ASSIGNMENT

IN
MACROECONOMICS

SUBMITTED BY:
JASTINE QUIEL G. EUSEBIO

SUBMITTED TO:
MR. BENJAMIN BUNYI

March 8, 2017
 FINANCIAL MARKETS

1. What is Stocks? Types of Stocks? Pros and Cons of issuing Stocks?

Stock is a share in the ownership of a company. Stock represents a claim on the

company's assets and earnings. As you acquire more stock, your ownership stake in the
company becomes greater. Whether you say shares, equity, or stock, it all means the same
thing.

There are two main types of stocks:

Common stock- When people talk about stocks they are usually referring to this
type. In fact, the majority of stock is issued is in this form. Common shares represent
ownership in a company and a claim (dividends) on a portion of profits. Investors get one
vote per share to elect the board members, who oversee the major decisions made by
management.

Over the long term, common stock, by means of capital growth, yields higher
returns than almost every other investment. This higher return comes at a cost since
common stocks entail the most risk. If a company goes bankrupt and liquidates, the
common shareholders will not receive money until the creditors, bondholders and
preferred shareholders are paid.

Preferred stock- represents some degree of ownership in a company but usually

doesn't come with the same voting rights. (This may vary depending on the company.)
With preferred shares, investors are usually guaranteed a fixed dividend forever. This is
different than common stock, which has variable dividends that are never guaranteed.
Another advantage is that in the event of liquidation, preferred shareholders are paid off
before the common shareholder (but still after debt holders). Preferred stock may also be
callable, meaning that the company has the option to purchase the shares from
shareholders at anytime for any reason (usually for a premium).

Some people consider preferred stock to be more like debt than equity. A good
way to think of these kinds of shares is to see them as being in between bonds and common
shares.

Pros
If your business doesn't have a stellar credit rating, you may not be able to borrow
the money you need. If you incorporate, you can sell stock in your company instead. This
is particularly attractive if you are a start-up with no track record. You can attract these
investors based on your potential for profit and growth. Selling stock gives you the
advantage of not owing any money to investors, because you are not borrowing. You
don't have to make any payments for the money you raise this way. In addition, a rising
stock value can increase your credit rating and make it easier to borrow money in the
future. Also, the constant need to justify your actions to shareholders can give your
company a sharp focus and profitability.
Cons
By selling shares of your company, you give each investor a piece of ownership.
This means you have to answer for all of your actions to shareholders. You may have to
reveal information to them that you would have preferred your competitors didn’t know.
Because they own a piece of your company, they have a right to demand explanations
and justifications for your business decisions. Depending on your company charter that lays
out rights and responsibilities of shareholders, they may have the right to vote on issues
affecting your company, the way you acquire and use assets, and how you keep your
records. You may have to offer a monthly or quarterly dividend to provide enough reward
for investors to take a chance on your company. If you have agreed to pay dividends,
shareholders have a right to those dividends, and if you default on a payment, you could
hurt your company’s reputation and its stock price. You have to incorporate in order to
sell stock, which can bring tax consequences.

2. What is Bonds? Types of Bonds? Pros and Cons of issuing Bonds?

A bond is a debt financing contract that allows investors to lend money to a borrower.
The borrowers are typically the government or corporations who need additional capital
or financing. The amount issued by the investors are paid with interest at a given term,
usually at a fixed interest rate.

Types of Bonds

Two types of bonds according to maturity:

1. Treasury Bills (T-Bills). Debt investments with short term maturity of less than a year.
According to the Bureau of Treasury, there are currently three tenors (maturity period) of
Treasury Bills:

• 91-day • 182-day • 364-day

2. Treasury Bonds (T-Bonds). Debt investments with long term maturity of more than one
year. According to the Bureau of Treasury, there are currently five (5) maturities of
Treasury Bonds:

• 2-year • 5–year • 7–year • 10–year • 20-year

Four types of bonds according to issuer:

1. Treasury Securities. Issued by the Bureau of Treasury. This is ideal for big corporations.
The website of the Bureau of Treasury has recently released their 18th Retail Treasury Bond
offering with 3.50% interest at quarterly payments. The issue of Retail Treasury Bond
(RTB) has a maturity of ten (10) years.

The minimum denomination is at P5,000, subject to the minimum deposit and

documentary requirements of the banks or Selling Agents. The offer period was from
September 6 to 16, 2016.

For the next round, investors may purchase RTBs from selling agents, and will be required
to open an account or designate their existing peso account where the interest and principal
payments will be made.

2. Government Bonds. Issued by government agencies, e.g. PAG-IBIG or the Home

Development Mutual Fund. The bonds offered by PAG-IBIG are also ideal for individual
investments because of their competitive interest rates.

3. Municipal Bonds. Issued and announced by local government

4. Corporate Bonds. Issued by large corporations. For instance, Ayala Land, Inc.’s
announcement to raise P8B from fixed-rate bonds.

Pros
1. Source of Cash. For companies in need of extra capital or resources for business
operations, issuing bonds is one of the most effective techniques to do it. By issuing bonds,
you get money from investors without making them part owner of the company. You
only need to pay interest for letting them use their money and even if they have invested
money in your organization, they are still not part of decision-making.

2. Tax Deductible. Another advantage of bond issuance is related to the interest an issuer
has to pay its investors. This is because the payment of interest is subjected to tax
deductions and considered an expense to the company. While this makes it possible to
have money for business operations, it also reduces the taxes that need to be paid.

3. Access to Funds. People who prefer issuing bonds over selling stocks say that this lets the
company to borrow money only when at a time it is needed. Instead of borrowing from
banking institutions, companies can borrow from investors and only pay lower interest
rates. Moreover, the issuing company can decide the period of maturity of the bond from
3 years or 30 years, depending on their preference. This also gives them control of their
debts.
Cons
1. Limitations. One of the setbacks of issuing bonds is the limited power or control of the
issuer over where the money borrowed will be used. Since the investor wants to ensure
that the money will be used responsibly, there will be limitations placed on the
disbursement of the bond, say in the case of a governmental agency that issues the bond.
If the money was intended to the construction of a bridge, this is where it should go. The
bond cannot be allocated for use of another project.

2. Repayments. The money invested in bonds need to be repaid on a monthly basis until
it matures, in which the issuer need to pay back the principal amount borrowed. As
opposed to stocks where the company will not be responsible in case the stocks did not
perform well, issuing bonds means that the issuer will have to come up with the interest
payment regularly.

3. Liability. Another disadvantage of bond issuance is the obligation of the issuer to pay
the investor the interest regardless of the financial status of the company. In stocks, the
company is not liable to the investors if the stocks are down unlike in bonds where the
issuer has to pay the investor. In addition, the interest rates will be a deduction to the
profit of the company.

Issuance of bonds has both advantages and disadvantages. Any entity planning to sell
bonds should understand the opportunities and responsibilities of these transactions.

3. What is Futures? Types of Futures? Pros and Cons of Futures Contract?

Futures are financial contracts obligating the buyer to purchase an asset or the seller to
sell an asset, such as a physical commodity or a financial instrument, at a predetermined
future date and price. Futures contracts detail the quality and quantity of the underlying
asset; they are standardized to facilitate trading on a futures exchange. Some futures
contracts may call for physical delivery of the asset, while others are settled in cash.

Types of Financial Futures

Eurodollar Futures
Eurodollar futures are U.S. dollars that are deposited outside the country in
commercial banks mainly in Europe which are known to settle international
transactions. They are not guaranteed by any government but only by the
obligation of the bank that is holding them.
 U.S. Treasury Futures
Because U.S. Dollars is the reserved currency for most countries, the stability
of the dollars allows for treasury futures market and instruments such as treasury
bonds and treasury bills.

Foreign Government Debt Futures

Most government issue debt that are corresponded to the futures markets
that are listed around the world.

Swap Futures
This is generally agreements that are between two parties to exchange
periodic interest payments.

Forex Futures
This type of futures is to manage the risks and take advantage of related forex
exchange rate fluctuations.

Single Stock Futures

Most popular futures contracts are related to the equity markets, they are
also known as security futures. There are about 10 companies in Malaysia that
offer single stock futures. They are Bursa Malaysia Bhd, Air Asia Bhd, AMMB
Holdings Bhd, Berjaya Sports Toto Bhd, Genting Bhd, IOI Corporation Bhd, Maxis
Communications Bhd, RHB Capital Bhd, Scomi Group Bhd and Telekom Malaysia
Bhd.

Index Futures
Futures that are based on the stock index. In the case of the Kuala Lumpur
Composite Index, the index futures will be the FTSE Bursa Malaysia KLCI Futures
(FKLI).

Types of Commodities Futures

Metals
Major metals traded with futures contracts include copper, gold, platinum,
palladium and silver, which are listed on the New York Mercantile Exchange which
has merged with the Chicago Mercantile Exchange.
 Energy
The most popular energy futures contracts are crude oil, heating oil and
natural gas. They have become an important indicator of world economic and
political developments and are very much influenced by producing nations such as
Malaysia.

Grains & Oil Seeds

Grains such as soybeans and oil seeds are essential to food and feed supplies,
and prices are sensitive to the weather conditions, and also to economic conditions
that affect demand. Because corn is integral to the increasing popularity of ethanol
fuel, the grain markets also are affected by the energy markets and the demand for
fuel.

Livestock
Commodity futures on live cattle, feeder cattle, lean hogs and pork bellies
are commodities traded at CME Group Inc and prices are affected by consumer
demand, competing protein sources, price of feed, and factors that influence the
number of animals born and sent to market, such as disease and weather.

Food and Fiber

The food and fiber category for futures trading includes cocoa, coffee, cotton
and sugar. In addition to consumer demand globally, factors such as disease, insect’s
infestation and drought affect prices of these commodities.
Pros
Offset the risk exposures
The main reason that companies or corporations use future contracts is to offset
their risk exposures and limit themselves from any fluctuations in price. The ultimate goal
of an investor using futures contracts to hedge is to perfectly offset their risk. In real life,
however, this is often impossible and, therefore, individuals attempt to neutralize risk as
much as possible instead. For example, if a commodity to be hedged is not available as a
futures contract, an investor will buy a futures contract in something that closely follows
the movements of that commodity minimized the stock risk.
Stock index futures have become a popular derivative product for hedging, for
several reasons. First, they create the possibility of speculative gains using leverage where
a relatively small amount of investment is required for trading a large amount of stocks.
Second, investors can sell contracts as readily as they can buy them, since there is
no significant difference in the amount required for either buying or selling and no special
restrictions on being short.
 Third, the standard feature in stock index futures contracts allows trades to be
completed sooner. With electronic trading, trading sessions allow investors to get in and
out of positions, often within minutes.
Fourth, stock index futures offer low transaction costs compared to the costs of
trading equities.
Fifthly, futures contracts can be effectively used for hedging the risk of underlying
spot.
Futures contracts can be very useful in limiting the risk exposure that an investor has
in a trade. The main advantage of participating in a futures contract is that it removes the
uncertainty about the future price of an item. By locking in a price for which you are able
to buy or sell a particular item, companies are able to eliminate the ambiguity having to
do with expected expenses and profits.
Cons
There are several factors which market timing is concerned with the ability to
forecast market movements, while stock selection relates to the ability of the fund manager
to spot stocks which are miss-priced influence the hedge ratios. Futures contracts come with
definite expiration dates. Even if you have established fixed prices for the assets in the
contract, as the expiration date approaches those prices can become much less attractive
to others. At times, this condition can cause futures contracts to expire as worthless
investments. Similar to banks that offer too many loans at fixed rates, changes in the market
increase the risk that some of their loans will come with well-below market rates. Futures
contract expiration dates, as they get closer, come with similar risks. The disadvantage
involves the sometimes fast movement of futures prices. Contract prices can tick-up or
down daily, sometimes within minutes.

4. What is Options? Types of Options? Pros and Cons of Option Contract?

An option is a contract that gives the buyer the right, but not the obligation, to buy
or sell an underlying asset at a specific price on or before a certain date. An option, just
like a stock or bond, is a security. It is also a binding contract with strictly defined terms
and properties.

Types of Options

Call options are contracts that give the owner the right to buy the underlying asset
in the future at an agreed price. You would buy a call if you believed that the underlying
asset was likely to increase in price over a given period of time. Calls have an expiration
date and, depending on the terms of the contract, the underlying asset can be bought any
time prior to the expiration date or on the expiration date.
 Put options are essentially the opposite of calls. The owner of a put has the right to
sell the underlying asset in the future at a pre-determined price. Therefore, you would buy
a put if you were expecting the underlying asset to fall in value. As with calls, there is an
expiration date in the contact.

Exchange Traded Options. Also known as listed options, this is the most common
form of options. The term “Exchanged Traded” is used to describe any options contract
that is listed on a public trading exchange. They can be bought and sold by anyone by
using the services of a suitable broker.
“Over The Counter” (OTC) options are only traded in the OTC markets, making
them less accessible to the general public. They tend to be customized contracts with more
complicated terms than most Exchange Traded contracts.

Employee Stock Options. These are a form of stock option where employees are
granted contracts based on the stock of the company they work for. They are generally
used as a form of remuneration, bonus, or incentive to join a company.
Cash Settled Options do not involve the physical transfer of the underlying asset
when they are exercised or settled. Instead, whichever party to the contract has made a
profit is paid in cash by the other party. These types of contracts are typically used when
the underlying asset is difficult or expensive to transfer to the other party.

THE FINANCIAL CRISIS OF 2007-2009

5. What are the two sectors in the economy which were affected by the Financial
Crisis of 2007-2009 in the US?

The two sectors are the financial sector and the real sector. The financial sector
consists of financial institutions: commercial banks, investment banks, hedge funds,
brokerage firms, and others. The real sector consists of firms that produce goods and
services, individuals who buy goods and services, and individuals who work for firms,
among others.

6. What are the different factors/causes that contributes to the financial crisis?

Problems contributing to the financial crisis included people not paying back the loans
they took out from the banks, depositors becoming afraid that their deposits were not safe
at the banks and en masse trying to withdraw them, banks having a hard time getting loans
from other banks, and banks finding themselves with declining asset values, moving them
toward insolvency (when their liabilities are greater than their assets). Problems in the
financial sector can bleed over into the real sector, producing problems such as decreased
borrowing and lending, decreased economic activity, a decline in sales, a rise in
unemployment, and much more. In other words, if the financial sector gets sick, that
sickness can do harm to the real sector.

7. What are the Government actions in addressing the financial crisis?

The federal government responded to the financial crisis and to the problems in the real
sector of the economy in a number of ways. The responses can be categorized as bailouts,
fiscal stimulus, and easy money.

Bailouts. The $700 billion Troubled Asset Relief Program (TARP) took several
forms: the U.S. Treasury’s buying some of the bad assets on the banks’ balance sheets, such
as MBSs, and the government investing directly in some of the largest banks in the country,
thus increasing the capital in banks. Also considered a bailout were the federal loans to
General Motors and Chrysler in December 2008 to prevent the bankruptcy of these
companies.

Fiscal Stimulus. The Congress passed and President Obama signed a $787 billion
fiscal stimulus bill in February 2009 in the hopes of injecting demand into the economy.

Easy Money. In November 2008, the Federal Reserve announced that it would buy
$800 billion of private debt. This was its attempt to increase lending and borrowing in the
economy.

8. What is Federal Deposit Insurance Corp. (FDIC)? How this affects the banking
system in the US?

The FDIC insures deposits in banks up to $250,000 per depositor. This insurance
cuts down on people running to banks to get their money out if they think the bank is
having problems. But it does so at the cost of pushing banks into taking a little more risk
than they might take on if deposits weren’t insured by the FDIC.

To illustrate, if depositors’ money is insured by the federal government, the bank

knows that it isn’t as likely to see a lot of people asking for their money all at once. This
environment makes it less likely that the bank will worry about having to pay off all its
depositors at once. Consequently, the banks may make riskier loans (riskier loans come
with higher expected returns) than it would if its liabilities (specifically, its depositors’
deposits) were not insured. But, of course, making riskier loans may raise the probability
that the bank will become insolvent. After all, riskier loans do not get paid back as often
as less risky loans.
 9. What is Global savings glut? How this affects the monetary policy of the US during
2007-2009?

A global savings glut describes an excess of savings over investment. Emerging

countries in the world began to save more, and much of the extra savings found its way
to the United States, where it increased the supply of loanable funds and lowered interest
rates. The increased supply of loanable funds played a role in the housing story, in which
low mortgage interest rates were already leading to greater borrowing to buy houses and
rising house prices.

10. What is Community Reinvestment Act of 1977? How this affects the lending system
of the banks in the US?

The Community Reinvestment Act (CRA) was passed in 1977. Its purpose was to
encourage financial institutions to meet the needs of borrowers in all segments of their
communities, including low- and moderate-income borrowers. In 1995, Congress revised
the CRA to give banks a stronger incentive to increase the percentage of mortgage loans
(among other loans) going to low- and moderate-income borrowers. Some have argued
that Congress was essentially imposing quotas on banks to apply “innovative or flexible”
standards to meet the borrowing needs of these borrowers. Some have argued that
essentially the CRA forced banks to relax lending standards so that they could make loans
that they otherwise would not have made. Some take a different position, arguing that
banks did not have to give out loans they didn’t want to. However, banks that were not
in compliance with CRA could find their applications for new branches, mergers, or
acquisitions denied.

11. What is the Subprime mortgage loans? Mortgage-backed securities (MBS)?

Collateralized debt obligations (CDO’s)? How these assets affect the bank balance
sheet?

Subprime mortgage loans and other nontraditional mortgage loans fall into the same
category. They are mortgage loans granted to persons who might have low credit ratings
or some other factors that suggest they could default on the debt repayment. Anyone who
is not paying for a house with cash has to take out a mortgage loan. Mortgage loans often
come with certain restrictions. They might specify that a borrower must make a down
payment equal to the a specified percentage (say, 10 percent) of the purchase price of the
house, that he needs a certain dollar income, that he has a good credit history, and so on.
Generally speaking, mortgage lending practices were stricter in the 1970s and 1980s than
they were in the late 1990s and early 2000s. In other words, lending practices loosened
up in the latter years. A drastic loosening is reflected in subprime and other nontraditional
mortgage loans. With subprime loans, loans were being given out to persons who could
not have qualified for traditional loans (with larger down payments, better documentation
of income, and so on).

Mortgage-backed securities (MBS) are a type of asset-backed security that is secured by a

mortgage or collection of mortgages. Here is how an MBS is created. Bank A has made
5,000 mortgage loans, some of which are subprime and other nontraditional loans. It
bundles all 5,000 loans into a package, which consists of the expected future payments
that will be made on the 5,000 loans. For example, one of the 5,000 loans was made to
Smith, who pays $2,400 a month on her mortgage loan. The bank cuts up the package of
5,000 loans into slices and sells them; these slices are the mortgage-backed securities
themselves. Thus, they are called mortgage-backed securities because they are backed by
(or composed of) mortgage loans. For example, if you buy a slice that represents 1/1,000
of the pool of mortgages, then what you will receive is 1/1,000 of the payments made on
the 5,000 loans in the pool.

Collateralized debt obligations (CDOs) are like mortgage-backed securities, except that the
slices are not equal. Some people who hold certain slices get paid before other people with
other slices. These are called tranches, which are simply slices with different risk. What is
important is that the value of an MBS and a CDO depends on the people who are paying
off their mortgage loans. If a lot of people do not pay off their loans, then the MBSs and
CDOs lose their value. Look at it this way. You buy a slice of an MBS for $10,000, which
entitles you to a payment of $500 a month for x number of years. What happens to your
payments of $500 a month if the borrowers do not pay off their mortgage loans? All of a
sudden, you do not receive the payments you thought you were going to receive, and
your MBS is worthless.

In 2006, some people with subprime and other nontraditional loans were not able
to make their monthly payments on their mortgage loans. (We explain why later.) As a
result, banks and other financial institutions experienced a decline in the value of their
assets: the subprime loans, other nontraditional loans, MBSs, and CDOs listed as assets on
their balance sheets. As the value declined, some banks and financial institutions slid into
insolvency, and others were coming ever closer to insolvency.