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Lesson 2

The document discusses financial instruments, assets, and liabilities, noting that when a financial instrument is issued it gives rise to both a financial asset and liability. It also describes different types of debt instruments like bonds and equity instruments like stocks, as well as financial markets and institutions that channel funds between savers and borrowers, such as commercial banks, insurance companies, mutual funds, and pension funds. Financial markets are classified as either money markets for short-term securities or capital markets for longer-term bonds and stocks.

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10 views3 pages

Lesson 2

The document discusses financial instruments, assets, and liabilities, noting that when a financial instrument is issued it gives rise to both a financial asset and liability. It also describes different types of debt instruments like bonds and equity instruments like stocks, as well as financial markets and institutions that channel funds between savers and borrowers, such as commercial banks, insurance companies, mutual funds, and pension funds. Financial markets are classified as either money markets for short-term securities or capital markets for longer-term bonds and stocks.

Uploaded by

Cj
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Finance and the Activities of Financial Manager, and Financial Institutions and Markets

Diagram of a Financial System

—-----> Flow of funds ←—----- Flow of securities/notes/bonds/debt instruments

Financial Instrument
- is a real or a virtual document representing a legal agreement involving some sort-of monetary
value. These can be debt securities like corporate bonds or equity instruments like shares of
stock.
- **When a financial instrument is issued, it gives rise to a financial asset on one hand and a
financial liability on the other.

Financial Asset is any asset that is:


● Cash
● An equity instrument of another entity
● A contractual right to receive cash or another financial asset from another entity.
● A contractual right to exchange instruments with another entity under conditions that are
potentially favorable. (IAS 32.11)
● Examples: Notes receivable, loans receivable, investment in stocks, investment in bonds

Financial Liability is any liability that is a contractual obligation:


● To deliver cash or other financial instrument to another entity.
● To exchange financial instruments with another entity under conditions that are potentially
unfavorable. (IAS 32)
● Examples: Notes Payable, Loans Payable, Bonds Payable

When companies are in need of funding, they either sell debt securities (or bonds) or issue equity
instruments. The proceeds from the sale of the debt securities and issuance of bonds will be used to
finance the company's plans.

DEBT AND EQUITY INSTRUMENTS

Debt Instruments (bonds)


● A debt instrument is an asset that an entity, such as an individual, business, or the government,
uses to raise capital or to generate investment income.
● Generally, have fixed returns due to fixed interest rates.

Examples of Debt Instruments

Treasury Bonds and Treasury Bills - Issued by the Philippine government. These bonds and
bills have usually low interest rates and have very low risk of default since the government
assures that these will be paid.
Corporate Bonds are issued by publicly listed companies. These bonds usually have higher
interest rates than Treasury bonds. However, these bonds are not risk free. If the company which
issued the bonds goes bankrupt, the holder of the bonds will no longer receive any return from
their investment and even their principal investment can be wiped out.

Equity Instruments (stocks)


● Generally, have varied returns based on the performance of the issuing company.
● Returns from equity instruments come from either dividends or stock price appreciation.
Examples of Equity Instruments

Preferred Stock has priority over a common stock in terms of claims over the assets of a
company. This means that if a company were to be liquidated and its assets had to be distributed,
no asset will be distributed to common stockholders unless all the claims of the preferred
stockholders have been given. Dividends to preferred stockholders are usually in a fixed rate. No
cash dividends will be given to common stockholders unless all the dividends due to preferred
stockholders are paid first. (Cayanan, A. 2015)

Holders of Common Stock on the other hand are the real owners of the company. If the
company's growth is spurring, the common stockholders will benefit from the growth. Moreover,
during a profitable period for which a company may decide to declare higher dividends, preferred
stock will receive a fixed dividend rate while common stockholders receive all the excess.

Financial Market

Financial Markets - organized forums in which the suppliers and users of various types of funds can
make transactions directly

Let us now classify Financial Markets into comparative groups:


To raise money, users of funds will go to a primary market to issue new securities (either debt or equity)
through a public offering or a private placement. The sale of new securities to the general public is
referred to as a public offering and the first offering of stock is called an initial public offering.

The sale of new securities to one investor or a group of investors (institutional investors) is referred to as
a private placement. The sale of previously owned securities takes place in secondary markets. The
Philippine Stock Exchange (PSE) is both a primary and secondary market.

Money Markets vs. Capital Markets

Money markets are a venue wherein securities with short-term maturities are sold. They are created
because some individuals, businesses, governments, and financial institutions have temporarily idle funds
that they wish to invest in a relatively safe, interest-bearing asset. At the same time, other individuals,
businesses, governments, and financial institutions find themselves in need of seasonal or temporary
financing.

On the other hand, securities with longer-term maturities are sold in Capital markets. The key capital
market securities are bonds (long-term debt) and both common stock and preferred stock.

Financial Institutions: Roles and Purposes

Financial Institution - intermediaries that channel the savings of individuals, businesses, and
governments into loans or investments.

Commercial Banks
Individuals deposit funds at commercial banks, which use the deposited funds to provide
commercial loans to firms and personal loans to individuals, and purchase debt securities issued
by firms or government agencies.
Examples: BDO, Metrobank, BPI, Security Bank,

Insurance Companies
Individuals purchase insurance protection with insurance premiums. The insurance companies
pool these payments and invest the proceeds in various securities until the funds are needed to
pay off claims by policyholders.
Examples: (life, property and casualty, and health)

Mutual Fund
Mutual funds are owned by investment companies which enable small investors to enjoy the
benefits of investing in a diversified portfolio of securities purchased on their behalf by
professional investment managers.
Examples: (Philam Bond Fund, Inc., Cocolife Fixed Income Fund, Inc, ALFM Peso Bond

Pension Fund
Pension Funds - these are financial institutions that receive payments from employees and invest
the proceeds on their behalf. Examples: (GSIS, SSS)
Other financial institutions
include pension funds like Government Service Insurance System (GSIS) and Social Security
System (SSS), unit investment trust fund (UITF), investment banks, and credit unions, among
others.

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