COLLEGE OF BUSINESS AND ACCOUNTANCY

MANUEL S. ENVERGA UNIVERSITY FOUNDATION - LUCENA CITY, PHILIPPINES

An Autonomous University
CHED CEB Res. 076-2009

FINANCIAL MARKETS (AE121)

NAME: REGINA P. BASAN DATE: SEPTEMBER 12, 2021

PROGRAM AND YEAR: BSA - III PROFESSOR: IMELDA D. CABASCO
CLASS SCHEDULE: MWF 3:30-4:30 PM (C061)
MODULE 1
CHAPTER 1 – EXERCISES
1. Discuss the importance of Financial System
The development of any country depends on the economic growth the country
achieves over a period of time. Only when this grows, the people will experience growth in the
form of improved standard of living, namely economic development. To attain economic
development, a country needs more investment and production. This can happen only when
there is a facility for savings. For that, the importance of financial system is that it encourages
the public to save by offering attractive interest rates. These savings are distributed various
business which is involved in production and distribution. It also enables the financial
intermediation process, which facilitates the flow of funds between savers and borrowers, thus
ensuring that financial resources are allocated efficiently towards promoting economic growth
and development.
Clearly, in any functional economy, economic resources are limited, with individuals
having unlimited wants and desires. It challenges an economy in determining when, where, to
whom to distribute its resources. For instance, it resulted in a financial system structure
capable of efficiently allocating economic resources to stimulate growth. Also, it allows
participants to benefit by providing a way of making payments through banks, giving
participants a way of earning interest in the form of time value such as investment institutions,
protecting them against financial risks insurance, collecting and distributing financial
information via credit agencies, governing regulations to maintain stability through central
banks and governments, and lastly, maintaining liquidity and converting investments into cash
through financial institutions. To sum up, financial instability and its effects on the economy
can be very costly due to its contagion or spillover effects to other parts of the economy.
Indeed, it may lead to a financial crisis with adverse consequences for the economy. Hence, it
is fundamental to have a sound, stable and healthy financial system to support the efficient
allocation of resources and distribution of risks across the economy.
COLLEGE OF BUSINESS AND ACCOUNTANCY
MANUEL S. ENVERGA UNIVERSITY FOUNDATION - LUCENA CITY, PHILIPPINES
An Autonomous University
CHED CEB Res. 076-2009

2. How do Financial Markets help the economy and how can it hurt the economy?
Site an example.
The fact that there is a strong positive relationship between financial market
development and economic growth means well-developed, smoothly operating financial
markets play an important role in contributing to the health and efficiency of an economy.
Financial markets help the economy by efficiently directing the flow of savings and investment
in the economy in ways that facilitate the accumulation of capital and the production of goods
and services. This marketplace match buyers and sellers or lenders to buyers at a given time
and reflect the performance of the economy. Businesses need capital to grow and to expand
their respective business thus, where the financial market plays a critical role in the buildup of
capital and the production of goods and services providing access to capital. In a well-
developed and efficient market, the transaction costs are always lower with efficient transfer of
funds; it can be mean also a lower cost of financing and a safe return on investment. Then
again, well-developed effective financial system offers products to market participants that
provide borrowers and lenders with a close fit for their needs. It includes individuals,
businesses, and governments in the emergence of funds can easily discover which financial
institutions or markets may provide funding and at what cost. This allows investors to compare
the cost of financing to their expected return on investment, thus making the investment choice
that best fits their needs. Therefore, a good financial market helps in the creation of wealth and
provides a link between savings and investment that meet the short-term and long-term
financial needs of both the household and corporate sector through efficient mobilization and
allocation of surplus. A recent example is the Integration of existing European Union financial
markets, with its single banking market and single currency, it has created wide financial
markets and institutions. These markets use to facilitate saving, investment, borrowing, and
lending. It denominated stock, bond, and derivative markets serve all of the countries,
replacing smaller offerings and products that previously were available mostly on a country
basis.

Consequently, if being effective financial markets helps the economy, the limited
financial markets, as well as poorly defined legal systems will make it more costly to raise
capital and may lower the return on savings or investments. Limited information or lack of
financial transparency mean that information is not as readily available to market participants
and risks may be higher than in economies with more fully developed financial systems. In
such thin financial markets with little trading activity and few alternatives, it may be more
difficult and costly to find the right product, maturity, or risk profile to satisfy the needs of
borrowers and lenders. Hence, when financial markets fail, economic disruption including
recession and unemployment can result.
COLLEGE OF BUSINESS AND ACCOUNTANCY
MANUEL S. ENVERGA UNIVERSITY FOUNDATION - LUCENA CITY, PHILIPPINES
An Autonomous University
CHED CEB Res. 076-2009

3. What are the different Financial Intermediaries and explain how they carry out the
objectives of the financial system?
As we have seen, financial intermediaries have a key role to play in the world
economy today. They serve as the lubricants that keep the economy going. Due to the
increased complexity of financial transactions, it keeps re-inventing themselves and cater to
the needs of the investors. Financial intermediaries play a key role in improving economic
efficiency because they help financial markets channel funds from lender-savers to people with
productive investment opportunities. Without a well- functioning set of financial intermediaries,
it is usually argued that it would be very hard for an economy to reach its full potential.
On the other hand, the different financial intermediaries are commercial bank,
investment bank, mutual fund, credit union, or pension fund. In the financial system,
intermediaries like banks and insurance companies have a huge role to play given that it has
been estimated that a major proportion of every dollar financed externally has been done by
the banks. Financial intermediaries are an important source of external funding for corporates.
Unlike the capital markets where investors contract directly with the corporates creating
marketable securities, financial intermediaries borrow from lenders or consumers and lend to
the companies that need investment.
It carries the objective of financial system which is to offers products and services to
reduce financial risk by providing factoring, leasing, insurance plans, or other financial
services. Many intermediaries take part in securities exchanges and utilize long-term plans for
managing and growing their funds. Financial Intermediaries also offer a number of benefits to
the average consumer, including safety, liquidity, and economies of scale involved in banking
and asset management. These intermediaries help create efficient markets and lower the cost
of doing business. Also, it allows participants to benefit by providing a way of making
payments through banks, giving participants a way of earning interest in the form of time value
such as investment institutions, protecting them against financial risks insurance and collecting
and distributing financial information via credit agencies. Through a financial intermediary,
savers can pool their funds, enabling them to make large investments, which in turn benefits
the entity in which they are investing. The overall economic stability of a country may be
shown through the activities of financial intermediaries and the growth of the financial services
industry.
COLLEGE OF BUSINESS AND ACCOUNTANCY
MANUEL S. ENVERGA UNIVERSITY FOUNDATION - LUCENA CITY, PHILIPPINES
An Autonomous University
CHED CEB Res. 076-2009

.4. Differentiate Direct Financing and Indirect Financing as illustrated in the figure 1
above.

Based on the figure illustrated in the figure 1 above, indirect finance relates to raising
of funds by borrowers or firms indirectly from the savers through financial intermediaries like
banks who have the money of the savers. On the other hand, direct finance relates to raising
of funds by borrowers or firms directly from the savers through the financial markets.
In addition, indirect finance is where borrowers borrow funds from the financial market
through indirect means, such as through a financial intermediary. Indirect financing occurs
when you deal with loan packages through a third-party lender.
In direct financing, the main advantages are flexibility and customization. You can
apply for as many loans as you want, you can apply before or after you shop, and you have full
control over the process while working directly with your lender. The disadvantage is that the
process takes a lot more time and though you can apply broadly, you have to do some
research to determine the best options for your needs.
On the other hand, advantages in indirect financing may involve more parties than
working directly with a lender but having a team can speed up the process. The disadvantage
is that it might pay extra for the convenience and speed of the indirect financing process.
In conclusion, indirect financing is more important than direct financing methods. This is
due primarily to the added efficiency available through the financial intermediary. With indirect
financing, the intermediary takes care of gathering together multiple investors, reduces
investor risk by performing due diligence on the borrowers and provides a larger pool of funds
from which the borrower can pull quickly.
COLLEGE OF BUSINESS AND ACCOUNTANCY
MANUEL S. ENVERGA UNIVERSITY FOUNDATION - LUCENA CITY, PHILIPPINES
An Autonomous University
CHED CEB Res. 076-2009

5. What is the financial instruments? Give examples and explain each.

Financial instruments are contracts for monetary assets that can be
purchased, traded, created, modified, or settled for. In terms of contracts, there is a
contractual obligation between involved parties during a financial instrument transaction.
For example, when a company pay cash for a bond, the other party is obligated to deliver
a financial instrument for the transaction to be fully completed. One company is obligated
to provide cash, while the other is obligated to provide the bond. Hence, there is a
bilateral obligation.
There are typically three types of financial instruments: cash instruments, derivative
instruments, and foreign exchange instruments.

1. Cash instruments are financial instruments with values directly influenced by

the condition of the markets. Within cash instruments, there are two types:
securities and deposits, and loans.

• Securities: A security is a financial instrument that has monetary value and

is traded on the stock market. When purchased or traded, a security
represents ownership of a part of a publicly traded company on the stock
exchange.
• Deposits and Loans: Both deposits and loans are considered cash
instruments because they represent monetary assets that have some sort of
contractual agreement between parties.

2. Derivative instruments are financial instruments that have values determined

from the underlying assets such as resources, currency, bonds, stocks, and
stock indexes.
The five most common examples of derivatives instruments are synthetic agreements,
forwards, futures, options, and swaps. This is discussed in more detail below.
• Synthetic Agreement for Foreign Exchange (SAFE): it occurs in the over
the counter (OTC) market and is an agreement that guarantees a specified
exchange rate during an agreed period of time.

• Forward: is a contract between two parties that involves customizable

derivatives in which the exchange occurs at the end of the contract at a
specific price.
COLLEGE OF BUSINESS AND ACCOUNTANCY
MANUEL S. ENVERGA UNIVERSITY FOUNDATION - LUCENA CITY, PHILIPPINES
An Autonomous University
CHED CEB Res. 076-2009

• Future: is a derivative transaction that provides the exchange of derivatives

on a determined future date at a predetermined exchange rate.

• Options: is an agreement between two parties in which the seller grants the
buyer the right to purchase or sell a certain number of derivatives at a
predetermined price for a specific period of time.

• Interest Rate Swap: An interest rate swap is a derivative agreement

between two parties that involves the swapping of interest rates where each
party agrees to pay other interest rates on their loans in different currencies.

3. Foreign exchange instruments are financial instruments that are represented

on the foreign market and primarily consist of currency agreements and
derivatives.
In terms of currency agreements, they can be broken into three categories.
• Spot: A currency agreement in which the actual exchange of currency is no
later than the second working day after the original date of the agreement. It is
termed “spot” because the currency exchange is done “on the spot”.

• Outright Forwards: A currency agreement in which the actual exchange of

currency is done “forwardly” and before the actual date of the agreed
requirement. It is beneficial in cases of fluctuating exchange rates that change
often.

• Currency Swap- it refers to the act of simultaneously buying and selling

currencies with different specified value dates.