FUTURES EXCHANGE MARKET 3.

Options Contracts – the right (but not the obligation)

to buy or sell a particular good at a specified price.
Futures Market – is a market in which traders purchase and
4. Swap Contract – an agreement where two parties
sell futures contracts. They also buy and sell commodities. We
agree to exchange periodic cash flows.
also call it a futures exchange.
WHY DO WE NEED FUTURES MARKET? OR WHY DO
Participants trade, i.e., buy and sell their future delivery contracts
COMPANIES ENTER THIS MARKET?
and commodities in a futures market. The market provides a
medium for the complementary activities of speculation and Futures offer a fast, cost-effective way to trade financial and
hedging.
commodity markets.
Futures Contract – is a contract to exchange a specific
They are standardized contracts to buy or sell a particular
security for a specific price. The price, which is determined on
asset at a set price, on a set date in the future, in predefined
the day of the contract, is created for payment and delivery
quantity and quality. Traders worldwide use futures to easily
on a future date.
reduce risk or seek profits on changing markets.
The futures contracts are for delivery on a specific future
Different types of companies may enter futures contracts for
date.
different purposes. The most common reason is to hedge
against a certain type of risk. Companies may also trade
futures for speculative purposes.

Futures markets allow commodities producers and

consumers to engage in “hedging” in order to limit the risk of
losing money as commodity prices change.

Hedging – is typically defined as utilizing financial instruments

or contracts to reduce or eliminate the risk from future
changes in rates or prices. The purpose of hedging a
transaction is to replace an uncertain future cash flow, rate,
or price, with a fixed and certain cash flow, rate, or price.
FUNCTIONS OF FUTURES MARKET
Speculation – is to profit from a change in a future rate or
The futures exchange is an organized marketplace that: price. Speculating involves the assumption of additional risk.
 Provides and operates the facilities for trading Stock Futures – are financial contracts where the underlying
 Establishes, monitors and enforces the rules for asset is an individual stock. Stock Future contract is an
trading agreement to buy or sell a specified quantity of underlying
 Keeps and disseminates trading data. equity share for a future date at a price agreed upon between
the buyer and seller.
Derivative – a security whose value depends on the values of
other “underlying” securities (also known as “contingent The contracts have standardized specifications like market lot, expiry
claims”). day, unit of price quotation, tick size and method of settlement.

Spot Price – rate or price quoted for delivery in one or two HOW ARE STOCK FUTURES PRICED?
business days from the date of the transaction.
Futures Price = Spot Price + Cost of Carry
DERIVATIVE SECURITIES
The theoretical price of a future contract is sum of the current
1. Forward Contracts – a forward market is a market in spot price and cost of carry. However, the actual price of
which a commodity/exchange rate for a future futures contract very much depends upon the demand and
exchange of commodities or financial contracts is supply of the underlying stock. Generally, the futures prices
fixed today. are higher than the spot prices of the underlying stocks.
2. Futures Contracts – an agreement reached at one
Cost of carry – is the interest cost of a similar position in cash
point in time calling for the delivery of some
market and carried to maturity of the futures contract less
commodity at a specified later date at a price
any dividend expected till the expiry of the contract.
established at the time of contracting.
 Currency Future – a.k.a FX  future or a foreign exchange
future, is a futures contract to exchange one currency for
another at a specified date in the future at a price (exchange
FOREIGN EXCHANGE DERIVATIVES MARKET rate) that is fixed on the purchase date. Typically, one of
the currencies is the US dollar.
Foreign Exchange Market – is a financial derivative whose
payoff depends on the foreign exchange rates of two or more Currency Swap – an agreement in which two parties
currencies. These instruments are commonly used for currency exchange the principal amount of a loan and the interest in
speculation and arbitrage or for hedging foreign exchange risk. one currency for the principal and interest in another
currency.
FINANCIAL INSTITUTION PARTICIPATION IN FOREIGN
EXCHANGE MARKET Foreign Exchange Binary Option – a binary option is a
financial exotic option in which the payoff is either some fixed
Commercial Banks
monetary amount or nothing at all. Also called all-or-nothing
 Serve as financial intermediaries in the foreign exchange options.
market by buying or selling currencies.
 Speculate on foreign currency movements by taking long
Forward Foreign Exchange – a contract to purchase or sell a
positions in some currencies and short positions in others. set amount of a foreign currency at a specified price for
 Provide forward contracts to customers. settlement at a predetermined future date (closed forward)
 Offer currency options to customers, which can be tailored or within a range of dates in the future (open forward).
to a customer’s specific needs.
Foreign Exchange Option – or FX option is a derivative
International Mutual Funds financial instrument that gives the right but not the obligation
to exchange money denominated in one currency into
 Use foreign exchange markets to exchange currencies
when reconstructing their portfolios.
another currency at a pre-agreed exchange rate on a
 Use foreign exchange derivatives to hedge a portion of specified date.
their exposure.
Foreign Exchange Swap – a forex swap or FX swap is a
Brokerage Firms and Investment Banking Firms simultaneous purchase and sale of identical amounts of one
currency for another with two different value dates (normally
 Engage in foreign security transactions for their customers
spot to forward) and may use foreign exchange derivatives.
or for their own accounts
Forward Exchange Rate – the exchange rate at which a bank
Insurance Companies
agrees to exchange one currency for another at a future date
 Use foreign exchange markets when exchanging currencies when it enters into a forward contract with an investor.
for their international operations
 Use foreign exchange markets when purchasing foreign Non-deliverable Forward – is an outright forward or futures
securities for their investment portfolios or when selling contract in which counterparties settle the difference
foreign securities between the contracted NDF price or rate and the prevailing
 Use foreign exchange derivatives to hedge a portion of spot price or rate on an agreed notional amount.
their exposure
Dual-currency Note – a reverse dual-currency note is a note
Pension Funds which pays a foreign interest rate in the investor's domestic
 Require foreign exchange of currencies when investing in
currency.
foreign securities for their stock or bond portfolios
Margin Trading – which means you could pay part of margin
 Use foreign exchange derivatives to hedge a portion of
but make full transaction without the practically transferring
their exposure
of your principal. The end of contract mostly adopts the
INSTRUMENTS OF FOREIGN EXCHANGE DERIVATIVE settlement for differences. At the same time, the buyers need
MARKET not present full payment only when the physical delivery gets
performed on the maturity date.
Basis Swap – is an interest rate swap which involves the
exchange of two floating rate financial instruments. A basis FUNCTIONS OF FOREIGN EXCHANGE DERIVATIVE MARKET
swap functions as a floating-floating interest rate swap.
 Avoiding and managing systemically financial risk.
 Increasing financial systems’ ability to resist risk.
  Improving economic efficiency. It mainly refers to current account and fixed deposits. Interest paid on savings
raise the efficiency of business running and financial account deposits in lesser than that of fixed deposit.
market.
B. Loans – are the primary use of their funds and the principal
Risk and Return: Foreign exchange derivatives can allow way in which they earn income. Loans are typically made for
investors to engage in risk avoidance to keep value, but also fixed terms, at fixed rates and are typically secured with real
can earn profit through speculation. This kind of specific property; often the property that the loan is going to be used
duality makes derivatives more uncontrollable. Thus, foreign to purchase.
exchange derivative products can be risky while rewardable.
Bank loan officers decide which projects, and/or businesses,
COMMERCIAL BANK are worth pursuing and are deserving of capital.

Commercial Bank – is a type of financial institution that C. Consumer Lending

accepts deposits, offers checking account services, makes
1. Mortgage Lending – mortgages are used to buy residences
various loans, and offers basic financial products like
and the homes themselves are often the security that
certificate of deposits (CDs) and savings accounts to
collateralizes the loan. These are typically written for 30-year
individuals and small businesses.
repayment periods and interest rates may be fixed,
Provides loans and earning interest income from those loans. The adjustable, or variable.
types of loans a commercial bank can issue vary and may include
mortgages, auto loans, business loans, and personal loans. A 2. Automobile Lending – is another significant category of
commercial bank may specialize in just one or a few types of loans. secured lending for many banks. Compared to mortgage
lending, auto loans are typically for shorter terms and higher
HOW A COMMERCIAL BANK WORKS
rates. 
A. Deposits – referred to as "core deposits", these are
3. Credit Cards – are another significant lending type and an
typically the checking and savings accounts that so many
interesting case. Credit cards are, in essence, personal lines of
people currently have.
credit that can be drawn down at any time.
Largest source by far of funds for banks is deposits; money
4. Home Equity Lending – a fast growing segment of
that account holders entrust to the bank for safekeeping and
consumer lending for many banks. Home equity lending
use in future transactions, as well as modest amounts of
basically involves lending money to consumers, for whatever
interest.
purposes they wish, with the equity in their home, that is, the
In case the bank cannot attract customer through core deposits they offer: difference between the appraised value of the home and any
outstanding mortgage, as the collateral.
1. Wholesale Deposits – higher cost of wholesale funding
means that a bank either has to settle for a narrower interest FEATURES OF COMMERCIAL BANKS:
spread, and lower profits, or pursue higher yields from its
1. Borrowing
lending and investing, which usually means taking on greater risk.
2. Lending
2. Current Account Deposits – such deposits are payable on
demand and are, therefore, called demand deposits. These All financial institutions are not commercial banks because
can be withdrawn by the depositors any number of times only those which perform dual functions of (1) accepting
depending upon the balance in the account. deposits and (2) giving loans are termed as commercial
banks.
3. Fixed Deposits (Time Deposits) – fixed deposits have a
fixed period of maturity and are referred to as time deposits. “Banks borrow to lend.”
These are deposits for a fixed term, i.e., period of time
Borrowing Rate – the rate of interest offered by the banks to
ranging from a few days to a few years. They can be
depositors.
withdrawn only after the maturity of the specified fixed
period. They carry higher rate of interest.  Lending Rate – the rate at which banks lend out.
4. Savings Account Deposits – These are depositing whose The difference between the rates is called ‘spread’ which is
main objective is to save. Savings account is most suitable for appropriated by the banks. 
individual households. They combine the features of both
 FUNCTIONS OF COMMERCIAL BANKS
1. Primary Functions

 It accepts deposits
 Advancing Loans

2. Secondary Functions

 Transfer of funds
 General Utility Services
 Agency Services
 Credit Creation
OPTIONS MARKET

Options Market – are financial instruments that are

derivatives based on the value of underlying securities such as
stocks.

These are financial derivatives that give buyers the right, but
not the obligation, to buy or sell an underlying asset at an
agreed-upon price and date.

Options Contract – offers the buyer the opportunity to buy or

sell—depending on the type of contract they hold—the
underlying asset.
Each option contract will have a specific expiration date by
which the holder must exercise their option.
HOW OPTIONS WORK:
Options are a versatile financial product. These contracts
Strike Price – the stated price on an option.
involve a buyer and a seller, where the buyer pays an options
premium for the rights granted by the contract. Each call
Options are typically bought and sold through online or retail
option has a bullish buyer and a bearish seller, while put
brokers.
options have a bearish buyer and a bullish seller.

ARE OPTIONS BETTER THAN STOCKS?

Options Premium – is the current market price of an option
 Options Are Cheaper Than Stocks
contract.

it is a fact that options are significantly less expensive than

2 KINDS OF OPTIONS
the securities on which they are based. Each option contract
1. Call Options – allow the holder to buy the asset at a stated
gives you control of 100 shares of the equity, yet the cost to
price within a specific time frame. Investors buy calls when
purchase an option contract is nowhere near the expense of
they believe the price of the underlying asset will increase
buying an equivalent chunk of stock.
and sell calls if they believe it will decrease.

Options can be less risky for investors because they require

2. Put Options – allow the holder to sell the asset at a stated
less financial commitment than equities, and they can also be
price within a specific timeframe. Investors buy puts when
less risky due to their relative imperviousness to the
they believe the price of the underlying asset will decrease
potentially catastrophic effects of gap openings.
and sell puts if they believe it will increase.

Options are the most dependable form of hedge, and this

also makes them safer than stocks.

Key points:
Although there are many opportunities to profit with options,
investors should carefully weigh the risks
  Effective central bank control
 Formulation of suitable monetary policy
 Source of finance to government

INSTRUMENTS OF MONEY MARKET

1. Treasury bills
 The most marketable money market security.
 Issued with three-months, six-months, and one-year
maturities.
MONEY MARKET
 Purchased for a price that is less than their par value;
It is a money market for short terms financial assets that are when they mature, the government pays the holder
close substitute for money, facilitates the exchange of money the full par value
in primary and secondary market. The money market is a 2. Certificate of deposit
mechanism that deals with the lending and borrowing of  It is a time deposit with a bank
short-term funds.  It has specific maturity date, interest rate and it can
be issued in any denomination
A segment of the financial market in which financial instruments  The main advantage of CD is their safety
with high liquidity and very short maturities are traded. It doesn’t
3. Commercial Paper
actually deal in cash or money but deals with substitute of cash like
 It is a short-term unsecured loan issued by a
trade bills, promissory notes and government papers which can be
converted into cash without any loss at low transaction cost. corporation typically financing day to day operation.
It is a very safe investment because the financial
FEATURES OF MONEY MARKET situation of a company can easily be predicted over a
few months Only company with high credit rating
 It is a market for short-term funds or financial assets
issues CP’s
called near money.
 It is not meant for the general public and hence,
 It deals with financial assets having a maturity period
there is a restriction on the advertisement to market
of less than one year only.
the securities.
 Money market transaction is done through oral
 It is issued at a discount to the face value and upon
communication and writing communication
maturity; the face value becomes the redemption
transaction.
value. The maturity ranges from 1 to 270 days (9
 It is not homogeneous market, it comprises of
months) but usually, it is issued for 30 days or less.
several submarket like called money market,
acceptance and bill market. Kinds of Commercial papers
 The component of money market are commercial
banks and non-bank financial companies. Draft – a written instruction by a person to another to pay the
specified amount to a third party
OBJECTIVES OF MONEY MARKET
Check – a special form of draft where the drawee is a bank
 To provide a parking place to employ short-term
surplus funds Note – in this instrument, a promise is made by one person to
 To provide room for overcoming short-term deficits. pay another certain sum of money to another
 To enable the central bank to influence and regulate
liquidity in the economy Certificate of Deposit
 To provide a reasonable access to users of short- 4. Repurchase Agreement (Repos)
term funds to meet their requirement quickly,  It is a form of government borrowing and is used by
adequately at reasonable cost. those who deal in government securities. They are
usually very short term repurchases agreement,
IMPORTANCE OF MONEY MARKET
from overnight to 30 days or more.
 Development of trade and industry  The short-term maturity and government backing
 Development of capital market usually mean that Repos provide lenders with
 Smooth functioning of commercial banks extremely low risk.
  Repos are safe collateral loans. 1./ Open Market Operations – consist of repurchase and
5. Banker’s acceptance reverse repurchase transactions, outright transactions, and
 It is a short-term credit investment by a non-financial foreign exchange swaps. “In Purchase transactions, the Bangko
firm Sentral buys government securities with a dedication to sell it back
 It is guaranteed by a bank to make payment at a specified future date, and at a predetermined interest rate.”
 Acceptances are traded at discounts from face value The BSP’s payment increases reserve balances and expands
in the secondary market the monetary supply in the Philippines:
 BA acts as a negotiable time draft for financing
Reverse Repurchase – the government acts as the seller and
imports, exports or other transactions in goods
works to decrease the liquidity of money. These transactions
BOND MARKET usually have maturities ranging from overnight to one month.

Outright Transactions – when the BSP buys securities, it pays

It is a debt financing contract that allows investors to lend for them by directly crediting its counterparty’s Demand
money to a borrower. Deposit Account with the BSP. The reverse is done upon the
selling of securities.
The borrowers are typically the government or corporations
who need additional capital or financing. The amount issued Foreign Exchange Swaps – This refers to the actual exchange
by the investors are paid with interest at a given term, usually of two currencies at a specific date and the reverse exchange
at a fixed interest rate. of the currencies at a farther date in the future, also at an
interest rate agreed on deal date.
Features of Bonds
2./ Standing Facilities – To increase the volume of credit in
 Par value – the value stated on the face of the bond the financial system, the BSP extends loans, discounts, and
which the company or government body promises to pay advances to banking institutions. Rediscounting is a standing
at the time of maturity. credit facility provided by the BSP help banks meet temporary
 Coupon rate – the rate of interest payable to the liquidity needs by refinancing the loans.
bondholder
 Maturity date – the date at which the bond gets 3./ Reserve Requirements – In banking institutions, there
matured, the principal amount is paid to the bondholder are required amounts that banks cannot lend out to people.
 Redemption value – the value paid to the bondholder, at They always need to maintain a certain balance of money,
the time of expiry of the term for which bond is issued. which are called “reserves”. Once these reserve
requirements are changed and are varied, changes in the
Features of Debt Market monetary supply will be observed greatly.
 Efficient mobilization and allocation of resources in the
Types of Bonds
economy.
 Financing development activities of the Government Corporate Bonds – bonds issued by corporations, limited
 Trasmitting signals for implementation of monetary liability companies, and other commercial enterprises.
policy. Corporate bonds often offer higher yields than other types of
 Facilitating liquidity management in tune with overall bonds, but the tax code is not favorable to them.
short-term and long-term objectives.
Municipal Bonds – bonds issued by state and local
governments.
Monetary Policy
It is the monitoring and control of money supply by a central Government Bonds – Issued by government agencies, e.g.
bank, such as the Federal Reserve Board in the United States Pag-ibig or the Home Development Mutual Fund. It is a type
of America, and the Bangko Sentral ng Pilipinas in the of debt-based investment where you loan money to
Philippines. This is used by the government to be able to government in return for an agreed rate of interest. It is used
control inflation and stabilize currency. Monetary policy is to raise funds that can be spent on new projects or
generally the process by which the central bank, or infrastructure.
government controls the supply and availability of money,
Treasury Bonds – Debt investments with long term maturity
the cost of money, and the rate of interest.
of more than one year. According to the Bureau of Treasury,
there are currently fie maturities of Treasury Bonds: 2, 5, 7,
Monetary Policy Instruments
10 , 20 year
Treasury Bills (T-Bills) – Debt investments with short term 4. Deferred Payment with grace period – the payment
maturity of less than a year. of principal under this program is deferred, although
payments on interest are made. A variation of the
deferred payment plan allows the borrower a grace
period during which the payment of principal is
deferred.

MORTGAGE MARKET EX. ALVIN Corporation acquired a loan of Php 100,000.00

payable in 10 years at 8% annual interest.
A long-term loan secured by real estate and an amortized
loan whereby a fixed payment pays both principal and VALUATION OF LONG-TERM SECURITIES
interest
Value – Liquidation value represents the amount of money
A mortgage in a form of debt that finances investments in that could be realized if an asset or group of assets is sold
property. separately from its operating organization.

Liquidation value – the price of an asset when it is allowed

Types of Mortgages: insufficient time to sell on the open market, thereby reducing
1. Residential Mortgage its exposure to potential buyers. It is the total worth of a
2. Commercial Mortgage company’s assets when it goes out of business or if it were to
go out of business.
Acceptable Collateral for Mortgages
Generally, there are four levels of valuation for business
The real estate properties that can be mortgage can be assets:
divided into two broad categories:
1. Single family (one-to-four-family) residential 1. Market value
 House 2. Book value
 Condominiums 3. Liquidation value
 Cooperatives 4. Salvage value
 Apartments
2. Commercial properties “Liquidation is the difference between some value of
 Multifamily Properties e.g. apartment buildings tangible assets and liabilities.”
 Office buildings, industrial properties, warehouse,
shopping centers, hotels, etc. Assume that ALVIN Corporation had Php550,000
liabilities. The book value of assets found on the balance
Types of Mortgage Loans sheet is Php1,000,000.00, the salvage value is Php 50,000.00
1. Insured vs. Conventional Mortgages – If the down and the estimated value of selling all assets at auction is Php
payment is less than 20%, insurance is usually 750,000.00
required
The liquidation value is calculated by subtracting liabilities
2. Fixed-Rate Mortgages – The interest is fixed for the
from the auction value.
life of the mortgage
3. Adjustable-Rate Mortgages – The interest rate can Php 750,000.00
fluctuate within certain parameters
(Php 550,000.00)
Php 200,000.00 (liquidation value)
Repayment of Term Loans
1. Equal Principal Payment – the loan is repaid in equal
Going-concern value – represents the amount a firm could be
amounts of principal.
sold for as a continuing operating business; the value of a
2. Equal Amortization – the loan is repaid in equal
company under the assumption that it will continue to
installments
operate for the foreseeable future; this is in contrast to
3. Balloon Payment – the loan is repaid in equal
liquidation value, which assumes the company is going out of
installments for a number of years, then, a large and
business
final payment is made at maturity date.
Book Value represents either  Corporations issue bonds to raise money to run the
(1) an asset: the accounting value of an asset (the asset’s cost business.
minus its accumulated depreciation)  Government entities may issue bond to pay for a
(2) a firm: (total assets minus liabilities and preferred stock as project.
listed on the balance sheet.)  Every bond is issued with a specific face amount.
 The face amount of the bond is the amount an
Market value – represents the market price at which an asset investor receives at maturity.
trades and the highest estimated price that a buyer would  The maturity date of a bond is the date that the
pay, and a seller would accept for an item in an open and issuer must repay the face amount.
competitive market.  All of the details of the bond are listed on a bond
certificate.
Intrinsic Value – represents the price a security “ought to  If you buy Php 10,000, 6% IBM Corporate bond due
have” based on all factors bearing on valuation. It is the in 10 years, all of those details will be listed on the
actual value of a company or an asset based on an underlying electronic bond certificate.
perception of its true value including all aspects of the 10,000 x 6% x 10 = 6000
business, in terms of both tangible and intangible factors. The formula to calculate interest earned is (principal amount
multiplied by interest rate multiplied by time period)
Is the value the same as the current market value? – No.
Bond’s coupon rate – the stated rate of interest; the annual
Salvage Value – the estimated resale value of an asset at the interest payment divided by the bond’s face value.
end of its useful life. And it is used as a component of the
depreciation value. Coupon Rate
 The yield paid by a fixed-income security
 A fixed-income security’s coupon rate is simply just
Important Bond Terms
the annual coupon payments paid by the issuer
Bond – a long-term debt instrument issued by a corporation relative to bond’s face or par value.
or government; it is issued with a stated value, known as the  Coupon rate is the yield the bond paid on its issue
par, or face value; is the value at which the bond will be date.
bought back by the issuer upon its maturity and bonds are
issued with a 1,000-par value. Discount Rate (Capitalization Rate)
 is dependent on the risk of the bond and is
The maturity value (MV) [or face value] of a bond is the composed of the risk-free rate plus a premium for
stated value. risk.
 It is the interest used to price bonds via present
Most individual bonds have five features when they are
valuation calculations.
issued:
 It is also referred to as the bond’s yield to maturity
 issue size and is the return required to entice an investor to
 issue date invest in the bond.
 maturity date
 maturity value Different Types of Bonds
 coupon
1. Perpetual bond
Issue size – reflects both the borrowing needs of the entity  is a bond that never matures. It has an infinite life
issuing the bonds, as well as the market’s demand for the  it may be treated as equity, not as debt
bond at a yield that’s acceptable to the issuer  Issuers pay coupons on perpetual bonds forever, and
Maturity value – the amount payable to an investor at the they do not have to redeem the principal.
end of a debt instrument’s holding period (maturity date)
2. Zero-coupon bond
Why is a bond issued?  is a bond that pays no interest but sells at a deep
discount from its face value; it provides
 To raise money for some purpose
 compensation to investors in the form of price
appreciation.
 Since the entire payment is at maturity zero coupon
bonds tend to fluctuate in price much more than
coupon bonds.