CHAPTER 1 ROLE OF MONEY IN OUR ECONOMIC SYSTEM

Money has always been recognized as an essential tool in specialized economic society.
BARTER SYSTEM was the first stage of money development.

REASONS WHY BARTER SYSTEM END

1. It was difficult to look for that person who has the things you need and who also wants
things you are offering for exchange.
2. There is no common denominator to measure the value of goods and services sought for
exchange.
3. Most goods traded have unequal value.
4. Time-consuming and very inconvenient.
5. Lacks generalized purchasing power.

EVOLUTION OF MONEY

GOLDSMITHS- helped develop the use of money by accepting gold bullions to be converted
into coins. They also accepted gold deposits for safekeeping. They also helped in the transfer
of precious metals using receipts. The residents rent the goldsmith-secured vault to keep their
money safe. Goldsmith realized they could loan by issuing more receipts to borrowers, who
agreed to pay back gold interest. This is how banking started.
RECEIPTS- were originally nonnegotiable but become negotiable because it was a bearer
instrument. It is issued to represent gold deposits.

MINTING OF COINS- When gold bullions were converted into coins. COINS were considered
the first type of modern money. They were not in standard form which is why each transaction
required weighing and testing for its quality. The goldsmith, the king s, and bankers stamped
their coins to guarantee their integrity as to weight and fineness. THIS WAS HOW STANDARD
COINS CAME INTO USE.

SIGNIFICANCE OF MONEY
Money has become a very important moving factor in our society. It has tremendous power
over economic goods. With money income, individuals are encouraged to work and even
specialize in a particular undertaking which leads to the division of labor. The excessive desire
for money and profits sometimes induces businessmen and manufacturers to sacrifice the
quality of their products. The depletion of our natural resources can be a result of the desire
for too much money.

FUNCTIONS OF MONEY
1. MEDIUM OF EXCHANGE
2. STANDARD MEASURE OF VALUE
3. STORE OF VALUE
4. MEANS OF DEFERRED PAYMENT

* When the prices of goods rise the purchasing power of money declines

LIQUIDITY- the magnitude of the cost of converting an asset into money.

2 WAYS OF KEEPING MONEY FOR FUTURE USE:

1) SAVING- depositing in the bank.

2) INVESTING can be made in (1) business, (2) corporate or government securities such as
stocks and bonds, (3) money market, (4) real estate properties, and jewelry.
Investment in business has three divisions,
INDUSTRIAL BUSINESS- manufacture of goods, the raw material to finished product,
extraction of minerals from the ground and of fishes from the sea.
COMMERCIAL BUSINESS- bridging the gap between producer and consumer, deals with the
distribution of goods.
SERVICING BUSINESS- rendering of services such as restaurants, banks, recreation centers,
and parlors.
ATTRIBUTES OF GOOD MONEY
1. GENERAL ACCEPTABILITY- good money should be acceptable to everybody in a specific
territory.
2. STABILITY OF VALUE- this characteristic is a prerequisite to general acceptability. It must
have a stable value. The purchasing power of money should not change abruptly.
3. PORTABILITY- refers to the quality of money being easily carried from place to place.
4. COGNIZABILITY- can be easily distinguished from other kinds of money. A fake bill can be
recognized from a genuine bill. The best way to determine a counterfeit bill is through the red
and blue fibers scattered over the paper bill. Another method is through security design.
5. DIVISIBILITY- capable of being divided into smaller denominations without impairing or
destroying the value of a whole.
6. HOMOGENEITY- equal parts should have equal weight and fineness and must be made of
the same material and possess equal value.
7. ELASTICITY- refers to the volume of money being capable of manipulation by monetary
authorities.
8. DURABILITY- enables money to withstand wear and tear.

4 KINDS OF MONEY
- COMMODITY MONEY
-CREDIT MONEY
- FIAT MONEY
- LEGAL TENDER MONEY

1. COMMODITY MONEY- this is the type of money that has a commodity value or value of its
own. For it to circulate, commodity value should equal its money value.
Examples; SALT, CORN, TEA, AND TOBACCO (USED IN NORTH AMERICA)
IRON (USED IN CHINA) AND LEAD WERE USED IN BURMA.
- IN MODERN TIMES, THE TYPES OF COMMODITY MONEY ARE GOLD AND SILVER.
2. CREDIT MONEY- this is the credit instrument that is widely accepted in payment for goods
and services and the settlement of existing debts and obligations.
(3 TYPES OF CREDIT MONEY)
1. REPRESENTATIVE PAPER MONEY- backed up by 100% gold or silver reserves. This money
circulates in a country adopting full gold or silver standard.
2. FIDUCIARY PAPER MONEY- backed up by partial gold or silver reserve.
3. BANK NOTES- refers to a promise of a bank to pay the bearer or holder of a note a sum
certain in standard money upon demand of the note.

- BEFORE TWO BANKS WERE ALLOWED TO ISSUE BANK NOTES.

1. PHILIPPINE NATIONAL BANK
2. BANK OF THE PHILIPPINE ISLANDS

- TODAY THE BANGKO SENTRAL NG PILIPINAS IS THE SOLE NOTE ISSUER IN THE COUNTRY

3. FIAT MONEY- this is the kind of paper money issued by a government edict or decree. It is
often issued during a war whereby the occupying country circulates a kind of money paper
whose money value has no relationship at all with its intrinsic value. It is inconvertible paper
money because the government holds reserves to back it up.

4. LEGAL TENDER MONEY- money that circulates because of its legal tender power. By legal
tender, we mean that the debtor is authorized by law to offer it in payment of his debt or of
his existing obligation.

COINAGE- the process of making uniform coins from metals and stamping them with specific
designs as a guarantee of their weight and fineness and integrity of the country it represents.
COIN- is the product of coinage. It is defined as a mass of metal cast in some convenient shape
with a definite weight and fineness.
FINENESS- is defined as the ratio of pure gold and silver to the total weight of the coin.
THE VALUE OF THE PHILIPPINE PESO IN 1943:
- 12.9 GRAINS OF GOLD, 9/10 OF WHICH IS PURE GOLD AND 1/10 OF WHICH IS ALLOY.

MINT- a place or factory where coins are manufactured or minted. It is usually operated by the
government.
The metals are cast into bars or sometimes called INGOTS.
Coins are made of metal alloys rather than pure metal to give them durability. The silver peso
issued by the treasury in 1934 contained 80% silver and 20% alloy. Denominations 10
centavos to 50 centavos contain 75% silver and 25% alloy.
- the intrinsic value of the metal in the coin is LESS THAN the face value of the coin or the
value assigned to the coin.

KINDS OF COINAGE

1. GRATUITOUS COINAGE OR FREE COINAGE- a system whereby money metals may be

brought to the government mint and converted into standard money without any charge for
minting except for the delay involved in the process.
2. BRASSAGE- this is a kind of coinage where the fee charged by the government to mint
metals into coins is just sufficient to cover the cost of minting.
3. SEIGNIORAGE- a kind of coinage where the fee charged by the government is more than the
cost of minting so the government earns a profit.
4. LIMITED COINAGE- a system adopted by the country whereby government converts metals
into coins only at its option.

DETECTING COUNTERFEITED BILLS

NOTES
1. Paper 6. Background design
2. Portrait 7. Color of each denomination
3. Watermark 8. Style and size of the serial number
4. Security fiber 9. Vignette
5. Security thread 10. Cleanliness of print
COINS
1. Even flow of metallic grains
2. High relief of letters and numerals
3. Regularity of readings and beadings

HISTORY OF PHILIPPINE CURRENCY AND PHILIPPINE MONETARY

STANDARDS

NATURE OF MONETARY STANDARD

A country is said to establish a monetary standard or system when it sets down rules to govern
the creation of money and control the quantity in circulation whether the rules are strictly
followed.
STANDARD MONEY- is the monetary unit recognized by the government as the ultimate basic
standard of value upon which other kinds of money are convertible.

> In the case of the Philippines, the monetary system is the managed currency system.
PESO is the monetary unit.

MONETARY STANDARD- refers to the currency adopted by a country to provide a stable

medium of exchange for domestic transactions and means of international payment for
foreign obligations
MONETARY UNIT- is the ultimate standard unit of value. It also refers to standard money.

CLASSIFICATION OF MONETARY STANDARDS

1. COMMODITY STANDARD OR METALLIC STANDARD

2. NON-COMMODITY STANDARD OR FIAT STANDARD

COMMODITY STANDARD- a monetary system in which the purchasing power of the value of the monetary
unit is equal to the value of a designated quantity of a particular commodity. Sometimes called full-bodied
money because it is backed up by 100% gold or silver reserves.
A. COMMODITY STANDARDS MAY BE:

MONOMETALLIC- one metal standard whereby the county uses either gold or silver as a
standard unit of value.
BIMETALLIC- two metals standard whereby gold and silver are used as a standard unit of value.

>MONOMETALLIC IS DIVIDED INTO GOLD AND SILVER STANDARD

3 TYPES OF GOLD STANDARD
- GOLD COIN STANDARD
- GOLD BULLION STANDARD
- GOLD EXCHANGE STANDARD

GOLD COIN STANDARD- a country is said to be in the gold coin standard when the
government allows the conversion of gold bullions into coins, which are freely obtained by
the citizens of a country in exchange for forms of money.
Characteristics of gold coin standard are as follows:

1. The monetary unit of the country is stated in a definite weight and fineness of gold,
2. People are free to convert their bullions into coins,
3. The government allows gold to be used in any manner,
4. Gold can be freely imported and exported. This allows the automatic stabilization of the
domestic value of gold with its foreign value.
5. All other kinds of money and bills circulating in the country should be exchangeable for gold
coins.
6. Money supply is determined by the amount of gold reserves the country has,
7. There is a free coinage of gold whereby citizens can convert gold bullions into coins. This is
important because it equalizes the value of gold as a coin with its value as metal,
8. There is a free market of gold in that people are free to import and export gold.
GOLD BULLION STANDARD- a system wherein the monetary unit or standard money of
the country is expressed in a definite weight and fineness of gold in bar or bullion form.
CHARACTERISTICS OF GOLD BULLION STANDARD:
1. The monetary unit of the country is also expressed in a definite weight and fineness of gold,
but gold was kept in the form of bars,
2. People were forbidden to coin their gold and all the gold coins were melted into bars,
3. Redemption of representative money in gold coins was forbidden except for foreign
transactions subject to the approval of monetary authorities.
4. The government fixed the price of gold,
5. The government was required by law to buy and sell all gold metals that meet the
requirements of the law as to fineness,
6. Gold may be freely imported and exported,
7. All currencies circulating in the country are freely convertible into gold if the holder can
afford to buy 400 ounces, which is the weight of one gold bar.

ADVANTAGES OF THE GOLD BULLION STANDARD

- the expense of minting gold bullions into coins is eliminated and there is an economy in the
use of gold since gold bullions are no longer made into coins. People have the tendency not to
hoard gold, thereby allowing more gold reserves to support more money in circulation.
- Only legitimate demands for gold are met.

DISADVANTAGES OF GOLD BULLION STANDARD

- Small amounts of gold less than 400 ounces were not redeemed.
- Hinders the free movement of gold because exporters are required to present licenses, which
are quite difficult to obtain.
- when the government sells gold, it is usually much higher than when it buys metal thereby,
destroying gold and other forms of money.
PARITY- means that the different kinds of money in daily use within a country must be equal
to their purchasing power at a given ratio.
GOLD EXCHANGE STANDARD- is one in which the monetary unit of a country is expressed in
terms of gold. The domestic currency adopting this standard is interchangeable for foreign
gold drafts at a fixed rate.
-Reason, why some countries adopt this system, is because many countries have difficulty
establishing the gold coin standard, and changing from silver to gold standard is expensive.

CLASSIFICATION OF GOLD EXCHANGE STANDARD

Automatic gold exchange standard- standard adopts by a country that cannot put up any gold
reserves and therefore depends on the gold reserves of other countries to which they are
related.
Ex; India, was dependent on the gold reserves of England.

Manage gold exchange standard- adopted by the country which can maintain partial reserve
at home and would still count as part of its reserves.
Ex; The Philippine currency is related to the United States.1

CHARACTERISTICS OF GOLD EXCHANGE STANDARD

1. Gold does not have to be coined or used as bullions but the monetary unit of the country
must be defined in terms of a specific quantity of gold. (Philippine peso was equal to 12.9
grains of gold. 9 fines, where the U.S dollar was equal to 25.8 grains of gold, 9 fine.)
2. The central bank or treasury should build up a credit balance with banks in foreign countries
that adopt gold coin or gold bullion standards.
3. The treasury or Central Bank buys and sells any amount of gold drafts drawn upon banks
located in the foreign country to which it has related to its currency or foreign banks located in
the countries under the gold coin or bullion standard.
4. The government allows people to export and import their gold and even hoard it and use it
for any purpose.
5. All other kinds of currency circulating in the country can be redeemed at par in gold drafts,
which will eventually be equivalent to gold.
ADVANTAGES OF GOLD EXCHANGE STANDARD
1. The country can adopt any circulating medium to be used as the monetary unit.
2. The country does not have to maintain the large size of reserves as is needed in the full gold
standard.
3. Since gold coins do not circulate, there is an economy in the use of gold, and loss of gold
from abroad is prevented.
4. It avoids the expense incurred in handling, packing as well as shipping gold abroad.
5. Reserves deposited in foreign countries earn interest.
6. Borrowed money when deposited abroad may lead to a favorable credit transaction for the
depositing country.
7. The government realizes a profit from the buying and selling of foreign gold drafts.

DISADVANTAGES OF GOLD EXCHANGE STANDARD

1. Does not have the check and balance present in the gold coin and bullion standard,
2. Does not control its reserve deposited in the country.
3. There is a possibility of excessive exportation of gold. If this happens, people begin to lose
confidence in their monetary unit, thereby encouraging the hoarding of gold.
4. In Both countries the depository and depositing country are using the same reserves.

BIMETALLIC STANDARD- when every two metals provide the basis for the money in circulation
and the issuer stands ready to buy or sell either two metals at stated prices.
BIMETALLISM- is defined as a monetary system in which coins of two different metals at a
fixed legal ratio of weights and fineness are used as the standard value.
LEGAL RATIO, COINAGE RATIO, MINT RATIO- refers to the ratio between the weights of gold
coins and silver coins in the mint.
MARKET RATIO- the ratio of the value of gold and silver as being bought and sold in the
market.
GRESHAM’S LAW- states that the bad or overvalued money drives out the good or
undervalued money from circulation.
B. NON-COMMODITY OR FIAT STANDARD- refers to a monetary system in which the face
value of the monetary unit is much higher than that of the value of the material used as
money.
CHARACTERISTIC OF FIAT STANDARD
1. Fiat money is adopted as the standard unit of value or monetary unit.
2. fiat money is legal tender.
3. All other money issued by the government is redeemable in standard fiat money.

TYPES OF FIAT STANDARD

1. UTOPIAN PAPER STANDARD OR PURE FIAT STANDARD
2. INVOLUNTARY PAPER STANDARD- the Philippines adopted this standard during the
Japanese time from the year 1941 to 1945.
3. MANAGED CURRENCY STANDARD- espouses the use of inconvertible and irredeemable
paper money that is issued against no gold or silver reserves. The Philippines adopted it in
199 and still operates under the same standard up to the present.

LEGAL TENDER POWER- power is given to money to settle all obligations whether public or
private. It is given by law.

CHARACTERISTICS OF MANAGED CURRENCY STANDARD

1. The paper money is inconvertible and irredeemable.
2. No reserves are maintained to back up the domestic money supply.
3. The central bank is authorized to exercise control over the credit system to control the
money supply.
OBJECTIVES OF MANAGED CURRENCY STANDARD
- Facilitate production, (2), make prices stable: (3) make every Filipino maximize his income:

(4), promote full employment, (5), have an equitable distribution of wealth in the country (6)
preserve the international value of the peso and (7) to make the country economically rich

and politically and militarily strong and powerful.

ADVANTAGES OF MANAGED CURRENCY STANDARD

1. Money supply is not dependent on the gold reserves but is controlled by monetary

authorities.

2. There will be greater price stability since prices depend on the volume of money in circulation.

DISADVANTAGES OF MANAGED CURRENCY

1. There is always the danger of over issuance of money, which will lead to inflation.

2. Since foreign exchange rates are not fixed by the metallic content of currencies, may result in an erratic

fluctuation of prices.

3. Competitive monetary depreciation might easily be used by each nation in a fight for world

trade.

4. Froma political point of view, it is easier to issue paper money or what we termPRINTINGPRESS money

than increase taxes.

PRE- SPANISH REGIME
1521 coming of Spaniards.
- Rice has long been used as the principal primitive currency. Widely used as a unit of value.
-People used to measure their wealth by the number of carabaos they own.
-Land was sold for several heads of carabaos.
- between the 8th to the 14th century, the gold barter ring (coin made of gold in a ring form)
was used in trading with foreign merchants.

PENNIFORM GOLD BARTER RING

- PILONCITO- was made of crude rounded gold coin with flat sides.

diameter of about 3 eights of an inch. Was worth 2 tales.

SPANISH REGIME

- The Spanish regime started in 1571 coins were minted in Mexico

Macuquinas or cobs. Locally called hilis-kalamay, were irregularly-shaped coins hammered
in Span and Spanish America. These silver coins usually bore a cross on one side and the
Spanish coat of arms on the other. These were the earliest coins brought in by the galleons
from Mexico. The galleon trade (1565-1815) facilitated commerce among Asia, the Americas,
and Europe.

- During the reign of King Philip V 1700-1746. The first coin minted in the Philippines was
called SPANISH BARILLA. This is how we got the term barya. Means loose change today.
It was made of brass and valued at one centavo.

- In the 17th and 19th centuries, Manila became one of the centers of trade in the Fae East.
- Spanish Galleons sailed across the Pacific from Acapulco Mexico to Manila. The ships were
loaded with goods, gold, and silver coins which include the world’s famous coin the SPANISH
DOS MUNDOS.
-SPANISH DOS MUNDOS also known as the Mexican pillar dollar was struck in 1732-1772 at
the Mexican mints. These coins are known for their beauty. They bore the name “Dos
Mundos” which indicated their widespread use in the two hemispheres.
- In 1766 a second coin was minted in the Philippines. The colderillas. It was about half the size
of a Spanish barilla and was made of copper. It had the shape of a parallelogram. The
circulation of this coin was brief because it was replaced by round barillas bearing the bust
of Carlos lll.
- In 1770, the Spanish government ordered from the mint of Spanish Mexico 6,000 silver
quartillos. These coins were minted specifically for the Philippines. It had a diameter of 11.5
millimeters.
- The Cuatros bearing the bust of Carlos IV were issued in 1798-1807.
- After the death of King Ferdinand Vll, his daughter Queen Isabel ll became the new heir to
the Spanish throne. The coins were called Isabelinas.
- 1857 established the manila mint by Royal Decree
- March 19, 1861- Manila mint started its first operation.
- In 1877 a royal decree was promulgated to allow the manila mint to coin silver coins of the
same fineness as the Spanish coins. Mexican silver pesos remained the standard of value.
- In 1880, the value of the peso was higher than that of the American dollar. This explains why
Chinese traders did not want gold coins but instead silver and reales. This made Filipinos
export the gold coins in the exchange for Mexican silver pesos.
- The importation continued, and this made silver coins the sole currency in the Philippines.
- In 1852, the first banknote was printed. It was called the PESOS FUERTES by the El Banco
Espanol-Filipino de Isabel ll.
- In 1855, the five pesetas silver coins were circulated. This coin was believed minted in
Madrid or Paris.
-In 1887 the Isabel one real was issued and the word manila was engraved below the neck of
Queen Isabel.
- In 1877 the first treasury certificates were issued bearing the official seal of the Philippine
Government. It bore the signatures of Clem de Santiago, the Insular Treasurer.
- In 1897 importation of money is restricted.

THE FIRST PHILIPPINE REPUBLIC

The short-lived First Philippine Republic under the administration of Emilio Aguinaldo who was
the leader of the Philippine Revolution issued paper money that was backed up by the
resources of the Philippines.
-These notes were in Spanish and bore the signature of Pedro A. Paterno, the President of the
Council of State at that time. These were considered the SECOND TREASURY CERTIFICATES
that were issued by the Philippines.
- In 1899 Emilio Aguinaldo issued minted coins in denominations of two centimos, which were
made in copper. It had a diameter of 25 millimeters and had the inscription on the overse:
REPUBLICA FILIFINA around the upper half portion of the edge, with the sun and three stars in
the center, the rugged islands below the sun, and the year 1899 at the bottom. The reverse
showed the words; LIBERATED on top and the words; CENTIMOS DE PESO on the bottom of
the coin.
AMERICAN REGIME
- On August 28, 1898 American regime started in the Philippines. This was the date when the
American military governor started to perform his official duties.
- After the termination of the treaty of Paris, which was signed on December 10, 1898 and
ratified by the American senate on February 6, 1899, the sovereignty of the United States
over the Philippines started.
- Various currencies circulating in the Philippines were allowed to continue circulating in 1904
when the American Civil Government in the philippine demonetized it

PRINCIPAL CURRENCIES ALLOWED TO CIRCULATE WERE AS FOLLOWS;

1. MEXICAN SILVER DOLLAR OR PESO CONTAINING 8 REALS-Filipino silver peseta was

equivalent to 1/5 of the peso, Filipino silver ten centavos equal to 1/10 of the peso; Filipino
copper centavo equal to 1/100 of a peso. 20 cuartos equal to 1 real and 8 reals to a peso were
allowed to circulate.
2. AMERICAN DOLLAR- were allowed to circulate and declared legal tender.
-The Philippines was technically under the quasi-bimetallic standard because the American
dollar was made of gold and the Mexican peso that made of silver circulating in PH.
-The American dollars were slowly withdrawn from circulation due to the issuance of the
THIRD PHILIPPINE TREASURY CERTIFICATES.
- In 1901, Charles Connant American banking and finance expert came to the Philippines and
recommended the gold exchange standard. The monetary unit was based on gold.
- On March 2, 1903 passed the Philippine Coinage Act contained in organic Act of July 1902,
known as the Gold Exchange Standard. Provided the monetary unit of value of the Philippines
is 12.9 grains of gold 0.9 fine. The silver peso contains 416 grains of silver and 0.9 fine that half
value of the American dollar.
-Price of the silver in the market increased between 1903-1906 which resulted in the
exportation of the Philippine Coin to China. This depleted the supply of coins and people
began o hoard them. The government recoined at a smaller size and less fineness in
denominations of 500,100,50,20,10,5,2, and 1 peso was issued. These certificates represent
paper money because they represent the silver coins’ equal value reserves.
- Gold Standard Fund was established to maintain the parity of the silver peso with the
theoretical gold peso. Part of this was deposited in the National Treasury of Manila and the
greater part was deposited in American banks.
-The Philippines is ready to sell drafts from funds to settle international obligations. The drafts
were redeemable into American dollars, which in turn were convertible to gold coins.

PHILIPPINE BANK NOTES

-With the volume of trade increasing due to the increasing demand for Philippine products,
the money supply of the country was insufficient. The Philippine National Bank was authorized
to issue the Philippine Bank Notes. These notes were not legal tender.
-Later the El Banco De Las Islas Filipinas known as the Bank of the Philippine Island was
authorized to issue its own bank notes. These notes were not made legal tender.

DOLLAR EXCHANGE STANDARD

- In 1993, the USA abandoned the gold standard because the President of America Franklin
Delano Roosevelt proclaimed the gold embargo in his territories and colonies.
-We were affected and we abandoned the gold standard too. Our gold drafts could no longer
be redeemable to gold coins but only be exchanged for United States dollars. Because the
Philippine monetary unit is linked to the American dollar.
-The Philippine peso was kept at par with the dollar at an exchange rate of 2 to 1, under the
Gold Reserve Act of 1934.
-The dollar had to be devalued from 25.8 grains of gold 9 fine to 15 15/21 grains of gold, 9
fine.
- The Philippine peso had to be devalued from 12.9 grains of gold, 9 fine to 7 13/21 grains of
gold 9 fine.
- The 2:1 ratio was maintained because the gold value of the Philippines was exactly half of
the gold value of the dollar.
-The Philippine gold reserves increased by 40.94 percent because of the devaluation of the
peso. The gold standard fund was made into a dollar standard fund to keep the peso at par
with the dollar.
JAPANESE REGIME

-The Japanese forces occupied the Philippines they issued a great quantity of paper bills called
the Japanese War Notes. These were popularly known as “ Mickey Mouse” money. These bills
have no reserves. People were forced to accept these bills since there was no control over
their issuance, it became inflationary.
- The Philippines then was under the Involuntary Paper Standard.

POST-WAR PERIOD
-On July 4, 1944, after the American forces defeated the Japanese imperial army, the
Philippine Commonwealth was established under President Sergio Osmena.
-The Philippines issued executive order 4049 which declared all Japanese currency circulating
in the Philippines “illegal”. He ordered the closing of all banks and declared the withdrawal of
all Philippine National Bank Notes from circulation.
-A new treasury certificate with the word “victory” was ordered printed on the back of each
bill. ( 500, 200, 100, 50, 20, 10, 5, 2, and 1 peso.)

- The central bank was established in 1949 to improve the exchange controls and adopt
manage currency standards. The money supply can be increased and decreased as needed by
the economy.
-A new currency called Central Bank Notes was ordered and issued by President Manuel A.
Roxas.
-Meanwhile, the subsidiary coins disappeared from circulation. Some believed they were
smuggled out of the country.
-In June 16, 1956, the paper money denominated in 200 and 500 pesos was demonetized from
circulation and returned with a different design and color.
Period Monetary Monetary Unit Gold Value Gold Value Exchange
Standard of the Peso of the US$ rate
Pre Spanish No monetary All coins
Regime standard accepted by
Filipinos
Spanish No Official Mexican Silver
Regime Monetary Peso
Standard Spanish Silver
Peso
Spanish/Filipino
Silver peso

American
Regime
1898-1902 Quasi- Phil. Silver coins
bimetallic and US Gold
standard coins

1902- 1934 Gold Exchange Un- coined Gold 12.9 grains 25.8 grains P2.00-$1.00
Standard Peso of gold, of gold,
9/10 fine 9/10 fine
1934-1941 Dollar Peso 7/13 grains 15 15/21 P2.00-$1.00
Exchange of gold 9/10 grains of
Standard fine gold, 9/10
fine
1941- 1945 Involuntary Japanese War None
Paper Notes
Standard(fiat
standard)
PERIOD Monetary Monetary Unit Gold Value Gold Value
Standard of Peso of US$
Post War

1945-1949 Victory Notes 7 13/21 P2.00-$1.00

grains of
gold 9/10
fine
1949-1962 Managed 7 13/21 P2.00-$1.00
Currency grains of peso pegged
Standard gold 9/10 to the dollar
fine

1962-1970 Manage 3 19/21 P3.90-$1.00

Currency grains of Peso pegged
Standard gold. 9/10 to the dollar
fine

1970- Present Manage 3 19/21 Exchange

currency grains of rates increase
Standard gold. 9/10 through the
fine years

> In 1972 after the declaration of Martial Law the Central Bank Of the Philippines adopted the
Floating Rate, where the peso was allowed to seek its own level in relation to foreign
currencies depending on the demand and supply of such foreign currency.

HAWALA
The word Hawala is Hindi meaning “trust” or “exchange”. Often used in relation to the word
hundi, which stands for “bill of exchange”.
-Hawala is an unofficial alternative remittance and money exchange system enabling the
transfer of funds without their actual physical move.
-Hawaladars means “brokers” or “operators”. They collect funds at one end of a payment
chain and others distribute the funds at the other end.
-Usually, the hawaladars operate independently rather than as part of an organization.
-Code is used for identification and the details of the trade.

-For Asian immigrants hawala system provides a speedy, reliable, and trustworthy method to
remit money home. Hawala has been traditionally a method of moving money in South Asia
long before western banking became established in the region.
-In ancient China, it was known as “fei qian” or flying coins.
-Hawala Triangle is responsible for international money laundering activities. Hawala is illegal
in many countries.

CHAPTER 4 CREDIT, ITS USES, CLASSIFICATIONS, AND RISKS

CREDIT- is used as a substitute for money. It functions as a medium of exchange. As a medium

of exchange credit is faster and safer. And more convenient than using money. Credit tends to
elevate the moral standards of people because everyone who intends to have credit has to
prove himself worthy of trust. It allows wealth to fully utilize. The credit helps in the
expansion and contraction of the money supply.

CHARACTERISTICS OF CREDIT
1. Credit as a Bipartite Contract- Credit always involves two parties: the debtor who obtains
money and the creditor who lends his money, goods, or services for the right to collect on
demand or at a future determinable time.
2. Credit as Pecuniary Contract- Credit is always expressed in terms of money.
3. Credit as a Fiduciary Contract- the debtor must always be able to merit the trust and
confidence of the creditor. Without this, there can be no credit transaction.
In credit, the risk is always involved- there is always the possibility of the obligation not being
paid.
Credit always involves futurity- a credit payment is always done on a future date. Futurity
means a day or more after the credit is obtained.

SIGNIFICANCE OF CREDIT
- The use of credit allows the possible production of goods. When business opportunities
appear and businessmen forecast profitable market possibilities, businessmen are willing to
expand credit. As business opportunities decline, the need for credit also declines because
the financial burden accompanying it increases.
-Credit plays an important role in the distribution of goods. The great bulk of such goods is
financed by credit. The role of credit is to provide financial means for businessmen who take
advantage of market opportunities in both domestic and foreign markets.

CREDIT AND THE BUSINESS CYCLE

During the recession, when business activities decline, business and consumer products are
reduced. Thus, the need for credit declines.
On the other hand, during the recovery of the business cycle, this favorable outlook results in
increased purchases thus, the use of business and consumer credit increases.
In periods of depression, credit men want to aid in maintaining sales volume by relaxing credit
standards.

A. PERSONAL CREDIT- credit obtained for one’s use.

3 Types of personal credits
1. Service Credit- obtained from a doctor, dentist, lawyer, and other professionals.
2. Retail Credit- obtained mostly in retail and they fall under 3 categories;
> Regular Charge Account- you are charged the goods you obtain and you usually pay within
15 to 20 days after you are billed.
> Revolving Charge- the credit is not paid in full within this period. Paid in longer periods such
as semi-monthly installments. Ex; Anson and shoe mart credit cards, bank credit card.
> Installment Plan- the creditor required a down payment. It allows the purchase of an item,
which is to be paid in equal monthly payments. The payment period could range from 12
months to 36 months. Ex; Cars, appliances, and furniture.
3. Personal loan credit- cash or money is given as credit instead of goods and services.
are usually granted for the purchase of expensive consumer items. It is obtained purposely
for the acquisition, improvement, and expansion of real estate properties.
Good sources of this credit are GSIS, Pag-ibig Plan, and banks.

CRITERIA FOR GRANTING PERSONAL CREDIT

Employment and personal resources are the best criteria for granting personal credit.
Income from investments and a successful business have a better rating in considering a credit
application.
Paying habits of the borrower.
Occupation. An applicant who rents is not a good credit risk.

LENDING ACT
The “Truth in Lending Act” is an act designed to protect consumers against unfair billing
practices of people who extend credit to a purchaser of goods on an installment basis.
The law requires creditors to furnish each customer with the following information before the
transaction is consummated:
1. The cash price of the property to be serviced or acquired.
2. The down payment, if any, or the trade-in price.
3. The difference between the amounts under 1 and 2.
4. The charges, individually itemized, which are paid or to be paid in connection with the
transaction and which are not incidental to the extension of credit.
5. The total amount to be financed.
6. The finance charged is expressed in terms of pesos.
7. The percentage that finance charge bears to the total amount financed which is expressed
as a simple annual rate on the outstanding unpaid balance of the obligation.
The creditor who fails to disclose any of the required information is deemed to have violated
this act. To pay the amount of 100 or amount twice the charge required by him. Except that
such liability does not exceed 200 pesos on any credit transaction.
> Any person who willfully violates the provision of the act or any regulation issued there
under shall be fined not less than 5,000 pesos or imprisoned for not less than 6 months or
not more than one year or both.

B. COMMERCIAL OR MERCANTILE
Commercial or mercantile credits- are credits extended by one businessman to another
businessman.
> Manufacturers extend mercantile credit to a wholesaler and wholesalers to retailers.
> This transaction is called merchandise credits or trade credits because they are in form of
goods.
> Commercial credit is generally an unsecured short-term type of credit.
> It has the purpose of the facilitation of movements of goods through the different stages of
production and distribution.

C. BANK CREDIT OR BANK LOANS

Bank credits or bank loans are credits granted by banks to businessmen to finance their short-
term credit needs.
> Commercial Banks- usually grant these loans to finance current business operations, goods
in process, temporary working capital needs, and storage of inventories or purchase of
inventories. Commercial banks are limited to granting short-term loans.

D. EXPORT AND IMPORT CREDIT

Export credits are obtained to finance the selling of goods outside the country.
Import credits are also obtained to finance the buying of goods from other countries.
>These are obtained from the banks.

FINANCING AN IMPORT
E. INVESTMENT CREDIT
Long-term borrowing is one of the most common forms of financing used by the business
enterprise. When a business prefers to acquire funds by entering into a long-term borrowing
arrangement, the need for investment credit is to provide funds needed by the business to
acquire costly productive and marketing facilities.
- This Credit is often used for the acquisition of fixed assets such as land, buildings, heavy
equipment, and machinery.
- It is also used for supporting the working capital requirements of the business enterprise.

F. AGRICULTURAL CREDIT
Are credits given to farmers for the development, improvement, and cultivation of their lands.
They may be in the forms of:
1. Crop Loan- this loan is given to farmers to finance the production of a particular crop like
rice, corn, peanuts, soybeans, etc. The crops grown by the borrower may be used as
additional collateral.
-Farmer cannot sell his crop unless he notifies his creditor.

2. Livestock Loan- this loan is obtained to finance the raising of pigs, chickens, ducks, goats,
and other animals for breeding purposes.

3. Agricultural Time Loan- this loan is used to finance the development and improvement of
farmland.
-These are short-term loans. They are also used to finance the acquisition of farm equipment.

4. COMMODITY LOAN- this loan is obtained to finance the selling and distribution of farm
crops, which are kept in a warehouse and evidenced by warehouse receipts.
>The Development Bank of the Philippines (DBP) and the Land Bank of the Philippines (LBP)
are the principal supporters of agricultural loans in the Philippines

G. Industrial Credit
Are loans granted to industries to finance the acquisition of equipments and machineries to
finance the construction of a plant or factory and to some extent to finance the purchase of
raw materials for manufacturing capital goods or goods for consumption purposes.

H. REAL ESTATE CREDIT

These are loans to finance the purchase and improvement of real properties like houses or
buildings.
Usually, this loan is paid off by installment over a period of time.

I. GOVERNMENT OR PUBLIC CREDIT

Are credits obtained from any government institutions or their instrumentalities. The debtor
may be national, provincial, or local government.
J. SECURED AND UNSECURED CREDIT

SECURED CREDITS- are those credits that are covered by collaterals to guarantee loans.
UNSECURED CREDIT- the borrower has merited the full trust and confidence of the creditor.
> Sometimes it is called a Character loan or a Clean loan since no property of value was
pledged to secure it.
- Just a mere promise to pay.

K. SHORT-TERM, MEDIUM-TERM, and LONG-TERM LOANS

SHORT-TERM LOANS- payable within a year. Ex; Commercial bank loans, retail credits like
regular charge accounts, and revolving charge.

MEDIUM-TERM LOANS- are payable from one year to five years. Sometimes it is called an
intermediate term loan. Ex; Car loans, and installment plans on appliances.

LONG-TERM LOANS- are loans payable beyond five years and usually up to 15 to 20 years.
Ex; Real estate loans and Investment loans.

L. DIRECT LOANS, DISCOUNT LOANS, AND CREDIT LINES

Direct Loans- are loans whose interest payments are made at the time the loan matures.
Here the borrower gets the entire amount applied for, and upon maturity of the loan, he pays
the principal plus the interest.

DISCOUNT LOANS- these are those loans where interest payments are deducted at the time
the loans are granted. Principal minus the interest.
CREDIT LINE- an agreement between the debtor and the creditor wherein the debtor is
allowed to obtain funds from the creditor up to a certain amount.
Three types of credit lines:
1. Regular credit line- the debtor is allowed to draw funds from the creditor up to an amount
agreed upon and the funds are drawn when paid and can be borrowed again.
> In this case the debtor repeatedly borrows these funds from the creditor as long as these
funds are paid when due.
2. Maximum loan commitment- borrowed funds even when paid cannot be availed anymore.
In this type of loan, the most that the borrower can avail of is the credit limit agreed upon.
3. Overdraft Line- a credit line in which the bank allows its depositors to draw from the bank
beyond their actual deposits. Interest on overdrawn accounts is charged on a daily basis as
long as drawings are outstanding. It used to be the most popular type of credit line from the
banks.
- Banks may also require some collateral to guarantee the overdraft line. Today the Central
Bank has prohibited banks from granting overdraft lines.

SOURCES OF CREDIT
Banks- are the most common sources of credit. Most of the commercial credits including
industrial and agricultural credits are obtained from banks.
Banks are classified as:
Commercial banks
Thrift banks
Rural banks

COMMERCIAL BANKS- specializes in giving commercial loans to businessmen.

THRIFT BANKS
3 TYPES:
1. Savings and mortgage bank- it is organized for purpose of encouraging thriftiness among
people. It accumulates the savings of depositors and invests them together with its capital in
marketable securities such as bonds and other debt securities. They also invest in commercial
paper and accounts receivable.
2. Stock savings and loan association- engaged in the business of accumulating the savings of
the people and using such accumulated funds, together with its capital for loans and
investments in securities of productive enterprises or securities of government. Engaged in
proving personal loans and long-term financing on house building and development.
3. Private development bank- aims to develop and expand the economy of the country
pursuant to the socio-economic program of the government. This is a good source of
developmental loans for industrial and agricultural growth.

RURAL BANKS- are banks organized to cater to the needs of the farmers and small
businessmen in rural areas including cottage industries. The great bulk of loans granted in rural
areas come from the rural bank.

OTHER SOURCES OF CREDIT

Retail Stores- one of the biggest sources of personal credit. They give personal consumer loans
to their customers on an open-book account basis. Ex; sari-sari store
Credit Unions- these are cooperative organizations that lend savings of the members to other
members who are in need. This is one of the cheapest sources of credit since borrowing
members pay very low interest on loans.
-Reason, why a cooperative can afford to give a low-interest rate, is that the overhead expense
of operating a cooperative is very low.
Individual Money Lenders- individuals who have excess funds and usually lend such funds to
others who are in need. To charge exorbitant interest for the use of his money because the
risk is very great. Individual money lenders are sometimes referred to as Loan Sharks or
Usurers because they practice usury- which is charging exorbitant interest.

Insurance Companies- are sources of credit for insured individuals. Individuals could borrow
from their insurance companies an amount equivalent to the cash surrender value of their
policy.
Sales Finance Companies- one of the biggest sources of consumer’s credit. They also lease
motor vehicles and heavy equipment.
-It is specialized in buying installment contracts.
-factoring- purchasing of installment contracts without recourse basis.

CREDIT RISK- the possibility of non-payment of the obligation when it falls due. It can be
minimized by a careful examination of Cs of credit.
Character, Capacity, Capital, Collateral, and Condition.

Character- the quality of credit risk. A person's character is the total of his mental and moral
qualities. A quality inherent in an individual makes him conscientiously concerned about his
obligations.
Other evidence of character is the position held by an individual in a business or a social
organization and the stability of his employment and business connection.
In, general the quality of a small business or corporation reflects the character of the persons
operating it.
Credit Manager- gathers evidence.

Capacity
Capacity signifies the ability of a debtor to pay his obligation. Capacity includes the ability of a
company or management to make good its commitment. Capacity can be judged by objective
factors; the company's financial statements, the creditor’s appraisal of its management, and
information from credit reporting agencies.

Capital
Capital is the financial strength of a business. To the creditor, it is the guarantee that a credit
transaction entered can be redeemed. It can be determined by deducting total liabilities from
the total assets. This is the net worth of the business. Capital must be viewed relatively.

Collateral
Are properties of value pledged to secure a loan.
They may be personal or real properties. This includes financial and other resources such as
bank deposits, inventories, receivables, and other assets the company can pledge.
Chattel Mortgage- a loan secured by movable personal properties.
Real estate mortgage- Loan secured by fixed assets.
Other collaterals that may be given are;
Corporate Securities
Signatures of co-makers and co-signers
Goods in bonded warehouses represented by warehouse receipts
Hold outs on deposit
Pledges ob receivables

Condition
Refers to the environment in the customer’s industry, economically, legally, and politically in
relation to growth These are external factors over which the credit applicant has little or no
control.
According to Chapin and Hasset- most businesses are subject to two types of movement,
namely; Regular recurring seasonal activity, and regular oscillation of business as a whole.
Agricultural Industry and school supplies are examples of seasonal.
Business Cycle- The second movement may be in direct contrast with the larger movement

Hazard in the Use of Credit

Improper use of credit on non-productive goods may encourage consumption without a
corresponding increase in production and thus would result in inflation.
Since credit influences all units of our economy, the whole economy may suffer as a result of
the improper use of credit.

Credit Information
Using credit information from various sources is a basic and necessary part of every good
credit decision. The more information you have about your customer the more reliable your
credit decision becomes.

Credit information is very costly in terms of money, time, and effort. Credit information
changes very often making sure that information obtained is not obsolete.
Credit information on companies that are posted on the stock market is more reliable. The
more correlation of information from different sources, the more reliable the information is.

Sources of Credit Information

Application Form- the application for credit initiates the relationship between the debtor and
the creditor. It is the best source of data. It often ranges from single-page information to as
many as four to six pages. In installment credit, a new application is oftentimes filed for every
new purchase.
Personal Interview- The customer is the cheapest and easiest source of credit information.
A personal interview is necessary for opening new accounts. It is important for a manager to
make a preliminary investigation. The interview should be geared towards getting facts
regarding the organization, capital, strength, present condition, and future outlook of the
customer.
The General Mercantile Agency- the principal service rendered by the general mercantile
agency is to provide the credit information it has assembled from all parts of its business field
of operation. Credit information is collected through mailed inquiries from the enterprises
concerned and from creditors.
Dun and Bradstreet- the most frequently used general mercantile agency.
It is the oldest organization of its kind. They prepare trade summaries by canvassing all
subscribers who have ordered reports on company.
It is very reliable and no further investigation is required. It also provides other services such
as publishing a variety of reports like the Dun and Bradstreet reference book.

Special Mercantile Agencies- are sometimes referred to as trade agencies. Their scope of
coverage is limited to a single trade or limited to number of allies of business.
Its major function is to disseminate information through reports, periodic supplement
sheets, and rating books. Engaged in collecting delinquent accounts for members.
Personal Investigation- is another form of gathering information from credit files. The system
of personal investigation provides interviewers that can investigate methodically and regularly.
Public and Published Records- These consist of all legal recordings such as deeds, mortgages,
suits, judgments, and current news items such as clippings from newspapers and journals.
Credit Bureaus- are associations of businessmen providing information gathered from each
other to other members of the organization. In the United States, credit bureaus are generally
recognized as among the most important sources of credit information. These become the
principal clearinghouses for information.

There are two kinds of Credit Bureaus:

(1) Retail Credit Bureau
(2) Credit Interchange Bureau
Retail Credit Bureau- these may be mutual or cooperative associations. The association elects
a board of director, which in turn employs a manager to Operate it. The bureau may be
operated for profit. Some are owned by the local Chamber of Commerce.
Credit Interchange Bureau- is the exchanging of information among local credit bureaus. In
the United States, credit interchanges were first operated for local markets. Operation
gathered was insufficient.
The zone bureau is in charge of compiling the information and writing the credit interchange
report.
In the Philippines, there are quite a number of credit bureaus in operation.
Ex; Eastern Inspection Bureau, Philippine Credit Rating Company, and the Association of Credit
Men, Inc.
Bank Credit Department- The bank credit department is one of the best sources of credit
information. Banks are intimately involved in the activities of their customers.
Information from Reference- references indicated in information sheets and obtained from
the interview could give light on prospective customers’ creditworthiness.
Compilation Of The Credit Report- credit report is now compiled when all data have been
gathered. This includes financial statements, ledger experiences, and comments of references
and observations of reporters.
 CHAPTER VI THE FINANCIAL SYSTEM

Financial Intermediation
One of the most familiar activities of financial firms is acting as financial intermediaries. The financial
intermediaries act as simultaneously as borrowers and lenders. The financial system provides facilities for the
transfer of purchasing power from individual to individual and firm to firm both country and internationally.
Gross National Product- the accepted measure of aggregate output of the economy.
Value Added- is the difference between the market value of the product produced and sold by the industry by
way of financial intermediaries.
Primary Claims- the money market instruments, government securities, commercial paper, corporate and
municipal bonds, mortgages, and common stocks.
Secondary Claims- Banks life insurance companies, and mutual funds issue claims of their own to attract the
funds of individuals and firms.
Economic Role of Financial Intermediaries
The three main roles of financial intermediaries include asset storage, loans, and investments.
Risk and costs without Financial Intermediation
Asymmetric information- suggests that when sellers may possess more information than buyers or buyers
have more information than sellers. It is called a failure of information or an imbalance of information.
1. Adverse Selection- this is the tendency for those persons with the highest profitability of experiencing
financial problems to seek out and be granted loans. Such as individuals are more likely to borrow and are
willing to pay relative interest rates to obtain funds.
2. Moral Hazard-

 Understanding the role by sampling the absence of any financial institutions or MARKETS –
no banks, no stock markets, no money market mutual funds!
 The risks of a direct loan – asymmetric information (giving rise to 2 problems below)
 Adverse selection  Tendency for those persons highly probable of experiencing financial
problems TO BE GRANTED OF LOANS.  Individuals in dire need of funds are more willing to
pay relatively higher interest rates. YOU MAY BE UNWILLING TO MAKE THE LOAN.
 Moral hazard  The lender perceives, that because the borrower is more knowledgeable on
the use of the money in his business, could engage in IMMORAL activities. Because of this,
YOU MAY NOT BE WILLING TO LEND YOUR MONEY.
RATIONALE FOR THE EXISTENCE OF FINANCIAL INTERMEDIARIES?
Financial intermediaries are able to deal with asymmetric information and the associated
problems of adverse selection and moral hazard.
 Commercial banks, thrift institutions and finance companies specialize in assessing CREDIT
RISKS.
> They have information on deposit history, income, assets, liabilities, credit history.
 Hence, financial institutions are in a BETTER POSITION TO LEND YOUR MONEY
FINANCIAL INTERMEDIARIES’ ROLE
 Contribute materially to economic processes.
 Facilitates the flow of funds from a SURPLUS UNIT (lender) to a DEFICIT SPENDING UNIT
(borrower).
 Society’s welfare has been enhanced.
 Capital expenditures have increased.
 Boosted productivity and living standards.
THE CONCEPT OF TRANSACTION COSTS

 The money and time spent in carrying out financial transactions

> The search cost – the time in searching for a willing lender at a reasonable interest rate.
> After searching, the “time and money” in evaluating the viability of the financial transaction
to you (the lender) EXAMPLES: a. Hiring of a lawyer in drafting a loan contract b. Notarial fees
c. Documentary requirements
 Financial intermediaries take advantage of ECONOMIES OF SCALE
FINANCIAL INTERMEDIARIES’ ADVANTAGE
 Economies of scale
 Permit diversification
 Specialization
 Division of labor, For instance, a bank can use a STANDARD LOAN CONTRACT drafted by its
lawyer for use in hundreds of loans. Both surplus and deficit units are benefited when
transaction cost is reduced
THE PROBLEM OF MATCHING LENDER & BORROWER NEEDS

 Individual borrowers’ needs cannot be overestimated because borrowers and lenders have
different needs.
> One borrower might need P100 million for 25 years to build a new school.
> Another might need a 30-year, P5 million loan to purchase a new home.
> On the other end, an individual saver might have P50,000 to lend for one year.
> Another lender (a large firm) might have P75 million to lend out for 60 days.
 The major portion of the funds transferred today is CHANNELED THROUGH FINANCIAL
INTERMEDIARIES

CENTRAL BANKING AND THE MONETARY POLICIES (SALIENT PROVISIONS OF R.A. 11211)
REPUBLIC ACT NO. 11211
 AN ACT AMENDING R.A. 7653 OTHERWISE KNOWN AS THE NEW CENTRAL BANK ACT AND
FOR OTHER PURPOSES
 THE INDEPENDENT CENTRAL MONETARY AUTHORITY SHALL BE KNOWN AS THE “BANGKO
SENTRAL NG PILIPINAS”
 CAPITALIZATION OF THE BSP SHALL BE 200B PESOS, FULLY SUBSCRIBED BY THE REPUBLIC OF
THE PHILIPPINES.
 BSP shall provide policy directions in the areas of money, banking, and credit.
 BANKING- includes entities engaged in quasi-banking operations of non-bank financial
institutions.
 MONEY and CREDIT – regulatory and examination powers on money service entities, credit
granting businesses, and payment system operators
 BSP’s primary objective is to maintain PRICE STABILITY conducive to a balanced and
sustainable growth of the economy and employment.
 It shall also promote and maintain monetary stability and the convertibility of the peso.
 BSP shall closely work with Department of Finance, Securities and Exchange Commission, the
Insurance Commission and the Philippine Deposit Insurance Corporation.
 BSP shall oversee the payment and settlement systems in the Philippines including critical
FINANCIAL MARKET infrastructures in order to promote sound and prudent practices
consistent with the maintenance of financial stability.
 BSP shall aim for HIGH-QUALITY FINANCIAL SERVICES AND CONSIDER INTEREST OF THE
GENERAL PUBLIC
 MONETARY BOARD MEETINGS - shall meet at least once a week, called to meets by the
Governor OR at least 2 other members of the Board.
 The presence of 4 members shall constitute a quorum.
 The Governor or his duly designated alternate shall belong to the 4 members present.
 Section 6 amends Section 21 (Old CB Act). Deputy Governors – The Governor of the Bangko
Sentral ng Pilipinas, with the approval of the Monetary Board, shall appoint not more than five
(5) Deputy Governors who shall perform duties as may be assigned to them by the Governor
and the Board.
 Section 7 amends Section 23. Authority to Obtain Data and Information. The BSP shall have
the authority to require from any person or entity, including government offices and
instrumentalities, or GOCCs, any data for statistical and policy development purposes.
 Shall have the power to issue subpoenas for the production of books and records.
 Authority to require data from banks shall continue to be exercised
 Section 8 amends Section 25. Supervision and Examination. The BSP shall have supervision
over and conduct regular or special examinations of banking institutions and quasi-banks
including their subsidiaries and affiliates.
 Subsidiary – more than 50% of the voting stock
 Affiliate – 50% or less of the voting stock
 Section 11 amends Section 28. Examination and Fees. ...examine the operations of every
bank and quasi-bank, including their subsidiaries and affiliates engaged in allied activities. -
There shall be an interval of at least 12 months between regular examinations. - The Monetary
Board, by an affirmative vote of at least 5 members, may authorize a special examination if the
circumstances warrant. - Supervised institutions shall pay to the BSP, not later than May 31 of
each year, the annual fee prescribed by the Monetary Board
CHAPTER 3 MODERN MEASURE OF MONEY
CHAPTER III

MODERN MEASURES OF MONEY

According to Lloyd B. Thomas, in his book Money, Credit and Financial Markets, today's
industrial nations employ fairly standard measures of money that include the volume of
currency in circulation and the volume of deposits at any point in time. One measure of
money, known as the transactions or "narrow" measure, consists of currency and checking
accounts used for everyday expenditures. Broader measures of money add checking accounts
that are used predominantly as savings vehicles (instead of transaction vehicles) and some
other liquid financial assets such as Time and Savings deposits.

The Narrow Definition of Money

He states that traditionally, most economists have preferred the "narrow", or transactions,
measure of money, MI, which includes only currency, and consists of notes and coins, demand
deposits, other checking accounts, and traveler's checks. This measure of money emphasizes
on the medium-of exchange function of money that is, when one views money as consisting
strictly of those things widely used as a means of payment..

Until the 1980s, the narrow measure of money consisted only of currency. non-interest-
bearing demand deposits, and traveler's checks. However, financial innovations and
deregulation made that definition obsolete. Before the 1980s, the United States, banks were
generally prohibited from paying interest in checking accounts. As interest rates increased in
the 1970s in response to rising inflation, savings institutions in New England developed a new
instrument known as the Negotiable Order of Withdrawal (NOW) account. NOW accounts are
interest bearing savings account on which a limited number of checks may be written.

Today, "other checking account deposits" consisting of interest-bearing checking accounts

called the Negotiable Order of Withdrawal held in depository institutions by individuals and
nonprofit organizations, are also included as M1.
Broader Measures of Money: M2, M3

According to him although traditionally the Central Bank prefers the M1 money supply
measure, others have preferred the broader measures of money. If one is inclined to
emphasize the store-of-value function of money rather than the medium-of-exchange
function, broader measures are appropriate. However, once one admits items into the
measure of money that is not a media of exchange, the line of demarcation between money
and non-money assets becomes quite difficult to ascertain.
Assets may be classified on the basis of liquidity, or the ease and convenience with which they
may be converted into a medium of exchange, Three considerations determine an asset's
liquidity namely: how easily and quickly it can be sold; the cost of selling it; and the stability
and predictability of its price. An asset that can be sold quickly at a low transaction cost may
not be considered very liquid if the price has changed significantly since it was purchased.
There is a continuum of liquidity among assets, ranging from highly liquid passbook savings
accounts to highly illiquid real estate properties.

Passbook savings accounts are extremely liquid. One can convert them to media of exchange
(cash or checking accounts) quickly, without significant transaction costs, through a trip to the
bank or ATM machine. Their value is known in advance with certainty. At the other extreme
are houses and cars. Selling such real assets at a price near fair market value, which requires
several months and significantly large commissions are involved. Bonds are considered
relatively liquid. An active market exists for bonds, transaction costs are fairly low, and bond
prices are relatively stable --- especially for short-term bonds. Common stocks are less liquid
than bonds. While both can be sold quickly and easily, stock prices are more variables than
bond prices and sale commission (transaction costs) for stocks are significantly higher than
those for bonds.

The principle involved in constructing these monetary aggregates is to combine assets of

comparable levels of liquidity in each measure of money. Hence, in constructing M2, certain
highly liquid assets are added to MI. Overnight repurchase agreements (RAS), Eurodollar
deposits, and money market mutual fund shares are 'close substitutes for demand deposits. In
fact, some economists would include them in M1. Savings deposits, small time deposits, and
money market deposit accounts (MMDAs) in banks are quite liquid and are also included in
M2. M3 is constructed by adding certain slightly less liquid financial assets to M2. M3 includes
M2 plus large time deposits, certain repurchase agreements and Eurodollar deposits, and
money market mutual fund shares held by institutions, marginal deposits and deposit
substitutes

Weighted Measures of Money

M1, M2, and M3 are simple-sum weights and give equal weight to each of the items they
include. For example, M2 gives the same weight to passbook savings accounts and money
market mutual fund shares as to currency held by the public and demand deposits in banks.
Different financial assets have different degrees of "conversion into money" and are therefore
likely to influence expenditures differently. Just as the consumer price index places a higher
weight on houses than on candies, our money measures should probably place more weight
on items that strongly influence aggregate expenditures, such as demand deposits and
currency, than on items less closely linked to aggregate expenditures (for instance, small time
deposits in banks),

Inflation and deflation

Inflation is a sustained increase in the price level of commodities. It is an economic disorder,

which is characterized by spiraling of prices as a result of over issuance of money. This occurs
when money supply increases faster than the volume of trade in the economy. For example,
when the money in circulation is not properly channeled to production, the economy will
havelittle output. Thus, with so much money in circulation and fewer goods available, prices
will go up.

On the other hand, deflation is characterized by an uncontrolled decline in the general price
level as a result of undersupply of money. Because there is so much money with plenty of
goods available, the tendency is for prices to go down.

Both are economic disorders that may result to economic ruins if not properly and promptly
attended to. In case of inflation, if the increase in the general price level becomes
uncontrollable, it will reach a point where the cost of operation and production will be more
than the income from operation. The situation will force the closure of the business
enterprise. The same thing goes with deflation. If the decline in the general price level
becomes uncontrollable, there will come a time when the income derived from operation will
be much lesser than the cost of production. Thus, losses would occur.
In times of these economic disorders, the government has developed
measures in order to stabilize prices, thereby, stabilizing the value of money.

Criteria of Inflation
1. Whenever money supply or the level of credit increase by more than 15%, which is a normal
increase.
2. Whenever the lev I of price index number is more than 10%.

The basis of computation of index number is the existing level at the end of the corresponding
month of the proceeding year.

Disadvantages of Inflation

1. It is unfavorable for the fixed income group because the abnormal increase in prices would
mean that they would enjoy less consumer goods with a given income.

2. It may induce the occurrence of (business cycle) recession in the economy.

3. It disrupts debtor-creditor relationship.

The United States had a depression from 1937 to June 1938 where real GDP decline by 18.2%.
If we use this method, then the great Depression of 1930's can be seen as two separated
events: a severe depression lasting from 1920 to March 1933, when the real GDP declined by
almost 3.3%, period of recovery and then another depression of 1937 and 1938.

The United State had a recession in the post-war from November 1973 to March 1975 when
real GDP fell by 4.9%. In 2008 the U.S. economy experience a recession for the 3 quarter and
4" quarter where it had a record of 1.754%. Depression watch 2009, "In the U.S. Economy")
Mike Moffat former About.com Guide.
Disadvantages of Deflation
1. Deflation induces curtailment in production and activities of business firm, since a significant
decrease in prices will cut down all profits and may eventually cause losses.

2. It may cause a depression in employment and consequently a loss in purchasing power.

The Aggregate Demand - Aggregate Supply model

According to Lloyd .b. Thomas the analysis of the relationship between
the nation's money supply and economic activity is known as monetary
theory.
The aggregate demand - aggregate supply framework is important an
useful because it changes money supply and interest rates, which influence
economic activity chiefly by shifting the nation's aggregate demand curve.
The Aggregate Demand-Aggregate Supply Framework
In his basic model of total demand and total supply shows the nation's price level on the
vertical axis and its real output level on the horizontal axis. The intersection of the aggregate
demand (AD) and aggregate supply (AS) curves determine the nation's equilibrium price and
real output levels. A rightward shift of the AD curve, increases both the equilibrium price level
and the level of real output. A rightward shift of the AS curve increases the equilibrium level of
real output and reduces the nation's price level. This is shown on Figure 1.

The Aggregate Demand Curve

The nation's aggregate demand curve (AD curve) is defined as the relationship between the
nation's price level and the amount of real output demanded, other factors remaining
constant. In this relationship, the price level is the independent variable, while real output
demanded is the dependent variable that responds to changes in the price level.
Figure 1. The Aggregate Demand-Aggregate Supply Model. In the aggregate demand-
aggregate supply model, the nation's price level and real output are jointly determined by the
aggregate demand for and aggregate supply of goods and services.
In the case of the aggregate demand curve, however, there is no substitution effect because
the AD involves the demand for all goods and services. Also, there is no income effect in the
AD curve. As the nations price level declines, so do its nominal output and income, leaving real
income unaffected.

The downward slope of the AD curve is actually attributable to the fact that several of the
components of aggregate demand are influenced by the nation's price level. The nation's
aggregate demand for goods and services consists of four components: consumer demand (C),
investment demand (1), government purchases goods and services (G), and net country's
export of goods and services (XM), where X and M represents exports and imports,
respectively. Consumer demand, investment demand, and net exports of goods and services
are all affected by the country's price level.

Let us see why this is true. First, as the price level falls, the real value of such assets as the
nation's supply and government bond increases. This wealth effect of a lower price level
increases consumers' demand for goods and services (C). A decrease in the price level also
increases the real money supply, lowering interest rates and stimulating housing and other
forms of investment expenditures (I). In addition, if other factors are held constant, a

A fundamental national income identity states that the nominal value of output produced
equals the nominal value of income generated. If the prices of all goods and services were cut
in half, the nation's nominal income would also be cut in half. Real income would remain
constant Hence, there is no income effect associated with the changing national price level.
decline in a country's price level makes goods and services relatively more attractive in foreign
markets: this stimulates exports. Lower prices also tend to cause buyers to redirect demand
from imported goods toward its domestic products. Both these forces boost the net foreign
demand for domestic goods, The Aggregate Supply Curve

The aggregate supply curve (AS curve) is defined as the relationship between the nation's
price level and the amount of output firms collectively desire to produce, other factors
remaining constant. In this relationship. the price level is the independent variable, while the
quantity of real output supplied is the dependent variable.
The upward slope of the AS curve hinges on the fact that certain costs of production are fixed
in the short run. Wage rates. equipment costs, raw material prices - all tend to be constant,
changing only infrequently. Firms often contract to purchase inputs at prices that are fixed for
a year or longer. Because certain costs remain fixed in the short run. profit margins increase as
the nation's price level increases, inducing firms to increase production.

As the time period under considerations lengthens. more and more input prices are able to
adjust to the higher general price level. Hence, impetus given to profit margins by higher
output price diminishes. This means that the longer) the time period is under consideration.
the weaker is the supply response to higher prices and the steeper is the AS curve. In the long
run, a period long enough for all input prices to adjust fully to general price level the nation's
AS curve is vertical. That means that in the long run, the aggregate quantity of output
produced is independent of the nation's price level.

Equilibrium Output and the Equilibrium Price Level In Figure 2. he states that the AS and AD
curves intersect at A. yielding an equilibrium price level of PE and an equilibrium real output of
YE. Any other level of prices and real output will produce disequilibrium: generating forces
that will tend to push the economy back to A. For example, if the price level were PE above the
equilibrium, total production Y2 would exceed total expenditures or sales Y3. resulting in an
increase in the nation's inventories. The increase in the inventories would signal firms to cut
prices and reduce output in order to get back to optimal inventory levels. As price level
declined. production will be scaled back and sales would expand until the economy reached
the equilibrium A. On the other hand, if the price level were at PL below the equilibrium, total
sales would exceed total production. Inventories would decline each period, resulting in
shortages and a loss of sales and profits to firms. The shortage of goods and services would
signal firms to increase production and raise prices. The increase in prices would cause buyers
to reduce their purchases. Thus the economy will return again to the equilibrium A.

Inflation is the other term for a persistent increase in the nation's price level. Historically, the
predominant cause of inflation in all nations has been the increase in government
expenditures financed by an increasing supply of money

Factors That Shift the Aggregate Demand Curve

Other than a decrease in the nation's price level, any factor that increases any of the four
components of AD (C. I. G. or X-M) will shift the AD curve rightward (an increase in aggregate
demand). Non-price level factors that reduce any of the components will shift the AD curve
leftward (a reduction in aggregate demand).

1. Consumption (C
Determinants of consumer expenditures (C) include disposable income. wealth, interest rates,
and consumer confidence which shift the AD curve rightward are:
a) A reduction in income taxes by increasing disposable income would increase consumption
expenditures.
b) An increase in stock and bond prices by directly increasing wealth in the private sector
would stimulate consumption:
c) Lower interest rates would boost consumer expenditures on big-ticket items typically
bought on credit, such as cars, furniture, and majorappliances
d) An increase in consumer confidence owing perhaps to increased job stability or reduced
consumer indebtedness would stimulate consumption.

2. Investment (1)
Interest rates, business confidence, expected growth of aggregate expenditures or sales, the
current rate capacity utilization of existing plant and equipment, and tax policy are key
determinants of investment which will affect the shifting of the AD curve rightward due to the
following:

a) Lowering of interest rates stimulate investinent in plant, equipment, inventories, housing,

and other structures.

b) Boosting in investment expenditures associated with any given interest rate and
improvement of business confidence. c) Providing capacity to meet future market demand.

d) If sales are expected to expand sharply and the current utilization rate of plant and
equipment is relatively high. firms will increase their investment spending in order to provide
needed capacity for the future. Hence, an increase in expected sales and/or an increase in the
capacity utilization rate would stimulate investment. If expected sales growth is meager
and/or the current capacity utilization rate is low, firms will anticipate no need for additional
capacity and investment spending will be depressed.

e) Tax policy toward business in general and investment spending in particular, influences
investment spending. Implementation of more rapid depreciation allowances, enactment of
an investment tax credit. or a reduction in the corporate income tax will stimulate investment.
3. Government Purchases of Goods and Services (G) Government expenditures hinge political
decisions made by a state and local government units. State and local government
expenditures also depend on tax revenues and therefore on the general level of economic
activity Changes in government purchases will shift the AD curve. When the government
purchases increase. the AD curve shifts rightward. When the government purchases decrease,
the AD curve shifis leftward.
4. Net Exports of Goods and Services (A-M)
Foreign exchange rate, income in foreign nations, government income. and other factors
influence net exports (X M). For example, the Philippine peso depreciates against other major
currencies and the Philippine products become cheaper abroad. Given other factors, foreign
demand for Philippine exports (X) will increase because foreign-made products will become
more expensive. Philippine demand for imported goods (M) will be redirected toward its
goods and services. Hence, a lower Philippine peso stimulates net exports and aggregate
demand for its goods and services. Other factors that would stimulate include higher income
abroad. trade negotiations that reduce unfair trade practices by foreign nations, and
marketing campaigns by Philippine companies designed to promote their products. Factors
That Shift the Aggregate Supply Curve

Lloyd B. Thomas says that the quantity inputs available (labor. capital. materials), prices inputs,
and technological change are factors, which influence production decisions. Increases in the
quantity inputs and improvements in technology increase aggregate supply they shift the AS
curve rightward. Increase in input prices reduce aggregate supply. shifting the AS curve
leftward.

1. Quantity of Input
Labor, capital, land and raw materials are inputs in the production process. As population
grows, more labor becomes available and the nation's capacity to produce increases, shifting
the AS curve rightward. Similarly, as the capital stock grows over time. the labor force can
produce more output, and the AS curve shifts rightward. Capital deepening increasing the
amount of capital per worker stimulates productivity and shifts the AS curve rightward.
policies that seek to promote long-term economic growth focuses on stimulating investment
expenditures. War or natural disaster reduces a nation's capital stock and/or labor force will
shift the AS curve leftward.
2. Prices of Inputs
An increase in input prices makes production less profitable at each possible general price
level, shifting the AS curves leftward. For example, if Congress boosts the minimum wage. the
AS curves shifts leftward. An increase in raw material prices shifts the AS curves leftward.
When oil prices increased dramatically, the AS curves shifts sharply to the left and when oil
prices collapsed, the AS curve shifts upward.

3 Technological Change

Improvements in technology increase the amount of output the workforce can produce.
shifting the AS curve rightward. Economists believe that technological innovation has been the
most important single factor other than population growth in shifting the AS curves rightward.
Hence, technology growth is the key factor in raising workers' productivity and living
standards.

Applications of the aggregate demand - aggregate supply framework

The aggregate demand aggregate supply model is useful for understanding how a nation's
policy influences its output, employment, and price level.
Equilibrium Output versus the Full Employment Output level
According to Lloyd B. Thomas the economy's natural unemployment rate is defined as the
lowest rate of unemployment that could be sustained without producing an acceleration of
the nation's inflation rate. The level of output corresponding to this natural unemployment
rate is known as the natural output level. also called the full employment output level. In his
analysis in Figure 3. the full employment output level is YE. The full employment, output level
must be distinguished from the equilibrium output level which is determined jointly by the
nations AD and AS curves. If the equilibrium output level is lower than YF. the unemployment
rate exceeds the natural unemployment rate. In the left hand panel of Figure 3. the
equilibrium output (YEi) falls short of the full employment output level (YF). The magnitude by
which the equilibrium output level falls short of full employment output is known as a
recessionary gap. This situation, which involves a loss of national output and income (and
jobs), may call for stimulative measures in order to shift the AD curve rightward, increase
output. and reduce unemployment.

The inflationary gap is the magnitude by which output exceeds the full employment output
level. Such a situation may call for a restrictive action on the part of the monetary authorities
to shift AD curve to the left would bring down inflation..

The difference between a recession and a recessionary gap is that a recession is a period of
falling real output. A recessionary gap on the other hand is the much more common
phenomenon in which the real output a recessionary gap may still exist because output lies
below the natural output (whether rising or falling) lies below natural output. Output may be
rising, but level
Stabilization Policies

Lloyd B. Thomas says that monetary and fiscal policies work by predominantly altering the
position of the nation's AD curve. On the other hand, the government strives to avoid an
inflationary gap by preventing excessive aaggregatedemand. Also, government desires to
avoid large recessionary gaps and the associated losses of output, income and jobs. It wants
output to approach the full employment output level as closely as possible. Given the
following conditions that the positions and slopes of the AS and AD curves are uncertain; that
there are significant time lags between the implementation of government policy actions and
their impact on the nation's AD curve, output, and price level; and that the natural
unemployment rate (and YF) changes overtime and is uncertain at any point in time,
conducting effective monetary policy is a difficult task

The Dilemma Posed by Adverse Aggregate Supply Shocks

Figure 4 explains that before the oil price hike, the Philippine economy was at A, the
intersection of ASI and ADI. Equilibrium output (Y1) coincided with the full employment level
(YF), and the price level was Pl. When the OPEC oil cartel reached an agreement to curtail oil
production sharply there was an increase in the price of oil. The AS curved shifted leftward, to
AS2. If the nation had elected not to respond to this supply shock (leaving AD curve
unchanged), the economy would have moved to point B. The price level would have increased
to P2, and real output would have fallen to Y2.

A supply shock produces the worst of all worlds, a recession combined with higher inflation.
This phenomenon has been dubbed stagflation the combination of stagnant or falling output
and severe inflation. The government can choose between extremely high inflation coupled
with full employment. extremely high unemployment accompanied by stable inflation, or
some increase in both inflation and unemployment. Misery index is the sum of the
unemployment and inflation rates.

Suppose the Bangko Sentral were committed to maintaining full employment. Bangko Sentral
would implement simulative measures to shift the nation's AD curve rightward. to AD2. The
economy would move to point C with output returning to YF. Unfortunately, the price level
would soar to P3. and the nation would experience extremely severe inflation.

On the other hand, suppose the Bangko Sentral was committed to maintaining price level
stability that is, maintaining the nation's price level at Pl. In that event. the Bangko Sentral
would have to counter the supply shock with restrictive monetary actions, shifting the AD
curve down to AD3. The economy would move to point D. preventing the oil shock from
increasing the price level. Note, however, that output would decline to Y3, a severely
depressed level, causing the unemployment rate to soar.
Figure 4 Adverse Aggregate Supply Shocks and Monetary Policy Alternatives. When oil prices
increased sharply, the AS curve shifted leftward. This meant that a nation would have to
accept higher inflation, higher unemployment, or both.

THE THEORY OF THE VALUE OF MONEY

Demand for Money

Lloyd B. Thomas says that the value of money is measured by what a unit of money will buy in
terms of a representative group of economic goods. It is a reciprocal of the price level.
Changes in the value of money are indicated by changes in an appropriate index. It is a
customary approach in the study of the theory of the value of money by examining price
movements and attempting to find a reason for their occurrence. We may visualize the
problem of the value of money as the problem of explaining the behavior of price level. The
concept of the value of money is not simple rather; it is dependent upon whose money one is
talking about. The money of the businessmen may suffer a more rapid loss of value during a
period of rising prices than that of the consumers, whose main interests are in the cost of
living instead of in wholesale prices. The value of money measured by a general price index is
often considered different from that measured by an index of commodity crisis at wholesale.
Although one should keep in mind the limitations of any single index of prices, it is
nevertheless possible to use an index such as that of wholesale prices to obtain a rough but
unusable measure of changes in the value of money.
The Velocity of Money

The velocity of money refers to the rate of turnover of money or the frequency of spending
money. The determinants of the velocity of money may be grouped into six (6) categories:

1. Institutional factors that underlie the synchronization between receipt

and expenditures;
2. The state of financial technology:
3. Interest rate levels;
4. The prevailing degree of economic uncertainty or state of economic confidence:
5. Inflation expectations; and
6. Income level

Institutional Factors that Underlie the Synchronization between Receipt and Expenditures
The demand for and velocity of money are related to institutional considerations such as the
frequency of paydays, payment habits, price and employment behavior, investment
opportunities, the use of credit cards, and other institutional factors that govern the degree of
synchronization between receipt and disbursements of funds. More frequent paydays and
increase of use of credit cards reduce the demand for money and increase its velocity.

The State of Financial Technology

Comprising the financial technology are the availability of substitutes for money and the cost
involved in using those money substitutes as well as technical mechanisms developed by
banks that allow individuals and firms to hold less money. Financial innovations increase the
opportunity cost of holding money thereby reducing the demand for money.

When the government sells treasury bills or treasury notes, the opportunity cost of holding
bank checking accounts increases because these securities are highly attractive to millions of
individuals. They use their funds in their checking accounts or savings deposits to purchase
such securities. Their actions reduce the demand for MI and increase its velocity.

Another example is the proliferation of Automatic Teller Machines (ATMs), which reduces the
cost of switching funds from savings to checking accounts thereby reducing the demand for
MI. Anything that reduces the propensity to hold checking accounts increases the velocity of
money. Other instruments that provide attractive alternatives to holding money are Central
Bank Certificate of Indebtedness (CBCIs), commercial papers and repurchase agreements.
Financial innovations then increase the velocity of money.

Interest Rate Levels

An increase in interest rates reduces the demand for money, that is, it induces people to hold
less of their wealth in the form of transactions, precautionary, and speculative balances. This is
because the demand for and velocity of money are inversely related. An increase in the
interest rates raises velocity. Interest rates exhibit a distinct pattern that is rising during
economic expansion and falling during recessions.

Economic Uncertainty

Money is the safest of all assets in the sense that its nominal value remains constant no matter
what happens in the stock, bond. or real estate markets or in the economy itself. If the stock
or real estate market collapses. P20.000 in checking account is still equivalent to P20,000
pesos in value. For this reason, anytime an announcement or event raises the prospect or
possibility of trouble in the economy, demand for money increases. People tend to sell their
stocks or bonds and prefer to hold money. As the demand for money increases. its velocity is
reduced so that when economic, political or military outlook darkens, velocity of money falls.
When public confidence improves, people become more aggressive in holding assets other
than money thereby reducing the demand for money and increasing its velocity.

Inflation Expectations

Inflation reduces the real value of money at a rate equal to the difference between the annual
inflation rate and the interest rate (if any) paid on money. If inflation is running at ten percent
(10%) per year and there is no increase on interest rate. the real value of money depreciates at
ten percent (10%) per year. If the inflation rate is running at 10% per year and the interest rate
is five percent (50%) the real value of money depreciates at a rate of 5% per year. Here.
people will reduce their demand for money in an effort to escape inflation tax. If the value of
money depreciates rapidly when inflation is high. people tend to spend it quickly before it
depreciates.

During hyperinflation. when the implicit tax on money becomes extreme. velocity escalates as
people desperately try to rid themselves of money before its value plunges again by holding
assets rather than money.
Income Level

An increase in income usually results in increased expenditures by individuals and firms.. If a

doubling of income were to result in a doubling of expenditures and if people were induced to
hold twice as much money to finance the doubled level of expenditures velocity of money
would be unaffected by the increase of income. In this case, the income elasticity of demand
for money or the ratio of the percentage change in the demand for money to the percentage
change in income would be exactly 1.0 and changes on income would have no effect on
velocity.

Some economists view money as a luxury good which means that the income elasticity
demand for money is greater than 1. The more securities and less money one holds, the more
time one spends in managing one's money balances. Usually, an increase in income is likely to
increase the value one places on leisure time. Thus, an increase in income may boost the
demand for money not only to accommodate higher expenditures but also to reduce valuable
time spent on managing one's financial affairs. If an increase in income induces a greater-than
proportional increase in the demand for money. higher income leads to lower velocity.

On the other hand, there are "economies of scale" in cash management, so that the doubling
of income may require less than a doubling of average money balances to finance double level
of expenditures. Individuals with higher incomes and expenditures are more likely to use
credit cards. As income rises, firms are more likely to develop lines of credit with their banks.
Both these phenomena reduce the demand for money and boost to velocity and tend to
encourage intra-monthly securities transaction. In this event an increase in income and
expenditures could lead to less than proportional increase in the demand for money and an
increase in its velocity. A great majority of empirical studies of the demand for money have
found an income elasticity of the demand for money of less than 1. implying that the effect of
long-run income growth is to increase the velocity of money.

A useful way of illustrating the connection between money and economic activity is the
equation of exchange. Originally developed by Professor Irving Fisher, perhaps the most
eminent American economist of the first half of the twentieth century, the equation is stated
as MVT PT

Where:

M the average money supply in existence in a given year

VT the transactions velocity of money - that is, the number of times the average dollar is spent
per year (VT PT/M) P the average price of the transactions that take place during the

year

and

- the number of transactions occurring during the year

T

Note that the right-hand side of the equation (PT) is simply the total peso value of annual
transactions (the average price per transaction times the number of transactions). The left-
hand side of equation also expresses the value of annual transactions but does so in terms of
the money stock and the transaction velocity of money. This equation simply states that the
annual expenditures (MVT) equal annual expenditures (PT). Because VT is defined as annual
expenditures (PT) divided by the money stock (M) held during the period.

Here is an example, suppose that in a given year your total expenditures is P100,000.00.
Suppose also that during the year you maintain an average money balance (demand deposit
plus currency) of P50,000.00. If an average money balance of P50,000.00 is to accommodate
total transactions of P100,000.00 per year, your average peso must be spent, or turned over.
20 times annually. Your transaction velocity is thus 20 per year:

Annual expenditures

P100,000/yr

VT =

= 20/yr

Average money holdings

P50, 000

The nation's aggregate PT includes expenditures on goods in the early and intermediate stages
of production as well as spending on final goods and services (GDP) Gross Domestic Product.
PT also includes transactions in common stocks, bonds, used cars, garage-sale items, and many
other items. which are not included in GDP. Because we do not have reliable data on total
expenditures, PT, we cannot accurately measure the transactions velocity of money, PT/M.
The transactions velocity of currency and coins, which is an important component of the
money supply, cannot be measured. However, the government collects data on demand
deposit turnover, or the so-called transaction velocity of demand deposits. The data cover a
large sample of

2 Fisher referred to the left-hand side of the equation as the "money side" and the right-hand
side as the "good side" Thus, MVT represents the value of money expenditures in a given
period while PT indicates the value of the items purchased and sold in the period. The two
sides of the equation are equivalent because each side indicates annual expenditures. banks.
The demand deposit turnover rate is calculated by dividing total clearings through checking
accounts in a given year by average magnitude of demand deposits in that year. Because
demand deposits constitute the bulk of the narrow money supply (MI), the rate of turnover of
demand deposits is a proxy for the transaction velocity narrow of money, VT2.

The Income Velocity of Money

For purposes of conducting monetary policy, we are more interested in the volume of
expenditures on final goods and services (GDP) than the volume of transactions in everything
including stocks, bonds, raw materials, and used cars. Therefore it is useful to reformulate the
equation of exchange in terms of expenditures on final goods and services only. The formula is

Where:

MVY PY

M = the average money supply in existence in a given year

VT = the income velocity of money, or the number of times the average peso is spent on final
goods and services per year (VY PY/M or GDP/M)
p = the average price of all final goods and services purchased during the year the average
price of all goods and services constituting GDP. or an index of such prices relative to some
base year, and

Y = the number of final goods and services produced in the year, or an index of real GDP
relative to the base year

In this formulation, PY is the peso value of GDP expenditures in a given year (nominal GDP).
MVY or the average money supply (M) times the annual rate of turnover of money (VY) also
stands for aggregate spending on these final goods and services. Again. VY is defined in such a
way as to make the expression an identity (VY PY/M).

If the money supply (M) changes, one of two things happen: 1. Velocity (VY) must change
proportionally in the opposite direction, so

that aggregate GDP expenditures (MVY and PY) remain unchanged; or

2. GDP expenditure must move in the same direction as the money supply. If the money
supply increases 10 percent, GDP expenditures must also increase unless velocity declines 10
percent or more, negating the effect of the increase in M. At one hypothetical extreme, if VY is
constant, the money supply is the sole determinant of the level of nominal GDP expenditures
and economic activity. In this case, only the control of money supply is needed in order to
control GDP expenditures accurately. If velocity (VY) is not constant but is independent of the
money supply and is subject to reasonably good prediction, monetary policy can still be a
highly effective method of prediction, monetary policy can still be a highly effective method of
influencing economic activity. On the other extreme, if V fluctuates in a unpredictable manner.
changes in M. by the monetary board of the Central Bank, will have no predictable effect on
GDP In that event, monetary policy would be totally ineffective. To the extent that velocity is
at random. unpredictable, the power of the monetary policy and the influence of the Central
Bank on GDP expenditures and general economic activity are compromised.
Concerning the effectiveness of fiscal policy in influencing the economy. we can state that if
tax cut or an increase in government expenditures is to successfully stimulate GDP
expenditures in the face of a constant money supply, the fiscal stimulus must increase VY. If
velocity is constant or is not influenced by fiscal policy initiatives. fiscal policy will be
ineffective in influencing macroeconomic activity. On the other hand. if VY systematically
increases with stimulative fiscal measures and decreases with fiscal restraint fiscal policy may
be powerful. Clearly, the nature and behavior of velocity are important. The determinants of
velocity, and especially its responsiveness to monetary and fiscal actions. are key issues in
macroeconomics. Each measure of the money supply (MI. M2. and M3) has a corresponding
measure of income velocity. The amount of money (MI or M2) that people desire to maintain
is known as the demand for money.

Velocity and the Demand for Money

Currency plus demand deposits principle also applies to the income velocity of money. If the
Philippine money supply of P120 billion accommodates annual GDP expenditures (PY) of P720
billion (so that VY is 6.0). we know that, on the average, the public holds one-sixth of the peso
value of annual GDP in the form of money. The magnitude of money balances held relative to
annual GDP is the reciprocal of VY, the inconie velocity of money. Since VY GDP/M. I/VYM GDP

In this case. VY is the ratio of an annual peso flow (GDP) to an average peso stock (M).
Arithmetically, the peso signs cancel out, and we are left with a pure number per year. If GDP
is P720 billion per year and M are P120 billion, and then VY is six per year. If we look at the
reciprocal of VY we have the ratio of a stock of peso of money (M) to an annual flow (GDP)
Again, the peso signs cancel out and we have a number expressed as a fraction of a year. If M
is P120 billion and GDP is P720 billion per year, then the reciprocal of VY is one-sixth of 1 year,
or 60 days. If the income velocity of money (VY) is 6, this means that the average individual or
firm retains money balances sufficient to finance expenditures on final goods and services
(GDP) for 60 days. The Demand for Money

In the early twentieth century, a group of economists at Cambridge (inversity of England

began to analyze the economic role of money by t on the demand to hold money balances.
Their approach was a natural result of the widespread familiarity of the concept of demand in
economics. focusing Just as they examine the demand for automobiles and the demand for
housing. it seemed natural to devote attention to the factors underlying the demand for
money balances. Their investigations produced important insights and

advances in monetary theory. The Cambridge group and modern economists usually used an
expression

such as

Md kPY, where k =

Md

PY

In this formula, Md is the demand for money; k is the fraction of GDP (or PY) that the public
desires to hold money balances. If the economy is in equilibrium, so that the demand for
money (Md) equals the supply of money (VY) Ik and k 1 VY. If the demand of money rises
relative to GDP (if k rises). income velocity (VY) will fall. It people desire to reduce their
fraction of annual expenditures

held in money (if k falls), the income velocity of money will increase. Any

theory, which explains the behavior of k also explain the behavior of VY and

vice versa. Given the important role of k and VY variables, we can now

understand why economists invested more hours in researching for the demand

for money rather than the demands for automobiles or housing.

Motives for Holding Money
Because money (currency and demand deposits) typically earns little or no interest. we might
conclude that the average person would be foolish to maintain a money balance of
P100,000.00 throughout the year. Economists have identified three different motives for
holding money, which, together with the existence of credit cards, charge accounts, the
frequency of paydays. and many other factors, determine the public's demand for money. The
first and most essential motive is to finance expected transactions.

Transactions Demand

People hold money in part because they need to finance forthcoming expenditures for goods
and services. but the timing of their income payments does not coincide with their expected
pattern of expenditures. This demand for money to finance ordinary expenditures is called the
transactions demand for money. The principle is easy to illustrate. Suppose a Mr. X receives a
monthly income of P6,000.00 from part-time employment Assume that his monthly
expenditures are also P6,000.00, suppose that on the first day of each month he deposits
P5.000.00 into a checking account and retains P1.000.00 in currency. He uses these money
balances (P6,000.00) at a constant rate throughout the month, until they are depleted on the
last day of the month. He then replenishes the balances at the beginning of the next month.

It shows Mr. X's spending pattern and money balances. He holds a balance of P6,000.00 on the
first of the month. gradually depletes it, and ends the month with no money. If we average his
balances on each day of the month, we obtain an average balance of P3,000.00. Mr. X spends
P72.000.00 during the year and holds P3,000 00 on his average. His (transaction) velocity of
money is 24 times per year. That is, on an average day, he holds a balance equal to 1/24 of his
annual expenditures, a balance sufficient to finance 15 days of expenditures.

Now, suppose Mr. X begins to receive his paycheck on a weekly rather than a monthly basis.
To simplify the calculation, assume there are exactly 4 weeks in each month. On the first day
of each week, Mr. X has a balance of P1.500.00 in the form of demand deposit and currency.
By the end of each week, the funds have been depleted. Though he continues to spend
P72,000.00 per year. he now holds an average balance of only P750.00. thus his transactions
velocity is P72.000.00/yr P750.00, or 96 times per year. He keeps only 1/96 of his annual
expenditures in the form of money enough to finance slightly less than 4 days of expenditures.
From the example, it is clearly seen that an increase in the frequency with which income
payments are received produces a greater synchronization between receipts and
expenditures, reducing the demand for money relative to annual expenditures. When the
frequency of paydays increases, the velocity of money rises.

The time pattern of expenditures also has an effect on the demand for money balances. Let us
return to the example of the monthly receipt of P6,000.00 and a transaction velocity of 24 per
year. Suppose, however, that rather than sending his money balances at constant rate, Mr. X
depletes them by the middle of each month. Let us study his spending pattern. During the first
half of the month, he maintains an average balance of P3,000.00. In the second half of the
month, his average money holdings are zero. For the month as a whole, therefore. Mr. X keeps
an average balance of P1,500.00. Given his annual expenditures of P72,000.00, his transaction
velocity is 48 (contrast that with a transactions velocity of 24 when he drew down his balances
gradually over the entire month). Because Mr. X's expenditures are now more closely

If income were received just as frequently as it is spent, the demand for money would
approach zero and velocity would approach infinity People hold transactions balances only
because thes expenditures do not coincide with their receipts of funds umed and they
coincide with his receipt of income, his average demand for money is reduced and the velocity
of his money increases. In general, any factor that increases the degree of synchronization
between the receipt and distursement of funds reduces the demand of money and increases
its velocity

Let us look at a final example, which illustrates the impact of financial imovations on the
demand for velocity of money Return to the assumptions illustrated above, in which Mr.X's
transactions velocity was 24 times per year Suppose that he obtains a credit card and runs up
a bill of P3.000.00 each month (paying half of his expenditures with the credit card). On the
first day of each month, he spends P3,000.00 to pay off the credit card bill from the previous
month. As after the first day of each month, therefore, his balance is only P3,000.00 that
suffices to cover his needs, because he uses his credit card to meet half of his transactions.
Suppose the remaining P3,000.00 is used up at a constant rate throughout the remainder of
the month. This illustrates Mr. X's spending and money balance pattern. A quick look at the
figure shows that the use of a credit card reduces the average balance he holds during the
month to approximately P1,500.00. Assuming that the student's annual expenditures remain
at P72.000.00, the transactions velocity of his money becomes P72,000.00/yr P1,500.00-48/yr.
The introduction of the credit card has allowed Mr. X to reduce his average money balance by
50 percent. from P3,000.00 to P1.500.00. This doubles the velocity of his money. Credit cards
raise the velocity of money by reducing the demand for money relative to annual
expenditures. The same principles apply to other forms of credit, such as bank overdraft lines
and charge accounts.

Given payday schedules. the public's banking habits and institutional arrangements governing
the use of credit, the income level exerts a major impact on the transactions demand for
money. As income rises, people step up their expenditures. and their average transactions
demand for money rise accordingly. For example, if Mr. X's monthly income rises from
P6,000.00 to P12.000.00, he begins the month with a cash balance of P12,000.00 instead of
P6.000.00. Assuming that he spends the entire P12,000.00 evenly throughout the month. his
average demand for money will be P6,000.00 rather than P3,000.00. The transactions velocity
of his money remains unchanged, however, because his annual expenditures and his average
money balance have both increased by 100 percent.

Precautionary Demand

Most of us keep funds above and beyond the amount we actually expect to balances. It
attributes their existence to the possibility of unforeseen events use in a given period. This
provides a margin of error or precautionary requiring additional expenditures. Unexpected
medical or auto repair bills, the unanticipated markdown of a desired item to a bargain price
(prompting its purchase) these and other events may prompt expenditures not normally
expected Injury, illness, or an economic downturn could also disrupt the flow of family income.
The maintenance of money balances to meet unforeseen circumstances is called the
precautionary demand for money. The magnitude of such a cushion is likely to depend on the
level of income, An individual with an income of P200.000 per year is likely to maintain a
higher precautionary balance than a person who earns P100,000 annually.

Speculative Demand

In a nation as a whole, a significant amount of money is held for the purpose of capitalizing on
a good investment opportunity should one arise. Speculative demand for money includes
money balances held with the intent of securing profit from knowing better than the market
what the future will bring forth

For example, if an investor is fully invested in stocks, bonds and real estate and is holding no
money balances in excess of those needed for other transactions and precautionary purposes,
it may be difficult or impossible to take advantage of the opportunity to commit funds to the
stock market and to the corporate bond market. The investor may be able to finance new
purchase of stocks and bonds only by liquidating other securities or by selling real property.

When the securities market is depressed. selling some securities to purchase others is not a
desirable choice. and real property is relatively illiquid: it is difficult to sell on short notice for
its full value. The net result might be that the investor is forced to pass up the opportunity to
purchase securities at a most favorable time. So in order to avoid forgone opportunities, alert
and perceptive individuals and firms maintain money holdings in excess of those needed to
satisfy transactions and precautionary motives.

The speculative demand for money is highly volatile, because it depends heavily on the
changing nature of the public's expectations. If the outlook for the stock and bond markets
turns increasingly bleak, the speculative demand for money will increase as people unload
securities as the outlook clears up and becomes favorable. the speculative demand for money
will decline as people take the plunge and use their money to purchase stocks and bonds. The
speculative demand for money moves in the opposite direction from the speculative demand
for securities or other non-monetary assets.

The nature of the speculative demand for money is an important consideration in determining
the relative stability of the velocity of money, the link between money and GDP expenditures.
If the speculative demand for inoney is highly volatile. velocity will be quite variable and
difficult to predict This issue therefore has a bearing on the effectiveness of monetary and
fiscal policy. The nature and indeed the very existence of a speculative demand for money are
THE ROLE OF INTEREST RATES IN THE DEMAND FOR MONEY

The "price" one pays for holding money is called opportunity cost. It is the interest rate one
could have earned from non-monetary assets. One might expect it as the quantity of money
demanded to be a function of its price or that is, the market rate of interest. That would place
money on the same ground as other goods or services, whose quantity demanded, are cost
inversely related to their price.

Interest Rates and the Transactions Demand

Lloyd B. Thomas says as we have seen, transaction balances involve money, which must be
held in order to, bridge the inevitable time gap between the receipt of funds and their later
disbursement. If these funds must be held to finance expenditures later in the month, how can
their magnitude be related to the interest rates? The answer is that for the majority of
individuals, the interest rates are probably not a relevant consideration. However, wealthy
individuals. large business firms, and other organizations that have large receipts and
disbursements, the transaction demand for money is likely to be significantly influenced by
interest rates.

Let us illustrate the principle with an example. Suppose an individual carms and spends
P100.000 each month. Rather than deposit the full P100,000 in a checking account on the first
of the month, he initially deposits P50,000 and uses the rest of the money to purchase
Philippine Treasury bills with 30 days to maturity. In the middle of the month, as his checking
account approaches depletion. he deposits the proceeds from the matured Treasury bills
(P50,000 plus interest) into the account.

Note that by investing half his paycheck in Treasury bills, the person carns interest on P50.000
for half a month. Does his behavior make sense? Is it rational? That depends on the interest
rate and the transaction costs associated with purchase of the securities, including the
inconvenience associated with making extra transactions. If the interest rate on the Treasury
bills in this example is 12 percent and the securities are held for each month, the individual
will gross P6.000 per year, or P500 a month. From this must be deducted the out-of-pocket
transaction costs primarily the commission or brokerage fee charged by the agent who buys
the securities. The net return. then, must be weighed against the inconvenience of engaging in
the transactions and making extra trips to the bank. Suppose, on the other hand, the current
yield on Treasury bills is only & percent. In that case, the gross return earned by purchasing
P50,000 worth of Treasury Bills on the first of the month and liquidating them at mid-month
would be only P2,000 per year, or P166.67 per month. After deducting transaction fees, some
individuals might find the net return insufficient to compensate them for the inconvenience.
We can conclude that for wealthier individuals and for many business firms, the interest rate is
likely to be a significant influence on the transactions demand for money and therefore on the
velocity of money

The higher the interest rate, the lower the quantity of money demanded (the more wealth is
kept in bonds and other interest-bearing assets), and therefore the higher the velocity of
money.

Interest Rates and the Precautionary Demand

Precautionary money holdings may also be somewhat sensitive to interest rates. When
interest rates are very high, one may be tempted to pare down precautionary money balances
and keep as much wealth invested in interest earning assets as possible. Thus the treatment of
these balances is similar to that of transaction balances.

Interest Rates and the Speculative Demand

One of the most significant hypotheses is that people and firms hold a significant amount of
money for speculative purposes. The interest rate and the economic outlook or the public's
expectations are the key variables influencing the quantity of money that is held for this
purpose. And it is concluded that the demand for speculative money balances is inversely
related to the interest rate. That is, the lower the interest rate, the greater the desire to hold
wealth in the form of money with which to speculate.

Analysis of the problem lies on the context of an individual confronted with a choice between
investing in government bonds or holding wealth in the form of non-interest-earning money
balances. The crucial consideration is the current rate of interest on bonds relative to the rate
regarded by the individual as "normal", or the level toward which the actual interest rate is
expected to gravitate. Each individual forms a perception of the "normal" interest rate, largely
on the basis of past experience. Further, the level of this "normal rate was said not to be
heavily influenced by the current interest rate. If the current interest rate is quite low relative
to the "normal" rate. people will expect the interest rate to rise in the near future. If the
current interest rate is above "normal", people will expect a decline in interest rates.
To go from individual analysis to aggregate analysis, we must allow for the fact that different
individuals have different perceptions regarding the "normal" level of interest rates. The lower
the current interest rate, the larger the number of people who will think that the current
interest rate is below normal and likely to rise, the lower will be the demand for bonds and the
greater will be the demand for money. This relationship between the interest rate and the
demand for speculative money balances is known as liquidity preference schedule.

The Role of Interest Rates in the Demand for Money:

We have learned that the demand to hold money may be responsive to the opportunity cost
of holding money the market rate of interest. Each motives of holding money may depend in
part on the interest rate, and its increase makes holding money most costly. This is because
money pays a relatively non-competitive rate of interest, if any. To the extent that the demand
for money and therefore its velocity vary with interest rates, the link between money supply
and GDP expenditures becomes more uncertain because interest rates fluctuate significantly
overtime.

CHAPTER 5
A. Credit Instruments for Investment Purposes Credit Instruments for Investment Purposes are
subdivided into stock certificates, bond certificates and money market bills,

(a) Stock Certificates

Stock certificates are evidences of ownership in a corporation. The stockholder, who is a part
owner of a corporation, is entitled to its earnings known as dividends, the payment of which is
declared by its board of directors. He also shares in losses. if any Since a corporation is obliged
to compensate its stockholders for the money they have invested and for the risk they have
undertaken, we may consider their stocks certificates as credit instruments. In the event a
stockholder wants to sell or transfer his shares of stocks, he may do so by endorsing the stock
certificate on the space provided for it.
Stocks are divided into two types:
preferred stocks and the common stocks.
Preferred stocks are stocks having special privileges and carry certain limitations or
restrictions. Privileges may be as to dividends and as to assets. Preference as to dividends
means that the preferred stockholders receive their dividends ahead of the common
stockholders. Preference as to assets means that the preferred stockholders have prior claim
on the assets of the corporation over that of other stockholders. The preference therefore,
gives the holder greater security against risk. However, in exchange for their privilege. the
preferred stocks are denied the voting power or their voting rights may be limited. Common
stockholders are entitled to residual claim on the business They represent simple ownership in
the corporation, which entitles the holder to enjoy only the fundamental rights of the
stockholders. They have the voting power. (See Figure 19)

(b) Bond Certificates

Bond certificates are evidence of indebtedness of a corporation to bondholders. A

corporation raises huge amounts of funds this way. Most often, the issuance of bonded
indebtedness are in big amounts and of long duration. oftentimes for five years or more.
Bonds may be issued by the private or the government sector. In the Philippines, bonds are
issued only by corporate entities. Central Bank Certificate of Indebtedness, the LBP Bonds, DBP
Progress Bonds, and the Premyo Savings Bonds are examples of government owned bonds.
These credit instruments enjoy wide acceptance, especially among banks and financing
institutions. Many people invest in bonds because they are safer investments than stocks. In
case of forced liquidation on the part of the issuing corporation, the bondholder has a prior
claim over the stockholders on the undivided assets of the corporation. Bonds are transferable
by endorsement and delivery, or by mere delivery: They can be used as collaterals for loans.
Kinds of Bonds

Debenture bonds- These are unsecured bonds issued against the general credit standing of
the issuer. Usually these bonds earn higher interest rates than other types of bonds to
compensate for the greater risk involved. They may also be made attractive by the inclusion of
special features, such as profit sharing, conversion privilege, and a covenant of equal coverage.
(See Figure 20)
Collateral Trust bonds- Collateral trust bonds are secured by a pledge of corporate stocks and
bonds, and evidences of indebtedness of other corporations, which are owned by the issuing
corporation. Holders of the collateral trust bonds could have recourse not only against the
issuing corporation but also against the securities offered as collaterals.

Mortgage bonds- These are bonded indebtedness secured by a mortgage on real properties
of the corporation. In case the issuing corporation defaults, claims of bondholders may be
satisfied out of the proceeds from the sale of the assets given as collaterals.

Sinking Fund bonds- Sinking fund bonds are bonded indebtedness requiring the compulsory
maintenance of a sinking fund to redeem the bonds at maturity. A sinking fund is a reserve
accumulated from the annual income of the company used for a specific purpose. (See Figure
21)

Registered bonds- A registered bond is one, which is issued in the name of a particular person
or entity. The names of the bondholders are registered in the books of the corporation. Such
instruments could be negotiated by endorsement and delivery and registered in the name of
the new owner in the books of the corporation.

Guaranteed bonds- These are bonds whose principal and interest payments are guaranteed
by a company other than the issuing corporation. They usually arise due to reorganization and
consolidation.

Convertible bonds- These are bonds, which could be exchanged with other securities of the
corporation within the duration of the bonded indebtedness. The conversion clause usually
indicates the rate and time at which they could be converted.

Redeemable bonds- These are bonds, which are subject to call, redemption, or purchase
before they are due. Redemption may either be optional or mandatory. Optional redemption
means that the corporation may or may not redeem the bonds depending on the circumstance
prevailing In mandatory redemption the corporation is required to redeem the bonded
indebtedness within a specified time.
Serial bonds- These are bonded indebtedness of a single issue but are divided into groups of
different maturity dates and could possibly have variable terms and conditions. Serial
redemption is convenient for the issuing corporation because of its gradual redemption, which
cases amortization payments of the principal. (See Figure 22)

Income bonds- Generally, interest payments of bonds are fixed obligations of the corporation
regardless of earnings. However, the interest payments of income bonds are dependent on
the happening of an event or after the lapse of a certain period of time. These types of bonds
are usually issued to organizers of a corporation during the early years of the firm's operation,
or if the firm is in the process of reorganization. Coupon bonds- These are bonds with
detachable coupon which evidence interest obligations payable at specified periods. These
interest coupons may be negotiated separately from the bond. (See Figure 28-29)
Profit-sharing bonds- These are bonds allowed to participate in the earnings of the company
in addition to the interest payments. This feature is usually attached to low-grade bonds so as
to enhance their salability.

(c) Money Market Bills

Money market bills are negotiable financial instruments bought and sold in the market. A
money market is a meeting place for users and suppliers of short-term funds. Like in other
markets, transactions in a money market are consummated upon agreement on the price. The
price of the money is the rate: of interest charge for its use. For instance. we assume that the
money market has a bill that is well traded, widely acceptable and possesses the highest
degree of credit risk. If the market is well developed and efficient, there is a free interchange
for both money and bills. One is always related to the other and the relationship is expressed
through the price of money. When at a given price, participants find themselves in long money
position that is, whenever available reserves exceed statutory requirements relative to bills,
holders of bills tend to shift out of the bills to generate money. The shifting tends to exert
pressure on the interest.

In periods of excess liquidity, the surplus funds being invested into bills tend to increase the
price of bill or reduce the price of money. In periods of tight money when bills are sold for
cash, the bill's price tends to increase. Low rates of interest depict easier money conditions
when bills are in demand. High rates of interest depict conditions when money is ultimately
scarce and there is settle is the right price at which holders of cash are willing to transact bills,
an oversupply of hills and a great demand for money. The level at which they and vice versa.
The following are parties to a money market transaction:

a) Fund user

b) Fund supplier Broker

c) Broker
Fund users are those companies with a high credit ratings that are in need of funds.

Fund suppliers are individuals or corporations with excess liquidity who are looking for
possible investment outlets for their excess funds. Brokers are individuals or institutions
engaged in the buying and selling of money market instruments. They make a profit in the
difference between their buying and selling rates.

Kinds of Money Market Instruments

1. Inter-bank Call Loans- These are loans, which should be paid upon demand or call by the
lending institutions. They do not have definite maturity dates. These call loans are resorted to
by banks which borrow from and lend to each other overnight funds to meet their daily
reserve deficiency. This will enable the lending banks to earn from their excess reserves.

The inter-bank call loan market uses call tickets or call slips which are written instructions
issued by the transacting banks to the Central Bank to debit the deposit balance of the lending
banks and credit those of the borrowing banks. In repaying the call loan, an inter-bank call
loan repayment ticket is issued to the Central Bank by the debtor bank. (See Figure 23-24)

Promissory Notes- These are also called dealer papers. They are short term indebtedness
issued by institutions as direct obligors. The
promissory note facilitates the financing of corporations.

3. Repurchase Agreement- These are papers sold by dealers to buyers at an agreed price. The
dealer undertakes to buy the same paper from the buyer at a specified future time and at a
price agreed upon. Repurchase agreements may be sold on demand or call and term basis. The
interest obtained is relatively less than those purchased on an outright basis since the dealer
guarantees to repurchase the instrument at a stipulated price. Repurchase agreements are
commonly used by securities dealers as means of financing investments. (See Figure 25.)

4. Certificates of Assignments- These are debt instruments that evidence lawful ownership of
the holder to the extent of the Peso value indicated on the face of the instruments or a batch
of an original lump sum of promissory notes. These represent prime loans granted by
commercial banks, which are participated by several investors. The liability of the financial
intermediary is either primary or secondary. A certificate of assignment is non-negotiable and
is purchased on the basis of the recourse endorsement of the financial institution.
5. Certificates of Participation- These are also debt instruments which evidence lawful
ownership of the holder to the extent of the Peso value indicated on the face of the
instrument or a portion of an original lump sum obligation subsequently broken down and
denominated into a different Peso value. The financial intermediary will either have a primary
or secondary liability over the instruments. The funds are invested or reinvested by the trustee
in such investment outlets including those banks owned by the trustee or its subsidiaries or
affiliates as may be authorized in the contract. (See Figure 26)
The trustee shall have full discretion on the investment or reinvestment of the fund, which are
subject to limitation as specified in the plan.

The trustee shall not be liable for any loss arising from the investment or reinvestment of the
funds. Losses if any shall be for the account of the trustor. The trustor shall also shoulder all
incidental expenses pertinent to the investment as well as a fee to be paid to the trustee
depending on the lot size, client relationship and market conditions prevailing.

6. Commercial Papers- These are unsecured promissory notes issued by corporations that use
the proceeds to finance short-term working capital needs. Because these instruments are
neither insured nor backed up by collaterals, the issuers are presumably the highest quality
firms. It is also further defined as an instrument which is issued, endorsed, sold, transferred or
conveyed to another person or entity with or without recourse, specifying the indebtedness of
any person or entity, especially banks and non-banks performing quasi-banking functions. In
the Philippines, commercial banks are prohibited under existing regulations from selling
commercial papers on without recourse basis. Only non banks licensed as quasi-banks are
allowed to do so. Examples of these are investment and finance companies.

Commercial papers may either be financial or non-financial in nature. Financial institutions

issue the financial type of commercial paper while public utilities, commercial, agricultural and
industrial firms issue the non-financial type of commercial paper.

A commercial paper has certain advantages to the issuer. It is sold at a discount rather than
with a coupon rate of return or at other times it is quoted at a discount with the principal and
interest paid at maturity. The issuer has full use of the funds without maintaining a
compensating balance as required by many banks. An advantage to the investor is that the
issuer may be asked to obtain an irrevocable letter of credit from a bank that guarantees
payment in case the issuer defaults
7. CBCI's- These are Central Bank Certificate of Indebtedness. They are tax-free and earn
reasonable rate of interest. They are eligible for reserves, and are acceptable as collaterals for
loans. They come in different denominations such as P10,000, P50,000, and P100,000. They
have a term of three years with interest payable annually.

8. Treasury Bills- These are bearer notes or debt instruments sold every week at a discount by
the Central Bank through competitive auction. The investor earns a profit or a spread between
the buying price and the face value of the Treasury bill. A treasury bill is a liability of the
Philippine Government to pay the bearer a fixed sum after a specific number of days from the
date of issue. They have various maturity dates, which are not longer than one year. The bills
are denominated as follows: P1,000, P5.000. P10.000, P50,000, P100,000 and P500,000.
Because of its outstanding quality and frequent maturity, treasury bills dominate the
transactions in the money market. (See Figure 27 and 30)

9. D.B.P Progress Bonds- These are issued by the Development Bank of the Philippines and
secured by their assets. They are tax-free and convertible into preferred stocks of selected
private corporations, which are under the management of D.B.P. They are denominated into:
P100, P1,000 and P10.000. They are fully guaranteed by the national government. Interests
are paid semi-annually.
10. Other government securities:

a. PW and Ed Bonds - represent direct unconditional obligations of the Philippine government

for public works projects and improvements of educational facilities.

b. LBP Bonds Philippines. represent obligations of the Land Bank of the

c. Treasury Notes-have original maturity of one to ten years. It pays coupon interest
semiannually. These are also sold via close auction.

d. Treasury Bills- carry any original maturity but typically are issued to mature beyond ten
years. It also pays coupon interest semiannually. Banks buy these treasury notes and bonds
both in the auction and secondary markets.

e. Bonds -These are long term indebtedness issued by any government entity an example of
which are those issued by the Cultural Center of the Philippines to finance its operations and
projects.

f. ACA Notes - issued by the Agricultural Credit Administration.

8. EPZA Bonds - issued by the Export Processing Zone Authority to finance housing
development in Bataan Export Processing Zone.
h. Socio-economic Bonds
i. Premyo Savings Bonds (See Figure 31)

j. Biglang Bahay Bonds (See Figure 32)

k. NFA Bonds-issued by the National Food Authority.

1. NDC Bonds - issued by the National Development Company m. LRT Notes issued by the
Railways Transit Authority to meet funding requirements.

n. Bahayan Certificates - issued by the National Home Mortgage Finance Corporation to fund
the housing loans applied by PAG-IBIG members.

Dealers Intermediating in the Money Market:

1. Commercial Banks

2. Savings Banks

3. Investment Houses

4. Investment Companies

5. Finance Companies

6. Securities Dealers

Investors in the Money Market:

1. Individual Investors

2. Trust Funds and Pension Funds

3. Government Insurance
a. Social Security System (SSS)

b. Government Service Insurance System (GSIS)

4. Private insurance companies

5. Other government corporations

6. Other private corporations

7. Lending Investors - organized single proprietorships or partnership using their own capital
for the purpose of extending all types of loans.

8. National Government
9. Other institutions

a. Development Bank of the Philippines (DBP)

b. Land Bank of the Philippines

c. Philippine Amanah Bank (Islamic Bank)

A dealer as an intermediary in the exchange process actually becomes a party to a money

market transaction. He maintains an inventory of securities, sells his securities to other buyers,
and hopes to make a profit in the process of buying and selling these securities.
A broker is not a party to the transaction. He only acts as an agent for his clients who are
either buyers or sellers. He makes buyers and sellers meet Since he is knowledgeable of the
market, he can give proper advise to his clients and sees to it that transactions are properly
executed. He earns a commission in the transaction.

An underwriter, on the other hand, is a dealer who handles new lines of securities. He
purchases the securities and then sells them in the market hoping to make a profit or a spread
between the buying and selling of such securities. Some essential ingredients in an
underwriter's activities are his ability to provide accurate information to his clients as well as
proper contacts with established businesses.

Transactions in the primary market involve the issuance of new securities. Private individuals,
business firms, and government agencies issue the new securities.

Transactions in the secondary market, on the other hand, are confined to already issued and
outstanding securities. These are securities of well-known companies whose credit worthiness
are unquestionable and are usually of large volume. These securities are highly marketable
because the market has already been well developed.

B. Credit Instrument for Commercial Purposes

Credit instrument for commercial purposes, which is better known as instruments are further
subdivided into promise-to-pay and order-to-pay. A promise-to-pay instrument involves two
parties: the maker who is the debtor, and the payee who is the creditor or the party receiving
payment. An order-to pay instrument, on the other hand, involves three parties: the drawer,
the drawee and the payee. The drawer is the party who orders payment, the drawee, is the
party ordered to pay, and the payee is the receiver of the payment.
Promise to Pay instruments consists of (a) promissory notes, (b) financial institution deposits.
(c) letter of credit. (d) open book accounts

A promissory note is a written promise of one person to pay another sum certain of money on
demand or at a determinable future time. Promissory notes may be further classified into
negotiable or non-negotiable promissory notes, secured or unsecured. A promissory note is
both a commercial instrument and a banking instrument. The importance of a promissory note
is in the purpose for which it is used. It is used to evidence obligations incurred through the
purchase of merchandise or the acquisition of cash credit.
A promissory note has definite advantages over an open book account. They are as follows:

1. It is a very good proof of the existence of the indebtedness.

2. Since a specific time for payment is made, the debtor is obliged to meet it when due.

3. It can be discounted or rediscounted with the Central Bank for

funding. 4. It could be sold for a higher price because it is saleable.

A negotiable promissory note is one of that is transferable. This negotiable promissory note
may be discounted. used as collaterals and sold or disposed of in the financial markets. There
are certain important features of negotiability, which should be incorporated into the note
when desired.

A non-negotiable promissory note is non-transferable. It is popularly known as the 1.0.U. (I

owe you). The negotiability of the promissory note greatly depends on how well the public
merited the trust and confidence of the issuer of the note. (See Figure 33-34)

Secured promissory notes are guaranteed with properties of value. In case the note is not paid
when due, the creditor has the right to dispose of the collaterals pledged to secure the loans.
A space is usually provided in the body of the secured note to describe the securities pledged.

Unsecured promissory notes greatly depend upon the character of the borrower. They are
generally known as clean or character loans.
Financial institution deposits are promises of certain institutions to return money deposited
with them. Deposits may take the form of demand, time, and savings deposits. When funds
are deposited in any financial institution, the depositor receives an acknowledgement in the
form of a passbook for a savings deposit, certificate, for a time deposit, and a deposit stub or
duplicate for demand deposit. This indicates the institution's promise to pay on demand or
upon advance notice, or at any future determinable time an amount out of the depositor's
own account with the bank.
A Letter of Credit is a letter made by one bank addressed to another bank. whether domestic
or foreign. requesting the bank to honor drafts drawn against it in behalf of a third party under
specific terms and conditions as specified in the letter. The International Chamber of
Commerce sometimes calls it documentary credit. Letter of Credit may be divided into two
types,

The first type is the commercial letter of credit, which is often used, in international trade. It
includes import and export letter of credit.

The second type is the traveler letter of credit, which may be applied for by a traveler from
his home bank instead of purchasing a traveler's check. Just like the commercial letter of credit
in the traveler's letter of credit, the bank substitutes its credit for that of the borrower. The
letter is usually addressed to several correspondent banks that are induced to honor drafts
drawn against them, which should not exceed the amount indicated in the letter of credit. In
the Philippines, the use of traveler's letter of credit is not popular.

19 Open Book Account." Most of our mercantile credit transactions are evidenced not by
credit obligations signed by the debtor but by a mere entry made in the ledger of the creditor
to show the existence of a credit transaction. Since the seller's record alone is not a very good
evidence of debt, supporting documents are usually used in connection with the debt. These
may be a sales slip or invoice, delivery receipt or a signature of the debtor on the seller's
notebook acknowledging his debt.

Orders to pay Orders to pay are the second type of commercial credit instruments. Checks,
drafts, and money orders fall under this type of credit instrument.

Checks are the most commonly used bills of exchange for satisfying
credit obligations. They are always drawn on a bank and paid on demand. A check may be
defined as an order of a depositor to his bank, requesting it to pay a sum certain in money to a
person named therein, or to his order or the bearer. The drawer of the check may name any
one as payee including himself. The widespread use of checks is attributed to its convenience
and safety as means of payment. Despite its common use, checks are also considered credit
instruments but with limited acceptability.
Checks may be classified as follows: crossed check, post dated check, stale check,
manager'scheck, cashier's check, treasurer's check, bouncing or rubber check, counter check,
certified check, voucher check and cancelled check.
Crossed Check is a check bearing two parallel lines located at the left-hand corner. This
indicates that the check cannot be presented to the bank for encashment. It is only good for
deposit. Drawers usually cross their checks for two reasons: for safety purposes; that is in the
event of loss recovery is quite possible, and to delay payment. Since a crossed check has to b
deposited, this gives the depositor more time to fund the check with the bank, just in case he
may be short of that amount. He only has to make sure that he makes his deposit before the
Central Bank debits the account of the drawee bank: otherwise he may be charged a penalty
for using the bank's money to pay his check. Crossed checks may either be general or specially
crossed When between the parallel lines no words are written or the words "& Co." or "non-
negotiable" are written, then the check is generally crossed, that means it can be deposited in
any bank. When between the parallel lines the name of the bank is written, then the check is
specially crossed. If the check is specially crossed, it cautions the drawee bank to pay only
through the intervention of the bank named between the lines. A crossed check bearing the
words "For payees account only" or "For the credit of payee only" indicates that the collecting
bank could only credit the amount to the account of the person named therein. upper

Post Dated Check is a check that shows a future date. The check can be paid or deposited on
the date it bears. In the Philippines, people issue post dated checks when they are forced to
make payments at a time when they do not have sufficient funds to cover the account,
although they may be certain that they will have the funds to pay on the date designated.

Stale Check is a check, which is not encashed within a reasonable time Today a check becomes
stale if not encashed within six months. In case a check is stale, the payee may request the
drawee to issue him another check. If the check becomes stale due to the payee's own fault,
this may discharge the drawee from the liability, that is if the drawee bank becomes insolvent,
whereas previously the drawee bank was solvent and the check could have been paid had the
check been presented earlier.

Manager's Check, Cashier's Check and Treasurer's Check: A manager's check or a cashier's
check or a treasurer's check is a check drawn against the funds of the bank and drawn by a
bank official. If the check is drawn by the manager of the bank, then it is a manager's check. If
the check is drawn by the cashier of the bank, then it is a cashier's check and if a check is
drawn by the treasurer of the bank, it is a treasurer's check. Manager's checks and cashier's
checks are drawn for the following reasons: (1) to defray the bank's routinary
expenses, (2) to accommodate customers who do not have checking accounts but who are
constrained to pay in checks. (See Figure 35-36)

Bouncing or Rubber Check is a check issued without sufficient funds or drawn against
uncollected deposits. If a depositor allows his check to bounce he is fined P900 and an
additional P100 a day until the check is funded. A portion of the fine goes to the drawee bank
and the other portion goes to the collecting bank. Aside from this, the bank may also close the
depositor's account if he persists on issuing bouncing checks. The drawer's failure to honor a
bouncing check within three days after notification will be a prima facie evidence for the crime
of estafa.

Counter Check is used by a depositor who has forgotten his check or by a depositor who
would like to close his account bat whose booklet of checks has been exhausted. These may be
obtained from the lobby or counter of the bank. It usually comes in a special form and is non-
negotiable.

A Certified Check is a depositor's own check which the bank certifies. It bears the stamp
certified across its face to show that the bank guarantees the payment of the instrument.
However, there are only two things that the bank certifies and they are as follows: the
amount, and the signature of the drawer. When a bank officer certifies a check. he
immediately deducts the amount from the depositor's account. thereby making the bank
liable for it. The bank officer also sees to it that the signature appearing in the check is the
genuine signature of the depositor
A certified check is usually obtained when the payee does not know the drawer or when the
payee does not have that much confidence on the drawer. Only the depositor of a bank can
request for a certification of a check.

Falsified Check and Forged Check. A falsified check is a check, which has been deliberately
imitated to deceive the payee or the bank, while a forged check is one with an imitated
signature. A check may be genuine but the signature appearing therein is imitated and is
therefore, a forged check.

A Traveler's Check is a very common credit instrument used by travelers and which commands
almost universal acceptability. They are sold in denominations of $10. $20, $50 and $100. The
American Express Company the Bank of America, and the First National City Bank of New York
usually sell them. A traveler's check could be easily negotiated because all the holder has to do
is to affix a second signature, which matches the first signature he made when he purchased
the check.

Personal Check and Business Check: A personal check is used for defraying individual or
personal expenses. It is small in size and is handy. A business check on the other hand, is used
for defraying expenses incurred by business establishments. It is bigger in size but handy. In
most cases, the name of the drawer company is usually imprinted in big bold letters on the
check.
Cancelled Check is a check cancelled either by the drawer or by the bank A drawer may have
made a mistake in writing out a check and cancels it. It is cancelled by the bank because the
bank has already paid it In most cases banks cancel their checks by perforating them This is to
avoid further encashment just in case the check is use by people who would like to defraud
the bank or the drawer.

Returned Check is a check returned by the bank for various reasons, such as: amount in figure
does not tally with the amount in words. it is a post dated check, it is drawn against
uncollected deposits or drawn against insufficient funds, it has unsigned alterations, and it is a
forged check or is a falsified check
Advantages of Checks

1. They are easy and safe means of paying.

2 They are easily negotiated.

3. They are convenient to use for large payments.

4. Drawers can put a stop payment on their check in case of loss, robbery or theft, and non-
compliance of commitment.

5. Forged checks paid by the bank would be a responsibility of the bank

rather than of the depositor

6. Checks cancelled by the bank may serve as receipts for payments made.24

Disadvantages of Checks:

1. They are not readily accepted for payment especially if the drawer does

not know the payee or the payee does not trust the drawer.

2. Drawers have to carefully keep track of their deposits so they will not issue bouncing checks.

3. Carelessness on the part of the drawer may result in loss of his check and
thereby enable another to forge the lost check.

4. Most of the swindling cases were done because of checks.

The Giro System

The Giro System is a technique in credit transaction, which is now being used. It features the
use of electronic machines. The system operates where by the creditors such as reputable
department stores, utility companies, credit card organizations, the government, and other
financial intermediaries with prior agreement with banks and their customers can request
banks to debit a customer's account and credit such account to his bank for whatever
purchase the customer made. This, therefore, avoids the use of money or checks. A customer
from his bank may apply for an automatic loan or overdraft agreement so that this guarantees
that the bank will honor drafts even though his balance with the bank is below the amount in
the draft. The bank. therefore, has a standing authorization to make a loan up to an amount
agreed upon. Drafts are drawn upon the customer if the creditor's bank is not the same as the
customer's bank.

Drafts

A draft" is a bill of exchange which is an unconditional order made by the drawer requesting
the drawee to pay the payee a sum certain in money on demand or at a determinable future
time.

Difference between a Draft and a Check

A draft differs from a check in that in a draft, the drawer may or may not have funds with the
drawee, while in a check, the drawer must always have funds with the bank whether
deposited or pre-arranged loans. In a draft, the drawee may be a bank or a person, while in a
check the drawee is always the depository bank. In a draft, you always find the words "To:"
before the drawee's name, while in a check, the name of the drawee bank is printed on the
check itself.
Kinds of Drafts

Demand and Time Drafts: A demand draft, which is sometimes called a sight draft, is subject
to payment upon presentation or demand to the payee, or his order or bearer. It indicates the
date of issue, which the holder can present any time after that. A time draft, on the other
hand, is subject to payment at a determinable future time. A time draft may either be a time
date or a time sight. In a time date draft, the holder commences counting from the date
indicated in the draft, while in the time sight draft, the holder commences counting from the
time the draft is presented or exhibited to the drawee. (See Figure 37-38)

Bank Draft and the Commercial or Trade Draft: In a bank draft, the party ordered to pay is a
bank, while in a trade draft or commercial draft, the party ordered to pay is a businessman or a
business enterprise. Trade or commercial drafts finance commerce while bank drafts are often
purchased for investments because of their excellent ratings. Banks to carry on bank
transactions among themselves most often use bank drafts.
An Acceptance Draft is a time draft, which necessitates the acceptance of the drawee. Once
the drawee accepts the instrument and places the word ACCEPTED across the instrument, and
properly signs it and indicates the date it was accepted, the drawee becomes liable for the
draft. An acceptance draft is more negotiable than an ordinary draft. If a bank is induced to
accept a draft, then it is called a banker's acceptance draft or a bank acceptance draft. On the
other hand, if the drawee is a businessman and accepts the draft, then it is called a trader's
acceptance draft or a trade acceptance draft.
Generally, banker's acceptance drafts are preferred to trader's acceptance draft because the
general public has greater confidence in banks than in businessmen or in commercial
establishments. They are most often used in foreign trade. Trader's acceptance drafts are
more in use in the domestic trade. Usually, buyers do not have ready cash to pay for their
purchases, so they make arrangements with the seller to allow them to acquire the goods in
exchange for an acceptance draft to be paid at a latter date when the goods would have been
sold. The seller draws the draft against the buyer and the buyer acknowledges the acceptance.
Now, the obligation becomes more forceful. The seller may hold the bill until maturity or he
may discount it with his own bank. Trade acceptance drafts are acceptable to banks because
they are now two-name papers. (See Figure 39)
Documented Drafts are drafts that necessitate documents to accompany the draft when
presented for payment. They may be shipping documents, consular invoices, commercial
invoices, insurance policies, and trust receipts. (See Figure 40)

The necessity of presenting such documents is spelled out in the letter of credit. Clean drafts
are drafts that can be collected without presenting documents to accompany the drafts.

Money Order

Money orders are of two types: (1) bank money order which is an order of one bank to
another bank to pay a person named therein a sum certain in money on demand, and (2)
postal money order, which is an order of a post office to another post office to pay a person
named therein a sum certain in money on demand. (See Figure 41-42)

The negotiable instrument law states that an instrument is negotiated when it is transferred
from one person to another in such manner as to constitute the transferee as the holder
thereof. If payable to order, it is negotiated by the endorsement of the holder and completed
by delivery. If an instrument is payable to bearer, it is negotiated by mere delivery, but it may,
if desired, be endorsed.
An instrument is payable to bearer when it is expressed to be so, it is payable to a person
named or bearer, it is payable to the order of a fictitious or non-existing person and such fact
was known to the person making it so payable, the name of the payce does not purport to be
the name of any person. or the only or last endorsement is an endorsement in blank.

Negotiation by endorsement may be written at the back of the instrument or upon a paper
attached thereto called an allonge. The signature of the endorser, without additional words, is
a sufficient endorsement.

An endorsement is an act of affixing one's signature at the back of the instrument or an

allonge in evidence of his transfer of it.

Requisites for Negotiability

1. It must be in writing signed by the maker or the drawer. 2. It must be payable on demand or
at a future determinable time.

3. It must be payable to order or to bearer.

4. It must contain no conditions.

5. If it is addressed to a drawee, the name of the drawee must be indicated

with certainty.

6. Endorsement must be in the name appearing on the instrument.

7. If however, the name of the payee is misspelled or is erroneously written, the endorser may
endorse it in the same manner as it was written but must indicate below the endorsement his
real name with the word by.

Example: An instrument payable to Teresita M. Jimenez which should have been Teresita B.
Jimenez may not have to be altered by the drawer but instead may be endorsed as follows:

Teresita M. Jimenez

By Teresita B. Jimenez

It is therefore understood that Teresita B. Jimenez was the one who negotiated the instrument
in behalf of Teresita M. Jimenez.

An instrument may also be payable to a specific person or to his order.

3. Restrictive Endorsement. A restrictive endorsement prevents the further negotiation of the
instrument. An endorsement becomes restrictive in the following instance:

a.

When the endorsement prohibits the further negotiation of the instrument.

Example: Pay to Mary Ann Manaois and to no one else.

(Sgd.) Katherine Belandres 1. Pay to Mary Ann Manaois only

(Sgd.) Katherine Belandres

b. When the endorsement makes the endorsee the agent of the endorser.

Example: Pay to Mary Ann Manaois for collection only. (Sgd.) Katherine Belandres

1. Pay to P.N.B. for deposit only.

(Sgd.) Katherine Belandres

c. When the endorsement bestows the title to the endorsee in trust for or

to the account of another person. Example: Pay to Mary Ann Manaois in trust for Buddy
Manaois. (Sgd.) Katherine Belandres

Effect of restrictive endorsement- A restrictive endorsement confers upon the endorsee the
following rights:""
a. To receive payment of the instrument.

b. To bring any action thereon that the endorser could bring.

Suppose Katherine Belandres, the payee of a promissory note. endorses the instrument to
Mary Ann Manaois. At maturity, the endorsee demands payment from the maker, Carolyn
Laman and the maker refuses to pay it claiming she has no money. Mary Ann Manaois, the
endorsee, can file action against the maker, Carolyn Laman.

c. To transfer his rights as such endorser, where the form of the endorsement authorizes him
to do so.

Suppose Katherine Belandres, the payee endorsed the note payable as follows: Pay to Mary
Ann Manaois in trust for Victor Miranda, signed Katherine Belandres. Mary Ann Manaois may
endorse the instrument to another person, Maribel Jimenez; but if Maribel Jimenez collects
the proceeds of the instrument, she may only hold it in trust for Victor Miranda since all
subsequent endorsee acquires only the title of the first endorsee under the restrictive
endorsement.
4. Qualified Endorsement. A qualified endorsement constitutes the endorser a mere assignor
of the instrument. It may be made by adding to the endorser's signature the word "without
recourse" or any such words as "at the endorsee's own risk." Such an endorsement does not
impair the negotiable character of the instrument. A qualified endorsement is one which
restrains, limits or qualifies the liability of the endorser in any manner different from what the
law imports as his true liability. deductible from the nature of instruments. Qualified
endorsements are of two kinds: (a) endorsement without recourse and (b) endorsement not
showing such words but where the intent to qualify the endorsement is clear. Endorsement
without recourse indicates a purpose not to assume 313 the liability for its payment and is
sufficient to transfer title, and provided there is no fund, concealment or misrepresentation, it
exempts the transferor from all liability as endorser, except that he is still chargeable with
implied warranties as seller of the paper. An endorsement with words of similar import may
use the words "without warranty of any kind", "at his own risk", or" endorser not holder".
Examples: Pay to Mary Ann Manaois without recourse.

(Sgd.) Katherine Belandres

1. Pay to Mary Ann Manaois at her own risk.

(Sgd.) Katherine Belandres

2. Pay to Mary Ann Manaois, endorser not holder.

(Sgd.) Katherine Belandres

5 Conditional Endorsement. Where an endorsement is conditional. the person required to pay

the instrument may disregard the condition and make payment to the endorser or his
transferee whether the condition is fulfilled or not. But any person to whom an instrument so
endorsed is negotiable will hold the same or the proceeds thereof, subject to the rights of the
person endorsing conditionally."

Example:

Suppose Kristen Francisco, the payee of an order note for

P10,000.00 payable on demand endorses the instrument as

follows:

Pay to Elizabeth Laman if she goes to the

United States before November 30, 2014.

(Sgd.) Kristen Francisco

Here, the endorsement is conditional because it is subject to a contingency. The effect of the
conditional endorsement on the endorser is that the endorser is not bound unless the
condition is fulfilled. Thus, in the proceeding example, if Elizabeth Laman does not leave for
the United States before November 30, 2006, the endorsement is not binding on Kristen
Francisco. The maker or the drawee may disregard the condition and pay the instrument, and
thereby, is discharged of his obligation. The fact that she pays even before the condition is
fulfilled is not a valid reason for making her still liable. The endorsee under the conditional
endorsement of any subsequent holder who collects the sum payable before the fulfillment of
the condition shall hold the proceeds in the meantime. If the condition finally is fulfilled, then
she can appropriate the proceeds for herself. If the condition is not fulfilled, then she has to
return the proceeds to the conditional endorser." 32

Other Rules on Endorsement

1. Endorsements of instruments payable to bearer. When an instrument payable to bearer is

endorsed specially, it may be further negotiated by delivery, but the individual endorsing
specially is liable as endorser to only such holder as make title through his endorsement.

2. Endorsement where payable to two or more persons. When an instrument

is payable to the order of two or more payees or endorsees, and who are

not partners, all must endorse unless the person endorsing has authority to

endorse for the others.

CHAPTER VIII

CENTRAL BANKING AND THE EFFECTS OF ITS MONETARY POLICIES IN OUR ECONOMY

On June 15, 1948, the Central Bank Act or the Republic Act No. 265 was approved. This Act
provides for the creation of the Central Bank of the Philippines, which finally opened its doors
to the public on January 3, 1940 The capital of the bank, as provided by the Act, shall be ten
billion pesos (P10 000, 000, 000), with the initial subscription coming from the liquidated asses
of the Exchange Standard Fund.

The Central Bank is responsible for administering the monetary, banking and credit system of
the Republic. Therefore the bank should have achieved the following objectives:

1. Primarily to maintain internal and external monetary stability in the Philippines.

2. To preserve the international value of the peso and the convertibility the peso into other
freely convertible currencies;

of

3. To foster monetary, credit and exchange conditions conducive to a balanced and

sustainable growth of the economy: and

4. To maintain price stability in the economy.

The Old Monetary Board

The policy-making body of the Central Bank is the Monetary Board. which is composed of
seven members. The Chairman of the Board is also the Governor of the Central Bank. The
other members are: the Secretary of Finance, the Director General of the National Economic
Development Authority (NEDA), the Chairman of the Board of Investments, the Secretary of
Budget and Management, and two appointed representatives from the private sector. The
Chairman of the Old Monetary Board has a term of six years while the representatives from
the private sector have four years.

The person to be appointed to the Board must be a person of good moral character and of
unquestionable integrity and responsibility. He must also be competent in economics, banking,
finance, commerce, agriculture or industry All members of the Monetary Board must be
natural born Filipino citizens.
The New Central Bank

Republic Act 7653 is known as the New Central Bank Act. Section I of RA 7653 states that the
state shall maintain a Central Monetary Authority (CMA) that shall function and operate as an
independent body in the discharge of its mandated responsibilities concerning money,
banking, and credit. This established independent Central Monetary Authority shall be a
corporate body known as the Bangko Sentral ng Pilipinas hereafter referred to as the Bangko
Sentral.

The Bangko Sentral shall be capitalized at fifty billion pesos (P50. 000.000.000) to be fully
subscribed by the Government of the Republic of the Philippines. Ten billion of which shall be
fully paid for by the Government upon effectivity of this Act and the balance to be paid for
within a period of two (2) years from the effectivity of this Act in such manner and form as the
Secretary of Finance and the Secretary of Budget and Management may thereafter determine.

The Bangko Sentral shall provide policy directions in areas of money. banking and credit. It
shall have supervision over the operations of banks and exercise such regulatory powers as
provided in this Act and other pertinent laws over the operations of finance companies and
non-bank financial institutions performing quasi-banking functions, hereafter referred to as
quasi banks.

Composition of the New Monetary Board of Bangko Sentral

The powers and functions of the Bangko Sentral shall be exercised by the Bangko Sentral
Board composed of seven (7) members appointed by the President of the Philippines for a
term of six (6) years. The seven members are

(1) The Governor of the Bangko Sentral who shall be the Chairman of the Monetary Board.
The Governor of the Bangko Sentral shall be head of a department and his appointment shall
be subject to confirmation by the Commission on Appointments. Whenever the Governor is
unable to attend a meeting of the Board, he shall designate a Deputy Governor to act as an
alternate provided that in such event, the Monetary Board shall designate one of its members
as Acting Chairman.

(2) A member of the Cabinet is to be designated by the President of the Philippines.

Whenever the designated Cabinet Member is unable to attend a meeting of the Board, he
shall designate an Undersecretary in his Department to attend as his alternate.

(3) Five (5) members who shall come from the private sector, all of whom shall serve full-time.
Qualifications of the Monetary Board

The members of the Monetary Board must be natural born citizens of the Philippines at least
thirty five (35) years of age, with exception of the Governor who shall at least be forty (40)
years of age, of good moral character, of unquestionable integrity, of known probity and
patriotism, and with recognized competence in social and economic disciplines.

Bangko Sentral ng Pilipinas as Bank of Issue

The Bangko Sentral is the only bank authorized to manufacture and issue money. As the bank
of issue, it has the monopoly of note issue. Thus, anyone who makes money without the
authority given by the Bangko Sentral is guilty of counterfeiting.

Counterfeiting is the manufacture of money without due authority This

offense is a criminal offense and is therefore punishable by law.
Bangko Sentral as Lender of Last Resort

ln case banks need funds for lending to their clients, they may avail of the rediscount facilities
of the Central Bank. Through the rediscount window of the Central Bank, banks may borrow
funds by using their notes and having them rediscounted.

The Bangko Sentral charges interest on money lent to borrowing banks. When banks are
distressed, the Bangko Sentral comes to their rescue by lending to them extraordinary loans so
as to prevent banks from losing the confidence of the general public.

Domestic Monetary Stabilization

Actions when abnormal movements occur in the monetary aggregates, credit, or price level.
Whenever abnormal movements in the monetary aggregates, in credit, or in prices endanger
the stability of the Philippine economy or important sectors thereof, the Monetary Board
shall:

(a) Take such remedial measures as are appropriate and within the powers granted to the
Monetary Board and the Bangko Sentral under the provisions of Article 1, Chapter III, Section
63, of the New Central Bank Act (Republic Act 7653); and

(b) Submit to the President of the Philippines and the Congress, and make

public, a detailed report which shall include, as a minimum, a description and analysis of

(1) The causes of the rise and fall of the monetary aggregates, of credit of prices;
(2) The extent to which the changes in the monetary aggregates, in credit, or in prices have
been reflected in changes in the level of domestic output, employment, wages and economic
activity in general, and the nature and significance of any such changes; and
(3) The measures, which the Monetary Board has taken, and the other monetary, fiscal or
administrative measures, which it recommends to be adopted.

Whenever the monetary aggregates, or the level of credit increases or decreases by more than
fifteen percent (15%), or the cost of living index increases by more than ten percent (10%), in
relation to the level existing at the end of the corresponding month of the preceding year, or
even though any of these quantitative guidelines have not been reached when in its
judgement the circumstances so warrant, the Monetary Board shall submit reports mentioned
in this section and shall state therein whether, in the opinion of the Board, said changes in the
monetary aggregates, credit or cost of living represent a threat to the stability of the Philippine
economy or of important sectors thereof.

The Monetary Board shall continue to submit periodic reports to the President of the
Philippines and to Congress until it considers that the monetary, credit or price disturbances
have disappeared or have been adequately controlled.

Instruments of Central Bank Actions

In order to maintain monetary stability within and out of the country, the Bangko Sentral
endeavors to control the expansion or contraction of the money supply, the level of credit, or
any rise or fall in prices. Monetary authorities are empowered to institute a number of devices
for purposes of proper regulations of the volume of money supply.

The devices may be as follows:

(1) Control of legal reserve requirement

(2) Control of discount and rediscount rates

(3) Open market operation

(4) Control of collateral's required

(5) Imposition of portfolio ceiling

(6) Minimum capital ratio

(7) Margin requirements for L/C

(8) Moral suasion

Some of these devices may be needed to induce expansion or contraction of money supply.
However, certain devices may only be applied to induce decrease in money supply such as the
imposition of portfolio ceiling and minimum capital ratio, and the control of maturities of bank
loans.

It is also noteworthy that most of these devices are directed toward the operation of the
banking system and is the biggest source of the expansion of money supply. As noted,
commercial banks can increase money supply. through their lending operation such that when
there is a need to decrease it. the institution of these monetary devices are intended to
decrease the lending operation of banks. Likewise, if there is a need to increase money supply,
the devices are intended to encourage the banks lending operation.

Legal Bank Reserve Requirements.

Legal bank reserve refers to that portion of the bank's deposit liability that cannot be available
for lending. Instead, it will have to be set aside as a reserve in the Bangko Sentral, vaults of the
bank or temporarily invested in government securities to meet the withdrawal needs of the
depositors. The control of the percentage of the bank reserve is a powerful and effective
instrument that the Bangko Sentral may use in order to effect an expansion or contraction of
money supply.
During inflation, the objective of the Bangko Sentral is to decrease the volume of money
supply. In order to do this, it will increase the percentage of the legal reserve required on
banks. This action will give an effect of reducing the loanable funds of the banks because they
will have to set aside a bigger portion of their deposit liabilities as reserve to meet depositors'
withdrawals. Furthermore, this action decreases credit expansion.

During deflation, when money supply is insufficient, the percentage of legal bank reserve is
decreased to induce greater credit expansion. When the percentage of legal bank reserve is
decreased, the effect is an increase in investible funds, which may induce greater lending
operations and consequently, higher credit expansion.

Purposes of Imposing Legal Bank Reserve

1. As a monetary device for credit expansion and contraction

2. To protect the interest of depositors by not allowing the bank to use all the deposits for
lending operations

3. The pool of legal reserve may be used by the Bangko Sentral to help banks in financial
distress.
4. The pool of legal bank reserve deposits may also be used by banks in their "inter-bank call
loan system". This system is one whereby, a bank with deficiency in its bank reserve deposits
could borrow from a bank with excess reserve deposits. The lending bank imposes a
percentage of interest.

5. The pool of bank reserve deposits is also utilized in the settlement of bank claims and
counter claims against each other arising from the operation of checking account system
where the Bangko Sentral acts as the

clearinghouse.
In order to control the volume of money created by the credit operations of the banking
system, all banks operating in the Philippines shall be required to maintain reserves against
their deposit liabilities: Provided, that the Monetary Board may, at its discretion, also require
all banks and/or quasi banks to maintain reserves against funds held in trust and liabilities for
deposit substitutes as defined in this Act. The required reserves of each bank shall be
proportional to the volume of its deposit liabilities and shall ordinarily take the form of a
deposit in the Bangko Sentral Reserve requirements shall be applied to all banks of the same
category uniformly and without discrimination.

Laws Covering Legal Bank Reserves (RA 7653, Sec. 96 to Sec. 102)

Required reserves against peso deposit: The Monetary Board may fix and, when it deems
necessary, alter the minimum reserve ratio to peso deposits, as well as deposit substitutes,
which each bank and/or quasi-bank may maintain, and such ratio shall be applied uniformly to
all banks of the same category as well as to quasi-banks.

Required reserves against foreign currency deposit: The Monetary Board is similarly
authorized to prescribe and modify the minimum reserve ratios applicable to deposits
denominated in foreign currencies.

Required reserves against unused balances of overdraft line: In order to facilitate Bangko
Sentral's control over the volume of bank credits, the Monetary Board may established
minimum reserve requirements for unused balances of overdraft lines.

The powers of the Monetary Board to prescribe and modify reserve requiretnents against
unused balances of overdraft lines shall be the same as its powers with respect to reserve
requirements against demand deposits.

Increase in reserve requirements: Whenever in the opinion of the Monetary Board it becomes
necessary to increase reserve requirements against existing liabilities, the increase shall be
made in a gradual manner and shall not exceed four percentage points in any thirty-day
period. Banks and other affected financial institutions shall be notified reasonably in advance
of the date on which such increases are to become effective.
Computation on Reserves: The reserve position of each bank or quasi bank shall be calculated
daily on the basis of the amount, at the close of the business day of the institution's reserves
and the amount of its liability accounts against which reserves are required to be maintained:
Provided, that with reference to holidays or non-banking days, the reserve position as
calculated at the close of the business day immediately preceding such holidays or non-
banking days shall apply on such days. or quasi bank, its principal office in the Philippines and
all its branches and agencies located therein shall be considered a single unit.

Reserve deficiencies: Whenever the reserve position of any bank or quasi-bank, computed in
the manner specified in the preceding section of this Act, is below the required minimum, the
bank or quasi-bank shall pay the Bangko Sentral one-tenth of one percent (1/10 of 1%) per day
on the amount of deficiency or the prevailing ninety-day treasury bill rate plus three
percentage points, whichever is higher: Provided, however, that banks or quasi-banks shall
ordinarily be permitted to offset any reserve deficiency occurring on one or more days of the
week with any excess reserves which they may hold on other days of the same week and shall
be required to pay the penalty only on the average daily deficiency during the week. In cases
of abuse, the Monetary Board may deny any bank or quasi-bank the privilege of offsetting
reserve deficiencies in the aforesaid manner.

If a bank or quasi-bank chronically has a reserve deficiency, the Monetary Board may limit or
prohibit the making of new loans or investments by the institution and may require that part
or all of the net profits of the institution be assigned to surplus.

The Monetary Board may modify or set aside the reserve deficiency penalties provided in this
section, for part or the entire period of a strike or lockout affecting a bank or a quasi-bank as
defined in the Labor Code, or of a national emergency affecting operations of banks or quasi-
banks. The Monetary Board may also modify or set aside reserved deficiency penalties for the
rehabilitation program of a bank.

Inter-bank Settlement: The Bangko Sentral shall establish facilities for inter-bank clearing
under such rules and regulations as the Monetary Board may prescribe: Provided, that the
Bangko Sentral may charge administrative and other fees for the maintenance of such
facilities.
The deposit reserves maintained by the banks in the Bangko Sentral in accordance with the
provisions of Section 94 of this Act shall serve as basis for clearing of checks and the
settlement of inter-bank balances,
such rules and regulations as the Monetary Board may issue with such respect to such
operations: Provided, that any bank which incurs over-drawings in its deposit account with the
Bangko Sentral shall fully cover said overdraft, including interest thereon at a rate equivalent
to one-tenth of one percent (1/10 of 1%) per day or the prevailing ninety-one-day treasury bill
rate plus three percentage points, whichever is higher, not later than the next clearing day:
Provided, further, that settlement of clearing balances shall not be affected for any account
which continues to be overdrawn for five (5) consecutive banking days until such time as the
overdrawing is fully covered or otherwise converted into an emergency loan or advance
pursuant to the provisions of Section 84 of this Act: Provided, finally, that the appropriate
clearing office shall be officially notified of banks with overdrawn balances. Banks with existing
overdrafts with the Bangko Sentral as to the effectivity of this Act shall, within such period as
maybe prescribed by the Monetary Board, either convert the overdraft into an emergency
loan or advance with a plan of payment, or settle such overdrafts, and that, upon failure to so
comply herewith, the Bangko Sentral shall take such action against the bank as may be
warranted under this Act.
Interest and Rediscount Rates (RA 7653 Sec. 85)

The Bangko Sentral shall collect interest and other appropriate charges all loans and advances
it extends, the closure, receivership or liquidation of the debtor-institution notwithstanding.
On

The Monetary Board shall fix the interest and rediscount rates to be charged by the Bangko
Sentral on its credit operations in accordance with the character and term of the operation,
but after due consideration has been given to the credit needs of the market, the composition
of the Bangko Sentral’s portfolio, and the general requirements of the national monetary
policy. Interest and rediscount rates shall be applied to all banks of the same category
uniformly and without discrimination.
Open Market Operation in Government Securities This refers to the buying and selling of
government securities by the Bangko Sentral for the purpose of credit control. Government
securities referto evidences of indebtedness of the government.
There are two purposes of government securities:

1. To raise revenue 2. To control credit

The Central Bank plays a significant role in the issue and placement of government securities.
It also maintains the security stabilization fund, which is a reserve intended to be used in the
buying and selling of government securities to stabilize the value and liquidity of such
government securities.

During inflation, the Central Bank will undertake the following remedies:
2 Sell to the public government securities to absorb excess cash holdings

and to

b. Sell to the banking institutions government securities, so as to divert investment in loans to

investment in securities. The effects are: a decrease in available funds for loans, a decrease in
lending operations for banks, and a decrease in credit expansion.

During deflation the sale of government securities to the banks decreases money supply by
the amount it would have increased if the funds have been used by the banks in their lending
operation where they undergo a multiplier effect
Purchases and Sales of Government Securities (RA 7653 Sec. 91)

In order to achieve the monetary policy, the Bangko Sentral may in accordance with the
principle stated in Section 90 of RA 7653 and which such rules and regulations as may be
prescribed by the Monetary Board, buy and sell in the open market for its own account:

(a) Evidences of indebtedness issued directly by the Government of the Philippines or by its
political subdivisions: and
(b) Evidences of indebtedness issued by government instrumentalities and

fully guaranteed by the Government.

The evidences of indebtedness acquired under the provisions of this section must be freely
negotiable and regularly serviced and must be available to the general public through banking
institutions and local overnment treasuries in denominations of a thousand pesos or more.

Issue and Negotiation of Bangko Sentral Obligations (RA 7653 Sec. 92)

In order to provide the Bangko Sentral with effective instruments for open market operations,
the Bangko Sentral may, subject to such rules and regulations as the Monetary Board may
prescribe and in accordance with the principles stated in Section 90 of RA 7653, issue, place,
buy and sell freely negotiable evidences of indebtedness of the Bangko Sentral: Provided. That
issuance of such certificates of indebtedness shall be made only in cases of extraordinary
movement in price levels. Said evidences of indebtedness may be issued directly against the
international reserve of the Bangko Sentral or against the securities which it has acquired
under the provisions of Section 91. RA 7653, or may be issued without relation to specific
types of assets of the Bangko Sentral.

The Monetary Board shall determine the interest rates, maturities and other characteristics of
said obligations of the Bangko Sentral, and may, if it deems it advisable, denominate the
obligations in gold or foreign currencies.

Subject to the principles stated in Section 90 of RA 7653, the evidences of indebtedness of the
Bangko Sentral to which this section refers may be acquired by the Bangko Sentral before their
maturity, either through purchases in the open market or through redemptions at par and by
lot if the Bangko Sentral has reserved the right to make such redemptions. The evidences of
indebtedness acquired or redeemed by the Bangko Sentral shall not be included among its
assets, and shall be immediately retired and cancelled.
Control of the Collaterals Required on Bank Loans

The Bangko Sentral has the power to impose conditions or requirements

on the securities against the loans extended by the bank. This in effect increases the loan value
of the collateral. During inflation, the Bangko Sentral may increase collaterals required on
loans, which in effect decreases the loan value of the collaterals. This may discourage public
borrowings from the banks, decrease lending operation of

the banks, and decrease credit expansion.

During deflation, the Bangko Sentral may decrease collaterals, which may be an incentive to
borrowers.

Required Security against Bank Loans (RA 7653 Sec. 106)

In order to promote liquidity and solvency of the banking system, the Monetary Board may
issue such regulations as it may deem necessary with respect to the maximum permissible
maturities of the loans and investments which the banks may make, and the kind and amount
of security to be-required against the various types of credit operations of the banks.

Imposition of Portfolio Ceiling

This refers to the upper limit that the Bangko Sentral may place on the loans and investment
of banks. It is instituted only during inflation. It is a direct limitation on the volume of loans,
and investments that banks may extend. Such restrictions may not be instituted during
deflation. To do this, the Bangko Sentral sets a date and whatever is the total amount of loans
and investment the bank has on that date is its limit.

Portfolio Ceilings (RA 7653 Sec. 107)

Whenever the Monetary Board considers it advisable to prevent or check an expansion of
bank credit, the Board may place an upper limit on the amount of loans and investments
which banks may hold, or may place a limit on the rate of increase of such assets within
specified periods of time. The Monetary Board may apply such limits to the loans and
investments of each bank or to specific categories thereof.

In no case shall the Monetary Board establish limits, which are below the value of the loans or
investments of the banks on the date on which they are notified of such restrictions. The
restrictions shall be applied to all banks uniformly and without discrimination.
Minimum Capital Ratio

It is the maximum ratio that the combined capital account of surplus may bear on the banks’
corporate assets. The Bangko Sentral requires 10% of the risk assets of a bank as its minimum
capital. Thus, total assets minus non-risk assets equals risk assets.

Section 108 of RA 7653 states that the Monetary Board may prescribe the minimum ratios,
which the capital and surplus of the banks must bear to the volume of their assets, or to
specific categories thereof, and may alter, said ratios whenever it deems it necessary.

Margin Requirements against Letters of Credit (RA 7653 Sec. 105)

The Monetary Board may at any time prescribe minimum cash margins for the opening of
letters of credit, and may relate the size of the required margin to the nature of the
transactions to be financed.

Moral Suasion
This is more of a psychological approach in which the Bangko Sentral may use its persuasive
power to make the banks follow or support credit policies without direct imposition of
restrictions. There are cases when the Bangko Sentral shies away from imposition of credit
restrictions because of possible unfavorable repercussions such that, the Bangko Sentral may
just use their influence among banks for voluntary support of a credit policy. For instance,
during the imposition of free floating exchange rate in 1970, the Central Bank was able to
avoid buying and selling of US S at very high speculative rates. The banks agreed among
themselves to limit their trading in foreign transactions to an agreed foreign exchange rate.

Other Monetary Policies to Stabilize Banking Operations

1. Bangko Sentral may fix maturities in bank loans for the purpose of credit control or as a
means of payment.

2. Bangko Sentral may also fix the maximum interest that the bank may pay on deposit
substitutes for the purpose of preventing competition among banks in attracting depositors. 3.
Bangko Sentral may establish priorities for bank loans especially with

respect to funds, which has been borrowed from the Bangko Sentral.

4. Bangko Sentral makes periodic examination of the banks' accounting records and requires
banks to submit their financial statement at the end of every quarter.

5. Bangko Sentral looks into the character and integrity of the bank's incorporators and
members of the board as well as the top ranking executives of the banks.
Bangko Sentral as a Fiscal Agent

As a fiscal agent of the government, the Bangko Sentral has the following functions:

1. To be the official representative of the government to financial entities;

2. To be the depository banker of the government; 3. To be the financial adviser of the

government; and
4. To manage public debts

CHAPTER IX

COMMERCIAL BANK MANAGEMENT

Banks are managed by the Board of Directors and the set of officers of the bank. The Board of
Directors is the policy formulating body and the set of officers is the policy implementing body.

The Stockholders elect the Board of Directors by virtue of their right to vote. The Board of
Directors elect from among themselves the Chairman of the Board, the President, Vice
presidents, the Secretary. Treasurer, Comptroller and the Senior and Junior officers of the
bank.

DUTIES AND RESPONSIBILITIES OF THE STOCKHOLDERS

1. Amending the by-laws

2. Ammending the Articles of Incorporation

3. Increasing and decreasing the Authorized Capital Stock in the bank

4. Approving the minutes of the previous annual or special meeting of stockholders

5. Examining and approving or disapproving the operations of the bank for the year ending, as
disclosed through the annual report, books of account and other records submitted for their
attention

6. Approving the tentative budget for the ensuing year as presented by the president
7. Electing the Board of Directors

8. Delegating to the board of directors the authority to distribute earnings as dividends, as

circumstances may dictate.

Stockholders hold their meeting once a year but the stockholders meetings may also be called
at any other time of the year on (a number of days) notice provided that it is so ordered by a
majority of the Board of Directors or solicited by stockholders representing one third of the
outstanding stocks. In calling for such meeting, notice shall be given to each stockholder by the
secretary at least (number) days prior to the date set for the meeting
BOARD OF DIRECTORS

The Board of Directors is responsible to the stockholders for the management of the bank.
Because of the scope of responsibilities and details of management involved, they usually
delegate some of their responsibilities to committees:

DUTIES OF THE BOARD OF DIRECTORS OF THE BANK

1. Elects one of their members as Chairman of the Board and delegates to him the
responsibility of presiding at the meetings of the Board of Directors, the annual meetings of
stockholders, and acting as the liaison officer between the stockholders and the Board of
Directors

2. Elects the President and Chief Executive officer of the bank

3. Elects the heads of the various committees appointed by them

4. Elects an Executive Secretary who has the responsibility of maintaining all corporate records
of the bank, the corporate seal, and for recording all actions taken by the Board of Directors
and Executive Committee; takes down the minutes of the meeting for both the board of
directors and the stockholders meetings
5. Appoints upon the recommendation of the Chairman and President, senior or junior
officers, to whom are delegated the responsibility of supervising certain operating and
financial functions of the bank

6. Approves the compensation to be paid to the various officers and

employees of the bank

7. Approves the general assignment of duties and responsibilities of each officer as submitted
by the Chairman and the President 8. Determines, approves and sets forth, for the guidance of
all officers, the

loaning limitations of each administrative officer 9. Approves the amount of surety bonds to
be carried on each officer and

employee of the bank

10. Determines the loan and investment policy the bank set forth for the guidance of
administrative officers, the percentage and amount of the time and demand deposits and the
capital funds which should be invested in the various types of loans and investments

11. Approves and decides on all matters involving changes in the Capital Account and the
distribution of earnings or dividends in lieu of the authority granted by the stockholders
12. Authorizes the maintenance of correspondent bank accounts and all borrowing
arrangements with other banks 13. Approves all loans made to directors, officers, stockholders
and their

related interest as to amount and security as approved by the central bank 14. Reviews,
approves or disapproves the action of the various committees in
carrying out their respective functions and responsibilities

15. Appoints an Auditor, defines his duties and responsibilities, the scope of

the audit routine, and the manner in which he is to report the result of his

work to the Board of Directors

16. Formulates policies of the bank

COMMITTEES APPOINTED BY THE BOARD OF DIRECTORS

Since the Board of Directors has full responsibility and complete authority to decide on
matters pertaining to the bank. it usually delegates certain functional authority and
responsibility to the officers and committees. The committees assist the Board of Directors in
their functions. The committees created are the Executive Committee sometimes called the
Administrative Committee. Loans and Discount Committee, Investment Committee, Trust
Committee, and Examination Committee.

Executive Committee

The Executive Committee deals with Administrative matters. It acts as the advisory body to the
board in matters pertaining to the managerial conduct of the business such as:

1. Hiring of executive officers and determining their remunerations

2. Removal of such officers as may be deemed necessary by the committee

3. Discussing and reviewing any general matter pertaining to administration of the affairs of
the bank

4. Discussing, reviewing and making recommendations for the adoption or rejection of the
major changes in the operating routines and procedures of the bank

5. Identifying the problems in their area of responsibility and find solutions to the problems
Vice President

The Board of Directors assigns several vice presidents in accordance with the needs of the
bank. The executive vice president, who is sometimes called Vice President or Senior Vice
President. assists the President and acts in behalf of the president when the latter is absent

The Administrative Vice President is the coordinating officer of the bank and the liaison
between the president and all other officers. The Administrative Vice President sees to it that
the various departments and divisions of the bank are properly coordinated in their activities.

The general policies as set forth by the Board of Directors are

communicated to and followed by the administrative personnel.

The action taken by the administrative personnel should be in accordance

with policies established by the Board of Directors. The other Vice Presidents head the various
departments of the bank and report to the President through the administrative vice
president, any problem

arising from the department.

Assistant Vice Presidents

These are officers designated to assist the Vice Presidents in their functions. They are at times
delegated responsibilities, by the Board of Directors in connection with the various divisions,
sections, or offices of the bank.

Executive Secretary

The Secretary is the chief recording officer of the bank. His duties are:

1. Maintains all corporate records;

2. The custodian of the corporate seal which represents the legal authority of the bank;

3. Taking minutes of the meetings in both Board of Directors and Stockholders meetings;

4. Maintaining a complete and current list of stockholders and their

addresses;

5. Preparing the agenda for the meeting for both the Board of Directors and the Stockholders;

6. Notifying the Board of Directors or the Stockholders of the date and venue of the meeting.
DUTIES AND RESPOSPONSIBILITIES OF THE OFFICERS OF THE BANK

Chairman of the Board

1. Presides on all meetings of the Board of Directors, Executive Committee and the
Stockholders;

2. Sees to it that the stockholders are informed at all times on affairs of the bank which
concerns their interest:

3. Maintains together with the President liaison between the stockholders

and the Board of Directors:

4. Maintains together with the President liaison between the Board of Directors and the
various committees.

President

The president is the Chief Executive Officer of the bank. He is held responsible by the Board of
Directors for the active management of the bank. In small banks, the Chairman of the Board
and the President are one and the same, but in big banks two different individuals hold the
position of the Chairman of the Board and the President.

The duties of the President are as follows:

1. Presides at all meetings of the Board of Directors and the various committees if the
Chairman of the Board is absent;

2. Sees to it that all actions taken by the committees and decisions made by the officers and
administrative personnel are in conformity with the established bank policy:

3. Supervises the business and financial affairs of the bank;

4. Jointly signs with the cashier all checks or all financial documents in behalf of the bank;

5. To seat as a member of the board if he is not at the same time the Chairman of the Board
during board meetings, since he is in the best position to advise the board:

6. Carries out all responsibilities assigned or delegated from time to time by the Board of
Directors;

7. Implements the policies formulated by the Board of Directors.

Cashier

The Cashier is the chief financial officer of the bank and is elected to the law by the Board of
Directors of the bank. The cashier takes

Comptroller

Comptroller are the following:

care of all corporate funds, such as cash and negotiable instruments. The Comptroller is the
chief control officer of the bank. The duties of the accordingly.

1. Supervises the general accounting of the bank and prepares reports for the supervisory
agencies, management and others, which are conducting the affairs of the bank;

2. Approves all purchases of the office supplies, furniture and equipment forthe bank:

3. Directs the preparation of budget on income and expenses and other statistical information
required by the Board of Directors, the President, or the Administrative Vice President.
Auditor

The Auditor undertakes a periodic examination of the bank in accordance with the established
standards as approved by the Board of Directors. The Auditor is directly responsible to the
Board of Directors and therefore reports
to them the result of the examination.

VARIOUS DEPARTMENTS OF THE BANK

1. Cash department takes charge of all deposits and withdrawals in the bank

2. Credit Department in charge of all loans, discounts and collection of transactions entered
into by the bank

3. Foreign/International Department takes charge of all transactions regarding importation

and exportation of goods through letters of credit, drafts, and money orders; it is also in
charge of fund transfer from one country to another

4. Trust Department - takes charge of funds, properties, and securities entrusted to the bank
for management in behalf of a third party
5. Investment Department - takes charge of the investment portfolio of the bank
6. Money Market Department - takes charge of buying and selling securities such as stocks
and bonds including commercial papers for both the government and the private sectors to
the public

7. Branch Department - is in charge of managing all the branches and extension offices of the
bank 8. Human Resource and Development Department (HRD) — in charge of hiring, training,
assigning personnel to the various departments and branches of the bank, assessing their
performance and recommending their promotion or dismissal from the bank
9. Legal Department - takes charge of all legal matters regarding bank operation

10. General Services Department in charge of repair maintenance andsecurity of the bank

11. Administrative Department in charge of running the affairs of the bank

12. Accounting Department - takes charge of recording all transactions of the bank in
chronological order as the transaction took place. including the preparation of the balance
sheet. income statement and the budget of the bank

CHAPTER X

OVERVIEW OF BUSINESS FINANCE

In the olden days. we learned to do business through apprenticeship. People had to work for
free just for the opportunity to be able to work in a place where they can get the proper
experience of doing things. After working for several months or even years, the owner of the
firm or shop where the person worked would certify that he has had several months or years
of actual experience with him. Today, business ability is acquired through classroom
instructions and the study of textbooks. It is now recognized that business ability is acquired
through the study of subjects such as organization, management of business, accounting,
finance, advertising, merchandising. purchasing. office management, personnel management
and credit management. It now requires more general and specific knowledge than can be
picked up by mere observation alone.

Occasionally there may appear some business genius whose entire knowledge could be
attuned through mere observation and actual practice but his inborn abilities could have been
better and rapidly developed through a solid foundation of organized knowledge and full
understanding of the basic principles, successful practices and governing laws.
To be able to better understand the subject of organizing and financing a
business, one must have a clear concept of what business is. thru knowing the
details of organizing, financing and managing it.

What is business?

> Businesses must be understood to embrace every economic activity, which involves money,
property and industry with the hope of making a profit. Business, for many people means
operating a shop, and a merchandising store, such as buying and selling of goods.

> Business has an economic purpose, that is the production and marketing of every possible
article and service that will help supply human wants at the most convenient and reasonable
manner at a profit. Without a properly organized business, the world today would be without
thousands of everyday commodities looked upon as the most common necessities.

The direct purpose of businessmen is to make a profit out of which to support themselves
and their dependents. Furthermore, its aim is to set aside savings for the future either for
expansion of the business or for retirement. A person may not fully realize that the better he
serves the public, the better are his chances of success and profit. This legitimate desire to
make money
impels the businessman to manage his business efficiently Incidentally, i supplying human
wants with his products, merchandise and services, dealing with cargo transport like shipping
companies, freight trucks and cargo planes the businessman also furnishes a living to various
groups of employee working for a salary, commission or profit sharing basis. Finance is an
important part of the organization of a business, yet many people think of finance as stocks
and bonds or they would think of a business tycoon making financial decisions, which will earn
his billions from his luxurious office.

For all businesses whether large or small, finance is the constant day-to day problem of
planning short term or long-term needs of the business. The financial manager must look
forward and make financial decisions, which will achieve the objectives of management.
Categories of Business

Industrial Business Industrial business is concerned with the manufacture of goods, the
physical and chemical transformation of materials into finished products, and the extraction of
minerals from the ground and of fishes from the seas. Examples of these are: mining industry,
oil industry, and fishing industry.

Commercial business - is concerned with bridging the gap between the producer and the
ultimate consumer. It deals with the distribution of goods Those dealing with retail and
wholesale trades. fall under this category. It also includes those dealing with cargo transport
like shipping companies. freight trucks and planes.

Servicing business - is concerned with the rendering of services such as restaurants, tailoring
shops, dress shops, beauty parlors, recreation center's banks, hospitals, schools, and all
professional businesses such as law offices. accounting offices, management advisory services.
dental and medical clinics

Why do people go into business?

People go into business for various reasons:

The presence of business opportunity where a person sees the possibility of making a profit

2. The availability of idle funds that could be possibly employed to cam a better income than
what it earns from the bank

3. Advancement of technology due to the birth of new inventions led by amazing discoveries
4. To raise ones standard of living 5. To create employment for others

6. Opportunity created by the bi-product of ones existing business instead of going into waste
7 To make ones presence felt in various industries 8 For power as well as for social and
business prestige

• Challenges brought about by competition among businessmen We can mention some of the
businessmen who have diversified their business: John Gokongwei, who owns Robinson
Galleria, Asia Brewery, Asia Pacific Airlines, some real estate properties at Fort Bonifacio,
Henry Sy, who owns Shoe Mart Department Store, Cebu Pacific, real estate properties at
Asean Boulevard, and banks; Lucio Tan, who owns Latondena Distelleria Inc., Philippine
Airlines, University of the East etc., to mention a few.

Factors necessary for a successful business venture:

1. There should be enough capital resources to easily meet increase in product demand.

2. It is also important for a business to have an efficient management. The success of a

business is reliant on the ability of management to run the business efficiently. Many
businesses hire professional executives to run their business and they are willing to pay a large
sum of money just to entice professional executives to work for them.

3. The business must be able to create a demand for their product therefore this requires an
adequate market analysis.

4. There should be an effective advertisement of the product.

Two important functions of business are production and marketing. Production goes hand in
hand with marketing. The proper combination of these two functions are dependent upon the
intelligent operation of assisting functions, which are though subordinate in scope, but are
indispensable to the proper development of the two essential functions. Among the assisting
functions are organizing, financing, purchasing, advertising, accounting, office management,
inventory management, transportation management, factory and store management and
many other activities.

Organizing the business would mean the formation of the enterprise. This would include the
selection of the form of business organization to be adopted. This would involve legal matters.
Financing constitutes the primary requirement in starting and operating a business. It
comprises the largest of all activities, which consist of raising funds and managing such funds.
The word funds would refer to anything that could be used in business, which consists of
money, credit instruments such as promissory notes, drafts, checks, or goods that can be
available on credit including receivables available for collection. Funds may also consist of one
or all of the following: cash, marketable securities, working capital, net current assets and all
other financial resources. Business today, are largely conducted on credit basis.
Credit money is a credit instrument that is widely acceptable in payment for goods and
services in the settlement of existing debts and obligations. Personal credit refers to a credit
obtained for personal purposes.

Mercantile credit or Commercial credit is a credit given by a businessman to another

businessman for further processing or for re-sale. This credit is given by a manufacturer of a
raw material to a manufacturer of a finished or a semi-finished product. It could also be given
by a manufacturer to a wholesaler and a wholesaler to a retailer. These are goods sold on
credit which we sometimes call merchandise credit.

Secured credit is a credit evidenced by a document, which can enforce the credit obligation.
Unsecured credit is given only on the basis of the character and integrity of the buyer.

According to Laurence Gitman in his book Principles of Managerial Finance, he defines finance
as the art and science of managing money. Money is earned, made productive and spent
through business. investments and other transactions between individuals, businessmen and
or the government. Finance involves analyzing how money can be employed on thoroughly
evaluated proposed projects or productive undertakings that will provide desirable return to
the firm. The process calls for a sound decision-making and precision in allocating funds, which
can be best performed by a financial manager. Through this, finance provides a structure that
defines the processes, procedures, institutions, markets involved and the instruments used in
those transactions.
Managerial Finance is concerned with the financial manager's duties in the business. The
finance manager is actively involved with the proper management of the financial affairs of
varied businesses. Such businesses may be financial or non-financial in nature. They may be
profit or non-profit organizations and public or privately owned. Financial managers do varied
tasks such as cash management, credit administration, planning, assessing proposals,
budgeting, forecasting, investment analysis, and procurement of funds. Many of the top
executives come from the area of finance, since changing economic conditions and regulatory
environment have increased in importance in recent years.

The recent trend, requiring businesses to go global increases the need for financial managers
to help firms in competing with each other and other countries. The role of the financial
manager becomes more challenging as the risk becomes more intense. This results from
international transactions such as ensuring cash inflows, regulating cash outflows and the risk
of handling foreign exchange.
Finance can be summarized by reviewing the career opportunities in finance. This would be
financial services and managerial services. Financial service is concerned with the design and
delivery of advice and financial products to individuals, businesses and the government.
Today, it is one of the fastest growing areas of career opportunities in our country.

Career opportunities can be divided into two broad categories: Financial services and
managerial finance.

Financial service is the area of finance concerned with the design and the delivery of advice
and financial products to individuals, businesses and the government. It includes personal
financial planning, investments, insurance, banking institution, credit institutions, and related
institutions.

Career opportunities:

1. Personal Financial Planning - Career opportunities for personal financial planning has
increased tremendously in recent years because of new investment trends, changing
regulatory environment and complicated tax laws. Individuals who can provide sound advices
regarding the management of personal financial affairs are much in demand nowadays. There
is a great demand for these types of individuals in financial institutions, insurance companies,
consulting firms, and brokerage firms.

2. In the field of Investments - Trained individuals in financial services can work as investment
specialists, securities analysts in insurance companies, in brokerage firms and other financial
institutions. Investment specialists do the analysis of securities, develop marketing security
offerings, and construct portfolios that are geared towards the customer's needs. Corporate
and government issuers have a great need for their services.

3. Insurance companies and real estate companies - Individuals who are well trained in
finance are usually hired by insurance companies to help them manage their investment
portfolios. They hire insurance specialist such as sales agents, underwriter, and statisticians.
The real estate companies on the other hand, hires real estate brokers, appraisers, real estate
developers and mortgage bankers, to assist them in their real estate business.

4. Banking Institutions- Individuals trained in financial services are much in demand in

commercial banks, thrift banks, savings and loan Associations, mutual savings banks, financial
companies, credit unions and savings and loan associations. They may be loan officers
handling commercial loans, consumer loans, installment loans and real estate loans. They may
also be trust officers who manage the trust funds of estates, business firms and foundations.
Banking institutions are now offering various services for personal financial planning to real
estate firms, insurance firms, and even brokerage firms. Other examples of available
opportunities in banks are tellers, credit investigators, credit analysts, loan hookkeepers,
checking account bookkeepers, savings account Sookkeepers and credit card bookkeepers,
accountants, loan officers, assistant managers, and managers just to name some

Financial services include banking and credit institutions, investment, personal finance
planning, insurance and real estate.

Managerial finance is concerned with the duties and responsibilities of the financial manager
of a business concern. The financial manager is responsible for managing the financial affairs
of the business. Such businesses may be financial or non-financial in nature. They may be
profit or non-profit organizations and public or privately owned. They do various tasks such as
cash management, credit administration, investment analysis, the procurement of funds,
budgeting and financial forecasting. In recent years the importance of finance managers in
business has been increasingly in demand. Actually many of the high caliber executives in
business and industry including the government come from the area of finance.

The finance manager has a key role in running the business. For all areas in business he has a
born responsibility to understand the managerial finance function. These areas are accounting,
marketing, personnel. operation research, manufacturing, advertising, procurement of funds,
investment of idle funds, etc.

The financial manager places emphasis on cash flows, the inflow and out flow of funds. He
maintains the solvency of the firm by analyzing the cash flows necessary to pay current
obligations, and to acquire assets needed to achieve the firm's goals. The financial manager
uses the cash method to recognize the revenues and expenses only with respect to actual
inflows and outflows of cash.

Relationship of finance and economics

It is important that every financial manager must understand the economic framework of the
country since every business. operates within that framework. They must be ready to see the
consequences of the varying levels of economic activity such as changes of economic policies
and conditions in relation to their business. They must be able to use the economic theories
for efficient and eventually successful business operation. They must be able to understand
the theory of demand and supply, the price theory, and the profit maximizing strategies. They
must be able to correlate the economic environment and the decision techniques of
managerial finance. It is therefore very important that the finance manager should be
knowledgeable of the basic theories in economics.
Relationship of Finance to Accounting

Finance is also related to accounting in that the firm's accounting department or office that is
headed by a controller and the treasury department is under the control of the vice president
for finance. These functions are in one way or another interrelated and at times it is hard to
distinguish one from the other: In small corporations or firms, the accountants/controller does
the finance function while in large corporations or firms, the accountants are involved in
various finance activities. There are two basic differences between accounting and finance.
Accounting is related to funds recognition while finance is related to decision-making

1. Funds recognition - For methods of fund's recognition, the accountant's principal function is
to gather data and provide such data for measuring the performance of the firm, assessing its
financial position, investing funds not in use for the near future, as well as paying necessary
taxes. He uses the accrual method of preparing the financial statement that recognizes
revenue at the point of sale and expenses when incurred. They use certain standardized and
Generally Accepted Accounting Principles (GAAP) to do this.

The finance manager places primary emphasis on cash flows, its inflow and out flow. He
maintains the firm's solvency by analyzing and planning the cash inflows necessary to pay for
obligations and buy assets that are required by the firm. The finance manager uses the cash
method only to recognize the revenues and expenses with respect to actual inflows and
outflows of cash. The finance manager has for its goal the achieving of the firms objectives
that is profit and wealth maximization.

To achieve profit maximization, the financial manager performs major actions that are
expected to contribute to the firm's profitability. In considering each alternative choice the
finance manager would select an action, which he believes could obtain the highest monetary
return. Profit in a corporation is measured in terms of Earnings per Share (EPS) which
represent the total earnings available for the firm's stockholders. The firm's total ownership
divided by the common share/stocks outstanding is the earning's per share. If the managers
are successful in their endeavor they will also achieve their own financia! and personal
objectives.

The key factor that links profit and wealth maximization is risk. Risk can be used
interchangeably with uncertainty, which refers to the variability of returns associated with a
given asset. The more certain, the return from an investment is, the less risk there is. Risk is
the possibility of financial loss in a business venture. Assets having a greater chance of loss are
viewed as more risky than those with lesser chances of loss.
2. Decision Making- The second difference between the accountant and the financial manager
is decision making. While the accountant concentrates on collection and the presentation of
the data, and provides such data to the finance manager the finance manager evaluates such
data and makes decisions, after making the necessary analysis and adjustment. The
accountants' role is to provide consistently developed and easily interpreted data on the firm's
past, present and future operations. The finance manager uses these data either in raw form
or after making certain adjustments and analyses them as an important input to the decision
making process.
The Demand for Financial Managers - Companies find it harder to find high caliber financial
executives. The good ones leave their jobs for high paying executive jobs. The demand for
financial executives has helped make the chief financial executives the third highest paid
officer in many corporations. Financial officers get a greater percentage of their compensation
from performance related bonuses than most top employees.
arting a business - To start a business there are two primary decisions to make namely:

1. What type of business shall you choose? 2. What legal form of organization shall you adopt?

It could either be a sole proprietorship, a partnership or a corporation. Chapter 13 will

lengthily delve in this.

The answers to these questions are largely influenced by the prior experiences of the
prospective businessmen. The tendency of the business organization is to enter a business
field where he has some knowledge or experience. There are thousands of details of
information or tricks of business that come only through experience. In most cases it is the
experienced dressmaker who opens up a dress shop. The experienced merchandiser opens up
a trading business. Those whose parents are involved in shoe making business may also want
to put up a shoe factory in another place. It could either be a small retail store a servicing
business such as a repair shop. dress shop, or a commercial business such as merchandising,
manufacturing. transportation, utilities, banking real estate and insurance. Many simply follow
their parent's footsteps.

Of the great number of people who go into business for themselves, only a small number
estimated by various economists meet with sufficient success to enable them to remain in
business. Others fail in their attempt. Practically all of these failures can be attributed to lack of
business knowledge on the part of those concerned. Had they known enough of the business
principle, methods and practices, they could generally foresee that their business was doom to
failure even before it started. This is largely because the demand for their product is not large
enough to insure sufficient return to pay for all operating expense and interest on borrowed
capital or they failed to make a project study.

In supplying human wants or needs, the businessmen must determine in advance whether the
goods he intends to deal with or manufacture or supply are those that people want and can be
induced to buy. He must determine how much of that product is already being supplied by
others. How much share of the market can he have? If the new store could get a proportionate
share in the business but no one is making a profit, the one with the least capital or general
ability will be the first to fail. Even if there is a great demand for the product with a
considerable competition, it is highly unwise to enter business in any field with out a sound
knowledge of business principles and the business itself. It has been proven that the
knowledge could be obtained most often by experience and hard work.

Today business experience is bolstered by scholastic study with the combination of the two
that is experience and enough capital Today business experience is bolstered by scholastic
study with the combination of the two that is experience and enough capital

Promoting a business

Promotion is the painstaking performance of many preliminary activities necessary in bringing

together money. property and managerial ability to a point where the business is ready to
operate. Promotion embraces all activities including the careful investigation of the entire
proposition to determine the probability of business being profitable. It includes the
determination of the capital requirement, procurement of such capital, the selection of
qualified associates, registration of the business with the proper authorities, acquisition of the
franchise, patents, etc. when necessary and making of contracts if needed. A competent
promoter must be hired to do all these. A promoter is one who undertakes to form a business.
The promoter may be a person, an associated group of individuals or an organization whose
business is doing promotional jobs. There are three types of promoters namely: Owner
promoter, the occasional promoter and the professional promoter, which we sometime call
the institutional promoter.

The owner promoter is the owner of the business who under takes the promotional job
himself. The occasional promoter is usually a lawyer or a management consultant who is well
verse with the country's laws, rules and regulations. Usually small entrepreneurial businesses
are undertaken by owner promoters. The professional promoters or institutional promoters
are undertaken by people who do promotion as a business. They help promote businesses for
a fee. Promoters are paid in any of the following forms: 1) a fixed fee, 2) shares of stocks, 3.)
an amount which is equivalent to a percentage of the total capitalization of the business.

Promoters are paid large sum of money not for their services alone but also because of the
financial risk they take. An owner promoter may spend thousands of pesos in starting a
business only to find out that the business proposition is unsound and therefore must be
abandoned. This expenditure therefore is a total loss to him. If the promoter is paid in shares,
this will also evidence that he has confidence in the business. Although the stocks paid must
be held for some period of time before the stocks start to earn dividends it becomes attractive
as an investment to other prospective investors.

Stages of Promotion"

1. Discovery stage This is a stage where a person perceives a busines opportunity and where
the promoter analyses such business by preparing a project study or feasibility study to
determine the viability of the project. Feasibility study involves a systematic survey and
analysis of the survey and its eventual evaluation to determine if the business is viable or not.
Once the promoter believes that the business will earn a profit, he now will proceed to the
second stage, which is financing opportunity

2. Financing Stage - This is a stage where the promoter will raise the capital needed for the
business. Funds may be raised from the owners them selves, from the sale of stocks to the
incorporators and eventually to other stockholders. It could also come from borrowed money.
Financing is only undertaken when discovery stage has been accomplished. Here the promoter
devises the plan and method of raising the fund to start and carry on the business. Initial
capital will be needed for the following reasons:

a) To pay for the cost of organizing the business such as registration fee. preparation of the
contract, the forms initially needed in the business as well as the printing of the stock
certificates It also embraces expenses to be incurred during investigation of the project, the
economic justification of the project, legal requirements such as the procurement of licenses,
franchise, patent copy right, etc., bureau permit, funds to pay the promoter himself, his
associates and the staff he hires.

b) To finance the working capital needs of the business. At this point the business is already
incurring expenses such as salaries and wages, electric bills, telephone bills, water bills and all
other operating expenses.

c) To finance the actual construction of the business. For the purchase of the property such as
the building, machineries and equipment's, furniture and fixture, engineering costs, insurance
during construction, and advertisement for the sale of stocks,

d) As a margin of safety until such time as the business is self-sufficient to meet all financial
needs. It usually takes a business several months or at most two years of operation to be self-
sufficient. Once the breakeven point is reached that is the total receipts equal the total
disbursement, will the management feel relieved. While receipts fall short of expenditures
funds must be provided in advanced by the organizers.
3 Assembly Stage

This stage is undertaken when the promoter has procured enough initial capital to go into the
actual organization of the business by putting together all the necessary factors to make the
business a reality. The promoter has to assemble the following:

a) Compliance with all legal requirements b) Choose what business organization to adopt

c) Procurement of patents, franchise, etc., business permit and building contract d) The
combination of the economic factors such as capital, land, man power, natural resources,
choice of proper location and managerial competence

The actual construction of the business begins only when the entire promotion is completed
and the necessary funds have been obtained or assured in accordance with the financial plan.
Feasibility Study

Feasibility study consists of the following aspects:6

1. Management Aspect

a) Pre operating stage

b) Operating stage

2. Marketing Aspect

3. Production or Technical Aspect

a) Product or service description and specification such as the nature of the product its size,
weight, physical appearance. chemical properties mechanical components, clients to be
topped. If it were a service business, the nature of service to be offered.

b) Process of manufacturing

1) Technical process

2) Licensing contract, franchise contract, patent or copyrights

3) Raw materials needed the specifications, sources and cost

c) Plant layout, size and production schedule