CHAPTER 1

FINANCIAL SYSTEMS AND

THE FINANCIAL MARKET
THE FINANCIAL SYSTEM

In the world of commerce, finance is the key player in ensuring continuity of

operations. As they say, it is the life-blood of the company. Being the life-
blood, the management must ensure that its continuous flow is maximize.
Hence, financial management is an important process to ensure that profit and
wealth is maximized.
SOURCES OF WEALTH

• Labor – Salaries and Wages

• Land – Rent
• Capital – Interest
• Entrepreneurship - Profit
FINANCE

• It is the application of of economic principles to decision making that

involves the allocation of money under conditions of uncertainty
• It provides the framework for making decisions as to how those funds should
be obtained and then be invested.
• Finance is often referred to as financial economics.
FINANCE
came from the French word
“finer” which means to “end
and settle a debt”.
FINANCIAL SYSTEM

• It allows households, companies and government who have available funds

to invest these funds in more potentially productive vehicles that can result in
faster growth in economy.
• It encourages fund savings from its stakeholders and transform these savings
efficiently into investment vehicles that help the economy grow faster.
FINANCIAL SYSTEM

• “FINANCIAL SYSTEM is a set of arrangements or conventions embracing

the lending and borrowing of funds by non-financial economic units and the
intermediation of this function by financial intermediaries in order to
facilitate the transfer of funds, to create additional money when required, and
to create markets in debt and equity instruments (and their derivatives) so
that the price and allocation of funds are determined efficiently” – Faure AP
Who are Fund Providers?
They are households, companies and
government agencies who have
available funds because they spend
less than their income.
Who are Fund Demanders?
They are households, companies and
government agencies who have fund
shortage because of deciding to spend
more than their income.
Matching the difference in spending (excess
funds from one party to the fund gap of
another party ) is the main reason of the
existence of FINANCIAL SYSTEM.
FINANCIAL SYSTEMS serve as a regular,
time efficient and cost-effective link
between fund providers and fund
demanders.
DIRECT AND
INDIRECT
FINANCING
DIRECT FINANCING
In this route, the borrower-spenders borrow and deal
directly with lenders through selling financial instruments
(or securities). Financial instruments represent claims on
the future income or assets of the borrower. Borrowers
recognize financial liabilities while lenders recognize
these as an asset. Buying stocks directly from the
company is also considered as direct financing.
INDIRECT FINANCING
In this route, the borrowing activity between both
parties still happens though indirectly through the
intervention of a financial intermediary.
FINANCI
AL
SYSTEM

This Photo by Unknown Author is licensed under CC BY-SA

FINANCIAL
INSTRUMEN
TS
This Photo by Unknown Author is licensed under CC BY-SA-NC
 COMMERCIAL
PAPERS

• is an unsecured, short-term debt

instrument issued by a
corporation, typically for the
financing of accounts payable
and inventories and meeting
short-term liabilities. Maturities
on commercial paper rarely
range longer than 270 days.
 TREASURY
BILLS
• a short-dated
government security,
yielding no interest
but issued at a
discount on its
redemption price. This Photo by Unknown Author is licensed under CC BY-SA-NC
ELEMENTS OF FINANCIAL SYSTEM

1. Lenders and Borrowers (who are the players?)

2. Financial Intermediaries (How will the exchange occur?)
3. Financial Instruments (what will be used?) (it could be cash or
cash derivative financial instruments)
4. Financial Markets (where will it be traded?) (money market or
capital market)
5. Regulatory Environment (How it is controlled)
ELEMENTS OF FINANCIAL SYSTEM

5. Regulatory Environment (How it is controlled?) (BSP)

6. Money Creation (what is the value it creates?)
7. Price Discovery ( How much is created?)
-It is the process of determining or valuing the financial
instrument in the market.
FINANCIAL
MARKETS

• Refers to channels or
places where funds and
financial instruments
such as stocks, bonds,
and other securities are
exchanged between
willing
individuals/entities.
Exchanging of
financial instruments
is commonly known as
“trading”. Popular
examples of financial
markets are New York
Stocks Exchange and
Philippine Stocks
Exchange (PSE)
THREE MAJOR ECONOMIC FUNCTIONS OF
FINANCIAL MARKET

1. PRICE DISCOVERY – interaction between a seller and the buyer in order

to come up with price of the traded financial instrument.
2. LIQUIDITY
3. REDUCTION IN TRANSACTION COSTS
TYPES OF FINANCIAL MARKETS

• Based on Instruments Traded :

1. Money Market (short term) – serve as the conduit to efficiently transfer large amounts of
money from fund providers to fund demanders for short maturity term quickly and at a cheap
cost from the parties involved.
Money market instruments offers investment opportunity that yields higher return than
just mere holding of cash (which generates zero interest). Examples are Treasury bills,
Commercial Papers, Certificates of deposits, Repurchase agreements and Bank acceptances.
2. Capital Market (long term, more than 1 year) – serve as the conduit to efficiently
transfer large amounts of money from fund providers to fund demanders for short maturity
term quickly and at a cheap cost from the parties involved.
TYPES OF
FINANCIAL
MARKETS

• Based on
Market Type :
1. Primary
2. Secondary
ECONOMIC FUNCTIONS OF SECONDARY
MARKET INCLUDE :

1. Price Discovery – Secondary Markets provide about information about

prices of securities. The higher the price of securities in secondary market,
the higher the price that the issuing companies can set on new securities that
they will issue.
2. Liquidity and reduction in borrowing cost – Parties who want to buy and
sell are equally matched.
3. Support to the primary market – price discovery helps in giving information.
ECONOMIC FUNCTIONS OF SECONDARY
MARKET INCLUDE :

3. Support to the primary market – price discovery helps in giving information.

4. Implementation of monetary policy – secondary market allows regulators
such as BSP to trade securities to influence liquidity and interest rates set in the
financial system.