Instructional Materials for:

ACCO 20083 – Financial Markets

Compiled by: Rosalinda R. Madelo, MBA, MEM, CPA

College of Accountancy and Finance

Second Semester 2023-2024

Lesson 1 – Introduction to the Financial Market

Objectives:

At the end of the lesson, the student will be able to:

• Identify the key players in the financial markets.
• Understand the basic functions of the financial system.

Covered Topics:

• Nature and concept of financial market

• Types, classifications, and examples of financial institutions
• Elements of the financial system
• Differentiate the financial intermediary and financial market.

Overview:

A financial market is the place where financial assets (securities) can be purchased or
sold.
Financial markets facilitate financing and investment by households, firms, and
government agencies.
• Participants that provide funds are called surplus units.
e.g., households
• Participants that enter markets to obtain funds are deficit units.
e.g., the government

Financial Markets include any place or system that provides buyers and sellers with the
means to trade financial instruments, including bonds, equities, various international
currencies, and derivatives. Financial markets facilitate the interaction between those
needing capital and those with capital to invest. In addition to making, it possible to raise
capital, financial markets allow participants to transfer risk (generally through derivatives)
and promote commerce.

Nature of Financial Markets

Financial markets refer broadly to any marketplace where securities trading occurs,
including the stock market, bond market, forex market, and derivatives market. Financial
markets are vital to the smooth operation of capitalist economies.

Understanding the Financial Markets

Financial markets play a vital role in facilitating the smooth operation of capitalist
economies by allocating resources and creating liquidity for businesses and entrepreneurs.
The markets make it easy for buyers and sellers to trade their financial holdings. Financial
markets create securities products that provide a return for those with excess funds
(investors/lenders) and make these funds available to those needing additional money
(borrowers).
Functions of the Markets

The role of financial markets in the success and strength of an economy cannot be
underestimated. Here are four important functions of financial markets:

1. Puts savings into more productive use

As mentioned in the example above, a savings account that has money in it should not just
let that money sit in the vault. Thus, financial markets like banks open it up to individuals and
companies that need a home loan, student loan, or business loan.

2. Determines the price of securities

Investors aim to make profits from their securities. However, unlike goods and services
whose price is determined by the law of supply and demand, prices of securities are
determined by financial markets.

3. Makes financial assets liquid

Buyers and sellers can decide to trade their securities anytime. They can use financial
markets to sell their securities or make investments as they desire.

4. Lowers the cost of transactions

In financial markets, various types of information regarding securities can be acquired

without the need to spend.

Importance of Financial Markets

There are many things that financial markets make possible, including the following:

1. Financial markets provide a place where participants like investors and debtors,
regardless of their size, will receive fair and proper treatment.
2. They provide individuals, companies, and government organizations with access to
capital.
3. Financial markets help lower the unemployment rate because of the many job
opportunities it offers.

Types of Financial Markets

▪ Financial markets can be distinguished by the maturity structure and trading

structure of its securities
▪ Money versus capital markets
o The flow of short-term funds is facilitated by money markets.
o The flow of long-term funds is facilitated by capital markets.
▪ Primary versus secondary markets

Primary markets facilitate the issuance of new securities.

o e.g., the sale of new corporate stock or new Treasury securities

Secondary markets facilitate the trading of existing securities.

o e.g., the sale of existing stock

o Securities traded in secondary markets should be liquid.
 ▪ Organized versus over the counter markets
o A visible marketplace for secondary market transactions is an organized
exchange.
o Some transactions occur in the over-the-counter (OTC) market (a
telecommunications network)
▪ Knowledge of financial markets is power.
o Decide which markets to use to achieve our investment goals or financing
needs.
o Decide which markets to use as part of your job.
o Avoid common mistakes in investing and borrowing.

Securities Traded in Financial Markets

◼ Money market securities

 Money market securities are debt securities with a maturity of one year or
less.

 Characteristics:

◼ Liquid

◼ Low expected return

◼ Low degree of risk

Money Market Instruments

1. Negotiable Certificate of Deposit. It is a time deposit where the investor and the
bank agree on the terms of placement. The amount for this kind of security is
considerably higher than the regular time deposit. The investor may invest at least 14
days to less than a year and is entitled to receive the agreed interest payment. The
investor may sell the negotiable certificate of deposit even before it matures in the
secondary market.
2. Commercial paper. It is an unsecured promissory note with a fixed maturity of 1 to
270 days. It is a money-market security issued by high-credit rating companies to
meet short-term obligations.
3. Repurchase Agreement (repo). A financial instrument in which one party sells a
financial instrument to another party at a specified price with a commitment to
repurchase the financial instrument at a fixed amount agreed at a specific date. Many
repos have a maturity date of 1 to two weeks.
4. Treasury Bills (T-Bills) is an obligation by the national government. The interest is
normally higher than the savings and time deposit. T-bills are issued through a
competitive bidding process at a discount from par, which means that rather than
paying fixed interest payments, the return expected by the investor is through capital
appreciation. T-bills are regarded as a risk-free investment because the payment of
which is guaranteed by the government. It has a maturity of 91, 181, and 360 days.
 5. Banker’s Acceptance. It is a bank draft where the bank is required to pay the holder
a specified amount on a specified date. It has a maturity of 90 days from the date of
issue but can be extended up to 180 days. People who invest in bank drafts expect
capital appreciation. At the time of purchase, these bank drafts are sold at a
discount, and their value increases as it approaches their maturity date. The bank
draft normally transpired from export and import transactions. It is less risky
compared to other instruments because the payment is guaranteed by the importer’s
bank.

◼ Capital market securities.

 Capital market securities are those with a maturity of more than one year.

◼ Bonds and mortgages

◼ Stocks

 Capital market securities have a higher expected return and more risk than
money market securities.

Two important elements of the capital market

1. Organized security exchanges. This operates under the rules and regulations
formulated by an exchange. Investors actively trading on the exchange are aware of
the rules and conduct trades accordingly. In the Philippines, the most active security
exchange is the Philippine Stock Exchange. The transactions in organized security
exchanges are made in already outstanding securities.
2. Over-the-counter markets (OTC). It is involved in the buying and selling of financial
instruments but not in organized securities exchanges. These are stocks of
corporations that were registered and licensed by the Securities and Exchange
Commission (SEC) to sell stocks, which were not being traded in the PSE to the
public.

Types of Capital Market

1. Primary Market. It is a venue where firms and government agencies raise money
using issuing financial instruments like stocks or bonds for the first time. The
proceeds from the new issues go directly to the issuer. The dealer normally earns a
commission that is built into the price of the financial instrument. Once the
securities are sold to the public for the first time, it is called an initial public offering
(IPO).
Players in the Primary Market
a. Issuers. These are the public or private corporations. Funds are raised using
public issues, rights issues, or through private placements.
b. Financial instruments. These are the instruments purchased by the investors.
These may take the forms of bonds, equities, and warrants.
c. Financial intermediaries. These are the financial institutions that facilitate the
issuance of securities. Examples are universal banks and investment banks.
d. Investors, individuals, or firms that have excess funds and are willing to invest in
the securities offered.
2. Secondary Market. It is also called the aftermarket. It is the place where financial
instruments already issued are traded. The secondary market provides for the first
owner of the issued securities to be sold to the market. The securities are sold by the
investor to another investor for profit or cutting loss.
Other Examples of Financial Markets

1. Stock market

The stock market trades shares of ownership of public companies. Each share comes
with a price, and investors make money with the stocks when they perform well in the
market. It is easy to buy stocks. The real challenge is in choosing the right stocks that will
earn money for the investor.

There are various indices that investors can use to monitor how the stock market is doing,
such as the Dow Jones Industrial Average (DJIA) and the S&P 500. When stocks are
bought at a cheaper price and are sold at a higher price, the investor earns from the sale.

2. Bond market

The bond market offers opportunities for companies and the government to secure
money to finance a project or investment. In a bond market, investors buy bonds from a
company, and the company returns the amount of the bonds within an agreed period,
plus interest.

3. Commodities market

The commodities market is where traders and investors buy and sell natural resources or
commodities such as corn, oil, meat, and gold. A specific market is created for such
resources because their price is unpredictable. There is a commodities futures market
wherein the price of items that are to be delivered at a given future time is already
identified and sealed today.

4. Derivatives market

Such a market involves derivatives or contracts whose value is based on the market value
of the asset being traded. The futures mentioned above in the commodities market is an
example of a derivative.

5. Foreign exchange market

Banks normally have this as one of their functions. It is a global decentralized or over-
the-counter (OTC), for the trading of currencies. This market determines foreign
exchange rates for every currency. It includes aspects of buying, selling, and exchanging
currencies at the current or determined prices.

The financial system and its importance

Financial systems promote the overall domestic and international economic and financial
stability. They provide the framework for allowing economic transactions and implementing
monetary policies. These policies help properly facilitate investments and exchanges,
channeling savings into investments to support growth.

The financial system in the Philippines

The Philippines is a dynamic economy with a relatively smaller financial system than other
Asian emerging market economies, dominated by banks. The total assets of the system
amount to 126 percent of GDP. However, bank credit is just over 50 percent of GDP and
mostly goes to nonfinancial corporates (NFCs). June 7, 2022
The Basic Functions of the Financial System

1. Promote savings functions.

2. Payment function
3. Protection against risk functions
4. Means to Wealth Function
5. Provide Liquidity Function
6. Credit Facility Function

The most important parts of the financial system

The financial system can be broken down into six main parts: money, financial instruments,
financial markets, financial institutions, regulatory agencies, and central banks.

Different classifications of financial institutions

a. Banking institutions
A. Private Banking Institutions
1. Commercial Banks
a. Universal Bank – it provides financial service conglomerates that combine
investment banking, commercial banking, development banking, and
insurance to encompass a wider variety of services. The universal bank has
the authority to exercise as a commercial bank, the powers of an investment
house, and the power to invest in non-allied enterprises. Like all other
financial institutions, universal banks are under the supervision of the Banko
Sentral ng Pilipinas.
b. Commercial Banks – In terms of capitalization, this is next to the
universal bank. The common functions are as follows:
a. accept drafts and issue letters of credit,
b. discount and negotiate promissory notes, drafts, bills of exchange,
and other evidence of debt,
c. accept or create demand deposits,
d. receive other types of deposits and deposit substitutes,
e. buy and sell foreign exchange and gold or silver bullion,
f. acquire marketable bonds and other debt securities, and
g. extend credit, subject to such rules as the Monetary Board may
promulgate.
2. Thrift Bank. These banks are primarily concerned with the mobilization of savings
and loans and provide short-term working capital, medium, and long-term financing,
and diversified financial and allied services for their chosen market and
constituencies, especially for the small and medium enterprises and individuals
(RA7907-Thrift Act of 1995)

a. Savings and Mortgage Banks

b. Stocks savings and loan associations
c. Private Development Banks

3. Rural Banks
4. Cooperative Banks – It is a retail and commercial bank organized on a cooperative
basis. Cooperative banking, just like a thrift bank, accepts deposits and provides
loans to individuals to undertake ventures using the principles of the cooperative.

5. Islamic Banks.

Islamic banking has the function and purpose of conventional banking. However,
adhering to Islamic law and ensuring fair play are the core of Islamic banking. The
basic principle of Islamic banking is based on risk-sharing which is a component of
trade rather than risk-transfer which is seen in conventional banking.

6. Other classification of banks as determined by the Monetary Board of the Bangko

Sentral ng Pilipinas.

B. Government Bank. It Is a financial institution controlled by the government. This

kind of bank plays a special role in the economic development of one country.

1. Development Bank of the Philippines

2. Land Bank of the Philippines

b. Non-Bank Financial Institutions

a. Private Non-bank Financial Institutions

a. Investment Bank. It is an enterprise whose function is to underwirte

securities of another person or enterprise, including securities of government
and private companies. It also provides planning, consultancy, fund
management, and raising funds through equity financing and borrowings.
b. Investment companies- These companies are engaged in the buying and
selling of securities.
c. Securities Dealers/Brokers. These are companies that buy and sell stocks of
other companies to resell them for a profit. They do not receive commissions
since they are generating profits based on their trading. Securities brokers
are individuals of firms engaged in the buying and selling of stocks for
commission.
d. Insurance Companies. These are companies that provide insurance in case
of loss to the insured individuals and firms. They transfer the risk of a loss,
from one entity to another in exchange for payment called premium.
e. Credit Unions – these are composed of member-owned producers and
consumers. They are operated to promote thrift, short-term credit at
competitive rates, and provide other financial services to its members.
f. Pawnshops- They are financial institutions that cater to financing to relatively
low-income individuals. Borrowing requires collateral to guarantee payment.
Collateral may take the forms of rings, necklaces, earrings, gadgets, and any
small valuable items.

b. Government Non-Bank Financial Institution

1. Government Service Insurance System

2. Social Security System
Financial Intermediary

A financial intermediary refers to an institution that acts as a middleman between two

parties in to facilitate a financial transaction. The institutions that are commonly referred to
as financial intermediaries include commercial banks, investment banks, mutual funds,
and pension funds.

Financial intermediaries provide a middle ground between two parties in any financial
transaction. A prime example would be a bank, which serves many different roles: it acts as
a middleman between a borrower and a lender, and pools together funds for investment.

Difference between financial intermediary and financial market

A financial intermediary is typically an institution or entity that provides services to a client

related to their involvement in a financial market. A financial market on the other hand, is
the market on which we transact.

Difference between financial institutions and financial markets

Financial institutions are organizations like banks, credit unions, and investment companies
that help people manage and grow their money. Financial markets are places where people
can buy and sell things like stocks, bonds, and commodities, to make investments and trade
with each other.

Difference between a financial institution and a financial intermediary

Financial intermediaries connect entities with surplus funds to entities with deficit funds.
They facilitate the flow of money in the economy and promote economic growth.
Commercial banks, investment banks, mutual funds, and pension funds are all examples of
financial institutions.

Financial intermediaries provide a middle ground between two parties in any financial
transaction. A prime example would be a bank, which serves many different roles: it acts as
a middleman between a borrower and a lender, and pools together funds for investment.
References:
• Brigham Powerpoint, Financial Markets
• Lascano, M., Baron H. & Cachero A., Fundamentals of Financial Markets 2019
• Madura Powerpoint, Financial Markets
• Timbang, F.L. and Castro, N. F., Financial Markets, infopage Educational Services,
Inc. 2023
• Online searches:
(https://www.occ.treas.gov/topics/supervision-and-examination/capital-
markets/financial-markets/index-financial-
markets.html#:~:text=Financial%20Markets%20include%20any%20place,who%20
have%20capital%20to%20invest.)

https://www.investopedia.com/terms/f/financial-
market.asp#:~:text=Financial%20markets%20refer%20broadly%20to,smooth%20o
peration%20of%20capitalist%20economies.

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