Republic of the Philippines

President Ramon Magsaysay State University

Zambales
Telefax : 047-8111683/email address: prmsu.edu.ph

College of Accountancy and Business Admnistration

Course Title : Financial Markets

Credit Units : 3 units

Course Description : This course is intended to help students understand the role of
financial institutions and markets play in the business environment that students will face in the
future. It also helps students to develop a series of applications of principles from finance and
economics that explore the connection between financial markets, financial institutions, and the
economy. Students will learn commercial and investment banking, insurance companies, mutual
funds, the Bangko Sentral ng Pilipinas, and their role of in the economy.

Learning Objectives :
This course aims to achieve student learning competencies in Financial Markets. At the end of the
course the students should be able to:

1. Describe the financial systems in both local and international setting.

2. Determine the methodologies to assess the risks involve in financial markets particularly in debt
and equity security trading.

3. Identify the agencies that may affect and drive the continuous development of the financial
market structure.

4. Apply the skills and knowledge obtain in accounting and financial reporting

5. Create strategies on how to handle challenges in entering financial markets

Module 1: Introduction to Financial Systems and Financial Market

After studying this chapter, student should be able to:

1. Describe the elements of financial systems, particularly the financial market.

2. Describe the importance of financial market in maximizing firms profit and wealth.
3. Differentiate the different types of financial markets.

Overview.

Financial Market is the marketplace where investors go to raise money to grow their
businesses. It is the avenue where the sale, purchase, creation and trading of financial
instruments occur such as shares, bonds, derivatives, debentures, currencies, and the like. The
trading of the securities occurs in the stock market, forex market, derivative market or bond
market. It plays a crucial role in a country’s economy

Nature and Importance of Financial System

Finance defined.

Basically, finance represents money management and the process of acquiring needed
funds. It is the lifeblood of the business for continuity of business operations. Finance is the
application of economic principles to decision making that involves the allocation of money
under conditions of uncertainty. It is how funds are obtained and then how this will be invested
to make money.

What Is a Financial System?

A financial system is a set of institutions, such as banks, insurance companies, and

stock exchanges that permit the exchange of funds.

Financial systems exist on firm, regional, and global levels. Borrowers, lenders, and
investors exchange current funds to finance projects, either for consumption or productive
investments, and to pursue a return on their financial assets.

The financial system also includes sets of rules and practices that borrowers and
lenders use to decide which projects get financed, who finances projects, and terms of financial
deals.

 A financial system is the set of global, regional, or firm-specific institutions and

practices used to facilitate the exchange of funds.
 Financial systems can be organized using market principles, central planning, or a
hybrid of both.
 Institutions within a financial system include everything from banks to stock exchanges
and government treasuries.

Financial system acquires money from people who are keeping it idle and distribute it
among those who uses it for yielding income and generates wealth in country. It aims at
efficient allocation of financial resources by channelizing funds between net savers and net
spenders. Financial system has efficient role in minimizing the risk through diversification of
funds among large number of people.
Nature of Financial System

1. Transfer Funds / Allocate capital

Financial system helps in transferring of financial resources from one person to
another person. This system includes financial markets, financial intermediaries,
financial assets and services which facilitates fund movements in an economy.

It allows exchange (flow) of funds between lenders, investors, and borrowers.

Financial systems provide different channels to allocate funds: directly ( via markets)
or indirectly(via intermediaries)

2. Mobilizes Saving
It helps in allocating ideal lying resources with peoples into productive means.
Financial system is the one which obtains funds from savers and provide it to
those who are in need of it for various development purposes. Provides saving
instruments. Pooling funds that can be matched with borrower needs.

3. Risk Allocation
Diversification of risk in an economy is important feature of financial system. Financial
system allocates people’s funds in various sources due to which risk is diversified.

Role of Financial System

1. Facilitates Payment Mechanism

Financial system provides a payment mechanisms for the smooth flow of funds among peoples
in an economy. Buyers and sellers of goods or services are able to perform transactions with
each other due to the presence of a financial system.

2. Reduces Risk
It aims at reducing the risk by diversifying it among a large number of individuals. Financial
system distributes funds among a large number of peoples due to which risk is shared by many
peoples.

3. Brings Savers And Investors Together

Financial system serves as a means of bridging the gap between savings and investment. It
acquires money from those with whom it is lying idle and transfers it to those who need it for
investing in productive ventures.

4. Assist In Capital Formation

Financial system has an efficient role in the capital formation of the country. It enables big
corporates and industries to acquire the required funds for performing or expanding their
operations thereby leading to capital formation in the nation.

5. Improves Standard Of Living

It raises the standard of living of peoples by promoting regional and rural development of the
country. The financial system promotes the development of a weaker sections of society
through cooperative societies and rural development banks.

6. Facilitates Economic Development

 Financial system influences the pace of economic growth or development of an economy. It
aims at optimum utilization of all financial resources by investing all idle lying resources into
useful means which leads to the creation of wealth.
Elements of Financial System

1. Lenders and Borrowers.

The ultimate lenders (= surplus economic units) and borrowers (= deficit economic units), i.e.
the non-financial economic units that undertake the lending and borrowing process. The
ultimate lenders lend to borrowers either directly or indirectly via financial intermediaries, by
buying the securities they issue.

The ultimate borrowers comprise the four broad sectors of the economy :

- Household sector.
- Corporate (or business) sector.
- Government sector.
- Foreign sector

2.Financial Intermediaries (e.g., banks)

These intermediate the lending and borrowing process. They interpose themselves between
the lenders and borrowers, and earn a margin for the benefits of intermediation (including
lower risk for the lender). They buy the securities of the borrowers and issue their own to fund
these (and thereby become intermediaries).

3. Financial Instruments (cash or derivative)

Financial instruments (or assets), which are created/issued by the ultimate borrowers
and financial intermediaries to satisfy the financial requirements of the various participants.
These instruments may be marketable (e.g. treasury bills) or non-marketable (e.g. retirement
annuities).

4. Financial Markets (money or capital)

Financial markets, i.e. the institutional arrangements and conventions that exist for the
issue and trading (dealing) of the financial instruments.

5. Regulatory Environment -(e.g., Central banks)

6. Money creation.
The creation of money (= bank deposits) by banks when they satisfy the demand for
new bank credit. This is a unique feature of banks. Central banks have the tools to curb money
growth.

7. Price discovery.
Process of determining or valuing the financial instrument in the market. Price
discovery, i.e. the establishment in the financial markets of the price of money, i.e. the rates of
interest on debt (and deposit) instruments and the prices of share instruments.

Nature and Importance of Financial Market

In the beginning. The word “market” usually conjures up an image of the bustling,
paper strewn floor of stock exchanges or of traders motioning frantically in the futures pits of
big cities But formal exchanges such as these are only one aspect of the financial markets, and
far from the most important one. There were financial markets long before there were
exchanges and, in fact, long before there was organized trading of any sort.

Financial markets have been around ever since mankind settled down to growing crops
and trading them with others. After a bad harvest, those early farmers would have needed to
obtain seed for the next season’s planting, and perhaps to get food to see their families
through.

Both of these transactions would have required them to obtain credit from others with
seed or food to spare. After a good harvest, the farmers would have had to decide whether to
trade away their surplus immediately or to store it, a choice that any 20th-century commodities
trader would find familiar. The amount of fish those early farmers could obtain for a basket of
cassava would have varied day by day, depending upon the catch, the harvest and the weather;
in short, their exchange rates were volatile.

The independent decisions of all of those farmers constituted a basic financial market,
and that market fulfilled many of the same purposes as financial markets do today

What is a Financial Market?

A financial market is a market in which financial assets (securities) such as stocks and
bonds can be purchased or sold. Funds are transferred in financial markets when one party
purchases financial assets previously held by another party. Financial markets facilitate the flow
of funds and thereby allow financing and investing by households, firms, and government
agencies

TYPES OF FINANCIAL MARKET

Based on instruments traded

a. Money Market – this is the sector of the financial market where financial instruments
that will mature or be redeemed in one year or less from issuance date are traded.

Why do companies deal with money market?

- Cash requirements of entities do not coincide with their cash receipts (borrowers)
- Fund providers generates opportunity cost in the form of foregone interests by
investing excess cash in financial instruments that can quickly be converted to cash
when needed with minimal risk (lenders)

b. Capital market – this is the sector in the financial market where financial instruments
issued by government and corporations that will mature beyond one year from issuance date
are traded.
There are two types: (1) equity (share certificate) or (2) debt (PN, bonds)

MARKET INSTRUMENTS

Treasury bills —short-term obligations issued by the government.

 Repurchase agreements —agreements involving the sale of securities by one party to
another with a promise by the seller to repurchase the same securities from the buyer
at a specified date and price.
Commercial paper —short-term unsecured promissory notes issued by a company to
raise short-term cash.
Negotiable certificate of deposit —bank-issued time deposit that specifies an interest
rate and maturity date and is negotiable, (i.e., can be sold by the holder to another
party).
Banker’s acceptance —time draft payable to a seller of goods, with payment
guaranteed by a bank.

CAPITAL MARKET INSTRUMENTS

Corporate stock —the fundamental ownership claim in a public corporation.

Mortgages —loans to individuals or businesses to purchase a home, land, or other real
property.
Corporate bonds —long-term bonds issued by corporations.
Treasury bonds —long-term bonds issued government treasuries.
State and local government bonds —long-term bonds issued by state and local governments.
Bank and consumer loans —loans to commercial banks and individuals

Based on Market Type

a. Primary Market – this is the financial market wherein fund demanders like
corporation or government agencies raise funds through new issuances of financial instruments
(bonds or stocks).

Why? - Normally to finance new projects or expansions.

How? - Coursed thru investment banks as intermediary.
Who? - Borrowers are fund demanders and lenders are fund providers.

Four types of issue methods

1. Public offering – the issuer offers for subscription or sale to general public
2. Private placement -the issuer looks for single investor to purchase the whole
securities issuance than to general public
3. Auction – this is another offering to general public on treasury bills, bonds and other
securities issued by the govt.
4. Tap issue – this happens when issuer is open to receive bids for their securities at all
times. Issuers maintain the right to accept or reject the bid prices.

b. Secondary Market – this is where securities issued in the primary market are
subsequently traded (resold and repurchased – second hand).

Who are the players? - Securities brokers are facilitators - Sellers are demanders and
buyers are funds providers
Sources and references:

Guide to Financial Markets by Marc Levinson

Financial Market by Jeff Madura
https://www.investopedia.com/terms/f/financial-system.asp
https://commercemates.com/nature-and-role-of-financial-system/
https://ebrary.net/16/business_finance/six_elements_the_financial_system

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