Republic of the Philippines

Laguna State Polytechnic University

ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

LSPU Self-Paced Learning Module (SLM)

Course Capital Market (FM 104)
Sem/AY First Semester/2022-2023
Module No. 1
Lesson Title INTRODUCTION TO CAPITAL MARKETS
Week
2-4
Duration
Date
This lesson will discuss the basic characteristics and functions of financial assets and
Description financial markets. While the focus will be on the one part of the factor market, the
of the market for financial assets or more simply the financial market, which determines the
Lesson cost of capital.

Learning Outcomes
Intended Students should be able to meet the following intended learning outcomes:
Learning  Explain the characteristics of financial assets and the markets where they are
Outcomes traded.
Targets/ At the end of the lesson, students should be able to:
Objectives  Identify what a financial assets is
 Differentiate between a debt instrument and an equity instrument.
 Explain the general principles for determining the price of a financial asset.
 Enumerate the properties of financial assets
 Identify the principal economic functions of financial assets.
 Explain what a financial market is and its principal economic function it
performs.
 Identify the different ways to classify financial markets.
 Define what a derivative instrument is.
 Explain the reasons for the globalizations of financial markets.
 Enumerate the classifications of global financial markets.
 Identify what an asset class is.

Student Learning Strategies

Online Activities A. Online Discussion via Google Meet/Zoom/Messenger.

(Synchronous/ You will be directed to attend in a Three (3)-Hour class discussion on
the Introduction to Capital Markets. To have access to the Online
Asynchronous) Discussion, refer to the link I will provide every scheduled class.

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

(For further instructions, refer to your Google Classroom and see the
schedule of activities for this module)

B. Learning Guide Questions:

1. What is a financial asset?
2. Differentiate between a debt instrument and an equity claims.
3. What is the process of determining the fair value or price of a financial
asset?
4. Explain the role of a financial asset.
5. Enumerate the properties of a financial asset.
6. Define financial markets.
7. What are the role of financial markets?
8. Enumerate the classification of financial markets.
9. What is the globalization of financial markets?.
10. Enumerate the classification of global financial markets.
11. What is a derivative markets?
12. Enumerate and define what asset classes.

Note: The insight that you will post on online discussion forum using Learning Management
System (LMS) will receive additional scores in class participation.

Offline Activities
(e-Learning/Self- Lecture Guide
Paced)

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

FINANCIAL ASSETS

Asset – is any possession that has value in an exchange. Assets can be classified
as tangible and intangible. The value of tangible assets depends om particular
physical properties examples:
a. Buildings, lands or machinery.

Intangible assets by contrast, represent legal claims to some future benefit.

Their value bears no relation to the form, physical or otherwise in which the
claims are recorded. Financial assets, financial instruments or securities are
intangible assets. For these instruments, the typical future benefits comes in
the form of a claim to future cash.

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

The entity that agrees to make future cash payments is called the issuer of the
financial asset, the owner of the financial asset is referred to as the investor.

Examples of financial assets include the ff:

 A bond issued by the U.S. Dept of Treasury

 A bond issued by General Electric Corp.
 A bond issued by the state of California
 A bond issued by the government of France
 An automobile loan
 A home mortgage loan
 Common stock issued by Microsoft Corp.
 Common stock issued by Honda
 Common stock issued by Meralco and PLDT.

Debt vs. Equity

The claims of the holder of a financial asset may either a fixed dollar amount or
a varying, or residual amount. In the former case, the financial asset is referred
to as a debt instrument. The bonds issued by the U.S. Dept of Treasury,

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited
General Electric Corp. and state of California are examples of debt instruments
requiring fixed dollar payments to borrow the funds. The two loans are also
debt instruments.

An equity claim (also called a residual claim) obligates the issuer of the
financial asset to pay the holder an amount based on earning, if any, after
holders of debt instruments have been paid. Common stock is an example of an
equity claim. A partnership share in a business is another example.

Some financial assets fall into both categories. Preferred stock, for example,
represents an equity claim that entitles the investor to receive a fixed dollar
amount. This payment is contingent, however, due only after payments to debt
instrument holders are made. Another instrument is convertible bonds, which
allow the investor to convert debt into equity under certain circumstances.
Both debt and preferred stock that pays a fixed dollar amount are called fixed
income instruments.

The Value of Financial Asset

Valuation – is the process of determining the fair value or price of a financial

asset. The fundamental principle of valuation is the value of any financial asset
is the value of the cash flow expected. This principle applies regardless of the
financial asset. Consequently, it applies equally to common stock, a bond, a
loan, and real estate..

The principle is simple: Just determine the cash flow and then calculate the
present value. However, accomplishing the task is not simple.

Estimating the Cash Flow

The first problem encountered in valuing the financial asset is interpreting

what is meant by “cash flow”. Accountants use a set answer: It is the net income
after taxes plus non-cash outlays such as depreciation. Cash flow is simply the
cash that is expected to be received each period from investing in a particular
financial asset.

The type of financial asset, whether debt instrument or equity instrument, and
the characteristics of the issuer determine the degree of certainty of the cash
flow expected.

For example: assuming that the U.S. government never defaults on the dent
instrument it issues, the cash flow of securities by the U.S. Dept of Treasury is
known with certainty.

The cash flow of other debt instruments is not known with certainty for three
reasons.
1. The issuer might default
2. Provisions included in most debt instruments grant the issuer and the

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited
investor the right to change how the borrowed funds are repaired.
3. The interest rate the issuer pays can change over the time the borrowed
funds are outstanding.

The holder of common stock of a corporation faces uncertainty as to the

amount and the timing of dividend payments. Dividend payments relate to
corporate profits. Moreover, unlike debt instruments in which the borrowed
funds are to be repaid, an investor in common stock typically must sell the
stock in order to try to recover the amount invested. Whether the amount
received when the stock is sold is more or less than the amount initially
invested depends on the stock’s price at the time of sale, another uncertainty.

The Appropriate Interest Rate for Discounting the Cash Flow

Once the cash flow for a financial asset is estimated, the next step is to
determine the appropriate interest rate used to calculate the present value (or
discounted value). To determine the appropriate rate, the investor must
address the following two questions:
1. What is the minimum interest rate the investor should require?
2. How much more than the minimum interest rate should the investor
require?

FIGURE 1-1 Summary of the Process for Valuing a Financial Asset

Estimate the cash flow

(cash flow = interest, principal repayment, dividends, expected sale price of asset)

Determine the appropriate interest rate for discounting the clash flow
Minimum interest rate: rate on U.S. Treasury securities or some other low credit risk benchmark
Plus premium required for perceived risk

Value of financial asset= Present value of expected cash flow

Types of Risks
• Credit Risk or Default Risk – is the risk that the issuer or borrower will
default on obligation.
• Purchasing Power Risk or Inflation Risk – is the risk attached to the
potential purchasing power of the cash flow expected.
• Foreign Exchange Risk – financial asset whose cash flow is not

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited
denominated in U.S. dollars entail a risk that the exchange rate will
change adversely resulting in fewer U.S. dollars.

The Role of Financial Assets

Financial assets serve two principal economic functions.
1. Financial assets transfer funds from those parties who have
surplus funds to invest to those who need funds to invest
tangible assets.
2. They transfer funds in such a ways as to redistributed the
unavoidable risk associated with the cash flow generated by
tangible assets among those seeking and those providing the
funds.

Financial Intermediaries – seek to transform the final liabilities into different

financial assets preferred by the public.

10 Properties of Financial Asset

1. Moneyness
Some financial assets act as a medium of exchange or in settlement of
transactions. These assets are called money. Other financial assets, although
not money, closely approximate money in that they can be transformed into
money at little cost, delay or risk. They are referred to as near money, include
time and savings deposits and a security issued by the U.S. government with a
maturity of three months called a three-month Treasury bill.

2. Divisibility and Denomination

Divisibility – the minimum size at which a financial asset can be liquidated and
exchanged for money.

3. Reversibility
It refers to the cost of investing in a financial asset and then getting out of it and
back into cash again. It is also referred to as round-trip cost.
The most relevant component of round-trip cost is the so-called bid-ask
spread which consist of the difference between the price at which a market
maker is willing to sell a financial asset and the price at which a market maker
is willing to buy the financial asset.
The bid-ask spread referred to as the bid-offer spread.

4. Term to maturity
Is the length of the interval until the date when the instrument is scheduled to
make its final payment or the owner is entitled to demand liquidation.

5. Liquidity
According to Professor James Tobin, in terms of how much sellers stand to lose
if they wish to sell immediately against engaging in a costly and time
consuming search. An example of illiquid financial asset is the stock of a small
corporation or the bond issued by a small school district for which the market
is extremely thin and one must search out few suitable buyers.

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

For many other financial assets, liquidity is determined by contractual

arrangements. Ordinary deposits of a bank, for example are perfectly liquid
because the bank operates under a contractual obligation to convert them at
par on demand.

In contrast, financial contracts representing a claim on a private pension fund

may be regarded as totally illiquid, because they can be cashed only at
retirement.

6. Convertibility
When a bond is converted to another bond

7. Currency
Most financial assets are denominated in one currency, such as U.S. dollars or
yen or euros, and investors must choose them either that feature in mind.

8. Cash Flow and Return Predictability

The return that an investor will realize by holding a financial asset depends on
the cash flow expected to be receives, which include dividend payment on
stock and interest payments on debt instruments.
Return Predictability, a basic property of financial assets, provides the major
determinant of their value.

• Nominal Expected Return - considers the dollars expected to be

received but does not adjust those dollars to take into consideration
changes in their purchasing power.

• Real Expected Return - is the nominal expected return after

adjustment for the loss of purchasing power of the financial asset as as
result of inflation.

9. Complexity
They combine two or more simpler assets. To find the true value of such an
asset, one must “decompose” it into its component parts and price each
component separately.

10. Tax Status

Tax rates differ from year to year, country to country, and even among
municipal units within a country.

FINANCIAL MARKETS

Financial assets are exchanged in a financial market.

The Role of Financial Markets

Primary economic functions of financial assets:

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited
1. The interactions of buyers and sellers in a financial market determine
the price of the traded asset (price discovery process).
2. Financial markets provide a mechanism for an investor to sell a financial
asset.
3. Financial market reduces the search and information costs of
transacting.

• Search cost – represent explicit costs, such as the money spent to

advertise the desire to sell or purchase a financial asset, and implicit
costs, such as the value of time spent n locating a counterparty.

• Information cost – incurred in assessing the investment merits of a

financial asset, that is, the amount and the like hood of the cash flow
expected to be generated.

Classification of Financial Market

1. By the type of financial claim - The claims traded in a financial market
may be either for a fixed dollar amount or a residual amount.
• The former financial assets are referred to as debt instrument,
and the financial market in which such instruments are traded
are referred to as the debt market.
• The latter financial assets are called equity instruments and the
financial market where such instruments are traded s referred to
as equity market. Alternatively, this market is referred to as the
stock market.

Preferred stock – represents an equity claim that entitles the investor to

receive a fixed dollar amount. It shares characteristics of instruments classified
as part of the debt market and the equity market.

• Debt instrument and preferred stock is classified as part of the

fixed income market.
• The sector of stock market that does not include preferred stock
is called the common stock market.

2. By The maturity of the claims.

• Money market – a financial market for short-term financial
assets.
• Capital market – the one for longer maturity financial assets.

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

3. To classify financial markets is by whether the financial claims are

newly issued.
• Primary market – the market for newly issued assets.
• Secondary market – the market where this activity takes place.

4. A market can be classified by its organizational structure.

• Ex: Auction markets, over-the counter markets and immediate
markets

Globalization of Financial Markets

• Globalization – the integration of financial markets throughout the

world into an international financial market.

Factors contributing to the integration of financial markets

1. Deregulation or liberalization of markets and the activities of market
participant in key financial centers of the world.
2. Technological advances for monitoring world markets, executing orders
and analyzing financial opportunities.
3. Increased institutionalization of financial markets.

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

Two types of Investors

• Retail Investor are individuals, while Institutional Investors
are financial institutions such as pension funds, insurance
companies, investment companies, commercial banks, and
savings and loan association.

Institutionalization of Financial Markets

- The shifting of the financial markets in the U.S. and other
major industrialized countries from dominance by retail
investors to institutional investors.
- They show greater willingness to transfer funds across
national borders to improve the risk/reward
opportunities of a portfolio that includes financial assets
of foreign issuers.

Emerging markets
- Participation in the financial markets of developing
economies and continues to increase.

Classification of Global Financial Markets

Internal Market, also called the national market, can be decomposed into
two parts:
• Domestic market – where issuer domicile in the country issue
securities and where those securities are subsequently traded.
• Foreign market – securities of issuers not domiciled in the
country are sold and traded.

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

Derivative Markets
• Derivative instrument- some contracts give the contract holder either
the obligation or the choice to buy or sell a financial asset.
• Examples: Option contracts, futures contracts, forward contracts, swap
agreements, cap and floor agreements.
• The existence of derivative instruments is the key reason why investors
can more effectively implement investment decisions to achieve their
financial goals and issuers can more effectively raise funds on more
satisfactory terms.
• Derivative serves an important functions of the global financial
marketplace, providing end-users with opportunities to better manage
financial risks associated their business transactions.
• Problem: Derivative Instrument is not with the instruments but the lack
of understanding of their risk/return characteristics by some users.

Asset Classes

Four major asset class

1. Common stock
2. Bonds
3. Cash Equivalents
4. Real estate

Capitalization – market capitalization of the company’s common stock.

Market capitalization – is equal to the total market value of its common stock
outstanding.

For example: Suppose that a corp. has 50 million shares of stock outstanding
and each share has a market value of $40. Then the capitalization of this
company is $2billion (50 million shares times $40 per share).

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

A corporation’s market cap of a company is commonly referred to as its

“market cap” or simply “cap”.

Common Stocks and Bonds that refers to Equities in U.S. classified as asset
classes:
Large capitalization stocks
Mid capitalization stocks
Small capitalization stocks
Growth stocks
Value stocks

U.S. bonds also referred to fixed income securities are classified as asset
classes:
U.S. government bonds
Investment-grade corporate bonds
High-yield corporate bonds
Municipal bonds( state and local bonds)
Mortgage backed securities
Asset backed securities

For Non-US stocks and bonds, the following are classified as asset classes:
Developed market foreign stocks
Developed market foreign bonds
Emerging market foreign stocks
Emerging market foreign bonds

Emerging market – issuers rely on international investors for capital.

They cannot finance their fiscal deficits domestically because domestic
capital markets are poorly developed and local investors are unable or
unwilling to lend to the government.

Ways to define the characteristics of Emerging Markets:

1. Have economies that are in transition but have started implementing
political, economic, and financial market reforms in order to participate
in the global capital market.
2. May expose investors to significant price volatility attributable to
political risk and the unstable value of their currency
3. Have a short period over which their financial markets have operated.

Real Estate and all other asset classes are referred to as Non-traditional asset
classes or alternative asset classes. They include commodities, private equities,
hedge funds, and currencies.

Barometer is called a “benchmark index”, “market index” or simply “index”.

An example would be the Standard & Poor’s 500.

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

Engaging Activities

Essay: Individual output. Submit using individual emails. STRICTLY NO

PLAGIARISM
1. A Filipino investor who purchases the bonds issued by the Japanese
government made the following statement: “By buying this debt
instrument I am not exposed to default risk or purchasing power risk”.
Explain why you agree or disagree with this statement.

2. In March 2019, the Korean Development Bank issued $500 million of

bonds with a maturity of 10 years in the United States from the
perspective of the U.S. financial market, indicate whether this issue is
classified as being issued in the domestic market, the foreign market or
the offshore market.

3. Why is it difficult to determine the cash flow of a financial asset?

4. Written Report: “The Financial Market: Its Importance and How it

Affects the Performance of the Economy” (individual output). This is a
typewritten report and does not exceed one page.

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

Performance Tasks
Problem Solving

Directions: Kindly illustrate and explain the two economic functions/role of financial assets in these
three (3) situations: (individual output). Typewritten using MS Word. Submission using googlemail.

1. Gene Margolis obtained a license to manufacture Pooh Bear Wristwatches. Gene estimates that
he needs $1 million to purchase the plant and equipment to manufacture the watches.
Unfortunately, he has only $200,000 to invest, his life savings, which he does not want to invest
eventhough he feels confident a receptive market exists for the watches.

2. Susal Carlson recently inherited $730,000. She plans to spend $ 30,000 on some jewelry,
furniture and a few cruises and to invest the balance of $700,000.

3. Larry Stein, an up-and-coming attorney with a major New York law firm received a bonus check
that netted him $ 270,000 after taxes. He plans to spend $70,000 on a BMW and invest the
balance $200,000.

Suppose that quite by accident, Gene, Susan and Larry meet in New York City. Sometime during their
conversation, they discuss their financial plans. By the end of the evening, they agree to a deal. Gene
agrees to invest $100,000 of his savings in the business and sell a 50% interest to Susan for $750,000.
Larry agrees to lend Gene $ 200,000 for 4 years at an interest rate of 18% per year. Gene will be
responsible for operating the business without the assistance of Susan or Larry. Gene now has his $1
million to manufacture the watches.

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

Understanding Directed Assess

Rubrics for Assessment of the Essay and Problem Analysis.

1. Each essay will be assessed based on:

a. Originality of words and Authenticity (2 points)

b. Justification of the answer with basis on the subject matter. (3 points)
c. Topic Relatedness (2 points)
d. Application of the example.(3 points)

2. Problem Analysis based on:

a. Originality, Concept and Topic Relatedness: (30 points)

Totality of Rubrics Output: 70 points

Learning Resources

Mishkin, F.S.(2016).THE ECONOMICS OF MONEY, BANKING, AND FINANCIAL MARKETS.Global

Edition.Tenth Edition. Pearson

Kidwell,Blackwell,Whidbe.Sias.(2013).FINANCIAL INSTITUTIONS, MARKETS, and MONEY.John

Wiley & Sons, Inc.

Fabozzi, F.J. (2012). CAPITAL MARKETS INSTITUTIONS AND INSTRUMENTS. Fourth Edition. Pearson.
Prentice Hall.

Rose, Marquis (2011).MONEY AND CAPITAL MARKETS. Tenth Edition.McGraw-Hill International

Edition.

Schoenholtz,C. (2011).MONEY, BANKING AND FINANCIAL MARKETS.GLOBAL EDITION.McGraw-Hill

Education.

Johnson, S. (2010). 13 BANKERS: THE WALLSTREET TAKEOVER AND THE NEXT FINANCIAL
MELTDOWN.Pantheon.

Vanstone, B. (2010).DESIGNING STOCK MARKET TRADING SYSTEMS: WITH AND WITHOUT SOFT
COMPUTING. Harriman House.

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET

 Republic of the Philippines
Laguna State Polytechnic University
ISO 9001:2015 Certified
Province of Laguna
Level I Institutionally Accredited

Intellectual Property

This module is for educational purpose only. Under section Sec. 185 of RA 8293, which
states, “The fair use of a copyrighted work for criticism, comment, news reporting, teaching
including multiple copies for classroom use, scholarship, research, and similar purposes is not an
infringement of copyright.”

The unauthorized reproduction, use, and dissemination of this module, without joint
consent of authors and LSPU is strictly prohibited and shall be prosecuted to the full extent of the
law, including appropriate administrative sanctions, civil, and criminal.

LSPU SELF-PACED LEARNING MODULE: CAPITAL MARKET