FINANCIAL SYSTEMS

AND THE
FINANCIAL MARKET
FINANCIAL
SYSTEMS
 Financial management
is an important process
to ensure that profit and
wealth is maximized.
What are the different
sources of wealth?
THE ORIGIN OF WEALTH
 WHAT IS

FINANCE?
 WHAT IS

FINANCE?
- Came from the French
word “finer” which means “to
end and settle a debt”
 WHAT IS

FINANCE?
- the application of economic
principles to decision-making
that involves the allocation of
money under conditions of
 Finance provides the
framework for making the
decisions as to how those
funds should be obtained
and then invested.
The theoretical foundations of finance
draw from the field of economics that’s
why finance is often referred to as
financial economics.
However, tools used in financial
decision-making comes from outside
the field of economics:
The study of capital markets
focuses on three key areas:
- The financial systems
- Structure of interest rates
- Pricing of assets
 WHAT IS

FINANCIAL
SYSTEM?
Financial system allows
households, companies, and
the government who have
available funds to invest
these funds in more
potentially productive vehicles
 WHAT IS
FINANCIAL SYSTEM?
- It is the financial system that
provided the platform by which
funds are transferred from those
entities that have funds to invest
to those entities that need funds
The difference in spending is the main
reason for the existence of a financial
system.
• Fund providers
• Fund demanders
Financial systems serve as a regular,
time-efficient, and cost-effective link
between fund providers and fund
demanders.
Funds can flow from lender-savers to the
borrower-spenders in two routes:
• Direct Financing
• Indirect Financing
Direct Financing
• The borrower-spenders
borrow and deal directly with
lenders through selling
financial instruments.
indirect Financing
• The borrowing activity
between both parties still
happens though indirectly
through the intervention of a
 WHAT are the
importance of
financial
systems?
1. The transfer of funds
from providers to
demanders allows both
parties to gain some
return.
2. Important for the growth
of the economy
3. It enhances welfare of
individual consumers as they
have immediate access to
funds allowing them to
purchase things as they
prefer.
 WHAT are the
elements of
financial
systems?
• Lenders and borrowers
• Financial intermediaries
• Financial Instruments
• Financial Markets
• Regulatory environment
• Money creation
• Price discovery
• Lenders and borrowers
- Also known as the fund providers and
fund demanders
- These are the most essential
stakeholders that make up the foundation
of a transaction in the financial system.
 are parties that have
excess funds that they can lend out
to other entities for a required return
are parties who are
willing to pay the required return to
obtain additional funds to finance
• Lenders and borrowers
• Financial intermediaries
• Financial Instruments
• Financial Markets
• Regulatory environment
• Money creation
• Price discovery
• Financial intermediaries
- These are the special type of financial
entity that acts as a third party to facilitate
the borrowing activity between lenders and
borrowers.
- They gather funds from lenders and
then redistribute it to borrowers through an
investment vehicle like loan.
• Lenders and borrowers
• Financial intermediaries
• Financial Instruments
• Financial Markets
• Regulatory environment
• Money creation
• Price discovery
• Financial Instruments
- These are the medium of exchange of
contractual obligation of a party, where
such contract can be traded.
- According to IFRS, financial
instruments is a contract where a party
recognize it as an asset and another is a
liability.
There are two types of financial
instruments:
• Cash
• Derivative financial instruments
• Lenders and borrowers
• Financial intermediaries
• Financial Instruments
• Financial Markets
• Regulatory environment
• Money creation
• Price discovery
• Financial Markets
- This is the same with the other
economic markets where suppliers and
buyers of financial instruments meet.
There are two types of financial
markets depending on the
instruments that are being traded:
• Money market
• Capital market
• Lenders and borrowers
• Financial intermediaries
• Financial Instruments
• Financial Markets
• Regulatory environment
• Money creation
• Price discovery
• Regulatory environment
- This is the governance body to ensure
that the transactions that occur within the
financial system complies with the laws and
regulations imposed to the actors as well
as the elements that plays within the
systems.
Financial systems are normally regulated
by Central banks.
• Lenders and borrowers
• Financial intermediaries
• Financial Instruments
• Financial Markets
• Regulatory environment
• Money creation
• Price discovery
• Money creation
- Money is used to either be reinvested
or earned out from the system flows.
- The money as it was given value out
of the financial transactions because of the
exchange that occurred in the system may
be converted into another form.
• Lenders and borrowers
• Financial intermediaries
• Financial Instruments
• Financial Markets
• Regulatory environment
• Money creation
• Price discovery
• Price discovery
- This is the process of determining
or valuing the financial instrument in
the market.
The price is normally driven by the level
of risk on how the issuer of the financial
instrument.
FINANCIAL
MARKETS
 WHAT IS

FINANCial
market?
 WHAT IS

FINANCial market?
• channels or places where
funds and financial
instruments are exchanged
between willing individuals
and/or entities
 WHAT IS

FINANCial market?
• Stocks
• Bonds
• Other Securities
• Intend to establish a consistent,
efficient and cost-effective bridge
between fund providers and fund
demanders

• Additional options to lenders and

borrowers with a use of financial market
 Trading

• Exchanging financial instruments

–New York Exchange
–Philippine Stock Exchange (PSE)
 Primary market

economic
functions
 Price
Discovery
• Agreement between two parties in
determining price of Financial
Instruments
• It determines how the available funds
from the fund providers are allocated
towards the fund demanders based on
its willingness to accept the return
required by fund providers
 Liquidity

• From Financial Instruments of

investors into Cash
1. Debt Instruments – maturity date
2. Equity Instruments –
voluntary/involuntary liquidation
 Reduction In
Transaction Costs
• Costs incurred by parties’ transaction
to trade financial instruments
 TRANSACTION
COSTS

SEARCH INFORMATION
COSTS COSTS
Explict Implict
Costs Costs
 Types
Based on
INSTRUMENTS
TRADED
 Money Market

• The sector of the financial system where

financial instruments that will mature or be
redeemed in one year or less from the
issuance date are traded.
• Long-term investors also need the money
market as they tend to invest in this market to
meet their short-term liquidity needs.
 Money Market

• Money Market instruments are very

liquid and easily convertible to cash
and has very little default risk
because of associated short maturity
term
 Capital Market
• The sector of the financial markets where
financial instruments issued by governments
an corporations that will mature beyond one
year from issuance date are traded.
• It encompasses with longer than one year
with maturity and perpetual securities (no
maturity)
 Capital Market

• Foundation that is made by Dealer

and Broker Market
• Capital Market as Equity and Debt
 Types
Based on MARKET
TYPE
 PRIMARY MARKET

• Fund demanders such as

corporation or a government
agency raise funds through new
issuances of financial
instruments.
• Non-negotiable instruments are
issued only in primary markets
 PRIMARY MARKET

• Primary markets are coursed

through investment banks
which are financial institutions
that act as intermediaries.
Transactions in the primary
market can be classified based
on the intended purchasers of
the securities.
 Types of

issue
methods
 Public Offering

• Securities are offered for sale to the

general public
• The IPO (Initial Public Offering)
• The works given to Underwriters.
 Private Placement
(Limited Public Officer)
• when the issuer looks for single
investor, an institutional buyer or group
of buyers to purchase the securities
instead of offering to the general
public.
 Auction

a. Dutch auction
- the seller begins the sale at a
high price
B. english auction
- prospective buyers submit an
 Auction

c. Descending Price Sealed Auction

– Bidders submit their sealed
bids to the seller and the price
will be arrange in descending
order.
 Tap Issue
• issuers are open to receive bids for
their securities at all times. Issuer
maintain the right to accept or reject
the bid prices based on their how much
fund they need, when they need the
fund and what is their outlook of the
 SECONDARY MARKET
• refers to the market wherein
the securities issued in
primary market are
subsequently traded i.e.
resold and repurchased
(secondhand)
SECONDARY MARKET
SECONDARY SECONDARY
MARKET MARKET
BUYERS SELLERS

Household, businesses and governments who

Have excess Are in need of

funds funds
Secondary markets

economic
functions
 LIQUIDITY AND
PRICE DISCOVERY
REDUCTION
IN• Allows
BORROWING
• information active
COSTtrading which
about prices improves
of the liquidity and
securities marketability
of the
traded securities
Support to the primary market

• Helpful in setting prices for

new issuances executed in
the primary market
• Assessing receptiveness of
the market for new
issuances
Implementation of
monetary policy

• Allows regulators such as

the BSP to trade securities
to influence liquidity and
interest rates set in the
financial system
BENEFITS
 investors

gives them the opportunity to sell

securities at fair market value if they
need cash or purchase additional
securities that have differing risk and
return characteristics to diversify their
portfolio
 issuers

GIVES AN IDEA HOW MUCH IS THE

FAIR MARKET VALUE OF THEIR
FINANCIAL INSTRUMENTS, HOW
WELL THEY ARE USING THE FUNDS
AND HOW MUCH CAN SUBSEQUENT
DEBTS OR EQUITY ISSUANCES
Classifications
Based on market
structure
 Order-driven
(Auction Market)
• the buyers and sellers propose their
price through their brokers who
conveys the bid in centralized location
• The price is then matched and the
transaction is consummated.
Market orders
• orders placed with broker-
dealers with the instruction
to execute transaction at the
prevailing best market price.
limit orders
• orders placed where clients
set a price or price range that
may be below/above the
existing price
Day orders
• orders placed that only valid
until the end of the business
day. All orders not executed at
the end of day are cancelled
and removed from the system.
Good-until-cancelled orders
• orders placed that remains
valid for sustained period up
until the client voluntarily
cancels and remove these
 Quote- driven

• Also called as primary dealer

markets, professional markets or market-
made markets.
• The market makers set a bid quote
(to buy) and offer quote (to sell)
 Quote- driven
• The difference between bid quote
and offer quote is called “spread”, inures
to the benefit of the market makers as
profit.
• Spread is important as it represents
the transactional costs of trading and
Classifications
Based on where
the financial
instruments are
traded
 Exchange
(or formalized)
centralized trading locations where
financial instruments are purchased or
sold between market participants
 Exchange
(or formalized)
• In order to be traded, all financial
instruments should be listed by organized
exchange.
• All financial instruments should
comply with the regulations set forth by
 Over-the-Counter
(or informal)
where unlisted financial instruments are
allowed to be traded, in addition to listed
financial instruments.
• OTC markets can also be done in
computers
 Over-the-Counter
(or informal)
• OTC markets are very competitive
since all parties are aware of how price
are set for each available security.
 Classifications
Based on country’s
perspective
 Internal or
National Market
Refers to the financial market operating
in a certain country.
domestic markets
• refers to the market where
issuers who are considered
residents in a country issue the
securities and where these
securities are traded afterwards.
Foreign markets
• where issuers who are not
residents of a country can
sell or issue securities and
subsequently traded.
 External Market

refers to the financial market where

securities that have two unique
characteristics are being traded.
• international market, offshore market
and Euromarkets
 External Market
a. Upon issuances, these securities
are offered simultaneously to investor in
different countries
b. Securities are issued outside the
regulatory jurisdiction of any single
country.
Classifications
Based on manner
of Financial
Intermediaries
 Broker Market
the buyer and seller of the securities are
brought together by a broker and the
trade occurs at that point. (Ex: pse)
• Broker market is usually composed
of national and regional securities
exchanges
 Dealer Market

the buyer and seller are not brought

directly together by a third party. Instead,
Market Makers execute the sell or buy
orders.
 Dealer Market

Dealer Markets do not have centralized

trading floors as compared with
exchanges. Dealer markets consist of
many market makers that are connected
through it mass telecommunications
network.