FINANCIAL MARKETS AND INSTITUTIONS

CHAPTER 1  It also affects the performance of the company

as a whole.
RATIONALE IN STUDYING FINANCIAL MARKETS AND
 It allows small servers and borrowers to benefit
INSTITUTION
from the existence of financial markets thereby
THE NEED TO STUDY FINANCIAL MARKETS increasing the efficiency of the economy.

 Financial Market- a means for the buying and APPROACH IN STUDYING FINANCIAL MARKETS
selling of stocks, bonds, and other financial AND INSTITUTIONS
instruments. Way of selling bonds, stocks, etc.,
a) Understanding
through FM the financial institution and
Students learn to understand economic
individuals were able to communicate (ex.
analysis, that is, students develop the
Philippine Stock Exchange)
economic institution they need to organize
 The study of financial markets and institutions
concepts and facts.
not only influence your everyday life but also
b) Evaluating
involve huge flows of funds – trillions of dollars-
Students learn to evaluate current
throughout the world economy which in turn
development and the financial news. They
affect business profits, the production of goods
should learn to use financial data and
and services well-being of the countries around
economic analysis to think critically about
the world.
how they interpret current events.
 It will reward you with an understanding of
c) Predicting
many exciting issues such as how funds are
Students learn to use economic analysis to
transferred from people who have an excess of
predict likely changes in the economy and
available funds to people who have shortage.
the financial system.
 Well-functioning financial markets are a key
factor in producing high economic growth and CHAPTER 2
poorly performing financial market are one
INTRODUCING MONEY AND INTEREST RATES
reason that many countries in the world remain
desperately poor. ROLE OF MONEY IN THE ECONOMY
 This book provides answer to the businessmen’s
 Money- any item or commodity that is generally
questions by examining how financial markets
accepted as a means of payment for goods and
(such as those for stock bond, and foreign
services or for repayment of debt, and that
currency exchange) and financial institution
serves as an asset to its holder.
(such as banks, insurance companies, mutual
funds and other institution) work.  It is composed of bills and coins (currency).
 These are printed or minted by national
THE NEED TO STUDY FINANCIAL INSTITUTIONS government.
 It also includes funds stored as electronic
 Financial Institution- an organization that
entries in one’s checking account.
handles financial transactions for individuals,
 It’s an oil that keeps the machinery of our world
groups, and other organizations. The place
turning.
where financial transaction happens. (ex. Banks
 Before its invention, people bartered, but it is
and insurance companies)
sufficient for simple transactions, but not when
 Financial institutions are what make financial
the things traded are of differing values, or not
market work.
available at the same time.
 It helps financial market to move funds from
 At the start of modern age, individuals and
people who save to people who have
governments began to establish banks, and
productive investment opportunities.
other financial institutions were formed.
FINANCIAL MARKETS AND INSTITUTIONS
 Today it is the nation’s government and central
bank that control a country’s economy.
 The Federal Reserve (“The Fed”), central bank in
the US, issues currency, determine how much of
it is in circulation, and decides how much
interest it will charge banks to borrow its
money.
 In the Philippines, central bank that control the
country’s economy is “Bangko Sentral ng
Pilipinas”.
CHARACTERISTICS AND KEY FUNCTION OF MONEY
 Money must have value, be durable, portable,
uniform, divisible, in limited supply, and be
usable in means of exchange.
 STORE OF VALUE- money acts as a means by
which people can store their wealth for future
use.
 ITEMS OF WORTH- most money originally has
an intrinsic value.
 MEANS OF EXCHANGE- it must be possible to
exchange money freely and widely for goods,
and its value should be as stable as possible.
 UNIT OF ACCOUNT- money can be used to
record wealth possessed, traded or spent-
personally and nationally.
 STANDARD OF DEFERRED PAYMENT- money
can facilitate exchange and unit of account.
THE EVOLUTION OF MONEY
 Barter (10,000-3,000 BCE)
-A direct exchange of goods
-Adam Smith, 18th century author of The Wealth
of Nations, was one of the first to identify it as a
precursor to money.
 Barter in Practice
-Involves the exchange of an item for
one or more of a perceived equal value.
-Two parties bring the goods and hand
them over at the time of transaction.
-Sometimes, one of the parties will
accept and “I Owe You” or IOU even a
token, agreed can be exchanged for the
same goods or something else at a later
date.
 Advantages of Barter
o Trading relationship- foster
strong links between partners.
o Physical goods are exchanged-
barter does not rely on trust
that money will retain its value.
 Disadvantages
o Market needed- both parties
must want what the other
offers.
o Hard to establish a set value on
items- two goats may have a
certain value to one party one
day, but less a week.
o Goods may not be easily
divisible- ex. Living animal
cannot be divided
 Evidence of trade records (7000 BCE)
-Pictures items were used to record trade
exchanges, becoming more complex as values
coins that were established and documented.
 Coinage (600BCE-1100CE)
-Defined weights of precious metals used by
some merchants were later formalized as coins
that were usually issued by states.
 Bank notes (1100-2000)
-States began to use bank notes, issuing paper
IOSs that were traded as currency, and could be
exchanged for coins at any time.
 Digital money (2000 onwards)
-Money can now exist virtually, on computers
and large transactions can take place without
any physical cash changing hands.
ARTIFACTS OF MONEY
Money has come in many forms, from IOUs to tokens.
Cows, shells, and precious metals have all been used.
 Barter (5000 BCE)
-Involved directly exchanged items – often
perishable ones such as a cow.
 Sumerian cuneiform tablets (4000 BCE)
-Scribes recorded transactions on clay tables,
act as receipts.
FINANCIAL MARKETS AND INSTITUTIONS
 Cowrie shells (1000 BCE)
-Used as currency across India and South
Pacific. Appeared in many colors and sizes.
 Lydian gold coins (600 BCE)
-In Lydia, mixture of gold and silver was formed
into disks, or coins, stamped with inscriptions.
 Athenian drachma (600 BCE)
-The Athenians used silver from Laurion to mint
a currency used right across the Greek World.
 Han dynasty coin (200 BCE)
-Made of bronze or copper, early Chinese coins
had holes punched in their center.
 Roman coin (27 BCE)
-These coins circulated throughout the Roman
Empire.
 Byzantine coin (700 CE)
-Early Byzantine coins were pure gold, later
ones contained metals such as copper.
 Anglo- Saxon coin (900 CE)
-This 10th century silver penny has an inscription
stating that Offa is King(“rex”) of Mercia.
 Arabic dirham (900 CE)
-Many silver coins from the Islamic empire were
carried to Scandinavia by Vikings.
THE ECONOMIC OF MONEY
o 16TH century- understanding of the nature of
money became more sophisticated.
-economics as a discipline
emerged. Help explain the inflation caused by
Europe large- scale importation of silver from
the newly discovered Americans.
o Late 17th century- national banks were
established with the duty of regulating the
countries’ money supplies
o Early 20th century- money became separated
from its direct relationship to precious metal.
-The gold standard collapsed
altogether in 1930s.
o Mid-20th century – new ways of trading with
money appeared (credit cards, digital
transactions, and even forms of money such as
cryptocurrencies and financial derivatives).
-amount of money in
existence and in circulation increased
enormously.
 Potosi inflation (1540-1640)
-Spanish discovered silver in Potosi, Bolivia, and
caused a century of inflation by shipping 350
tons of the metal back to Europe annually.
 The great debasement (1542-1551)
-England’s Henry VIII debased silver penny by
making it three-quarters copper. Inflation
increased as price dropped.
 Early joint-stock companies (1553)
-Merchants in England began to form
companies, its investors bought shares
(stock)and shared its rewards.
 Bank of England (1694)
-The bank of England was created as a body that
could raise fund at a low interest rate and
manage national debt.
 The Royal Mint (1696)
-Isaac Newton became Warden and argued that
debasing undermined confidence. All coins
were recalled and new silver ones were minted.
 US dollar (1775)
-It was authorized by Continental congress, but
the first currency was not minted by the US
Treasury until 1794.
 Gold Standard (from 1844)
-British pound was tied to a defined equivalent
of gold. Other countries adopted similar gold
standard.
 Credit cards (1970s)
-its creation enabled consumers to access short-
term credit to make smaller purchases. Resulted
to growth personal debt.
 Digital money (1990s)
-easy transfer of funds and convenience of
electronic payments became increasingly
popular as internet used increased.
 Euro (1990)
-12 EU countries joined together and replaced
their national currencies with the Euro. Banks
notes and coins were issued three years later
 Bitcoin (2008)
-it is a form of electronic money that exist solely
as encrypted data on servers-is announced. First
transaction was place in January 2009.
FINANCIAL MARKETS AND INSTITUTIONS
HIGHLIGHTS IN THE HISTORY OF MONEY IN THE
PHILIPPINES
 Pre-Spanish Regime
-before 1521, the Philippines was already
trading with neighboring countries such as
China, Java, and Macau.
-some coins were circulating in the Philippines
as early as the 8th century.
-gold, gold dust, silver wires, coffee, sugar rice,
spices carabao and other commodities were in
circulation.
-between 8th and 14th century the penniform
gold barter rings were predominantly used by
foreign merchants.
-piloncitos ] circulation.
 Spanish Regime
-During colonization in 1521, Spanish
introduced coins in the Philippines. During 1861
silver coins minted in Mexico were
predominantly used.
 American Regime
-After gaining independence on 1898 with
Spain, they ceded us to United States. The first
local currency, the Philippine Peso, was
introduced after the Spanish-Filipino peso.
-The Philippine National bank was authorized to
issue Philippine Bank Notes.
-the bank of the Philippine Island was
authorized to issue its own bank notes.
Redeemable by issuer but not made legal
tender.
 Japanese Regime
-during World War II, Japanese issued the
Japanese war notes.
-mickey mouse money- bills had no reserves nor
backed up by any government asset.
 Post-War Period
-1194, American forces defeated Japan Imperial
army.
-all Japanese currencies circulating in the
Philippines were declared illegal.
-all banks were closed and all Philippine
National Bank notes were withdrawn from
circulation.
-new treasury certificate (victory money) was
printed in P500, P200, P100, P50, P20, P10, P5,
P2 and P1. Establishement of central bank.
-1949, “central bank notes” was issued (new
currency).
-2010, Central Bank launched the “New
Generation Currency”, uniform in size,
significant events in Philippine history, iconic
buildings and heritage were featured.
-2018, NGC coin series put in circulation.
THE SUPPLY AND DEMAND FOR MONEY
 Money facilitates the flow of resources in the
circular model of macroeconomy.
 Monitoring the supply and demand for money is
vital for economy’s central bank’s monetary
policy, which aims to stabilize price levels and to
support economic growth.
THE MONEY SUPPLY
 M1
-narrowest measure of the money supply.
-money used as medium of exchanged.
 M2
-addition to m1
-includes money held in savings deposits,
money market deposit accounts,
noninstitutional money market mutual funds
and other short-term money market assets.
-money used as store of value.
 M3
-addition to m2
-measure includes financial institution
-money used as a unit of account.
 L
-addition to m3
-measure includes liquid and near-liquid assets.
 Check payments from one person to another
are not included in the money supply because
check merely transfer money without being a
net addition to the supply of money.
 Consumer credit cards are not included in the
money supply, they are considered instant loans
to the consumers.
 BSP is responsible for determining the supply of
money.
FINANCIAL MARKETS AND INSTITUTIONS
 Changes in the supply of money will affect the
interest rate and therefore the cost of
borrowing money.
THE DEMAND FOR MONEY
 Transaction demand
-money demanded for day-to-day payments
through balances held by household and firms.
-it does not depend on the rate of interest; it
varies with GDP.
 Precautionary demand
-money demanded as a result of unanticipated
payments.
-varies with GDP.
 Speculative demand
-money demanded because of expectations
about interest rates in the future.
-people expand their money balances and hold
off on bond purchases if they expect interest
rates to rise.
-has negative relationship with interest rate.
THE QUANTITY THEORY OF MONEY
 Rate of interest- price paid in the money
market for the use of money (for loans). The
rate is the percentage of the amount borrowed.
THE IMPACT OF MONEY
 In the macroeconomic short-run, some prices
will be flexible. This causes economic
fluctuations, with real GDP either potential GDP
(recessionary gap) or above potential GDP
(inflationary gap).
 BSP’s monetary policy has an immediate, short-
run impact on the economy.
 Higher interest rate=decrease investment,
THE TIME VALUE OF MONEY
consumption, and net export. It becomes more
expensive to borrow money, and will also
decrease consumption because consumers will
tend to, save more as interest rates increase.
 As higher interest rates increase the demand for
peso on the foreign exchange markets (higher
returns on Philippine deposits). Higher
pesos=decrease exports, by making them
increasingly expensive.
 BSP raises interest rate=real GDP growth and
inflation rate slow. Vice versa.
 Money policy can be applied in the short run
when the economy faces an inflationary gap
(real GDP exceeds potential GDP).
 To avoid inflation, the BSP may decrease the
quantity of money and raising the interest rate.
 Decrease in aggregate demand=decrease in real
GDP and lower flexible price level.
 Macroeconomic long run, prices are assumed to
be fully flexible, and this will move real GDP
towards potential GDP.
 Economy at its long run equilibrium- BSP
increases the money supply, it will increase
aggregate demand.
 Price level goes up as well as the real GDP
 Inflationary gap exists, with the actual
unemployment rate being below the natural
rate.
 Tightness in the labor=rise money wage rate.
 Higher labor cost=short run aggregate supply
will increase. Returning real GDP to the level of
potential GDP.
 It holds the changes in the money supply MS
directly influences the economy’s price level,
but nothing else.
 MxV=PxY
M= quantity of money
V= velocity of money
P= price level
Y= real GDP
 Money growth rate and the inflation rate are
positively related in the long run. However, the
year-to-year relationship is weaker.
 Interest
 in general business term- cost of using
money over time.
 in economist – time value of money.
 Present value (present discounted value)
 peso of cash flow paid to you one year
from now is less valuable to you than
peso paid to you today.
FINANCIAL MARKETS AND INSTITUTIONS
 Principal x (1+i) ^n
INTEREST RATES
 Allows individuals to evaluate the present value
(the value today) of future income and costs.
 Market price of earlier availability.
 For potential borrower’s viewpoint, it is a
premium that must be paid in order to acquire
goods sooner and pay for them later.
 For lender’s viewpoint, it is a reward for waiting
a payment.
 It allows lender to calculate the future benefit
of extending a loan or saving funds today.
 Aside from money itself that is desired by the
borrower, IR is the earlier availability of goods
and services purchased.
HOW INTEREST RATES ARE DETERMINED
 It is determined by the demand for and supply
of loanable funds.
 According to Keynesian Theory, rate of interest
is determined as a price in two markets:
 Investment funds – the rate of interest
balances the demand for funds
(required for investment) and the
supply of funds (from savings).
Households delay consumption by
saving depending on their time
preference and the rate of interest.
 Liquid assets – households and
businesses may have reasons to hold
assets in liquid form.
THE NOMINAL OR MONEY RATE VERSUS THE REAL
RATE OF INTEREST
 During period of inflation, the nominal interest
rate or money rate of interest is misleading
indicator of how much borrowers are paying
and lenders are receiving.
 High rates inflation will lead to a high money
rate of interest.
INTEREST RATES AND RISK
 In real world, there are many interest rates.
There is the mortgage rate, the prime interest
rate, the consumer loan rate and the credit card
rate, to name but a few.
 In a loanable funds, it is riskier. Example, to loan
money to an unemployed worker than to a well-
established business chiwith substantial assets.
 Three components of money interest
 Risk premium
 Inflationary premium
 Pure interest
THE IMPACT OF CHANGING INTEREST RATES
 If the BSP pushes short-term interest rates up or
down, the effects of its actions are felt most
directly by interest-rate sensitive sector
economy.
 When it is expensive to borrow people will
make fewer purchases require borrowing.
 When BSP cuts the short-term interest rate,
that encourages borrowing and spending in the
economy and puts upward pressure on prices.
 If interest rates fluctuated all the time, the
economy would become volatile.
 Every time interest rate changed, it sends a
signal to society to either spend or save.
 Borrowings becomes less attractive as interest
repayments are steeper, and banks are more
selective about whom they lend to.
WHEN INTEREST RATES ARE RAISED
 Makes loans less affordable
 On savings accounts, it encourages saving
rather than spending.
WHEN INTEREST RATES ARE LOWERED
 Make it cheaper to take out loans and hence to
spend more money.
 Savings becomes less attractive as interest rates
are low.
 Demand for product and services rise,
stimulating businesses and increasing
employment.
CHAPTER 3
THE PAYMENTS SYSTEM: AN OVERVIEW
 Payments system – the mechanism for
conducting such transactions.
FINANCIAL MARKETS AND INSTITUTIONS
TRANSACTION FROM COMMODITY MONEY TO FIAT
MONEY
 Commodity money- good used as money that
has value independent of its use as money.
 Fait money- refers to money such as paper
currency that has no value apart from its use as
money.
 money is also useful because of its ability to
serve as a standard of deferred payment. It can
facilitate exchange at a given point in time by
providing a medium of exchange and unit of
account.
 Using of metallic coins
 China 100 ac
 Greece 700 ac
 people have difficulty transporting large
number of gold coins to settle transactions and
also run the risk of being robbed.
 1500 A.D. in Europe -government and private
firms – early banks – began to store gold coins
in safe places and issue paper certificates
(medium of exchange).
 Anyone receiving a paper certificate
could claim the equivalent amount of
gold.
 in effect, paper currencies had been
invented.
 The modern BSP payments system is a fiat
money system because the BSP does not
exchange paper currency for gold or any other
commodity money.
 Today, BSP has a legal monopoly on the right to
issue currency.
THE IMPORTANCE OF CHECK
 Another major innovation in the payments
system came in the early 20 th century, with the
increasing use of check.
 Checks- promises to pay on demand money
deposited with the bank or other financial
institution.
-they can be written for any amount,
and using them is a convenient way to
settle transactions.
-it requires more step when used in
settling transactions then with
currencies.
-processing enormous flow of it
worldwide costs the economy billion
dollars each year.
-accepting checks requires more trust
on the part of the seller than does
accepting peso bill.
NEW TEACHNOLOGY AND THE PAYMENTS SYSTEM
 BSP supervises the payments system but
doesn’t directly control it because many
payments are processed by banks and other
private firms
 Five most desirable outcome for payment
system:
 Security- episodes in which criminals
have hacked into retail credit card
systems and other parts of the
payments system have raised concern s
about security. Better security increases
consumers’ and businesses’ confidence
that funds will not be stolen
electronically.
 Efficiency- resources devoted to
processing paper checks or other
aspects of processing payments are
diverted from producing other goods
and services. Increasing it when it
comes to payments system allows it to
function using fewer workers and
computers, or other capital which
benefits the economy.
 Speed- fast settlement of payments
facilitates transactions by both
households and businesses.
 Smooth international transaction-
increasing amount of business that
takes place across boarders can be
facilitated if payments can be made
quickly and conveniently.
 Effective collaboration among
participants in the system- the
payments system needs to
efficientlyinvolve governments,
FINANCIAL MARKETS AND INSTITUTIONS
financial firms such as banks, and other
business around the world.
 Debit cards can be used like checks.
 In recent years, many consumers have begun
using apps on their smart-phones or smart-
watches that are linked to credit or debit cards.
 Automated clearing house (ACH)- transactions
include direct deposits of payroll checks into the
checking accounts of workers and electronic
payments on car loans and mortgages, where
payments are sent electronically.
 40 years ago Automated Teller Machine (ATMs)
did not exist. To deposit or withdraw you need
to fill out a deposit or withdrawal slip and wait
in line a bank teller’s window.
 10AM-4PM bank hours. ATM most convenient
for transactions.
E-MONEY, BITCOIN, AND BLOCKCHAIN
 E-money or electronic money- digital cash
people use to buy goods and services.
 PayPal- best known forms of e-
money
 central bank does not control e-
money, though, so it is essential
a private payments system.
 Bitcoin- new form of e-money.
 Unlike paypal it is not owned by
firm.
 It is produced by people
performing the complicated
calculations necessary to
ensure that online purchases
made with bitcoins are
legitimate, someone doesn’t try
to spend the same bitcoin
multiple times.
 People successfully complete
these calculations are awarded
a fixed number of bitcoins-
typically 25.
 The process of bitcoin “mining”
will continue until the
maximum of 21 million bitcoins
has been produced in 2030.
 it is a cryptocurrency to others
 a number of websites, such as
BitPay, which is based in
Atlanta, allow merchants to
process purchases made with
bitcoins in a way similar to how
they process credit card
payments.
 Most popular online bitcoin
exchange, Japan-based Mt. Gox,
closed in 2015.
 Blockchain- underlying technology behind
bitcoin.
 Has attracted interest from
both firms and governments as
they attempt to increase the
speed, efficiency, and security
of the payments system.
 It is the “distributed ledger” or
an online network that registers
ownership of funds, securities
or any other good, including
movies and songs.
 It allows a transaction to settle
instantly and securely on
encrypted sites
CASHLESS SOCIETY
 blockchain and other new payment
technologies are exciting and lead some
commentators to predict a cashless society.
 Electronic payments now make up 2/3 of
noncash payments
 No. of checks has been dropping more than 2
billion per year.
 In reality, an entirely cashless (checkless)
society may be difficult to attain in the near
future for 2 key reasons:
o Infrastructure for an e-payments
system is expensive to build.
o Many households and firms worry
about protecting privacy in an
electronic system that is subject to
computer hackers.
FINANCIAL MARKETS AND INSTITUTIONS