Group 1 - Module 1

Garcia, Catherine Stacy

Garcia, Kimberly Kate
Lamanilao, Harah Jean
Mendoza, Carl Gabriel

What are Financial Markets?

• A marketplace where the trading of financial assets occurs.

Financial market is BROAD. It can be anywhere in the world and is vital to the smooth operation
of capitalist economies. As stated, it is a marketplace where everyone can trade money,
securities, mutual funds, insurance, stocks, etc. or also known as the financial assets or we can
also refer to financial instruments, which I will discuss right away.

What are Financial Assets?

• Financial assets are intangible assets where typically the future benefits come in the form
of a claim to future cash.

What do we mean by “financial assets are intangible assets?”. If we can recall, assets are any
resources that are expected to provide future benefits, may it be in cash or any other benefits
that any person can claim in the future, hence, assets have economic value. And assets are
divided into two categories, the tangible and intangible assets. Tangible assets are assets that
depend on its physical properties like buildings, cars, machinery, equipment, land, etc. On the
other hand, intangible assets are assets that are not physical in nature, it has no shape or form,
and on Financial Markets, intangible assets represent a legal claim to some future economic
benefits and that is why financial assets are intangible assets.

Financial assets can also be defined as an investment asset because those who participate in
trading financial assets are “investing” through the financial asset whose value is derived from
the contractual claim of what they represent. The best example would be the stock market, if
you buy a stock for in the stock market, it means that you’re investing on that stock, the money
that you used to invest on that stock is your capital, and the future economic benefit of the stock
you bought would be the profit that you’ll get through the capital gains.

Examples of Financial Assets

• Bond
• Securities
• Stock
• Option
• Debenture
• Cash
• Cash Equivalent
• Certificate of deposit
• Government Bond
Two Parties Involved in a Financial Asset
1. Issuer - the party that has agreed to make future cash payments.
2. Investor - the party that owns the financial asset and therefore the right to receive the
payments.

Debt vs Equity Instrument

• A financial instrument can be classified by the type of claims that the investor has on the
issuer.

Debt Instrument
• Also referred to as an Instrument of Indebtedness is an asset that an entity, such as an
individual, or the government, uses to raise capital or to generate investment income
through a debt.

In simple terms, debt instruments are just a debt or a loan that you give to the state or a
corporation to earn interest revenue. How does it work? The issuer borrows capital from an
investor and that capital will be used to finance projects or in expanding business. After the
agreed term, the investor’s principal or the money they lent to the issuer must be repaid back
with interest.

Equity Instrument
• Equity Instruments represents ownership of an asset, it is an investment for people who
want to own an asset or part of an asset while also receiving an income on it.

The investors will buy an asset and will just wait for that asset to gain an income.
An Equity Instrument’s value is measured on the profit and loss of the company, and anyone
who invests in them not only becomes a part-owner of the company, but also a risk bearer,
owners of equity instruments can hold these instruments indefinitely as long as they want or
even sell it to other investors. The best example of an equity instrument is the stock market.

DEBT INSTRUMENT EQUITY INSTRUMENT

The issuer becomes a bondholder, lender, or The issuer becomes a co-owner and a
just an investor who receives fixed monthly shareholder.
income.

The investor does not have decision-making The investor gets decision-making power
power. within the company.
 The investor receives monthly fixed interests The investor carries the company’s risks since
without shouldering any risk. they have an incentive to receive higher
dividends.

General Principles for Determining the Price of a Financial Asset

Supply and Demand

• The most fundamental and basic principle is the interaction of supply and demand.
If more people want to buy an asset than sell it, its price tends to rise, and vice
versa.
• Supply and demand are the fundamental economic principle that describes the
relationship between the availability of a product or service (supply) and the desire
or need for that product or service (demand), which determines its price and
quantity in a market.

Example of the Principle of Supply and Demand:

• Suppose a popular company, ABC Corp., announces impressive earnings
and future growth prospects, sparking high investor demand for its shares
(increased demand). As more investors rush to buy ABC Corp’s stock, the
limited supply of available shares in the market becomes scarcer, leading to
a surge in its price (higher price due to increased demand).

Cash Flow Analysis

• is a financial evaluation method used to assess the inflows and outflows of cash
associated with a business, investment, project, or financial asset over a specific
period.
• Cash flow analysis plays a crucial role in determining the value or price of a financial
asset, especially when it comes to assessing the intrinsic value of income-
generating assets like stocks, bonds, or real estate investment properties.

Examples of Methods Used in Cash Flow Analysis

1. Yield-to-Maturity - represents the total return an investor can expect if they
hold the bond until maturity.
 2. Yield-to-Call - calculates the annualized yield an investor can expect if they
hold a callable bond until the call date.
3. Yield-to-Put - calculates the annualized yield an investor can expect if they
hold a bond with a put option until the put date.
4. Discounted Cash Flow - assesses the present value of expected future cash
flows, often used for stocks and businesses, with consideration of growth
rates and discount rates.
5. Dividend Discount Model - calculates the present value of expected future
dividends for stocks, assuming a constant or growing dividend stream.
Regulatory Environment
• Financial markets and institutions are subject to extensive laws and regulations
aimed at protecting investors and safeguarding the stability and integrity of the
financial system.

Government Agencies Governing Financial Assets

• Securities and Exchange Commission - It enforces rules related to
disclosures, trading practices, and registration of securities.
• Bangko Sentral ng Pilipinas - It supervises banks, financial institutions, and
the stability of the financial system.

Example of Regulatory Environment:

• The implementation of Republic Act No. 7183, also known as the
"Firecracker Law", affected the fireworks industry because of its restrictive
rules. Since many types of firecrackers were regulated or discontinued, like
the well-known “Pop-Pop” firecracker, manufacturing corporations
associated with those products plummeted. Investors are not interested in
purchasing their stocks or investing due to the regulatory risks
accompanying the industry.

Economic Indicators
• Economic factors like GDP growth, inflation rates, and interest rate trends can
impact asset prices. They can be essential factors in determining the value or price
of financial assets because they help investors and analysts assess the broader
economic environment in which those assets operate. A strong economy generally
supports higher asset prices.

Risk Assessment
• This involves evaluating the potential risks associated with an investment or
financial instrument. It aims to quantify, understand, and manage the various risks
that investors may face when allocating their capital.
 • Higher-risk assets typically require higher expected returns.

Example of High-Risk Assets with Higher Prices & Returns

• Biotechnology Stocks - the biotech sector often develops groundbreaking
drugs and technologies, which can lead to substantial price increases if they
receive regulatory approval or make scientific breakthroughs. However,
they are also prone to setbacks and regulatory challenges.

Model Related to Risk Assessment

• Capital Asset Pricing Model - provides a framework for estimating the

expected return on an investment, considering the asset's systematic risk
or market risk.
1. Risk-Free Rate - This rate is considered the baseline return that
investors can earn with no risk of loss.
2. Market Risk Premium - represents the expected additional return
that investors demand for taking on risks associated with the
market.
3. Beta (β) - quantifies how much an asset's returns tend to move in
relation to the overall market. An asset with a beta of 1 moves in
line with the market, while a beta greater than 1 indicates higher
sensitivity (higher risk), and a beta less than 1 indicates lower
sensitivity (lower risk).

Eleven Properties of Financial Assets

1. Moneyness

• Ability to be used in settling transactions.

• Referred to as “near money”.
• Examples are time and saving deposits.
• Desirable property for investors.
2. Divisibility

• Minimum size to be exchanged for money.

• Smaller means more divisible; better for investors and worse for borrowers.

Example: Investing 100 bonds worth P1,000 each, if the value of bonds increases to P10,000 then
investors will realize a 900,000-peso gain. In a similar manner, if borrowers borrow 100 bonds
worth 1 P1,000 each, if the value of bonds increases to P10,000 then investors will realize a
900,000-peso loss since they will have to pay back what they borrowed.
3. Reversibility
 • Cost of investing and then getting out of it and turning it into cash again.
• Bank Deposits are highly reversible since it costs nothing to deposit additional funds and to
withdraw said funds.
4. Cash Flow

• Return that an investor will realize by holding a financial asset.

• Two types which are Nominal Return and Real Return
• Nominal Return Does not take into consideration inflation while real return does.
• If the nominal return is 6% and the inflation is 4%, then the real return is approximately 2%.
5. Term for Maturity

• This is the length of period until the date of last payment.

Example: 2 years, 3 years, 10 years till maturity.
6. Convertibility

• This is the property of financial assets to be converted into a different kind of financial asset.
Example: Preference Stocks which could be converted into Common Stock.
7. Currency

• Financial assets are denominated in currencies such as dollar, euro, or yen.

Example: Bonds/stocks in PH are often bought using peso, and the same rules may apply to other
countries, or they could be paid using the dollar if they operate internationally.

The difference between this property and Moneyness is: Moneyness refers to the ability to be used
as money (currency/exchange), while currency is the property of Financial Assets to be
denominated in currency.
8. Liquidity

• Ability of the financial asset to be converted into cash on demand.

Example: Ordinary Deposits are perfectly liquid, while stocks/bond of a small corporation could be
considered illiquid since must be bought to be converted into cash (and may not be bought
depending on the state of the market and competition).
9. Return Predictability

• Financial Assets often have returns and are very important to investors.
• ” Will it have cash flow?”
 • The difference between this property and cash flow is that cash flow already refers to how
much cash will be realized by holding a financial asset, while return predictability is figuring
out whether the financial asset will have returns in the first place.
10. Complexity

• Some Financial Assets are combinations of two or more simple assets.

Example: Bonds that are convertible to stock (Convertibility) but can also be paid in either peso or
dollar (Currency).
11. Tax Status

• Property of Financial assets to or not to be taxed by the Government.

Example: Generally, Pension funds are exempt from income tax; Consequently, Interest from Bank
Deposits are included in passive income tax.

Financial Market

In a financial market we have the general market where many commodities are traded and the
specialized markets where only one commodity is traded. Markets work by placing many
interested sellers in one place and making them easier to find for prospective buyers.

Functions of Financial Market

1. The raising of finds in the capital market.

2. The transfer of risk in the derivative market.
3. International trade in the currency market.

Capital Market

• Stock market - which provides capital through the issuance of shares and allows the
subsequent trading thereof in the secondary market.

• Bond market - which facilitates financing through the issuance of bonds and enables the
subsequent trading.
Commodities Market

• Is a market where primary products such as raw materials are traded on a regulated
commodities exchange in which they are bought and sold in standardized contracts.

Mutual Fund

• Mutual funds are companies that pool money from investors to purchase stocks, bonds
and other assets. Mutual funds create a more diversified portfolio than most investors
could on their own. "Mutual funds" are a category that include index funds, bond funds
and target-date funds.

Derivatives

• Are financial contracts designed to create pure exposure to an underlying commodity,

asset, rate, index, or events. It refers to how the price of a particular contact is derived
from the price of an underlying commodity or security or an interest rate, exchange rate
or an index.