Third Year Comprehensive Examination (TYCE) Handout Page 1 of 33

BM2004
Table of Contents
(Week 1) Overview of Financial Systems and Markets ..................................................................................................3

Sources of Wealth ......................................................................................................................................................3
The Flow of Funds .....................................................................................................................................................3
Elements of the Financial System .............................................................................................................................. 4
Nature of Financial Markets .......................................................................................................................................4
Types of Financial Markets ........................................................................................................................................5
(Week 2) Philippine Financial System ............................................................................................................................ 7
Financial Regulation...................................................................................................................................................7
Regulation of Market Drivers ......................................................................................................................................7
Financial Regulators ..................................................................................................................................................7
Monetary Policy.......................................................................................................................................................... 8
Basic Approaches to Monetary Policy ........................................................................................................................ 8
Inflation Defined ......................................................................................................................................................... 9
Fiscal Policy ............................................................................................................................................................... 9
Financial Reporting of Banking Institutions .............................................................................................................. 10
(Weeks 3-4) Managing Credit Risk .............................................................................................................................. 11
Loanable Funds Theory ........................................................................................................................................... 11
Expectations Theory ................................................................................................................................................ 11
Market Segmentation Theory ................................................................................................................................... 12
Determining the Interest Rates................................................................................................................................. 12
Nominal and Real Rates .......................................................................................................................................... 13
Bonds Issued at Premium ........................................................................................................................................ 14
Bonds Issued at Discount ........................................................................................................................................ 14
Interest Rate Risks ................................................................................................................................................... 15
The Yield Curve ....................................................................................................................................................... 15
Mitigating the Interest Rate Risk .............................................................................................................................. 15
Credit Ratings .......................................................................................................................................................... 15
(Weeks 6-7) Money Market Instruments ...................................................................................................................... 17
Role of Money Market in the Financial System ........................................................................................................ 17
The Financial Instruments ........................................................................................................................................ 17
The Financial Instruments ........................................................................................................................................ 17
Types of Money Market Instruments ........................................................................................................................ 18
Money Market Valuation .......................................................................................................................................... 19
(Weeks 8-9) Bond Market ............................................................................................................................................ 20
Purpose of the Capital Market .................................................................................................................................. 20
The Bond Market...................................................................................................................................................... 20
Types of Debt Securities .......................................................................................................................................... 20
Types of Bonds ........................................................................................................................................................ 20
Characteristics of Bonds .......................................................................................................................................... 22
Bond Valuation ......................................................................................................................................................... 23
(Weeks 11-13) Equity Market ....................................................................................................................................... 25
Third Year Comprehensive Examination (TYCE) Handout *Property of STI

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Purpose of Equity Securities .................................................................................................................................... 25

Equity vs. Debt ......................................................................................................................................................... 25
Types of Stocks........................................................................................................................................................ 26
Types of Stock Markets ............................................................................................................................................ 26
Market Capitalization ................................................................................................................................................ 27
Capital Market Platforms .......................................................................................................................................... 28
Stock Valuation ........................................................................................................................................................ 28
(Week 15) Types of Investments.................................................................................................................................. 29
Direct Investments ................................................................................................................................................... 29
Collective Investment Schemes (CIS) ...................................................................................................................... 29
Collective Investment Schemes (CIS) ........................................................................ Error! Bookmark not defined.
Classifications of CIS ............................................................................................................................................... 29
Examples of contractual CIS .................................................................................................................................... 29
(Weeks 16-17) International Financial Market and Innovations ................................................................................... 30
Nature of International Financial Market .................................................................................................................. 30
Motives for Investing ................................................................................................................................................ 30
Motives for Providing Credits ................................................................................................................................... 30
Motives for Borrowing .............................................................................................................................................. 30
Types of Foreign Direct Investments (FDIs) ............................................................................................................. 31
The Country Risk Premium (CRP) ........................................................................................................................... 31
Foreign Exchange Market ........................................................................................................................................ 31
Other International Investment Instruments ............................................................................................................. 32
Sectors of World Bank Group................................................................................................................................... 32

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(Week 1) Overview of Financial Systems and Markets
Sources of Wealth
• Finance provides the decision-making framework for obtaining and investing funds. Finance obtain
funds by generating money or wealth. In economics, there are different sources of wealth. Figure 1
shows the sources or origin of wealth and the type of wealth obtained from them.
Figure 1. Origin of Wealth

Source: Fundamentals of Financial Markets, 2019, p. 8
• Labor through hard work will allow a person to earn a salary or wage. As the person continuously
earns, he can save and eventually acquire land that may be used in his business or be leased to
someone else, ultimately generating wealth in the form of rent. As land and labor become profitable,
he will start aiming for a higher return, thus venturing to higher risk. He starts to invest his capital either
in financial or industrial, which makes him an investor. As the venture realizes good returns, the capital
will earn interest.
• Moreover, when the business matures and grows, it needs more focus; thus, he will eventually
participate in the venture. Then, from being an investor, he becomes an entrepreneur, which requires
entrepreneurial skills in managing commercial affairs and ensuring that the company continuously
grows and generates profit. Profits will be accumulated, and investment will be diversified as it grows,
a new breed of individuals and labor force will now be employed, and the cycle goes on.
The Flow of Funds
• The financial system provides the platform by which funds are transferred from those that have funds
to those that need funds to invest. The generated funds from the various sources of wealth will now
flow into the financial system, as shown in Figure 2.
INDIRECT FINANCE
FUNDS FUNDS
Financial
Intermediaries
Lenders Borrowers
1. Household 1. Business
FUNDS Financial FUNDS
2. Business 2. Government
Markets
3. Government 3. Households
4. Foreigners 4. Foreigners
DIRECT FINANCE
Figure 2. The Flow of Funds

Source: Fundamentals of Financial Markets, 2019, p. 10
• The primary lenders, otherwise known as savers, investors, fund providers, and surplus units, are the
households, business firms, government, and foreigners who received more money than they spend.
The excess of the money they received over the money they spent is called savings. They lend out
the said savings to other entities for a required return.
• On the other end are the borrowers, otherwise known as spenders, fund demanders, and deficit units,
primarily composed of business firms and governments. They spend more money than they received;

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thus, they need to borrow funds from the lenders. Businesses borrow funds to support growth and
expansion, while governments use the funds to finance infrastructure and other community projects.
• There are two (2) routes where funds can be transferred from the lenders to the borrowers: direct and
indirect financing. Direct financing is where fund demanders borrow directly from the fund providers
by selling financial instruments in the financial markets. On the other hand, indirect financing is the
route where borrowing between both parties happens indirectly through the intervention of another
party called the financial intermediary.
Elements of the Financial System
1. Lenders and borrowers (Who are the players?) – They are the non-financial economic units that
undertake the lending and borrowing process.
• Lenders – Also known as fund providers, they are parties that have excess funds that they can
lend out to other entities for a required return.
• Borrowers – Also known as fund demanders, they are the parties who are willing to pay the
required return to obtain additional funds to finance their investment initiative.
2. Financial intermediaries (How will the exchange occur?) – They intermediate the lending and
borrowing process. They gather funds from lenders and redistribute them to borrowers through an
investment vehicle like loans.
3. Financial Instrument (What will be used?) – It is the medium of exchange of a party's contractual
obligation, where such a contract can be traded. These can be marketable or non-marketable.
4. Financial Markets (Where will it be traded?) – They are the economic market where the suppliers and
buyers meet.
5. Regulatory Environment (How is it controlled?) – The governing body that ensures the compliance of
transactions that occur within the financial system with the laws and regulations imposed on the actors
and the elements that play within.
6. Creation of money (What is the value created?) - With the flow of financial instruments, money is
created. Then, the money is either reinvested or earned out of the system flows.
7. Price discovery (How much is created?) – It is the process of determining or valuing the financial
instrument in the market.
8. Brokers and Dealers – They are members of financial intermediaries that facilitate the trade of financial
instruments. Some examples of brokers-dealers in the Philippines are COL Financial Group, Inc., BPI
Securities Corporation, BDO Nomura Securities, Inc., and First Metro Securities Brokerage
Corporation.
9. Fund Managers – They are corporate entities or departments of financial intermediaries that manage
funds on behalf of principals (owners or holders of money). Some examples of fund managers in the
country are BPI- Asset Management & Trust Corp (BPI-AMTC); BDO Unibank, Inc. (BDO); BSP
Provident Fund Office (BSPPFO); and Land Bank of the Philippines (LBP).
10. Financial Exchanges – They allow the broker-dealers to facilitate trading in securities and create a
mechanism for clearing and settlement of trades in a risk-minimizing manner. The national exchange
in the country is the Philippine Stock Exchange (PSE).
11. Credit Rating Agencies – They analyze relevant financial and economic data about the issuers of
securities and assign ratings to the securities reflecting the probability of the issuers meeting their
financial obligations (interest and principal). The three (3) major rating companies are Standard &
Poor’s Corporation (S&P), Moody’s Investor Service, and Fitch Ratings.
Nature of Financial Markets

• Price Determination or Price Discovery – This refers to the interaction between buyers and sellers
in the financial market wherein price is set at the level the buyers are willing to buy. The sellers are
willing to sell to come up with the price of the traded financial instrument.
EXAMPLE: Hanna Hartendorp sells her 10,000 shares from Aboitiz Equity Venture at the Philippine
Stock Exchange (PSE). Initially, the shares were offered at a spot price of P150.00 per share. Many
buyers offer to buy the said shares; thus, increasing the price of each share at P180.00 (increase in
demand results in a price rise). The shares were sold at the agreed price of P175.00.
• Liquidity – Financial markets serve as a forum where holders can sell their financial instruments to
other investors to earn cash. Easy access to a venue where investors can sell financial instruments for

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cash offers liquidity to the investors. Liquidity is significant because, without it, an investor will be forced
to hold the financial instrument. The seller will not be contractually obligated to pay until such a time
when the conditions in the agreement to dispose or sell the instrument, respectively, happen.
EXAMPLE: Santi Corporation plans to increase its production of cleanroom products. The plan will
eventually increase the needed raw materials. To finance the materials, Santi Company may just enter
the money market and issue its instrument, rather than personally searching for a company to buy it.
• Reduction in Transaction Costs – The financial markets reduce the cost of asymmetric information
between the buyer and the seller, specifically in terms of economies of scale and expertise. Economies
of scale can be achieved when the company has cheaper access to capital. Asymmetric information
occurs when one party to an economic transaction possesses greater material knowledge than the
other party.
EXAMPLE: Lite Shipping Incorporated plans to add six (6) vessels that will serve passengers from
Bohol to Cagayan De Oro City. The Chief of Financial Officer (CFO) of the shipping line is looking for
a possible financial instrument to finance the plan. Instead of establishing an in-house department to
look for potential investment, the CFO may enter a financial market. Entering the market will reduce the
cost of information in evaluating the characteristics of an instrument (e.g., profitability, marketability,
liquidity, etc.).
Types of Financial Markets

A. Based on Market Type
1. Primary Market - The type of financial market wherein fund demanders such as a corporation or
a government agency raise funds through new issuances of financial instruments.
There are four (4) issue methods that can be done in the primary markets:
a. Public Offering – This occurs when securities are offered for sale to the general public. It is
done by issuing a prospectus or placing a document that contains an offer to the general public
to purchase or subscribe to the securities at a stated price. The process of selling the shares
of private companies to the public, for the first time, is called an initial public offering (IPO).
A public offering can either be an offer for sale or an offer for subscription.
• Offer for sale – The existing potential shareholders invite potential subscribers to buy a
portion of the shares they own. The proceeds from this offer are enjoyed by the current
shareholders and not by the company.
• Offer for a subscription – The general public is invited to subscribe to unissued shares
of the company. The proceeds from this offer are enjoyed by the company and can be used
to finance their investment activities.
b. Limited public offer – This is also known as a private placement. It is when the issuer looks
for a single investor, an institutional buyer, or group of buyers instead of offering the securities
to the general public. However, because of very limited parties, securities sold through private
placements tend to be illiquid (not easily converted into cash).
c. Auction – It is usually used for the issuance of treasury bills, bonds, and other securities issued
by the government and is commonly executed exclusively with market makers. It can be done
in three (3) methods.
• Dutch Auction – The seller begins the sale at a high price. The price is continuously
lowered down at specific intervals until the potential buyer agrees to purchase the
securities.
• English Auction – Where the prospective buyers commence the auction by submitting an
initial bid price. Other buyers who are interested in purchasing the securities submit a new
bid to top the previous one. The bidding stops when no other bidders want to top the last
bid. The last highest bid price becomes the price of the securities that the highest bidder
should pay.
• Descending Price Sealed Auction – Where bidders submit sealed bids to the sellers. The
sealed bids are ranked from highest to lowest price. The number of securities is allocated
first to the highest bid price and follows a descending order. The highest bid price receives
full allocation while the lower bids receive pro-rata allocations.

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d. Tap Issue – It occurs when issuers are open to receive bids for their securities at all times.
They maintain the right to accept or reject the bid prices based on how much funds they need
and when they need them.
2. Secondary market - Where the securities issued in the primary market are subsequently traded.
It also becomes a centralized marketplace wherein buyers and sellers can quickly and efficiently
transact to save on search and information as they do not need to look for transactions
independently.
There are two (2) classifications of secondary markets according to market structure.
a. Order-Driven Market Structure - It is also known as the auction market, wherein the buyers
and sellers propose their prices through their brokers, who convey the bid in a centralized
location. The securities will be awarded to the buyer with the same offer price as the seller's
selling price.
These are the types of orders in an order-driven market structure:
• Day orders – Orders that are only valid until the end of the business day. All orders not
executed at the end of the day will be canceled and removed from the system.
• Limit orders – Orders where clients set a price or price range below or above the existing
price.
• Good-till-canceled order – Orders that last until they are completed or canceled within a
sustained period.
• Market orders – Orders that are placed under broker-dealers. The client relies on the
expertise and integrity of the broker-dealer to execute deals when the current price is
considered best.
b. Quote-Driven Market Structure – This is also known as the primary dealer market or market-
made market. In this structure, market makers play a major role. Market makers are dealers
who create a market by establishing a bid quote and an offer quote. Bid quote or bid price
represents the highest price an investor is willing to pay for a security, while offer quote or ask
price represents the price that an investor is willing to sell the security for. Generally, the bid
quote is lower than the offer quote, and their difference, which is called the spread, becomes
the profit of the market makers.
B. Based on Where the Instruments are Traded
1. Over-the-counter (OTC) – This is the place where in addition to listed securities, unlisted financial
instruments are allowed to be traded. This market does not have a trading floor. Instead, the buy
and sell orders are completed through a communication network such as the National Association
of Securities Dealers Automated Quotations (Nasdaq), Instinet, Selectnet, and Bloomberg Trade
book.
2. Exchanges – They are centralized trading locations where financial instruments are purchased or
sold between market participants. To be traded, all instruments must be listed by the organized
exchange. To reiterate, the national exchange in the country is the PSE.
C. Based on Instruments Traded

1. Money Market – Where financial instruments with short-term maturity or redeemed in one (1) year
or less from the date of issuance are traded. It caters funds to demanders who need short-term
funds from fund providers who have excess short-term funds.
2. Capital Market – Where financial instruments that have a long-term maturity or will mature beyond
one (1) year from the date of issuance are traded. Capital market securities are classified into two
(2): equity and debt.
a. Equity – Stocks or equity securities represent a share of ownership in the corporations that
issue them. They are classified as capital market securities because they have no maturity.
b. Debt – Debt instruments such as government bonds, corporate bonds, certificates of deposit,
municipal bonds, or preferred stock bought or sold between two (2) parties.
D. Based on the Country’s Perspective

1. Internal or National Market – This is the financial market that is operating in a certain country. It
can be divided into two (2):

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a. Domestic Market –The issuers who are considered residents in a country issue securities and
afterward trade them inside their country. For example, a Philippine company issues and trades
securities within the Philippines.
b. Foreign Market – The issuers who are residents of a country issue securities and subsequently
trade them in that country. For example, a US company issues and trades securities within the
Philippines.
2. External Market – Where securities that have two (2) unique characteristics are being traded.
a. Upon issuance, these securities are offered simultaneously to investors in different countries.
b. Securities are issued outside the regulatory jurisdiction of any single country.
E. Based on the Manner of Financial Intermediaries

1. Broker Market – The buyer and seller of the securities are brought together by a broker in the
market, and the trade occurs. In the Philippines, the sole broker market is the Philippine Stock
Exchange (PSE).
2. Dealer Market – The market makers (dealers who create a market by offering to sell or buy
securities) execute the sell or buy orders. The seller sells his securities to a market maker, and the
buyer buys from the market maker.
(Week 2) Philippine Financial System
Financial Regulation
• Systemic risk – The firm’s probability of failing its objective that will result in a ripple effect.
• Consumer protection – The government must consider the effects of implementing the rules and
policies on the consumers' welfare.
• Efficiency enhancement – Ensures dynamism and agility of the government policies to adapt in a
fast-changing environment. The essential tools in enhancing the efficiency of the financial system are
competition policy and antitrust enforcement.
• Social objectives – The government policies must be aligned with the goals of society. Among the
risks and factors, the “social objectives” have a broader scope.
Regulation of Market Drivers
• Competitiveness – The firms in the financial market should know how to respond and maximize their
leverage in the industry.
• Market Behavior – The integrity of the firms in the market can be shown through their activities and
representations.
• Consistency – How firms could maintain their rapport in terms of shared information dictates the
clients' trust.
• Stability – A challenge arises when a firm will not meet its commitment because it fails to forecast and
mitigate the market risks. Otherwise, systemic instability occurs. Systemic instability arises when a firm
will not meet its commitment because it fails to address market risks.
Financial Regulators
1. Bangko Sentral ng Pilipinas (BSP) – An attached agency of the Department of Finance, created
under the Republic Act 7653 (New Central Bank Act). The BSP acts as the central monetary authority,
a corporate body responsible for money, banking, and credit. It is also responsible for the supervision
of financial institutions, and it exercises regulatory powers.
Its function includes the following:
• Liquidity Management – It formulates and issues monetary policy aimed at influencing money
supply to maintain price stability.
• Currency Issue – It has the sole responsibility of issuing notes and coins representing the national
currency of the Philippines.
• Lender of last resort – The provider of discounts, advances, and financial support to a financial
institution to maintain its liquidity.
• Financial supervision – It regularly supervises the financial institutions and over non-banking
institutions performing quasi-banking functions.

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• Management of foreign currency reserves – It ensures that sufficient international reserves will
be made available on time.
• Determination of exchange rate policy – It determines the rate of the Philippine Peso over the
different currencies.
• Other activities – It acts as a banker, financial advisor, and official depositary of the government
and its instrumentalities.
To carry its functions, the BSP is divided into four (4) sectors which are:
• Currency Management Sector (CMS) – It is responsible for the production, distribution, disposal,
or retirement of currencies in the Philippines. Examples of offices are the Currency Issue and
Integrity Office, BSP Regional Offices and Branches, and Cash Department.
• Monetary and Economics Sector (MES) – It conducts monetary policy formulation, ensures its
implementation, and assesses its effectiveness. Examples of offices under this sector are the
Department of Economic Research, Department of Economic Statistics, and the International
Relations Department.
• Financial Supervision Sector (FSS) – It is responsible for the supervision and regulation of banks
and other financial institutions under the scope of BSP. Examples of offices under this sector are
the Department of Supervisory Analytics, Financial System Integrity Department, and Financial
Supervision Departments.
• Corporate Services Sector (CSS) – It is a support group that conducts capital management,
financial services, information technology support, and other corporate resource management. The
Provident Fund Office, Payment and Settlements Office, Sectoral Operations Management
Department are examples of offices under this sector.
2. Insurance Commission (IC) – Under Executive Order No. 192 series of 2015, the Insurance
Commission was established to ensure enforcement of the provisions of R.A. 10607 (Insurance Code).
Its purpose is to regulate and supervise the industry of insurance, pre-need, and health maintenance
organization. It is also responsible for issuing licenses to insurance agents, general agents, resident
agents, underwriters, brokers, adjusters, and actuaries.
3. Security and Exchange Commission (SEC) – It is a national government regulatory agency created
on October 26, 1963, under Commonwealth Act No. 83. It is tasked to administer oversight on the
corporate sector, capital market participants, securities, and investment instruments and promote
corporate governance.
4. Board of Investments (BOI) – It is an attached agency of the Department of Trade and Industry (DTI),
created under E.O. No. 226 (Omnibus Investment Code of 1987). It promotes local and foreign
investments in the Philippines. It provides advisory, actualization, and post services to the investors.
Monetary Policy
1. Expansionary Monetary Policy – The setting that intends to increase the level of liquidity/money
supply in the economy and which could also result in a relatively higher inflation path for the economy.
Examples are the lowering of policy interest rates and the reduction in reserve requirements. It tends
to encourage economic activity as more funds are made available for lending by banks. It, in turn,
increases aggregate demand, which could eventually fuel inflation pressures in the domestic economy.
2. Contractionary Monetary Policy – The setting that intends to decrease the level of liquidity/money
supply in the economy and which could also result in a relatively lower inflation path for the economy.
Examples of this are increases in policy interest rates and reserve requirements. It tends to limit
economic activity as fewer funds are made available for lending by banks. It, in turn, lowers aggregate
demand, which could eventually temper inflation pressures in the domestic economy.
Basic Approaches to Monetary Policy
• Inflation Targeting – This is the current approach wherein the BSP announces an explicit inflation
target. It is done by setting an official target for inflation then adding a “tolerance band” in which inflation
can fluctuate (example: 3.0% official target ± 1.0% tolerance band is equal to 3.0%± 1.0% point). It
focuses on achieving price stability as the ultimate objective of the monetary policy. Thus, the BSP can
exceed the monetary targets as long as the actual inflation rate is kept within program levels.
• Monetary Aggregate Targeting – This is the old approach. This approach assumes a stable and
predictable relationship between money, output, and inflation. When money velocity, which is the

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number of times that the average unit of currency is used to purchased goods and services, remains
steady over time, changes in the money supply are directly related to price changes or inflation. Given
the desired level of inflation consistent with economic growth objectives, it is assumed that the BSP
can determine the level of money supply needed; thus, the BSP indirectly controls inflation by targeting
money supply.
Inflation Defined
• Inflation refers to the rate of change in the average price of goods and services typically purchased by
consumers. There is price stability if inflation is low and stable. Sometimes, inflation is also defined as
the annual percentage change in the Consumer Price Index (CPI), which is the average price of a
standard basket of goods and services consumed by a typical Filipino family for a given period.
𝐶𝑃𝐼1
𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 = {( ) − 1} 𝑥 100%
𝐶𝑃𝐼0
Where,
𝐶𝑃𝐼1 is the consumer price index of the current year; and
𝐶𝑃𝐼0 is the consumer price index of the prior year.
Illustrative Example:
The average price of a standard basket of goods and services consumed by a typical Filipino for the
years 2018 and 2019 were 118 and 120. Therefore, inflation for the year 2019 is:
120
𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 = {( ) − 1} 𝑥 100
118
𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 = 0.0169 𝑥 100%
𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 = 1.69%
It means that prices went up by 1.69% for the year 2019. Thus, the purchasing power of P1.00 for the
year 2019 is 1.69% lesser than in 2018.
• Two (2) types of inflation:
1. Headline Inflation – The rate of change in the weighted average prices of all goods and services in
the CPI.
2. Core Inflation – It is an alternative measure of inflation that eliminates transitory or temporary effects
on the CPI. It is done by removing certain components subject to volatile price movements from
the goods and services. Examples are food and energy and other items affected by supply-side
factors, in which the monetary policy cannot control price changes.
Fiscal Policy
• Fiscal policy is the government’s policy on generating its resources through taxation and/or borrowing
and the setting of the level and allocation of expenditures.
There are also two (2) fiscal policy setting:
1. Expansionary Fiscal Policy – It increases the level of aggregate demand through either increase
in government spending or reductions in taxes. The expansionary policy can do this by:
a. Increasing consumption by raising disposable income through cuts in personal income taxes or
payroll taxes;
b. Increasing investments by raising after-tax profits through cuts in business taxes; and
c. Increasing government purchases through increased spending by the government on final
goods and services and raising grants for local governments to increase their expenditures on
final goods and services.
2. Contractionary Fiscal Policy – It decreases the level of aggregate demand by reducing
consumption, investments, and government spending through cuts in government spending or
increases in taxes.
• Fiscal policy also has three (3) components: the revenue policy, debt management policy, and
expenditure policy.

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1. Revenue Policy – The government's policy in raising revenues, which is rooted in the "ability to
pay” concept. Revenues can be raised administratively or legislatively through taxation. Revenue
generation must be equitable and efficient.
2. Debt Management Policy – It is the government’s policy in attaining a manageable debt level. A
manageable debt level is obtained when the country can afford to pay its maturing liabilities as
scheduled. Usually, borrowings are incurred to finance development projects. However, recently,
they are used as budget support for various government programs and projects, such as Overseas
Development Assistance (ODA).
3. Expenditure Policy – The government’s policy of effective and efficient allocation of funds to
implement public policy. The funds are disbursed by the government to efficiently deliver services
to the public and help the economy grow by supporting priority sectors. Moreover, it is also a means
of ensuring that government expenditures are consistent with the approved surplus or deficit
program for the year. The surplus program is implemented at times of inflation to reduce aggregate
demand, while a deficit program is implemented in times of recession to generate additional
demand.
Financial Reporting of Banking Institutions
A. Philippine Financial Reporting Standards (PFRS)/Philippine Accounting Standards (PAS) –
These are a set of Generally Accepted Accounting Principles (GAAP) issued by the Accounting
Standard Council. As a general rule all, BSP-Supervised Financial Institutions (BSFIs) shall comply
with all provisions of PFRS/PAS in preparing their audited financial statements, EXCEPT for the
following:
• Consolidated financial statements – Under PAS 27, all bank/quasi-bank subsidiaries, regardless
of type, are consolidated on a line-by-line basis. However, for prudential reporting purposes,
financial allied subsidiaries, except insurance companies, are consolidated with the financial
statements of the parent bank on a line-by-line basis. Non-financial allied subsidiaries and
insurance subsidiaries are accounted for using the equity method.
• Provisioning requirement – The BSFIs adopt the provisions of PFRS/PAS in booking provisions
for credit losses in preparing the general-purpose financial statements/audited financial statements.
However, for prudential reporting purposes, BSFIs are required to adopt the expected credit loss
model in measuring credit impairment following the provisions of PFRS 9. The BSFIs are also
required to set up general loan loss provision (GLLP) equivalent to 1% of all outstanding Stage 1
on-balance sheet loans, except for accounts considered credit risk-free under existing regulations.
However, they are not required to provide a 1% GP on other credit exposures covered by PFRS 9,
such as off-balance-sheet accounts and investments. Allowance for credit losses for Stages 1, 2,
and 3 accounts shall be recognized in the profit or loss statement. In cases when the computed
allowance for credit losses on Stage 1 accounts is less than the 1 % GP required, the deficiency
shall be recognized by appropriating the Retained Earnings (RE) account.
• Deemed cost of real and other properties acquired in settlement of loans (ROPA) – In
computing the deemed cost of ROPA, BSFIs are required to value the property at initial recognition
based on the carrying amount of the asset given up in the exchange (i.e., carrying amount of the
loan, instead of the fair value of the real and other property acquired).
• Accrual of interest income on non-performing loans – Interest income is allowed to be
recognized on non-performing exposures for purposes of preparing the general-purpose financial
statements/audited financial statements. However, for prudential reporting purposes, BSFIs cannot
recognize interest income on non-performing exposures, except when payment is received.
B. Basel II Capital Adequacy Framework – It is an international banking standard set by the Basel
Committee on Banking. It is also known as the International Convergence of Capital Measurement and
Capital Standards. One of the framework guidelines is establishing a 10% risk-based capital adequacy
ratio (CAR) of universal and commercial banks. The CAR is expressed as a percentage of the qualifying
capital to risk-weighted assets.
It is also designed to meet the BSP’s statistical requirements in the Philippine banking system, such as
the following:
1. Capital Adequacy Ratio (CAR) – The ratio of total qualifying capital to risk-weighted assets
computed under the risk-based capital adequacy framework.

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2. Density Ratio – It refers to the ratio of the total number of domestic banking offices to the total
number of cities/municipalities in the Philippines.
3. Customer Ratio – It refers to the ratio of the total population to the total number of domestic
banking offices.
All banking institutions are required to prepare the FRP in any of the following applicable bases:
1. Solo Basis – It is the combined financial statements of the head office and branches/other offices.
2. Consolidated Basis – The combined financial statements of the parent bank and subsidiaries
consolidated on a line by line basis. Thus, a balance sheet item of the parent bank is combined
with the item of the subsidiaries (e.g. inventory of the parent bank is combined with the inventory
of the subsidiaries). Only banks with financial allied subsidiaries, excluding insurance subsidiaries,
shall submit the report on a consolidated basis.
Also, the FRP is designed to reflect the two (2) types of books:
1. Regular Banking Book – It is composed of peso accounts and foreign accounts.
2. Foreign Currency Deposit Units (FCDU) – It is composed of foreign currency deposits.
(Weeks 3-4) Managing Credit Risk
Loanable Funds Theory

• Knuck Wicksell introduced it in the 1900s. The theory is useful in explaining the general movement of
interest rates for a particular country. It assumes that the higher the interest rates, sectors in the market
will be more willing to supply loanable funds; the lower the level of the interest, the less they are willing
to provide.
• The sectors also demand loanable funds when the level of interest is low and demands less when the
interest rate level is high. These sectors are the following:
a. Households – They commonly demand loanable funds to finance housing expenditures, purchase
of automobiles, and household items, resulting in installment debt. On the other hand, the
household sector is also the largest supplier of loanable funds because they save the most.
b. Businesses – They demand loanable funds to invest in long-term (fixed) and short-term assets.
The quantity of funds required by enterprises depends on the number of business projects to be
implemented. However, some businesses whose cash inflow exceed outflows act as a supplier of
loanable funds.
c. Government – It demands loanable funds when its planned expenditures cannot be entirely
covered by its incoming revenues from taxes and other sources. To obtain funds, the municipal
governments issue municipal bonds, while the national government and its agencies issue
Treasury and agency securities.
Expectations Theory
• This theory assumes that interest rates are driven by expectations of the lender or borrowers in risks
that might be present in the market in the future. This theory attempts to predict what short-term interest
rates will be in the future based on current long-term interest rates.
a. Pure Expectations Theory – This theory believes that the term structure reflected in the shape of
the yield curve is determined solely by the expectations of interest rates.
(1+𝑡 𝑖2 )2 = (1+𝑡 𝑖1 )(1+𝑡+1 𝑟1 )
Where,
+𝑡 𝑖2 is the known annualized interest rate of two-year security at time 𝑡,
+𝑡 𝑖𝑖 is the known annualized interest rate of one-year security at time 𝑡, and
+𝑡+1 𝑟1 is the one-year interest rate that is anticipated as of time 𝑡 + 1. It is also known as
the forward rate.
A 1-year treasury bill has a coupon rate of 2%, and a 2-year treasury note has a coupon rate of
3%. Based on the pure expectations theory, what is the 1-year interest rate that is anticipated at
𝑡 + 1 (2nd year)?

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Answer:
Let +𝑡 𝑖2 = 3%;
+𝑡 𝑖𝑖 = 2%
+𝑡+1 𝑟1 = 𝑥
(1+𝑡 𝑖2 )2 = (1+𝑡 𝑖𝑖 )(1+𝑡+1 𝑟1 )
Substitute the given values in the formula,
(1.03)2 = (1.02)(1 + 𝑥)
Then, find the value of 𝑥,
1.0609 = 1.02 + 1.02𝑥
𝑥 = 4.00980%
Therefore, the 1-year interest rate that is anticipated in the 2nd year is 4.00980%.
b. Biased Expectations Theory – This theory proposes that the future value of interest rates is always
biased. It is based on expectations, sentiments, and what people expect from the market today.
The present market expectations affect the term structure of the loans as well as interest rates.
Forward rates (the interest rate that applies to financial transactions that will take place in the future)
are adjusted if the borrower's liquidity will be weaker or more reliable in the future. It is also known
as a liquidity premium. Biased Expectations Theory is further divided into two (2):
o Liquidity Preference Theory – This theory believes that investors prefer short-term liquid
securities and may be willing only to invest in long-term securities if compensated with a
premium for the lower degree of liquidity.
o Preferred Habit Theory – This theory proposes that, although investors and borrowers may
normally concentrate on a particular maturity market, certain events may cause them to wander
from their “natural” market/habitat. The natural market is the range of security maturity the
investors and borrowers preferred. For example, commercial banks that obtain mostly short-
term funds may select investments with short-term maturities as a natural habitat. However, if
they wish to benefit from an anticipated decline in interest rates, they may select medium and
long-term maturities instead.
Market Segmentation Theory

• This theory assumes that investors choose securities with maturities that satisfy their forecasted cash
needs rather than on their expectations of future interest rates. For example, pension funds and life
insurance companies may generally prefer long-term bonds that coincide with their long-term liabilities
and in maximizing their income. Commercial banks may prefer more short-term bonds to coincide with
their short-term obligations and to protect their liquidity
• However, the limitation of the theory is that some borrowers may have the flexibility to choose among
various maturity markets. Corporations that need long-term funds may initially obtain short-term
financing if they expect interest rates to decline. Investors with long-term funds may make short-term
investments if they expect interest rates to rise.
Determining the Interest Rates

• Interest can be determined by the function of the risk and the investor's compensation on the difference
between the risk-free rate and the market fluctuation.
𝑖 = 𝑅𝑓 + 𝐷𝑚
Where,
𝑖 is interest;
𝐷𝑚 is the debt margin or debt spread or the risk premium; and
𝑅𝑓 is the risk-free rate.

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Punzalan Merchandise plans to borrow P1,000,000 funds from Cristine Company. The risk-free rate
imposed on the loan is 5%. Cristine’s debt margin is 3%. How much interest rate should Cristine
Company impose on Punzalan Merchandise?
Solution:
Let 𝑖 = interest,
𝑅𝑓 = 5%
𝐷𝑚 = 3%
𝑖 = 5% + 3%
• The risk-premium is the spread between the interest rates on bonds with default risk and default-free
bonds with the same maturity. An example of it is the difference between the interest rates of a Treasury
bond and a corporate bond. The BSP issued the Treasury Bond while a private company issues the
corporate bond. Initially, both bonds have the same attribute: identical default risk, equilibrium prices,
and maturity; and the risk premium on the corporate bond is zero (0).
• If there is a possibility of an increase in default because a corporation suffers a loss, the default risk of
the corporate bond will increase. Thus, decreasing the expected return of the said bond will cause the
demand curve of the corporate bond to shift to the left (decrease in demand). A decrease in demand
for the bond will lower the bond price and thus lower the price of the interest rate.
Nominal and Real Rates

• More than 70 years ago, Irving Fisher proposed a theory of interest rate determination that is still widely
used today. Fisher suggests that nominal interest payments compensate savers – the households,
businesses, and governments, in two (2) ways.
• First, they compensate them for reduced purchasing power. When the savers loan out their money,
they give up the goods and services they could have bought from that money; thus incurring opportunity
costs. To compensate for the opportunity cost, they are paid with interest.
• Second, they provide an additional premium to savers for forgoing present consumption. Savers are
willing to sacrifice consumption only if they receive a premium on their savings above the anticipated
rate of inflation. The effect of inflation on the interest rate is called the Fisher Effect. The concept can
be expressed in the following equation:
𝑅𝑓 = 𝑅𝑓𝑟 + 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛
• The equation above is the formula of a nominal rate. The nominal rate (𝑅𝑓 ) is a rate that does not adjust
for inflation. It is the rate quoted on bonds and loans. For example, if you borrow P100 at a 6% interest
rate, you can expect to pay P6 in interest without considering inflation.
• On the other hand, the real-risk free rate ( 𝑅𝑓𝑟 ) is a rate that adjusts to the expected inflation or the
purchasing power of the Philippine Peso. It reflects the real cost of funds and the real yield to the lender
or borrower. It can be expressed in the following formula:
𝑅𝑓𝑟 = 𝑅𝑓 − 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛
• Suppose the bank loans a person P200,000 to purchase a house at a rate of 3% - the nominal interest
rate not factoring the inflation. Assume the inflation rate is 2%. The real interest rate the borrower is
paying is 1%. The real interest rate the bank is receiving is 1%. It means the purchasing power of the
bank only increases by 1%.
Tulang Corp. plans to borrow P1,000,000 funds from Caventa Financing. The risk-free rate imposed
on the loan is 6%. Currently, the BSP announces a 2% inflation. In the following year, the monetary
board expects a 1% increase in inflation. Caventa still finds that the 4% debt margin remains to be
relevant. How much interest rate should Caventa Financing impose on Tulang Corporation?
Solution:

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The given 6% risk-free rate is the nominal rate. Compute for the real risk-free rate using its formula by
subtracting the current inflation rate from the nominal rate,
𝑅𝑓𝑟 = 𝑅𝑓 − 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛
𝑅𝑓𝑟 = 6% − 2%
𝑅𝑓𝑟 = 4%
The real risk-free rate is 4%. ,

𝑅𝑓 = 𝑅𝑓𝑟 + 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛
𝑅𝑓 = 4% + 3%
𝑅𝑓 = 7%
Then, compute the applicable interest rate or return that Caventa Financing should issue to Tulang
Corporation.
𝑖 = 7% + 4%
𝑖 = 11%
Thus, the interest that Caventa should impose on Tulang Corporation is 11%. But will this be acceptable
to Tulang Corporation? It depends on the assessment that the company will make. If the company
assessed that the interest would go worse than 11% in the future, then the loan is a good offer. On the
other hand, if Tulang Corporation finds a financing company that offers lower than the 11% of Caventa
Financing, then it might reconsider.
Bonds Issued at Premium

• A bond is issued at a premium when the market rate is lower than the nominal rate.
Garcia Company issued bonds with a 5% nominal rate for P1,000 par value, payable for 10 years. The
bonds were sold for P1,300. How much is the interest rate of the said bond in the market?
Answer:
𝑉−𝑀 1,000 − 1,300 −300
𝐼+( ) (1,000 )(5%) + ( ) 50 + ( )
𝑖= 𝑛 𝑥 100% = 10 𝑥 100%𝑖 = 10 𝑥 100
𝑉+𝑀 1,000 + 1,300 2,300
2 2 2
50 − 30 20
= 𝑥 100% = 𝑥 100%
1150 1150
𝒊 = 𝟏. 𝟕𝟒 %
The interest rate in the market, which is 1.74%, is lower than the nominal interest of 5%, meaning the bonds
are perceived to be riskier than the nominal rate.
Bonds Issued at Discount

• A bond is issued at a discount when the market rate is higher than the nominal rate.
Garcia Company issued bonds with a 5% nominal rate for P1,000 par value, payable for 10 years. The
bonds were sold for P700. How much is the interest rate of the said bond in the market?
Answer:

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𝑉−𝑀 1,000 − 700 300

𝐼+( ) (1,000 )(5%) + ( ) 50 + ( )
𝑖= 𝑛 𝑥 100% = 10 𝑥 100% = 10 𝑥 100%
𝑉+𝑀 1,000 + 700 1700
2 2 2
50 + 30 80
𝑖= 𝑥 100% = 𝑥 100%
850 850
𝒊 = 𝟗. 𝟒𝟏 %
The market rate now is 6.96%, which is higher than the nominal rate of 5%.
Interest Rate Risks

• Default Risk – A business cannot make payments consistently.
• Liquidity Risk – A business cannot meet its current maturing obligation.
• Legal Risk – The lenders and borrowers cannot comply with the covenants of the contract.
• Market Risk – The borrowers cannot settle the obligation due to market drivers.
• Interest Rate Risk – The danger that the value of a bond or other fixed-income investment will suffer
as the result of a change in interest rates.
The Yield Curve

• Upward Curve – This is the usual flow of the slope, which means that the long-term interest rates are
above the short-term interest rates. This yield curve can be observed when bond investors expect the
economy to grow at a normal pace, without significant changes in the rate of inflation or major
interruptions in available credit. However, there are times when the curve's shape deviates, signaling
potential turning points in the economy.
• Inverted Curve – This is when the long-term interest rates are below short-term interest rates. This yield
curve is often taken as a sign that the economy may soon stagnate. While this is rare, investors should
never ignore it. An inverted yield curve is often followed by an economic slowdown—or an outright
recession—as well as lower interest rates along with all points of the yield curve.
• Flat or Constant Curve – This is when short and long-term interest rates are the same. Historically,
economic slowdown and lower interest rates follow a period of flattening yields.
Mitigating the Interest Rate Risk

• Spot Rate – It is the interest rate or yield available immediately, which is equivalent to the prevailing
market rate at a particular time. The spot rate is used to mitigate the risk by referring to the historical
yield. Various factors that affect the historical yield are also identified so that if they recur, adjustments
are to be made in the current spot rate.
• Forward Rate – It is the rate that is guaranteed today for a transaction that will occur or be completed
in the future. The spot rate is typically used as the starting point for negotiating the forward rate.
• Swap Rate – It is the fixed-rate exchange for a certain market rate at a certain maturity. The swap rate
is demanded by a receiver (the party that receives the fixed rate, from a payer (the party that pays the
fixed rate). The demander is compensated for the uncertainty regarding fluctuations in the floating rate.
The most commonly encountered design of interest rate swaps involves exchanging a fixed interest
rate for the floating interest rate. The floating interest rate is typically expressed as a value of a variable
index such as LIBOR plus or minus a spread. In such a case, the fixed interest rate is referred to as
the swap/reference rate. LIBOR is calculated by using the Intercontinental Exchange (ICE).
Credit Ratings
1. Standard and Poor’s Corporation (S&P) – An American financial service founded by Henry Varnum
Poor in New York in 1941. It gathers data from 128 countries using 1,500 credit analysts. The credit
rating provided by S&P were categorized to Investment Grade and Non-Investment Grade.
Category Definition
AAA S&P Global Ratings assigns the highest rating. The obligor's capacity to meet its
financial commitments on the obligation is extremely strong.

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Category Definition
AA The obligor's capacity to meet its financial commitments on the obligation is very
strong.
A Somewhat more susceptible to the adverse effects of changes in circumstances
and economic conditions than obligations in higher-rated categories. However, the
obligor's capacity to meet its financial commitments on the obligation is still strong.
BBB Exhibits adequate protection parameters. However, adverse economic conditions
or changing circumstances are more likely to weaken the obligor's capacity to meet
its financial commitments on the obligation.
BB, B, CCC, Regarded as having significant speculative characteristics. BB indicates the least
CC, and C degree of speculation and C the highest. While such obligations will likely have
some quality and protective characteristics, these may be outweighed by large
uncertainties or significant exposure to adverse conditions.
BB Less vulnerable to nonpayment than other speculative issues. However, it faces
significant ongoing uncertainties or exposure to adverse business, financial, or
economic conditions that could lead to the obligor's inadequate capacity to meet its
financial commitments on the obligation.
B More vulnerable to nonpayment than obligations rated BB, but the obligor currently
can meet its financial commitments on the obligation. Adverse business, financial,
or economic conditions will likely impair the obligor's capacity or willingness to meet
its financial commitments on the obligation.
CCC Currently vulnerable to nonpayment and depends on favorable business, financial,
and economic conditions for the obligor to meet its financial commitments on the
obligation. In the event of adverse business, financial, or economic conditions, the
obligor is not likely to have the capacity to meet its financial commitments on the
obligation.
CC Currently highly vulnerable to nonpayment. It is used when a default has not yet
occurred, but S&P Global Ratings expects default to be a virtual certainty,
regardless of the anticipated time to default.
C Currently highly vulnerable to nonpayment, and the obligation is expected to have
lower relative seniority or lower ultimate recovery compared with obligations that
are rated higher.
D In default or breach of an imputed promise. For non-hybrid capital instruments, it is
used when payments on an obligation are not made on the date due, unless S&P
Global Ratings believes that such payments will be made within five (5) business
days in the absence of a stated grace period or within the earlier of the stated
grace period or 30 calendar days. It is also used upon the filing of a bankruptcy
petition or in taking of similar action. It when the default on an obligation is a virtual
certainty, for example, due to automatic stay provisions.
2. Moody’s Investors Service (Moody’s) – A credit rating company on debt securities established in
1909 in New York, USA. It gathers information from more than 130 countries, more than 4,000 non -
corporate financial issues, and financial institutions.
Category Definition
Aaa Obligations rated Aaa are judged to be of the highest quality, with minimal credit risk
Aa Obligations rated Aa are judged to be of high quality and are subject to very low
credit risk.
A Obligations rated A are considered upper-medium grade and are subject to low credit
risk
Baa Obligations rated Baa are subject to moderate credit risk. They are considered
medium-grade and, as such, may possess certain speculative characteristics.
Ba Obligations rated Ba are judged to have speculative elements and are subject to
substantial credit risk
B Obligations rated B are considered speculative and are subject to high credit risk

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Category Definition
Caa Obligations rated Caa are judged to be of poor standing and are subject to very high
credit risk.
Ca Obligations rated Ca are highly speculative and are likely in, or very near, default,
with some prospect of recovery of principal and interest.
C Obligations rated C are the lowest rated and are typically in default, with little
prospect for recovery of principal or interest.
3. Fitch Ratings – It was founded in 1914 in New York, USA. It is owned by the global and information
company Hearst. Fitch provides credit opinions based on credit analysis and extensive research.
Category Definition
AAA Highest credit quality
AA Very high credit quality
A High credit quality
BBB Good credit quality
BB Speculative
B Highly speculative
CCC Substantially credit risk
CC Very high levels of credit risk
C Near default
RD Restricted default
D Default
(Weeks 6-7) Money Market Instruments
Role of Money Market in the Financial System

• According to the Conceptual Framework for Financial Reporting, an asset is a resource controlled by
the entity due to past events and from which future economic benefits are expected to flow to the entity.
It can be classified in terms of physicality: tangible and intangible.
o Tangible assets. Assets with physical properties and, thus, can be easily seen, touched, or
perceived by the five senses. Examples: Buildings, equipment, machinery, land, and supplies.
o Intangible assets. Identifiable assets that do not have physical substance and usually represent
a legal claim to some future economic benefit. Example: Financial instruments.
The Financial Instruments
• Financial instruments are the main vehicles used for transactions in the financial markets. It is one of
the elements of the financial system. They may be presented in the financial statements as cash
equivalents or investments, depending on their maturity. Instruments that are maturing within 90 days
or less are classified as cash equivalents; otherwise, they are classified as investments. There are two
(2) parties involved in a financial instrument: the issuer and the investor.
o Issuer. The party that issues the financial instrument and agrees to make future cash payments
to the investor.
o Investor. The party that receives and owns the financial instrument. He bears the right to receive
payments made by the issuer. For debt obligations (in the case of notes or bond issuances), the
issuer is known as the borrower while the investor is the creditor.
• At the issuance of the instrument, the issuer usually receives something of value, such as cash, from
the investor. The financial instrument becomes the proof or security of the future claim of the investor
from the issuer. For example, Coreen Lim issued a negotiable certificate of deposit to Marie Kondo in
return for P5,000,000. Coreen is the issuer, Marie Kondo is the investor, and P5,000,000 is the value
received.
The Financial Instruments
• The money market is a market where financial instruments with short-term maturity or be redeemed in
one (1) year or less from the date of issuance are traded. The financial instruments traded in the money
market are called money market instruments or money market securities.

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Money market securities have three (3) fundamental characteristics:

o Higher marketability – Most of the transactions in the money markets are very large. Hence,
money markets are considered wholesale markets.
o Low default risk – Because of their liquidity and the nature of the lenders, they are subject to low
default risk.
o Mature in one (1) year or less – Most of the money market securities mature in less than four (4)
months.
Here are some of the participants in the money market:
o Commercial banks – They issue treasury securities; sell certificates of deposits and extend loans;
offer individual investor accounts that can be used to invest in money markets. Moreover, they
are also the primary issuer of negotiable certificates of deposits, banker’s acceptance, and
repurchase agreements. Examples of commercial banks are Bank of the Philippine Islands (BPI),
Banco de Oro (BDO) Private Bank, Security Bank Corporation, and Citibank, N.A.
o Private individuals – These private individuals made their investments through money market
mutual funds.
o Investment companies – They trade securities on behalf of their clients. Moreover, they create a
market for money market securities by maintaining an inventory of them. They also make sure
that sellers can easily sell their securities when needed and maintain the liquidity in the money
market. Examples of investment companies in the country are Sun Life Prosperity Money Market
Fund, Inc. and First Metro Asset and Management (FAMI) Inc.
o Money market mutual funds – These funds permit small investors to invest in the money market
by accumulating funds from numerous small investors to buy large-denomination of money
market securities. An example of a mutual fund company in the country is the Philam Managed
Income Fund, Inc.
o Insurance companies – These are companies that invest in the money market to maintain liquidity
level in unexpected demands, especially for casualty and insurance companies.
o Bureau of the Treasury – The BTR is the principal custodian of the national government's financial
assets, agencies, and instrumentalities. The bureau sells government securities to raise funds.
Their short-term issuances of government securities allow the government to obtain cash until
tax revenues are collected.
o Commercial Non-Financial Institutions – These entities buy and sell money market securities to
manage their cash. For example, it temporarily stores excess funds in exchange for a somewhat
higher return and obtains short-term funds.
o Pension Funds – They maintain funds in the money market to prepare long-term investment in
stock and bond markets. Examples of pension fund companies in the country are Loyola Plans,
Inc., Philam Plans, Inc., and Ayala Plans, Inc.
Types of Money Market Instruments
• Treasury Bills – Popularly known as T-bills, they are government securities issued by the Bureau of the
Treasury (BTr). There are three (3) terms of Treasury bills: 91-day, 182-day, and 364-day. The number
of days is based on the universal practice to ensure that the bills mature on a business day, traditionally,
Wednesday. Moreover, Treasury Bills are quoted either by their yield or discount rate or by their price
based on 100 points per unit. Treasury bills that will mature in less than 90 days, such as 35 and 42
days, are called cash management bills (CMB).
• Repurchase Agreement – This is also known as a repo, RP, or sale-and-repurchase agreement. One
party sells an asset, usually fixed-income securities, to another party at one price in a repo. He now
commits to repurchase the same or another part of the same asset from the second party at a different
price at a future date or, in the case of an open repo, on-demand. If the seller defaults during the life of
the repo, the buyer, as the new owner, can sell the asset to a third party to offset his loss. The asset,
therefore, acts as collateral and mitigates the credit risk that the buyer has on the seller. Thus,
repurchase agreements are usually treated as low-risk investments with low interest.
• Negotiable Certificates of Deposit (NCD) – A security issued by banks that records a deposit made.
The certificate indicates the interest rate and the maturity date of the deposit. Since the maturity date
is stated in the certificate, NCDs are treated as term securities with a specific maturity date. The
depositor cannot easily withdraw it since it is different from a demand deposit account wherein money
can be withdrawn upon the depositor's demand. A certificate of deposit essentially restricts the holders

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from withdrawing funds on demand. The concept behind the NCD is that investors are willing to accept
a higher return in exchange for having no access to liquidity.
• Commercial Paper – It is a short-term debt instrument issued only by well-known, creditworthy firms
typically unsecured. Examples of firms that issue commercial papers in the country are Phoenix
Petroleum Philippines, Cirtek Holdings Philippines Corp, and BDO Leasing and Finance, Inc.
Commercial paper is normally issued to provide liquidity or finance a firm’s investment in inventory and
accounts receivable. The issuance of commercial paper is an alternative to short-term bank loans.
Some large firms prefer to issue commercial paper rather than borrow from a bank because it is usually
a cheaper source of funds. Nevertheless, even the large creditworthy firms that can issue commercial
paper normally obtain short-term loans from commercial banks to maintain a business relationship.
Financial institutions such as finance companies and bank holding companies are major issuers of
commercial paper.
• Banker’s Acceptances – An order to pay a specified amount of money to the bearer on a specified date.
Banker’s acceptances are often used to finance the purchase of goods that have not yet been
transferred from the seller to the buyer. Moreover, it is formed when the bank’s client makes a draft or
a promise to pay and the bank then ultimately accepts to pay on behalf of the client. The bank’s
acceptance of the drafts translates to a promise to pay to whoever will present it to the bank. The client
now then gives the draft to the vendor to finance the purchase.
Money Market Valuation
• One should understand and evaluate which market securities to invest in, depending on the purpose
of the business. In the money market, securities may be evaluated based on their interest rates and
liquidity.
• Interest rates dictate the potential return that can be received from an investment. Interest rates on
money market securities tend to be relatively low due to the low risks associated with them and the
short maturity period. Moreover, they have a deep market, and thus, they are competitively priced. Also,
most money market securities carry the same profile and attributes, making each instrument a close
substitute for the other. Hence, if particular security may have an interest rate that deviates from the
average rate, the supply and demand forces in the market would ultimately correct it and force it back
to the average rate.
• On the other hand, liquidity refers to how quick, efficient, and cheap the security can be converted to
cash. Treasury bills with a secondary market are considered to be more liquid than commercial papers
that do not have a secondary market. It is for the reason that, as mentioned above, commercial papers
are held until it matures. Thus, the brokers shall make more effort to look for potential buyers of the
securities compared to treasury bills. Eventually, this will lead the brokers to charge a higher fee for
investors who wanted to liquidate their commercial paper.
• Another way of evaluating the money market securities is by evaluating their market value. Valuation
is important because it will help an investor determine what amount he/she is willing to pay in exchange
for security. It can be done through the present value approach. The formula in solving the present
value of the future cash flows of a money market security is given below.
𝑆𝑏
𝑀𝑎𝑟𝑘𝑒𝑡 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 =
(1 + 𝐼)𝑛
Where,
𝑆𝑏 is the face value of the security,
𝐼 is the interest rate, and
𝑛 is the number of periods.
Rosemarie Ayuban is planning to invest in the money market. One of the alternatives is to invest in a one-
year Treasury bill with a face value of P10,000 and an annual interest rate of 3%. Using the formula above,
the market price or market security value is:
𝑆𝑏 P10,000
𝑀𝑎𝑟𝑘𝑒𝑡 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 = = = 𝐏𝟗. 𝟕𝟎𝟖. 𝟕𝟒
(1 + 𝐼)𝑛 (1 + 3%)1

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This means that Rosemarie will be willing to pay P9,708.74 for a Treasury bill based on the risks
surrounding the instrument. Moreover, Rosemarie will get a return of P291.26 from the investment.
Assume instead that another P10,000 Treasury bill with a maturity term of 90 days with an annual interest
rate of 4% is being evaluated. Using 360 days, the value of the Treasury bill is:
𝑆𝑏 P10,000
𝑀𝑎𝑟𝑘𝑒𝑡 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 = = = 𝐏𝟗, 𝟗𝟎𝟏
(1 + 𝐼)𝑛 (1 + 1%)1
The term in the above example is 90 days, while the given rate is an annual rate. Thus, 4% must be
90
multiplied by to get the interest rate in the said tenor, which is 1%.
360
In solving for the market value of an instrument, one must remember the general rule: as the interest rate
rises, the value of security lowers. This means that the market risk increases, which causes the value of
the security to reduce.
(Weeks 8-9) Bond Market
Purpose of the Capital Market

• Firms and individuals use money markets primarily to warehouse funds for short periods until a more
important need or a more productive use for the funds arises. By contrast, firms and individuals use
capital markets for long-term investments.
The Bond Market
• The market of the bond is called the debt market or bond market. The bond market primarily includes
government and corporate-issued debt securities. Moreover, participants in the bond market can issue
new debt through the primary market and trade their existing securities in the secondary market. Also,
the goal of the bond market is to provide long-term financial aid and funding to public and private
projects and expenditures.
• All types of financial institutions participate in the bond markets. Below are some of them and their
participation:
o Commercial Banks – They purchase bonds for their asset portfolio. They issue bonds to have a
source of secondary capital.
o Finance Companies – They commonly issue bonds as a source of long-term funds.
o Mutual Funds – They use funds received from investors to purchase bonds. Some mutual funds
specialize in particular types of bonds, while others invest in all types.
o Brokerage Firms – They facilitate bond trading by matching up buyers and sellers of bonds in the
secondary market.
o Investment Banking Firms – They perform underwriting activities for the government and
corporations. As underwriters, they may place the bonds and assume the risk of market price
uncertainty or place the bonds on a best-efforts basis in which they do not guarantee a price for
the issuer. For example, in a 5 Billion Peso issuance by Globe Telecom, only 4 Billion was
subscribed by the public, the Investment Banking firm will be forced to buy the other 1 Billion.
o Insurance companies and Pension Funds – They purchase funds for their asset portfolio.
Types of Debt Securities
• Money market debt securities – These are debt securities with maturities of not greater than one (1)
year. Treasury bills and certificates of deposit are examples of money market debt securities.
• Capital market debt securities – These are debt securities with maturities of longer than one (1) year.
Types of Bonds
• Government Bonds. The government commonly wants to use a fiscal policy of spending more money
than it receives from taxes. Under these conditions, it needs to borrow funds to cover the difference
between what it wants to spend versus what it receives. To facilitate its fiscal policy, the Bureau of
Treasury (BTr) issues Treasury bonds to finance government expenditures. The Treasury pays a yield
to investors that reflects the risk-free rate, as it is presumed that the Treasury will not default on its

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payments. Because the Treasury notes and bonds are free from credit (default) risk, they enable the
Treasury to borrow funds at a relatively low cost. Although governments rarely default on their debt
obligations, there were past instances when they did. In the Philippines, there are specific types of
government bonds that are being issued. They are the following:
o Treasury Bonds – Peso-denominated securities regularly issued by the national government. Their
issuance can be done through the following methods of origination as may be prescribed in an
offering document:
1. Auction – It is a mode of sale or offering government securities participated by accredited
Government Securities Eligible Dealers (GSEDs) such as Bank of Commerce, Bank of the
Philippine Islands (BPI), BDO Capital, and Investment Corporation, and Land Bank of the
Philippines (LBP). GSEDs submit their bids electronically through the auction front-end system
of the Bureau of Treasury (BTr) called the Automated Debt Auction Processing System
(ADAPS). Submitted bids are evaluated for acceptance, award, or rejection by the Auction
Committee composed of the secretary of the Department of Finance (DOF) as chairman; the
treasurer of the Philippines as vice chairman; the deputy treasurer of the Philippines as a
member and executive director; and an assistant secretary of the DOF, the deputy governor of
the Bangko Sentral ng Pilipinas (BSP), the head of Treasury of the BSP, and the head of Market
Regulation Department of the Securities and Exchange Commission (SEC) as members. A
regular division of the BTr provides administrative support to the Auction Committee.
2. Tap Method – It is the sale of government securities (GS) exclusively to GSEDs whenever
there is an acute shortage of securities in the market. The BTr conducts the issuance of GS
through the tap method.
3. Over-the-Counter (OTC) Method – It is the sale of government securities to tax-exempt
institutions, government-owned and controlled corporations (GOCCs), and local government
units (LGUs). The BTr conducts the issuance of GS through the OTC Method.
o Retail Treasury Bonds (RTBs) – They are direct and unconditional obligations of the national
government that primarily caters to the retail market or the end-users. They are interest-bearing
bonds that carry a term of more than one (1) year. The bonds can be traded in the secondary
market before maturity. Also, RTBs offer attractive returns to investors because of their liquidity
and safety. Unlike regular Treasury bonds, the interest income per coupon of an RTB is paid to the
investor quarterly. The said income is subject to the 20% final withholding tax.
Moreover, RTBs serve as a critical part of the government’s program to make government
securities available to small investors. They are issued to mobilize savings and encourage retail
investors to purchase long-term papers with a maturity of 25 years. Also, the minimum placement
of RTBs in the primary market is P5,000 while P200,000 in the secondary market.
o Multi-Currency Retail Treasury Bonds (MTRBs) – They are issued to overseas Filipinos and their
qualified beneficiaries. MRTBs are issued within the Philippine jurisdiction. However, apart from
overseas Filipinos, Foreign Currency Deposit Units are allowed to invest in MRTBs under certain
preferential tax applications according to the 1997 Tax Code and the Bureau of Internal Revenue
(BIR). Interest income per coupon from MTRB is also subject to final withholding tax, currently at
20%. The issuer assumes the corresponding final withholding tax on interest income per coupon
for overseas Filipino holders or their qualified beneficiaries.
• Municipal Bonds. Like the national government, the local governments frequently spend more than the
revenues they receive. To finance the difference, they issue municipal bonds, most of which can be
classified as either general obligation bonds or revenue bonds. Payments on general obligation bonds
are supported by the municipal government’s ability to tax. In contrast, payments on revenue bonds
must be generated by revenues of the government’s projects such as tollway, toll bridge, state college
dormitory, for which the bonds were issued. Revenue bonds are more common than general obligation
bonds.
• Corporate Bonds. These are long-term debt securities issued by corporations that promise the owner
coupon payments or interest payments within one (1) to 30 years. They are medium to long-term
investments issued by SEC-Registered Philippine corporations.

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o Secured Bonds – They are corporate bonds with collateral attached. Examples of secured bonds
are mortgage bonds and equipment trust certificates. Mortgage bonds are used to finance a specific
project. For example, a building may be the collateral for bonds issued for its construction. If the
firm fails to make payments as promised, mortgage bondholders have the right to liquidate the
property to be paid. Because these bonds have specific property pledged as collateral, they are
less risky than comparable unsecured bonds. As a result, they will have a lower interest rate.
On the other hand, equipment trust certificates are bonds secured by tangible non-real-estate
property, such as heavy equipment and airplanes. Typically, the collateral backing these bonds is
more easily marketed than the real property backing mortgage bonds. As with mortgage bonds,
collateral reduces the risk of the bonds and so lowers their interest rates.
o Unsecured Bond Debentures – Otherwise known as a debenture, unsecured bond debentures are
long-term unsecured corporate bonds backed only by the issuer's general creditworthiness. No
specific collateral is pledged to repay the debt. In the event of default, the bondholders must go to
court to seize assets. The collateral that has been pledged to other debtors is not available to the
holders of debentures. Debentures usually have an attached contract that spells out the terms of
the bond and the responsibilities of management. The contract attached to the debenture is called
an indenture. Debentures have lower priority than secured bonds if the firm defaults. As a result,
they will have a higher interest rate than otherwise comparable secured bonds.
o Junk Bonds – They are corporate bonds that are perceived to have a very high risk. The primary
investors in junk bonds are mutual funds, life insurance companies, and pension funds. Some bond
mutual funds invest only in bonds with high ratings, but more than a hundred high-yield mutual
funds commonly invest in junk bonds. High-yield mutual funds allow individual investors to invest
in a diversified portfolio of junk bonds with a small investment. Junk bonds offer high yields that
contain a risk premium (spread) to compensate investors for the high risk. Typically, the premium
is between three (3) and seven (7) percentage points above Treasury bonds with the same
maturity. Although investors always require a higher yield on junk bonds than on other bonds, they
also require a higher premium when the economy is weak because there is a greater likelihood that
the issuer will not generate sufficient cash to cover the debt payments.
Characteristics of Bonds
• Par Value/Face Value – Also known as the principal, the par value is the amount of money a holder will
get back once a bond matures. In finance and accounting, par value means the stated value or face
value of the instrument. From this comes the expressions at par (at the par value), over par (over par
value), and under par (under par value). When a bond trades at a price above the face value, it is said
to be selling at a premium. When a bond sells below face value, it is said to be selling at a discount.
• Coupon Interest Rate – The amount of interest that the bondholder will receive expressed as a
percentage of the par value. Usually, this rate is fixed throughout the life of the bond. It can also vary
with a money market index, such as London Interbank Offered Rate (LIBOR). The bond will also specify
when the interest is to be paid, whether monthly, quarterly, semi-annually, or annually. The name
“coupon” is used because, in the past, paper bond certificates were issued that had coupons attached
to them, one for each interest payment. On the due dates, the bondholder would hand in the coupon to
a bank in exchange for the interest payment. Based on different coupon rates, bonds are classified into
many types, which include:
o Fixed-rate bonds –Bonds with a coupon that remains constant throughout the life of the bond.
o Stepped-coupon bonds – Variation of the fixed-rate bonds where their coupon increases during the
life of the bonds.
o Floating-rate notes (FRN) – Otherwise known as floaters, floating-rate notes have a variable
coupon that is linked to a reference rate of interest, such as the London Interbank Offered Rate
(LIBOR) or Euro Interbank Offered Rate (Euribor). For example, the coupon may be defined as
three (3) months LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every one
(1) or three (3) months.
o Inflation-linked bonds – Otherwise known as linkers, inflation-linked bonds indexed the principal
amount and the interest payments to inflation. The interest rate is normally lower than for fixed-rate
bonds with a comparable maturity. However, as the principal amount grows, the payments increase
with inflation. The United Kingdom was the first sovereign issuer to issue inflation-linked Gilts in the

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1980s. Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation-linked
bonds issued by the U.S. government.
• Maturity Date – Otherwise known as redemption date, maturity date refers to the final payment date of
a loan or other financial instrument, at which point all remaining interest dues are to be paid. The issuer
has to repay the nominal amount on the maturity date. As long as all due payments have been made,
the issuer has no further obligations to the bondholders after the maturity date. The length of time until
the maturity date is referred to as the term or tenor or maturity of a bond. The maturity can be any
length of time, although debt securities with a term of less than one year are generally designated
money market instruments rather than bonds. Most bonds have a term of up to 30 years. Some bonds
have been issued with terms of 50 years or more, and, historically, there have been some issues with
no maturity date or irredeemable. Normally, the maturity of a bond is fixed. However, a bond may
contain an embedded option. It grants option-like features to the holder or the issuer to either call or
put the bond.
o Callable Bond – Also known as a redeemable bond, a callable bond allows the issuer of the bond
to retain the privilege of redeeming the bond at some point before the bond reaches its date of
maturity. In other words, on the call date, the issuer has the right, but not the obligation, to buy back
the bonds from the bondholders at a defined call price. The bonds are not bought and held by the
issuer. They are instead canceled immediately.
o Puttable Bond – Otherwise known as a retractable bond, a puttable bond gives the holder the right
to force the issuer to repay the bond before the maturity date on the put dates. This type of bond
protects investors: if interest rates rise after bond purchase, the future value of coupon payments
will become less valuable. Therefore, investors sell bonds back to the issuer and may lend
proceeds elsewhere at a higher rate. Bondholders are ready to pay for such protection by accepting
a lower yield relative to a straight bond. A death put is an optional redemption feature on a debt
instrument allowing the beneficiary of the estate of a deceased bondholder to put (sell) the bond
(back to the issuer) at face value in the event of the bondholder’s death or legal incapacitation.
• Sinking Fund – A method by which an organization sets aside money over time to retire its indebtedness
by repaying or purchasing outstanding loans and securities held against the entity. More specifically, it
is a fund into which money can be deposited so that over time preferred stock, debentures, or stocks
can be retired. Sinking funds can also be used to set aside money to replace capital equipment as it
becomes obsolete. Sinking fund provision of the corporate bond indenture requires a certain portion of
the issue to be retired periodically. The entire bond issue can be liquidated by the maturity date. Issuers
may either pay to trustees, which in turn call randomly selected bonds in the issue, or purchase bonds
in the open market, then return them to trustees.
Bond Valuation
• Bond valuation is a technique for determining the theoretical fair value or bond price of a particular
bond. It includes calculating the present value of the bond’s future interest payments, known as its cash
flows, and the bond’s value upon maturity, also known as its face or par value.
• To compute the present value of the coupon payments, you need to get the present value of the annuity
of coupon payments. An annuity is a series of payments made at fixed intervals of time. The present
value of an annuity is the value of a stream of payments, discounted by the interest rate to account for
the payments being made at various moments in the future. It can be solved using the following formula:
𝑛 1
𝑃𝑉𝐴 = 𝐼 × [∑ 𝑛]
𝑡=1 (1 + 𝑟𝑑 )
Where,
𝑃𝑉𝐴 is the present value of an annuity of coupon payments
𝐼 is the annual interest paid
𝑛 is the number of years to maturity
𝑟𝑑 is the required return in the market
On the other hand, to solve for the present value of the par value or face value, use the simple present
value formula:

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1
𝑃𝑉 = 𝑀 × [ ]
(1 + 𝑟𝑑 )𝑛
Where 𝑀 is the amount of the par value.
Thus, to get the bond price, we need to add the above formulas:
𝑛 1 1
𝐵𝑜 = 𝐼 × [∑ 𝑛 ]+𝑀 × [ ]
𝑡=1 (1 + 𝑟𝑑 ) (1 + 𝑟𝑑 )𝑛
Where 𝐵𝑜 is the present value of the bond.
Carl John Corporation issued a 10-year 10% corporate bond with a par-value of P1,000. A similar bond
is expecting an 8% return in the market. How much is the price of the bond?
Solution:
To get the value of the bond, determine first the annual interest that should be paid for the bond.
𝐼 = 𝑀 × 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒
𝐼 = P1,000 × 10%
𝐼 = P100
Then use the formula to get the bond price:
𝑛 1 1
𝐵𝑜 = 𝐼 × [∑ 𝑛
]+𝑉× [ ]
𝑡=1 (1 + 𝑟𝑑 ) (1 + 𝑟𝑑 )𝑛
Let,
𝐼 = P100
𝑛 = 10 𝑦𝑒𝑎𝑟𝑠
𝑉 = P1,000
𝑟𝑑 = 8%
Substitute the values in the formula:
𝑛 1 1
𝐵𝑜 = 𝐼 × [∑ 𝑛
]+𝑉 × [ ]
𝑡=1 (1 + 𝑟𝑑 ) (1 + 𝑟𝑑 )𝑛
10 1 1
𝐵𝑜 = 𝑃100 × [∑ 10
] + 𝑃1,000 × [ ]
𝑡=1 (1 + 8%) (1 + 8%)10
𝐵𝑜 = (𝑃100 × 6.71001) + (𝑃1,000 × 0.4631)

𝐵𝑜 = P671.01 + P463.19
𝐵𝑜 = P1,134.20
The price of the bond is higher than the par value; thus, it is issued at a premium. The market offers a
lower return of 8% compared with the guaranteed returns of 10%. The principle is that the bond can be
resold at P1,134.20 since this is what the market perceives as the best for everyone.

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(Weeks 11-13) Equity Market
Purpose of Equity Securities

• Equity securities represent ownership claims on a company’s net assets. It represents a significant
portion of many individual and institutional investment portfolios.
• Shares or stocks represent ownership in a company. An individual who owns a share is called a
shareholder or stockholder. He owns a portion of the business. Stock certificates, the legal
documents which certify the ownership, are given to shareholders. Thus, the company is the issuing
party, and the shareholders who purchased the shares are the investors
• The shares to be issued by the company must not exceed the total amount stated in its Articles of
Incorporation. This amount is also known as the authorized capital stock, which can be subscribed
to or paid by the corporation's investors. Companies may increase their capital stock by amending their
Articles of Incorporation and seeking approval from regulatory agencies.
• Shares issued or sold to investors from the available authorized capital stock are known as
outstanding shares. These shares include all restricted shares held by the company’s officers and
senior employees. However, they do not include treasury shares. Treasury shares are shares issued
to the investors but were repurchased or bought back by the company.
• Investors in equity securities can be classified as individual or institutional. The investment by
individuals in a large corporation commonly exceeds 50% of the total equity. Each individual’s
investment is typically small, which means that ownership is scattered among numerous individual
shareholders. On the other hand, institutional investors hold large amounts of stock, and their collective
sales or purchases can significantly affect stock market prices. Some of the institutions that participate
in the stock market are:
o Commercial Banks. They issue stock to boost their capital base. They also manage trust funds that
usually contain stocks.
o Savings Banks. Invest in stocks for their investment portfolios.
o Finance Companies. Just like commercial banks, they issue stock to boost their capital base.
o Securities Firms. They place new issues of stock. They also offer advice to corporations that
consider acquiring the stock of other companies and execute the buy and sell of the said
transaction.
o Insurance Companies. They invest a large proportion of their premiums in the stock market
o Pension Funds. They invest a large proportion of pension fund contributions in the stock market.
Equity vs. Debt

• Voice in management. In debt investment, the creditors do not have voting privileges on company
matters. They only rely on the contractual obligation inherent to the debt. While in equity investment,
shareholders have a voice in the management as owners of the company. They possess voting rights
on certain decisions that affect the company, such as the election of company directors and other
special issues.
• Claim on assets and income. Debt is prioritized over equity. The claims of the creditors, such as interest
on the debt and principal repayment, shall be paid first before claims on the income of shareholders
are satisfied. If a company fails and liquidates, the creditors have a prioritized claim over equity holders
on the company's assets. It means that once assets are sold during the liquidation process, proceeds
will be used to settle the following in order: secured creditors, unsecured creditors, and shareholders.
Thus, upon liquidation, shareholders only receive the remaining proceeds.
• Maturity. There is no maturity date for equity, while in debts, it is the date when the company should
pay the principal.
• Risk profile. Debt has a lower risk profile. It is because the return of invested money is more certain
due to the contractual obligation. On the other hand, equity has a high-risk profile. It is due to the high
uncertainty of returns associated with shares, such as yearly earnings and proceeds from asset
liquidation. Moreover, the prices of shares in the secondary market always fluctuate.
• Return expectations. Debt has a lower return than equity because its return is only up to the interest in
the contract. On the other hand, equity has a high return in dividends and capital appreciation, which
may increase indefinitely if the business is growing.

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• Tax implications. In debt, interest paid by the issuer can be used as a tax-deductible expense of the
company. However, in equity investment, dividend payments to shareholders cannot be used as a tax-
deductible expense. Instead, they are treated as deductions in the retained earnings (RE) of the
company.
Types of Stocks
• Preference Shares. These shares give the holders distinct rights that enable them to be prioritized
over the holders of ordinary shares. It is since preference shares are treated as quasi-debt. The
required dividend to be paid on the holders is treated like interest on the debt, which should be settled
first before the claims of ordinary shares. In instances of liquidating the assets of the corporation, the
claims of preference shareholders are prioritized over common shareholders. However, it is only up to
the par value of the preference shares, and only when the liabilities to creditors are being paid. Thus,
the distribution of the proceeds from the liquidation shall be settled in the following order: debt,
preference shares, and common shares. Preference shares also have unique features. Some of them
are:
o Cumulative. All dividends in arrears (dividends that are not paid in previous periods), together with
the current dividend, should be paid before paying the shareholders' dividends. If preference shares
are non-cumulative, only the current dividend will be paid by the corporation.
o Callable. It allows the issuing corporation to retire or repurchase outstanding shares within a
predetermined period at a specified price. Usually, the call price is established higher than the
issuance price but may gradually decrease over time. This feature permits the corporation to end
the fixed-payment commitment associated with the preference shares if the market conditions
make it favorable.
o Convertible. It allows the shareholders to convert their shares into a stated number of ordinary
shares on a certain date. The number of ordinary shares that the preference shares can be
exchanged varies over time based on the predetermined formula.
• Ordinary Shares. These shares represent the true owners of the corporation. The owners are also
known as residual owners since they will only receive what will remain after all claims of the creditors
and preference shareholders are satisfied. However, the owners may reap the benefits if the business
goes well in the future. They also have the assurance that they will only lose up to the extent of the
investments they had in the company in case of bankruptcy. Dividends are not guaranteed for ordinary
shareholders, unlike the preferred shareholders. But because of that uncertainty, shareholders expect
to have higher returns. Ordinary shares can be classified according to ownership:
o Privately. Shares are owned by private investors, and thus, generally, shares are not publicly
traded. If publicly traded, the transactions are usually between private investors only, and an
organization's consent is needed.
o Closely. Shares owned by individual investors or a small group of private investors such as family.
o Publicly. Shares are actively traded in the stock market and are owned by a mix of public and
private investors.
o Widely. Shares owned by unrelated individuals or institutional parties.
In recent years, other types of ordinary shares were offered to shareholders to meet different objectives:
o Supervoting Shares. Shares that have multiple votes associated with one share. It allows
shareholders to maintain control against any group who may plan for a hostile takeover. Hostile
takeover happens when an outside group tries to gain controlling ownership of a company without
the support of the management.
o Nonvoting ordinary shares. Shares that have no voting rights but are offered by the companies that
want to raise capital but do not want to give up any voting control.
Types of Stock Markets

• Generally, the stock markets can be physical or virtual. The physical site where shares are purchased
and sold face-to-face on a trading floor is called a stock exchange. The most well-known organized
exchange is the New York Stock Exchange (NYSE). In the country, the sole trading floor is the
Philippine Stock Exchange (PSE).
• Shares can now be traded by the dealers who are connected electronically by computers. This type of
stock market is also known as the over-the-counter (OTC) market. One example of an OTC market

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is the National Association of Securities Dealers Automated Quotation System (NASDAQ). Dealers,
also known as market makers, in an OTC “make a market” by matching the buy and sell orders that
they receive from the investors. They are the ones responsible for setting the bid and ask prices. There
can be multiple market makers for a given stock, and each shall provide his/her bid and ask for
quotations in the system. Once this is done, the dealers must buy or sell a minimum of 1,000 securities
at the given price. Once the trade is executed, they can enter a new bid or quote in the system. Thus,
they can earn in two (2) means: through the spread between the bid price and ask price and through
trade commissions.
• An electronic communications network (EC) directly links major brokerage firms and traders and
removed the need for a middleman. Examples of ECNs are Instinet, SelectNet, and NYSE Arca. ECN
has been gaining ground lately for the following reasons:
o Transparency. Traders in the ECN can easily view if there are unfilled orders on time. This input
allows them to understand supply and demand for the shares and modify their strategy accordingly.
Some exchanges also provide this information but not as timely and complete as ECN can provide.
o Cost reduction. The removal of middleman and commission reduces the transaction costs
associated with the trade. Spread is also reduced and sometimes removed.
o Faster execution. Trades are matched faster and confirmed quicker since the ECN is fully
automated. Individual trades are done with minimal human intervention.
o After-hours trading. Trading can continue at any time of the day because of the availability of ECN.
Traders can react accordingly based on news reports and information that come out after trading
hours.
• Exchange-traded funds (ETF) happen when a portfolio containing various securities is purchased,
and a share is created based on this specific portfolio that can be traded in the exchange. ETFs are
listed and can be traded as individual shares in the exchange. They are often indexed instead of being
actively managed. It means that there is no active management since the fund manager simply follows
the index's composition. Moreover, the ETFs are valued based on the underlying net asset value of the
shares inside the index portfolio. Information about the shares inside the ETF is publicly available so
that intraday arbitrage can help keep ETF price close to the implied value.
Market Capitalization
• Mega-cap. This category includes companies that have a market cap of $200 billion or higher. They
are the largest publicly traded companies by market value and typically represent a particular industry
sector or market leaders. A limited number of companies qualify for this category. For example, as of
Sept. 28, 2020, technology leader Apple Inc. (AAPL) has a market cap of $1.966 trillion, while the online
retail giant Amazon.com Inc. (AMZN) stood next with $1.59 trillion.
• Large-cap. Companies in this category have a market cap between $10 billion to $200 billion.
International Business Machines Corp. (IBM) has a market cap of $108.41 billion, and General Electric
Co. (GE) has a figure of $54.27 billion.
• Mid-cap. Ranging from $2 billion to $10 billion worth of market cap, this group of companies is
considered more volatile than the large-cap and mega-cap companies. Growth stocks represent a
significant portion of the mid-caps. Some companies might not be industry leaders, but they may be on
their way to becoming one. Juniper Networks Inc. (JNPR), with a market cap of $7.29 billion, is one.
• Small-cap. These are companies that have a market cap between $300 million to $2 billion. While the
bulk of this category comprises relatively young companies that may have promising growth potential,
a few established old businesses that may have lost value in recent times for a variety of reasons are
included in the list. One example is Bed Bath & Beyond Inc. (BBBY), which has a market cap of 1.87
billion.
• Micro-cap. This category mainly consists of penny stocks, denoting companies with market
capitalizations between $50 million to $300 million. For instance, a lesser-known pharmaceutical
company with no marketable product and working on developing a drug for an incurable disease, or a
5-people small company working on artificial intelligence (AI)-powered robotics technology, may be
listed with small valuation and limited trading activity. While the upward potential of such companies is
high if they succeed in hitting the bull’s eye, the downside potential is equally worse if they completely
fail. Investments in such companies may not be for the faint-hearted as they do not offer the safest
investment, and a great deal of research should be done before entering such a position.

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BM2004
• Nano-cap. These are companies having market caps below $50 million. They are considered to be the
riskiest lot, and the potential for gain varies widely.
Capital Market Platforms

• Conventional Brokerage. In a conventional brokerage, the investors buy or sell shares by opening an
account with a stockbroker. The broker will buy and sell shares on behalf of the investor in exchange
for a payment called commission. For instance, Anna wanted to sell her shares from GMA Network,
Inc. To do so, she may find a stockbroker, such as AB Capital Securities, Inc., to sell her shares. In
return, a commission will be paid to the broker.
• Online Trading. Many investors are now shifting towards digital platforms to trade shares due to the
advent of technology. Moreover, online brokers typically charge a lower commission compared to
conventional brokers. However, they do not offer any investment advice and other services that a
traditional broker may give.
• Mutual Funds. Instead of buying individual stocks, investors can also opt to buy shares in mutual funds.
Mutual funds are investment companies that pool money from various investors and invest them in
different securities based on the fund's investment objective. Mutual funds allow investors to diversify
portfolios since they hold shares in different companies.
Stock Valuation
• One-Period Valuation Model. This model generally assumes that an investor is prepared to hold the
stock for only one (1) year. Because of the short holding period, the cash flows expected to be
generated by the stock are the single dividend payment and the selling price of the respective stock.
Hence, to determine the stock's fair price, the sum of the future dividend payment and that of the
estimated selling price must be computed and discounted back to their present values.
• Multiple-Period Valuation Model. This model is an extension of the one-period dividend discount
model wherein an investor expects to hold a stock for multiple periods. The main challenge of this
model is that forecasting dividend payments for different periods are required.
• Zero-growth Model. This model assumes that dividends will be fixed and will not change anymore in
the future. It is the simplest approach to share valuation. It is very useful in valuing preferred shares
since the dividend is fixed upon issuance. Dividends of preference shares are expected to be received
if the shareholders hold the stock.
• Constant Growth Model. This model is also known as the Gordon Growth Model, named after Myron
Gordon, a famous American economist.
• Variable Growth Model. An inherent limitation associated with zero-growth and constant growth
models is that they do not allow flexibility in growth rate expectations. Since future growth rates may go
up or down due to changes in economic conditions, the variable growth model was developed.
• Free Cash Flows (FCF). These refer to the cash flows available for debt creditors and shareholders
after satisfying all other operating obligations. This method is an alternative to the dividend-based
share valuation.
• Book Value (BV) per Share. It refers to the amount per share that will be received if all the company’s
assets are sold based on its exact book or accounting values. The proceeds will go to ordinary
shareholders after satisfying all the claims from creditors and preference shareholders. Book value per
share is easy to compute since the book value can be easily derived from accounting records. However,
the drawback of this method is its reliance on historical balance sheet data. It does not consider the
earning potential of the firm. Moreover, it does not have a link or relationship to the firm's true value in
the market.
• Liquidation Value (LV) per Share. It pertains to the actual amount per share that will be received if:
o All assets are sold based on their current market value;
o All liabilities, including preference shares, are fully paid; and
o The remaining proceeds are divided between the shareholders.
• Price-Earnings (P/E) Multiples. This method uses the price-earnings ratio to compute the price. The
price-earnings ratio shows the amount that investors are willing to pay for each peso earnings.

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BM2004
(Week 15) Types of Investments
Direct Investments
• When individuals and institutions directly own a particular financial asset or buy it from the market, they
make direct investments.
• Direct investment can be applied in a single asset or a portfolio of assets. A property portfolio is a group
of property investments owned by an individual or company that shares the same financial goals. One
of the benefits of having a property portfolio over a single asset is that return expectations can be
diversified; if one asset doesn’t hit its target, other investments might compensate. The overall expected
returns of a portfolio aim for a balanced return from different properties over time.
Collective Investment Schemes (CIS)

• Open-end. This is a type of CIS where securities can be sold to investors anytime. Moreover, they also
allow investors to sell the shares back to the fund at any time. For example, Emmanuel Rivera is one
of the investors in a CIS, and thus, shares or units are issued to him, representing his claim from the
pooled fund. Emmanuel wanted to have cash, so he sold his shares or units back to the pooled fund.
Therefore, the numbers of shares or units in an open-end CIS are always changing. Examples of open-
end CIS are mutual funds (MFs), unit investment trust funds (UITFs), and exchange-traded funds
(ETFs).
• Closed-end. These are any investment schemes other than open-end. This type of CIS is where a
fixed number of shares are offered in an initial public offering (IPO). Although the investor cannot sell
the shares back to the pooled fund, closed-end funds can be traded in an organized market. Thus, if
he invested in a closed-end fund in the case of Emmanuel, he is not allowed to sell his shares back to
the pooled fund but may sell it in an organized market.
Classifications of CIS
• Corporate structure. This type of collective investment scheme is in the form of an entity, such as an
investment company. An investment company is a stock corporation organized as a corporate CIS
engaged in investing, reinvesting, and/or trading securities. Examples of investment companies are
mutual funds (MFs). MFs pool funds from the public and fund managers will now manage these funds.
On behalf of the investors, the fund managers will invest the fund in a diversified portfolio of stocks,
bonds, money market instruments, or even other mutual funds. However, fund managers cannot just
trade the funds in any way they like. They need to follow the investment objective found in the
prospectus – a document that shares information about the investment objective, risks, costs, and other
policies. Thus, a bond fund can only purchase bonds, while a stock fund can only buy stocks traded in
the Philippines Stock Exchange (PSE).
• Contractual structure. It is a CIS that is:
o Organized under a contract such as a trust indenture or as an investment component of an
insurance contract;
o Engaged, or holds itself out as being engaged, or proposes to engage, in the business of investing,
reinvesting, and/or trading in securities or other investment assets allowed by the regulation; and
o That issues unit of participation, each representing an undivided interest in a pool of investment
assets.
Examples of contractual CIS

• Unit Investment Trust Fund (UITF). It is a pool of money from the public that is invested in optimizing
returns. It is a pooled or managed fund where it gathers funds from investors with similar investment
goals and trades securities to increase the value for them. In the Philippines, all UITFs are managed
by trust entities through banks and are regulated by the Bangko Sentral ng Pilipinas (BSP). A UITF is
also considered open-ended. It means anyone can invest and get back their money at any time. UITF
earns by investing in stocks and bonds, which a fund manager trades on behalf of investors. Just like
MF, UITF also earns through dividend and stock price increase.
• Variable Universal Life Insurance (VUL). Otherwise known as variable unit-linked insurance, VUL is a
type of life insurance with a built-in saving. Its basic form is a “permanent life insurance” that pays off

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BM2004
when the policyholder dies. At the same time, a part of the premium goes to some sort of income-
earning financial instrument. Premium is the amount paid by the policyholder.
(Weeks 16-17) International Financial Market and Innovations
Nature of International Financial Market

• Firms that have business internationally are called Multinational Corporations (MNCs). Initially,
MNCs merely attempt to export products to a certain country or import supplies from a foreign
manufacturer. Somehow, over time, many of them recognized the additional foreign opportunities and
thus established subsidiaries in foreign countries. Examples of them are Dow Chemical, IBM, and Nike,
in which more than half of their assets are in foreign countries.
• However, investing in the foreign market, either real or financial assets, has several barriers. Some of
them are tax differentials, tariffs, quotas, labor immobility, cultural differences, financial reporting
services, etc. Nevertheless, these barriers also create unique opportunities for investors. For example,
if the tariff in a certain country is much favorable than the other, investors may want to capitalize in such
a country.
Motives for Investing

• Economic conditions. They expect firms in a particular foreign country to achieve more favorable
performance than those in their home country. For example, the loosening of restrictions in Eastern
European countries created favorable economic conditions there. Such conditions attracted foreign
investors and creditors.
• Exchange rate expectations. They purchase financial securities denominated in a currency that is
expected to appreciate against their own. The performance of such an investment is highly dependent
on the currency movement over the investment horizon.
• International diversification. They may achieve benefits from internationally diversifying their asset
portfolio. When an investor’s entire portfolio does not depend solely on a single country’s economy,
cross-border differences in economic conditions can allow for risk-reduction benefits. A stock portfolio
representing firms across European countries is less risky than a stock portfolio representing firms in
any European country. Furthermore, access to foreign markets allows investors to spread their funds
across a more diverse group of industries than available domestically. This is especially true for
investors residing in countries where firms are concentrated in a relatively small number of industries.
Motives for Providing Credits

• High foreign interest rates. Some countries experience a shortage of loanable funds, which can cause
market interest rates to be relatively high, even after considering default risk. Foreign creditors attempt
to capitalize on the higher rates, thereby providing capital to overseas markets. Yet, relatively high-
interest rates are often perceived as a reflection of relatively high inflationary expectations in that
country. When inflation is high, it may depreciate the value of the local currency against others.
However, such a relationship is not precise because other factors also affect the movement of the
currency. Thus, some creditors still provide capital because they believe that the depreciation of its
currency will not offset the interest rate advantage in a particular country.
• Exchange rate expectations. Creditors may consider supplying capital to countries whose currencies
are expected to appreciate against their own. Whether the form of the transaction is a bond or a loan,
the creditor benefit when the currency of denomination appreciates against the creditor’s home
currency. International diversification. Creditors can benefit from international diversification, which may
reduce the probability of simultaneous bankruptcy across borrowers. The effectiveness of such a
strategy depends on the correlation between the economic conditions of countries. If the countries of
concern tend to experience somewhat similar business cycles, diversification across countries will be
less effective.
Motives for Borrowing
• Low-interest rates. Some countries have a large supply of funds available than the demand for funds,
which can cause relatively low interest rates. Borrowers attempt to borrow funds from creditors in these
countries because the interest rate charged is lower. Yet, a relatively low interest rate is often perceived
as a reflection of a relatively low inflation rate. When inflation is low, it put upward pressure on the
foreign currency’s value, which offsets the advantage of lower interest rates. However, such a

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relationship is not precise because other factors also affect the movement of the currency. Thus, some
borrowers still choose to borrow from markets with low interest rates.
• Exchange rate expectations. When a foreign subsidiary of an MNC remits funds to its parent, the funds
must be converted to the parent's currency and, thus, will be subject to exchange rate risk. The MNC
will be adversely affected if the foreign currency depreciates at that time. To prevent such, the MNC
may speculate. If it expects that the foreign currency may depreciate against the dollar, it can reduce
the exchange rate risk by letting its subsidiary borrow funds locally to support its business. This will
result in less remittance of funds to the parent because the subsidiary must pay interest on local debt.
Thus, the amount of funds converted to the currency of its parent will be smaller, resulting in less
exposure to exchange rate risk.
Types of Foreign Direct Investments (FDIs)

• Horizontal. An investor established the same type of business operation in a foreign country as it
operates in its home country. For example, Huawei Technologies Co., Ltd., a China-based corporation,
established stores in the Philippines. Another example is the American multinational investment bank
and financial services holding company J.P. Morgan Chase & Co.
• Vertical. When an investor established or acquired a business that is different but related to their
business activities in its home country. For example, a manufacturing company acquires an interest in
a foreign company that supplies parts or raw materials required for the manufacturing company to make
its products.
• Conglomerate. When a company or individual makes a foreign investment in a business unrelated to
its existing business in its home country. This type of investment often takes the form of a joint venture
with a foreign company operating in a certain industry. It is because the foreign investors have no
previous experience with the regulations in the industry of a specific country. For example, China
Telecommunication Corporation entered into a joint venture with Udenna Corporation and Chelsea
Logistics and Infrastructure Holdings Corporation (CLC) to establish the third major telecommunication
provider in the country, the DITO Telecommunity Corporation. China Telecom is a Chinese state-owned
telecommunication company, while Udenna Corporation and CLC are Filipino-owned distributors and
retailers of finished petroleum products and providers of shipping and logistics services.
The Country Risk Premium (CRP)

• Economic risk. It refers to a country's ability to pay back its debts. A country with stable finances and a
stronger economy should provide more reliable investments than a country with weaker finances or an
unsound economy.
• Political risk. It refers to the political decisions made within a country that might result in an unanticipated
loss to investors. While economic risk is often referred to as a country's ability to pay back its debts,
political risk is sometimes referred to as the willingness of a country to pay debts or maintain a
hospitable climate for outside investment. Even if a country's economy is strong, if the political climate
is unfriendly or becomes unfriendly to outside investors, the country may not be a good candidate for
investment.
• Sovereign risk. This is the risk that a foreign central bank will alter its foreign exchange regulations,
significantly reducing or nullifying the value of its foreign exchange contracts. Analyzing sovereign risk
factors is beneficial for both equity and bond investors. However, it is more directly beneficial to bond
investors because the underlying asset for a bond is the country itself and its ability to grow and
generate revenue.
Foreign Exchange Market

• The trading of currencies and bank deposits denominated in particular currencies takes place in the
foreign exchange market. Transactions conducted in the foreign exchange market determine the rates
at which currencies are exchanged, which determines the cost of purchasing foreign goods and
financial assets.
• Exchange rates are important because they affect the relative price of domestic and foreign goods. The
interaction of two factors determines the dollar price of French goods to a Filipino: the price of French
goods in euros and the euro–peso exchange rate. For example, Rody is a Filipino wine taster. He
decides to buy a bottle of 1961 Château Lafite Rothschild to complete his wine cellar. If the price of the
wine in France is 1,000 euros and the exchange rate is P57.30 to the euro, the wine will cost Rody

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BM2004
P57,300 (1,000 euros × P57.30/euro). Now suppose that Rody delays his purchase by two (2) months,
at which time the euro has appreciated to P58.10 per euro. If the domestic price of the bottle of Lafite
Rothschild remains 1,000 euros, its peso cost will have risen from P57,300 to P58,100.
• As stated above, the trading of foreign currency takes place in the foreign exchange market. It is
organized as an over-the-counter (OTC) market in which several hundred dealers, mostly banks, stand
ready to buy and sell deposits denominated in foreign currencies. The market is very competitive
because the dealers are in constant telephone and computer contact. In effect, it functions similarly to
a centralized market. When individuals and institutions talk about buying and selling currencies in
foreign exchange markets, it does not mean that they take a handful of peso bills and sell them for
American dollar bills. Instead, most trades involve the buying and selling of bank deposits denominated
in different currencies. Thus, when a Filipino bank is buying a dollar in the foreign exchange market, it
means buying deposits denominated in the dollar.
Other International Investment Instruments

• Open-End Fund. A diversified portfolio of pooled investor money that can issue an unlimited number of
shares. The fund sponsor sells shares directly to investors and redeems them as well. These shares
are priced daily based on their current net asset value (NAV).
• Closed-End Fund. A portfolio of pooled assets that raises a fixed amount of capital through an initial
public offering (IPO) and then lists shares for trade on a stock exchange. It is professionally managed,
just like mutual funds. Also, just like Exchanged-Traded Funds (ETFs), it is traded in the stock
exchange.
• Exchange-Traded Fund (ETF). A type of security that involves a collection of securities, such as stocks,
that often tracks an underlying index. However, it can invest in any number of industry sectors or use
various strategies. ETFs are in many ways similar to mutual funds; however, they are listed on
exchanges. Their shares are traded throughout the day, just like ordinary stocks.
• Real Estate Investment Trust (REIT). A corporation that owns, operates, or finances income-producing
real estate. In REIT, investors earn through regular income streams and long-term capital appreciation.
It is required that 90% of the REIT’s income should be pay-out as dividends to investors. An individual
may buy shares in a REIT listed on major stock exchanges, just like any other public stock.
• Commodity Funds. Pooled funds that invest in commodities such as oil & natural gas, wheat & corn,
livestock, gold & silver.
• Structured Products. Pre-packaged investments that combine underlying assets such as shares,
bonds, indices, currencies, and commodities with derivatives.
• Hedge Funds. Pooled funds that use derivatives and leverage to achieve high returns and accessible
only to accredited investors.
• Private Equities. Pooled funds that invest in non-listed or private companies. Can engage in venture
capital or company buy-outs.
• Sukuk Investments. Financial instruments that comply with Islamic laws known as Sharia. Sharia
prohibits “ribe” or interest; thus, issuers sell assets to investors with the promise of buying them back
at a specified period, just like repurchase agreements. Possession of the asset remains with the issuer
who leases it and pays rent to the investor.
• Gold Bonds. These are types of bonds wherein investors get fixed coupons, but their maturity proceeds
depend on the market value of gold on the maturity date.
Sectors of World Bank Group

• International Bank of Reconstruction and Development (IBRD). It aids middle-income and poor but
creditworthy countries. It also works as an umbrella for more specialized bodies under the World Bank.
The IBRD was the original arm of the World Bank responsible for the reconstruction of post-war Europe.
A country must be a member of the IBRD before it can gain membership in other WGB institutions.
• International Development Association (IDA). It is the part of the WBG that helps the world’s poorest
countries. Overseen by 173 shareholder nations, IDA aims to reduce poverty by providing zero to low-
interest loans (called “credits”) and grants for programs that boost economic growth, reduce
inequalities, and improve people’s living conditions. IDA complements the IBRD, which was the original
lending arm of the WBG. It was established to function as a self-sustaining business and provides loans

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and advice to middle-income and credit-worthy poor countries. IBRD and IDA share the same staff and
headquarters and evaluate projects with the same rigorous standards.
• International Center for Settlement of Investment Disputes (ICSID). An institution that settles
international investment disputes. It provides settlement of disputes by conciliation, arbitration, or fact-
finding. It also promotes greater awareness of international law on foreign investment and the ICSID
process. It has an extensive program of publications, including the leading ICSID Review-Foreign
Investment Law Journal, and it regularly publishes information about its activities and cases. ICSID
staff organize events, give numerous presentations, and participate in international investment dispute
settlement conferences worldwide.
• Multilateral Investment Guarantee Agency (MIGA). It promotes cross-border investment in developing
countries by providing guarantees, such as political risk insurance (PRI) and credit enhancement, to
investors and lenders. PRI is a tool for businesses to mitigate and manage risks arising from
governments' adverse actions or inactions. As a risk-mitigation tool, it provides a more stable
environment for investments into developing countries and unlocks better access to finance.
• International Finance Corporation (IFC). It provides financing of private-enterprise investment in
developing countries worldwide through both loans and direct investments. It also provides advisory
services to encourage the development of private enterprises in nations that might be lacking the
necessary infrastructure or liquidity for businesses to secure financing. Its most recent stated goals
include the development of sustainable agriculture, expanding small businesses' access to
microfinance, supporting infrastructure improvements, and promoting climate, health, and education
policies. The IFC is governed by its 184-member countries and is headquartered in Washington, D.C.

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BM2004

(Week 1) Overview of Financial Systems and Markets ..................................................................................................3

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Purpose of Equity Securities .................................................................................................................................... 25

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

(Week 1) Overview of Financial Systems and Markets

Figure 1. Origin of Wealth

Figure 2. The Flow of Funds

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Nature of Financial Markets

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Types of Financial Markets

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

C. Based on Instruments Traded

D. Based on the Country’s Perspective

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

E. Based on the Manner of Financial Intermediaries

(Week 2) Philippine Financial System

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

(Weeks 3-4) Managing Credit Risk

Loanable Funds Theory

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Substitute the given values in the formula,

Market Segmentation Theory

Determining the Interest Rates

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Nominal and Real Rates

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

The real risk-free rate is 4%. ,

Bonds Issued at Premium

Bonds Issued at Discount

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

𝑉−𝑀 1,000 − 700 300

Interest Rate Risks

The Yield Curve

Mitigating the Interest Rate Risk

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

(Weeks 6-7) Money Market Instruments

Role of Money Market in the Financial System

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Money market securities have three (3) fundamental characteristics:

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

(Weeks 8-9) Bond Market

Purpose of the Capital Market

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

Where 𝑀 is the amount of the par value.

Where 𝐵𝑜 is the present value of the bond.

Then use the formula to get the bond price:

Substitute the values in the formula:

𝐵𝑜 = (𝑃100 × 6.71001) + (𝑃1,000 × 0.4631)

Third Year Comprehensive Examination (TYCE) Handout *Property of STI

(Weeks 11-13) Equity Market

Purpose of Equity Securities

Equity vs. Debt