choose to borrow from a market where nominal
'teest ates ane ew. s nce they do not expect an adverse currency movement to
X. \ xYhsstP's advantage.
• Exchange rate expectations.
W'e" a foreign subsidiary of a U.S.-based MNC remits funds to its U.S. parent,
the *unds *x.st be oon\ erted to dollars and are subject to exchange rate risk. The
V\C w be adv erseX affected if the foreign currency depreciates at that time. If
P'e \’\C expects that the foreign currency may depreciate against the dollar, it
ca ' e<x.ce the exchange rate risk by having the subsidiary borrow funds locally to
support ts business. The subsidiary will remit less funds to the parent if it must pay
interest on oca debt before remitting the funds. Thus, the amount of funds
cenx erted to cc ars w ill be smaller, resulting in less exposure to exchange rate
risk.
If the U.S. parent needs to borrow funds for its own purposes, it may pursue a
mere ^ggresssv e strategy and borrow a foreign currency that is expected to
depreciate. In this case, the parent would borrow' that currency and convert it to
dollars for use. The value of the foreign currency when converted to dollars would
exceed the v alue when the MNC repurchases the currency to repay the loan. The
fax enable currency effect can offset part, or all of the interest owed on the funds
borrowed. Such a strategy may be especially desirable if the foreign currency has
a lew interest rate compared to the U.S. interest rate.
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History of Foreign Exchange
I he foreign exchange market allows currencies to be exchanged in order to

facilitate International trade or financial transactions. MNCsrely on the foreign exchange
market to exchange their home currency for a foreign currency that they need to purchase
imports or use for direct foreign investment. Alternatively, they may need the foreign
exchange market to exchange a foreign currency that they receive into their home
currency. I he system for establishing exchange rates has changed overtime.
1 he system used for exchanging foreign currencies has evolved from the gold
standard, to an agreement on fixed exchange rates, to a floating rate system.
• Gold Standard.
From 1876 to 1913, exchange rates were

dictated by the gold standard. Each currency was Point of
convertible into gold at a specified rate. Thus, the Information!
exchange rate between two currencies was The countries with the
determined by their relative convertibility rates per largest gold reserves are
ounce of gold. Each country used gold to back its United States, Germany,
currency. When World War I began in 1914, the gold Italy, France, and Russia.
standard was suspended. Some countries reverted As of 2019, US gold
reserves amounts to
to the gold standard in the 1920s but abandoned it
about USD 335 Billion.
as a result of a banking panic in the United States
and Europe during the Great Depression. In the
1930s, some countries attempted to peg their currency to the dollar or the British
pound, but there were frequent revisions. As a result of the instability in the foreign
exchange market and the severe restrictions on international transactions during
this period, the volume of international trade declined.
• Agreements on Fixed Exchange Rates.
In 1944, an international agreement (known as the Bretton Woods

Agreement) called for fixed exchange rates between currencies. This agreement
lasted until 1971. During this period, governments would intervene to prevent
exchange rates from moving more than 1 percent above or below their initially
established levels. By 1971, the U.S. dollar appeared to be overvalued; the foreign
demand for U.S. dollars was substantially less than the supply of dollars for sale
(to be exchanged for other currencies). Representatives from the major nations
met to discuss this dilemma. As a result of this conference, which became known
as the Smithsonian Agreement, the U.S. dollar was devalued relative to the other
major currencies. The degree to which the dollar was devalued varied with each
foreign currency. Not only was the dollar’s value reset, but exchange rates were
also allowed to fluctuate by 2 percent in either direction from the newly set rates.
This was the first step in letting market forces (supply and demand) determine the
219
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appropriate price of a currency. Although boundaries still existed for exchange

rates, they were widened, allowing the currency values to move more freely toward
their appropriate levels.
• Floating Exchange Rate System.
Even after the Smithsonian Agreement, governments still had difficulty

maintaining exchange rates within the stated boundaries. By March 1973, the more
widely traded currencies were allowed to fluctuate in accordance with market
forces, and the official boundaries were eliminated.
Foreign Exchange Transactions
The foreign exchange market should not be thought of as a specific building or

location where traders exchange currencies. Companies normally exchange one currency
for another through a commercial bank over a telecommunications network.
• Spot Market.
The most common type of foreign exchange transaction is for immediate

exchange at the so-called spot rate. The market where these transactions occur is
known as the spot market. The average daily foreign exchange trading by banks
around the world now exceeds $1.5 trillion. The average daily foreign exchange
trading in the United States alone exceeds $200 billion.
The U.S. dollar is not part of every transaction. Foreign currencies can be
traded for each other. For example, a Japanese firm may need British pounds to
pay for imports from the United Kingdom. Much of the foreign exchange trading is
conducted by banks in London, New York, and Tokyo, the three largest foreign
exchange trading centers. Many foreign transactions do not require an exchange
of currencies but allow a given currency to cross country borders. For example,
the U.S. dollar is commonly accepted as a medium of exchange by merchants in
many countries, especially in countries such as Bolivia, Brazil, China, Cuba,
Indonesia, Russia, and Vietnam where the home currency is either weak or subject
to foreign exchange restrictions. Many merchants accept U.S. dollars because
they can use them to purchase goods from other countries. The U.S. dollar is the
official currency of Liberia and Panama.
There are various websites where you can see the historical exchange rate
movementsand current exchange rate, one of which is http:Avww.oanda.com.Just
click on FXHistory to review daily exchange rates for a currency that you specify
over a period of time that you specify. Identify the two currencies for which you
want to viewthe exchange rate and the period in which you want data. The website
provides the data that you request.
Spot Market Structure.
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Hundreds of banks facilitate foreign exchange transactions, but the top 20

handles about 50 percent of the transactions. Deutsche Bank (Germany). Citibank
(subsidiary of Citigroup. U S ), and J P Morgan Chase are the largest traders cf
foreign exchange Some banks and other financial institutions have formed
alliances (one example is FX Alliance LLC) to offer currency transactions over the
Internet At any given point in time, the exchange rate between two currencies
should be similar across the various banks that provide foreign exchange services
If there is a large discrepancy, customers or other banks will purchase large
amounts of a currency from whatever bank quotes a relatively low price and
immediately sell it to whatever bank quotes a relatively high price Such actions
cause adjustments in the exchange rate quotations that eliminate any discrepancy
If a bank begins to experience a shortage in a particular foreign currency, it can
purchase that currency from other banks. This trading between banks occurs in
what is often referred to as the interbank market. Within this market, banks can
obtain quotes, or they can contact brokers who sometimes act as intermediaries,
matching one bank desiring to sell a given currency with another bank desiring to
buy that currency. About 10 foreign exchange brokerage firms handle much of the
interbank transaction volume. Although foreign exchange trading is conducted only
during normal business hours in a given location, these hours vary among
locations due to different time zones. Thus, at any given time on a weekday,
somewhere around the world a bank is open and ready to accommodate foreign
exchange requests. When the foreign exchange market opens in the United States
each morning, the opening exchange rate quotations are based on the prevailing
rates quoted by banks in London and other locations where the foreign exchange
markets have opened earlier. Suppose the quoted spot rate of the British pound
was S1 80 at the previous close of the U.S. foreign exchange market, but by the
time the market opens the following day, the opening spot rate is $1.76. News
occurring in the morning before the U.S. market opened could have changed the
supply and demand conditions for British pounds in the London foreign exchange
market, reducing the quoted price for the pound. With the newest electronic
devices, foreign currency trades are negotiated on computer terminals, and a push
of a button confirmsthe trade. Traders now use electronic trading boards that allow
them to instantly register transactions and check their bank’s positions in various
currencies. Also, several U.S. banks have established night trading desks. The
largest banks initiated night trading to capitalize on foreign exchange movements
at night and to accommodate corporate requests for currency trades. Even some
medium-sized banks have begun to use night trading to accommodate corporate
clients.
• Forward Transactions.
In addition to the spot market, a forward market for currencies enables an

MNC to lock in the exchange rate (called a forward rate) at which it will buy or sell
a currency. A forward contract specifies the amount of a particular currency that
will be purchased or sold by the MNC at a specified future point in time and at a
specified exchange rate. Commercial banks accommodate the MNCsthat desire
forward contracts. MNCs commonly use the forward market to hedge future
payments that they expect to make or receive in a foreign currency. In this way,
221 |
OF FINANCIALM A R K ET
they do not have to worry about fluctuations in the spot rate until the time of their
future payments.
• Currency Futures and Options
A currency futures contract specifies a standard volume of a particular

currency to be exchanged on a specific settlement date. Some MNCs involved in
international trade use the currency futures markets to hedge their positions.
Futures contracts are somewhat similar to forward contracts except that they are
sold on an exchange whereas forward contracts are offered by commercial banks.
Currency options contracts can be classified as calls or puts. A currency
call option provides the right to buy a specific currency at a specific price (called
the strike price or exercise price) within a specific period of time. It is used to hedge
future payables. A currency put option provides the right to sell a specific currency
at a specific price within a specific period of time. It is used to hedge future
receivables. Currency call and put options can be purchased on an exchange.
They offer more flexibility than forward or futures contracts because they do not
require any obligation. That is, the firm can elect not to exercise the option.
Currency options have become a popular means of hedging. The Coca-
Cola Co. has replaced about 30 to 40 percent of its forward contracting with
currency options. FMC, a U.S. manufacturer of chemicals and machinery, now
hedges its foreign sales with currency options instead of forward contracts. A
recent study by the Whitney Group found that 85 percent of U.S.-based MNCs use
currency options.
To illustrate, Memphis Co. has ordered supplies from European

countries that are denominated in euros. It expects the euro to increase in
value over time and therefore desires to hedge its payables in euros.
Memphis buys futures contracts on euros to lock in the price that it will pay
for euros at a future point in time. Meanwhile, it will receive Mexican pesos
in the future and wants to hedge these receivables. Memphis sells futures
contracts on pesos to lock in the dollars that it will receive when it sells the
pesos at a specified point in the future.
• Eurocurrency Market
Financial markets exist in every country to ensure that funds are transferred
efficiently from surplus units (savers) to deficit units (borrowers). These markets
are overseen by various regulators that attempt to enhance the markets’ safety
and efficiency. The financial institutions that serve these financial markets exist
primarily to provide information and expertise. The surplus units typically do not
know who needs to borrow funds at any particular point in time. Furthermore, they
often cannot adequately evaluate the credit risk of any potential borrowers or
establish the documentation necessary when providing loans. Financial institutions
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specialize in collecting funds from surplus units and then repackaging and
transferring the funds to deficit units.
Development of the Eurocurrency Market
Like domestic firms, MNCs sometimes obtain funding through short-term

loans from local financial institutions or by issuing short-term securities such as
commercial paper. However, they can also obtain funds from the financial
institutions in foreign markets. International financial intermediation emerged in the
1960s and 1970s as MNCs expanded their operations. During this period, the
Eurodollar market, or what is now referred to as the Eurocurrency market, grew to
accommodate the increasing international business. The Eurodollar market was
created as corporations in the United States deposited U.S. dollars in European
banks. These European banks were willing to accept dollar deposits, since they
could then lend dollars to corporate customers based in Europe. Because the U.S.
dollar is widely used even by foreign countries as a medium for international trade,
there is a consistent need for dollars in Europe. U.S.-dollar deposits in banks
located in Europe and on other continents as well became known as Eurodollars.
The growth of the Eurodollar market was stimulated by U.S. regulations in 1968,
which limited foreign lending by U.S. banks. Foreign subsidiaries of U.S.-based
MNCs could obtain U.S. dollars from banks in Europe. In addition, when ceilings
were placed on the interest rates of dollar deposits in the United States, dollars
were transferred to the Eurodollar market, which had no ceilings. Furthermore,
Eurodollar deposits were not subject to reserve requirements. Thus, banks could
reduce the spread between what they paid on such deposits and charged on loans
and still make a reasonable profit. This added to the popularity of the Eurodollar
market, since banks could offer attractive deposit rates to corporations and
governments with excess cash and attractive loan rates to corporations and
governments with deficient funds.
Composition of the Eurocurrency Market

The Eurocurrency market is composed of several large banks (referred to
as Eurobanks) that accept deposits and provide loans in various currencies.
Countries in the Organization of Petroleum Exporting Countries (OPEC) also use
the Eurocurrency market to deposit a portion of their petroleum revenues. The
deposits usually are denominated in U.S. dollars because OPEC generally
requires payment for oil in dollars. The deposits are sometimes referred to as
petrodollars. The Eurocurrency market has historically recycled the oil revenues
from the oil-exporting countries to other countries. That is, oil revenues deposited
in the Eurobanks are sometimes lent to oil-importing countries that are short of
cash. As these countries purchase more oil, funds are again transferred to oil
exporting countries, which in turn results in new deposits. This recycling process
has been an important source of funds for some countries. The Eurocurrency
market normally focuses on business transactions that involve large deposits and
loans, often the equivalent of $1 million or more. Large financial transactions such
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FUNDAMENTALS OF FINANCIALMARKFT
PDFelement
as these can reduce a bank’s operating expenses. This is another reason why
Eurobanks can offer attractive rates on deposits and loans.
Syndicated Eurocurrency Loans
Although the Eurocurrency market concentrates on large-volume
transactions, at times no single Eurobank may be willing to provide the amount
needed by a particular corporation or government agency. In this case, a syndicate
of Eurobanks may be organized. Each bank within the syndicate participates in the
lending. A lead bank is responsible for negotiating terms with the borrower. Then
the lead bank organizes a group of banks to underwrite the loans. The syndicate
of banks is usually formed in about six weeks, or less if the borrower is well known
because the credit evaluation can then be conducted more quickly. Borrowers that
receive a syndicated loan incur various fees besides the interest on the loan. Front
end management fees are paid to cover the costs of organizing the syndicate and
underwriting the loan. In addition, a commitment fee of about .25 percent or .50
percent is charged annually on the unused portion of the available credit extended
by the syndicate. Syndicated loans can be denominated in a variety of currencies.
The interest rate depends on the currency denominating the loan, the maturity of
the loan, and the creditworthiness of the borrower. Interest rates on syndicated
loans are commonly adjustable according to movements in an interbank lending
rate, and the adjustment may occur every six months or every year. Syndicated
Eurocurrency loans not only reduce the default risk of a large loan to the degree
of participation for each individual bank, but they can also add an extra incentive
for the borrower to repay the loan. If a government defaults on a loan to a
syndicate, word will quickly spread among banks, and the government will likely
have difficulty obtaining future loans. Borrowers are therefore strongly encouraged
to repay syndicated loans promptly. From the perspective of the banks, syndicated
Eurocurrency loans increase the probability of prompt repayment.
Standardizing Bank Regulations within the Eurocurrency Market
The trend toward globalization in the banking industry is attributed to the

growing standardization of regulations around the world. Two of the more
significant regulatory events allowing for a more competitive global playing field
are (1) the Single European Act and (2) the Basel Accord, which are described
next.
• Single European Act. One of the most significant events affecting
international banking is the Single European Act, which was phased
in by 1992 throughout the European Union (EU) countries. The
following are some of the more relevant provisions of the Single
European Act for the banking industry:
■ Capital can flow freely throughout Europe.

■ Banks can offer a wide variety of lending, leasing, and
securities activities in the EU.
- Regulations regarding competition, mergers, and taxes are
similar throughout the EU.
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MARKET
■ A bank established in any one of the EU countries has the

right to expand into any or all of the other EU countries.
As a result of this act, banks have expanded across European
countries. Efficiency in the European banking markets has
increased because banks can more easily cross countries without
concern for country-specific regulations that prevailed in the past.
Another key provision of the act is that banks entering Europe
receive the same banking powers as other banks there. Similar
provisions apply to non-U.S. banks that enter the United States.
• Basel Accord. Before 1987, capital standards imposed on banks

varied across countries, which allowed some banks to have a
comparative global advantage over others. As an example,
suppose that a bank in the United States was subject to a 6 percent
capital ratio, which was twice that of a foreign bank. The foreign
bank could achieve the same return on equity as the U.S. bank by
generating a return on assets that was only one-half that of the U.S.
bank. In essence, the foreign bank’s equity multiplier (assets
divided by equity) was double that of the U.S. bank, which would
offset the low return on assets. Given these conditions, foreign
banks could accept lower profit margins while still achieving the
same return on equity. This afforded them a stronger competitive
position. In addition, they could grow more easily, as a relatively
small amount of capital was needed to support an increase in
assets.
Some analysts countered that these advantages were
somewhat offset by the perception that banks with low capital ratios
entailed higher risks. Nevertheless, because the governments in
those countries were likely to back banks that experienced financial
problems, the banks with low capital were not necessarily perceived
as too risky. Therefore, some non-U.S. banks had globally
competitive advantages over U.S. banks, without being subject to
excessive risk. In December 1987, 12 major industrialized countries
attempted to resolve the disparity by proposing uniform bank
standards. In July 1988, in the Basel Accord, central bank
governors of the 12 countries agreed on standardized guidelines.
Capital was classified as either Tier 1 (“core”) capital or Tier 2
(“supplemental”) capital (Tier 1 capital being at least 4 percent of
risk-weighted assets). The use of risk weightings on assets
implicitly created a higher required capital ratio for riskier assets.
Off-balance sheet items were also accounted for so that banks
could not circumvent capital requirements by focusing on services
(such as letters of credit and interest rate swaps) that are not
explicitly shown on a balance sheet. The uniform capital
requirements represent significant progress toward a more level
global field.
225 |
PDFelement
• Asian Dollar Market

AUKouph tt>e Eurocurrency market can be broadly defined to include banks
m As<a ttiat accept deposits and make loans m foreign currencies (mostly dollars),
tbrs market ts sometimes referred to separately as the Asian dollar market. Most
activity takes place in Hong Kong and Singapore The only significant difference
between the Asian market and the Eurocurrency market is location Like the
Eurocurrency market, the Asian dollar market grew to accommodate the needs of
businesses that were using the U.S dollar (and some other foreign currencies) as
a medom of exchange for international trade These businesses could not rely on
banks m Europe because of the distance and different time zones. The primary
function of banks in the Asian dollar market is to channel funds from depositors to
borrowers The major sources of Asian dollar deposits are MNCs with excess cash
and government agencies Manufacturers are major borrowers in this market
Another function is interbank lending and borrowing. Banks that have more
qualified loan applicants than they can accommodate use the interbank market to
obtain additional funds Banks in the Asian market commonly borrow from or lend
to banks in the Eurocurrency market.
• Eurocredit Market
Multinational corporations and domestic firms sometimes obtain medium

term funds through term loans from local financial institutions or through the
issuance of notes (medium-term debt obligations) in their local markets. However,
MNCs also have access to medium-term funds through Eurobanks located in
foreign markets. Loans of one year or longer extended by Eurobanks to MNCs or
government agencies are commonly called Eurocredits or Eurocredit loans.
These loans are provided in the so-called Eurocredit market. The loans can be
denominated in dollars or many other currencies and commonly have a maturity
of five years.
Because Eurobanks accept short-term deposits and sometimes provide
longer term loans, their asset and liability maturities do not match. This can
adversely affect a bank’s performance during periods of rising interest rates, since
the bank may have locked in a rate on its Eurocredit loans while the rate it pays on
short term deposits is rising overtime. To avoid this risk, Eurobanks now commonly
use floating rate Eurocredit loans. The loan rate floats in accordance with the
movement of some market interest rate, such as the London Interbank Offer
Rate (LIBOR), which is the rate commonly charged for loans between Eurobanks.
For example, a Eurocredit loan may have a loan rate that adjusts every six months
and is set at “LIBOR plus 3 percent.” The premium paid above LIBOR will depend
on the credit risk of the borrower.
• Eurobond Market
MNCs, like domestic firms, can obtain long-term debt by issuing bonds in
their local markets. MNCs can access long-term funds in foreign markets by
issuing bonds in the international bond markets. International bonds are typically
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classified as either foreign bonds or Eurobonds. A foreign bond is issued by a

borrower foreign to the country where the bond is placed. For example, a U.S.
corporation may issue a bond denominated in Japanese yen, which is sold to
investors in Japan. In some cases, a firm may issue a variety of bonds in various
countries. The currency denominating each type of bond is determined by the
country where it is sold. These foreign bonds are sometimes specifically referred
to as parallel bonds.
Eurobonds are sold in countries other than the country represented by the
currency denominating them. They have been very popular during the last decade
as a means of attracting long-term funds. U.S.-based MNCssuch as McDonald’s
and Walt Disney commonly use the Eurobond market. Non-U.S. firms such as
Guinness, Nestle, and Volkswagen also use this market as a source of funds. In
recent years, governments and corporations from emerging markets such as
Croatia, Ukraine, Romania, and Hungary have frequently utilized the Eurobond
market. New corporations that have been established in emerging markets rely on
the Eurobond market to finance their growth. They have to pay a risk premium of
at least three percentage points annually above the U.S. Treasury bond rate on
dollar-denominated Eurobonds.
Development of the Eurobond Market
The emergence of the Eurobond market was partially the result of the
Interest Equalization Tax (IET) imposed by the U.S. government in 1963 to
discourage U.S. investors from investing in foreign securities. Thus, non-U.S.
borrowers that historically had sold securities to U.S. investors began to look
elsewhere for funds. Before 1984, investors that directly purchased U.S.-placed
bonds were subject to a 30 percent withholding tax. The issuers of these bonds
retained 30 percent of the interest payments to satisfy the withholding tax laws. In
some cases, however, tax treaties between the United States and other countries
modified this role, causing the tax to affect investors in some countries more than
those in others. Because of the withholding tax, many U.S. bonds were issued in
the Eurobond market through financing subsidiaries in the Netherlands Antilles. A
tax treaty allowed interest payments from Antilles subsidiaries of U.S.-based
corporations to non-U.S. investors to be exempt from the withholding tax. U.S.
firms that used this method of financing were able to sell their bonds at a relatively
high price because of the tax exemption. Thus, they obtained funds at a relatively
low cost. Some U.S. firms did not use this financing method, because they knew
the U.S. government might prohibit this method of circumventing the tax at some
point in the future. Indeed, in July 1984, the U.S. government abolished the
withholding tax and allowed U.S. corporations to issue bearer bonds directly to
non-U.S. investors. The result was a large increase in the volume of bonds sold by
U.S. corporations to non-U.S. investors.
Underwriting Process
Eurobonds are underwritten by a multinational syndicate of investment banks and
simultaneously placed in many countries, providing a wide spectrum of fund
sources to tap. The underwriting process takes place in a sequence of steps. The
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multinational managing syndicate sells the bonds to a large underwriting crew. In

many cases, a special distribution to regional underwriters is allocated before the
bonds finally reach the bond purchasers. One problem with the distribution method
is that the second- and third-stage underwriters do not always follow up on their
promise to sell the bonds. The managing syndicate is therefore forced to
redistribute the unsold bonds or to sell them directly, which creates “digestion”
problems in the market and adds to the distribution cost. To avoid such problems,
bonds are often distributed in higher volume to underwriters that have fulfilled their
commitments in the past at the expense of those that have not. This has helped
the Eurobond market maintain its desirability as a bond placement center.
Features
Eurobonds have several distinguishing features. They usually are issued in bearer
form, and coupon payments are made yearly. Some Eurobonds carry a
convertibility clause allowing them to be converted into a specified number of
common stock shares. Eurobonds typically have few, if any, protective covenants,
which is an advantage to the issuer. Also, even short-maturity Eurobonds include
call provisions. Some Eurobonds, called floating rate notes (FRNs), have a
variable rate provision that adjusts the coupon rate over time according to
prevailing market rates.
• Denominations.
Various currencies are commonly used to denominate Eurobonds. The

U.S. dollar is used the most, denominating 70 to 75 percent of the Eurobonds,
but many Eurobonds will likely be denominated in euros in the future. Recently,
some firms have denominated debt in Japanese yen because of Japan’s
extremely low interest rates. For example, some MNCs were able to issue
bonds at a yield of about 1 percent in the late 1990s.
Interest rates for each currency and credit conditions in the Eurobond
market change constantly, causing the popularity of the Eurobond market to
vary among currencies. MNCs that need funds attempt to “read” market
conditions so that they can properly time their bond offerings. They prefer to
issue bonds in the desired currency when the interest rate for that currency is
low and when the institutional investors who invest in the Eurobond market
charge a minimal premium (above the currency’s risk-free rate) for credit risk.
In the late 1990s, the credit risk premium required by institutional investors in
various currencies was generally low (especially for MNCs with limited
exposure to Asia), which encouraged many MNCs to obtain funds by issuing
Eurobonds.
• Secondary Market.
Eurobonds also havea secondary market. The market makers are in many
cases the same underwriters who sell the primary issues. A technological
advancement called Euro-clear helps to inform all traders about outstanding
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issues for sale, thus allow tog a more active seeoodaiy market. The
in ermediaries tn the secondary market are based tn 10 different countries, with
ose in the United Kingdom dominating the action They can act not only as
rokers but also as dealers that hold inventories of Eurobonds Many of these
intermediaries, such as Bank of Amenca International. Salomon Smith Barney,
and Citicorp International, ate subsidiaries of U S corporations.
Before the adoption of the euro, each country's MNCs would commonly
prefer to issue bonds in their ow n local currency. The market for bonds in each
currency was limited Now, with the adoption of the euro by many countnes,
MNCs from many different countnes can issue bonds denominated in euros,
which allows for a much larger and more liquid market. This is beneficial to
MNCs because they can more easily obtain debt by issuing bonds, as investors
know that there will be adequate liquidity in the secondary market,
• Ratings
Although ratings are available for most Eurobond issues, purchasers have
tended to ignore ratings in favor of a well-known name. This provides an
advantage for well-known U.S. firms that have not been assigned the highest
rating. About one-fourth of the debt issues in the Eurobond market are for less
than $100 million, while more than one-third of the issues are for more than
$300 million. For example, Gillette, which is known worldwide, raised $300
million from a single issue in the Eurobond market and paid an annual yield of
just .14 percent above U.S. Treasury' bonds.
International Stock Markets
MNCs and domestic firms commonly obtain long-term funding by issuing

stock locally. Yet, MNCs can also attract funds from foreign investors by issuing
stock in international markets. The stock offering may be more easily digested
when it is issued in several markets. In addition, the issuance of stock in a foreign
country can enhance the firm’s image and name recognition there. The recent
conversion of many European countries to a single currency (the euro) has
resulted in more stock offerings in Europe by U.S.- and European-based MNCs,
In the past, an MNC needed a different currency in every country where it
conducted business and therefore borrowed currencies from local banks in those
countries. Now, it can use the euro to finance its operations across several
European countries and may be able to obtain all the financing it needs with one
stock offering in which the stock is denominated in euros. The MNCs can then use
a portion of the revenue (in euros) to pay dividends to shareholders who have
purchased the stock.
Issuance of Foreign Stock in the United States
Non-U.S, corporations or governments that need large amounts of funds
sometimes issue the stock in the United States (these are called Yankee stock
offerings) due to the liquidity of the new-issues market there. In other words, a
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foreign corporation or government may be more likely to sell an entire issue of

stock in the U.S. market, whereas in other, smaller markets, the entire issue may
not necessarily sell. The U.S. investment banks commonly serve as underwriters
of the stock targeted for the U.S. market and receive underwriting fees ranging
from about 3 to 6 percent of the value of stock issued. Since many financial
institutions in the United States purchase non-U.S. stocks as investments, non
U.S. firms may be able to place an entire stock offering within the United States.
Firms that issue stock in the United States typically are required to satisfy stringent
disclosure rules on their financial condition. However, they are exempt from some
of these rules when they qualify for a Securities and Exchange Commission
guideline (called Rule 144a) through a direct placement of stock to institutional
investors. Many of the recent stock offerings in the United States by non-U.S. firms
have resulted from privatization programs in Latin America and Europe, whereby
businesses that were previously government owned are being sold to U.S.
shareholders. Given the large size of some of these businesses, the local stock
markets are not large enough to digest the stock offerings. Consequently, U.S.
investors are financing many privatized businesses based in foreign countries.
When a non-U.S. firm issues stock in its own country, its shareholder base is quite
limited, as a few large institutional investors may own most of the shares. By
issuing stock in the United States, such a firm diversifies its shareholder base,
which can reduce share price volatility caused when large investors sell shares.
Non-U.S. firms also obtain equity financing by using American depository receipts
(ADRs), which are certificates representing bundles of stock. The use of ADRs
circumvents some disclosure requirements imposed on stock offerings in the
United States yet enables non-U.S. firms to tap the U.S. market for funds. The
ADR market grew after businesses were privatized in the early 1990s, as some of
these businesses issued ADRs to obtain financing.
Issuance of Stock in Foreign Markets

Although the U.S. market offers an advantage for new stock issues due to
its size, the registration requirements can sometimes cause delays in selling the
new issues. For this reason, some U.S. firms have issued new stock in foreign
markets in recent years. Other U.S. firms issue stock in foreign markets simply to
enhance their global image. The existence of various markets for new issues
provides corporations in need of equity with a choice. This competition among
various new-issues markets should increase the efficiency of new issues.
The locations of an MNC’s operations can influence the decision about

where to place stock, as the MNC may desire a country where it is likely to
generate enough future cash flows to cover dividend payments. The stocks of
some U.S. based MNCsare widely traded on numerous stock exchanges around
the world. For example, the stock of The Coca-Cola Co., IBM. TRW and many
other U.S. based MNCs have their stock listed on several different stock
exchanges overseas. When an MNC’s stock is listed on foreign stock exchanges,
it can easily be traded by foreign investors who have access to those exchanges.
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Impact of the Euro.

The adoption of the euro by many European countries has encouraged
MNCs based in Europe to issue stock. Investors throughout Europe are more
willing to invest in stocks when they do not have to worry about exchange rate
effects. For example, a German insurance company may be more willing to buy a
stock issued by a firm in Portugal now that the same currency is used in both
countries. The secondary market for stocks denominated in euros is more liquid
as a result of the participation by investors from several different countries that
have adopted the euro.
Comparison of Stock Markets.
Some foreign stock markets are much smaller than the U.S. markets
because their firms have relied more on debt financing than equity financing in the
past. Recently, however, firms outside the United States have been issuing stock
more frequently, which has resulted in the growth of non-U.S. stock markets. The
percentage of individual versus institutional ownership of shares varies across
stock markets. Financial institutions and other firms own a large proportion of the
shares outside the United States, while individual investors own a relatively small
proportion of shares.
Large MNCs have begun to float new stock issues simultaneously in
various countries. Investment banks underwrite stocks through one or more
syndicates across countries. The global distribution of stock can reach a much
larger market, so greater quantities of stock can be issued at a given price. The
site at quote.yahoo.com provides access to various domestic and international
financial markets and financial market news, as well as links to national financial
news servers.
In recent years, many new stock markets have been developed. These so-
called emerging markets enable foreign firms to raise large amounts of capital by
issuing stock. These markets may enable U.S. firms doing business in emerging
markets to raise funds by issuing stock there and listing their stock on the local
stock exchanges. Market characteristics such as the amount of trading relative to
market capitalization and the applicable tax rates can vary substantially among
emerging markets.
Alliances and ECNs.
Several stock markets in Europe have created alliances that enable their
stocks to be traded across exchanges. Several stock markets on different
continents are conducting ongoing discussions of alliances, which will result in the
consolidation of markets.
In recent years, electronic communications networks (ECNs) have been
created to match orders between buyers and sellers. ECNs do not have a visible
trading floor, as the trades are executed by a computer network. Examples of
popular ECNs include Archipelago, Instinet, and Tradebook. ECNs will likely
become more popular overtime and may ultimately be merged with each other or
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with other exchanges to create a single global stock exchange, where any stock
can be traded at any time.
Foreign Direct Investments
Foreign direct investment (FDI) is an investment made by a firm or individual in

one country into business interests located in another country. Generally, FDI takes place
when an investor establishes foreign business operations or acquires foreign business
assets, including establishing ownership or controlling interest in a foreign company.
Foreign direct investments are distinguished from portfolio investments in which an
investor merely purchases equities of foreign-based companies.
Foreign direct investments are commonly made in open economies that offer a
skilled workforce and above-average growth prospects for the investor, as opposed to
tightly regulated economies. Foreign direct investment frequently involves more than just
a capital investment. It may include provisions of management or technology as well. The
key feature of foreign direct investment is that it establishes either effective control of, or
at least substantial influence over, the decision-making of a foreign business.
The Bureau of Economic Analysis (BEA), which tracks expenditures by foreign
direct investors into U.S. businesses, reported total FDI into U.S. businesses of $259.7
billion in 2017, marking a 32% decrease from the prior year. As per usual, acquisitions
made up the overwhelming majority of new foreign direct investments into the U.S.,
BEA as investments to either establish a new business or to expand an existing foreign-

owned business, comprised a much lighter $6.5 billion.
Methods of Foreign Direct Investment
Foreign direct investments can be made in a variety of ways, including the opening
of a subsidiary or associate company in a foreign country, acquiring a controlling interest
in an existing foreign company, or by means of a merger or joint venture with a foreign
company.
The threshold fora foreign direct investment that establishes a controlling interest,
per guidelines established by the Organisation of Economic Co-operation and
Development (OECD), is a minimum 10% ownership stake in a foreign-based company.
However, that definition is flexible, as there are instances where effective controlling
interest in a firm can be established with less than 10% of the company's voting shares.
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Types of Foreign Direct Investment
Foreign direct investments are commonly cateqorized as being horizontal, vertical

or conglomerate. j »
Horizontal direct investment refers to the investor establishing the same type cf
usmess operation in a foreign country as it operates in its home country, for example, a
ce phone provider based in the United States opening stores in China. A vertical
investment is one in which different but related business activities from the investor's main
business are established or acquired in a foreign country, such as when a manufacturing
company acquires an interest in a foreign company that supplies parts or raw materials
required for the manufacturing company to make its products.
Conglomerate or Vertical direct investment type of foreign direct investment is

one where a company or individual makes a foreign investment in a business that is
unrelated to its existing business in its home country. Since this type of investment
involves entering an industry in which the investor has no previous experience, it often
takes the form of a joint venture with a foreign company already operating in the industry.
Impact of Foreign Direct Investments

Foreign direct investments and the laws governing them can be pivotal to a
company's growth strategy. In 2017, for example, U.S.-based Apple announced a $507.1
million investment to boost its research and development work in China, Apple's third-
largest market behind the Americasand Europe. The announced investment relayed CEO
Tim Cook's bullishness toward the Chinese market despite a 12% year-over-year decline
in Apple's Greater China revenue in the quarter preceding the announcement. China's
economy has been fuelled by an influx of FDI targeting the nation's high-tech
manufacturing and services, which according to China's Ministry of Commerce, grew
11.1% and 20.4% year over year, respectively, in the first half of 2017. Meanwhile, relaxed
FDI regulation in India now allows 100% foreign direct investment in single-brand retail
without government approval. The regulatory decision reportedly facilitates Apple's desire
to open a physical store in the Indian market, where the firm's iPhones have thus far only
been available through third-party physical and online retailers.
Country Risk Premium
Country Risk Premium (CRP) is the additional return or premium demanded by

investors to compensate them for the higher risk associated with investing in a foreign
country, compared with investing in the domestic market. Overseas investment
opportunities are accompanied by higher risk because of the plethora of geopolitical and
macroeconomic risk factors that need to be considered. These increased risks make
investors wary of investing in foreign countries and as a result, they demand a risk
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premium for investing in them. The country risk premium (CRP) is generally higher for
developing markets than for developed nations.
Country risk encompasses numerous factors, including:
• Political instability;
• Economic risks such as recessionary conditions, higher inflation etc.;
• Sovereign debt burden and default probability;
• Currency fluctuations;
• Adverse government regulations (such as expropriation or currency controls).
Country risk is a key factor to be considered when investing in foreign markets.

Most national export development agencies have in-depth dossiers on the risks
associated with doing business in various countries around the world. Country Risk
Premium can have a significant impacton valuation and corporate finance calculations.
The calculation of CRP involves estimating the risk premium fora mature market such as
the United States and adding a default spread to it.
Estimating/Calculating Country Risk Premium
In determining the CRP, two common approach or methodologies were observed.

These methods are sovereign debt method and equity risk method.
• Sovereign Debt Method. In the sovereign debt method, CRP for a particular
country can be estimated by comparing the spread on sovereign debt yields
between the country and a mature market like the U.S.
• Equity Risk Method. In equity risk method, CRP is measured on the basis of
the relative volatility of equity market returns between a specific country and a
developed nation.
However, there are drawbacks to both methods. If a country is perceived to have

an increased risk of defaulting on its sovereign debt, yields on its sovereign debt would
soar, as was the case fora number of European countries in the second decade of the
current millennium. In such cases, the spread on sovereign debt yields may not
necessarily be a useful indicator of the risks faced by investors in such countries. As for
the equity risk method, it may significantly understate CRP if a country's market volatility
is abnormally low because of market illiquidity and fewer public companies, which may be
characteristic of some frontier markets.
A third method of calculating a CRP number that can be used by equity investors
overcomes the drawbacks of the above two approaches. For a given Country A, country
risk premium can be calculated in Eq 8.1
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Eq 8.1 CRP= (Rc-Rf) x
Rc - Yield on a country’s US-denominated sovereign debt instrument
Ri — Risk-free rate of a same US debt instrument
cjce — standard deviation of an equity index
cTeb— standard deviation of an US debt instrument index
Annualized standard deviation is a measure of volatility. The rationale behind

comparing the volatility of the stock and sovereign bond markets fora specific country in
this method is that they compete with each other for investor funds. Thus, if a country's
stock market is significantly more volatile than the sovereign bond market, its CRP would
be on the higher side, implying that investors would demand a larger premium to invest in
the country’s equity market (compared to the bond market) as it would be deemed riskier.
Note that for the purposes of this calculation, a country's sovereign bonds should be
denominated in a currency where a default-free entity exists, such as the US dollar or
Euro.
Since the risk premium calculated in this manner is applicable to equity investing,
CRP in this case is synonymous with Country Equity Risk Premium, and the two terms
are often used interchangeably.
To illustrate for example, Philippine 10-year USD-denominated bond yields 6% in
the market, while the US 10-year Treasury bond rate is 2.5%. The standard deviation of
the Philippine Stock Market is 30% while the USD-denominated sovereign bond standard
deviation index is 15%.
CRP = 3.5% x 2
CRP = 7.0%
Countries with the highest CRP

Aswath Damodaran, Professor of Finance at NYU's Stern School of Business,
maintains a public database of his CRP estimates that are widely used in the finance
industry. As of January 2019, the countries with the highest Country Risk Premia are
shown in the Table 8.1. The Table 8.1 displays total equity risk premium in the second
column and Country (Equity) Risk Premium in the third column. As noted earlier, CRP
calculation entails estimating the risk premium for a mature market and adding a default
spread to it. Damodaran assumes the risk premium for a mature equity market at 5.96%
(as of January 1, 2019). Thus, Venezuela has a CRP of 22.14% and a total equity risk
premium of 28.10% (22.14% + 5.96%).
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Table 8.1 Countries with the Highest CRP
COUNTRIES WITH THE HIGHEST CRP
Total Equity Risk Country Risk Premium

Country
Premium
Venezuela 28.10% 22.14%
Barbados 19.83% 13.87%
Mozambique 19.83% 13.87%
Congo (Republic
18.46% 12.50%
of)
Cuba 18.46% 12.50%
El Salvador 16.37% 10.41%
Gabon 16.37% 10.41%
Iraq 16.37% 10.41%
Ukraine 16.37% 1 10.41%
Zambia 16.37% 10.41%
Incorporating CRP into the CAPM
The Capital Asset Pricing Model (CAPM) can be adjusted to reflect the additional
risks of international investing. The CAPM details the relationship between systematic risk
and expected return for assets, particularly stocks. The CAPM model, as described in Eq
8.2, is widely used throughout the financial services industry for the purposes of pricing of
risky securities, generating subsequent expected returns for assets, and calculating
capital costs.
Eq 8.2 r = Rf + p(<Rrn-rf)
r = required return on equity

Rf = risk-free rate
Rm = market return
/3 = equity beta
There are three approaches for incorporating a Country Risk Premium into the
CAPM so as to derive an Equity Risk Premium that can be used to assess the risk of
investing in a company located in a foreign country.
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As a total risk premium
The first approach assumes that every company in the foreign country is equally
exposed to country risk. While this approach is commonly used, it makes no
distinction between any two companies in the foreign country, even if one is a huge
export-oriented firm and the other is a small local business. In such case, CRP
would be added to the mature market expected return, so that CAPM would be as
illustrated in Eq 8.3.
Eq 8.3 r = Rf + (3(<Rrn-rf>) + CRP
• As part of the Market Risk Premium
The difference between market return and the risk free rate is the market risk
premium. The second approach assumes that a company's exposure to country
risk is similar to its exposure to other market risk. CAPM should be formulated in
Eq 8.4.
Eq 8.3 r = Rf + p^Rm-rf + CRP)
• The third approach considers country risk as a separate risk factor, multiplying
CRP with a variable (generally denoted by lambda or A). In general terms, a
company that has significant exposure to a foreign country - by virtue of getting a
large percentage of its revenues from that country (Sx) or having a substantial
share of its manufacturing located there - would have a higher A value than a
company that is less exposed to that country (Sc). Illustrated in 8.4
Eq 8.4 r = Rf + 0(Rm - rf) 4- (cRP X
Country Risk Premium - Pros and Cons

While most would agree that country risk premium help by representing that a
country, such as Myanmar, would present more uncertainty than, say, Germany, some
opponents question the utility of CRP. Some suggest that country risk is diversifiable. With
regard to the CAPM described above, along with other risk and return models — which
entail non-diversifiable market risk — the question remains as to whether additional
emerging market risk is able to be diversified away. In this case, some argue no additional
premium should be charged.
Others believe the traditional CAPM can be broadened into a global model, thus
incorporating various CRPs. In this view, a global CAPM would capture a single global
equity risk premium, relying on an asset’s beta to determine volatility. A final major
argument rests on the belief that country risk is better reflected in a company’s cash flows
than the utilized discount rate. Adjustments for possible negative events within a nation,
such as political and/or economic instability, would be worked into expected cash flows,
therefore eliminating the need for adjustments elsewhere in the calculation.
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Overall though, the Country Risk Premium serves a useful purpose by quantifying
the higher return expectations for investments in foreign jurisdictions, which undoubtedly
have an additional layer of risk compared with domestic investments. As of 2019, the risks
of overseas investing appear to be on the rise, given the increase in trade tensions and
other concerns globally. BlackRock, the world's largest asset manager, has a "Geopolitical
Risk Dashboard" that analyzes leading risks. As of March 2019, these risks included -
European fragmentation, US-China competition, South Asia tensions, global trade
tensions. North Korea and Russia-NATO conflicts, major terror attacksand cyber-attacks.
While some of these issues may well be resolved in time, it would seem prudent to account
for these risk factors in any evaluation of returns from a project or investment located in a
foreign country.
Cryptocurrency
A cryptocurrency is a digital or virtual currency that uses cryptography for

security. A cryptocurrency is difficult to counterfeit because of this security feature. Many
cryptocurrencies are decentralized systems based on blockchain technology, a distributed
ledger enforced by a disparate network of computers. A defining feature of a
cryptocurrency, and arguably its biggest allure, is its organic nature; it is not issued by any
central authority, rendering it theoretically immune to government interference or
manipulation.
The first blockchain-based cryptocurrency was Bitcoin, which still remains the most
popular and most valuable. Today, there are thousands of alternate cryptocurrencies with
various functions or specifications. Some of these are clones of Bitcoin while others are
forks, or new cryptocurrencies that split off from an already existing one.
Cryptocurrencies are systems that allow for the secure payments of online
transactions that are denominated in termsof a virtual "token," representing ledger entries
internal to the system itself. "Crypto" refers to the fact that various encryption algorithms
and cryptographic techniques, such as elliptical curve encryption, public-private key pairs,
and hashing functions, are employed.
The first cryptocurrency to capture the public imagination was Bitcoin, which was
launched in 2009 by an individual or group known under the pseudonym, Satoshi
Nakamoto. As of February 2019, there were over 17.53 million bitcoins in circulation with
a total market value of around $63 billion (although the market price of bitcoin can fluctuate
quite a bit). Bitcoin's success has spawned a number of competing cryptocurrencies,
known as "altcoins" such as Litecoin, Namecoin and Peercoin, as well as Ethereum, EOS,
and Cardano. Today, there are literally thousands of cryptocurrencies in existence, with
an aggregate market value of over $120 billion (Bitcoin currently represents more than
50% of the total value).
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Cryptocurrency Benefits and Drawbacks
Cryptocurrencies hold the promise of making it easier to transfer funds directly

between two parties in a transaction, without the need for a trusted third party such as a
bank or credit card company; these transfers are facilitated through the use of public keys
and private keys for security purposes. In modern cryptocurrency systems, a user's
wallet, or account address, has the public key, and the private key is used to sign
transactions. Fund transfers are done with minimal processing fees, allowing users to
avoid the steep fees charged by most banks and financial institutions for wire transfers.
Central to the appeal and function of Bitcoin is the blockchain technology it uses
to store an online ledger of all the transactions that have ever been conducted using
bitcoins, providing a data structure for this ledger that is exposed to a limited threat from
hackers and can be copied across all computers running Bitcoin software. Every new
block generated must be verified by the ledgers of each user on the market, making it
almost impossible to forge transaction histories. Many experts see this blockchain as
having important uses in technologies such as online voting and crowdfunding, and major
financial institutions such as JPMorgan Chase see potential in cryptocurrencies to lower
transaction costs by making payment processing more efficient. However, because
cryptocurrencies are virtual and do not have a central repository, a digital cryptocurrency
balance can be wiped out by a computer crash if a backup copy of the holdings does not
exist, or if somebody simply loses their private keys. At the same time, there is no central
authority, government, or corporation that has access to your funds or your personal
information.
The semi-anonymous nature of cryptocurrency transactions makes them well-
suited for a host of nefarious activities, such as money laundering and tax evasion.
However, cryptocurrency advocates often value the anonymity highly. Some
cryptocurrencies are more private than others. Bitcoin, for instance, is a relatively poor
choice for conducting illegal business online, and forensic analysis of bitcoin transactions
has led authorities to arrest and prosecute criminals. More privacy-oriented coins do exist,
such as Dash, ZCash, or Monero, which are far more difficult to trace.
Since prices are based on supply and demand, the rate at which a
cryptocurrency can be exchanged for another currency can fluctuate widely.
However, plenty of research has been undertaken to identify the fundamental price
driversof cryptocurrencies. Bitcoin has indeed experienced some rapid surges and
collapses in value, reaching as high as $19,000 per bitcoin in December of 2017
before returning to around $7,000 in the following months. Cryptocurrencies are
thus considered by some economists to be a short-lived fad or speculative bubble.
There is concern especially that the currency units, such as bitcoins, are not rooted
in any material goods. Some research has identified that the cost of producing a
bitcoin, which takes an increasingly large amount of energy, is directly related to
its market price.
Cryptocurrencies' blockchains are secure, but other aspects of a
cryptocurrency ecosystem are not immune to the threat of hacking. In Bitcoin’s 10-
year history, several online exchanges have been the subject of hacking and theft,
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FUNDAMENTALS OF FINANCIALM A R K ET
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sometimes with millions of dollars’ worth of 'coins' stolen. Still, many observers
look at cryptocurrencies as hope that a currency can exist that preserves value,
facilitates exchange, is more transportable than hard metals, and is outside the
influence of central banks and governments.
Offshore banking Unit (OBU)
An offshore banking unit (OBU) is a bank shell branch, located in another

international financial center (or, in the case of India, a Special Economic Zone). Offshore
banking units (OBUs) make loans in the Eurocurrency market, when they accept deposits
from foreign banks and other OBUs. Local monetary authorities and governments do not
restrict OBUs' activities; however, they are not allowed to accept domestic deposits or
make loans to residents of the country, in which they are physically situated. Overall OBUs
can enjoy significantly more flexibility regarding national regulations.
OBUs have proliferated across the globe since the 1970s. They are found
throughout Europe, as well as in the Middle East, Asia and the Caribbean. U.S. OBUs are
concentrated in the Bahamas, the Cayman Islands, Hong Kong, Panama and Singapore.
In some cases, offshore banking units may be branches of resident and/or nonresident
banks; while in other cases an OBU may be an independent establishment. In the first
case the OBU is within direct control of a parent company; in the second, even though an
OBU may take the name of the parent company, the entity’s management and accounts
are separate.
Some investors may, at times, consider moving money into OBUs to avoid taxation
and/or retain privacy. More specifically, tax exemptions on withholding tax and other relief
packages on activities, such as offshore borrowing, are occasionally available. In some
cases, it is possible to to obtain better interest rates from OBUs. Offshore banking units
also often do not have currency restrictions. This enables them to make loans and
payments in multiple currencies, often opening more flexible international trade options.
History of Offshore Banking Units
The euro market allowed the first application of an offshore banking unit. Shortly
afterwards Singapore, Hong Kong, India and other nations followed suit as the option
allowed them to become more viable financial centers. While it took Australia longer to
join, given less favorable tax policies, in 1990, the nation established more supportive
legislation.
In the United States, the International Banking Facility (IBF) acts as an in-house
shell branch. Its function serves to make loans to foreign customers. As with other OBUs,
IBF deposits are limited to non-U.S. applicants.
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FUNDAMENTALS OF FINANCIAL MARKET^
The World Bank
War II Rirnr^°rl? Bank Group (WBG) was established in 1944 to rebuild post-World
It is one of a *nternat'°nal Bank for Reconstruction and Development (IBRD).
J rie y of organizations seeking to shape the world economy.
r>r>wOrtx/T1°d^x’ World Bank functions as an international organization that fights
P ° erin9developmental assistance to middle-income and low-income countries.
\i\i ?a?S and °ffer>ng advice and training in both the private and public sectors, the
World Bank aims to eliminate poverty by helping people help themselves. Under the World
Bank Group, there are complementary institutions that aid in its goals to provide
assistance.
Membership in the World Bank
As of 2019, There are 189 member countries that are shareholders in the IBRD,
the primary arm of the WBG. To become a member, however, a country must first join the
International Monetary Fund (IMF). The size of the World Bank's shareholders, like that of
the IMF's shareholders, depends on the size of a country's economy. Thus, the cost of a
subscription to the World Bank is a factor of the quota paid to the IMF.
Joining the IMF comes with a variety of

Point of Information! responsibilities that help it carry out its functions. There is
an obligatory subscription fee, which is equivalent to
Board of Governors are
composed of representatives 88.29% of the quota that a country has to pay to the IMF.
of the member countries. It is In addition, a country is obligated to buy 195 World Bank
consists of 1 governor and shares (US$120,635 per share, reflecting a capital
alternate governor. Normally increase madein 1988). Of these 195 shares, 0.60% must
it is the country’s chief be paid in cash in U.S. dollars, while 5.40% can be paid
finance minister assumes
in a country's local currency, in U.S. dollars, or in non-
the governor role.
negotiable non-interest bearing notes. The balance of the
195 shares is left as "callable capital," meaning the World
Bank reserves the right to ask for the monetary value of these shares when and if
necessary. A country can subscribe a further 250 shares, which do not require payment
at the time of membership but are left as "callable capital."
The president of the World Bank comes from the largest shareholder, which is the
United States, and members are represented by a board of governors. Throughout the
year, however, powers are delegated to a board of 24 executive directors (EDs). The five
largest shareholders—the U.S., U.K., France, Germany, and Japan—each have an
individual ED, and the additional 19 EDs represent the rest of the member states as groups
of constituencies. Of these 19, however, China, Russia, and Saudi Arabia have opted to
be single-country constituencies, which means that they each have one representative
within the 19 EDs. This decision is based on the fact that these countries have large,
influential economies, requiring that their interests be voiced individually rather than
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FUNDAMENTALS OF FINANCIALMAP^r-p
PDFelement
diluted within a group. The World Bank gets its funding from rich countries, as well as from
the issuance of bonds on the world's capital markets.
Sectors of World Bank Group
In order for the World Bank to carry its mission to its member states it created
different sectors to address the financing needs of these nations. Most of them took the
form of financing institutions or dispute agencies.
The International Bank of Construction and Development (IBRD) aids middle
income and poor, but creditworthy, countries. It also works as an umbrella for more
specialized bodies under the World Bank. The IBRD was the original arm of the World
Bank that was responsible for the reconstruction of post-war Europe. Before gaining
membership in the WBG's affiliates (the International Development Association, the
International Finance Corporation, the Multilateral Investment Guarantee Agency and the
International Centre for Settlement of Investment Disputes), a country must be a member
of the IBRD.
The International Development Association offers loans to the world's poorest
countries. These loans come in the form of "credits" and are essentially interest-free. They
offer a 10-year grace period and hold a maturity of 35 years to 40 years.
The Multilateral Investment Guarantee Agency (MIGA) supports direct foreign
investment into a country by offering security against the investment in the event of political
turmoil. These guarantees come in the form of political risk insurance, meaning that MIGA
offers insurance against the political risk that an investment in a developing country may
bear.
The International Centre for Settlement of Investment Disputes facilitates and
works towards a settlement in the event of a dispute between a foreign investor and a
local country.
The International Finance Corporation (IFC) works to promote private sector
investments by both foreign and local investors. It provides advice to investors and
businesses, and it offers normalized financial market information through its publications,
which can be used to compare across markets. The IFC also acts as an investor in capital
markets and will help governments privatize inefficient public enterprises.
The International Finance Corporation (IFC) is an organization dedicated to
helping the private sector within developing countries. It provides investment and asset
management services to encourage the development of private enterprise in nations that
might be lacking the necessary infrastructure or liquidity for businesses to secure
financing.
The IFC was established in 1956 as a sector of the World Bank Group, focused on
alleviating poverty and creating jobs through the development of private enterprise. To
that end, IFC also ensures that private enterprises in developing nations have access to
markets and financing. Its most recent goals include the development of sustainable
242 I
PDFelement
^provernenteXa«nd'?9 Smal1 businesses’ access to microfinance, infrastructure

itsP184 n^mh ’ W® 35 Climate’ health, and education policies. The IFC is governed by
lts 184 membercountr.es and is headquartered in Washington, D.C.
A classic example of an IFC investment is in 2017. The IFC invested in Pakistan’s

airy in u ry. Although Pakistan is the fourth-largest milk-producing country in the world,
demand has consistently outpaced supply. Coupled with poor infrastructure and an
ou a e supply chain, Pakistan’s dairy increasingly falls short of its ability to deliver what s
expected. Small subsistence farms account for nearly 80 percent of the industry’s output,
making things inefficient.
The IFC s contributed $145 million to one of the world’s largest dairy producers,
FrieslandCampina, to help it acquire 51 percent of Engro Foods, Pakistan’s leading dairy
processor. The Dutch cooperative FrieslandCampina has promised to share its
experience and best practices with the smaller farmers who supply Engro Foods, along
with the majority of the dairy processors in Pakistan. The goal is to help these small
farmers increase productivity and decrease their waste.
The IFC expects that 200,000 farmers and 270,000 distributors will benefit from
FrieslandCampina's acquisition of Engro Foods. In addition, the return on investment
(ROI)forthe IFC will be a projected 1,000 new jobs in the dairy supply chain.
The IFC views itself as a partner to its clients, delivering not only support with
financing but also technical expertise, global experience, and innovative thinking to help
developing nations overcome a range of problems, including financial, operational, and
even at times political. The IFC also aims to mobilize third-party resources for its projects,
often engaging in difficult environments and leading crowding-in private finance, with the
notion of extending its impact beyond its direct resources
Comparison of International Financial Markets
Below figure illustrates the foreign cash flow movementsofa typical MNC. These
cash flows can be classified into four corporate functions, all of which generally require
use of the foreign exchange markets. The spot market, forward market, currency futures
market, and currency options market are all classified as foreign exchange markets.
The first function is foreign trade with business clients Exports generate foreign
cash inflows, while imports require cash outflows A second function is direct foreign
investment, or the acquisition of foreign real assets This function requires cash outflows
but generates future inflows through remitted dividends back to the MNC parent or the
sale of these foreign assets A third function is short-term investment or financing in foreign
securities. The Eurocurrency market is commonly used for this purpose A fourth function
is long-term financing in the Eurocredit. Eurobond, or international stock markets.
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PDFelement
Long Term Financing
Figure 8.1 Relationship and Dynamics of International Financial Market
How Financial Markets Affect an MNC’s Value
The use of international financial markets can affect the value of an MNC, as shown in
figure below. To the extent that issuing stock in a foreign market creates more name
recognition in a foreign country, an MNC may be able to increase its presence in that
country, which can lead to higher cash flows generated from that country and a higher
valuation. Financial markets can also affect an MNC’s value by influencing the cost of
borrowing forforeign customers of the MNC. Changes in foreign interest rates can affect
economic growth, which in turn affects the demand for products sold by foreign
subsidiaries of the MNC. A lower interest rate can stimulate borrowing and spending,
which would result in a higher demand for products produced by the foreign subsidiaries
and therefore increase foreign currency cash flows. Conversely, an increase in local
interest rates would reduce economic growth in the country, reduce the demand for the
foreign subsidiary’s products, reduce its foreign currency cash flows, and therefore reduce
its value. Since interest rates commonly vary among countries, an MNC’s parent may use
the Eurocurrency, Eurocredit, or Eurobond market to obtain funds at a lower cost than the
cost of funds obtained locally. It reduces its cost of debt and therefore reduces its weighted
average cost of capital, which results in a higher valuation. An MNC’s parent may be able
to achieve a lower weighted average cost of capital by issuing equity in some foreign
markets rather than issuing equity in its local market. If the MNC achieves a lower cost cf
capital, it can achieve a lower required rate of return and a higher valuation.
244
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FUNDAMENTALS OF financialmarket
————-—
SUMMARY
• The existence of imperfect markets has precipitated the interna

of financial markets.
trade or financial transactions.
gold standard, to g°r excân9'n9 foreign currencies has evolved from the
greement on fixed exchange rates, to a floating rate
Companies normally exchange one currency for another through a

commercial bank over a telecommunications network such as spot market,
orward contracts, and currency futures and options.
• The Eurocurrency market is composed of several large banks that accept

deposits and provide short-term loans in various currencies. This market is
primarily used by governments and large corporations.
• The Eurocredit market is .composed of the same commercial banks that

serve the Eurocurrency market. These banks convert some of the deposits
received into Eurocredit loans (for medium-term periods) to governments
and large corporations.
• The Eurobond market facilitates international transfers of long-term credit,

thereby enabling governments and large corporations to borrow funds from
various countries. Eurobonds are underwritten by a multinational syndicate
of investment banks and are placed in various countries.
• Eurocurrency, Eurocredit, and Eurobond markets enable firms to borrow

funds in foreign countries while international stock markets enable firms to
obtain equity financing in foreign countries. Thus, these marketshave helped
MNCs finance their international expansion.
• The use of international financial markets can affect the value of an MNC
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PDFelement
NAME: _________ ___________________ __________ Date:
true.
1. When international trade in financial assets is easy and reliable, due to low
transactions costs in liquid markets, we say international financial markets
are characterized by high capital mobility.
2. The early 20th century brought two world wars and the Great Oppression.
3. Post-war efforts to increase the stability and integration of markets for
goods and services included the creation of the General Agreement on
Tariffs and Trade (the GATT, the precursor to the World Health
Organization, or WHO).
4. The high level of capital mobility is reflected in the economic models of the
1950s and 1960s: economists felt comfortable conducting international
analyses under the assumption of capital immobility.
5. Industrial Revolution lowered the costs of international transactions. These
factors, combined with the liberalizations of capital controls in the 1970s
and 1980s, led to the development of highly integrated world financial
markets.
6. International capital flows surged after the oil shock of 1973 to 1974, which
spurred financial intermediation on a global scale.
7. The Mexican peso crisis of December 1994 led to a modest slowdown in
capital flows to emerging markets in 1995, they surged again thereafter
until the Asian crisis erupted in the summer of 1997.
8. The existence of perfect markets has precipitated the internationalization
of financial markets.
9. Motives for Investing in Foreign Market: Economic conditions. Investors

may expect firms in a particular foreign country to achieve more favorable
performance than those in the investor’s home country.
10. Motives for Investing in Foreign Market: Exchange rate expectations.

Some investors purchase financial securities denominated in a currency
that is expected to appreciate against their own.
11. Motives for Investing in Foreign Market: International diversification.

Investors may achieve benefits from internationally diversifying their asset
portfolio.
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FUNDAMENTALS OF ciNANCIALMARKET
Some country Vldin9 Credit in foreign markets: Low foreign interest ra

market int^r exPer'ence a shortage of loanable funds, which can cau
risk Fortin 1 rat®S tO be relatively high, even after considering defau
therehv J9" cred,tors may attempt to capitalize on the higher rates,
thereby providing capital to overseas markets.
f°r Providing Credit in foreign markets: Exchange rate

expectations. Creditors may consider supplying capital to countries whose
currencies are expected to appreciate against their own.
diversification Debto^*09 Credit in foreign markets: International

may reduce thf» ber>efit from international diversification, which
he probabl,lty Of simultaneous bankruptcy across borrowers.
15. Motives in Borrowing in Foreign Markets: Low interest rates. Some
countries have a large supply of funds available compared to the demand
for funds, which can cause relatively low interest rates.
16. Motives in Borrowing in Foreign Markets: Exchange rate expectations.

When a foreign subsidiary of a U.S.-based MNC remits funds to its U.S.
parent, the funds must be converted to dollars and are subject to exchange
rate risk.
17. The foreign exchange market allows currencies to be exchanged in order

to facilitate international trade or financial transactions.
18. The system used forexchanging foreign currencies has evolved from the
barter standard, to an agreement on fixed exchange rates, to a floating rate
system.
19. Silver Standard. From 1876 to 1913, exchange rates were dictated by the
silver standard. Each currency was convertible into silver at a specified
rate.
20. Agreements on Fixed Exchange Rates. In 1944, an international

agreement (known as the Bretton Woods Agreement) called for fixed
exchange rates between currencies. This agreement lasted until 1971.
21. Floating Exchange Rate System. Even after the Smithsonian Agreement,
governments still had difficulty maintaining exchange rates within the
stated boundaries.
22. Companies normally exchange one currency for another through a
commercial bank over a telecommunications network.
23. Spot Market. The most common type of foreign exchange transaction is
for immediate exchange at the so-called forward rate. The market where
these transactions occur is known as the spot market.
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PDFelement
24. A currency futures contract specifies the amount of a particular currency

that will be purchased or sold by the MNC at a specified future point in time
and at a specified exchange rate.
25. MNCs commonly use the forward market to hedge future payments that
they expect to make or receive in a foreign currency. In this way, they do
not have to worry about fluctuations in the spot rate until the time of their
future payments.
26. A currency futures contract specifies nonstandard volume of a particular
currency to be exchanged on a specific settlement date. Some MNCs
involved in international trade use the currency futures markets to hedge
their positions.
27. Futures contracts are somewhat similar to forward contracts except that
they are sold on an exchange whereas forward contracts are offered by
commercial banks.
28. Currency options contracts can be classified as calls or puts. A currency
call option provides the right to buy a specific currency at a specific price
(called the strike price or exercise price) within a specific period of time. It
is used to hedge future receivables.
29. A currency put option provides the right to sell a specific currency at a
specific price within a specific period of time. It is used to hedge future
payables.
30. The Eurodollar market was created as joint ventures in the United States
deposited U.S. dollars in European banks. These European banks were
willing to accept dollar deposits, since they could then lend dollars to
corporate customers based in Europe.
31. U.S.-dollar deposits in banks located in Europe and on other continents

as well became known as Eurodollars.
32. The Eurocurrency market is composed of several large banks (referred to

as Eurobanks) that accept deposits and provide loans in various
currencies.
33. The syndicate of banks is usually formed in about six weeks, or less if the
borrower is well known because the credit evaluation can then be
conducted more quickly.
34. The trend toward globalization in the banking industry is attributed to the
growing standardization of regulations around the world. Two of the more
significant regulatory events allowing fora more competitive global playing
field are (1) the Single European Act and (2) the Basel Accord
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F U N DA M E NTA LSOF FINANCIAL-MARKET
35. On© of th©

Single European1 Art^k^ events affecting international banking is the
European Union (EU)countCh W3S phased in by 1992 throu9hout the
36. In July 1988, in the Basel Accord, central bank governors of .the Is
countries agreed on standardized guidelines. Capital was caDital
either Tier 1 ("supplemental") capital or Tier 2 ("core") capital (Tier 1 cap
being at least 4 percent of risk-weighted assets).
37. Although the Eurocurrency market can be broadly deflâd currencies

banks in Asia that accept deposits and make loans in or 9 as the
(mostly dollars), this market is sometimes referred to sep
Asian dollar market.
38- The only significant difference between the Asian market and the
Eurocurrency market is spelling.
39. Loans of one year or longer extended by Eurobanks to MNCs or
government agencies are commonly called Eurocredits or Eurocredit
loans.
40. MNCs can access long-term funds in foreign markets by issuing bonds in
the international bond markets. International bonds are typically classified
as either foreign bonds or Eurobonds.
41. Eurobonds have several distinguishing features. They usually are issued
in order form, and coupon payments are made yearly.
42. The recent conversion of many European countries to a single currency
(the euro) has resulted in more stock offerings in Europe by U.S.- and
European-based MNCs.
43. Non-U.S. corporations or governments that need large amounts of funds
sometimes issue the stock in the United States (these are called Yankee
stock offerings) due to the liquidity of the new-issues market there.
44. Although the U.S. market offers an advantage for new stock issues due
to its size, the registration requirements can sometimes cause delays in
selling the new issues. For this reason, some U.S. firmshave issued new
stock in foreign markets in recent years.
45. The adoption of the euro by many European countries has encouraged
MNCs based in Europe to issue stock. Investors throughout Europe are
more willing to invest in stocks when they do not have to worry about
exchange rate effects.
46. Some foreign stock markets are much smaller than the U.S. markets
because their firms have relied more on equity financing than debt
financing in the past.
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PDFelement
1. u . . .h fhA amount of trading relative to market

Market charactenstics
47,capitalization such as tne amuu
and the appltcabte lax rates can vary ..iharfaniiniiv/
substantially among
emerging markets
48 in recent years, etectric communications networks (ECNs) have been
created to match orders between buyers and sellers ECN.donothave a
visible trading floor, as the trades are execute y P
49 The spot market, forward market, currency futures market, and currency
options market are all classified as foreign stoc mar
50. Financial marketscan also affect an MNC's value by influencing the cost
of borrowing for foreign customers of the MNC. Changes in foreign interest
rates can affect economic growth, which in turn affects the demand for
products sold by foreign subsidiaries of the MNC.
PDFelement
------------------------------- FUNDAMENTALS OF FINANCIALMARKET
NAME:___________ ______
—------------ ----------- Date:
E8-2. Crossword. Fill un tho
P crossword puzzle based on the description or definition
given.
Across Down
3. Market that for immediate exchange 1. CRP is risk premium
7. Loans extended by Eurobanks to Multinational Corporations 2. Exchange for specific standard volume of currency to be traded in the
9. This could either be cafl or put future rate
4. Exchange Rate System is used to manage fluctuation wrth
10. Currency used in the EuroCurrency Market
market forces
5. A digital or virtual currency that uses cryptography for security
6. Investments made by a firm to another country
8. Oldest international currency used since 1876
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NAME: _ ________________ Date:
1 GATT is the precursor of WTO. GATT means ________________ •

a. General Agreement on Tariffsand Trade
b. Global Agreement on Tariffsand Trade
c. General Agreement on Trade and Tariffs
d. Global Agreement on Trade and Tariffs
2. What precipitated the internationalization of financial markets?

a. World War I
b. World War II
c. Existence of Imperfect market
d. Capital immobility
3. Which of the following is not a motive for Investing in the Foreign Market?
a. Economic Conditions
b. Exchange rate expectations
c. International Diversification
d. High foreign interest rates
4. Which of the following is not a motive for providing Credit in Foreign Market?
a. Low foreign interest rate
5. Which of the following is a motive for Borrowing in Foreign Markets?

a. Economic Conditions
6. MNCsrely on the to exchange their home

currency for a foreign currency that they need to purchase imports or use for direct
foreign investment.
a. Foreign Currency Market
b. Financial Exchange Market
c. Foreign Exchange Market
d. Financial Currency Market
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PDFelement
7. Which of the following is not related to the system used for exchanging foreign
currencies?
a. Gold Standard
b. Barter System
c. Bretton Woods Agreement
d. Floating Exchange Rate System
------------------------ is the most common type of foreign exchange transaction.

a. Spot Market
b. Forward Market
c. Futures Market
d. Option Market
A specifies the amount of a particular currency that will be

purchased or sold by the MNC at a specified future point in time and at a specified
exchange rate.
a. Spot Contract
b. Forward Contract
c. Futures Contract
d. Option Contract
10. are somewhat similar to forward contracts except that they are
sold on an exchange whereas forward contracts are offered by commercial banks.
a. Spot Contract
b. Forward Contract
c. Futures Contract
d. Option Contract
11. A currency call option provides the right to buy a specific currency at a specific price
(called the strike price or exercise price) within a specific period of time. It is used to
hedge .
a. future payables
b. future receivables
c. contingent payable
d. contingent receivables
12. A currency put option provides the right to sell a specific currency at a specific price
within a specific period of time. It is used to hedge .
a. future payables
b. future receivables
c. contingent payable
d. contingent receivables
13 Which of the following statements is incorrect related to Eurocurrency market?
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f UNOAMf NTALSOF PDFelement
FINANCIAL MARKET
» The Eurodollar martuM was created a* corporations in the United States deposited
U S dollars in European banks
b The growth of the Eurodollar market was stimulated by U.S. regulations in 1968,
which limited foreign lending by U S banks
c Eurodollar deposits were not subject to reserve requirements.
d The Eurocurrency market m composed of several large banks (referred to as
Eurobanks) that accept loans and provide deposits in various currencies.
14 Countries in the OPEC also use the Eurocurrency market to deposit a portion of their
petroleum revenues OPEC stands for __________________ ■
a Organization of Petroleum Exporting Countries
b Organized Petroleum Exporting Countries
c Organized Petroleum Exporters Cooperation
d Organization of Petroleum Exporters Cooperation
15 Although the Eurocurrency market concentrates on large-volume transactions, at

times no single Eurobank may be willing to provide the amount needed by a particular
corporation or government agency. In this case, a of Eurobanks
may be organized.
a. group
b. joint venture
c. corporation
d. syndicate
16. Which of the following is not a relevant provision of Single European Act?
a. Capital can flow freely throughout Europe.
b. Banks can offer a wide variety of lending, leasing, and securities activities in the EU.
c. Regulations regarding competition, mergers, and taxes are similar throughout the
EU.
d. A bank established in any one of the EU countries has the right to expand into any
or all of the other EU countries and Asian countries.
17. Two of the more significant regulatory events allowing fora more competitive global
playing field are .
a. Single Euro Currency Act of 1992 and Basel Accord of 1988
b. Single European Act and Basel Accord
c. Uniform European Act for the banking Industry and Basel Uniform Bank Standards
d. Uniform Currency Act and Basel Uniform Standards
18. Although the Eurocurrency market can be broadly defined to include banks in Asia
that accept deposits and make loans in foreign currencies (mostly dollars), this market
is sometimes referred to separately as the . Most activity takes
place in Hong Kong and Singapore.
a. Asian Dollar Market
b. Hong Kong EU dollar Market
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FINANCIAL MARKET
c. Singapore EU dollar market

d. Hong Kong and Singapore EU dollar market
19 °r !°n9er extended by Eurobanks to MNCsor government

The so-Slted "'y called ____________ loans. These loans are provided in
market.
a. Foreign credit
b. Eurocredit
c. Eurobonds
d. Eurocurrency
20. Which of the following statement is not correct?

a- Loans of one year or longer extended by Eurobanks to MNCsor government
agencies are commonly called Eurocredits or Eurocredit loans.
b. Because Eurobanks accept short-term deposits and sometimes provide longer term
loans, their asset and liability maturities do match.
c. To avoid this risk, Eurobanks now commonly use floating rate Eurocredit loans. The
loan rate floats in accordance with the movement of some market interest rate,
such as the London Interbank Offer Rate (LIBOR), which is the rate commonly
charged for loans between Eurobanks.
d. The premium paid above LIBOR will depend on the credit risk of the borrower.
21. MNCs can access long-term funds in foreign markets by issuing bonds in the
international bond markets. International bonds are typically classified as either foreign
bonds or .
a. Foreign credit
b. Eurocredit
c. Eurobonds
d. Eurocurrency
22. Which of the following is not a feature of Eurobonds?

a. Denominations
b. Secondary Market
c. Ratings
d. All of the above
23. Which of the following is not correct about International Stock Market?
a. MNCs and domestic firms commonly obtain long-term funding by issuing stock
locally. Yet, MNCs can also attract funds from foreign investors by issuing stock in
international markets.
b. the issuance of stock in a foreign country can enhance the firm’s image and name
recognition there.
c. The recent conversion of many European countries to a single currency (the euro)
has resulted in few stock offerings in Europe by U.S.-and European-based MNCs.
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<5 The stock oh***^g mey be mom *m»s*V <i<gestpd wfi<*n rt ♦« rs*u*»d tn several
maftm
24 NcwU s corpora'' «ns <x pcvemmeot* that need torQ*» amounts of funds sometimes
•*»**MP the stock in the Umm State* to toe kow*My of the new issues market there
f beep offerings are ratted __________________ —•
a Van* ee Stock Offerings
b USf’ ck Offerings
C EU Stock Offerings
d Initial Stock Offerings
25 in recent years. ECNs have been created to match orders between buyers and
setters ECNs do not have a visible trading floor, as the trades are executed by a
computer network ECN stands for _
a Electnc Communications Network
b Extended Communications Network
c Electronic Communications Network
d Expanded Communications Network
26 Which of the following is not a popular ECN?

a Archipelago
b. Instmet
c. Tradebook
d Exchange
27. International Financial Markets involve cashflows that can be classified into four
corporate functions. Which of the following is not?
a. Foreign Trade with Business Clients
b. Direct Foreign Investment
c. Short Term Investment
d. long term Investment
28. Which of the following is not within the function of long-term financing?
a. Eurobond
b. Eurocredit
c. International Stock Market
d. Commercial Paper
29. Which of the following is not correct?

a. The use of international financial marketscan affect the value of an MNC
b. To the extent that issuing stock in a foreign market creates more name recognition
in a foreign country, an MNC may be able to increase its presence in that country,
which can lead to higher cash flows generated from that country and a lower
valuation.
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"tarkete can also affect an MNC's value by influencing the cost of

borrowing for foreign customers of the MNC. Changes m foreign interest rates can
arrect economic groz/th, //hich in turn affects the demand for products sold by
foreign subsidiaries of the MNC.
d. An MNC s parent may be able to achieve a lo//er //eighted average cost of capital
by issuing equity in some foreign markets rather than issuing equity in its local
market. If the MNC achieves a lower cost of capital, it can achieve a lower required
rate of return and a higher valuation.
30. MNC stands for?

a. Multinational Companies
b. Multicurrency Companies
c. Multiportfolio Companies
d. Multilocation Companies
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FINANCIALMA R K FT
Date:
Use of lntemart»ot'»i»i Finiw»c»/wl Markets Like most MNCs, Nike frequently uses
1
international financial markets to facilitate its international business operations
Since its cush flcnvs are poing to or coming from foreign subsidiaries. Nike
freouentiy uses the foreign exchange market to facilitate its transactions It also
maintains short-term deposits at foreign banks and has access to short-term debt
from foreign banks It issued bonds denominated in Japanese yen to borrow the
equivalent of about $100 million Why do you think that Nike's foreign
subsidiaries do not just rely on a large bank in the United States to provide all of
its foreign exchange services and its deposit or loan services?
Bullet. Inc., a U S. firm, is planning to issue new stock in the United States during
2
this month The only decision still to be made is the specific day on which the
stock will be issued Why do youthink Bullet monitors results of the Tokyo stock
market every morning?
Recently, Wal-Mart established two retail outlets in the city of Shanzen, China,
3
which has a population of 3.7 million. These outlets are massive and contain
products purchased locally as well as imports. As Wal-Mart generates earnings
beyond what it needs in Shanzen, it may remitthose earnings back to the United
States. Wal-Mart is likely to build additional outlets in Shanzan or in other cities in
the future a. Explain how the Wal-Mart outlets in China would use the spot
market in foreign exchange, b. Explain how Wal-Mart might utilize the
Eurocurrency market when it is establishing other Wal-Mart stores in Asia. c.
Explain how Wal-Mart could use the Eurobond market to finance the
establishment of new outlets in foreign markets.
4. How do you think the terrorist attack on the United States could cause a decline
in U.S. interest rates? Given the potential decline in U.S. interest rates and stock
prices, how might capital flows between the United States and other countries be
affected?
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Appendix 1
AMENDED IRR ON
REPUBLIC ACT NO. 9160
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fun damentalsof financial m a r k et
REVISED IMPLEMENTING RULES AND REGULATIONS

OF REPUBLIC ACT NO. 9160, AS AMENDED
BY REPUBLIC ACT NO. 9194 AND REPUBLIC ACT NO. 10167
RULE 1
Title
Rule 1.a. Title. - These Rules shall be known and cited as the "Revised Implementing Rules and
Regulations of Republic Act No. 9160” otherwise known as The Anti-Money Laundering Act of
2001, as amended by Republic Act. No. 9194 and Republic Act No. 10167 (the AMLA, as
amended).
Rule 1.b. Purpose.- These Rules are promulgated to prescribe the procedures and guidelines for
the implementation of the AMLA, as amended.
RULE 2
Declaration of Policy
Rule 2. Declaration of Policy. - It is hereby declared the policy of the State to protect the integrity
and confidentiality of bank accounts and to ensure that the Philippines shall not be used as a money
laundering site for the proceeds of any unlawful activity. Consistent with its foreign policy, the
Philippines shall extend cooperation in transnational investigations and prosecutions of persons
involved in money laundering activities wherever committed.
RULE 3
Definitions
Rule 3. Definitions. - For purposes of this Act, the following terms are hereby defined as follows:
Rule 3. a. “Covered Institution” refers to:
Rule 3.a.1. Banks, offshore banking units, quasi-banks, trust entities, non-stock savings and
loan associations, pawnshops, foreign exchange dealers, money changers, remittance agents,
electronic money issuers and other financial institutions which under special laws are subject to
Bangko Sentral ng Pilipinas (BSP) supervision and/or regulation, including their subsidiaries and
affiliates.
(a) A subsidiary means an entity more than fifty percent (50%) of the outstanding voting stock of
which is owned by a bank, quasi-bank, trust entity or any other institution supervised or regulated
by the BSP.
(b) An affiliate means an entity at least twenty percent (20%) but not exceeding fifty percent (50%)
of the voting stock of which is owned by a bank, quasi-bank, trust entity, or any other institution
supervised and/or regulated by the BSP.
Rule 3.a.2. Insurance companies, insurance agents, insurance brokers, professional

reinsurers, reinsurance brokers, holding companies, holding company systems, pre-need
companies, mutual benefit associations and all other persons and entities supervised and/or
regulated by the Insurance Commission (IC).
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(a) An insurance company includp<i th

Philippines, whether life or non-iif^ n°se entities authorized to transact insurance business in the
a foreign entity. A contract nf 300 whether domestic, domestically incorporated or branch of
consideration to indemnify anothJrt^nC? .'S an a9reement whereby one undertakes fora
contingent event. Transactino °SL °SS’ dama9e or liability arising from an unknown or
insurer, any insurance contract nr bus,ness lnc,udes making or proposing to make, as
merely incidental to any other’ leaftUnX h COntract of suretyshiP as a vocat,on and. not as
business SDecificallv rJLJ- .I®9 1 mate business or activity of the surety, doing any kind of
meaning of Presidential Decree^D iTfii?9 d°in0 °f 3n insurance busineas within
dninn nr nronnQinn ° u *. D*' No- 612> as amended, including a reinsurance business and
.9 . h any business *n substance equivalent to any of the foregoing in a manner
designed to evade the provisions of P.D. No. 612, as amended.
(b) An insurance agent includes any person who solicits or obtains insurance on behalf of any
insurance company or transmits fora person other than himself an application fora policy or
contract ot insurance to or from such company or offers or assumes to act in the negotiation of
such insurance.
(c) An insurance broker includes any person who acts oraids in any manner in soliciting, negotiating
or procuring the making of any insurance contract or in placing risk or taking out insurance, on
behalf of an insured other than himself.
(d) A professional reinsurer includes any person, partnership, association or corporation that
transacts solely and exclusively reinsurance business in the Philippines, whether domestic,
domestically incorporated or a branch of a foreign entity. A contract of reinsurance is one by which
an insurer procures a third person to insure him against loss or liability by reason of such original
insurance.
(e) A reinsurance broker includes any person who, not being a duly authorized agent, employee or
officer of an insurer in which any reinsurance is effected, acts oraids in any manner in negotiating
contracts of reinsurance or placing risks of effecting reinsurance, for any insurance company
authorized to do business in the Philippines.
(f) A holding company includes any person who directly or indirectly controls any authorized
insurer. A holding company system includes a holding company together with its controlled insurers
and controlled persons.
(g) A pre-need company refers to any corporation registered with the Commission and
authorized/licensed to sell or offer to sell pre-need plans. The term “pre-need company” also refers
to schools, memorial chapels, banks, non-bank financial institutions and other entities which have
also been authorized/licensed to sell or offer to sell pre-need plans insofar as their pre-need
activities or business are concerned.
Pre-need plans are contracts, agreements, deeds or plans for the benefit of the planholders
which provide for the performance of future service/s, payment of monetary considerations or
delivery of other benefits at the time of actual need or agreed maturity date, as specified therein, in
exchange for cash or installment amounts with or without interest or insurance coverage and
includes life, pension, education, interment and other plans, instruments, contracts or deeds as
may in the future be determined by the Commission.
(h) Mutual Benefit Association refers to any society, association or corporation, without capital
stock, formed or organized not for profit but mainly for the purpose of paying sick benefits to
members, or of furnishing financial support to members while out of employment, or of paying to
relatives of deceased members of fixed or any sum of money, irrespective of whether such aim or
purpose is carried out by means of fixed dues or assessments collected regularly from the
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members, or of providing, by the issuance of certificates of insurance, payment of its members of

accident or life insurance benefits out of such fixed and regular dues or assessments, but in no
case shall include any society, association, or corporation with such mutual benefit features and
which shall be carried out purely from voluntary contributions collected not regularly and or no fixed
amount from whomsoever may contribute.
Rule 3.a.3. (i) Securities dealers, brokers, salesmen, investment houses, investment agents
and consultants, trading advisors, and other entities managing securities or rendering similar
services; (ii) mutual funds or open-end investment companies, close-end investment companies,
common trust funds or issuers and other similar entities; (iii) transfer companies and other similar
entities; and (iv) other entities administering or otherwise dealing in currency, commodities or
financial derivatives based thereon, valuable objects, cash substitutes and other similar monetary
instruments or property supervised and/or regulated by the Securities and Exchange Commission
(SEC).
(a) A securities broker includes a person engaged in the business of buying and selling securities
for the account of others.
(b) A securities dealer includes any person who buys and sells securities for his/her account in the
ordinary course of business.
(c) An investment house includes an enterprise which engages or purports to engage, whether
regularly or on an isolated basis, in the underwriting of securities of another person or enterprise,
including securities of the Government and its instrumentalities.
(d) A mutual fund or an open-end investment company includes an investment company which is
offering for sale or has outstanding, any redeemable security of which it is the issuer.
(e) A closed-end investment company includes an investment company other than open-end
investment company.
(f) A common trust fund includes a fund maintained by an entity authorized to perform trust
functions under a written and formally established plan, exclusively for the collective investment
and reinvestment of certain money representing participation in the plan received by it in its capacity
as trustee, for the purpose of administration, holding or management of such funds and/or
properties for the use, benefit or advantage of the trustor or of others known as beneficiaries.
(g) Investment Advisor/Agent/Consultant shall refer to any person:
(1) who foran advisory feeis engaged in the business of advising others, either directly orthrough
circulars, reports, publications or writings, as to the value of any security and as to the advisability
of trading in any security;
(2) who for compensation and as part of a regular business, issues or promulgates, analyzes
reports concerning the capital market, except:
(a) any bank or trust company;
(b) any journalist, reporter, columnist, editor, lawyer, accountant, teacher;
(c) the publisher of any bona fide newspaper, news, business or financial publication of general
and regular circulation, including their employees;
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FUNDAMENTALS of FINANCIAL MARKET
(d) any contract market;
p) who undertakes the management of por„o,,„

|he arrangement of purchases, sales or exchange ‘’oTXX’,nC,Ud"«
officials, senior executives of government or state owned

- — —or w v ■ wwwiv ■ w anda aimportant
• controlled corporations va i vvai aw
political party officials.
Rule 3.c. Offender” refers to any person who commits a money laundering offense.
Rule 3.d. “Person” refers to any natural or juridical person.
Rule 3.e. “Proceeds” refers to an amount derived or realized from an unlawful activity. It includes:
(i) All material results, profits, effects and any amount realized from any unlawful activity;
(ii) All monetary, financial or economic means, devices, documents, papers or things used in or
having any relation to any unlawful activity; and
(iii) All moneys, expenditures, payments, disbursements, costs, outlays, charges, accounts,
refunds and other similar items for the financing, operations, and maintenance of any unlawful
activity.
Rule3.e,1. “Monetary Instrument” refers to:
(a) Coins or currency of legal tender of the Philippines, or of any other country;
(b) Drafts, checks and notes;
(c) Securities or negotiable instruments, bonds, commercial papers, deposit certificates, trust
certificates, custodial receipts or deposit substitute instruments, trading orders, transaction tickets
and confirmations of sale or investments and money market instruments;
(d) Contracts or policies of insurance, life or non-life, contracts of suretyship, pre-need plans and
mutual benefit association instruments; and
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(e) Other similar instruments where title thereto passes to another by endorsement, assignment
or delivery.
Rule 3.e.2. "Property" includes any thing or item of value, real or personal, tangible or
intangible, or any interest therein or any benefit, privilege, claim or right with respect thereto.
Rule 3.e.3. "Related Accounts” are those accounts, the fundsand sources of which originated
from and/or are materially linked to the monetary instruments or properties subject of the freeze
order.
Rule 3.e.3.a. Materially linked accounts include but are not limited to the following:
(1) All accounts or monetary instruments belonging to the same person whose accounts,
monetary instruments or properties are the subject of the freeze order,
(2) All accounts or monetary instruments held, owned or controlled by the owner or holder of the
accounts, monetary instruments or properties subject of the freeze order, whether such accounts
are held, owned or controlled singly or jointly with another person;
(3) All accounts or monetary instruments the funds of which are transferred to the accounts,
monetary instruments or properties subject of the freeze order without any legal or trade obligation,
purpose or economic justification;
(4) All “In Trust For” (ITF) accounts where the person whose accounts, monetary instruments or
properties are the subject of the freeze order is either the trustee or the trustor;
(5) All accounts held forthe benefit or in the interest of the person whose accounts, monetary
instruments or properties are the subject of the freeze order;
(6) All accounts or monetary instruments under the name of the immediate family or household
members of the person whose accounts, monetary instruments or properties are the subject of the
freeze order if the amount or value involved is not commensurate with the business or financial
capacity of the said family or household member;
(7) All accounts of corporate and juridical entities that are substantially owned, controlled or
effectively controlled by the person whose accounts, monetary instruments or properties are
subject of the freeze order;
(8) All shares or units in any investment accounts and/or pooled funds of the person whose
accounts, monetary instruments or properties are subject of the freeze order; and
(9) All other accounts, shares, units or monetary instruments that are similar, analogous or
identical to any of the foregoing.
Rule 3.f. “Supervising Authority” refers to the BSP, the SEC and the IC. Where the BSP, SEC or
IC supervision applies only to the registration of the covered institution, the BSP, the SEC or the
IC, within the limits of the AMLA, as amended, shall have the authority to require and ask assistance
from the government agency having regulatory power and/or licensing authority over said covered
institution forthe implementation and enforcement of the AMLA, as amended, and these Rules.
Rule 3.g. “Transaction” refers to any act establishing any right or obligation or giving rise to any
contractual or legal relationship between the parties thereto. It also includes any movement of funds
by any means with a covered institution.
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Rule 3.g.1. "Covered Transaction is a transaction in cash or other equivalent monetary

instrument involving a total amount in excess of five hundred thousand pesos (Php500,000.00)
within one (1) banking day.
Rule 3.g.2. Suspicious Transaction” is a transaction, regardless of amount, where any of the
following circumstance exists:
(a) there is no underlying legal or trade obligation, purpose or economic justification;
(b) the client is not properly identified;
(c) the amount involved is not commensurate with the business or financial capacity of the client;
(d) taking into account all known circumstances, it may be perceived that the client’s transaction
is structured in order to avoid being the subject of reporting requirements under the act;
(e) any circumstance relating to the transaction which is observed to deviate from the profile of
the client and/or the client’s past transactions with the covered institution;
(f) the transaction is in any way related to an unlawful activity or any money laundering activity or
offense under the AMLA, as amended, is being or has been committed;
(g) any transaction that is similar, analogous or identical to any of theforegoing.
Rule 3.h. “Unlawful activity” ref ers to any act or omission or series or combination thereof involving
or having relation, to the following:
(a.) Kidnapping for ransom under Article 267 of Act No. 3815, otherwise known as the Revised
Penal Code, as amended;
(1) Kidnapping for ransom;
(b.) Sections 4, 5, 6, 8, 9, 10, 11, 12,13, 14, 15 and 16 of Republic Act No. 9165, otherwise known
as the Comprehensive Dangerous Drugs Act of 2002;
(2) Importation of prohibited drugs;
(3) Sale of prohibited drugs;
(4) Administration of prohibited drugs;
(5) Delivery of prohibited drugs;
(6) Distribution of prohibited drugs;
(7) Transportation of prohibited drugs;
(8) Maintenance of a Den, Dive or Resort for prohibited drugs;
(9) Manufacture of prohibited drugs;
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(10) Possession of prohibited drugs;
(11) Use of prohibited drugs;
(12) Cultivation of plants which are sources of prohibited drugs;
(13) Culture of plants which are sources of prohibited drugs;
(c.) Section 3 paragraphs b, c, e, g, h and i of Republic Act No. 3019, as amended, otherwise
known as the Anti-Graft and Corrupt Practices Act;
(14) Directly or indirectly requesting or receiving any gift, present, share, percentage or
benefit for himself or for any other person in connection with any contractor transaction between
the Government and any party, wherein the public officer in his official capacity has to intervene
under the law;
(15) Directly or indirectly requesting or receiving any gift, present or other pecuniary or material
benefit, for himself or for another, from any person for whom the public officer, in any manner or
capacity, has secured or obtained, or will secure or obtain, any government permit or license, in
consideration for the help given or to be given, without prejudice to Section 13 of R.A. 3019;
(16) Causing any undue injury to any party, including the government, or giving any
private party any unwarranted benefits, advantage or preference in the discharge of his official,
administrative or judicialfunctions through manifest partiality, evident bad faithorgross inexcusable
negligence;
(17) Entering, on behalf of the government, into any contract or transaction manifestly
and grossly disadvantageous to the same, whether or not the public officer profited or will profit
thereby;
(18) Directly or indirectly having financial or pecuniary interest in any business contract
or transaction in connection with which he intervenes or takes part in his official capacity, or in
which he is prohibited by the Constitution or by any law from having any interest;
(19) Directly or indirectly becoming interested, for personal gain, or having material
interest in any transaction or act requiring the approval of a board, panel or group of which he is a
member, and which exercise of discretion in such approval, even if he votes against the same or
he does not participate in the action of the board, committee, panel or group;
(d.) Plunder under Republic Act No. 7080, as amended;
(20) Plunder through misappropriation, conversion, misuse or malversation of public funds or raids
upon the public treasury;
(21) Plunder by receiving, directly or indirectly, any commission, gift, share, percentage, kickbacks
or any other form of pecuniary benefit from any person and/or entity in connection with any
government contract or project or by reason of the office or position of the public officer concerned;
(22) Plunder by the illegal or fraudulent conveyance or disposition of assets belonging to the
National Government or any of its subdivisions, agencies, instrumentalities or government-owned
or controlled corporations or their subsidiaries;
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(23) plun.d®r '°ceivln9 or accepting, directly or indirectly, any shares of stock, equity
or any other lerest or participation Including the promise of future employment in any
business enterprise or undertaking;
(24) Plunder by establishing agricultural, Industrial or commercial monopolies or other

combinations and/or Implementation of decrees and orders Intended to benefit particular persons
or special Interests;
(25) Plunder by taking undue advantage of official position, authority, relationship, connection or
Influence to unjustly enrich himself orthemselves at the expense and to the damage and prejudice
of the Filipino people and the Republic of the Philippines;
(e.) Robbery and extortion under Articles 294, 295, 296, 299, 300, 301 and 302 of the Revised
(26) Robbery with violence or intimidation of persons;
(27) Robbery with physical injuries, committed in an uninhabited place and by a band, or with use
of firearms on a street, road or alley;
(28) Robbery in an uninhabited house or public building or edifice devoted to worship;
(f .) Jueteng and Masiao punished as illegal gambling under Presidential Decree No 1602;
(29) Jueteng;
(30) Masiao;
(g.) Piracy on the high seas under the Revised Penal Code, as amended and Presidential Decree
No. 532;
(31) Piracy on the high seas;
(32) Piracy in inland Philippine waters;
(33) Aiding and abetting pirates and brigands;
(h.) Qualified theft under Article 310 of the Revised Penal Code, as amended;
(34) Qualified theft;
(i.) Swindling under Article 315 of the Revised Penal Code, as amended;
(35) Estafa with unfaithfulness or abuse of confidence by altering the substance, quality or quantity
of anything of value which the offender shall deliver by virtue of an obligation to do so, even though
such obligation be based on an Immoral or illegal consideration;
f36l Fstafa with unfaithfulness or abuse of confidence by misappropriating or converting, to the

ore udiceof another money, goods or any other personal property received by the offender in trust
?Tcomml.sZ or for administration, or under any other obligation involving the duty to make
delivery or to return the same. even though such oblloatlon be totally or partially guaranteed by a
bond orby denymg having received such money, goods, or other property;
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(37) Estafa with unfaithfulness or abuse of confidence by taking undue advantage of the signature
of the offended party in blank, and by writing any document above such signature in blank, to the
prejudice of the offended party or any third person;
(38) Estafa by using a fictitious name, or falsely pretending to possess power, influence,
qualifications, property, credit, agency, business or imaginary transactions, or by means of other
similar deceits;
(39) Estafa by altering the quality, fineness orweight of anything pertaining to his art or business;
(40) Estafa by pretending to have bribed any government employee;
(41) Estafa by postdating a check, or issuing a check in payment of an obligation when the
offender has no funds in the bank, or his funds deposited therein were not sufficient to cover the
amount of the check;
(42) Estafa by inducing another, by means of deceit, to sign any document;
(43) Estafa by resorting to some fraudulent practice to ensure success in a gambling game;
(44) Estafa by removing, concealing or destroying, in whole or in part, any court record, office
files, document orany other papers;
(j.) Smuggling under Sections 2702 and 2703 of Act No. 2711, otherwise known as the Revised
Administrative Code of 1917, as amended by Republic Act No. 455 and under Republic Act No.
1937, as amended, otherwise known as the Tariff and Customs Code of the Philippines;
(45) Fraudulent importation of any vehicle;
(46) Fraudulent exportation of any vehicle;
(47) Assisting in any fraudulent importation;
(48) Assisting in any fraudulent exportation;
(49) Receiving smuggled article after fraudulent importation;
(50) Concealing smuggled article after fraudulent importation;
(51) Buying smuggled article after fraudulent importation;
(52) Selling smuggled article after fraudulent importation;
(53) Transportation of smuggled article after fraudulent importation;
(54) Fraudulent practices against customs revenue;
(k.) Violations under Republic Act No. 8792, otherwise known as the Electronic Commerce Act of
2000;
k.1. Hacking or cracking, which refers to:
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(55) unauthorized access into or interference in a computer system/server or information and

communication system;
(56) any access in order to corrupt, alter, steal, or destroy using a computer or other similar
information and communication devices, information and communications system, including the
knowledge and consent of the owner of the computer, or
(57) the introduction of computer viruses and the like, resulting in the corruption, destruction,
alteration, theft or loss of electronic data messages or electronic document;
k.2. Piracy, which refers to:
(58) the unauthorized copying, reproduction;
(59) the unauthorized dissemination, distribution;
(60) the unauthorized importation;
(61) the unauthorized use, removal, alteration, substitution, modification;
(62) the unauthorized storage, uploading, downloading, communication, making available to the
public, or
(63) the unauthorized broadcasting of protected material, electronic signature or copyrighted works
including legally protected sound recordings or phonograms or information material on protected
works, through the use of telecommunication networks, such as, but not limited to, the internet, in
a manner that infringes intellectual property rights;
k.3. Violations under Republic Act No. 7394, otherwise known as The Consumer Act of the
Philippines and other relevant or pertinent laws through transactions covered by or using electronic
data messages or electronic documents:
(64) Sale of any consumer product that is not in conformity with standards under the Consumer
Act;
(65) Sale of any product that has been banned by a rule under the Consumer Act;
(66) Sale of any adulterated or mislabeled product using electronic documents;
(67) Adulteration or misbranding of any consumer product;
(68) Forging, counterfeiting or simulating any mark, stamp, tag, label orother identification device;
(69) Revealing trade secrets;
(70) Alteration or removal of the labeling of any drug or device held for sale;
(71) Sale of any drug or device not registered in accordance with the provisions of the E-
Commerce Act;
(72) Sale of any drug or device by any person not licensed in accordance with the provisions of
the E-Commerce Act;
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(73) Sale of any drug or device beyond its expiration date;
(74) Introduction into commerce of any mislabeled or banned hazardous substance;
(75) Alteration or removal of the labeling of a hazardous substance;
(76) Deceptive sales acts and practices;
(77) Unfair or unconscionable sales acts and practices;
(78) Fraudulent practices relative to weights and measures;
(79) False representations in advertisements as the existence of a warranty or guarantee;
(80) Violation of price tag requirements;
(81) Mislabeling consumer products;
(82) False, deceptive or misleading advertisements;
(83) Violation of required disclosures on consumer loans;
(84) Other violations of the provisions of the E-Commerce Act;
(I.) Hijacking and other violations under Republic Act No. 6235, otherwise known as the Anti
Hijacking Law; destructive arson and murder, as defined under the Revised Penal Code, as
amended, including those perpetrated by terrorists against non-combatant persons and similar
targets;
(85) Hijacking;
(86) Destructive arson;
(87) Murder;
(88) Hijacking, destructive arson or murder perpetrated by terrorists against non-combatant

persons and similar targets;
(m.) Fraudulent practices and other violations under Republic Act No. 8799, otherwise known as
the Securities Regulation Code of 2000;
(89) Sale, offer or distribution of securities within the Philippines without a registration statement
duly filed with and approved by the SEC;
(90) Violation of reportorial requirements imposed upon issuers of securities;
(91) Manipulation of security prices by creating a false or misleading appearance of active trading
in any listed security traded in an Exchange or any other trading market;
(92) Manipulation of security prices by effecting, alone or with others, a series of transactions in
securities that raises their prices to induce the purchase of a security, whether of the same or
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by <TtfêreâSS’ same *ssuer or of a controlling, controlled or commonly controlled company
se™rifanifhUlatiOn Of security prices by effecting, alone or with others, a series of transactions in

ones that depresses their price to induce the sale of asecurity, whether of the same or different
c ass, of the same issuer or of a controlling, controlled or commonly controlled company by others;
( ) Manipulation of security prices by effecting, alone or with others, a series of transactions in

securities that creates active trading to induce such a purchase orsale though manipulative devices
such as marking the close, painting the tape, squeezing the float, hype and dump, boiler room
operations and such other similar devices;
(95) Manipulation of security prices by circulating or disseminating information that the price of any
security listed in an Exchange will or is likely to rise or fall because of manipulative market
operations of any one or more persons conducted forthe purpose of raising or depressing the price
of the security forthe purpose of inducing the purchase or sale of such security;
(96) Manipulation of security prices by making false or misleading statements with respect to any
material fact, which he knew or had reasonable ground to believe was so false and misleading, for
the purpose of inducing the purchase orsale of any security listed or traded in an Exchange;
(97) Manipulation of security prices by effecting, alone or with others, any series of transactions
forthe purchase and/or sale of any security traded in an Exchange forthe purpose of pegging,
fixing or stabilizing the price of such security, unless otherwise allowed by the Securities Regulation
Code or by the rules of the SEC;
(98) Sale or purchase of any security using any manipulative deceptive device or contrivance;
(99) Execution of short sales or stop-loss order in connection with the purchase or sale of any
security not in accordance with such rules and regulations as the SEC may prescribe as necessary
and appropriate in the public interest or the protection of the investors;
(100) Employment of any device, scheme or artificeto defraud in connection with the purchase and
sale of any securities;
(101) Obtaining money or property in connection with the purchase and sale of any security by
means of any untrue statement of a material fact or any omission to state a material fact necessary
in order to make the statements made, in the light of the circumstances under which they were
made, not misleading;
(102) Engaging in any act, transaction, practice or course of action in the sale and purchase of any
security which operates or would operate as a fraud or deceit upon any person;
(103) Insider trading;
(104) Engaging in the business of buying and selling securities in the Philippines as a broker or
dealer or acting as a salesman, or an associated person of any broker or dealer without any
registration from the Commission;
(105) Employment by a broker or dealer of any salesman or associated person or by an issuer of

any salesman, not registered with the SEC;
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(106) Effecting any transaction in any security, or reporting such transaction, in an Exchange or
using the facility of an Exchange which is not registered with the SEC,
(107) Making use of the facility of a clearing agency which is not registered with the SEC;
(108) Violations of margin requirements;
(109) Violations on the restrictions on borrowings by members, brokers and dealers;
(110) Aiding and Abetting in any violations of the Securities Regulation Code;
(111) Hindering, obstructing or delaying the filing of any document required under the Securities
Regulation Code or the rules and regulations of the SEC;
(112) Violations of any of the provisions of the implementing rules and regulations of the SEC;
(113) Any other violations of any of the provisions of the Securities Regulation Code;
(n.) Sections 4, 5, 6 and 7 of Republic Act No. 10168, otherwise known as the Terrorism Financing
Prevention and Suppression Act of 2012:
(114) Directly or indirectly, willfully and, without lawful excuse, possessing, providing, collecting or
using property or funds or making available property, funds or financial service or other related
services, by any means, with the unlawful and willful intention that they should be used or with the
knowledge that they are to be used, in full or in part: (a) to carry out or facilitate the commission of
any terrorist act; (b) by a terrorist organization, association or group; or (c) by an individual
terrorist;
(115) Organizing or directing others to commit financing of terrorism;
(116) Attempt to commit the crimes of financing of terrorism and dealing with property or funds of
designated persons;
(117) Conspiracy to commit the crimes of financing of terrorism and dealing with property orfunds
of designated persons;
(118) Cooperating, by previous or simultaneous acts, in the execution of either the crime of
financing of terrorism or conspiracy to commit the crime of financing of terrorism;
(119) Having knowledge of the commission of the crime of financing of terrorism but without having
participated therein as principal, taking part subsequent to the commission of the crime of financing
of terrorism by profiting from it or by assisting the principal or principals in the crime of financing of
terrorism to profit by the effects of the crime, or by concealing or destroying the effects of the crime
in order to prevent its discovery, or by harboring, concealing or assisting in the escape of the
principal in the crime of financing of terrorism; and
(o) Felonies or offenses of a similar nature to the aforementioned unlawful activities that are
punishable under the penal laws of other countries.
In determining whether or not a felony or offense punishable under the penal laws of other
countries is "of a similar nature”, as to constitute an unlawful activity under the AMLA, as amended,
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^Ted°under'ruI^ 3°h Sa'd felony or offense need not be identical to any of the unlawful activities
St Wire/Fund Transfer” refers to any transaction carried out on behalf of an originator (both
"Jun.dlca|) through a financial institution (Originating Institution) by electronic means with
Tr r rnak,n9 an amount of money available to a beneficiary at another financial institution
( ene iciary Institution). The originatorperson and the beneficiary person may be the same person.
Role Cross Border” transfer refers to any wire transfer where the originating and
beneficiary institutions are located in different countries. It shall also refer to any chain of wire
transfers that has at least one cross-border element.
Rule 3.i.2. Domestic Transfer” refers to any wire transfer where the originating and
beneficiary institutions are located in the same country. It shall refer to any chain of wire transfers
that takes place entirely within the borders of a single country, even though the system used to
effect the fund/wire transfer may be located in another country.
Rule 3.i.3. “Originating institution” refers to the entity utilized by the originatorto transfer funds
to the beneficiary and can either be (a) a covered institution as specifically defined by these Rules
and as generally defined by the AMLA, as amended, and these Rules, or (b) a financial institution
or other entity operating outside the Philippines that is other than the covered institution referred to
in (a) but conducts business operations and activities similar to it.
Rule 3.i.4. “Beneficiary institution” refers to the entity that will pay out the money to the
beneficiary and can either be (a) a covered institution as specifically defined by these Rules and
as generally defined by the AMLA, as amended, and these Rules, or (b) a financial institution or
other entity operating outside the Philippines that is other than the covered institution referred to in
(a) but conducts business operations and activities similar to it.
Rule 3.i.5. “Intermediary institution” refers to the entity utilized by the originating and
beneficiary institutions where both have no correspondent banking relationship with each other but
have established relationship with the intermediary institution. It can either be (a) a covered
institution as specifically defined by the AMLA, as amended, and these Rules, or (b) a financial
institution or other entity operating outside the Philippines that is other than the covered institution
referred to in (a) but conducts business operations and activities similar to it.
RULE 4
Money Laundering Offense
Rule 4. Money Laundering Offense. - Money laundering is a crime whereby the proceeds of an
unlawful activity as herein defined are transacted, thereby making them appear to have originated
from legitimate sources. It is committed by the following:
(a) Any person knowing that any monetary instrument or property represents, involves, or relates
to, the proceeds of any unlawful activity, transacts or attempts to transact said monetary instrument
or property.
(b) Any person knowing that any monetary instrument or property involves the proceeds of any
unlawful activity, performs or fails to perform any act as a result of which he facilitates the offense
of money laundering referred to in paragraph (a) above.
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(c) Any person knowing that any monetary instrument or property is required under the AMLA, as
amended, be disclosed and filed with the Anti-Money Laundering Council (AMLC), fails to do so.
RULE 5
Jurisdiction of Money Laundering Cases and Money Laundering Investigation Procedures
Rule 5.a. Jurisdiction of Money Laundering Cases. - The Regional Trial Courts shall have the
jurisdiction to try all cases on money laundering. Those committed by public officers and private
persons who are in conspiracy with such public officers shall be under the jurisdiction of the
Sandiganbayan.
Rule 5,b. Investigation of Money Laundering Offenses. - The AMLC shall investigate:
(1) suspicious transactions;
(2) covered transactions deemed suspicious after an investigation conducted by the AMLC;
(3) money laundering activities; and
(4) other violations of the AMLA, as amended.
Rule 5.c. Attempts at Transactions. - Section 4 (a) and (b) of the AMLA, as amended, provides
that any person who attempts to transact any monetary instrument or property representing,
involving or relating to the proceeds of any unlawful activity shall be prosecuted for a money
laundering offense. Accordingly, the reports required under Rule 9.c of these Rules shall include
those pertaining to any attempt by any person to transact any monetary instrument or property
representing, involving or relating to the proceeds of any unlawful activity.
RULE 6
Prosecution of Money Laundering
Rule 6.a. Prosecution of Money Laundering. -
(1) Any person may be charged with and convicted of both the offense of money laundering and
the unlawful activity as defined under Section 3.i of the AMLA, as amended.
(2) Any proceeding relating to the unlawful activity shall be given precedence over the prosecution
of any offense or violation under the AMLA, as amended, without prejudice to the ex-parte
application by the AMLC with the Court of Appeals fora freeze order with respect to the monetary
instrument or property involved therein and resort to other remedies provided under the AMLA, as
amended, the Rules of Court and other pertinent laws and rules.
Rule 6.b. When the AMLC finds, after investigation, that there is probable cause to charge
any person with a money laundering offense under Section 4 of the AMLA, as amended, it shall
cause a complaint to be filed, pursuant to Section 7 (4) of the AMLA, as amended, before the
Department of Justice or the Office of the Ombudsman, which shall then conduct the preliminary
investigation of the case.
Rule 6.c. If after due notice and hearing in the preliminary investigation proceedings, the
Department of Justice, or the Office of the Ombudsman, as the case may be, finds probable cause
fora money laundering offense, it shall file the necessary information before the Regional Trial
Courts or the Sandiganbayan.
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Cnmirri^pP11* J°r *be money laundering offense shall proceed in accordance with the Code of
oce ure or the Rules of Procedure of the Sandiganbanyan, as the case may be.
or^relatPR knowledge of theoffenderthat any monetary instrument or property represents, involves,

reauimrt 10 Pr°ceeds of an unlawful activity or that any monetary instrument or property is
wstcKii 1 ?i.ei 16 as amended, to be disclosed and filed with the AMLC, may be
s it.c y direct evidence or inferred from the attendant circumstances.
Rule 6.f All the elements of every money laundering offense under Section 4 of the AMLA, as
knr^Ci h ’ be Proved by evidence beyond reasonable doubt, including the element of
o e ge that the monetary instrument or property represents, involves or relates to the proceeds
of any unlawful activity.
Rule 6.g. No element of the unlawful activity, however, including the identity of the perpetrators
and the details of the actual commission of the unlawful activity need be established by proof
beyond reasonable doubt. The elements of the offense of money laundering are separate and
distinct from the elements of the felony or offense constituting the unlawful activity.
RULE 7
Creation of Anti-Money Laundering Council (AMLC)
Rule 7.a. The Anti-Money Laundering Council -
Rule 7.a.1. Composition. - The Anti-Money Laundering Council is hereby created and shall
be composed of the Governor of the Bangko Sentral ng Pilipinas as Chairman, the Commissioner
of the Insurance Commission and the Chairman of the Securities and Exchange Commission as
Members
Rule 7.a.2. Unanimous Decision. - The AMLC shall act unanimously in discharging its
functions as defined in the AMLA, as amended, and in these Rules. However, in the case of the
incapacity, absence or disability of any member to discharge his functions, the officer duly
designated or authorized to discharge the functions of the Governor of the BSP, the Chairman of
the SEC or the Insurance Commissioner, as the case may be, shall act in his stead in the AMLC.
Rule 7.b. Functions. - The functions of the AMLC are defined hereunder:
(1) to require and receive covered or suspicious transaction reports from covered institutions;
(2) to issue orders addressed to the appropriate Supervising Authority or the covered institution
to determine the true identity of the owner of any monetary instrument or property subject of a
covered or suspicious transaction report, or request forassistance from a foreign State, or believed
by the Council, on the basis of substantial evidence, to be, in whole or in part, wherever located,
representing, involving, or related to, directly or indirectly, in any manner or by any means, the
proceeds of any unlawful activity,
(3) to investigate suspicious transactions and covered transactions deemed suspicious after an
investigation by the AMLC, money laundering activities and other violations of the AMLA, as
amended;
to file with the Court of Appeals, ex-parte, through the Off ice of the Solicitor General:
(4)
. a petition for the freezing of any monetary instrument or property alleged to be proceeds of
any unlawful activity as defined under sub-paragraphs (a) to (o)of Rule 3.h hereof;
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b.) an application for authority to inquire into or examine any particular depositor investment,
including related accounts, with any banking institution or non-bank financial institution;
(5) to institute civil forfeiture proceedings and all other remedial proceedings through the Office of
the Solicitor General;
(6) to file complaints with the Department of Justice or the Office of the Ombudsman for the
prosecution of money laundering offenses and other violations under the AMLA, as amended;
(7) to formulate and implement such measures as may be inherent, necessary, implied, incidental
and justified under the AMLA, as amended, to counteract money laundering. Subject to such
limitations provided by law, the AMLC is authorized under Section 7 (7) of the AMLA, as amended,
to establish an information sharing system that will enable the AMLC to store, track, analyze and
investigate money laundering transactions and to disseminate results of its analysis and
investigation to competent authorities for the resolute prevention, detection and prosecution of
money laundering offenses and other violations of the AMLA, as amended. For this purpose, the
AMLC shall install a computerized system that will be used in the creation and maintenance of an
information database;
(8) to receive and take action in respect of any request from foreign states for assistance in their
own anti-money laundering operations as provided in the AMLA, as amended. The AMLC is
authorized under Sections 7 (8) and 13 (b) and (d) of the AMLA, as amended, to receive and take
action in respect of any request from foreign states for assistance in their own anti-money
laundering operations, in respect of conventions, resolutions and other directives of the United
Nations (UN), the UN Security Council, and other international organizations of which the
Philippines is a member. However, the AMLC may refuse to comply with such request, convention,
resolution or directive where the action sought therein contravenes the provisions of the
Constitution, orthe execution thereof is likely to prejudice the national interest of the Philippines;
(9) to develop educational programs on the pernicious effects of money laundering, the methods
and techniques used in money laundering, the viable means of preventing money laundering and
the effective ways of prosecuting and punishing offenders;
(10) to enlist the assistance of any branch, department, bureau, office, agency or instrumentality of
the government, including government-owned and -controlled corporations, in undertaking any and
all anti-money laundering operations, which may include the use of its personnel, facilities and
resources for the more resolute prevention, detection and investigation of money laundering
offenses and prosecution of offenders. The AMLC may require the intelligence units of the Armed
Forces of the Philippines, the Philippine National Police, the Department of Finance, the
Department of Justice, as well as their attached agencies, and other domestic or transnational
governmental or non-governmental organizations or groups to divulge to the AMLC all information
that may, in any way, facilitate the resolute prevention, investigation and prosecution of money
laundering offensesand other violations of the AMLA, as amended, and other relevant laws and
regulations;
(11) to issue and implement rules, regulations, orders and resolutions as may be necessary and
proper to effectively implement the AMLA, as amended, and other relevant laws and regulations;
and
(12) to impose administrative sanctions pursuant to Rule 14.a.4 for the violation of laws, rules,
regulations, ordersand resolutions issued pursuant thereto, as may be determined by the AMLC.
Rule 7.c. Meetings. - The AMLC shall meet once a month, or as often as may be necessary at the
call of the Chairman.
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RULE 8
Creation of a Secretariat
AMLC Secretanat^nOfKey^LaUnderin9 Councl1 Secretariat. - The Council shall be assisted by the
at in the d.scharge of its functions
shall be appointed hv ?V^Ctor’ '17165 Secretariat shall be headed by an Executive Director who
Bar. at least thirtv-f /Te^MLC 7or a terrn of five (5) years. He must be a member of the Philippine
BSP the SFr years of age, must have served for at least five (5) years either at the
He shall \,ar>d of good moral character, unquestionable integrity and known probity.
Governor and ch 3 fu,l"t'me permanent employee of the BSP with the rank of Assistant
’ a be entitled to such benefits and subject to rules and regulations, as well as
prohibitions, as are applicable to officers of similar rank.
Rule 8.b. Composition. - In organizing the Secretariat, the AMLC may choose from those who
nave served, continuously or cumulatively, for at least five (5) years in the BSP, the SEC or the IC.
i< members of the Secretariat shall be considered regular employees of the BSP and shall be
entitled to such benefits and subject to such rules and regulations as are applicable to BSP
employees of similar rank.
Rule 8.c. Detail and Secondment. - The AMLC is authorized under Section 7(10) of the AMLA,
as amended, to enlist the assistance of the BSP, the SEC or the IC, or any other branch,
department, bureau, office, agency or instrumentality of the government, including government-
owned and controlled corporations, in undertaking any and all anti-money laundering operations.
This includes the use of any member of their personnel who may be detailed or seconded to the
AMLC. subject to existing laws and Civil Service Rules and Regulations. Detailed personnel shall
continue to receive their salaries, benefits and emoluments from their respective mother units.
Seconded personnel shall receive, in lieu of their respective compensation packages from their
respective mother units, the salaries, emoluments and all other benefits which their AMLC
Secretariat positions are entitled to.
RULE 9
Prevention of Money Laundering;
Customer Identification Requirements and Record Keeping
Rule 9.a. Customer Identification Requirements.
Rule 9.a.1. Customer Identification. - Covered institutions shall establish and record the true
identity of its clients based on official documents. They shall maintain a system of verifying the true
identity of their clients and, in case of corporate clients, require a system of verifying their legal
existence and organizational structure, as well as the authority and identification of all persons
purporting to act on their behalf. Covered institutions shall establish appropriate systems and
methods based on internationally compliant standards and adequate internal controls for verifying
and recording the true and full identity of their customers.
Rule 9.a.2. Trustee, Nominee and Agent Accounts. - When dealing with customers who
are acting as trustee, nominee, agent or in any capacity for and on behalf of another, covered
institutions shall verify and record the true and full identity of the persons on whose behalf a
transaction is being conducted. Covered institutions shall also establish and record the true and
full identity of such trustees, nominees, agents and other persons and the nature of their capacity
and duties. In case a covered institution has doubts as to whether such persons are being used as
dummies in circumvention of existing laws, it shall immediately make the necessary inquiries to
verify the status of the business relationship between the parties.
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Rule 9.a.3. Minimum Informatlon/Documents Required for Individual Customers. -

Covered institutions shall require customers to produce original documents of identity issued by an
official authority, bearing a photograph of the customer. Examples of such documents are identity
cards and passports. The following minimum information/documents shall be obtained from
individual customers:
(a) Name;
(b) Present address;
(c) Permanent address;
(d) Date and place of birth;
(e) Nationality;
(f) Nature of work and name of employer or nature of self-employment/business;
(g) Contact numbers;
(h) Tax identification number, Social Security System number or Government Service Insurance
System number;
(i) Specimen signature;
(j) Source of funds; and
(k) Names of beneficiaries in case of insurance contracts and whenever applicable.
Rule 9.a.4 Valid Identification Documents. - Customers and the authorized signatory/ies of
a corporate or juridical entity who engage in a financial transaction with a covered institution for the
first time shall be required to present the original and submit a clear copy of at least one (1) valid
photo-bearing ID issued by an official authority.
For this purpose, the term official authority shall refer to any of the following:
i. Government of the Republic of the Philippines
ii. Its political subdivisions and instrumentalities;
iii. Government-Owned or-Controlled Corporations (GOCCs); and
iv. Private entities or institutions registered with orsupervised or regulated either by the BSP,
SECorlC.
In case the identification document presented to the covered institution does not bear any
photo of the customer or authorized signatory, or the photo bearing ID or a copy thereof does not
clearly show the face of the customer or authorized signatory, a covered institution may utilize its
own technology to take the photo of the customer or authorized signatory.
Rule 9.a.5. Minimum Information/Documents Required for Corporate and Juridical

Entities. - Before establishing business relationships, covered institutions shall endeavorto ensure
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being dissolved wound ?.T°rae or Juridical entity which has not been oris not in the process of
the process of bînr. P or voided, or that its business or operations has not been or is not in
and corporations ,shut.down. Phased out, or terminated. Dealings with shell companies
through which finanniJi te9a ent'ties which have no business substance in their own right b
caution ^he tranSaCtions maV be conducted, should be undertaken with extreme
corDorate or iuriHi^?9 ra.'n,rnum mformation/documents shall be obtained from customers that are
substancp irJthai 3 entlt,es’ including shell companies and corporations which have no business
ir own right but through which financial transactions may be conducted:
(a) Certificates of Registration issued by the Department of Trade and Industry for single
propnetors,
or by the Securities and Exchange Commission for corporations and partnerships, and by the
BSP for money changers/foreign exchange dealers and remittance agents;
(b) Articles of Incorporation/Partnership;
(c) Latest General Information Sheet which lists the names of directors/trustees/partners, principal
stockholders owning at least twenty percent (20%) of the outstanding capital stock and primary
officers such as the President and Treasurer;
(d) Beneficial owners and beneficiaries of the corporate and/or juridical entities;
(e) Board or Partners’ resolution duly certified by the Corporate/Partners’ Secretary authorizing
the signatory to sign on behalf of the entity; and
(f) For entities registered outside of the Philippines, similar documents and/or information shall
be obtained duly authenticated by the Philippine Consulate where said entities are registered.
Rule 9.a.6. Prohibition against Certain Accounts. - Covered institutions shall maintain
accounts only in the true and full name of the account owner or holder. The provisions of existing
laws to the contrary notwithstanding, anonymous accounts, accounts under fictitious names, and
all other similar accounts shall be absolutely prohibited.
Rule 9.a.7. Prohibition against opening of Accounts without Face-to-face Contact. - No

new account shall be opened and created without face-to-face contact and full compliance with the
requirements under Rule 9.a.3 of these Rules.
Rule 9.a.8. Numbered Accounts. - Peso and foreign currency non-checking numbered
accounts shall be allowed: Provided, That the true identity of the customers of all peso and foreign
currency non-checking numbered accounts are satisfactorily established based on official and
other reliable documentsand records, and that the information and documents required under the
provisions of these Rules are obtained and recorded by the covered institution. No peso and foreign
currency non-checking accounts shall be allowed without the establishment of such identity and in
the manner herein provided. Provided, further, That covered and suspicious transaction reports
involving peso and foreign currency non-checking numbered accounts submitted to the AMLC
pursuant to Rule 7.b.1 of these Rules shall contain the true name of the account holder. The BSP
may conduct annual testing forthe purpose of determining the existence and true identity of the
owners of such accounts. The SEC and the IC may conduct similar testing more often than once a
year and covering such other related purposes as may be allowed under their respective charters.
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Rule 9.a.9. Risk-based Customer Identification Process. - A covered institution shall

develop clear, written and graduated customer acceptance policies and procedures including a set
of criteria for customers that are likely to pose low, normal or high risk to their operations as well
as the standards in applying reduced, average and enhanced due diligence including a set of
conditions forthe denial of account opening. These policies and procedures shall ensure that the
financially or socially disadvantaged are not denied access to financial services while at the same
time prevent suspicious individuals or entities from opening an account.
Rule 9.a.9.a. Enhanced Due Diligence. - Enhanced due diligence shall be applied to customers
that are assessed by the covered institution or these Rules as high risk formoney laundering and
terrorist financing, which enhanced diligence, at a minimum, should observe the following
measures:
i. Obtain senior management approval for establishing or continuing, (for existing customers)
such business relationships;
ii. Take reasonable measures to establish the source of wealth and source of funds; and
iii. Conduct enhanced ongoing monitoring of the business relationship.
Rule 9.a.9.a.1. Reduced Due Diligence. - Whenever reduced due diligence is applied in
accordance with the covered institution’s customer acceptance policy, the following rules shall
apply:
a. ) For individual customers classified as low risk, a covered institution may open an account
under the true and full name of the account owner or owners upon presentation of an acceptable
ID only.
b. ) For corporate, partnership, and sole proprietorship entities, and other entities such as banking
institutions, trust entities and quasi-banks authorized by the Supervising Authorities to operate as
such, publicly listed companies subject to regulatory disclosure requirements, government
agencies including GOCCs, a covered institution may open an account under the official name of
these entities with only item (e) of those required under Rule 9.a.5 (Board or Partners’ Resolution
duly certified by the Corporate/Partners’ Secretary authorizing the signatory to sign on behalf of the
entity) obtained at the time of account opening.
Rule 9.a.9.b. High-risk customer. - A customer from a country other than the Philippines that is
recognized as having inadequate internationally accepted anti-money laundering standards, or
does not sufficiently apply regulatory supervision or the Financial Action Task Force (FATF)
recommendations, orpresents greater risk for money laundering, its associated predicate offenses
including corruption and terrorism financing, is considered a high risk customer and shall be subject
to enhanced due diligence measures under Rule 9.a.9.a. Information relative to these are available
from publicly available information such as the websites of FATF, FATF Style Regional Bodies
(FSRB) like the Asia Pacific Group on Money Laundering and the Egmont Group, the Office of
Foreign Assets Control (OFAC) of the U.S. Department of the Treasury, or other reliable third
parties such as regulators or exchanges, which shall be a component of a covered institution’s
customer identification process.
Rule 9.a.10. Outsourcing of the Conduct of Face-to-Face Contact. - Subject to the rules
promulgated forthe purpose by the Supervising Authorities, a covered institution may outsource to
a counterparty the conduct of the requisite face-to-face contact.
Rule 9.a.11. Third party reliance. - Subjectto the rules promulgated forthe purpose by the
Supervising Authorities, where a third party has already conducted the requisite face-to-face
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and its own Money Laundermn on its own customer in accordance with these Rules
may rely on the representation of Financing Prevention Program, a covered institution
contact and customer identification P3rty <hat '* haS already undertaken said face-to-face
2 3 * * * 9auit,^r9faKtherin9 °f minimum Information and/or documents

Subj^'^the^ru^s1 p°romu?a -
institution mav out<smirr0 ♦ gated for the purpose by the Supervising Authorities, a covered
documents reouired ir> k counter-party the gathering of the minimum information and/or
knXTa he e°b,ained b* Rules provided that the ultimate responsibility for
institution an ^°r êeP’n3 ê identification documents shall lie with the covered
. k rustee, Nominee, Agent or Intermediary account. - Where any transaction

is con uc e y a trustee, nominee, agent or intermediary, either as an individual or through a
fiduciary relationship, a corporate vehicle or partnership, on behalf of a trustor, principal, beneficial
owner or person on whose behalf a transaction is being conducted, covered institutions shall
establish and record the true and full identity and existence of both the (1) trustee, nominee, agent
or intermediary and the (2) trustor, principal, beneficial owner or person on whose behalf the
transaction is being conducted. The covered institution shall determine the true nature of the
parties capacities and duties by obtaining a copy of the written document evidencing their
relationship and apply the same standards for assessing the risk profile and determining the
standard of due diligence to be applied to both.
In case it entertains doubts as to whether the trustee, nominee, agent, or intermediary is being
used as a dummy in circumvention of existing laws, it shall apply enhanced due diligence under
Rule 9.a.9.a.
Rule 9.a.14. Where the Customer Transacts Through a Trustee, Nominee, Agent or
Intermediary which is a Third Party. - A covered institution may rely on the customer identification
process undertaken by a third party subject to the rules on Third Party reliance to be promulgated
by the Supervising Authorities.
Rule 9.a.15. On-going monitoring of customers, accounts and transactions. -A covered

institution shall, on the basis of materiality and risk, update all identification information and
documents of existing customers required to be obtained under the AMLA, as amended, and these
Rules.
A covered institution shall establish a system that will enable it to understand the normal and
reasonable account activity of customers and to detect unusual or suspicious patterns of account
activity. A risk-and-materiality-based on-going monitoring of customers’ accounts and transactions
shall be part of a covered institution’s customer due diligence procedures.
Rule 9.a.15.a. Unusual or suspicious patterns of account activity. - A covered institution

shall apply enhanced due diligence under Rule 9.a.9.a on its customer if it acquires information in
the course of its customer account ortransaction monitoring that:
1 Raises doubt as to the accuracy of any information or document provided or the ownership
of the entity;
2 Justifies re-classification of the customer from low or normal risk to high-risk pursuant to
these Rules or by its own criteria; or
3 Indicates that any of the circumstances for the filing of a suspicious transaction exists such
as but not limited to the following:
a Transacting without any underlying legal or trade obligation, purpose or economic
justification;
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b. Transacting an amount that is not commensurate with the business or financial

capacity of the customer or deviates from his profile;
c. Structuring of transactions in order to avoid being the subject of covered
transaction reporting; or
d. Knowing that a customer was or is engaged or engaging in any unlawful activity
as herein defined.
Where additional information cannot be obtained, or any information or document provided is false
or falsified, or result of the validation process is unsatisfactory, the covered institution shall
terminate and refrain from further conducting business relationship with the customer without
prejudice to the reporting of a suspicious transaction to the AMLC when circumstances warrant.
Rule 9.a.16. Politically Exposed Persons. - A Covered institution shall take reasonable
measures to determine whether a customer or beneficial owner is a PEP as defined under Rule
3.b.2 hereof. In cases of higher risk business relationship with such persons including foreign PEPs,
a covered institution shall apply the enhanced due diligence measures under Rule 9.a.9.a.
The requirements for all types of PEPs should also apply to family members or close
associates of such PEPs.
Rule 9.a.17. Correspondent Banking. - Correspondent banking refers to activities of one

bank (the correspondent bank) having direct connection or friendly service relations with another
bank (the respondent bank). Because of the risk associated with dealing with correspondent
accounts where it may unknowingly facilitate the transmission, or holding and management of
proceeds of unlawful activities or funds intended to finance terrorist activities, a covered institution
shall adopt policies and procedures for correspondent banking activities and designate an officer
responsible in ensuring compliance with these policies and procedures A covered institution may
rely on the customer identification process undertaken by the respondent bank In such case, it
shall apply the rules on Third Party reliance to be promulgated by the Supervising Authorities,
treating the respondent bank as the Third Party as defined therein In addition, the correspondent
bank shall:
(a) Gather sufficient information about the respondent institution to understand fully the nature of
the respondent’s business and to determine from publicly available information the reputation of
the institution and the quality of supervision, including whether it has been subject to money
laundering or terrorist financing investigation or regulatory action
(b) Assess the respondent institution’s anti-money laundering and terrorist financing controls.
(c) Obtain approval from senior management before establishing correspondent relationships.
(d) Document the respective responsibilities of both institutions
(e) With respect to “payable-through accounts’’, be satisfied that the respondent bank has verified
the identity of, and performed on-going due diligence on, the customers having direct access
accounts of the correspondent and that it is able to provide relevant customer identification data
upon request by the correspondent bank
Correspondent banking customers presenting greater risk, including shell companies, shall be
subject to enhanced due diligence under Rule 9.a.9.a.
Rule 9.a.18. Wire/Fund Transfers - Because of the risk associated with dealing with
wire/fund transfers, where a covered institution may unknowingly transmit proceeds of unlawful
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,o *<n«nc« tenons! activities, it shall establish policies and procedures

P event it from being utilized for that purpose which shall include, but not limited to. the
ta) r beneficiary institution shall not accept instructions to pay-out wire/fund transfers to non
customer beneficiary, unless it has conducted the necessary customer due diligence to establish
the true and full identity and existence of said beneficiary Should the originator and beneficiary be
the same person, the beneficiary institution may rely on the customer due diligence conducted by
the onginatmg institution subject to the rules on Third Party reliance to be promulgated by the
Supervising Authonties, treating the originating institution as Third Party as herein defined.
(b) The onginating institution shall not accept instructions to wire/fund transfer from a non
customer ong inator, unless it has conducted the necessary customer due diligence to establish the
true and full identity and existence of said originator;
(c) In cross border wire/fund transfers, if the originator is a high risk customer as herein desenbed,
the beneficiary institution shall conduct enhanced due diligence under Rule 9.a.9.a on the
beneficiary and the originator Where additional information cannot be obtained, or any information
or document provided is false or falsified, or result of the validation process is unsatisfactory, the
beneficiary institution shall refuse to effect the wire/fund transfers or the pay-out of funds without
prejudice to the reporting of a suspicious transaction to the AMLC when circumstances warrant;
(d) Whenever possible, manually initiated fund transfer (MIFT) instructions should not be the
pnmary delivery method Every effort shall be made to provide client with an electronic banking
solution However, where MIFT is utilized, the Supervising Authorities shall issue pertinent rules on
validation procedures:
(e) Cross border and domestic wire/fund transfers and related message not exceeding a threshold
amount to be determined by the Supervising Authorities or its equivalent in foreign currency shall
include accurate and meaningful originator and beneficiary information. The following information
shall remain with the transfer or related message through the payment chain;
1. the name of the originator;

2. the name of the beneficiary; and
3 an account number of the originator and beneficiary, or in its absence, a unique transaction
reference number
For cross border and domestic wire/fund transfers and related message amounting to said
threshold amount to be determined by the Supervising Authorities or more or its equivalent in
foreign currency, the following information accompanying all qualifying wire transfers should always
contain:
1. the name of the originator;

2 the originator account number where such an account is used to process the transaction;
3 the onginator’s address, or national identity number, or customer identification number, or
date and place of birth;
4 the name of the beneficiary; and
5. the beneficiary account number where such an account is used to process the transaction.
(f) Should any wire/fund transfer amounting to the threshold amount to be determined by the
Supervising Authorities or more or its equivalent in foreign currency be unaccompanied by the
required onginator and beneficiary information, the beneficiary institution shall exert all efforts to
establish the true and full identity and existence of the originator by requiring additional information
from the originating institution or intermediary institution. It shall likewise apply enhanced due
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diligence under Rule 9,a.9.a to establish the true and documentLrovidS®1

Where additional information cannot be obtained, or y . th bAn^fieiarJ3- d ,s false
or falsified, or result of the validation process is unsat'Sôfy, the be,nstltution shall
refuse to effect the wire/fund transferor the pay-out of funds without prejudice to the reporting of a
suspicious transaction to the AMLC when circumstances warran .
Rule 9.a.19. Shell Company/Shell Bank. - A covered institution shall undertake

business/banking relationship with a shell company with extreme caution and always apply
enhanced due diligence under Rule 9.a.9.a.
No shell bank shall be allowed to operate or be established in the Philippines. A covered

institution shall refuse to enter into, or continue, correspondent banking relationship with them. It
shall likewise guard against establishing relations with foreign financial institutions that permit their
accounts to be used by shell banks.
Rule 9.a.20. Foreign Exchange Dealers, Money Changers and Remittance Agents - A
covered institution shall require their customers which are foreign exchange dealers, money
changers and remittance agents to submit a copy of the certificate of registration issued to them by
the BSP as part of their customer identification requirement. Such customers shall be subject to
enhanced due diligence under Rule 9.a.9.a.
Rule 9.b. Record Keeping Requirements.
Rule9.b.1. Record Keeping: Kinds of Records and Period for Retention. — All records of
all transactions of covered institutions shall be maintained and safely stored for five (5) years from
the dates of transactions. Said records and files shall contain the full and true identity of the owners
or holders of the accounts involved in the covered transactions and all other customer identification
documents. Covered institutions shall undertake the necessary adequate security measures to
ensure the confidentiality of such records and files. Covered institutions shall prepare and maintain
documentation, in accordance with the aforementioned client identification requirements, on their
customer accounts, relationships and transactions such that any account, relationship or
transaction can be so reconstructed as to enable the AMLC, and/or the courts to establish an audit
trail for money laundering. Covered institutions shall likewise keep the electronic copies of all
covered and suspicious transaction reports for at least five (5) years from the dates of submission
to the AMLC.
Rule 9.b.2. Existing and New Accounts and New Transactions. - All records of existing
and new accountsand of new transactions shall be maintained and safely stored for five (5) years
from October 17, 2001 or from the dates of the accounts or transactions, whichever is later.
Rule 9.b.3. Closed Accounts. - With respect to closed accounts, the records on customer
identification, account files and business correspondence shall be preserved and safely stored for
at least five (5) years from the dates when they were closed.
Rule 9.b.4. Retention of Records Where a Case of Money Laundering, Civil Forfeiture
or Underlying Unlawful Activity, Has Been Filed in Court. — If a money laundering, civilforfeitue
or the underlying unlawful activity case based on or pertaining to any record kept by the covered
institution concerned has been filed in court, said record must be retained and safely kept beyond
the period stipulated in the three (3) immediately preceding sub-Rules, as the case may be, until it
is confirmed that the case has been resolved, decided or terminated with finality by the court.
Rule 9.b.5. Form of Records. — Records shall be retained as originals in such forms as are
admissible in court pursuant to existing laws and the applicable rules promulgated by the Supreme
Court.
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Rule 9.c. Reporting of Covered and Suspicious Transactions.
Per'?d. Of ReP°rt'ng Covered Transactions and Suspicious Transactions. -

... . f '°nS Sâ ' report to the AMLC all covered transactions and suspicious transactions
wi in rive (5) working days from occurrence thereof, unless the supervising authority concerned
presences a longer period not exceeding ten (10) working days.
Should a transaction be determined to be both a covered and a suspicious transaction, the

covered institution shall report the same as a suspicious transaction.
Rule 9.c.2. Covered and Suspicious Transaction Report Forms. — The Covered
Transaction Report (CTR) and the Suspicious Transaction Report (STR) shall be in the forms
prescribed by the AMLC.
Covered transaction reports and suspicious transaction reports shall be submitted in a secured
manner to the AMLC in electronic form.
Rule 9.C.3. Exemption from Bank Secrecy Laws. — When reporting covered or suspicious
transactions to the AMLC, covered institutions and their officers and employees, shall not be
deemed to have violated R.A. No. 1405, as amended, R.A. No. 6426, as amended, R.A. No. 8791
and other similar laws, but are prohibited from communicating, directly or indirectly, in any manner
or by any means, to any person the fact that a covered orsuspicious transaction report was made,
the contents thereof, or any other information in relation thereto. In case of violation thereof, the
concerned officerand employee of the covered institution shall be criminally liable.
Rule 9.C.4. Confidentiality Provisions. - When reporting covered transactions or suspicious

transactions to the AMLC, covered institutions and their officers and employees, are prohibited
from communicating, directly or indirectly, in any manner or by any means, to any person, entity,
the media, the fact that a covered orsuspicious transaction report was made, the contents thereof,
or any other information in relation thereto. Neither may such reporting be published or aired in any
manner or form by the mass media, electronic mail, or other similar devices. In case of violation
thereof, the concerned officer, and employee, of the covered institution, or media shall be held
criminally liable.
Rule 9.C.5. Safe Harbor Provisions. — No administrative, criminal or civil proceedings shall
lie against any person for having made a covered transaction report or a suspicious transaction
report in the regular performance of his duties and in good faith, whether or not such reporting
results in any criminal prosecution under this Act or any other Philippine law.
RULE 10
Authority to File Petitions for Freeze Order
Rule 10.a. Freezing of any monetary instrument or property. -
m UDon verified exparte petition by the AMLC and after determi nation that probable cause exists
that anv monetary instrument or property is in any way related to any unlawful activity as defined
in Rule 3 h hereof or to a money laundering offense, the Court of Appeals may issue a freeze order
on said monetary instrument or property which shall be effective immediately.
The Rule of Procedure in Cases of Civil Forfeiture, Asset Preservation, and Freezing of
Mnnetarv Instrument, Property, or Proceeds representing, Involving, or Relating to an Unlawful
A t vity or Money Laundering Offense under Republic Act No. 9160, As Amended (A.M. No. 05-
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11-04-SC) shall govern the proceedings in all petitions forfreeze order instituted pursuant to R.A.
No. 9160, as amended,
(3) Considering the intricate and diverse web of related and interlocking accounts pertaining to
the monetary instruments or properties that any person may create in the different covered
institutions, their branches and/or other units, the AMLC may filea petition with the Court of Appeals
for the freezing of the monetary instruments or properties in the names of the reported
owners/holders and monetary instruments or properties named in the Petition of the AMLC
including related accounts as defined under Rule 3.e.3 of these Rules.
(3) The freeze order shall be effective for twenty (20) days unless extended by the Court of
Appeals upon motion by the AMLC.
(4) The Court shall act on the petition to freeze within twenty-four (24) hours from filing of the
petition. If the petition is filed a day before a nonworking day, the computation of the twenty-four
(24) hour period shall exclude the nonworking days.
(5) A person whose account has been frozen may file a motion to lift the freeze order and the
court must resolve this motion before the expiration of the twenty (20) — day original freeze order.
(6) No court shall issue a temporary restraining order or a writ of injunction against any freeze
order, except the Supreme Court.
Rule 10.b. Definition of Probable Cause. - Probable cause includes such facts and
circumstances which would lead a reasonably discreet, prudent or cautious man to believe that an
unlawful activity and/or a money laundering offense is about to be, is being or has been committed
and that the account or any monetary instrument or property sought to be frozen is in any way
related to said unlawful activity and/or money laundering offense.
Rule 10.c. Duty of Covered Institutions upon receipt thereof. —
Rule 10.C.1. Upon receipt of the notice of the freeze order, the covered institution concerned
shall immediately freeze the monetary instrument or property and related accounts subject thereof.
Rule 10.C.2. The covered institution shall likewise immediately furnish a copy of the notice of
the freeze order upon the owner or holder of the monetary instrument or property or related
accounts subject thereof.
Rule 10.C.3. Within twenty-four (24) hours from receipt of the freeze order, the covered
institution concerned shall submit to the Court of Appeals and the AMLC, by personal delivery, a
detailed written return on the freeze order, specifying all the pertinent and relevant information
which shall include the following:
(a) the account numbers;
(b) the names of the account owners or holders;
(c) the amount of the monetary instrument, property or related accounts as of the time they
were frozen;
(d) all relevant information as to the nature of the monetary instrument or property;
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nronprfv a"V Information on the related accounts pertaining to the monetary instrument or
property subject of the freeze order; and
(f) the time when the freeze thereon took effect
Rule 1O.d. Upon receipt of the freeze order issued by the Court of Appeals and upon verification
y e covered institution that the related accounts originated from and/or are materially linked to
tne monetary instrument or property subject of the freeze order, the covered institution shall freeze
these related accounts wherever these may be found.
The return of the covered institution as required under Rule 10.C.3 shall include the fact of such
freezing and an explanation as to the grounds for the identification of the related accounts.
If the related accounts cannot be determined within twenty-four (24) hours from receipt of the freeze
order due to the volume and/or complexity of the transactions or any other justifiable factor(s), the
covered institution shall effect the freezing of the related accounts, monetary instruments and
properties as soon as practicable and shall submit a supplemental return thereof to the Court of
Appeals and the AMLC within twenty-four (24) hours from the freezing of said related accounts,
monetary instruments and properties.
Rule 1O.e. Extension of the Freeze Order. - Before the twenty (20) day period of the freeze order
issued by the Court of Appeals expires, the AMLC may file a motion with the same court foran
extension of said period. Upon the timely filing of such motion and pending resolution thereof by
the Court of Appeals to extend the period, said period shall be deemed suspended and the freeze
order shall remain effective. However, the covered institution shall not lift the effects of the freeze
order without securing official confirmation from the AMLC.
Rule 10.f. Prohibition against Issuance of Freeze Orders against candidates foran electoral
office during election period. — No assets shall be frozen to the prejudice of a candidate foran
electoral office during an election period within twenty-four (24) hours from the freezing of said
related accounts, monetary instruments and properties.
RULE 11
Authority to Inquire into Deposits or Investments
Rule 11.a. Authority to Inquire into Deposits or Investments with court order.
RULE 11.a.1 Notwithstanding the provisions of Republic Act No. 1405, as amended; Republic
Act No. 6426, as amended; Republic Act No. 8791, and other laws, the AMLC may inquire into or
examine any particular deposit or investment, including related accounts, with any banking
institution or non-bank financial institution and their subsidiaries and affiliates upon order by the
Court of Appeals based on an ex parte application in cases of violation of this Act, when it has been
established that there is probable cause that the deposits or investments involved, including related
accounts, are related to an unlawful activity as defined in Rule 3.h hereof ora money laundering
offense under Rule 4 hereof; except in cases as provided under Rule 11.b.
Rule 11.a.2. The Court of Appeals shall act on the application to inquire into or examine any
deposit or investment with any banking institution or non-bank financial institution within twenty-
four (24) hours from filing of the application.
Rule 11.a.3 A court order ex parte must be obtained before the AMLC can inquire into the
related accounts; provided, that the procedure for the ex parte application for an order of inquiry
into the principal account shall be the same with that of the related accounts.
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Rule 11.a.4. The authority to inquire into or examine the main account and the relate
accounts shall comply with the requirements of Article III, Sections 2 and 3 of the 1987 Constitution
which are hereby incorporated by reference.
Rule 11.b. Authority to Inquire Into Bank Deposits without court order. — The AMLC may
inquire into or examine any deposit or investment with any banking institution or non-bank financial
institution and their subsidiaries and affiliates without a court order in cases involving any of the
following unlawful activities:
(1) Kidnapping for ransom under Article 267 of Act No. 3815, otherwise known as the Revised
(2) Sections 4, 5, 6, 8, 9, 10, 11, 12, 13, 14, 15 and 16 of Republic Act No. 9165, otherwise known
as the Comprehensive Dangerous Drugs Act of 2002;
(3) Hijacking and other violations under Republic Act No. 6235; destructive arson and murder, as
defined under the Revised Penal Code, as amended, including those perpetrated by terrorists
against non-combatant persons and similar targets; and
(4) Felonies or offenses of a nature similar to those mentioned in Section 3(i) (1), (2) and (12) of
the AMLA, as amended, which are punishable under the penal laws of other countries, and
terrorism and conspiracy to commit terrorism as defined and penalized under Republic Act No.
9372.
Rule 11.b.1. Procedure forexamination without a court order. - Where any of the unlawful
activities enumerated under Rule 11.b is involved, and there is probable cause that the deposits or
investments with any banking institution or non-bank financial institution and their subsidiaries and
affiliates are in anyway related to any of these unlawful activities, the AMLC shall issue a resolution
authorizing the inquiry into or examination of any deposit orinvestment with such banking institution
or non-bank financial institution and their subsidiaries and affiliates concerned.
Rule 11.b.2. Duty of the banking institution or non-bank financial institution upon
receipt of the AMLC resolution. - The banking institution or the non-bank financial institution and
their subsidiaries and affiliates shall, immediately upon receipt of the AMLC resolution, allow the
AMLC and/or its authorized representatives full access to all records pertaining to the depositor
investment account.
Any officer, employee, stockholder, owner, representative, agent, manager, director or officer-in-
charge of any banking institution or non-bank financial institution who purposely fails or willfully
refuses to permit the AMLC or its Secretariat’s duly authorized personnel to conduct an inquiry into
or examination of any deposit or investment shall be punished by a fine of not less than One
Hundred Thousand Philippine Pesos (PHP100,000.00) nor more than Five Hundred Thousand
Philippine Pesos (PHP500.000.00). The imposition of administrative penalty shall be without
prejudice to the filing of appropriate criminal charges against said officer, employee, stockholder,
owner, representative, agent, manager, director or officer-in-charge of any banking institution or
non-bank financial institution.
Rule 11.c. - BSP Authority to check compliance with the AMLA, as amended, and these
Rules. -To ensure compliance with the requirements of the AMLA, as amended, and these Rules,
the BSP may, in the course of a periodic or special examination, check the complianceof a covered
institution through generally accepted examination techniques which may include account
transaction sampling and use of electronic audit software in accordance with BSP Examination
Procedures for AML/CFT Activities. For this purpose, it may undertake the following activities:
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1.
exisbm ?tOmer identiflca“°n and account opening documents and records of
’'"a a‘COUnta- ,ncludln9 but not limited to deposits, investments, loans, treasury,
JP’ tr?St and f,duc|ary accounts, to determine compliance with the requisite: a)
q f face-to-face contact except as provided for under Rules 9.a. 10, 9.a. 11 and
' these Rules; b) completeness and accuracy of the minimum information and
documents required to be obtained under these Rules; and c) records-retention period, as
wen as compliance with all other regulations issued by the AMLC and the BSP to assess
that the covered institution has properly established and verified the true and full identity of
its customers.
2. Require a covered institution to provide BSP examiners access to electronic copies of all
covered and suspicious transaction reports filed by the covered institution with the AMLC
in order to determine accurate and complete reporting of said transactions to the AMLC
pursuant to the AMLA, as amended, these Rules and BSP issuances.
3. Review supporting transaction records and documents, including the electronic or manual
AML/CFT system, forpurposes of ascertaining that all covered and suspicious transactions
were captured and reported to the AMLC, within the period allowed by the AMLA, as
amended, and these Rules, and to determine proper maintenance and retention of
transaction documents and records.
4. Review all documents and records related to closed accounts, peso and foreign currency
non-checking numbered accounts, high-risk accounts, suspicious transactions reported to
the AMLC and accounts which are the subject of a money laundering case, to ensure that
a covered institution is properly monitoring these types of accounts/transactions and is
complying with records-retention requirements under the AMLA, as amended, these Rules
and/or BSP AML/CFT regulations.
Rule 11.C.1 BSP Examination Procedures for AML/CFT Activities and Risk Rating
System. - To ensure compliance with the AMLA, as amended, and these Rules, the BSP shall
promulgate its examination procedures for AML/CFT activities and adopt a risk rating system that
will assess a covered institution and its subsidiaries and affiliates’ overall AML/CFT risk
management system.
Any findings of the BSP which may constitute a violation of any provision of the AMLA, as
amended, and these Rules shall be referred to the AMLC forits appropriate action without prejudice
to the BSP taking appropriateaction against a non-complying covered institution and its responsible
personnel.
RULE 12
Authority to Institute Forfeiture Proceedings
Rule 12.a. Authority to Institute Civil Forfeiture Proceedings. - The AMLC is authorized under
Section 7 (3) of the AMLA, as amended, to institute civil forfeiture proceedings and all other
remedial proceedings through the Office of the Solicitor General.
Rule 12.b. Applicable Rule. The Rule of Procedure in Cases of Civil Forfeiture Asset
Preservation, and Freezing of Monetary Instrument, Property, or Proceeds Representinq Involving
or Relating to an Unlawful Activity or Money Laundering Offense under Republic Act nA Qi«n
Amended (A.M. No. 05-11-04-SC) shall govern all civil forfeiture proceedings instituted pursuant^
the AMLA, as amended. H
Rule 12.c. Claim on Forfeited Assets. - Where the court has issued an order of forfeiture in a
proceeding instituted pursuant to Section 12 of the AMLA, as amended, any other person claiminq
an interest therein may apply, by verified petition, for a declaration that the same legitimate?
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belongs to him, and for segregation or exclusion of the monetary instrument or property
corresponding thereto. The verified petition shall be filed with the court which rendered the order of
forfeiture within fifteen (15) days from the date of finality of theorder of forfeiture, in default of which
the said order shall become executory.
Rule 12.d. Payment in lieu of Forfeiture. - Where the court has issued an order of forfeiture of
the monetary instrument or property related to an unlawful activity under Section 3 (i) of the AM LA
as amended, or a money laundering offense under Section 4 of the AMLA, as amended, and said
order cannot be enforced because any particular monetary instrument or property cannot, with due
diligence, be located, or it has been substantially altered, destroyed, diminished in value or
otherwise rendered worthless by any act or omission, directly or indirectly, attributable to the
offender, or it has been concealed, removed, converted or otherwise transferred to prevent the
same from being found orto avoid forfeiture thereof, or it is located outside the Philippines or has
been placed or brought outside the jurisdiction of the court, or it has been commingled with other
monetary instruments orproperty belonging to either the offender himself or a third person or entity
thereby rendering the same difficult to identify or be segregated for purposes of forfeiture, the court
may, instead of enforcing the order of forfeiture of the monetary instrument or property or part
thereof or interest therein, accordingly order the offender to pay an amount equal to the value of
said monetary instrument orproperty. This provision shall apply in both civil and criminal forfeiture.
RULE 13
Mutual Assistance among States
Rule 13.a. Request for Assistance from a Foreign State. - Where a foreign State makes a
request for assistance in the investigation or prosecution of a money laundering offense, the AMLC
may execute the request or refuse to execute the same and inform the foreign State of any valid
reason for not executing the request or for delaying the execution thereof. The principles of
mutuality and reciprocity shall, for this purpose, beat all times recognized.
Rule 13.b. Powers of the AMLC to Act on a Request for Assistance from a Foreign State. -
The AMLC may execute a request for assistance from a foreign State by: (1) tracking down,
freezing, restraining and seizing assets alleged to be proceeds of any unlawful activity under the
procedures laid down in the AMLA, as amended, and in these Rules; (2) giving information needed
by the foreign State within the procedures laid down in the AMLA, as amended, and in these Rules;
and (3) applying for an order of forfeiture of any monetary instrument or property with the court:
Provided, That the court shall not issue such an order unless the application is accompanied by an
authenticated copy of the order of a court in the requesting State ordering the forfeiture of said
monetary instrument or property of a person who has been convicted of a money laundering
offense or an unlawful activity in the requesting State, and a certification or an affidavit of a
competent officerof the requesting State stating that the conviction and the order of forfeiture are
final and that no further appeal lies in respect of either.
Rule 13.c. Obtaining Assistance from Foreign States. - The AMLC may make a request to any
foreign State for assistance in (1) tracking down, freezing, restraining and seizing assets alleged to
be proceeds of any unlawful activity; (2) obtaining pertinent information and documents that it needs
relating to any money laundering offense or any other matter directly or indirectly related thereto;
(3) to the extent allowed by the law of the foreign State, applying with the proper court therein for
an order to enter any premises belonging to or in the possession or control of, any or all of the
persons named in said request, and/or search any or all such persons named therein and/or
remove any document, material or object named in said request: Provided, That the documents
accompanying the request in support of the application have been duly authenticated in accordance
with the applicable law or regulation of the foreign State; and (4) applying for an order of forfeiture
of any monetary instrument or property in the proper court in the foreign State: Provided, That the
request is accompanied by an authenticated copy of the order of the Regional Trial Court ordering
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tlrH^he ordX-'oVforfpitur'1^3^ ir^strurnent or property and an affidavit of the clerk of court stating
that the order of forfeiture is final and that no further appeal lies in respect of it.
R4hennv ^fb,121ittTtlOnS On Rec>uests for Mutual Assistance. - The AMLC may refuse to comply
w?rnnS?fnHt/r?raSÎStanCeWhere the action sought by the request contravenes any provision
2fhmnnSic 1 °r the executlon of a request is likely to prejudice the national interest of the
Philippines, unless there is a treaty between the Philippines and the requesting State relating to
the provision of assistance in relation to money laundering offenses.
Rule 13.e. Requirements for Requests for Mutual Assistance from Foreign States. - A request
for mutual assistance from a foreign State must (1) confirm that an investigation or prosecution is
being conducted in respect of a money launderer named therein or that he has been convicted of
any money laundering offense; (2) state the grounds on which any person is being investigated or
prosecuted formoney laundering or the details of his conviction; (3) give sufficient particulars as to
the identity of said person; (4) give particulars sufficient to identify any covered institution believed
to have any information, document, material or object which may be of assistance to the
investigation or prosecution; (5) ask from the covered institution concerned any information,
document, material or object which may be of assistance to the investigation or prosecution; (6)
specify the manner in which and to whom said information, document, material or object obtained
pursuant to said request, is to be produced; (7) give all the particulars necessary forthe issuance
by the court in the requested State of the writs, orders or processes needed by the requesting
State; and (8) contain such other information as may assist in the execution of the request.
Rule 13.f. Authentication of Documents. - For purposes of Sections 7 and 13 (f) of the AMLA,
as amended, a document is authenticated if the same is signed or certified by a judge, magistrate
or equivalent officer in or of, the requesting State, and authenticated by the oath or affirmation of a
witness or sealed with an official or public seal of a minister, secretary of state, or officer in or of,
the government of the requesting State, or of the person administering the government or a
department of the requesting territory, protectorate or colony. The certificate of authentication may
also be made by a secretary of the embassy or legation, consul general, consul, vice consul,
consular agent or any officer in the foreign service of the Philippines stationed in the foreign State
in which the record is kept, and authenticated by the seal of his office.
Rule 13.g. Suppletory Application of the Revised Rules of Court. —
Rule 13.g.1. For attachment of Philippine properties in the name of persons convicted of any
unlawful activity as defined in Section 3 (i) of the AMLA, as amended, execution and satisfaction of
final judgments of forfeiture, application for examination of witnesses, procuring search warrants,
production of bank documents and other materials and all other actions not specified in the AMLA,
as amended, and these Rules, and assistance for any of the aforementioned actions, which is
subject of a request by a foreign State, resort may be had to the proceedings pertinent thereto
under the Revised Rules of Court.
Rule 13.g.2. Authority to Assist the United Nations and other International
Organizations and Foreign States. — The AMLC is authorized under Sections 7 (8) and 13 (b)
and (d) of the AMLA, as amended, to receive and take action in respect of any request of foreign
States for assistance in their own anti-money laundering operations. It is also authorized under
Section 7 (7) of the AMLA, as amended, to cooperate with the National Government and/or take
appropriate action in respect of conventions, resolutions and other directives of the United Nations
(UN), the UN Security Council, and other international organizations of which the Philippines is a
member. However, the AMLC may refuse to comply with any such request, convention, resolution
or directive where the action sought therein contravenes the provision of the Constitution or the
execution thereof is likely to prejudice the national interest of the Philippines.
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Rule 13.h. Extradition. — The Philippines shall negotiate for the inclusion of money laundering
offenses as defined under Section 4 of the AMLA. as amended, among the extraditable offenses
in all future treaties. With respect, however, to the state parties that are signatories to the United
Nations Convention Against Transnational Organized Crime that was ratified by the Philippine
Senate on October22, 2001, money laundering is deemed to be included as an extraditable offense
in any extradition treaty existing between said state parties, and the Philippines shall include money
laundering as an extraditable offense in every extradition treaty that may be concluded between
the Philippines and any of said state parties in the future.
RULE 14
Penal Provisions
Rule 14.a. Penalties for the Crime of Money Laundering.
Rule 14.a.1. Penalties under Section 4 (a) of the AMLA, as amended. - The penalty of
imprisonment ranging from seven (7) to fourteen (14) years and a fine of not less than Three Million
Philippine Pesos (PHP3,000,000.00) but not more than twice the value of the monetary instrument
or property involved in the offense, shall be imposed upon a person convicted under Section 4 (a)
of the AMLA, as amended.
Rule 14.a.2. Penalties under Section 4 (b) of the AMLA, as amended. - The penalty of
imprisonment from four (4) to seven (7) years and a fine of not less than One Million Five Hundred
Thousand Philippine Pesos (PHP1,500,000.00) but not more than Three Million Philippine Pesos
(PHP3,000,000.00), shall be imposed upon a person convicted under Section 4 (b) of the AMLA,
as amended.
Rule 14.a.3. Penalties under Section 4 (c) of the AMLA, as amended. - The penalty of
imprisonment from six (6) months tofour(4) years or a fine of not less than One Hundred Thousand
Philippine Pesos (PHP100,000.00) but not more than Five Hundred Thousand Philippine Pesos
(PHP500,000.00), or both, shall be imposed on a person convicted under Section 4(c) of the AMLA,
as amended.
Rule 14.a.4. Administrative Sanctions. — (1) After due notice and hearing, the AMLC shall,
at its discretion, impose fines upon any covered institution, its officers and employees, or any
person who violates any of the provisions of Republic Act No. 9160, as amended by Republic Act
No. 9194 and Republic Act No. 10167 and rules, regulations, orders and resolutions issued
pursuant thereto. The fines shall be in amounts as may be determined by the Council, taking into
consideration all the attendant circumstances, such as the nature and gravity of the violation or
irregularity, but in no case shall such fines be less than One Hundred Thousand Philippine Pesos
(PHP100,000.00) but not to exceed Five Hundred Thousand Philippine Pesos (PHP500,000.00).
The imposition of the administrative sanctions shall be without prejudice to the filing of criminal
charges against the persons responsible for the violations.
Rule 14.b. Penalties for Failure to Keep Records - The penalty of imprisonment from six (6)
months to one (1) year or a fine of not less than One Hundred Thousand Philippine Pesos
(PHP100,000.00) but not more than Five Hundred Thousand Philippine Pesos (PHP500,000.00),
or both, shall be imposed on a person convicted under Section 9 (b) of the AMLA, as amended.
Rule 14.c. Penalties for Malicious Reporting. - Any person who, with malice, or in bad faith,
reports or files a completely unwarranted or false information relative to money laundering
transaction against any person shall be subject to a penalty of six (6) months to four (4) years
imprisonment and a fine of not less than One Hundred Thousand Philippine Pesos (PHP100,
000.00) but not more than Five Hundred Thousand Philippine Pesos (PHP500, 000.00), at the
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discretion of the court. Provided That

Probation Law the offender is not entitled to avail the benefits of the
from three nHcwMoht Broach of Confidentiality. -The punishment of imprisonment ranging

fPHP500 000 00/ ycars and a fine of notlessthan Five Hundred "Thousand Philippine Pesos
mnnsedon a oLorl ? ôre than One Million Philippine Pesos (PHP 1.000,000.00), shall be
mF r i a p®reon convicted for a violation under Section 9(c) of the AMLA, as amended. In
case of a breach of confidentiality that is published or reported by the media, the responsible
repoitei, writer, president, publisher, manager and editor-in-chief shall be liable under the AMLA,
as amended.
Rule 14.o. Refusal by a Public Official or Employee to Testify. - Any public official or employee
who is called upon to test it y and ref uses to do the same or purposely fails to testify shall suffer the
same penalties prescribed herein.
Rule 14.f. Where Offender is a Juridical Person, Alien or Public Officer. - if the offenderis a
corporation, association, partnership or any other juridical person, the penalty of imprisonment
and/or fine shall be imposed upon the responsible officers, as the case may be, who participated
in, or allowed by their gross negligence the commission of the crime and the court may suspend or
revoke its license If the offender is an alien, he shall, in addition to the penalties herein prescribed,
be deported without further proceedings after serving the penalties herein prescribed. If the
offenderis a public official or employee, he shall, in addition to the penalties prescribed herein,
suffer perpetual or temporary absolute disqualification from office, as the case may be.
RULE 15
Prohibitions Against Political Harassment
Rule 15.a. Prohibition against Political Persecution. — The AMLA, as amended, and these
Rules shall not be used for political persecution or harassment or as an instrument to hamper
competition in trade and commerce. No case for money laundering may be filed to the prejudice of
a candidate for an electoral office during an election period.
Rule 15.b. Provisional Remedies Application; Exception. —
Rule 15.b.1. - The AMLC may apply, in the course of the criminal proceedings, for provisional
remedies to prevent the monetary instrument or property, including related accounts, subject
thereof from being removed, concealed, converted, commingled with other property or otherwise
to prevent its being found or taken by the applicant or otherwise placed or taken beyond the
jurisdiction of the court.
Rule 15.b.2. Where there is conviction for money laundering under Section 4 of the AMLA, as
amended, the court shall issue a judgment of forfeiture in favorof the Government of the Philippines
with respect to the monetary instrument or property, including related accounts, found to be
proceeds of one or more unlawful activities.
RULE 16
Restitution
Rule 16. Restitution. - Restitution for any aggrieved party shall begoverned by the provisions of
the New Civil Code.
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RULE 17
Implementing Rules and Regulations and
Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) Programs
Rule 17.a. Implementing Rules and Regulations. — These Rules or any portion thereof may be
revised or amended by unanimous vote of the members of the AMLC.
Rule 17.b. The BSP. the SEC and the IC shall issue their respective AML/CFT Guidelines and
Circulars to assist the AMLC in effectively implementing the provisions of the AMLA, as amended,
these Rules, as well as other pertinent laws and rules.
Rule 17,c. Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT)

Programs (AML/CFT Program). —
Rule 17.C.1. All covered institutions shall formulate and implement their AML/CFT Programs
in accordance with Section 9 and other pertinent provisions of the AMLA, as amended, these Rules,
and AML/CFT Guidelines and Circulars issued by the Supervising Authorities including, but not
limited to, information dissemination on money laundering and terrorism financing activities and
their prevention, detection and reporting, and the training of their responsible personnel. Every
covered institution shall make available, upon request by the AMLC or the Supervising Authorities,
its AML/CFT Program.
Every covered institution shall regularly update its AML/CFT Program in no case longer than,
at least once every two (2) years, to incorporate changes in AML/CFT policies and procedures,
latest trends in money laundering and terrorism financing typologies, and latest pertinent issuances
by the Supervising Authorities. Any revision or update in the AML/CFT Program shall likewise be
approved by the Board of Directors or the country/regional head or its equivalent for local branches
of foreign banks/entities/companies.
Rule 17.C.2. Every covered institution’s AML/CFT Program shall include detailed procedures
implementing a comprehensive, institution-wide “know-your-client” policy, set-up an effective
dissemination of information on money laundering and terrorism financing activities and their
prevention, detection and reporting, adopt internal policies, procedures and controls, designate
compliance officers at senior officer level, institute adequate screening and recruitment procedures,
and set-up internal audit and compliance functions to test the AML/CFT system.
Rule 17.C.3. Covered institutions shall adopt, as part of their AML/CFT Programs, a system
of flagging and monitoring transactions that qualify as suspicious transactions or covered
transactions. All covered institutions, including banks insofar as non-deposit and non-government
bond investment transactions are concerned, shall incorporate in their AML.CFT Programs the
provisions of these Rules and such other guidelines for reporting to the AMLC of all transactions
that engender the reasonable belief that a money laundering offense is about to be, is being, or
has been committed.
Rule 17.d. Training of Personnel. - Covered institutions shall provide all their responsible officers
and personnel with efficient and effective training and continuing education programs to enable
them to fully comply with all their obligations under the AMLA, as amended, and these Rules.
RULE 18
Appropriations For and Budget of the AMLC
Rule 18.a. Budget. - The annual budget appropriated by Congress for the AMLC in the General
Appropriations Act shall be used to defray the capital, maintenance and operational expenses of
the AMLC.
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ovUnZn\8^ r»foStS ExPenses - The budget shall answer for indemnification for legal costs and
expenses reasonably incurred for the services of external counsel in connection with any civil,
r administrative action, suit or proceeding to which members of the AMLC and the
Executive Director and other members of the Secretariat may be made a party by reason of the
performance of their functions or duties. The costs and expenses incurred in defending the
aforementioned action, suit or proceeding may be paid by the AMLC in advance of the final
disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of the
member to repay the amount advanced should it be ultimately determined that said member is not
entitled to such indemnification.
RULE 19
Separability Clause
Rule 19. Separability Clause. — If any provision of these Rules or the application thereof to any
person or circumstance is held to be invalid, the other provisions of these Rules, and the application
of such provision or Rule to other persons or circumstances, shall not be affected thereby.
RULE 20
Repealing Clause
Rule 20. Repealing Clause. — All laws, decrees, executive orders, rules and regulations or parts
thereof, including the relevant provisions of Republic Act No. 1405, as amended; Republic Act No.
6426, as amended; Republic Act No. 8791, as amended, and other similar laws, as are inconsistent
with the AMLA, as amended, are hereby repealed, amended or modified accordingly; Provided,
that the penal provisions shall not apply to acts done prior to the effectivity of the AMLA on October
17, 2001.
RULE 21
Effectivity of the Rules
Rule 22. Effectivity. — These Rules shall take effect fifteen (15) days after complete publication in
the Official Gazette or in a newspaper of general circulation.
Approved this 23rd day of August 2012 in the City of Manila.
By the Anti-Money Laundering Council:
AMANDO M. TETANGCO, JR.

Chairman
(Governor, Bangko Sentral ng Pilipinas)
TERESITA J. HERBOSA
Member
(Chairperson, Securities and Exchange Commission)
EMMANUEL F. DOOC
Member
(Commissioner, Insurance Commission)
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Appendix 2
INFLATION TARGETING
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INFLATION targeting framework
*S drivQrs that affect the interest rates as well as the

pu tn P ™er er>ce ability of the people to manage their obligation or their cash
flows that can be invested.
Source: Bangko Sentral ng Pilipinas Primer on Inflation Targeting
297 |
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FUNDAMENTALS OF FINANCIALMPDFelement
ARKET
references
habOZZ'lnvet?mentdMDarnafemente'fo09nar,Ce: Capital Market’ Financial Manasement and
Gitman J_awrence and Zutter, Chad. Principles of Managerial Finance 13th ed. Pearson.
Glenn, Hubbard, O’ Brien, Anthony Patrick. Money, Banking and Financial Systems.
USA. 2007.
Mishkin, Frederic S. and Serletis, Apostolos. The Economics of Money, Banking and
Financial Markets. 4th Edition. Toronto, Canada. 2011.
Faure, Dr AP. Financial System: An Introduction. 1st Edition. 2013.
Saunders, Anthony and Cornett, Marcia. Financial Market and Institutions. 5th Edition.
New York, USA. 2012.
Special Thanks to the following Government Agencies
Bangko Sentral ng Pilipinas
Board of Investments
Bureau of Treasury
Bureau of Internal Revenue
Insurance Commission
Philippine Stock Exchange
Philippine Securities and Exchange Commission
World Bank
299 |

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Marvin V. Lascano, CPA, CFC,.MBA

Fundamentals of Financial Market

Marvin V. Lascano, CPA, CFC, MBA

Financial Resource is vital in every company. This is c

Marvin V. Lascano is a Certified Public Accountant and Certified Financial Consultant by

DR. HERBERT C. BARON, CPA

ANDREW TIMOTHY L. CACHERO, CPA

systems and the financial market 5

Evaluating Money Market Securities

DEBT SECURITIES MARKETS 145

Debt Security .........................................

The Financial System

In the world ol commerce finance is a key player in ensuring continuity d

To cite another good definition of financial system:

“Financial system is a set of arrangements or conventions embracing the

Financial system is composed of network of inter-related systems of financial markets,

In a country, there are households, companies

Figure 1.2. Financial Systems

A properly functioning financial system also enhances welfare of individual

To become more efficient, the financial system of a country commonly addresses

Elements of the Financial System

2. Financial intermediaries (How will the exchange occur?)

Financial instruments are medium of exchange of contractual obligation cf

4. Financial markets (Where will it be traded?)

Financial Markets is same with the other economic markets where

Regulatory environment (How it is controlled?)

6. Money creation (What is the value it creates?)

7 Price discovery (How much is created?)

The Financial markets

Financial market refers to channels or places where funds and financial

The main economic function of the financial markets is to serve as a channel to

Exchanging of financial instruments is also more commonly known as "trading”.

The second function of the financial market is liquidity. Financial markets

Without liquidity, an investor is forced to hold to financial instrument up until

• Reduction in transaction costs

Reduction in transaction costs is the last function of a financial market

, arp costs related in evaluating investment characteristics

Types of Financial Markets

Based on Instruments Traded

cessiveholdin9S ofcash by fund providers also generates opportunity

fund providers to fund demandersfor ,ransfer lar9e amounts of money from

Capital market is the sector of the financial markets where financial

Based on Market Type

Another categorization of financial market is to what type of market it is being

Figure 1.3. Primary vs Secondary Markets

Public offering can either be an offerfor subscription or an offerfor sale. In an offer

Most of the time, an underwriter is appointed for public offerings. An underwriter

One variation of a private placement is that an underwriter subscribes to all

new securities in the primary market.

- ---------- —' ***^WK4| lU^O.

• Order-Driven Market Structure „ _ir

• Quote-Driven Market Structure

• Exchange (or formalized)

Exchanges are centralized trading locations where financial instruments are

r market (or informal)

Over-the-cou t roTC) market

^'^"ptancesand foreign exchange. ne9otiab,e ce“s*

Figure 1.4. Trade Segregation for Primary and Secondary Markets

Examples of external market includes international market, offshore market and

Based on Manner of Financial Intermediaries

1. Financial system is a set of arrangements or conventions embracing the

2. Financial system is composed of network of inter-related systems of

NAME:______________________ Date:-------------------------