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 HAPTER 7
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 1. Describe what financial markets are.
Financial market is describe as a meeting place for people, corporations and
institutions that either need money or have money to lend or invest. In a broad
context, the financial markets exist as a vast global network of individuals and
financial institutions that may be lenders, borrowers or owners of public
companies worldwide.

2. Distinguish between public financial markets and corporate financial

market.
Participants in the financial markets also include national, state and local governments that
are primarily borrowers of funds for highways, education, welfare and other public activities;
their markets are referred to as public financial markets. Large corporations raise funds in
the corporate financial markets.

3. Distinguish between primary market and secondary market.

When a corporation uses the financial markets to raise new funds, the sale of securities is said
to be made in the primary market by way of a new issue. After the securities are sold to the
public (institutions and individuals), they are traded in the secondary market between
investors. It is in the secondary market that prices are continually changing as investors buy
and sell securities based on their expectations of a corporation's prospects and also financial
managers are given feedback about their firm's performance.

4. What are the basic functions of the financial markets? Explain

them briefly.

Raising capital Commercial transactions

The financial markets are also an important source This includes such things as arranging payment for the
of capital for individuals who wish to buy homes or sale of a product abroad, and providing working capital
cars, or even to make credit-card purchases. so that a firm can pay employees if payments from
customers run late.
Price setting
Asset valuation
Markets provide price discovery, a way to
Market prices offer the best way to determine the value
determine the relative ale of different items, based
of a firm or of the firm's assets or property. This is
upon the prices at which individuals are willing to
important not only to those buying and selling
buy and sell them .
businesses, but also to regulators.
Arbitrage
As traders in financial markets attempt to profit Investing
from these divergences, prices move towards a The stock, bond and money markets provide an
uniform level, making the entire economy more opportunity to earn a return on funds that are not needed
efficient. immediately and to accumulate assets that will provide an
income in future.
Risk management
Futures, options and other derivatives contracts can provide protection against many types of risk, such as the
possibility that a foreign currency will lose value against the domestic currency before an export payment is
received.
 5. What are the two principal sources of funds in the financial market?
Explain briefly.
Debt instrument
Such as a bond or a mortgage, which is a
contractual agreement by the borrower to pay
the holder of the instrument fixed peso amounts
at regular intervals (interest and principal
payments) until a specified date (the maturity
date), when a final payment is made. Debt
instruments with a maturity between one and
ten years are said to be intermediate-term.
Equity instrument
Such as common or ordinary stock, which
are claims to share in the net income
(income after expenses and taxes) and the
assets of a business. Equities often make
periodic payments (dividends) to their
holders and are considered long-term
securities because they have no maturity
date.

6. Distinguish between the organized stock exchange and over-the-

counter exchange.
The Organized Stock Exchange are the stock exchanges will have a physical location where stocks
buying and selling transactions take place in the stock exchange floor (e.g., Philippine Stock Exchange, New
York Stock Exchange, Japan Nikkei, Shanghai Components, NASDAQ, etc.). On the other hand, Over-the-
Counter (OTC) Exchange is where shares, bonds and money market instruments are traded using a system of
computer screens and telephones. The NASDAQ is an example of an over-the counter market in which dealers
linked by computer buy and sell stocks. Many common stocks are traded over the counter although the
majority of the largest corporations have their shares traded at organized stock exchange.

7. What are the attributes of financial markets that investors as well as creditors
are looking for? Explain them briefly.
Liquidity
The ease with which trading can be conducted. Trading is easier and spreads are
narrower in more liquid Because liquidity benefits almost everyone, trading usually
concentrates in markets that are already busy.
Transparency
The availability of prompt and complete information about trades and prices. Generally, the less transparent the
market, the less willing people are to trade there.
Reliability
Particularly when it comes to ensuring that trades are completed quickly according to the terms agreed.
Legal procedures
Adequate to settle disputes and enforce contracts.
Suitable investor protection and regulation
Excessive regulation can stifle a market. Trading will also be deterred if investors lack confidence in the
available information about the securities they may wish to trade.
Low transaction costs
Many financial-market transactions are not tied to a specific geographic location, and the participants will
strive to complete them in places where trading costs, regulatory costs and taxes are reasonable.

8. What are the forces that brought about the major changes in
the financial markets for the last two to three decades?
The forces that brought about the major changes in the financial markets for the
last two to three decades are technology, deregulation, liberalization, consolidation
and globalization.
 9. What benefits could be achieved if the Code of Ethics
governing Financial Market Activities would be implemented and
followed by the participants.

"Code of Ethics Governing Financial Market Activities in the Philippines" to provide a reference for
banks, brokerage firms and other financial institutions in setting high ethical standards and professional
excellence for market practitioners. The Code was designed to be generally principles-based which can be
applied a minimun standard in trading across financial product markets. It is aimed to guide members in
decision making when faced with ethical situations, and determining the nature of their responsibilities to
one another, to clients and the market. It is important then that all market practitioners observe the
guiding principles embodied in this Code to continue to promote greater professionalism in our treasury
markets.

10. What is a stock exchange? What is its main purpose?

Stock exchange is an organized secondary market where securities like shares,
debentures of public companies, government securities and bonds issued by municipalities,
public corporations, utility undertakings, port trusts and such other local authorities are
purchased and sold. In order to bring liquidity, the stocks are traded systematically in a stock
exchange. It is an entity (a corporation or mutual organization) which is in the business of
bringing buyers and sellers of stocks and securities together. The purpose of stock exchange is to
facilitate the exchange of securities between buyers and sellers, thus providing a market place,
virtual or real.

11. What does "listing of securities" mean?

Listing means admission of securities to dealings on a recognized stock exchange of
any incorporated company, central and stage governments, quasi governmental and other
financial institutions/corporations, municipalities, electricity boards, housing boards and
so forth. The principal objective of listing is to provide liquidity and marketability to listed
securities and ensure effective monitoring of trading for the benefits of all participants in
the market.

12. What is the implication of the SEC granting a "Self-Regulation

Organization" status to the Philippine Stock Exchange?
The Securities and Exchange Commission granted the PSE a "Self-Regulation Organization"(SRO) status, which
meant that the bourse can implement its own rules and establish penalties on erring trading participants and
listed companies.
 CHAPTER
CHAPTER 8:
8:
MONEY
MONEY MARKETS
MARKETS
AND
AND CAPITAL
CAPITAL
MARKETS
MARKETS
 1. Explain the phrase "money market".
"Money Market" refers to the network of corporations, financial institutions, investors and
governments which deal with the flow of short-term capital. When a business needs cash for a couple of
months until a big payment arrives, or when a bank wants to invest money that depositors may withdraw at
any moment, or when a government tries to meet its payroll in the face of big seasonal fluctuations in tax
receipts, the short-term liquidity transactions occur in the money market.

2. Describe how the money market mechanism works to bring providers and users of
short-term fund together.
The money market exists to provide the loans that financial institutions and governments need to
carry out their day-to-day operations. For instance, banks may sometimes need to borrow in the short term
to fulfill, their obligations to their customers, and they use the money market to do so.The money markets
are the mechanisms that bring these borrowers and investors together without the comparatively costly
intermediation of banks. They make it possible for borrowers to meet short-run liquidity needs and deal with
irregular cash flows without resorting to more costly means of raising money.

3. Explain how banks, companies and investors use financial instruments in the
money market.
Companies
When companies need to raise money to cover their payroll or running costs, they may issue commercial
paper-short term, unsecured loans for P100.000 or more that mature within 1-9 months.
A company that has a cash surplus may "park" money for a time in short term, debt-based financial
instruments such as treasury commercial bills and paper certificates of deposit, or bank deposits.
Banks
If demand for long-term loans and mortgages is not covered by deposits from savings accounts, banks
may then issue certificates of deposit, with a set interest rate and fixed-term maturity of up to five years.
Investors
Individuals seeking to invest large sums of money at relatively low risk may invest in financial
instruments Sums of less than P50,000 invested in market funds can money be invested in money
market funds.

4. Give and describe the types of money-market instruments.

Commercial paper
Commercial paper is a short-term debt obligation of a private-sector firm or a government-sponsored
corporation. Only companies with good credit ratings issue commercial paper because investors are
reluctant to bring the debt of financially compromised companies.
Bankers' acceptances
Before the 1980s, bankers' acceptances were the main way for firms to raise short-term funds in the
money markets. An acceptance is a promissory note issued by a non-financial firm to a bank in return for
a loan. The bank resells the note in the money market at a discount and guarantees payment.
Acceptances usually have a maturity of less than six months.
Treasury bills
Treasury bills, often referred to as T-bills, are securities with a maturity of one year or less, issued
national governments. Treasury bills issued by a government in its own currency are generally
considered the safest of all possible investments in that currency.
Government agency notes
National government agencies and government-sponsored corporations are heavy borrowers in the
money markets in many countries. These include entities such as development banks, housing finance
corporations, education lending agencies and agricultural finance agencies.
Local government notes
Local government notes are issued by, provincial or local governments, and by agencies of these
governments such as schools authorities and transport commissions
Interbank loans
Loans extended from one bank to another with which it has no affiliation are called interbank loans.
Many of these loans are across international boundaries and are used by the borrowing institution to re-
lend to its own customers
Time deposits
Time deposits, another name for certificates of deposit or CDs, are interest bearing bank deposits that
cannot be withdrawn without penalty before a specified date.
Repos
Repurchase agreements known as repos, play a critical role in the money markets. They serve to keep the
markets highly liquid, which in turn ensures that there will be a constant supply of buyers for new
money-market instruments.
5. Explain what capital market is.
Capital market is a financial market in which longer-term debt (original maturity of one year or
greater) and equity instruments are traded. Capital market securities include bonds, stocks, and mortgages
Capital market securities are often held by financial intermediaries such as insurance companies and pension
funds, which have little uncertainty about the amount of funds they will have available in the future.

6. Who are the primary issuers of capital market securities?

National and local government Corporations
The national government issues long-term notes and Corporations issue both bonds and stock to
bonds fund the national debt while local governments finance capital investment expenditures and
issue notes and bonds to finance capital projects. fund other investment opportunities.
 7. What does capital market trading occur?

Capital market trading occurs in either the primary market or the secondary market. The primary
market is where new issues of stocks and bonds are introduced. Investment funds, corporations, and
individual investors can all purchase securities offered in the primary market. The capital markets have well-
developed secondary markets. A secondary market is where the sale of previously issued securities takes
place, and it is important because most investors plan to sell long-term bonds before they reach maturity and
eventually to sell their holdings of stock as well.

8. What are the bonds? How are they traded?

A bond is any long-term promissory note issued by the firm. A bond certificate is the tangible
evidence of debt issued by a corporation or a governmental body and represents a loan made by investors to
the issuer. Bonds are the most prevalent example of the interest only loan with investors receiving exactly the
same two sets of cash flows; (1) the periodic interest payments, and (2) the principal (par value or face value)
returned at maturity.
The initial or primary sale of corporate bond issues occurs either through a public offering, using
an investment bank serving as a security underwriter or through a private placement to a small group of
investors (often financial institutions). Generally, when a firm issues bonds to the public, many investment
banks are interested in underwriting the bonds The bonds can generally be sold in a national market. Most
often, corporate bonds are offered publicly through investment banking firms as underwriters. Normally, the
investment bank facilitates this transactic using a firm commitment underwriting.

9. Enumerate the advantages and disadvantages of issuing bonds as a source of

long-term funds.
Advantages
1. Long-term debt is generally less expensive than
other forms of financing because (a) investors view
debt as a relatively safe investment alternative and
demand a lower rate of return, and (b) interest
expenses are tax deductible
2. Bondholders do not participate in extraordinary
profits, the payments are limited to interest.
3. Bondholders do not have voting rights..
4. Flotation costs of bonds are generally lower than
those of ordinary (common) equity shares.
Disadvantages
1. Debt (other than income bonds) results in interest
payments that, if not met, can force the firm into
bankruptcy.
2 Debt (other than income bonds) produces fixed
charges, increasing the firm's financial leverage.
Although this may not be a disadvantage to all firms,
it certainly is for some firms with unstable earnings
streams.
3. Debt must be repaid at maturity and thus at some
point involves a major cash outflow.
4. The typically restrictive nature of indenture
covenants may limit the firm's future financial
flexibility.
 10. How is the bond's internal rate of return or yield to maturity determined?
Yield to Maturity refers to the bond's internal rate of return. It is the discount rate that equates the
present value of the interest and principal payments with the current market price of the bond.The Yield to
maturity is the internal rate of return earned by an investor who bought the bond today at the market price,
assuming that the bond will be held until maturity, and that all coupon and principal payments will be made
on schedule.
Yield to maturity (YTM) = [(Face value/Present value)1/Time period]-1.
If the YTM is less than the bond’s coupon rate, then the market value of the bond is greater than par value
( premium bond). If a bond’s coupon rate is less than its YTM, then the bond is selling at a discount. If a
bond’s coupon rate is equal to its YTM, then the bond is selling at par

11. How is credit quality risk of bonds may be issued by a corporation minimized?
Credit quality risk is the chance that the bond issuer will not be able to make timely payments.
Bond ratings involve a judgment about the future risk potential of the bond provided by rating agencies.
Bond ratings are favorably affected by (a) A low utilization of financial leverage, (b) Profitable operations: (c)
A low variability of past earnings. (d) Large firm size: (e) Little use of subordinated debt.

12. What is the relationship between bond rating and expected rate of return?
The poorer the bond rating, the higher the rate of return demanded in the capital markets.The bond
credit ratings agencies assign similar rating based on detailed analyses of issuers' financial condition, general
economic and credit market conditions, and the economic value of any underlying collateral. The agencies
conduct general economic analyses of companies business and analyze firm's specific financial situations. A
single company for instance may carry several outstanding bond issues and if these issues feature
fundamental differences, then they may have different credit level risks. High quality corporate bonds are
considered investment grade, while higher credit risk bonds are speculative, also called junk bonds and high-
yield bonds.

13. Describe the following types of bonds

i. Unsecured long-term bonds
Debentures
These are unsecured long-term debt and backed only by the reputation and financial stability of the
corporation. To provide some protection to the bondholder, the issuing firm may be prohibited from
issuing future secured long-term debt that would create additional encumbrance of assets.
Subordinated Debentures
Claims of bondholders of subordinated debentures are honored only after the claims of secured debt and
unsubordinated debentures have been satisfied.
Income Bonds
An income bond requires interest payments only if earned and non payment of interest does not lead to
bankruptcy.
ii. Secured long-term bonds
Mortgage Bonds
A mortgage bond is a bond secured by a lien on real property. Typically. the market value of the real property
is greater than that of the mortgage bonds issued.

First Mortgage Bonds

The first mortgage bonds have the senior claim on the secured assets if the same property has been
pledged on more than one mortgage bond.
Second Mortgage Bonds
These bonds have the second claim on assets and are paid only after the claims of the first mortgage
bonds have been satisfied.
Blanket or Ger Mortgage Bonds
All the assets of the firm are used as security for this type of bonds.
Closed-end Mortgage Bonds
The closed-end mortgage bonds forbid the further use of the pledged assets security for other bonds. This
protects the bondholders from dilution of their claims on the assets by any future mortgage bonds.
Open-end Mortgage Bonds
These bonds allow the issuance of additional mortgage bonds using the same secured assets as security.
However, a restriction may be placed upon the borrower, requiring that additional assets should be
added to the secured property if new debt is issued.
Limited Open-end Mortgage Bonds
These bonds allow the issuance of additional bonds up to a limited amount at the same priority level
using the already mortgaged assets as security.

iii. Junk bonds

Junk or low rated bonds are bonds rated BB or below. The major participants of this market are new
firms that do not have an established record of performance, although in recent years junk bonds have been
increasingly issued to finance corporate buyouts. Since junk bonds are of speculative grade, they carry a
coupon rate of between 3 to 5 percent more than AAA grade long-term debt.

iv. Floating rate of variable rate bonds

A floating rate bond is one in which the interest payment. changes with market conditions. In
periods of unstable interest rates this type of debt offering becomes appealing to issuers and investors.To the
issuers like banks and finance companies, whose revenues go up when interest rates rise and decline as
interest rates fall, this type of debt eliminates some of the risk and variability in earnings that accompany
interest rate swings. To the investor, it eliminates major swings in the market value of the debt that would
otherwise have occurred if interest rates had changed.
 14. Distinguish between ordinary or common stock and preferred stock.
Ordinary equity shares (traditionally known as ordinary equity share) is a form of long-term equity
that represents ownership interest of the firm Ordinary equity shareholders are called residual owners
because their claim to earnings and assets is what remains after satisfying the prior claims of various
creditors and preferred shareholders Ordinary (common) equity shareholders are the true owners of the
corporation and consequently bear the ultimate risks and rewards of ownership. While, Preferred share is a
class of equity shares which has preference over ordinary (common) equity shares in the payment of
dividends and in the distribution of corporation assets in the event of liquidation. Preference means only that
the holders of the preferred share must receive a dividend (in the case of a going concern firm) before holder
of ordinary (common) equity shares are entitled to anything. Generally has no voting privileges but it is a
form of equity from a legal and tax stand point

15. Compare the features of bonds, ordinary equity shares and preferre share in
terms of
ORDINARY EQUITY

PREFERRED SHARES BONDS
SHARES

Belongs to ordinary
equity shareholders Limited nights under
Ownership and Limited rights when
through voting night default in interest
control of the firm dividends are missed
and residual claim to payments
income

Must receive payment

Obligation to provide
None before ordinary Contractual obligation
return
shareholder

Bondholders and
Claim to assets in Lowest claim of any
creditors must be Highest claim
bankruptcy security holder
satisfied first

Cost of distribution Highest Moderate Lowest

Highest risk. highest

Moderate risk Lowest risk, moderate
Risk-return trade off return (at least in
moderate return return
theory)

Tax status of Tax deductible Cost

payment by Not deductible Not deductible Interest payment x (1
corporation Tax rate)

A portion of Dividend
Tax status of paid to another Same as ordinary Government bond
payment to recipient corporation is tax shares interest is tax exempt
exempt
 CHAPTER
CHAPTER 99
FOREIGN
FOREIGN EXCHANGE
EXCHANGE
MARKET
MARKET
1. List the factors that affect the value of a currency in foreign exchange markets.
Inflation
Inflation tends to deflate the value of a currency because holding the currency results in reduced
purchasing power.
Interest rates
If interest returns in a particular country are higher relative to other countries, individuals and
companies will be enticed to invest in that country. As a result, there will be an increased demand for the
country's currency.
Balance of payments
Balance of payments is used to refer to a system of accounts that catalogs the flow of goods between the
residents of two countries. For instance, if Philippines is a net exporter of goods and therefore has a
surplus balance of trade, countries purchasing the goods must use the country's currency. This increases
the demand for the currency and its relative value.
Government intervention
Through intervention (eg, having or selling the currency in the foreign exchange markets), the central
bank of a country may support or depress the value of its currency.
Other factors
Other factors that may affect exchange rates are political and economic stability, extended stock market
rallies and significant declines in the demand for major exports.
2. Explain how exports and imports tend to influence the value of a currency.
If a country exports more than it imports, there is a high demand for its goods, and thus, for its
currency. The economics of supply and demand dictate that when demand is high, prices rise and the
currency appreciates in value. In contrast, if a country imports more than it exports, there is relatively less
demand for its currency, so prices should decline. In the case of currency, it depreciates or loses value.Trade
influences the demand for currency, which helps drive currency prices.
3. Differentiate between the spot exchange rate and the forward exchange rate.
Spot Transactions
Spot transactions are those which involve immediate (two-day) exchange of bank deposits. The spot exchange
rate is the exchange rate for the spot transactions. A typical spot transaction may involve a Philippine firm
buying foreign currency from its bank and paying for it in Philippine pesos (or an American firm buying
currency from its bank and paying for it in US dollar). The spot rare for a currency is the exchange rate at
which the currency is traded for immediate delivery.

Forward Transactions
Forward transactions involve the exchange of bank deposits at some specified future date. The forward
exchange rate. The forward rate for a currency is the exchange rate at which the currency for future delivery is
quoted. The trading of currencies for future delivery is called a forward market transaction. The forward
exchange rate could be slightly different from the spot rate prevailing at that time. Forward rates may be
greater than the current spot rate (premium) or less than the current spot rate (discount).
 4. What is meant by translation exposure in terms of foreign exchange risk?
Translation exposure (also known as translation risk) is the risk that a company's equities, assets,
liabilities, or income will change in value as a result of exchange rate changes. This occurs when a firm
denominates a portion of its equities, assets, liabilities, or income in a foreign currency. It is also known as
"accounting exposure.” Translation exposure is most evident in multinational organizations since a
portion of their operations and assets will be based in a foreign currency. It can also affect companies that
produce goods or services that are sold in foreign markets even if they have no other business dealings
within that country.

5. What procedures(s) would you recommend for a multinational company in

studying exposure to political risk? what actual strategies can be used to guard
against such risk?
Political risk refers to the possibility that a host country's political policies will have a negative
impact on a multinational company's revenues or ambitions. The simplest option is to conduct study about
a country's riskiness, either by paying for studies from experts who specialize in such assessments or by
conducting your own research utilizing the numerous free resources available on the internet. Then you'll
be better prepared to avoid establishing operations in countries where political risk is high. If you do decide
to visit a high-risk country, one of the best options is to acquire political risk insurance. Multinational
corporations might obtain a policy from one of the many organizations that specialize in offering political
risk insurance, which would recompense them in the event of a negative incident. Purchasing political risk
insurance does not ensure that a corporation will be compensated promptly following a negative incident.

6. What is LIBOR? How does it compare to the U.S. prime rate?

Libor is a floating rate as it fluctuates continually. US Prime Rate is a fixed rate, which means it
typically remains unchanged for extended periods of time. Prime rate is a fixed rate, whereas Libor is a
floating rate. First, Prime interest rates are set by each bank, are tied to the U.S. Federal Funds Rate, and
remain fixed until the Federal Open Market Committee meets and changes the Federal Funds Rate. Prime is
variable, but may remain fixed for a long period of time. LIBOR is the London interbank offered rate,
representing the basic rate of interest used in the lending between banks on the London interbank market,
and the rates are actively traded on the open market. LIBOR is a short-term variable interest rate and the
spread between LIBOR and Prime vary daily, weekly, and monthly since LIBOR is traded daily and reacts to
current market events.
 CHAPTER
CHAPTER 10
10
MORTGAGE
MORTGAGE MARKET
MARKET
AND
AND DERIVATIVES
DERIVATIVES
 1. What distinguishes the mortgage from other capital market?
Mortgage markets, where borrowers - individual businesses and governments
can obtain long-term collaterized loans. Mortgage markets differ from the stock and
bond markets in a number of ways. First, the usual borrowers in the capital markets are
businesses and government entities, whereas the usual borrowers in the mortgage
markets are individuals. Second, mortgage loans are made for varying amounts and
maturities, depending on the borrowers' needs, features that cause problems for
developing a secondary market. Mortgages are long-term loan secured by real estate.
Both individuals and businesses obtain mortgages loans to finance real estate purchases.

2. Most mortgage loans once had balloon payments: Now, most

current mortgage loans are fully amortized. What is the
difference between a balloon loan and a fully amortizing loan?

A balloon loan comprises a stream of constant payments followed by a large

payment at the end, which is called the balloon payment. In contrast, a fully amortized
loan is composed of equal payments, which are paid through the life of the loan. The
balance at the end of the payments, in such a case, is zero. A balloon loan is a type of loan
that does not fully amortize over its term. Since it is not fully amortized, a balloon
payment is required at the end of the term to repay the remaining principal balance of
the loan. A fully amortized payment is one where if you make every payment according
to the original schedule on your term loan, your loan will be fully paid off by the end of
the term.

3. Give and explain briefly the three important factors that

affect the interest rate on the loan.
1. Current long-term market rates
Long-term market rates are determined by the supply of and demand for long-term
funds, which are in turn affected by a number of global, national, and regional
factors.
2. Term or Life of the mortgage
Generally, longer-term mortgages have higher interest rates than short-term
mortgages. The usual mortgage lifetime is 15 or 30 years.
3. Number of Discount Points Paid
Discount points (or simply points) are interest payments made at the beginning of a
loan. A loan with one discount point means that the borrower pays 1% of the loan
amount at closing, the moment when the borrower signs the loan paper and receives
the proceeds of the loan. Typically, discount points should not be paid if the
borrower will pay off the loan in five years or less.

4. What features contribute to keeping long-term mortgage

interest rates low
Maintain a good credit score
Having a long and consistent work history
Shop around for the best rate
Ask your bank or credit union for better rate
 5. Distinguish between conventional mortgage loan and insured
mortgage loan.
Conventional Mortgages are originated by banks or other mortgage lenders but
are not guaranteed by government or government controlled entities. Most lenders
though now insure many conventional loans against default or they require the
borrower to obtain private mortgage insurance on loans. On the other hand, Insured
Mortgages are mortgages are originated by banks or other mortgage lenders but are
guaranteed by either the government or government-controlled entities.

6. Describe briefly the following mortgage loans

a. Equity participating mortgage loan
In EPM, an outside investor shares in the appreciation of the property. This
investor will either provide a portion of the purchase price of the property or
supplement the monthly payment. In return, the investor receives a portion of any
appreciation of the property.
b. Shared-appreciation mortgage loan
In a SAM, the lender lowers the interest rate in the mortgage in exchange for
a share of any appreciation in the real estate (if the property sells for more than a
stated amount, the lender is entitled to a portion of the gain).
c. Growing equity mortgage loan
With a GEM, the payments will initially be the same as on a conventional
mortgage. Over time, however, the payment will increase. This increase will reduce
the principal more quickly than the conventional payment stream would).

d. Graduated-payment mortgage loan

These mortgages are useful for home buyers who expect their incomes to rise.
The GPM has lower payments in the first few years, then the payments rise. s time
passes, the borrower expects income to increase so that higher payment will not be
too much of a burden.
e. Fixed-rate mortgage loan
In fixed-rate mortgages, the interest rate and the monthly payment do not
vary over the life of the mortgage.

7. Give the largest providers of funds for mortgage loans

Mortgage tools and trusts 49%

Commercial banks 24%

Government agencies and others 15%

Life insurance companies 9%

Savings and loans associates 9%

 8. What is meant by "securitization of mortgages"?
Mortgage-backed security is a security that is collateralized by a pool of
mortgage loans. This is also known as securitized mortgage. Securitization is the
process of transforming illiquid financial assets into marketable capital market
instruments. The most common type of mortgage-backed security is the mortgage
pass through, a security that has the borrower's mortgages pass through the trustee
before being disbursed to the investors in the mortgage-pass through. If borrowers
pre-pay their loans, investors receive more principal than expected.

9. Describe the impact of securitized mortgage on the mortgage

market.
a. SM has reduced the problems and risks caused by regional lending institutions'
sensitivity to local economic fluctuations.

b. Borrowers now have access to a national capital market

c. Investors can enjoying the low-risk and long-term nature of investing in

mortgages without having to service the loan

d. Mortgage rates are now more open to national and international influences. As a
consequence, mortgage rates are more volatile than they were in the past.

10. What is meant by the term underlying as it relates to

derivative financial instruments?
Underlying refers to the security or asset that must be delivered when a contract or
warrant is exercised. In derivatives, the underlying is the security or asset that provides
cash flow to a derivative. The underlying of a derivative can be an asset, an index, or even
another derivative. An underlying is a special interest rate, security price, commodity
price, index of prices or rates, or other market-related variable. Changes in the underlying
determine changes in the value of the derivative. Payment is determined by the interaction
of the underlying with the face amount and the number of shares, or other units specified
in the derivative contract.

11. What are the main distinctions between a traditional financial

instrument and derivative financial instrument?
For a traditional financial instrument, an investor generally must pay the full cost,
while derivatives require little initial investment. In addition, the holder of a traditional
security is exposed to all risks of ownership, while most derivatives are not exposed to all
risks associated with ownership in the underlying. Finally, unlike a traditional financial
instrument, the holder of a derivative could realize a profit without ever having to take
possession of the underlying.

12. In what situation will the unrealized holding gain or loss on a

a non-trading equity investment be reported in income?
The unrealized holding gain or loss on inventory should be reported as income
when this inventory is designated as a hedged item in a qualifying fair value hedge. If the
hedge meets the special hedge accounting criteria (designation, documentation, and
effectiveness), the unrealized holding gain or loss is reported as income.
 13. Which of the following is not a derivative?

A. EQUITY CONTRACTS
b. Futures contracts
c. Option contracts
d. Swap contracts

14. An interest rate swap in which a company has a fixed rate of

interest and pays a variable rate is called a:

a. cash flow hedge

b. fair value hedge
c. deferred hedge
D. HEDGE OF FOREIGN CURRENCY EXPOSURE OF A NET
INVESTMENT IN FOREIGN OPERATIONS.

15. A derivative may be:

a. An asset account
b. A liability account
c. An owner equity account
D. EITHER AN ASSET OR A LIABILITY ACCOUNT

16. On August 1, 2020, Blossom Co. purchased 5,000 pound of

Italian pasta for 50,000 Euro payable in 60 days. On August, one
euro is worth P70.77. On September 1, the day of payment, the
euro is worth P70.60. the 60-day forward rate on August 1 for
one euro = P71.10. Blossom Company should record the cost of
the pasta as

a. P3,538,500
b. P3,530,000
C. P25,000
d. P3,555,000
 CHAPTER
CHAPTER 11
11
INTERNALIZATION
INTERNALIZATION OF
OF
FINANCIAL
FINANCIAL MARKETS
MARKETS
1. In what way do global financial markets help government
individuals, businesses and investors?

Without the global financial markets, governments would not be able to

borrow money, companies would not have access to the capital they need to
expand and, investors and individuals would be unable to buy and sell foreign
currencies.Markets provide finance for companies so they can hire, invest and
grow. They provide money for the government to help it pay for new roads, schools
and hospitals. And they can help lower the costs you face buying food at the
supermarket, taking out a mortgage or saving for your retirement.A look at
international bond markets and world stock markets will give us a picture of how
this globalization of financial markets is taking place.

2. What is the largest financial market in the world?

Until recently, the U.S. stock market was by far the largest in the world,
but foreign stock markets have been growing in importance. Now the United States
is not always number one: In the 1990s, the value of stocks traded in Japan at times
exceeded the value of stocks traded in the United States.

3. Is it easy to estimate the worldwide size of its financial

markets?
Estimating the overall size of the financial markets is difficult. It is hard in
the first place to decide exactly what transactions should be included under the
rubric "financial markets", and there is no way to compile complete data on each
of the millions of sales and purchases occurring each year.

4. What is meant by Cross-Border financing?

Another way of measuring the growth of finance is to examine the value of
cross border financing. Cross-border finance is by no means new, and at various
times in the past (in the late 19th century, for example) it has been quite large
relative to the size of the world economy. Cross-border financing refers to the
process of providing funding for business activities that occur outside a country's
borders. Companies that seek cross-border financing want to compete globally and
expand their business beyond their current domestic borders.

5. Explain the development of financial instruments in the

international markets.
The traditional instruments in the international bond market are known as
foreign bonds. Foreign bonds are sold in a foreign country and are denominated in that
country's currency. Foreign bonds have been an important instrument in the
international capital market for centuries.
1993 - bonds accounted for 59% of international Financing
1997- only 47% of the funds raised on international markets were obtained through
bond issues
2000- Equities became an important source of cross-border financing
2007-2010 - bonds and loans regained importance in the low-interest-rate
environment
2018- syndicated lending fell off as lack of capital forced banks to restrain their
lending activities
Years following 2018- Issuance of international bonds
6. Explain briefly how the following factors influenced the
long-run trends of increased financial market activity
i. Lower inflation
Inflation rates around the have fallen markedly since the 1990s. Inflation
erodes the value of financial assets and increases the value of physical assets, such
as houses and machines, which will cost far more to replace than they are worth
today.
ii. Pensions
A significant change in pension policies occurred many countries starting in
the 1990s. Changes in demography and working patterns have made pay-as-you-go
schemes increasingly costly to support as there are fewer young workers relative to
the number of pensioners.
iii. Stock and bond market performance
Many countries' stock and bond markets performed well during most of the
1990s and in the period before 2008, with the global bond-market boom
continuing until interest rates began to rise in 2013. Stock markets, after several
difficult years, rose steeply in many countries in 2012 and 2013.

iv. Risk management

Innovation has generated many new financial products, such as derivatives
and asset-backed securities, whose basic purpose is to redistribute risk. This led to
enormous growth in the use of financial markets for risk-management purposes.
The risk-management revolution thus resulted in an enormous expansion of
financial-market activity.
v. Investors
Yield is the income the investor receives while owning an investment.
Capital gains are increases in the value of the investment itself, and are often
not available to the owner until the investment is sold

7. Give the explain briefly the types of institutional investors.

Mutual funds
The fastest-growing institutional investors are investment companies, which
combine the investments of a number of individuals with the aim of achieving
particular financial goals in an efficient way.
Hedge funds
Another type of investment company, a hedge fund, can accept investments
from only a small number of wealthy individuals or big institutions.
Insurance companies
Insurance companies are the most important type of institutional investor,
owning one-third of all the financial assets owned by institutions.
Pension funds
Pension funds aggregate the retirement savings of a large number of workers.
Typically, pension funds are sponsored by an employer, a group of employers or
a labour union.
Algorithmic traders
Algorithmic trading, also known as high-frequency trading, has expanded
dramatically in recent years as a result of increased computing power and the
availability of low-cost, high-speed communications.
8. Distinguish between the major types of international credit
markets
Eurocredits
This is the market for floating-rate bank loans whose rates are tied to
LIBOR, which stands for London Interbank Offer Rate. LIBOR is the interest rate
offered by the largest and strongest banks on large deposits. Eurocredits are
usually issued for a fixed term with no early repayment Currently, Eurocredit exist
for most major trading currencies.

Eurobond market
A Eurobond is an international bond underwritten by an international
syndicate of banks and sold to investors in countries other than the one in whose
money unit the bond is denominated. Eurobonds can be issued with either a
floating-coupon rate depending on the preferences of the issuer and they have
medium or long-term maturities

Foreign bond market

Foreign bonds are international bonds issued in the country in whose
currency the bond is denominated, and they are underwritten by investment bank
in that country. The borrower may be located in a different country. They can have
a floating-rate coupon or a fixed-rate coupon and they have the same maturities as
the purely domestic bonds with which they must compete for funds.