CHAPTER I

OVERVIEW OF BUSINESS ENVIRONMENT AND FINANCIAL MARKETS

TOPICS:
1. Definition of terms
2. Reasons why people engage in business
3. Sources of capital
4. Why firms invest and borrow
5. What are financial markets
6. Benefits of financial markets
7. Methods of which financial markets transfer funds
8. Financial intermediaries
8.1 Surplus Spending Units (funds supplier) and Deficit Spending Units (funds
user) 9. Classification of financial markets
10. A corporation as a form of business

LEARNING OUTCOMES:
After this Chapter, you should be able to:
1. Understand the respective meaning of major financial terminologies, and those
salient values why do people engage in business.
2. Have a perspective knowledge on the transfer of funds from savers to borrowers.
3. Learn the classifications and benefits of financial markets.
4. Have a perspective overview of a corporation as a form of business.

LECTURE PROPER
In the Philippines, like any other countries around the globe, market economy does not
operate in perfect situation due to presence of economic inequalities, where resources of
production are concentrated in the hands of the few and the difference in individual’s
purchasing power. Greater purchasing power is vested to affluent members of the society while
small purchasing power retains by the poor. Hence, government regulations and intervention in
the operation of capitalistic economy are necessitated so as to meet the needs of consumers
having lower purchasing power, and to promote the welfare of the majority as a whole.
At present, the world is widely embracing an advanced technology development and
innovative spectrums vis-à-vis the challenges and opportunities of e-Commerce/e-Business.
Invasion of e-Business activities and strategies have been in placed to a greater extent through
internet to spur productivity and profits.

DEFINITION OF TERMS
Major terminologies associated to the operation of a business and finance, such as: 1.
Financial Management is a decision-level responsibility for fund generation, fund
allocation, fund restructuring and profit supervision. It is responsible for the liquidity,
solvency and profitability and financial control of the enterprise. The management
responsibilities include financial planning, analysis of financial performance and direction of
financial operation.
a. Fund generation or procurement refers to a fund sourcing activities engaged
by an enterprise purposely for a successful delivery of a business venture. It
may include issuance of corporate securities, bank loans or borrowed funds,
sale or exchange of capital assets, personal savings, grants or donations, fund
raising activities, etc.
Financial loans may either secured or unsecured. Secured loans are those
financial obligation that backed up with collaterals. Unsecured loans are clean
loans.
b. Fund allocation is the rationalized allocation of funds for a project or activity
which will construe budgeting hierarchy of priorities.
 1
c. Capital restructuring involves the provision or reduction of financial resources
for a company, and as negotiate new partnership agreements for new
investment portfolio.
d. Profit supervision. Profits remain the primary objective of business as it
potentially corresponds to the goals of corporate finance— stockholders’
wealth maximization and profit maximization.

2. Business is any lawful economic activity concerned with the production and distribution
of goods and services for profit. Whether or not is actually makes profits is immaterial.
An entity is still a business concern if its objective is to make profits.

3. Financial system describes collectively the financial markets. The financial system
participants, and the financial instruments and securities that are traded in the financial
markets. The functions of financial systems are:
a. to channel the funds from lenders/savers to borrowers;
b. to provide a medium exchange;
c. to provide a mechanism for risks sharing; and
d. to provide a channel through which the central banks can influence the
economy, and the financial system, in particular.

MAJOR REASONS WHY PEOPLE ENGAGE IN BUSINESS

More and more people go into business for variety of reasons, may be as
owners/entrepreneurs or as employees. Whether a person goes into business as an employer or
an employee, both are facing the hazards of loss and other problems inherent in business.
Likewise, they also enjoy certain values which are derived when going into business, the
following:
a. Social approval. The businessman may gain a high social standing. Successful
businessmen may even using their dominant business position as a
springboard in entering politics or positions in the government bureaucracy,
like the Villars, Dominguez, Gatchalians, and other business tycoons.
b. Profit. Profit is considered the primordial reason that motivates person to
engage in business because of the anticipation of higher return of investment.
In addition, the seek for a means of livelihood goes closely with the desire for
profit.
c. Service to community. Businessman’s values nowadays has dynamically
shifted to community involvement or what is called “corporate social
responsibility” which goes with a business maxim that states “he profits most
who serves best.” Sponsoring community activities, setting up facilities for
community needs, providing employment to host community, sponsoring
civic activities, etc.
Corporate Social Responsibilities (CSR), the manager should not only think of
himself as a businessman, nor the organization as business venture, but he
should have more concern with the larger society. An enterprise is strong if
the community it serve is strong. The benefits generated by business should
be diffused in the community in the form of: a) fair price, b) just wages and
compensation, c) gainful employment, d) tax support, and e) civic
participation.
d. Personal satisfaction. It may spell on the businessman’s desire to fulfill his
dreams, benefitting from the fruits of his endeavors and self-fulfillment in his
chosen field.
e. Power. Some people enter business because they expect to rise up to
positions of social prestige, power and leadership. Successful businessmen
mostly entered politics to have drawn influence, authority and power.
f. Protection. Running a family business would likely ensure protection for the
generation of the clan. Protection may in securing the future of family
 members, the young ones in particular who would inherent the business
empire.

SOURCES OF CAPITAL
Capital refers to all items of value, whether owned or borrowed, used in business operation to
generate income. It also referred to the total productive assets which can be utilized to produce
or attain the desired business objectives. The two major sources of capital are: 1. Equity Capital
- owner’s investment or shared capital by the owners.
2. Borrowed Capital – are creditor’s capital either in cash or in kind. It is the most
substantial and expedient source of funds, but it entails higher cost of
financing.

WHY FIRMS INVEST AND BORROW

Business firms at one time or another, are confronted by the capital shortage or
deficiency. This happens when opportunities for additional investment and prospect for
business expansion come by and capital expenditures as well. When owners cannot provide
additional capital for the venture will resort to borrowings. Basically, businessmen invest to
maximize wealth and profits.

WHAT ARE FINANCIAL MARKETS

Financial Markets are structures through which funds flow. These institutions serves as a
medium and catalyst for channeling savings to investment. It further serves as financial conduits
in which direct and indirect financing activities are done. Financial markets provide a permanent
venue for savers and borrowers, and which render financial services whenever required by their
customers. These perform of meeting the investment (saver) and the needs of the end user.
Financial markets, therefore mobilize investible assets to liquidity towards a more productive
and beneficial purpose.
The efficient financial system should direct the bulk of the investment to the capital
markets— the sources and outlets for developmental funds, to finance capital expenditures for
the establishment of new ventures or the expansion of existing ones.

BENEFITS OF FINANCIAL MARKETS

The operation of financial markets for advantages such as:
1. Funds are directed from Surplus Spending Units (SSUs) to Deficit Spending
Units (DSUs) in which the latter can use them efficiently;
2. Liquidity is provided to savers or Surplus Spending Units (SSUs).
Deficit Spending Units (DSUs) include households, business firms, and government
bureaucracy that can use borrowed funds in the most productive manner and can afford to pay
higher interest rates.
Surplus Spending Units (SSUs) are savers and providers of funds for profits. Financial
markets provide liquidity to savers/SSUs. Without the intervention of financial markets, savers
will directly lend to borrowers, which in turn forces the lender to wait the maturity date of the
loan before he gets his money back. This problem is eliminated when financial markets are
tapped.
METHODS WHICH FINANCIAL MARKETS TRANSFER FUNDS
When firms used funds, the financial markets provide two methods by which funds could
be transferred to them— consist of direct and indirect finance.
1. Direct finance refers to lending by ultimate borrowers with no financial
intermediary. Under this method, the SSU gives money to DSU in exchange
for financial claims on the DSU. Direct financing provides SSUs with a venue
for savings with expected returns. On the other hand, DSUs are provided
with a source of funds for consumption or investment.
The following methods of direct financing are as follows:
a. Private placement, which refers to the selling of securities by private
negotiations directly to commercial banks, insurance company,
pension funds, mutual savings funds, corporate and individual
 investors.
b. Broker is one who acts as an intermediary between buyers and sellers
of securities on account of others.
c. Dealer is one who is in the security business acting as a principal rather
than an agent. A dealer buys securities for his own account and sells
the same for profit. Thus, a dealer can both play the role of a broker
and a dealer unlike a broker who always remains as broker/agent.
d. Investment banker is a person who provides financial advice and who
underwrites and distributes new investment securities.
2. Indirect finance refers to lending money by a lender to financial intermediary,
then relends to ultimate borrowers.

FINANCIAL INTERMEDIARIES
- includes commercial banks, mutual savings banks, credit unions, lending institutions,
contributes to the greater mobilization of investable funds and their channeling into meaningful
investment undertakings. Financial intermediary acts as the middleman or bridge that will
facilitate the flow of funds from SSU to DSU. Financial intermediation, therefore mobilizes those
funds lying idle in order to activate the productive capability of various corporations/investors.

Indirect Finance

1. Fund Borrowers-
Households Spenders (DSU)
2. Business
Financial
firms
3. Intermediaries 1. Business firms 2.
Government Government 3.
agencies Households
Lender-Savers (SSU) 4. Foreigners Fund 4. Foreigners

Fig. 1 Flow of
funds from lenders to borrowers with intermediary

The financial intermediaries may become SSUs when they relend to DSUs the funds that
lender-savers have invested upon them. The same situation that borrowers-spenders may also
become saver-SSU when they will relend the borrowed funds to ultimate
borrowers-DSU.

Direct Finance

SSU/Supplier of funds/Savers - Primary Securities

Households
Fund
- Business firms
- Gov’t agencies
DSU/User of funds/Borrowers -
- Foreigners
Households
- Issuing corporation - Business
firms
- Gov’t agencies
- Foreigners
 Fig. 2 Flow
of funds from lender to borrowers without intermediaries
CLASSIFICATION OF FINANCIAL MARKETS
Financial markets may be classified as follows:
1. Primary Market
2. Secondary Market
3. Money Market
4. Capital Market
5. Auction Market
6. Over-the-counter Market
7. Futures Market
8. Options Market
9. Negotiation Market
10. Foreign Exchange Market (FOREX)
11. Organized Market

1. Primary Market – is a financial market in which newly issued securities are traded
for the first time. Investors who buy these new issues are supplying funds to
DSUs which issue the securities, large corporations needing large amount of fuds
usually tap the primary market through bond issuance.

2. Secondary Market – is the financial market which existing and seasoned securities
are traded. SSUs which bought new securities from the primary market may sell
the same to the secondary market before maturity dates. As such, secondary
market provides liquidity to the SSUs with securities held.
The bank, as a financial intermediary, can create secondary securities that it can
sell. It can pool deposits to avail a bigger amounts that can be transformed or
created into secondary securities like loans, commercial papers or negotiable
certificate of deposits (NCD). Bank loan is a secondary security. For example, a
bank gives 4% interest rate to depositors, but charges the borrowers of 12%,
having the spread of 8%. A spread refers to the mark-up imposed upon the loan
transaction.

3. Money Market – is that financial market on which debt securities with maturity of
one year or less are traded. Banks are likewise perform the money market
functions.
Primary Market: New
Issues/Initial Public Offering

Investment Banker, Direct

Funds invested
New funds Placement, Broker, Dealer

New common
stock/bond Business
certificate
sector/Investor
Funds
Household
New stock and
bond certificate
Common stock and
bond certificate
 Common stock and Funds
bond certificate
Over-the-Counter
Market

Secondary Market: Seasoned or existing

securities

Stock Exchange and

sector,
corporation

Fig. 3 The flow

of funds and securities in the Primary and Secondary Markets

The Philippine government issues Treasury bills (T-bills) which mature in less
than one year, under respective tenors: a) 91-day; b) 182-day; and c) 364-day. T-bills are
sold at a discount (less than the principal), hence, the yield to the investor is the
difference between the purchase price and the principal.

4. Capital Market – is a market for securities (debt and equity) where business
enterprise and government can raise long-term funds, usually more than one
year. The main functions of capital markets include a) Raise capital for industry,
and b) Provide liquidity for financial instruments that trade
in a secondary market. It further mobilizes long term
savings to finance long term investments.
Capital market is subdivided in three parts:
a. the bond market – is a market of debt instruments of any kind.
b. the stock market – is a financial market where common and
preferred stocks are traded, and
c. the mortgage market – is a portion of financial market which
deals on real estate loans.

5. Auction Market – is one where trading is conducted by an independent third party

according to a matching of prices on order received to buy and sell a particular
security. At PSE, as an organized auction market, allows buyers and sellers of
securities make their bids and offers in the trading floor.

6. Over-the-Counter Market – is that market consisting of large collection brokers

and dealers, connected electronically by telephones and computers that provide
for trading in unlisted securities. All securities not traded in the stock exchange
are traded over the counter.

7. Futures Market – is that market where contracts are originated and traded that
give the holder the right to buy something in the future and a price specified by
the contract.

8. Options Market – is one where stock options are traded. A stock options is a
 contract giving the owner the rights to either buy or sell a fixed number of shares
of stock at any time before the expiration date at a price specified in the option.

9. Negotiation Market – exists when buyers and sellers of securities negotiate with
each other regarding price and volume either through a broker or dealer.

10. Foreign Exchanged Market (FOREX) – is the market where people buy and sell
foreign currencies.

11. Organized Market – are the exchanges that have physical location with definite
rules of trading governed by set of officers like PSE, NYSE, and many stock
exchanges around the world. Non-members cannot trade in the exchange.

A CORPORATION AS A FORM OF BUSINESS

Corporation is defined as an artificial being created by the operation of law having the
right of succession and the powers, attributes and properties expressly authorized by law or
incident to its existence.
Corporation is a complex business organization that dominates in various facets of
industry. It has salient characteristics as follows:
1. It is an artificial being. A corporation comes into its existence through a
creation of law having its own name and independent status separate from
its owners/stockholders. It becomes a juridical person with a separate legal
personality, which can sue and be sued in court in the name of the
Corporation.
2. Right of succession. By the provision of the Corporation and limited for 50
years subject for renewal. Shareholders and owner’s interest can be
relinquished through sell, donation on gift, inheritance through a last will
testament to serving spouse/children.
3. The Corporation organization is wide in scope.
4. The function of a corporation is public. It is that assumption for the creation of
a Corporation for the benefit of the society as it has vested with certain
public responsibilities, and
5. The basic structure of a Corporation is simple. It is composed of
stockholders/shareholders who are the owners of the Corporation, governed
by a Board of Directors as its policy-making body, and managed by corporate
officials of the Company.
Corporation has minimum of 11 but not more than 15 elected Members of
the Board of Directors.
6. Limited liability of the stockholders. Stockholders-owners are only liable to
the obligations of the Corporation limited to their interest/shareholders in
the firm.
Incorporators are those individuals who originally formed the Corporation and whose
names are reflected in the Articles of Incorporation and By-laws.

Fig. 4
Corporate Management Structure

Shareholders/stockholders

Elect

Board of Directors

Appoint
 President/CEO

A holding company is a Corporation organized not to operate any one enterprise

directly, but to own stocks and usually control two or more corporations. It may usually obtain
controlling interest by owning a majority (51% or more) of the shares. By securing a controlling
interest in two or more firms. The holding company is in a position to nominate the boards of
directors, link various business enterprise into an efficient and coordinated system, thus,
gaining the advantage of pooled resources and elimination of duplication.