Financial

Markets
Presented by Group 4
 Table of Contents

01.
RATIONALE IN STUDYING
FINANCIAL MARKETS
AND INSTITUTIONS

02. INTRODUCING MONEY

AND INTEREST RATES

03. THE PAYMENT SYSTEM:

AN OVERVIEW

04. OVERVIEW OF THE

FINANCIAL SYSTEM
RATIONALE IN
STUDYING
FINANCIAL
MARKETS
AND
INSTITUTIONS
WHAT ARE FINANCIAL
MARKETS?
Financial Markets include any place or system that
provides buyers and sellers the means to trade financial
instruments.
BENEFIT OF STUDYING
FINANCIAL MARKETS
1.The backbone of resource allocation
2. Constant price discovery mechanism
3.Capital formation
4.Policymakers monitoring economic conditions
WHAT ARE FINANCIAL
INSTITUTIONS?
A Financial Institution is a company engaged in the
business of dealing with financial and monetary
transactions.
BENEFITS OF STUDYING
FINANCIAL INSTITUTIONS
1.For Economic Stability
2.Navigation of Banking System
3.Secure Financial Services and Information about
Investment Decisions
APPROACH IN UNDERSTANDING
STUDYING
FINANCIAL EVALUATING
MARKETS AND
FINANCIAL PREDICTING
INSTITUTIONS
INTRODUCING
MONEY AND
INTEREST
RATES
Role of MONEY in the
Economy
MONEY is any item or commodity that is generally
accepted as a means of payment for goods and services or
for repayment of debt, and that serves as an asset to its
holder.
The central bank that controls the country’s economy is
the “BANGKO SENTRAL NG PILIPINAS”
 CHARACTERISTICS
AND KEY FUNCTIONS
OF MONEY
MONEY must have value, be durable, portable, uniform,
divisible, in limited supply, and be usable as a mean of
exchange.
CHARACTERISTICS AND KEY
FUNCTIONS OF MONEY
STORE OF ITEM OF WORTH MEANS OF
VALUE EXCHANGE
Most money
Money acts as a It must be
originally has an
means by which possible to
intrinsic value,
people can store exchange money
such as that of the
their wealth for freely and widely
precious metal
future use. for goods, and its
that was used to
make the coin. value should be as
stable as possible.
CHARACTERISTICS AND KEY
FUNCTIONS OF MONEY
UNIT OF STANDARD OF
ACCOUNT DEFERRED
PAYMENT
Money can be
used to record Money is useful
wealth possessed, because of it's
traded or spent ability to serve as
personally and a standard of
nationally. deferred payment.
 The Evolution of
Money
BARTER(10000 - 3000 BCE)
In early forms of trading, specific
items were exchange for others
agreed by the negotiating parties to
be of SIMILAR VALUE.
Is the DIRECT EXCHANGE of goods.
Bring the goods with them and hand
them over at the time of transaction.
But sometimes, one of the parties
will accept an ‘I owe you” or IOU, or
even a token, that is agreed can be
exchanged for the same goods or
something else at a later date.
ADVANTAGES
TRADING RELATIONSHIP - Fostering strong links
between partners.
PHYSICAL GOODS ARE EXCHANGED - Barter does not
rely on the trust that money will retain its value.
DISADVANTAGES
MARKET NEEDED - Both parties must want what the
other offers.
HARD TO ESTABLISH A SET VALUE ON ITEMS
GOODS MAY NOT BE EASILY DIVISIBLE - Cannot be
divided.
LARGE-SCALE TRANSACTIONS CAN BE DIFFICULT
 The Evolution of
Money
EVIDENCE OF COINAGE BANK NOTES DIGITAL MONEY
TRADE RECORDS (600 BCE-1100CE) (1100-2000) (2000 onwards)
(7000 BCE)
Define weights of Issuing paper IOUs Money can now exist
Pictures of items
precious metals used that were traded as virtually on
were used to record
by some merchants currency, and could computers, and large
trade exchanges,
were later formalized be exchanged for transactions can take
becoming more
as coins that were coins at anytime. place without any
complex as values
usually issued bt physical cash
were established and
states. changing hands.
documented.
ARTIFACTS
OF MONEY
Barter ( 5,000 BCE )
Early trade involved
directly exchanged
items - often
perishable ones such
as a cow.
Sumerian
Cuneiform
Tablets ( 4,000
BCE )
Scribes recorded
transactions on clay
tablets, which could also
act as receipts.
Cowrie Shells
( 1,000 BCE )
Used as currency
across India and
South Pacific, they
appeared in many
colors and sizes.
Lydian Gold Coins
( 600 BCE )
In Lydia, a mixture of
gold and silver was
formed into disks, or
coins, stamped with
inscriptions.
Athenian Drachma
( 600 BCE )
The Athenians used
silver from Laurion to
mint a currency used
right across the Greek
world.
Han Dynasty Coin
( 200 BCE )
Often made of bronze or
copper, early Chinese
coins had holes punched
in their center.
Roman Coin
( 27 BCE )
Bearing the head of
the emperor, these
coins circulated
throughout the Roman
Empire.
Byzantine Coin
( 700 CE )
Early Byzantine coins
were pure gold; later
ones also contained
metals such as copper.
Anglo- Saxon Coin
( 900 CE )
This 10th century
silver penny has an
inscription stating
that Offa is King
("rex") of Mercia.
Arabic Dirham
( 900 CE )
Many silver coins from
the Islamic empire were
carried to Scandinavia
by Vikings.
 THE SUPPLY
AND DEMAND
FOR MONEY
Monitoring the supply and
demand for money is vital for the
economy’s central bank’s
monetary policy, which aims to
stabilize price levels and to
support economic growth.
 The Money Supply

M1 M3
Refers primarily to money Refers primarily to money

THE KEY
used as a medium of used as a unit of account.
exchange.

MEASURES
FOR THE
MONEY
SUPPLY
M2 L
Refers primarily to money This measure includes
used as a store of value. liquid and near liquid
assets.
The Demand for Money
THE SOURCES OF THE DEMAND FOR MONEY

01. TRANSACTION DEMAND

02. PRECAUTIONARY
DEMAND

03. SPECULATIVE
DEMAND
 IMPACT OF MONEY
- In the macroeconomic short-run, some prices will be inflexible.
This causes economic fluctuations, with real GDP either below
potential GDP or above potential GDP.
- The higher interest rates will decrease investments and
increase the demand for peso on the foreign exchange markets.
- Monetary policy can be applied in the short- run when the
economy faces an inflationary gap.
-If the economy is at its long-run equilibrium and the BSP
increases the money supply, it will increase aggregate demand.
The Quantity Theory of Money
The Quantity Theory of Money

COVERS THE ACTION OF BUYERS

M-How much money it covers?
V-How much money we spent?
COVERS THE ACTION OF SELLERS
P-How much is the price we charge?
Y- What are the things we sell and provide?

NOTE: M is directly proportional to P

Velocity of money classifications:
Low velocity - money sleeps
High Velocity - spend or invest the money quikly
 THE TIME VALUE OF
MONEY
Present Value or present discounted value
Based on the commonsense notion that a
peso of cash flow paid to you one year from
now is less valuable to you than a peso
paid to you today.
 Present Value
The lender provides the borrower with an amount of funds that must be repaid to the lender at
the maturity date, along with an additional payment for the interest.

i = P 10 / P 100 = 0.10 or 10%

If you make this P100 loan, at the end of the year you should have P110, which can be written as:
P100 x (1 + 0.10 ) = P100
If you then lent outthe P110,at the end of the second year you would have:
P110 x (1 + 0.10 ) = P121
or, equivalently ,
P100 x (1 + 0.10 )x (1+0.10)=P100x(1+0.10)²=P121
Continuing with the loan again, you would have at the end of the third
year:
P121 x (1 + 0.10 ) = P100x(1+0.10)³ =P133
Generalizing, we can see that at the end of n years, your P100 would turn into:
P100x(1+i)ⁿ

The amounts you would have at the end of each year by making the P100 loan today
can be seen in the following timeline.
. Today. Year 1. Year 2. Year 3. n Year
. P100. P110. P121. P133. P100 x(1+0.10)ⁿ
INTEREST RATE
Define as the price of loanable funds.

From the viewpoint of potential borrower,

the interest rate is the premium that must
be paid in order to acquire goods sooner
and pay for them later.

From the lenders viewpoint, it is a reward

for waiting - a payment for supplying others
with current purchasing power. The interest
rates allows the lender to calculate the
future benefit of extending a loan or saving
funds today.
HOW INTEREST RATES
ARE DETERMINED
Interest rates are determined by the demand for and
supply of loanable funds. Investors demand funds in
order to finance capital assets that they believe will
increase output and generate profit. Simultaneously,
consumers demand loanable funds because they have a
positive rate of time preference.
Determining the Interest Rate
At the equilibrium
interest rate, the
quantity of funds
borrowers demand for
investment and
consumption now will
just equal the quantity
of funds lenders save.
Money Market Equilibrium
Equilibrium in the money
market market occurs when
the MD and MS curves
intersect at the equilibrium
interest rate. If the BSP were
to decide to increase the
quantity of.money from MS to
MS¹, the supply of money
curve would shift to the right,
resulting in a decrease in the
equilibrium interest rate.
 Investment Funds
The rate of interest balances the demand

According to
for funds and the supply funds.
Households delay consumption by saving

Keynesian Theory,
depending on their time preference and
the rate of interest.

Rate Interest is
determined as a
price in two Liquid Assets
Keynes introduced the influence of the

markets liquidity preference on the interest

rate. The classical economists, who
considered investment funds as the
critical market for the interest rate,
disregarded the topic of liquidity
preference.
THE NOMINAL OR MONEY RATE VS.
THE REAL RATE OF INTEREST
NOMINAL RATE
The nominal interest rate is the stated interest
rate actually paid for a loan.
It shows the price of money and reflects current
market conditions.
Example: If the nominal rate on a loan is 5%, you
can expect to pay $50 of interest for $1,000
borrowed. At the year's end, you'll pay $1,050.
THE NOMINAL OR MONEY RATE VS.
THE REAL RATE OF INTEREST
REAL RATE
The real interest rate is the nominal interest rate minus
the rate of inflation.
It is one that has been adjusted for inflation, to show
the real cost and purchasing power of money that is lent
or invested.
Example : Say the initial interest rate on a bond was
9.62% and the projected rate of inflation was 3.6%.
When you subtract 3.6% from 9.62%, the real interest
rate is 6.02%. Even with significant inflation, this
investment choice will increase your purchasing power.
INTEREST
RATES AND
RISK
Interest rates in the loanable funds market will
differ mainly because of differences in the risks
associated with the loans.
But, credit card loans are riskier than loans
secured by an asset.
This risk also increases with the duration of the
loan. The longer the time period of the loan, the
more likely it is that the borrower's ability to
repay the loan will deteriorate or market
conditios changes in an highly unfavorable
manner.
 The RISK- PREMIUM COMPONENT

01.
reflects the probability of default
( the risk imposed on the lender by
the possibility that the borrower
may be unable to repay the loan).

The Three 02.

The INFLATIONARY PREMIUM
reflects the expectation that the

Components of
loan will be repaid with pesos of
less purchasing power as the
result of inflation.

Money Interest The PURE INTEREST

03. COMPONENT is the real price

must pay for erlier availability
 THE IMPACT OF CHANGING
INTEREST RATES
Every time the interest rate is change, it send a signal to society to
either spend or save - and many also increase or decrease confindence
in the state of the economy.
A rise interest rates encourages saving, since higher interest will be
paid on money in savings accounts, and investments can grow.
Meanwhile, borrowing becomes less attractive as interest repayments
are steeper, and banks more selective about whom they lend to.
As interest rates move up, the cost of borrowing becomes more
expensive. This means that demand for lower-yield bonds will drop,
causing their price to drop.
As interest rates fall, it becomes easier to borrow money, and many
companies will issue new bonds to finance expansion.
Generally, higher interest rates increase the value of a country's
currency. Higher interest rates tend to attract foreign investment,
increasing the demand for and value of the home country's currency.
 THE
PAYMENT
SYSTEM:
AN
OVERVIEW
 The Transition from Commodity
money to Fiat money
Commodity money refers to a good used as money
that has value independent of its use as money.

Fiat money refers to money, such as paper

currency that has no value apart from its use as
money
The Importance of
Checks
Checks are promises to pay on
demand money deposited with a
bank or other financial institution.
They can be written for any
amount, and using them is
convenient way to settle
transactions
 01. 02.
Security and Speed
Effeciency New
Technology
and the
03. Payments 04.
Smooth
international
Systems effective
collaboration
transactions among participants
E-Money,
Bitcoins, and
Blockchain
E-Money or Electric money
is a digital cash people use to buy goods
and services. Best known payPal and gcash
Bitcoins
another form of e-money, it is not owned by
a firm but instead the product of
decentralized system of linked computers;
cryptocurrency;
digital wallet

Blockchain
a distributed ledger, or an online network
that registers ownership of funds, securities
or any other goods;
allows settlement of transactions instantly
and securely on encrypted sites.
 CASHLESS SOCIETY
difficult to attain for two key reasons:
(1) expensive to build

(2) individuals worry about their privacy

Overview of
the
Financial
System
Financial systems
It is a set of institution which
allow the exchange of funds
between lenders, borrowers,
and investors.
The flow funds through the financial system
 The Key Component of the
Financial System

01. FINANCIAL
INSTRUMENT THE CENTRAL

03. BANK AND

OTHER
FINANCIAL FINANCIAL
02. MARKETS AND
INSTITUTE
REGULATOR
 RISK
01. SHARING
Function of
Financial 02. LIQUIDITY

System
INFORMATION
03. GATHERING AND
SHARING
 Adverse Moral
Selection Hazards
This is the problem Problems This is the problem

arising from
investors experience investors experience
in distinguishing in verifying that
low-risk borrowers
from high-risk
asymmetric borrowers are using
their funds as
borrowers before
making an
information intended.

investment.
How intermediaries reduce:
Adverse Selection
Moral Hazards
How intermediaries reduce adverse selection?
1. Requiring borrowers to disclose material
information on their financial performance and
financial position.
2. Collecting information on firms and selling that
information to investors.
3. Convincing lenders to require borrowers to pledge
some of their assets as collateral which the lender
can claim of the borrower defaults.
How intermediaries reduce moral hazards?
1. Specializing in monitoring borrowers and
developing effective technique.
2. Imposing restrictive covenants
Thank you
very much!