FINANCIAL MARKETS: AN OVERVIEW

INTRODUCTION

A developed economy relies on financial markets and institutions for efficient transfer of funds from savers to borrowers.

Financial markets are the meeting place for people, corporations and institutions that either need money or have money to lend or invest. In a broad context, the
financial markets exist as a vast global network of individuals and financial institutions that may be lenders, borrowers or owners of public companies worldwide.

The flow of money around the world is essential for businesses to operate and grow. Stock markets are places where individual investors and corporations can trade
currencies, invest in companies, and arrange loans. Without the global financial markets, governments would not be able to borrow money, companies would not
have access to the capital they need to expand, and investors and individuals would be unable to buy and sell foreign currencies.

Participants in the financial markets also include national, state and local governments that are primarily borrowers of funds for highways, education. welfare and
other public activities; their markets are referred to as public financial markets. Large corporations raise funds in the corporate financial markets.

FINANCIAL MARKETS IN ACTION

Thanks to the global financial markets, money flows around the world between investors, businesses, customers, and stock markets. Investors are not restricted to
placing their money with companies in the country where they live, and big businesses now have international offices, so money needs to move efficiently between
countries and continents. It is also important for the growth of the global economy that people are able to invest money outside of their domestic markets.

Corporations rely on the financial markets to provide funds for short-term operations and for new plants and equipment. A firm may go to the markets and raise
financial capital by either borrowing money through a debt offering of corporate bonds or short-term notes, or by selling ownership in the company through an issue
of common stock.

When a corporation uses the financial markets to raise new funds, the sale of securities is said to be made in the primary market by way of a new issue.

After the securities are sold to the public (institutions and individuals), they are traded in the secondary market between investors. It is in the secondary market that
prices are continually changing as investors buy and sell securities based on their expectations of a corporation's prospects. It is also in the secondary market that
financial managers are given feedback about their firm's performance. Those companies that perform well and are rewarded by the market with high priced securities
have an easier time raising new funds in the money and capital markets than their competitors. They are also able to raise funds at a lower cost.

FUNCTION OF FINANCIAL MARKETS

This Chapter offers a preliminary overview of the fascinating study of financial markets. The more detailed treatment of the regulation, structure and evaluation of
financial markets are covered in Units III and IV.

Financial markets (bond and stock markets) and financial intermediaries (banks, insurance companies among others) have the basic function of getting people
together by moving funds from those who have a surplus of funds to those who have a shortage of funds. Well-functioning financial markets and financial
intermediaries are crucial to our economic health. Indeed, when the financial system breaks down, as it has in Europe and in Southeast Asia recently, severe
economic hardship results.

To determine the effects of financial markets and financial intermediaries on the economy we need to acquire an understanding of their general structure and
operation.

Discussion:

Those who have savings and are lending funds (the lender-savers), are at the left and those who must borrow funds to finance their spending (the borrowers-
spenders), are at the right.

The principal lender-savers are households, but business enterprises and the government as well as foreigners and their government, sometimes also find themselves
with excess funds and so lend them out.

The most important borrower-spenders are businesses and the government (particularly the material government) but households and foreigners also borrow to
finance their purchases of cars, furniture's and houses.

The arrows show that funds flow from lender-savers to borrower-spenders, both directly and indirectly.

Funds flow from lenders to borrowers indirectly through financial intermediaries such as banks or directly through financial markets, such as the Philippine Stock
Exchange.
WHAT FINANCIAL MARKETS DO

Financial markets take many different forms and operate in diverse ways. But all of them, whether highly organized, like the New York Exchange, or highly informal,
like the money changers on the street corners of some African cities, serve the same basic functions.

• Raising capital. Firms often require funds to build new facilities, replace machinery or expand their business in other ways. Shares, bonds and other types of
financial instruments make this possible. The financial markets are also an important source of capital for individuals who wish to buy homes or cars, or even to make
credit-card purchases.

• Commercial transactions. As well as long-term capital, the financial markets provide the grease that makes many commercial transactions possible. This includes
such things as arranging payment for the sale of a product abroad, and providing working capital so that a firm can pay employees if payments from customers run
late.

Price setting. The value of an ounce of gold or a share of stock is no more, and no less, than what someone is willing to pay to own it. Markets provide price discovery,
a way to determine the relative values of different items, based upon the prices at which individuals are willing to buy and sell them.

⚫ Asset valuation. Market prices offer the best way to determine the value of a firm or of the firm's assets, or property. This is important not only to those buying and
selling businesses, but also to regulators. An insurer, for example, may appear strong if it values the securities it owns at the prices it paid for them years ago, but the
relevant question for judging its solvency is what prices those securities could be sold for if it needed cash to pay claims today.

⚫ Arbitrage. In countries with poorly developed financial markets, commodities and currencies may trade at very different prices in different locations. As traders in
financial markets attempt to profit from these divergences, prices move towards a uniform level, making the entire economy more efficient.

• Investing. The stock, bond and money markets provide an opportunity to earn a return on funds that are not needed immediately, and to accumulate assets that
will provide an income in future.

⚫ Risk management. Futures, options and other derivatives contracts can provide protection against many types of risk, such as the possibility that a foreign currency
will lose value against the domestic currency before an export payment is received. They also enable the markets to attach a price to risk, allowing firms and
individuals to trade risks so they can reduce their exposure to some while retaining exposure to others.

STRUCTURE OF FINANCIAL MARKETS

Now that we understand the basic function of financial markets, let us study their structure. The essential categories and features of these markets are described in
the following sections.

There are many different financial markets in a developed economy each dealing with a different type of security serving a different set of customers, or operating in
a different part of the country.

Debt and Equity Markets

Funds in a financial market can be obtained by a firm or an individual in two ways.

The most common method is to issue a debt instrument, such as a bond or a mortgage, which is a contractual agreement by the borrower to pay the holder of the
instrument fixed peso amounts at regular intervals (interest and principal payments) until a specified date (the maturity date), when a final payment is made. The
maturity of a debt instrument is the number of years (term) until that instrument's expiration date. A debt instrument is short- term if its maturity is less than a year
and long-term if its maturity is ten years or longer. Debt instruments with a maturity between one and ten years are said to be intermediate-term.

The second method of raising funds is by issuing equity instruments, such as common or ordinary stock, which are claims to share in the net income (income after
expenses and taxes) and the assets of a business. If you own one share of common stock in a company that has issued one million shares. you are entitled to I one-
millionth of the firm's net income and I one- millionth of the firm's assets. Equities often make periodic payments (dividends) to their holders and are considered long-
term securities because they have no maturity date. In addition, owning stock means that you own a portion of the firm and thus have the right to vote on issues
important to the firm and to elect its directors.

The main disadvantage of owning a corporation's equities rather than its debt is that an equity holder is a residual claimant, that is, the corporation must pay all its
debt holders before it pays its equity holders. The advantage of holding equities is that equity holders benefit directly from any increases in the corporation's
profitability or asset value because equities confer ownership rights on the equity holders. Debt holders do not share in this benefit because their peso payments are
fixed.
The following markets are of most interest to the financial manager:

Financial Market functions as both primary and secondary markets for debt and equity securities,

• Primary Market
Primary Market refers to original sale of securities by governments and corporations. The primary markets for securities are not well known to the public because the
selling of securities to initial buyers often takes place behind closed door. In a primary market transaction; the corporation or the government is the seller and the
transaction raises money for the corporation or the government.
Corporations engage in two types of primary market transactions, public offerings and private placements. A public offering, as the name suggests, involves selling
securities to the general public whereas a private placement is a negotiated sale involving a specific buyer. Public offerings of debt and equity must be approved by
and registered with the Securities and Exchange Commission. Registration requires the firm to disclose a great deal of information before selling any securities. The
accounting legal and selling costs of public offerings can be considerable.
To avoid partly the various regulatory requirements and the expense of public offerings, debt and equity are often sold privately to large financial institutions such as
insurance companies or mutual funds. Such private placements need also to be approved and registered with the SEC. An important financial institution that assists in
the initial sale of securities in the primary market is the investment bank. It does this by underwriting securities. It guarantees a price for a corporation's securities and
then sells them to the public.

⚫ Secondary Market
After the securities are sold to the public (institutions and individuals) they can be traded in the secondary market between investors. Secondary market is popularly
known as Stock Market or Exchange.
Securities brokers and dealers are crucial to a well-functioning secondary market. Brokers are agents of investors who match buyers with sellers of securities, dealers
link buyers and sellers by buying and selling securities and stated prices.

There are two broad segments of the stock markets:

1. The Organized Stock Exchange. The stock exchanges will have a physical location where stocks buying and selling transactions take place in the stock exchange floor
(e.g. Philippine Stock Exchange, New York Stock Exchange. Japan Nikkei. Shanghai Components, NASDAQ, etc.)
2. The Over-the-Counter (OTC) Exchange. Where shares, bonds and money market instruments are traded using a system of computer screens and telephones. The
NASDAQ is an example of an over-the- counter market in which dealers linked by computer buy and sell stocks. Dealers in an over-the-counter market attempt to
match up the orders they receive from investors to buy and sell its stock. Dealers maintain an inventory of the stocks they trade to help balance buy and sell orders.
Many common stocks are traded over the counter although the majority of the largest corporations have their shares traded at organized stock exchange.

Secondary markets serve two important functions:

1. They make it easier to sell these financial instruments to raise cash; that is they make the financial instruments more liquid. The increased liquidity of these
instruments then makes them more desirable and thus easier for the issuing firm to sell in the primary market.
2. They determine the price of the security that the issuing firm sells in the primary market. The firms that buy securities in the primary market will pay the issuing
corporation no more than the price that they think the secondary market will set for this security. The higher the security's price in the secondary market, the higher
will be the price that the issuing firm will receive for a new security in the primary market and hence the grater the amount of capital it can raise. Conditions in the
secondary market are therefore the most relevant corporations issuing securities.

Stock Exchange
Stock exchange is an organized secondary market where securities like shares. debentures of public companies, government securities and bonds issued by
municipalities, public corporations, utility undertakings, port trusts and such other local authorities are purchased and sold. In order to bring liquidity, the stocks are
traded systematically in a stock exchange.

The stock exchange is an entity (a corporation or mutual organization) which is in the business of bringing buyers and sellers of stocks and securities together. The
purpose of stock exchange is to facilitate the exchange of securities between buyers and sellers, thus providing a market place. virtual or real. The stock market that
does not have a physical presence, it is a virtual market. Share brokers may be assembled in a place called the "trading ring" and bought and sold shares. Technology

has enabled the ring to be located on a central computer, which has millions of buye rs and sellers attached to it through a telecommunication network. These buyers
and sellers indicate their intentions through a computer at home or the office, their own or their broker's. Buyers' and sellers' orders are matched by the central
computer, and if quantities and prices correspond, then a trade is set to be executed. The entire process of sending the order to the stock exchange computer,
confirmation of order and execution, if any, is communicated within a fraction of a second.

The stock exchange supplies a platform from which to buy and sell shares in certain listed companies. It regulates the company's behaviour through requirements
agreed upon by the company in order to be listed. This is called a listing agreement which ensures that the company provides all the information pertaining to its
working from time to time, including events that affect its valuation, such as mergers, amalgamations and such other sensitive matters. Large volumes are possible in
these markets because of two things. One is the ease of settlements. The shares that are traded in are received and delivered through an electronic entry in the
books of buyers and sellers. The second reason is guarantee of trades. Sellers get their money, buyers get their shares. The stock market is known as barometer of the
company's economy. The companies listed on stock exchanges collectively contribute to the country's gross domestic product (GDP).
Stocks that trade on an organized exchange are said to be listed on that exchange. To be listed, firms must meet certain minimum criteria concerning, for example
number of share holder and asset size. These criteria differ from one exchange to another.

Listing of Securities on Stock Exchange

Listing means admission of securities to dealings on a recognized stock exchange of any incorporated company, central and stage governments, quasi govemmental
and other financial institutions/corporations, municipalities, electricity boards, housing boards and so forth. The principal objective of listing is to provide liquidity and
marketability to listed securities and ensure effective monitoring of trading for the benefits of all participants in the market. A company desiring to get listing has to
enter into listing agreement with the concerned stock exchange and is required to pay the specified listing fees. Thereafter, the company is required to comply with
all clauses of the listing agreement and to send details of book closure, record dates, copies of annual report, quarterly and half-yearly reports and cash flow
statements to the respective stock exchange where the securities are listed. A recognized stock exchange means a stock exchange being recognized by the national
government through the Securities and Exchange Commission (SEC). Securities are bought and sold in recognized stock exchanges through members who are known
as brokers. The price at which the securities are bought and sold on a recognized exchange is known as official quotation.

The securities of an entity may be listed at any of the following stages:

• At the time of public issue of shares or debentures

⚫ At the time of rights issue of shares or debentures

⚫ At the time of bonus issue of shares

⚫ Shares issued on amalgamation or merger

THE PHILIPPINE STOCK EXCHANGE

The Philippine Stock Exchange, Inc. (Filipino: Pamilihang Supi ng Pilipinas; PSE: PSE) is the national stock exchange of the Philippines. The exchange was created in
1992 from the merger of the Manila Stock Exchange and the Makati Stock Exchange. Including previous forms, the exchange has been in operation since 1927.

The main index for PSE is the PSE Composite Index (PSE) composed of thirty (30) listed companies. The selection of companies in the PSEi is based on a specific set of
criteria. There are also six additional sector-based indices. The PSE is overseen by a 15-member Board of Directors, chaired by José T. Pardo.

Snapshot of PSE History

On February 3, 1936, the Securities and Exchange Commission announced that it had "relinquished control of the Manila Stock Exchange."

The Philippine Stock Exchange was formed on December 23, 1992 from the merger of the Manila Stock Exchange (MSE) (established on August 12, 1927, based on
Muelle de la Industria, Binondo, Manila) and the Makati Stock Exchange (MKSE) (established on May 15, 1963, based in the Makati Central Business District, within
Ayala Tower One). Both exchanges traded the same stocks of the same companies.

In June 1998, the Securities and Exchange Commission (SEC) granted the PSE a "Self-Regulatory Organization" (SRO) status, which meant that the bourse can
implement its own rules and establish penalties on erring trading participants (TPS) and listed companies.

In 2001, the PSE was transformed from a non-profit, non-stock, member-governed organization into a shareholder-based, revenue-earning corporation headed by a
president and a board of directors and on December 15, 2003 listed its own shares on the exchange (traded under the ticker symbol PSE).

On July 26, 2010 the PSE launched its new trading system, PSEtrade, which was acquired from the New York Stock Exchange.

In 2019, the PSE introduced a new index that will help track the overall returns of the main index. The Total Return Index (PSE, TRI), is part of the effort to create a
broader investor base for the market.

The Philippine newspapers publish daily the activities in the Philippine Stock Exchange by reporting (a) the PSE index, gain / loss and (b) individual trading outcome of
publicly-listed securities.

A list of companies (323) registered with the Philippine Stock Exchange where stock are actively traded as of September, 2019 is shown in Appendix B.
THE OVER-THE-COUNTER MARKET

The vast majority of publicly available equities are seldom bought or sold and are of no interest to institutional investors. Such shares are usually traded over the
counter (OTC). In the United States, which has far more publicly traded companies than any other country, an estimated 25,000 firms trade over the counter, about
three times as many as trade on organized exchanges. Most of these are very small firms, and some do not file the periodic financial reports and audited financial
statements required by stock exchanges. (In the United States, trading on the NASDAQ stockmarket is sometimes referred to as over-the counter trading, but this
convention is outdated).

OTC trading requires a brokerage firm to match a prospective buyer and a prospective seller at a price acceptable to both. Alternatively, the brokerage firm may
purchase shares for its own account or sell shares that it has been holding. Several electronic services post bid and offer prices for OTC shares as well as information
about trading volume. However, as such shares trade infrequently, a trade may be difficult to arrange owing to a lack of sellers or investors, and the price at which the
transaction is completed may be very different from the last price at which those shares were traded days or even hours before. Firms, whose shares trade over the
counter normally have few shareholders and little equity outstanding. If a firm wishes to raise larger amounts of capital in the equity market and to appeal to a
broader shareholder base, it will seek to list its shares on a stock exchange.

DAY TRADING

Day trading is the buying and selling of shares, currency, or other financial instruments in a single day. The intention is to profit from small price fluctuations -
sometimes traders hold shares for only a few minutes.

How it works

Investors typically buy or sell a share based on their analysis of economic or market trends, research into specific companies, or as part of a strategy to benefit from
the regular dividends that companies issue. Unlike such investors, day traders look for small movements in prices that they can exploit to make a quick profit.

Day traders favor shares that are liquid -- those are easy to buy and sell in the secondary market. They may hold shares only momentarily, buying at one price and
selling when the price rises by a few cents, perhaps only minutes later. Day traders make profits by trading large volumes of shares in one transaction, or by making
multiple trades during the course of the day. They buy (or sell) shares and then sell (or buy) them again before payment becomes due, and usually "close out" all
trades (selling the shares they have bought, and vice versa) at the end of the day to protect themselves from off-hours movements in the market. This is different
from long-term investing, in which assets are held for longer periods in order to generate growth or income.

Potential Day Traders should be knowledgeable of the following:

Market data
The current trading information for each day-trading market. Rather than using market data that is available free of charge but can be up to an hour old, day traders
pay a premium for access to real-time data. Day traders must be able to trade on news or announcements quickly, so they need to watch the market and stay close to
their trading screens at all times.

Scalping

A strategy in which traders hold their share or financial asset (known as their "position") for just a few minutes or even seconds.

Margin trading

A method of buying shares that involves the day trader borrowing a part of the sum needed from the broker who is executing the transaction.

Bid-offer spread

The difference between a price at which a share is sold, and that at which it is bought.

Potential Day Traders should be aware that:

⚫ Day trading is a high risk occupation - Day traders typically suffer severe losses in their first months to trading, and many never graduate to profit-making status.

⚫ Day trading is a stressful- Day traders must watch the market nonstop during the day, concentrating on dozens of fluctuating indicators in the hope of spotting
market trends.

⚫ Day trading is expensive - Day traders pay large sums in commissions, for training, and for computers.
THE RISE OF THE FORMAL MARKETS

The formal financial markets have expanded rapidly in recent years, as governments in countries marked by shadowy, semi-legal markets have sought to organize
institutions. The motivation was in part self-interest: informal markets generate no tax revenue. but officially recognized markets do. Every country has financial
markets of one sort or another. In countries as diverse-as China, Peru and Zimbabwe, investors can purchase shares and bonds issued by local companies. Even in
places whose governments loudly reject capitalist ideas, traders, often labeled disparagingly as speculators, make markets in foreign currencies and in commodities

such as oil. Gover nments have also recognized that if businesses are to thrive they must be able to raise capital, and formal means of doing this, such as selling
shares on a stock exchange, are much more efficient than informal means such as borrowing from moneylenders.

Investors have many reasons to prefer financial markets to street-corner trading. Yet not all formal markets are successful, as investors gravitate to certain markets
and leave others underutilized. The busier ones, generally, have important attributes that smaller markets often lack:

⚫ Liquidity, the ease with which trading can be conducted. In an illiquid market an investor may have difficulty finding another party ready to make the desired trade,
and the difference, or "spread", between the price at which a security can be bought and the price for which it can be sold, may be high. Trading is easier and spreads
are narrower in more liquid markets. Because liquidity benefits almost everyone, trading usually concentrates in markets that are already busy.

Transparency, the availability of prompt and complete information about trades and prices. Generally, the less transparent the market, the less willing people are to
trade there.

• Reliability, particularly when it comes to ensuring that trades are completed quickly according to the terms agreed.

Legal procedures adequate to settle disputes and enforce contracts.

• Suitable investor protection and regulation. Excessive regulation can stifle a market. However, trading will also be deterred if investors lack confidence in the
available information about the securities they may wish to trade, the procedures for trading, the ability of trading partners and intermediaries to meet their
commitments, and the treatment they will receive as owners of a security or commodity once a trade has been completed.

• Low transaction costs. Many financial-market transactions are not tied to a specific geographic location, and the participants will strive to complete them in places
where trading costs, regulatory costs and taxes are reasonable.

THE FORCES OF CHANGE

Today's financial markets would be almost unrecognizable to someone who traded there only two or three decades ago. The speed of change has been accelerating
as market participants struggle to adjust to increased competition and constant innovation.

⚫ Technology. Almost everything about the markets has been reshaped by the forces of technology. Abundant computing power and cheap telecommunications
have encouraged the growth of entirely new types of financial instruments and have dramatically changed the cost structure of every part of the financial industry.

• Deregulation. The trend towards deregulation has been worldwide. It is not long since authorities everywhere kept tight controls on financial markets in the name
of protecting consumers and preserving financial stability. But since 1975, when the United States prohibited stockbrokers from setting uniform commissions for
share trading, the restraints have been loosened in one country after another. Although there are great differences, most national regulators agree on the principles
that individual investors need substantial protection, but that dealings involving institutional investors require little regulation.

• Liberalization. The reduction of regulations has been accompanied by a general liberalization of rules governing participation in the markets. Many of the conditions
that once separated banks, investment banks, insurers, investment companies and other financial institutions have been lowered, allowing such firms to enter each
other's businesses. Rules that made it difficult for companies to issue shares have generally been eased as well, leaving the decision of whether a young, unprofitable
firm's shares represent a worthwhile investment to investors rather than regulators. The big market economies, most recently Japan and South Korea, have also
allowed foreign firms to enter financial sectors that were formerly reserved for domestic companies.

⚫ Consolidation. Liberalization has led to consolidation, as firms merge to take advantage of economies of scale or to enter other areas of finance. Almost all the UK's
leading investment banks and brokerage houses, for example, have been acquired by foreigners seeking a bigger presence in London, and many of the medium-sized
investment banks in the United States were bought by commercial banks wishing to use new powers to expand in share dealing and corporate finance. Financial crisis
led to further consolidation, as the insolvency of many major banks and investment banks led to forced mergers in 2008. However, the crisis also prompted law
makers and regulators in some countries to force banks to provide safety nets in their consumer banking operations, separating them from their trading and
corporate banking operations so that consumers' deposits will not be at risk if other, riskier businesses produce large losses.
Globalization. Most o f the important financial firms are now highly international, with operations in all the major financial centres. Many companies and
governments take advantage of these global networks to issue shares and outside their home countries. Investors increasingly take a global approach as well, putting
their money wherever they expect the greatest return for the risk involved, without worrying about geography.

Code of Ethics Governing Market Activities in the Philippines

On February 24, 2010 Former Deputy Governor Nestor A. Espenilla Jr. issued Circular Letter No. CL 2010-013 addressed to all banks, their subdivision and other
affiliates to non-bank which contains financial institutes supervised by the BSP. The Code of Ethics Governing Financial Market Activities in the Philippines is presented
in Appendix