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CHAPTER 1: Rationale in Studying Financial Markets and
Institutions
The Need To Study Financial Markets
1. Plays a vital role in the financial system
2. Involve huge flow of funds throughout the world
economy and economic well being of the countries
around the world
The Need To Study Financial Institutions
1. Financial institutions are financial intermediaries
that acquire funds by issuing liabilities and in turn use
those funds to acquire assets by purchasing
securities or making loans.
2. It reduces transaction costs, allowing sharing, and
solve problems and allow small savers and borrowers
to benefit from the existence of Financial markets,
increasing the efficiency of the economy
Approach in Studying Financial Markets and Institutions
a. Understanding - to understand economic analysis
and develop economic intuition they need to organize
concepts and facts.
b. Evaluating - to evaluate current developments and
the financial news and to use financial data and
economic analysis to think critically about how they
interpret current events.
c. Predicting - to use economic analysis to predict likely
changes in the economy and the financial system.
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CHAPTER 2: Introducing Money and Interest Rates
Role of Money in The Economy
Money is any item or commodity that is generally accepted as
a means of payment for goods and services or for repayment
of debt, and that serves as an asset to its holder. It is
composed of the bills and coins which have been printed or
minted by the National Government.
Characteristics and Key Functions of Money
1. Store of value - It acts as a means by which people
can store their wealth for future use. It can be stored
and transported easily.
2. Item of worth - It has an intrinsic value, such as that
of the precious metal that was used to make the coin.
3. Means of Exchange - It must be possible to
exchange money freely and widely for goods, and its
value should be as stable as possible.
4. Unit of account - It can be used to record wealth
possessed, traded or spent personally and nationally.
5. Standard of deferred payment - It is also useful
because of its ability to serve as a standard of
deferred payment.
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The Evolution of Money
Bartering - is known as a process in which people originally
traded surplus commodities with each other.
● Barter (10,000 - 3,000BCE) - the direct exchange of
goods, formed the basis of trade for thousands of
years, The Wealth of Nations, was one of the first to
identify it as a precursor to money - Adam Smith.
Advantage:
❏ Trading relationship
❏ Physical goods are exchanged
Disadvantage
❏ Market needed - parties must want the goods
❏ Hard to establish a set value on items
❏ Goods may not be easily divisible
❏ Large-scale transaction can be difficult
● Evidence of trade records (7,000BCE)
● Coinage (600 - 1,100BCE)
● Bank Notes (1,100 - 2,000BCE)
● Digital Money (2,000 onward)
Highlights in the History of Money in the Philippines
1. Pre-Spanish Regime - Philippine was already
trading with neighboring countries such as China,
Java and Macau by the use of barter. Commodity
money such as gold, gold dust, silver wires, coffee,
sugar rice, spices, carabao were used as money.
2. Spanish Regime - The Spanish introduced coins.
3. American Regime - The Philippine Peso was
introduced replacing Spanish-Filipino Peso.
4. Japanese Regime - The Japanese issued War Notes
and introduced mickey mouse money.
5. Post-War Period - in 2010, the Central bank
launched the New Generation Currency.
The Supply and Demand For Money
The Money Supply
The Key Measures for the Money Supply are:
M1 - The narrowest measure of the money supply. Refers
primarily to money used as a medium of exchange, it
includes currency in circulation held by the nonbank public,
demand deposits, other checkable deposits, and traveler's
checks.
M2 - Refers primarily to money used as a store of value. This
includes money held in savings deposits, money market
deposit accounts, institutional money market mutual funds
and other smarter money market assets.
M3 -Refers primarily to money used as a unit of account. It
includes financial institutions.
L - These measures include liquid and near-liquid assets like
short term treasury notes, high grade commercial papers and
bank acceptance notes.
The Bangko Sentral ng Pilipinas (BSP) is
responsible for determining the supply of money.
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The Demand For Money At the equilibrium interest

1. Transaction demand - money demanded for
day-to-day payment through balances held by
households and firms. it varies with gdp and not
depend on the rate of interest
2. Precautionary demand - money demanded as a
result of anticipated payments. varies with gdp
3. Speculative demand - money demanded because
of expectations about interest rates in the future
The rate of interest is the price paid in the money market for
the use of money.
The quantity theory of money
The quantity theory of money holds that changes in
the money supply MS directly influences the economy’s price
level.
Formula: M x V = P x Y
Where: M = quantity of money
V = velocity of money (the average number of times a
unit of money is used during a year to purchase GDP’s goods
and services)
P = price level
Y = real GDP
● The equation of exchange essentially states that
economies nominal gdp or expenditures equal the
money acted used in the economy.
● V is not affected by M
● Also Y is not affected by M
The Time Value of Money
● The interest is defined as the cause of using money
over time.
● The concept of present value based on the common
sense notion that a peso of cash flow paid to you one
year from now is less valuable to you than peso paid
to you today.
● Principal is the lender provides the borrower with an
amount of funds.
Interest Rates
From the viewpoint of a potential borrower, the
interest rate is the premium that must be paid in order to
acquire goods sooner and pay for them later.
rate, the quantity of fun borrowers
demand for investment and
consumption now rather than later
will just equal to the quantity of fund
lenders save.
According to Keynesian theory, the rate of interest is
determined as a price in two markets:
1. Investment funds - the rate of interest balances the
demand for fund and the supply of fund
2. Liquid assets - household and businesses may
have reason to hold as that in liquid form because
borrowers require cash in the long term and they are
willing to compensate lenders for giving up liquidity
The Nominal or Money Rate Versus The Real Rate of
Interest
Nominal or money rate - used when the inflation is
common, will recognize they are being repaid with pesos of
less purchasing power.
Real rate of interest - used during a period of inflation or
reduces the purchasing power of a loan's principal.
Rising prices means that, when the borrower repays the
principal in the future, it will not purchase as much as it would
have when the funds were initially loaned.
Interest Rates and Risk
The three component of money interest
1. The pure interest component is the real price one
must pay for earlier availability.
2. The inflationary premium component reflects the
expectation that loan will be repaired with pesos of
less purchasing power as the result of inflation
3. The risk premium component reflects the
probability of default ( the risk imposed on the lender
by there a possibility of the borrower may be unable
to repay the loan).
Risk Premium
Inflationary Premium
Pure Interest

How Interest Rates are Determined ---------------------------

Interest rates are determined by the demand for and
supply of loanable funds. Investors demand funds in order to
finance capital assets that they
believe will increase output and
generate profit.
CHAPTER 3: The Payment System: An Overview
Money facilitates transactions in the economy. The
mechanism for conducting such transactions is called a
payment system.

As the interest rate rises, the quantity The Transition From Commodity Money to Fiat Money
of funds supplied to the loanable ● Commodity money refers to a good used as money
funds market will increase. that has value independent of its use as money.

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● Fiat money refers to money, such as paper currency
that has no value apart from its use as money. bsp is
a fiat money system.
The Importance of Checks
Checks our promises to pay on demand money deposited
with a bank or other financial institution. they can be written
for any amount, and using them is a convenient way to settle
transactions.
New Technology and The Payments System
BSP has listed what is believed to be the five most
desirable outcome for a payments system:
1. Security - better security increases consumers' and
businesses' confidence that funds will not be stolen
electronically.
2. Efficiency - increasing the efficiency of the payment
system allows it to function using fewer workers and
computers, or other capital, which benefits the
economy.
3. Speed - fast settlement of payments facilitates
transaction by both households and businesses
4. Smooth international transactions - the increasing
amount of business that takes place across borders
can be facilitated if payments can be made quickly
and conveniently
5. Effective collaboration among participants in the
system - the payment system needs to efficiently
involve governments, financial firms such as banks,
and other businesses around the world.
Debit cards can be used like checks. Cash registers in
supermarkets and retail stores are linked to bank computers,
so when you use a debit card to buy groceries or other
products, your bank instantly credits the store's account with
the amount and deduct it from your account.
Proximity mobile payments - like apple pay and android
pay
Automated clearing house (ACH) - transactions include
direct deposits of payroll checks to the checking account of
workers and electronic payment on car loans and mortgages,
where the payments are sent electronically from the
borrower's account and deposited in the lender's account.
E-money or electronic money - which is digital cash people
used to buy goods and services like paypal services.
Bitcoin - are produced by people performing the complicated
calculations necessary to ensure that online purchases made
with bitcoins are legitimate, that is, that someone doesn't try
to spend the same bitcoin multiple times.
Buy and sell bitcoins in exchange for dollars and other
currencies on websites some people refer to it as a
cryptocurrency.
Despite the problems with bitcoin, the underlying technology
behind it, known as blockchain, has attracted interest from
both films and update attempt to increase the speed,
efficiency, and security of the payments system.
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Blockchain is technically a distributed ledger, or an online
network that registers ownership of funds, securities, or any
other good, rooting movies and songs.
Cashless society
Blockchain and other new payment technologies are
exciting and lead some commentators to predict a cashless
society.
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CHAPTER 4: Financial Instruments
Nature of Financial Instruments
● Financial instrument is any contract that gives rise
to a financial asset of one entity and a financial
liability or equity instrument of another entity.
● Contract refers to an agreement or more parties that
have clear economic consequences.
● Financial instruments include primarily instruments
and derivative financial instruments.
● Financial instruments include financial assets,
financial liabilities, equity instruments and derivatives.
Financial Assets
A financial asset is an asset that is a cash, equity
instrument of another entity like investment in ordinary shares
of a corporation, and receivables.
Financial instruments representing financial assets
A. Cash on hand and in banks
1. Petty cash - refers to cash balances kept on hand at
various locations to pay for mine on expenditures
2. Demand, savings and time deposits
3. Undeposited checks - are checks payable to the
enterprise or bearer but not yet represented to the
bank for payment
4. Foreign currencies
5. Money orders - are financial instruments similar to
backdrops but are drawn generally from authorized
post offices or other financial institutions
6. Bank drafts - are commitments by banking
institutions to advanced funds on demand by the
party to whom the draft was directed.
B. Accounts, notes and loans receivable an investment in
bonds and other debt instrument issued by other entities are
trade-receivables, promissory notes, bond certificates.
C. Interest in shares and other equity instruments issued by
other entities are a stock certificate and publicly listed
securities.
D. Derivative financial assets are future contracts, forward
contract, call option, foreign currency futures, and interest rate
swaps.
Financial Liabilities
A financial liability is any liability that is a contractual
obligation and a contract that will or may be settled in the
entity's own equity instruments.
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It may be:
● A non-derivative for which the entity is or may be
obliged to deliver a variable number of the entity's
own equity instrument.
● A derivative that will or may be settled other than by
the exchanging of a fixed amount of cash.
Examples of the liabilities are accounts and notes
payable, derivative financial liabilities, obligation to deliver
own shares worth a fixed amount of cash, some derivatives
on own equity instruments.
Equity Instruments
An equity instrument is any contract that evidence a
residual interest in the assets of an entity after deducting all of
its liabilities.
Examples of equity instruments are ordinary shares,
preference shares, and warrants.
Warrant or written call options that allow the holder to
subscribe or purchase ordinary shares and exchange for a
fixed amount of each or another financial asset.
Derivative Financial Instruments
Derivatives are financial instruments that derive their value
on the contractually required cash flow from some other
security or index.
Examples of derivatives
1. Futures contracts - is an agreement between a
seller and a buyer that requires that seller deliver a
particular commodity at a designated future date, at a
predetermined price.
2. Forward contracts - is similar to a futures contract
but differs in three ways:
● a forward contract calls for delivery on a specific date
● a forward usually is not traded on a market exchange
● a forward contract does not call for a daily cash
settlement for price changes in the underlying
contract
3. Call options - options give it holder the riot either to
buy or sell instrument
4. Foreign currency futures - foreign loans frequently
are denominated in the currency of the lender like
japanese yen and so on.
5. Interest rate swap - there are contracts to exchange
cash flows as of a specified date or a series of
specified dates based on a national amount and fixed
and floating rates.
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CHAPTER 5: Overview of the Financial System
Nature and Objective of The Financial System
Having a well functioning financial system in the place
that directs funds today our most productive uses is a crucial
prerequisite for economic development.
In direct finance, borrowers borrow funds directly from
the lender in the financial market by selling them security, also
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called financial instruments, which are claims on the
borrowers future income or asset.
Functions of The Financial System
The main task of the financial system is to channel
funds from sectors that have a surplus to sectors not having a
shortage of funds.
Economists believe there are three key services
that the financial system provide to savers and
borrowers:
1. Risk Sharing
● Risk is the chance that the value of financial assets
will exchange relative to what one expects.
● Diversification is a splitting of well into many asset
to reduce risk
● The financial system provides risk sharing by allowing
savers to hold many assets.
2. Liquidity
● It is the ease with which an asset can be exchanged
for money which savers view as a benefit.
● The financial system and increase the liquidity of
many assets besides stocks and bonds through the
process of securitization. This process has made it
possible to buy and sell securities based on loans.
3. Information
● Facts about borrowers and expectation of returns of
financial assets. Banks collect information on
borrowers to forecast their livelihood or repaying
loans.
The Problems of Adverse Selection and Moral Hazard
Asymmetric information describes the situation in
which one party to an economic transaction has better
information than those the other party.
Two problems arising from a symmetric information are:
1. Adverse selection - this is the problem investors
experienced in distinguishing low risk borrowers from
high risk borrowers before making an investment.
2. Moral hazard - this is the problem investors
experienced in verifying that borrowers are using their
funds as intended.
Nature and Impact of Transaction Information Costs
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● Transaction costs - the concept of trade or financial
transaction; for example, the brokerage commission
charged for buying and selling a financial asset.
● Information costs - the cost that savers incur to
determine the creditworthiness of borrowers and to
monitor how they use the funds acquired.
How Financial Intermediaries Reduce Adverse Selection
1. Requiring borrowers to disclose material information
on their financial performance and financial position.
2. Collecting information on firms and selling that
information to investors.
3. Convincing lenders to require borrowers to pledge
some of their assets as collateral which the lender
can claim of the borrower defaults.
How Financial Intermediaries Reduce Moral Hazard
Problem
1. Specialising in monitor maneuvers and developing
effective techniques to ensure that the funds they
loan are actually used for their intended purposes.
2. Imposing restrictive covenants - may involve place
in limitations on the uses of funds.
How Financial Intermediaries Reduce Transaction Costs
1. Financial intermediaries take advantage of
economies of scale which refers to the reduction in
average cost that result from an increase in the
volume of a good or service produced.
2. Take advantage of economies of skills in other ways
like they rely on standardized legal contracts.
3. Take advantage of technology to provide financial
services, such as those that automated teller machine
networks provide.
4. Increasingly rely on sophisticated software to
evaluate the creditworthiness of loan applicants.
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CHAPTER 6: The Philippine Financial System
Structure of The Philippine Financial System
I. Bangko Sentral ng Pilipinas
II. Banking Institution
A. Private Banking Institutions
1. Universal Bank or Expanded Commercial Bank -
is any commercial bank, which performs the
investment house function in addition to its
commercial banking authority.
2. Commercial Bank or Domestic Bank- is confined
only to commercial bank functions such as accepting
draft and issuing letters of credit, discounting and
negotiating promissory notes, draft and bills of
exchange, and other evidence of death, etc.
3. Thrift Banks - this includes savings and mortgage
banks, savings and loan associations and private
development banks.
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a. Stock Savings and Mortgage Bank - is any
corporation organized for the purpose of
accumulating the savings of depositors and investing
them in readily marketable bonds and bond
securities.
b. Private Development Bank - is a bank that
exercises all the powers and assumes all the
obligations of the savings and mortgage bank as
provided in the General Banking Act except as
otherwise stated.
c. Stock Savings and Loan Association - is any
corporation engaged in the business of accumulating
the savings of its members or stockholders and using
such accumulated funds insecurities of productive
enterprises.
4. Rural Banks - Is any bank authorized by the
central bank to accept deposits and make credit
available to farmers, businessmen and cottage
industries in the rural areas.
5. Cooperative Banks - are banks established to
assist the various cooperatives by lending those
funds at a reasonable interest rate.
B. Government Banks or Specialized Government
Banking Institution
1. Development Bank of the Philippines - provides
loan for developmental purposes, gives loan to the
agricultural sector, commercial sectors and the
industrial sector.
2. Land Bank of the Philippines - is a government
bank, which provides financial support in the
implementation of the Agrarian Reform Program of
the government.
3. Philippine Al-Amanah Islamic Investment Bank -
the Republic Act no. 6048 provides for the charter of
the Al-Amanah Islamic Investment Bank. This act
authorizes the bank to promote and accelerate the
socio-economic development of the Autonomous
Region of Muslim Mindanao by performing banking,
financing and investment operation.
III. Non-bank Financial Institutions
A. Private Non-bank Financial Institution
1. Investment House - s any enterprise, which engages
in underwriting securities of other corporations. It also
generates income from sales of investment in
securities.
2. Investment Banks - it differs from commercial banks
in that they do not take in deposits and until very
recently rarely length directly to the households. They
provide a device to firms issuing stocks and bonds or
considering mergers with other firms.
3. Financing Company - is any business enterprise
where the primary purpose is to extend credit facilities
to consumers and to industrial, commercial
agricultural entities as either by discounting or
factoring commercial papers or accounts.
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4. Securities Dealer - is any person or entity engaged
in the business of buying and selling securities for his
own or its client's account thereby making a profit
from the difference between the purchase price and
selling price of securities.
5. Savings and Loans Associations - which have
traditionally served individual savers and residential
and commercial mortgage borrowers, accumulate the
funds of many small savers and then lend this money
to home buyers and other types of borrowers.
6. Mutual Funds - are corporations which accept
money for savers and use these funds to buy stocks,
long-term bonds, are short term debt instruments
issued by businesses or government units.
7. Pawnshops - refer to persons or entities engaged in
the business of lending money with personal property,
jewelry, and other durable goods as collateral for the
loan given.
8. Lending Investor - is any person or entity engaged
in the business of effecting securities transactions,
giving loans and earning interest from them.
9. Pension Funds - are retirement plans funded by
corporations or government agencies for their
workers and administered primarily by the thrust
departments of commercial banks or by life insurance
companies.
10. Insurance Companies - take savings in the form of
annual premiums, then invest these funds in stocks,
bonds, real estate, and mortgages, and finally make
payments to the beneficiaries of the insured parties.
11. Credit Unions - are cooperative associations whose
members have a common bond, such as being
employees of the same firm.
B. Government Non-bank Financial Institutions
1. Government Service Insurance System (GSiS) -
Provides retirement benefits, housing loans, personal
loans, emergency and calamity loans to government
employees.
2. Social Security System (SSS) - provides retirement
benefits, funnel benefits, housing loans, personal
loans and calamity loans to the employees who are
working in private companies and offers.
3. Home Development Mutual Fund (Pag-IBIG Fund)
- provides housing loans to both government and
private employees.
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CHAPTER 7: Financial Markets: An Overview
Financial markets are the meeting place for people,
corporations and institutions that either need money or have
money to lend or invest.
● Public financial markets include national, state and
local government that are primarily borrowers of
funds for highways, education, welfare etc.
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● Corporate financial markets are large companies
that raise funds.
Function of Financial Markets
Financial markets, bond and stock markets, and
financial intermediaries, banks, insurance companies among
others, have the basic function of getting people together by
moving funds from those who have a surplus of funds to
those who have a shortage of funds.
What Financial Markets Do
1. Raising capital - to require funds to build new
facilities, replace machinery or expand their business
in other ways.
2. Commercial transactions - the financial markets
provide the grease that makes many commercial
transactions possible.
3. Price setting - market provides price discovery, a
way to determine the relative values of different items
in market values.
4. Asset valuation - market prices offered the best way
to determine the value of a firm or of the firm's asset
or property.
5. Arbitrage - financial markets attempt to profit from
these divergences, prices move towards a uniform
level, making the entire economy more efficient.
6. Investing - markets provide an opportunity to earn a
return of funds that are not needed immediately, and
to accumulate as at that will provide an income in
future.
7. Risk management - futures, options and other
derivatives contracts can provide protection against
many types of risk.
Primary and Secondary markets for debt and equity
securities
1. Primary market refers to original sale of securities by
governments and corporations. The primary market
for securities is not well known to the public because
the selling of securities to initially buyers often takes
place behind closed doors.
2. After the security that is sold to the public, institutions
and individuals, they can be traded in the secondary
market between investors. It is popularly known as a
Stock market or exchange.
● brokers are agents of investors who match buyers
but sellers or securities.
● dealers link buyers and sellers by buying and selling
securities are stated prices.
Two Broad Segments of The Stock Markets
1. The organized stock exchange - the stock
exchanges will have a physical location where stock
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buying and selling transaction take place, example
pse
2. The over the counter exchange - where shares,
bond and money market instruments are traded using
a system of computer screens and telephones.
Stock Exchange
● Stock exchange is an organized secondary market
for securities like shares, debentures of public
companies, government securities and bonds issued
by municipalities, public corporations, utility
undertakings, port trusts and such other local
authorities are purchased and sold.
● The purpose of stock exchange is to facilitate the
exchange of securities between buyers and sellers,
providing a marketplace, virtual for real.
● Trading ring is a place where share brokers may be
assembled, bought and sold shares.
● Listing agreement regulates the company's behavior
through requirements agreed upon by the company in
order to be listed.
Day trading is the buying and selling of shares,
currency, or other financial instruments in a single day.
Potential day traders should knowledgeable of the
following:
● Market data - the current trading information for each
day-trading market.
● Scalping - a strategy in which traders hold their
shares or financial assets for just a few minutes or
even seconds.
● Margin trading - a method of buying shares that
involves the day trader borrow being a part of the
sum needed from the broker who is executing the
transaction.
● Bid-offer spread - the difference between a price at
which a share is sold, and that to which it is bought.
Potential Day Trader Should Be Aware That:
1. day trading is a higher risk occupation
2. day trading is a stressful
3. day trading is expensive
The Rise of The Formal Markets
Important attributes that the smaller markets often lack:
● Liquidity - the ease with which trading can be
conducted.
● Transparency - the availability of prompt and
complete information about rates and prices.
● Reliability - when it comes to ensuring the traders
are completed quickly according to the term agreed.
● Legal procedures - adequate to settle disputes and
enforce contracts.
● Suitable investor protection and regulation -
excessive regulation can stifle a market.
● Lower transaction costs
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The Forces of Change
1. Technology
2. Deregulation
3. Liberalization
4. Consolidation
5. Globalization
CHAPTER 8: Money Market and Capital Market
Money market refers to the network of corporations,
financial institutions, investors and governments which deal
with the flow of short-term capital.
Disintermediation is the process referred to general
outflow of money from the banking industry.
How it Works
● The money markets used to provide the loans that
financial institutions and governments need to their
day to day operations.
● The money markets are the mechanisms that bring
these borrowers and investors together without the
comparatively costly intermediation of banks.
Who uses the money market?
● Companies - if companies need to raise money to
cover their operating expenses.
● Banks - banks maiden issue certificates of deposit
when demand for long-term loans and mortgages is
not covered by deposits from savings accounts.
● Investors - anyone who is seeking to invest large
sums of money at relatively low risk may have money
market funds.
What Money Markets Do
● The money markets are thus related to the bond
markets, in which corporations and governments
borrow and lend based on longer-term contracts.
● Similar to bond investors, money market investors are
extending credit, without taking any ownership in the
borrowing entity or any control over management.
Types of Money Market Instruments
Money market securities are short-term instrument
with an original maturity of less than one year.
1. Commercial paper - is a short-term debt obligation
of a private sector firm or a government-sponsored
corporation. The paper has a lifetime, or maturity
greater than 90 days but less than 9 months.
2. Bankers' acceptances - is a promissory note issued
by a non financial firm to a bank in return for a loan.
The bank resells the note in the money market at a
discount and guarantees payment. acceptances
usually have a maturity of less than 6 months.
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3. Treasury bill - open referred to as T-bills, are
securities with maturity of one year or less, issued by
national governments.
4. Government agency notes - these include entities
such as development banks, housing finance
corporations, education lending agencies, and
agricultural finance agencies.
5. Local government notes - are issued by provincial
or local governments, and by agencies of these
governments such as a schools securities and
transport commissions.
6. Interbank loans - these are loans extended from
one bank to another with which it has no affiliation.
7. Time deposit - another name for certificates of
deposit or CDs, are interest bearing bank deposits
that cannot be withdrawn without penalty before a
specified date.
8. Repos - repurchase agreement known as repos,
they serve to keep the markets highly liquid, which in
turn ensures that there will be a constant supply of
buyers for new money market instruments.
Capital Markets
The capital market is a financial market in which
longer- term debt, originally maturity of one year or greater,
and equity instruments are traded. capital market securities
include bonds, stocks and mortgages.
Capital Market Participants
1. The national government issues long term notes
and bonds to fund the national government issue
notes and bonds to finance capital projects.
2. The corporations issue both bonds and stuff to
finance capital investment expenditures and fund
other investment opportunities.
A. Bonds
A bond is any long term promissory note issued by
the firm. A bond certificate is tangible evidence of debt
issued by a corporation or a governmental body and
represents a loan made by investors to the issuer.
Trading Process for Corporate Bonds
Features of Corporate Bonds
1. Par Value - The face value of the bond is returned to
the bondholder at maturity.
2. Coupon Interest Rate - The percentage of the par
value of the bond that will be paid out annually in the
form of interest.
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3. Maturity - The length of time until the bond issuer
returns the par value to the bondholder and
terminates the bond.
4. Indenture - The agreement between the firm issuing
the bonds and the bond trustee who represents the
bondholders. It provides the specific terms of the loan
agreement, including the description of the bonds, the
right of the bondholders, the right of the issuing firm
and responsibilities of the trustees.
5. Current Yield - This refers to the ratio of the annual
interest payment to the bond's market price.
6. Yield to Maturity - This refers to the bond's internal
rate of return. It is the discount rate that equates the
present value of the interest and the principal
payments with the current market price of the bonds.
7. Credit quality risk is the chance that the bond issuer
will not be able to make timely payments.
Bond ratings involve a judgment about their future
risk potential of the bond provided by rating agencies
such as Moody's, Standard and Poor's and Fitch
IBCA, inc. bond ratings are a favorably affected by:
a. a low utilization of financial leverage
b. profitable operations
c. a low variability of past earnings
d. large firm size
e. little use of subordinated debt
Credit Ratings
1. Credit Risk: Highest Quality
Credit Rating: AAA
Description: The obligor's or issuer's capacity to meet
its financial commitment on the obligation is
extremely strong.
2. Credit Risk: High Quality
Credit Rating: AA
Description: The obligor's or issuer's capacity to meet
its financial commitment on the obligation is very
strong.
3. Credit Risk: Upper Medium Grade
Credit Rating: A
Description: The obligor's or issuer's capacity to meet
its financial commitment on the obligation is still
strong, though somewhat susceptible to the adverse
effect of changes in circumstances and economic
conditions.
4. Credit Risk: Medium Grade
Credit Rating: BBB
Description: The obligator exhibits adequate
protection. However, adverse economic conditions or
changing circumstances are more likely to lead a
weakened capacity to meet its financial commitment.
Types of Bonds
A. Unsecured Long-Term Bonds
1. Debentures - These are unsecured long term debt
and backed only by the reputation And financial
instability of the corporation.
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2. Subordinated Debentures - Claims of bondholders
of subordinated debentures are honored only after
the claims of the secured debt and unsubordinated
debentures have been satisfied.
3. Income Bonds - It requires interest payment only if
earned and non payment of interest does not lead to
bankruptcy.
B. Secured Long-Term Bonds
1. Mortgage Bonds - It is a bond secured by a lien on
real property. Typically, the market value of the real
property is greater than that of the mortgage bonds
issued.
a. First Mortgage Bonds - the first mortgage bonds
have been the senior claim on the secured asset if
the same property has been pledged on more than
one mortgage bond.
b. Second Mortgage Bonds - These bonds have the
second claim on assets and are paid only after the
claims of the first mortgage bond have been satisfied.
c. Blanket or General Mortgage Bonds - All the
assets of the firm are used as security for this type of
bonds.
d. Closed-end Mortgage Bonds - The closed-end
mortgage bonds for being the further use of the
pledge as a security for other bonds.
e. Open-end Mortgage Bonds - These bonds allow the
issuance of additional mortgage bonds using the
same secured assets as security. However, a
restriction may be placed upon the borrower,
requiring that additional assets should be added to
the secured property if new debt is issued.
f. Limited Open-end Mortgage Bonds - These bonds
allowed the issuance of additional bonds up to a
limited amount at the same priority level using the
already mortgaged assets as security.
Other Types of Bonds
1. Floating rate or variable rate bonds - is one in
which the interest payment changes with market
conditions.
2. Junk or low rated bonds - are bonds rated bb or
below. The major participants of this market are new
firms that do not have an established record
performance.
3. Eurobonds - are bonds payable or denominated in
borrower's currency, but sold outside the country of
the borrower, usually buy an international syndicate of
investment bankers.
4. Treasury bonds - carry the full-faith-and-credit
backing of the government and investors considering
them among the safest fixed income investment in
the world.
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CHAPTER 9: Foreign Exchange Market
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● Devaluation is a major adjustment in the exchange
rate by changing the parity rate with respect to the
dollar.
● An upvaluation or revelation resulted when a currency
became more expensive with respect to the dollar.
● Determination of exchange rate influenced by such
important factors
a. the country's economic strength
b. it's level of exports and imports
c. the level of monetary activity
d. the deficit or surplus as in the balances of
payments
The Foreign Currency Exchange Market
● The forex market provides a service to individuals,
businesses, and governments who need to buy or sell
currencies other than that used in their country.
● The foreign exchange market provides a
mechanism for the transfer of purchasing power from
one country to another.
Exchange Rates
● An exchange rate is simply the price of one country's
currency expressed in terms of another country's
currency. In industry practice, almost all trading
currencies take place in terms of the US dollars.
Why are Exchange Rates Important?
● It serves as the basic link between the local and the
overseas market for various goods, services and
financial assets. Using the exchange rate, we are
able to compare prices of goods, services, and assets
quoted in different currencies.
● The exchange rates are important as it can affect the
relative price of domestic and foreign goods.
Factors Influencing Exchange Rates
1. Inflation - when it tends to deflate the value of a
currency.
2. Interest Rates - if interest returns in a particular
country are higher relative to the other countries.
3. Balance of Payments - it refers to a system of
account that catalogs flow of goods between the
residence of two countries.
4. Government Intervention - the central bank the
country may have intervention to support or
depressed the value of its current.
5. Other Factors - other factors that may affect
exchange rate are political and economic stability,
extended stock market rallies and significant declines
in the demand for major exports.
A managed float is the current method of exchange
rate denomination.
Theory of Purchasing Power Parity
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It states that the exchange rate between any two
currencies will adjust to reflect changes in the price level of
the two countries. The theory of ppp is simply an application
of the law of one price to national price levels.
The two kinds of foreign exchange rate transactions
1. Spot transactions are those which involve
immediate to-day exchange of bank deposits. The
spot exchange rate is the exchange rate for the spot
transactions.
2. Forward transactions involve the exchange of bank
deposits at some specific future date. The forward
exchange rate is the change rate for the forward
transaction.
Foreign exchange risk refers to the possibility of a
drop in revenue or an increase in cost in an international
transaction due to a change in foreign exchange rates.
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CHAPTER 10: The Mortgage Markets and Derivatives
Mortgage markets, where borrowers - individual
businesses and governments can obtain long-term
collateralized loans.
Mortgages are long term loans secured by real
estate. Both individuals and businesses obtain mortgages
loans to finance real estate purchases.
Characteristics of The Residential Mortgage
A. Mortgage Interest Rates
Three important factors that affects the interest rate on
the loan:
1. Current long-term market rates - market rates tend
to stay above the less risky treasury bonds most of
the time but tend to track along with them.
2. Term or life of the mortgage - long term mortgages
have higher interest rates than short-term mortgages.
the usual mortgage life is 15 or 30 years.
3. Number of discount points paid - discount points
are interest payments made at a beginning of a loan.
B. Long Terms - mortgage loan contracts contain many legal
and financial terms, most which protects the lenders from
financial loss.
C. Collateral - one characteristic common to mortgage loans
is the requirement that collateral, usually the real estate being
financed, be pledged as security.
D. Down Payment - the lender also requires the borrower to
make down payment on the property.
E. Private Mortgage Insurance (PMI) - is an insurance
policy that guarantees as to make up any discrepancy
between the value of the property and the loan amount,
should a default occur.
F. Borrower qualification - the lender will determine
whether the borrower qualifies for it.
Amortization of Mortgage Loan
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Fully amortized - means that the payment will pay
off the outstanding indebtedness by the time the loan
matures.
Types of Mortgage Loan
1. Conventional Mortgage - loan is not guaranteed;
usually requires private mortgage insurance; 5%-
20% down payment
2. Insured mortgage - loan is guaranteed by FHA or
VA; low or zero down payment
3. Adjustable-rate mortgage (ARM) - interest rate is
tied to some other security and is adjusted
periodically; size of adjustment is subject to annual
limits
4. Graduated-payment mortgage (GPM) - initial law
payment increases each year; loan usually amortizes
in 30 years.
5. Growing-equity mortgage (GEM) - initial payment
increases each year; loan amortizes in less than 30
years.
6. Shared-appreciation mortgage - in exchange for
providing a low interest rate, the lender shares in any
appreciation you of the real estate
7. Equity participation mortgage - in exchange for
being a portion of the down payment or for
supplementing the monthly payments, an outside
investor shares in an appreciation in value of the real
estate.
8. Second mortgage - long is secured by a second lien
against does real estate; open used for line of credit
or home improvement loans.
9. Reverse annuity mortgage - lenders disburses a
monthly payment to the borrower on an
increasing-balance loan; loan comes due when the
real estate is sold.
Securitization of Mortgages
● Mortgage-backed security is a security that is
collateralized by a pool of mortgage loans. This is
also known as security mortgage.
● Securitization is the process of transforming illiquid
financial assets into marketable capital market
instruments.
● Mortgage pass-through, the most common type of
mortgage backed security, is security that has the
borrower's mortgage passed through the trustee
before being disbursed to the investors in the
mortgage pass through.
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CHAPTER 11: Internationalization of Financial Markets
Cross-border Measure
Another way of measuring the growth of finance is to
examine the value of cross border financing. Cross border
finance is by no means new, and at various times in the past it
has been quite large relative to the size of the world economy.