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FM201 Financial Market Finals
FM201 Financial Market Finals
VI. Module Outcomes After the study of all the lessons, you are expected to:
Understand key concepts under mortgage markets
Describe the uses of derivatives for hedging and speculation
Recognize what hedging and speculation are
Describe how do the primary stock market and secondary stock
markets work
Differentiate and apply technical and fundamental analysis in stock
trading
Lesson Objectives:
At the end of this lesson, you should be able to:
1. Describe what are mortgages
2. Explain how mortgage markets differ from stock and bond markets
3. Enumerate and explain the characteristics of a mortgage
4. Enumerate and explain the important factors that affect the interest rate on the loan
5. Distinguish between:
futures contracts
forward contracts
options
Getting Started:
Here are some useful resources about the 2008 financial crisis.
1. YouTube video title: The Causes and Effects of the Financial Crisis 2008
By Vivien Yeow
https://www.youtube.com/watch?v=N9YLta5Tr2A
Discussion:
Introduction
For one perspective, the mortgage markets form a subcategory of the capital markets because mortgages involve long-
term funds. But the mortgage markets differ from the stock and bond markets in several ways.
First, the usual borrowers in the capital markets are businesses and government entities, Whereas the usual borrowers in
the mortgage markets are individuals.
Second, mortgage loans are made for varying amounts and maturities, depending on the borrowers’ needs, features that
cause problems for developing a secondary market.
Mortgages are long-term loans secured by real estate. Both individuals and businesses obtain loans to finance real estate
purchases.
In another definition, mortgages are loans to individuals or businesses to purchase a home, land or other
real property. The property purchased with a loan serves as collateral backing the loan.
A developer may obtain a mortgage loan to finance the construction of an office building, or a family may obtain a
mortgage loan to finance the purchase of a home. In both cases, the loan is amortized. The borrower pays it off overtime
in some combination of principle and interest payments that result in full payment of the debt by maturity.
Amortized – A mortgage is amortized when the fixed principal and interest payments fully pay off the mortgage
by the maturity date.
take into account how long they will hold onto the loan. Typically, discount point should not be paid if the
borrower will pay off the loan in five years or less.
2. Loan terms
Mortgage loan contracts contain many legal and financial terms, most of which protect the lender from financial
loss.
3. Collateral
All mortgage loans are backed by specific piece of property that serves as collateral to the mortgage loan. As part
of the mortgage agreement, the financial institution will place a lien against a property that remains in place until
the loan is fully paid off. A lien is a public record attached to the title of the property that gives the financial
institution the right to sell the property if the mortgage borrower defaults or falls into arrears on his or her
payments. the mortgage is secured by the lien – that is, until the loan is paid off, no one can buy the property and
obtained clear title to it.
4. Down Payment
To obtain a mortgage loan, the lender also requires the borrower to make a down payment on the property, that is,
to pay a portion of the purchase price. The balance of the purchase price is made by the loan proceeds. Down
payments are intended to make the borrower less likely to default on the loan. A borrower who does not make a
down payment could walk away from the house and alone and lose nothing. Furthermore, if real estate prices drop
even a small amount, the balance due on the loan will exceed the value of the collateral. The down payment
reduces moral hazard for the borrower. The amount of the down payment depends on the type of the mortgage
loan. Many lenders require that the borrower pay 5% of the purchase price; in other situations, up to 20% may be
required.
5. Private Mortgage Insurance
Private Mortgage Insurance (PMI) is an insurance policy that guarantees to make up any discrepancy between the
value of the property and the loan amount, should a default occur. For example, if the balance on your loan was
PhP 120,000 at the time of default and the property was worth only PhP100,000. PMI would pay the lending
institution PhP20,000. The default still appears on the credit of the borrower, but the lender avoids sustaining the
loss.
6. Borrower Qualifications
Before granting a mortgage loan the lender will determine whether the borrower qualifies for it. Qualifying for a
mortgage loan is different from qualifying for a bank loan because most lenders sell their mortgage loans to one
of a few government agencies in the secondary mortgage market. these agencies establish very precise guidelines
that must be followed before they will accept the loan. If the lender gives a mortgage loan to a borrower who
does not fit these guidelines, the lender may not be able to resell the loan. That ties up the lender’s funds. Banks
can be more flexible with loans that are kept on the bank’s own book
Conventional Mortgages
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These are originated by banks or other mortgage lenders but are not guaranteed by government or government-controlled
entities. Most lenders though now insure many conventional loans against default, or they require the borrower to obtain
private mortgage insurance on loans.
Insured Mortgages
These mortgages are originated by banks for other mortgage lenders but are guaranteed by either the governments or
government-controlled entities.
Fixed-rate Mortgages
In fixed-rate mortgages, the interest rate in the monthly payment did not vary over the life of the mortgage.
A mortgage that locks in the borrower’s interest rate and thus the required monthly payment over the life of
the mortgage, regardless of how market rates change.
In EPM, an outside investor shares in the appreciation of the property. This investor will either provide a portion of the
purchase price of the property or supplement the monthly payment. In return, the investor receives a portion of any
appreciation of the property. As with the SAM, the borrower benefits by being able to qualify for a larger loan than
without such help.
Second Mortgages
These are launched that are secured by the same real estate that is used first mortgage. The second mortgage is junior to
the original loan which means That you know default occurs the second mortgage Holder will be paid only after the
original loan has been paid off if sufficient funds remain.
Derivatives are financial instruments that “derive” their value on contractually required cash flows from some
other security or index. For instance, a contract allowing a company to purchase a particular asset (say gold,
flour, or coffee bean) at a designated future date, at a predetermined price is a financial instrument that derives its
value from expected and actual changes in the price of the underlying asset.
Any security whose value is determined by, or derived from, the value of another asset.
Underlying asset – the asset from which the derivative gets its value.
o Can take in many form (stocks, bonds, commodities, currencies, interest rates and market indexes)
The value of the instrument depends upon the value of something else.
Characteristics of Derivatives:
A derivative is a financial instrument:
whose value changes in response to the change in specified interest rate, security price, commodity price,
foreign exchange rate, index of prices or rates, credit rating or credit index, or similar variable
that requires no initial net investment or little net investment relative to other types of contracts that have a
similar response to changes in market conditions; and
2. For Speculation
Speculation – n. investment in stocks, property, or other ventures in the hope of gain but with the risk of loss
Investors may buy or sell an asset in the hope of generating a profit from the asset’s price fluctuations. usually this
is done on a short-term basis in assets but are liquid or easily traded.
Example: an investor notices a company’s share prices going up and buy some option on the share. an option
gives a right to the Holder to buy shares at a future date. If share prices do rise, the investor can profit by buying
at a fixed option price and selling at the current higher price. If share prices fall, the investor can sell the option
or let it lapse, losing a fraction of the value of the asset itself.
Types of Derivatives:
Futures Contracts
A futures contract is an agreement between a seller and a buyer that requires that seller to deliver a particular commodity
(say corn, gold or soya beans) at a designated future date, at a predetermined price. These contracts are actively treated on
regulated future exchanges and are generally referred to as “commodity Futures contract”. When the “commodity” is a
financial instrument such as a Treasury bill or commercial paper, the agreement is referred to as a financial futures
contract. Futures contracts are purchased either as an investment or as a hedge against the risks of future price changes.
Forward Contracts
A forward contract is similar to a futures contract but differs in three ways:
Future contact-An agreement between a seller and a buyer that requires that seller to deliver a particular commodity at
designated future date at predetermined price.
Forward contract agreement to buy or sell an asset at a specific price on a specified date in the future.
Option contract- a form of derivative financial instruments in which two parties contractually agree to transact an assets at a
specified price.
1. A forward contract calls for delivery on a specific date whereas a futures contract permits the seller to decide
later which specific day within the specified but it will be the delivery date (if it gets as far as actual delivery
before it is closed out).
2. Unlike a futures contract, a forward usually is not traded on a market exchange.
3. unlike a futures contract, a forward contract does not call for a daily cash settlement for price changes in
the underlying contract. Gains and losses on forward contracts are paid only when they are closed out.
Example:
Please refer to this YouTube video: Understanding Forward contracts. What are forward contracts used for?
Link: https://www.youtube.com/watch?v=t5XWCy21lyo
Options
Options give its holder the right either to buy or sell an instrument, say a treasury bill, at a specified price and within a
given time period. Options frequently are purchased to hedge exposure to the effects of changing interest rates. options
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serve the same purpose as futures in that respect but are fundamentally different. Importantly, though, the option holder
has no obligation to exercise the option. on the other hand, the holder of a futures contract must buy or sell within a
specified. Unless the contract is closed out before delivery comes due.
Example:
Please refer to this YouTube video: Bill Poulos Presents: Call Options & Put Options Explained In 8 Minutes (Options
For Beginners)
Link: https://www.youtube.com/watch?v=EfmTWu2yn5Q
Foreign loans are frequently denominated in the currency of the lender. when loans must be repaid in foreign currencies, a
new element of risk is introduced. this is because if exchange rates change, the peso equivalent of the foreign currency that
must be repaid differs from the peso equivalent of the foreign currency borrowed.
To hedge against “foreign exchange risk” exposure, some firms buy or sell foreign currency futures contracts. These are
similar to financial futures except specific foreign currencies are specified in the futures contracts rather than specific debt
instruments. They work the same way to protect against foreign exchange risk as financial futures protect against fair
value or cash flow risk.
Example:
Please refer to this YouTube video: Fundamentals and FX Futures by CME Group
Link: https://www.youtube.com/watch?v=8XVPdXiroB0
Interest Rate Swaps
An agreements between two parties to exchange one stream of interest payment for another, over a set period of a time.
There are contracts to exchange cash flows as of a specified date or a series of specified dates based on a notional amount
and fixed and floating rates.
These contracts exchanged fixed interest payments for floating rate payments or vice versa, without exchanging the
underlying principal amounts. For example, suppose you owe PhP 100,000 on a 10% fixed-rate home loan. You envy
your neighbor who is also paying 10% on her PhP 100,000 mortgage, but hers is a floating rate loan, so if the market
rates fall, so will her loan rate. To the contrary, she is envious of your fixed rate, fearful that rates will rise, increasing her
payments. A solution would be for the two of you to effectively swap interest payments using an interest rate swap
agreement.
The way a swap works you both would continue to make your own interest payments but would exchange the net cash
difference between payments at specified intervals. So, in this case, if market rates (and thus floating payments) increase,
you will pay your neighbor; if rates fall, she pays you. The net effect is to exchange the consequences of rate exchanges.
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In other words, you have effectively converted your fixed-rate debt to floating rate debt; your neighbor has done the
opposite.
For more resources about interest rate swap, please refer to this YouTube video: Interest Rate Swap
Explained Link: https://www.youtube.com/watch?v=JIdcips9vPU
Application:
Pretend that you are going to buy a house and lot worth PhP 2M. What will you choose – a 15-year loan with a 3%
interest or a 30-year loan with 8% interest? There are no right or wrong answers. Please state your choice and do your
best to explain why.
Derivative is any security whose value is determined by, or derived from, the value of another asset.
Enrichment Activity:
Conduct a research on which Philippine banks/financial institutions provide:
Mortgages
Derivatives products
Cite your sources (news articles, press releases, etc.)
Assessment:
Answer the following questions:
1. What distinguishes the mortgage from other capital market?
2. Give and explain briefly the three important factors that affect the interest rate on the loan.
3. What contributes to keeping long-term mortgage interest rates low?
4. Distinguish between:
a. conventional mortgage loan and insured mortgage loan.
b. fixed-rate mortgages and adjustable-rate mortgages
References:
1. Financial Markets and Institutions by Ma. Elenita Balatbat Cabrera, 2020 Edition
2. Vivien Yeow. (2012, July 23). The Causes and Effects of the Financial Crisis 2008 [Video]. YouTube.
https://www.youtube.com/watch?v=N9YLta5Tr2A
3. Amadeo, K. (2020, May 29). Causes of the 2008 Global Financial Crisis. Investopedia.
https://www.thebalance.com/what-caused-2008-global-financial-crisis-3306176
4. FINMAESTRO. (2017, November 20). Understanding Forward contracts. What are forward contracts used
for? [Video]. YouTube. https://www.youtube.com/watch?v=t5XWCy21lyo
5. Profits Run. (2013, December 10). Bill Poulos Presents: Call Options & Put Options Explained In 8 Minutes
(Options For Beginners) [Video]. YouTube. https://www.youtube.com/watch?v=EfmTWu2yn5Q
6. CME Group. (2018, April 6). Fundamentals and FX Futures [Video]. YouTube.
https://www.youtube.com/watch?v=8XVPdXiroB0
7. Xpono VF. (2012, June 25). Interest Rate Swap Explained [Video]. YouTube.
https://www.youtube.com/watch?v=JIdcips9vPU
Lesson Objectives:
At the end of this lesson, you should be able to:
1. Understand what the stock market is
2. Differentiate the primary stock market from the secondary stock market
Getting Started:
Why Do We Need A Stock Market
By: John Mangun (Business Mirror)
This trend is so strong that there are those that call for government to steal (and it is stealing) companies that private
individuals have created, finance, and operated and give ownership over to the government. The world would be a better
place if government just could take ownership and control.
However, the interesting thing is that government, including here in the Philippines, already controls a great amount of the
national wealth. Who owns the most amount of land in the Philippines? National and local government units. Who is the
largest employer in virtually all countries? The governments. Who has unlimited money available to spend as it wishes?
Governments.
That is not to say that government does not have an important role in supporting private enterprise. But it should support.
not replace.
So where does the stock market figure into the great scheme of things? Even the most rabid anti-American, anti-capitalist
must accept that everything from the paper clip to the automobile was a product of capitalism particularly American
capitalism.
American historian Ron Chernow wrote, “there is no country in the world where it’s as easy to find venture capital in the
stock market as the United States”. it is the private capital that allows research, development, and production. And the
great thing about private capital is that it helps the winners to succeed and almost guarantees the bad ideas will disappear.
Government money sometimes works the opposite way.
Companies use the stock market to raise money from investors. Investors benefit from participating in the hopefully bright
corporate future. In 1976 Ronald Wayne sold his 10% shareholding in Apple Corporation for US$ 801. Today he shares
would be worth nearly US$ 50 billion.
I am never going to own a bank, property company, Department store or a snack food factory. But I can be a partial owner
of those companies operated by knowledgeable and successful people that are owners. And here is the best part. If those
companies do not make money, I can sell out instantly.
While governments cannot claim any direct credit for what happens both good and bad in the stock market, it is an
important clue as to local financial sentiment. If 10,000,000 Filipinos suddenly show up to get their money from the banks
you probably have a crisis in confidence of the banking system. The same applies to the stock market.
As far as the stock market not helping the economy and the people, that is total nonsense and is an ignorant thought. The
local property companies have raised billions in the last two years to build projects. Apparently those developments are
going to be constructed with robots and not real employed workers.
the Stock Exchange is a marketplace for a business capital; nothing more and nothing less in the same way the wet market
saves you from the trouble of buying directly from the piggery. It is a business where people come together to make
business.
Discussion:
Ordinary equity shares/common shares and preferred shares were discussed in Lesson 6. For this lesson, more details will
be discussed t
Stock Market
Refers to the collection of markets and exchanges where regular activities of buying, selling, and issuance of
shares of publicly-held companies take place.
This is a market in which corporations raise funds through new issues of stocks. the new stock securities are sold
to initial investors (suppliers of funds) in exchange for funds (money) that the issuer (user of funds) needs.
Public offerings must be registered and approved by the Securities and Exchange Commission Registration
requires the firm to disclose a great deal of information before selling any securities.
An important financial institution that assists in the initial sale of securities in the primary market is the
investment bank. It does this by underwriting securities. It guarantees a price for a corporations securities and
then sells them to the public.
Examples of famous/biggest IPOs:
1. Facebook
Funds raised: US$ 16 Billion
2. Saudi Aramco
Funds raised: US$ 29.4 Billion
Examples of Philippine IPOs in 2020:
1. Merry Mart Consumer Corporation
Listing Date: June 15, 2020
2. Converge
Listing Date: Oct 12, 2020
Prospectus - A company’s prospectus is a formal legal document designed to provide information and full details about
an investment offering for sale to the public.
For the two local IPOs mentioned above, both Merry Mart and Converge published their prospectuses so the investing
public may discern if the investing in their IPOs would be worthwhile.
Once the company’s shares are listed on a stock exchange and trading in it commences, the price of these shares will
fluctuate as investors and traders assess and reassess their intrinsic value
These are the markets in which stocks, once issued – that is, bought and sold by investors. In the Philippines, the
Philippine Stock Exchange is an example.
Once shares are issued to investors (through the primary market), they can now be traded at the secondary
market through stock brokers.
A stock is a portion of ownership in a company.
Stock Broker
Stockbroker or broker is a professional individual who executes the buy and sell orders on behalf of clients for stocks and
other securities in a listed market or over the counter, usually for a fee or commission.
COL Financial
AAA Equities
BPI Trade
BDO Nomura
AB Capital Securities
Philstocks
Alpha Securities
Eagle Equities
First, it is important to know what is the minimum number of shares that you can buy.
Lot size/Board lot – this is the minimum number of shares that you may purchase, and it is also the number
of increments in which you are allowed to buy
Price
From To Board Lot
0.0001 0.0099 1,000,000
0.01 0.0495 100,000
0.05 0.495 10,000
0.5 4.99 1,000
5 49.95 100
50 999 10
1000 above 5
For example: The last traded price of NOW Corporation is 2.95. From the board lot table, this means that you can only
purchase the stock in increments of 1000 shares.
Place your orders through your stock broker (for online platforms you can do this yourself).
This is the bid and ask board which shows the current buyers (bid size) and sellers (ask side) of the stock.
To give an example, we’ll read the first order: There are 8 people/entities who are willing to buy a total number of
151,000 shares at PhP 3.90 per share. (First row at the top, left side)
For a second example, we’ll read the third ask order: There are 3 people/entities who wish to buy 9,000 shares at PhP 3.93
per share.
The bid and ask board provides a good way to strategize on trading because you can identify at which prices got the
amount of volume. Here, you can identify the support and resistance on a given stock. Secondly, you can also see how
much shares you can buy or sell at a certain time. From the example above: If you are planning to buy 500,000 shares of
this stock, you can immediately get filled by posting a buy order at PhP 3.91.
The stock market works in the best interest of the aggressive buyer and seller.
Referring again to the image above, let’s say you placed a buy order at PhP4.00, but your order got filled at PhP 3.92.
This means that if you can buy shares lower than PhP4.00, then the broker automatically executes your order. This
works on your best interest because you were able to buy shares lower than what you bid for.
The same way also happens when you try to sell your shares. If you posted a sell order at PhP 3.60, your order here may
get filled for something higher than that, given that there are bids who are willing to buy shares higher than your asking
price. The broker executes this trade in your favor. This can be more profitable for you because you were able to sell your
stocks higher than your expected price.
Analysis of a stock, or company, through the use of price movement, data and chart patterns.
2. Fundamental Analysis
Analysis of a stock or company through the use of economic factors, company growth, financial ratios and
other different factors that can a business.
The most common framework for fundamental analysis utilizes the following approach:
First you study about the general economic conditions/indicators (GDP, foreign exchange rate,
inflation, interest rates).
Next you study the thriving or flourishing industries within the economy (mining, property,
services, holdings, etc)
This explains why the diagram above is an inverted triangle – as an investor you narrow down your
stock/company picks as you go along in studying them fundamentally.
Here is a video on fundamental analysis: https://www.youtube.com/watch?v=UQm5gTyWnQI&t=2s
Video: InvestaUniversity: Fundamental Analysis vs. Technical Analysis (FOR BEGINNERS)
By: InvestaTV
Application:
Do the following activity. Answer these on a separate sheet:
Find about the Philippine Stock Exchange market crash during the pandemic which started in March.
By what percentage was the drop of the index from the previous trading day?