Introduction to Finance

Finance defined:
● The study of how individuals, institutions, governments, and businesses acquire, spend,
and manage money & other financial assets.
● Both an Art and a Science
○ As an art, creatively think of how to manage money & how to apply theories and
manage funds effectively & efficiently. Behavioral aspect, study the movement of
your surroundings.
○ Social science, under the umbrella of economics, uses economic concepts in
studying & dealing with finance such as the law on supply & demand. Uses
theories in explaining phenomena in finance.

The need to study Finance:

1. Deal with finance in our daily lives.
2. Make informed investment decisions.
3. Determine good financing resources.
4. Know tools to maximize returns and minimize risk.

The Areas of Finance

Areas of studies
1. Financial management - the study or science in a corporate setting. Focusing on
managing finances, as the title suggests. Decisions that are made would be with regards
to how much and what types of assets to acquire, how a firm would raise capital to
acquire those assets, and how to manage or run the firm to raise its value.

2. Capital markets and institutions - relates to the study of financial systems and its
components, interest and securities valuation, and the regulation of financial markets
and institutions. Provides knowledge and analytical tools on how to analyze the
movement in the financial system, what comprises the activities, roles of the institutions
established by society to help the people to allocate funds.

3. Investments - focuses on decisions concerning stock & bond investments, security

analysis, portfolio management, and market analysis. How to analyze the movement and
behavior of stocks and bonds in the market. Analyze the risk & return on your
investments on stocks, bonds and treasury bills, how to maintain the assets in one
portfolio. The most difficult to study among other areas of study..

Areas of Application

1. Corporate finance - application of finance tools in investing and financing decisions in an

institutional setting. Analyze fund management of the corporation.
 2. Application of finance tools in the management of individual and family financial
resources. Analyzing personal and family fund management decisions, overall cash flow.
Financial literacy.

3. Public finance - application of finance tools for the effective allocation of public funds for
government services, public investment, and public debt. Financial analytics for the
management of the public fund, money maintained in the national treasury(government).

Areas of career paths

1. Financial management- concerned with the administration of the financial affairs of the
business, which includes tasks such as developing financial plans, extending customer
credits, evaluating large investment projects, and raising money to fund the firm’s
operations. Work as financial managers, familiar andmastery on how to apply the
techniques and tools in decision making for the company. This career is concerned with
decision-making and action recommendation. Your target is to increase the value of the
company, and not of the products. Concerned with the administration of the financial
affairs of the firm, including tasks such as developing financial plans, extending customer
credits, evaluating large investment projects, and raising money to fund business
operations.
2. Financial services - concerned with the design and delivery of advice and financial
products to individuals, businesses, and governments. Likely be engaged in the
provision of the advice for your clients such as fund managers.

Fundamental Principles in Finance

1. Money has time value - a peso received today is worth more than a peso in the future.
2. There is a risk-return tradeoff - investors will hold risky investments if they expect to be
compensated with additional return. (Investors are not risk takers)
3. Cash flows are the source of value - cash- not profit - is king
4. Market prices reflect information - investors respond to new information by buying and
selling their investments. Market price is not driven alone by the demand and supply, but
may be triggered by it.
5. The principal’s and agent’s interests may differ - manager’s decisions may not be
necessarily aligned with the owner’s interests unless incentivized adequately. There are
companies who uses stock option as compensation:
a. Split of stock - register in SEC of amendment of articles of incorporation.
b. Owner’s decision will always prevail over the management.
The Financial System

Financial system defined:

● the institutional mechanism established by society to produce and deliver financial

services and allocate resources participated by different economic units, which takes into
account the use of money, credit, and various instruments associated with money.
● Consists of business firms supplying financial services, the customers of the financial
service firms, and the government regulatory entities that enforce the rules prevailing
within the financial sector.
● Without the financial system, both ends of the spectrum would not meet. (Demanders
and suppliers of funds)
● Some individuals and firms may have surplus which can be made available for savings
or investment (savings-surplus units or suppliers of funds).
● Businesses, government, and individuals often need to raise capital (savings-deficit units
or demanders of funds):
○ Support in increasing firm’s operations (operational expansion)
○ Investment in project proposals (capital expenditures)
○ Infrastructure projects
○ Investment in real estate

The Capital Allocation Process

Two types of transfer can be done in the FS: direct and indirect transfer.
1. Direct Transfer - there are no intermediaries between the demanders and savers of
funds.
Demanders transfer securities to savers; Savers transfer cash/funds to demanders.

2. Indirect transfer - uses intermediaries. Intermediaries do not have to be limited to just

one, savers can have their own intermediary different from that of the demanders.

a. Through investment banks - Savers +20%, sellers/demanders -20%. Dealer vs.

Broker. The dealer is the investment bank that buys securities from the
demanders and sells to the savers/investors by syndicating what the demanders
are selling, but will be sold at premium. (Do not assume commission)
Demanders transfer securities to investment banks; Investment banks transfer the same
securities to the savers; Savers transfer cash to the investment bank; investment bank transfers
cash to demanders.

b. Through financial intermediaries - mutual fund in financial intermediary: like a

stock but identified as a portfolio (a group of assets). Specific rate, identifiable
time, fixed income securities (debt securities). Preferred/preference shares
Demanders transfer company securities to financial intermediary; Financial intermediary
transfers intermediary securities to savers; Savers transfer cash to financial intermediary;
financial intermediary transfers cash to demanders

Why is there a need to separate investment banks and intermediaries

Investment banks
● offer different services, transfers money, does not make products to sell to customers.
● The securities they sell are still the same as bought from the issuer of securities.
Functions similar to merchandisers.

Financial intermediaries
● securities bought from the issuer will become a different product such as a mutual fund
or portfolio.

The type of intermediary

● depends on how rich the investor is, if they are rich, then investment banks.

Elements of Financial System

1. Financial Instruments - evidence of debt or ownership that are traded in the market.
2. Financial Sector - consists of financial markets & institutions.
3. Financial Regulators - rules and standards issued by pertinent government agencies in
regulating the activities in the financial sector. (PDIC, SEC, BSP &
Insurancecommission) in the Ph there are 4 regulators: Board of Investment should have
been part of the regulators but it focuses on how to encourage this under trade.

Financial Instruments
● One that is used to facilitate the provision of funds for a certain economic undertaking.
● Take the form of documents, which contain certain characteristics that meet the
requirements of the issue and investor.
● Legal contracts or indentures specifying the amount of the transaction and the terms &
conditions for repayment.

Differences Among Financial Instruments (Characteristics)

1. Denomination - the stated value that you stated in the instruments. Such as the number
5 in the 5 pesos. The par value in stocks.
a. Ordinary shares pwedeng walang par value/ stated value/ registered value (in
the articles of corporation) as long as hindi bababa ng 5 pesos. Preferred
shares cannot be valueless. A corporation can issue preference shares and
ordinary shares, all are required at least one type of ordinary shares/ preferred
stocks and preference shares.
2. Maturity - expiration of the securities. Instruments like the money market, such as
treasury bills.
a. Certificate of deposits is a certification that an individual or institution has a time
deposit in a bank, they deposit money in an account that is restricted for a certain
period of time. If a time deposit is sold and you have the certificate…negotiability
features. Stocks have no maturity, unless the corporation takes the stocks and
retires it. Stocks don’t mature but liquidate.
b. Short term (less or 1 year) and long term instruments (more than 1 year)

3. Claim against the issuer - if it's a debt instrument, the holder will have a right as a
creditor of the company issuing the same instrument, you have the right to collect the
amount of utang sayo and nakapaloob na interest that is shown in the instruments. Most
of the instruments in the markets are debt instruments by the number of types, not the
volume. If you buy debt security, you may still call yourself as an investor, but your right
is similar to the creditor. Equity instrument, you have the right as an owner of the
company. You have a technical right of the firm or institution, pwede ka makialam, to
make a decision, no matter how big or small your share, but depends on how influential
your share is.
a. Equity instruments - shares/stocks. If you have preference shares, you cannot
exercise all the rights, your rights are limited to receiving a PREDETERMINED
amount should the corporation declare distribution of dividends. Pag mag
liquidate na, preference shareholders are a priority, they are like creditors kasi
priority sila, after settling all liabilities. Your claim is a hybrid
i. Hybrid claim - mixture of ownership and creditor claim, but not all, only
specific rights. vote, and will not receive cash flows, unless declares
dividends. If you want money, preferred. If you want to exercise power,
and if you want to earn from trading,ordinary shares. Preferred shares are
for financial purposes, and to limit the voting rights of shareholders to not
distort the ownership control. Non-controlling interests ang subsidiaries.
Preference shares in terms of claims are considered hybrid. Convertible
bonds are hybrid instruments.

4. Collateral - only applicable for debt instruments/securities, because you won't promise
anything for equity instruments. Debt securities that you issue may or may not have a
security with it, such as attached dedicated assets. Most debt securities available in the
market have no asset dedicated to pay for the amount of the issued bonds. If the bonds
are serial (series of payment to be made based on contracts) in nature, you are required
to a portion to ensure the payment of the bond, but not to a specific asset, general
apportionment lang, or general ang appropriation. You will appropriate a part of the
retained earnings for your contractual obligation to pay for the total amount of liabilities
generated by the sale. Other bonds issued would not have any collateral. In the case of
loans, you can also have securities with them depending on the requirement of the
financial institution where you have negotiated with the loans. If the financial institution
asks for something, then whatever you issue has collateral. When there are multiple
 creditors, such as issuing commercial paper in the market and part of the deal is you are
backing it up with inventories, that inventory when sold, you will use the proceeds to pay
debt securities.

5. Marketability - the ability to sell the instrument; salability. Stocks are the most common
in the Ph (PH stock exchange), while bonds are low in marketability (PH dealings
exchange). Most stocks sold in the stock exchange are ordinary shares. Fixed income
securities (kasi predetermined) are bonds & money market. Large corporations are
allowed to sell commercial papers e.g. promissory notes (short term) from large
corporations. Long term commercial paper are bonds. Treasury bills are short term,
treasury bonds are long term, but before maging treasury bond dadaan muna as
treasury notes (2 years average).

6. Form of Interest Payment - May be compounded payment or simple

interest/coupon. Quarterly, semi-annual, and monthly interest payments. Ex. 12% p.a.
X 1/n. Simple interest - principal x 12% x 1/n or P x R x N. If compound P x R x T =
Balance 1, then Balance 1 x rate x time = balance 2. Terms of payment may be
Quarterly, semi-annual, and monthly. If non-interest bearing ang securities, nasa
denomination of the amount na ang interest.

7. Form of Returns - sasabay sa anong form of securities was issued. If debt securities
were issued, the return would be interest. If equity, the returns are dividends. The return
is from the provider of the fund, while for the issuer it will be cost.

8. Options - most instruments don't bear any options although companies are not
prohibited. Convertibility option is exercised by the holder of the security, which allows
the conversion of one instrument. (E.g. Collable bonds)
a. Call - the one who has the right to call the shot is the issuer.
b. Put - The investor or holder has the option to recall or retrieve. The holder
surrenders the instrument, and they are compensated for the principal amount
and accrued interest. It's still possible that in the terms compensation is included,
but puttable instrument
c. Placed in the securities wherein either the issuance or holder of the security
recalls or retrieves the instrument for permanent distinguishment or permanent
derecognition of the security for the books of accounting.
d. get again to permanently derecognize the contract
e. companies should make/ remove the instrument that has been returned to them,
or in the case of equity security, resell.
f. Compensation amount should be written in the instrument.

When put or called:

● For debt instruments - wala na siya, extinguished, automatic derecognition
● For equity - resell it, or extinguish that quantity, keep it for treasury for future purposes.
Purpose of Cutting or Putting:
1. Stated in the terms
2. Risk of the security being recalled (investor)

● The company wants temporary issuance, but there is no other way to do that

● They recall, especially for equity securities, that they should be ready for future fund
needs of the company, probably thinking of a big project such as expansion.

Note: Convertibility - option that is exercised by the holder of the securities which enables
conversion of an instrument to another instrument.

If they call - issuer pays the amount + the returns of the investment securities + compensation

If put - issuer is only required to pay the principal amount + accrued interest (compensation is
optional, usually none, but if stated in the instruments they should be paid)

9. Currency - What is quoted, can also change. Uses the term pecetas instead of pesos.

Financial Institutions

● Financial intermediaries that channel the savings of individuals, businesses, and

governments into loans and investments.
● They serve as a media to channel funds from those who have surplus to those with
deficit in funds.

Key features of Financial Institutions

● they convert primary instruments received (savings) into another financial product
(secondary instruments e.g. loans, insurance, policies, equity investments, etc.)
● They provide intermediation (the process by which savings are accumulated and lent or
invested) rather than provide a forum where demanders and suppliers of funds can
come together
● They provide financial services and advice to both suppliers and demanders of funds.
● Financial institutions help supplier of funds rather than the demanders.

Note: there are no investment banks in ZC. Pag-Ibig is a mutual fund company (financial
institution) metro first credit (has an online platform for investment banks).
Financial Institutions

Services Performed by Financial Institutions

Two distinctions of services: 1. Benefit the suppliers of funds 2. Economy as a whole; for
demanders none, kasi suppliers ay mas nakakatulong kaysa sa demanders.
1. Monitoring costs - the relatively large size of the FI allows collection of information and
monitoring of actions of firms to be accomplished at a lower average cost (economies of
scale).
2. Liquidity and Price risk - FIs provide financial claims to household savers with superior
liquidity attributes and with lower price risk.
3. Transaction cost services - Similar to economies of scale in information production costs,
and FIs size can result in economies of scale in transaction costs. Invest, Reinvest,
Divest.
4. Maturity intermediation - risk of the mismatch of the maturity of the securities, essentially
at times, when we invest in witprimary securities, especially those with debt instrument in
nature, there is a specific date when matatanggap ang total investment pero medyo
mahirap imaliquidate when needed. malaki ang loss that we may take, if ibenta mo
naman walag assurance na makula mo yung same value unlike if iliquidate mo.
5. denomination intermediation - pool investments from a lot of investors and putting in the
market, becaue there is a strict quantity minsan volume or value. allow small investors to
overcome constraints to buying assets imposed by large minimum denomination size.
a. lot size - required minimum volume or quantity needed to transact for specific
investments on the financial market depending on the value or price of one
investment or instrument or a value or bond. minimum requirement to be
followed.
6. credit allocation - mor eon the ability of some othe FIs to make credit available to small
borrowers that cannot be catered by the bank because of minimum requirements. while
banks are FIs per say, the credit allocation or allowance of borrowings of other entities
should not be limited from borrowing from the banks lang. e.g. credit unions/coops. and
mempco, lending. it helps the economy as it enables the money to circulate to everyone
para maengganyo ang mga borrowers.
a. economies of scale - make production cost lower because of the amount of
products produced. since the cost is divided among people. if you want to
achieve being a cost leader, then you are encouraged to prodcue more of that
the cost incurred, the cost is distributed among the units produced in one batch.
7. Intergenerational wealth transfers - FIs, especially life insurance companies and pension
funds, provide savers with the ability to transfer wealth from one generation to the next.
● Movement of funds within the family, if mamatay doon ka pa makareceive ng beneficiaries,
funds circulate around the economy
● Pension fund, the fund is kept in how many decades, assured that funds is circulated. The
wealth grows.
8. Payment Services - the efficiency with which depository institutions and provide payment
services directly the beneftis the economy
● Collectiong channel for exports and imports
● Foreign exchange transactions

Categories of FIs
DEPOSITORY INSTITUTIONS - pinaka common, characteristic ay tumatanggap ng deposit
from clients and turned into loans. under depository institutions

1. commercial banks - not largest type of banks

ONB - > BDO
2. Credit unions - member ony facilities/depository institutions. contributions of the
members ang ginagamit pang loan. pahulugan/paluwagan. Non-profit, member benefit.

3. Savings bank - no membership needed, but caters to lower members. smaller than
commercial banks, individual ang clients, and not institutional. mortagage (need
collateral usually immovable properties e.g. real estate) ex. PS Bank, ONB (only exists in
Mindanao)

4. savings and loans association - credit coop and savings bank, but accepts intitutional
borrowers para lumago ang income ng lending facilities. member only deposits, but not
borrowing. e.g. AFPSLAI

Categories of Financial Institutions

1. Securities Firm: financial institutions whosemain business activities involves accepting

savings from individuals or businesses and pool them to invest in financial securities and
to facilitate and transfer securities between investors.

a. Investment Banks - institutions engaged in underwriting (selling or marketing

new) securities issued by businesses to potential investors and in providing
financial advices to their clients in obtaining financing.
i. Always serves asmiddleman of demanders and savers of funds, basically
help find the securities that would fit the needs of the savers, and find the
demand of fund for the demanders.
ii. Either functioning as broker, whether the client is a saver or demander
OR dealers of securities, wherein they would buy the securities and sell at
a higher price. Also could be underwriters, they have the ability to
syndicate (sell) securities in the market. Could also act as fund managers,
 manage the growth of your money, nagkakaroon ng trustfund at sila na
ang mag maintain para lumago ang money, youmay also inform them
which market you want your investment would be placed.
iii. Never naging collective ang funds, individual accounts are managed.

b. Mutual Funds - FIs that pool financial resources of individuals and businesses
and invest those in diversified portfolios and asset.
i. Technically similar to a fund manager, but they would solicit small clients
who would want to put money n securities investments and those money
will be grouped and placed collectively in the FM, whether a portfolio of
stocks or debt securities, or even a mix. Putting up a trustfund, and
mutual funds will manage but they will sell specific securities sayo, money
will be pooled and mixed and placed in the securities.
ii. Always offer not necessary the securities but the different type of security.
iii. Money market mutual fund and ???

ADDITIONAL NOTES:

To be a certifed broker, you might need to get a license already from the SEC and not PRC.

Most investment banks are attached to commercial banks in the Philippines.

Your company asset is a deposit liability (payable of bank to their depositors) in the bank.

In the PH, your deposit would only be limited tio 500,000 when the bank bankrupts. Divide
assets into 500,000 in order to protect your assets.

2. Finance Firms: FIs engaged in providing loans directly to consumers and businesses,
and helping borrowers obtain mortgage loans on real property.

a. Finance/ Credit Companies - institutions that provide loans directly to individuals

and businesses or aid indvidual in obtaining finance, where one can obtain them
from commercial banks. Can issue collateralized or non-collateralized loans, but
mostly the former.
i. Caused 2008 crash in the US, for real-estate, they allowed borrowing of
money without looking at the qualities or characteristics of the borrowers.
That time, finance firms were no longer able to collect the mortgage loans
from the borrowers, which resulted to the ruin of institutions, therefore the
investors also crashed. A lot of investors in the CDOs (Collateralized Debt
???) including entities out of US. Invetsment backed by CDOs also
crashed and investors were not able to recover from the securities, and
sabay sabay nag crash ang mga investors because most of them were
big investorms. Liman brothers. IAG was an insurer of the CDO and they
would pay for a portion of the investments to the investors. 16 days after
 the crash of US economy, in 2007 began the crash but the Liman brothers
was the trigger as it affected the world. RESEARCH GLOBAL
FINANCIALCRISIS.

b. Mortgage Banking Firms - firms that are engaged in aiding inividuals to obtain
mortgage loans by bringing together borrowers and institutional investors.

FINANCIAL MARKETS

● where the transactions happen.

● A mechanism in which buyers and sellers trade financial assets (stocks, bonds,
currencies, etc.
● They provide for platform/forum onto which the providers and demanders of funds can
do financial transactions directly.
● Derivatives are securities which does not take value of its own, but takes its value from
another instrument. - as an hedging intrument (panugal). Are contracts similar to bonds,
but does not have its own value.
● As an exporter, umasa sa foreign client ng bayad nila, at the date ofcompletion, saleis
recorded kasi expected na may kita na, however,exportation is in foreign currencies such
as dollars. If you want to protect from the flactuation of exchange rate, get an
angreement with an FI that would absorb. Whatever the exchange rate on the date of
completion or transaction, you would want to receive the 59 is to 1 dollar. When the
buyer pays, the bank will credit 59 is to 1 exchange rate. On the bank’s part, they will
absorb the gain or loss. As a bank you will credit 59 i to 1, the 1 is yours if at that time 60
pesos na ang exchange rate.

Categories of FMs

● Spot Markets - platform where goods are essentially agreed and delivered on the spot.
Do not agree on future periods, in this market you talk and deal and everything is
perfected during that point. Delivery and payment is decided on the spot, but may have
terms such as the delivery will be made 1 day after contract and payment 10 days after
contract. Usually one time transactions. E.g. cafeteria. Immediate delivery
● Futures Market - performed on the date agreed upon with specific date of the delivery
and completion of the trade. E.g. catering services, line of credit (loan). Agreed upon
contract completion. Always have a contract.
○ Financial Market -

2 types of Financial Market (depends on how virgin the securities are)

● Primary Market - as long as the securities have not been previously sold to another.
Seller is necessarily the issuer. Selling the share that's in my own equity. Shares not
outstanding, but from authorized shares. Characteristics: corp is directly involved,
criteria: look at the instrument was it sold before? Incase of treasury shares that are
reacquired and reissue the instrument is no longer primary
 ● Secondary Market - pre-loved/pre-owned, secondary instruments are sold, such as
previously issued instruments or securities. If the issuer is not directly involved then it is
a secondary instrument.

Difference between the maturity of instruments

● Money market - short-term, treasury bills, negotiable certificate of deposits, commercial
papers. Easily converted to money, so highly liquid. 1 year or less
● Capital market - long-term securities, more than 1 year to liquidate. Instruments that do
not have maturity. E.g. bonds, stocks, foreign exchange

Money Market - difference is the maturity, short term instruments

Capital Market - long term securities, maturity of the instrument would take more than 1 year
before it can be liquidated, also includes that does not have maturity at all.

Debt Market (long term)

● Bond Market -
● Mortgage Market - mortgage securities being offered, makikita ang mortgage lenders,
● nagpapautang with collateral

Stock Market
● over the counter -
● organized stock exchange - specific organized platform where you deal and trade
between the buyers or bidders of stocks. There are processes that are followed in doing
the transactions. Those who are involved are usually brokers. Famous organized stock
exchange - PSE, in Europe - London SE, in US - New York SE, in Japan - Tokyo SE.

Derivatives Market - buy for derivatives and conduct ledging activities when you feel the need to
counter risk associated with it, e.g. foreign exchange.
● Options Market - transfer agreement with those other people wh would want to buy
shares at a protected rate at the time of exercise of the options would come, stock
options, may or maynot be lower of the stock price at
● Swap Market - Swapping risks, may be related to interest swaps. In loans, the
agreement is payment for variable rate on the periods that is enclosed within the loan, to
protect your cash flows, you go to a bank and swap. On your part, you pay interest rate
with the swapper
○ Foreign Exchange Market - a form of security na may specifications, ₱59 = $1,
complicated ang computation to the point you need to use calculus