Week one
Financial Markets and Institutions
Capitalism
1. Financial Markets
2. Central Banks
3. Financial Institutions
How do you define market?
- Buying and selling
- A place wherein a transaction is made
What is the function of financial
markets?
“channeling funds from households, firms, and
governments that have surplus funds by
spending less than their income to those that
have a shortage of funds because they wish to
spend more than their income”
What are the structure of financial
markets?
 Debt or Equity Market
 What do you get from
investing?
 Primary or Secondary Market
 Private = Investment Bank
(Underwriting)
 Public = NYSE, NASDAQ,
ForEx, Futures, Options
 Exchanges or OTC Market
 One central location
 Electronic
 Money or Capital Market
 Short-term
 Long-term
Remember!
 “when an individual buys security in
the secondary market, the person who
has said the security receives money in
exchange for the security, but the
corporation that issued the security
acquires no new funds. A corporation
acquires new funds only when its
securities are first sold in primary
market”
Broker VS Dealer
 Broker = matches buyer with seller
 Dealer = buys and sells securities
What are the functions of financial
intermediaries?
“Financial intermediation is the primary route
for moving fund from lenders or savers to
borrowers or spenders.”
Why are financial intermediaries
important?
 Reduce transaction costs (economies
of cost)
 Promotes risk sharing
 Diversification
 Achieves economies of scope
 Good credit rating = easier to
sell its bonds to public
 Reduces asymmetric information or
“information failure”
 Occurs when one party to an
economic transaction
possesses greater material
knowledge than the other
party
 Adverse selection = before
transaction
 Moral hazard = after
transaction
 Week one

Adverse Selection VS Moral Hazard Hedge funds Partnership Stocks,

participation bonds,
loans,
foreign
“risky firms are the most eager to sell currencies,
securities to investors” and many
other assts
“borrower might engage in undesirable
activities”
How is the financial system
regulated?
Regulatory Subject of Nature of
Both leads to investors’ loss of confidence in
Agency Regulation Regulations
financial markets.
Securities and Organized Requires
exchange exchanges disclosure of
What are the types of financial Commission and financial information;
intermediaries? (SEC) markets restricts
insider
Type of Primary Primary trading
Intermediary Liabilities Assets (Uses Commodities Futures Regulates
(Source of of Funds) Futures market procedures
Funds) Trading exchanges for trading in
Depository Commission future
Institutions (CFTC) markets
(banks) Office of the Federally Charters and
Commercial Deposits Business and Controller of chartered examines the
banks consumer the Currency commercial books of
loans, banks and federally
mortgages, thrift chartered
U.S. institutions commercial
government banks and
securities, and thrift
municipal institutions;
bonds. imposes
Savings and Deposits Mortgages restrictions
loan on assets they
associations can hold
Mutual savings Deposits Mortgages National Federally Charters and
banks Credit Union chartered examines the
Credit unions Deposits Consumer Administration credit unions books of
loans federally
chartered
credit unions
Investment
and imposes
intermediaries
restrictions
Finance Commercial Consumer on assets they
companies paper, stocks, and can hold.
bonds business
State banking State-charted Charter and
loans
and insurance depository examine the
Mutual funds Shares Stocks, commissions institutions books of
bonds state-
Money market Shares Money chartered
mutual funds market banks and
instruments
 Week one

insurance  Would you buy a house or a car when

companies; interest rates are high?
impose  Would you be encouraged to save
restrictions money when interest rates are high?
on assets they
can hold; and “interest rates have important effects on
impose individuals, financial institutions, businesses,
restrictions and overall economy”
on branching.
Federal Commercial Provides  We are going to study what
Deposit banks, insurance of interest rate is, movement in
Insurance mutual up to interest rates, and why they vary.
Corporation savings $250,000 for  Because financial crisis affects
(FDIC) banks, each everyone.
savings and depositor at a
loan bank;
association examines the
books of
insured banks
and imposes
restrictions
on assets they
can hold.
Federal All Examines the
Reserve depository books of
System Institutions commercial Bull Market VS Bear Market?
banks that are
member of  A bull is an investor who thinks the
the system; market, a specific security or an
sets reserve industry is poised to rise.
requirements  A bear is an investor who is
for all banks. pessimistic about the markets and
expects prices to decline.

How is the financial system

regulated?
 By increasing information available to
investors
 Ensuring the soundness of financial
system
 Restrictions on entry
 Disclosure
 Restrictions on assets and
activities
 Deposit insurance
 Limits on competition
 Restrictions on interest rate

Financial Markets + Institutions

Why do you have to study financial
markets + institutions
 Week two

Time value of money  Principal plus installment

payments
- “a dollar today is worth more than a  Discount Bonds
dollar received in the future”  Interest deducted in advance

What is Interest Rate? First type: Simple Loan

Second type: Fully Amortized Loan

Why is it important?

- It enables us to figure out today’s

value of a credit market instrument at
a given simple interest rate by just
adding up the present value of all the
future cash flows received.
- It allows us to compare the value of
two instruments with very different
timing of their cash flows.

What are the four types of credit

market instruments?
 Simple Loan
 Single maturity
 Fixed-payment Loan
 Several payments or
installment
 Amortization = allocation of
payments to or between
principal and interest
 Coupon Bond Third type: Coupon Bond
 Week two

Combination of PV of Principal using all available information equals

the security’s equilibrium return.
- Financial economists state it more
simply: a security’s price fully reflects
all available information in an
efficient market.
Combination of PV of Payment

What is YTM?
- Yield-to-Maturity of an instrument is
the interest rate that equates the
present value of the future cash flows
- It uses a variation of the “rate of
to its value today
return” equation
- Because the procedure for calculating
- It implies that security’s price is equal
the YTM is based on sound economic
to its equilibrium return (based on the
principles, this is the measure that
economics of quantity demanded and
financial economists think most
quantity supplied)
accurately describes “interest rate”

Interest Rate VS Rate of Return

- The rate of return is defined as the
payments to the owner plus the change
in its value, expressed as a fraction of
its purchase price.

How does the pandemic affect

prevailing interest rate in the
Philippines?

Are the financial markets efficient?

Efficient Market Hypothesis
- It states that prices of securities in
financial markets fully reflect all
available information.
- It tells us that current prices in a
financial market will be set so that the
optimal forecast of a security’s return
2.25% low as of June 2020
 Borrowers will pay lower interest on
loans and mortgages
 It helps poor household and
suffering businesses
 Week two

 Banks pay lower interest rates on

deposits
 it helps the bank to survive
 Flow of money from those who have
savings to those who are borrowing
 Moreover, BSP supplied tons of
money to government because
government funds are running out