FINANCIAL MARKETS

BY: Mrs. Belen Apostol

 FINANCIAL MARKETS

• Brings together individuals and firms who

want to borrow money with those who
want to lend.
• Provide a permanent venue for savers and
borrowers, and which render financial
services whenever required by their
customers.
• Expedite the creation and trading of
financial instruments.
 DIRECT FINANCING Channels for Funds and
Private placements Financial Instruments in the
Direct Credit Brokers Financial Market
Market Dealers Primary
Funds Investment Bankers Securities
Funds

SURPLUS Primary
DEFICIT
SPENDING Securities
SPENDING
UNITS
UNITS
Households Secondary
Households
Business Firms Securities
Business Firms
Government
Government
INDIRECT FINANCING BY
FINANCIAL
Funds INTERMEDIARIES Primary
Commercial Banks Securities
Savings & Loans Associations
Funds
Mutual Savings Banks
Credit Unions
Insurance companies
Intermediation
Finance companies
Market
Mutual Funds Direct Credit
Money Market Funds Market
 Benefits of Financial Markets

The operation of financial markets offer advantages

which covers the following:
1. Funds are directed to DSUs which can use them
most efficiently
DSUs that can use borrowed funds in the most
productive manner can afford to pay higher interest
rates. For this, they have an edge in the bidding for
loanable amounts.
Big and small business firms compete for the use of
the funds made available by the financial market.
Interest rates becomes higher and it motivates
savers to save more to have more funds for lending
 Benefits of Financial Markets

2. Liquidity is provided to savers

Without financial market, savers lend
directly to borrowers. They wait for the
maturity date of the loan before they get
their money back. Lenders could not get
their money even if they need it before the
maturity date. Thru financial markets, the
financial instruments issued to lenders
could be converted to cash before the
maturity date by endorsement or sale.
 Why firms Invest and Borrow

• Quantity discounts for bulk purchases

granted by suppliers; and

• Additional revenues from sales.

Methods by which Financial Markets transfer funds
1. Direct Finance
2. Indirect Finance
Direct Finance – lending by ultimate borrowers with no
intermediary. The SSU gives money to the DSU in
exchange for financial claims on the DSU. The
claims issued are called direct claims and are
typically sold in direct credit markets such as the
money or capital markets.
- provides SSUs with a venue for saving with
expected return. DSUs are provided with a source
of funds for consumption or investment. (increases
the efficiency of the financial market)
 Direct Financing

Disadvantages
1.There are few DSUs which can transact in
the direct market because the
denominations of securities sold are very
large (millions of pesos)
2.It is difficult to match the requirements of
SSUs and DSUs in terms of denomination,
maturity and other factors.
 Methods of Direct Financing

1. Private placements

1. Brokers and dealers; and

1. Investment brokers
Methods of Direct Financing
Private placement – selling of securities by private negotiation
directly to insurance companies, commercial banks, pension
funds, large-scale corporate investors, and wealthy individual
investors

Broker – an intermediary between buyers and sellers but does not

take title to the securities traded
Dealer – one who is in the security business acting as a principal
rather than an agent. The dealer buys for his account and sells
to customer from inventory. He makes profits by selling his
inventory of securities at a price higher than the acquisition cost.

Investment banker – provides financial advice and underwrites

and distributes new investment securities
 Indirect Finance

• Also called financial intermediation –

refers to lending by an ultimate lender to a
financial intermediary that then relends to
ultimate borrowers

• Includes commercial banks, mutual

savings banks, credit unions, life
insurance companies, and pension funds.
 INDIRECT FINANCE

FINANCIAL INTERMEDIARIES

Funds
Funds Funds

Lenders – Savers Borrowers - Spenders

1.Households 1.Business Firms
2.Business Firms FINANCIAL 2.Government
3.Government MARKETS 3.Households
4.Foreigners Funds Funds 4.Foreigners

DIRECT FINANCE

Transfer of Funds From Lenders to Borrowers

 Classification of Financial Markets

1. Primary market 9. Auction market

2. Secondary market 10. Negotiation market
3. Money market 11. Organized market
4. Capital market 12. Over-the-counter
5. Bond market market
6. Stock market 13. Spot market
7. Mortgage market 14. Futures market
8. Consumer credit 15. Options market
market 16. Foreign exchange
market
 Primary Market

• A financial market in which newly issued primary

and secondary securities are traded for the first
time

• Investors who buy these new issues are

supplying funds to DSUs which issue securities

• Large corporations needing large amount of

funds usually tap the primary market through
bond issuance.
 Secondary Market

• Existing financial securities are traded

• SSUs which bought new securities from the primary

market may sell the same to the secondary market
anytime they wish to change their portfolios before
maturity dates. (provides liquidity to the SSUs with
securities held)

• When banks buy Treasury Bills from the Banko

Sentral they do so in consideration of their clients
who buy the T- Bills from them and which forms a
solid secondary market.
 Money Market

• A financial market on which debt

securities with an original maturity of
one year or less are traded.

Long- term securities may also be traded in the

money market if they have six months or less left
to maturity.

Banks like Land Bank of the Philippines perform

money market functions.
 The Flow of Funds and
PRIMARY MARKET: New Issues Securities in Primary
and Secondary Markets
Money Invested
Investment Bankers and New Funds
Private Placement

New Common Stock New Stock

and Bond Certificates and Bond Certificates

Household
Money Business
Sector
Common Stock Sector
and Bond Certificates

Common Stock
and Bond Certificates
Stock Exchanges and
Over-the-Counter
Money Market

SECONDARY MARKET: Seasoned or Existing Issues

 Capital Market

• Trading is undertaken for securities with maturity

of more than one year. Banks that bid for two -
year Treasury bonds are considered part of the
capital market.

• The capital market is subdivided into three parts:

1. The bond market

2. The stock market; and
3. The mortgage market
 Bond Market

• The market for debt instruments of any kind.

• It operates through a system of dealers using a

telecommunications network, rather than in a
single physical location for trading. Dealers
include giant banking firms located around the
world.
 Stock Market

• The common and preferred stocks issued by

corporations are traded. It has two components:
1. the organized exchanges
2. less formal over-the-counter markets
• There are many organized exchanges
throughout the world like New York and London
Stock Exchanges. In the Philippines, stocks are
openly traded in the Philippine Stock Exchange.
 Stock Market
• The companies whose stocks are traded in the Philippine Stock
Exchange are classified into the following categories:
1. Banks
2. Financial service
3. Communication
4. Power and energy
5. Transportation services
6. Construction and other related products
7. Food, beverages, and tobacco
8. Holding firms
9. Manufacturing, distribution and trading
10.Hotel, recreation, and other services
11.Bonds, preferred stocks and warrants
12.others
 Mortgage Market
• Deals with loans on residential, commercial, and
industrial real estate and farmland
• The mortgage market is composed of various financial
institutions.
• This may be derived from a review of advertisements in
newspapers where financial institutions invite interested
parties to buy foreclosed properties.
• Banks, National Home Mortgage Finance Corporation,
Government Service Insurance System (GSIS), and
Social Security System (SSS) grant mortgage loans
secured by house and lot collaterals.
 Consumer Credit Market
• Involved in auto, appliances, education, and travel loans.

• A no. of financing institutions extend auto and salary and

various personal loans to consumers

Auction Market

• Trading is conducted by an independent party according to a

matching of prices on orders received to buy and sell a
particular security

• Stocks are sold to the highest bidder

on the trading floors
 Auction Market
• At the Philippine Stock exchange, buyers of securities make
their bids and prospective sellers make their offer.

• Bids and offers stipulate both price and volume and are
handled by the trader.

• Trader – an agent of the auction market

• Offers are ranked from the lowest price up; bids from the
highest price down. Bids and offers are matched with one
another. If there is a match, trade is consummated. Buyers and
sellers do not directly trade with one another, but through a
trader
• E.g. Philippine Stock Exchange
 Negotiation Market
• Buyers and sellers of securities negotiate with each other
regarding price and volume, either directly or through a broker
or dealer.

• Securities that are not frequently traded and which are in large
volumes may not be readily accommodated in the auction
market for lack of time to receive sufficient orders. This situation
is remedied by the negotiation market where the buyers and
sellers are given sufficient time to locate one another and to
revise either price or volume in order to clear the market.

• The Philippine government, negotiates with

institutions like the World Bank for loans
intended for various projects.
 Organized Market
• A financial market with fixed trading rules.
• It is situated at a central location in the financial district which
trading is generally conducted by auction.
• The Philippine Stock Exchange is an example of organized
market where common and preferred stocks, bonds and
warrants are sold
• Stock exchanges have specifically designated members
• Board – elected governing body
• Members have seats in the exchange, which are bought and
sold.
• The seat gives the holder the right to trade
on exchange
• The board of governors of the Philippine Stock
Exchange is composed of 15 members
 Over-the-Counter Market
• Consists of large collection of brokers and dealers,
connected electronically by telephones and computers
that provide for trading in unlisted securities.
• All securities not traded in the stock exchange are traded
over the counter
• The over-the-counter market consists of facilities, namely:
1. Relatively few dealers who hold inventories or over-the-
counter securities and act as a securities market.
2. The many brokers who act as agents in bringing
these dealers together with investors; and
3. The computers, terminals and electronic
networks that provide communications link
between dealers and brokers
 Spot Market
• Securities are traded for immediate delivery and
payment.
• The spot price is the feature of the spot market and
which is actually the price paid for a security that will be
delivered on the spot immediately.
• Immediately may mean one or two days to one week
depending on the facilities used or the tradition in the
area.
• An alternative to the futures market
 Futures Market
• Contracts are originated and traded that give the holder
the right to buy something in the future at a price
specified by the contract.
• Futures market used to operate in the Philippines but it
was dissolved because of some difficulties.
• The Bankers Association of the Philippines has
recommended key reforms in government regulations
that will pave the way for the resumption of futures
trading in the country.
 Options Market
• One where stock options are traded
• Stock option – a contract giving the owner the right to either buy
or sell a fixed number of shares of a stock (usually 100) at any
time before the expiration date at a price specified in the option.
• Options contracts may cover items like gold and Treasury
bonds. Options are traded in organized securities exchanges
like the Philippine Stock Exchange.
• One purpose of the options market is to make possible for
investors who wish to reduce the risk of losing money due to
price changes in the future.
• For instance, an importer purchasing goods to be paid in foreign
currency may avoid the risk of a sharp rise in the
foreign exchange rate by buying an
options contract
 Foreign Exchange Market
• People buy and sell foreign currencies
• Composed of the following:

1. Banks located throughout the world buying and selling

foreign monies, in the form of foreign currencies and
deposits in foreign banks;
2. Foreign exchange dealers; and
3. Currency exchanges catering mostly to tourists and are
found in the downtown areas, airports and railroad
stations in major tourist centers.
 Homework
• Why is knowledge of financial markets an important
requirement in business finance?