CHAPTER 8: Financial System
an asset to bring more income
Most transactions use cash and near-cash items
as they are considered a more efficient way to
do business as compared to the barter system.
THREE MAIN ROLES OF MONEY
1. Medium of exchange
2. Store of value and unit of account
3. Standard measurement
For economist, money is used as:
 Medium of exchange – because it has
value
 Legal tender – a debtor may require a
creditor to accept in payment of a debt.
Nowadays, it moves around electronically.
Bitcoins – gaining popularity in the digital
financial system.
FINANCIAL SYSTEM
 A network of institutions, markets, and
contracts that bring together lenders
and borrowers.
TWO MAIN PLAYERS IN THE SYSTEM
 Lenders and borrowers
LENDERS
 Those who believe that money that
they have now has the potential of
snowballing in the future; hence they
lend it to a financial institution like
bank.
BORROWERS
 Household that needs to buy a house or
a car but does not have enough money
on hand to acquire it.
 A firm that needs more capital to fund
 The government that typically spends
more than it owns.
AGREEMENT OF LENDERS AND
BORROWERS TO FULFILL THEIR GOALS
THROUGH EXCHANGES IN THREE WAYS
1. Banking System: The banking
system where depositors are
considered lenders, and of course,
those who loan funds for
themselves.
2. Bond Market: Government may
choose to increase its funds by
issuing IOU promising to pay on a
regular basis and the principal at a
certain date and the stock market,
which is basically a place where
ownership in a company may be
sold and bought.
3. Exchanges of Stocks: Changes in the
stock market may just be reactions
to real or perceived changes in the
performance of an economy or of
the company.
Crowdsourcing of funds, raising capital
from investors, and distributing the risk
that is attached to the investment are
essentially a financial system.
FINANCIAL INSTITUTIONS
INVESTMENT
 committing funds to one or more
assets, which can be a financial or real
asset
 most individuals and firms make this
decision to increase their wealth and
secure the future.
 FINANCIAL ASSETS

SAVINGS 1. Stocks
2. Bonds
 part of wealth that may be used to fund 3. Currencies
the investment of another 4. Commodity
FINANCIAL SYSTEM REAL ASSETS
 works in a way that it considers the 1. Real estate
interaction of the investors and the 2. commodity
savers, as in savers put their assets into
an institution to penetrate the market GOLD and SILVER may be considered either
for the investor’s use. financial assets or real assets, depending on the
behaviour in the market and how it is traded.
FINANCIAL ASSET
SHORT-TERM INSTRUMENTS
 someone else’s liability
 For example, money is a liability of the  Securities that mature in less than one
central bank, whereas real asset is year are traded in the money market
something with intrinsic value.
LONG-TERM INSTRUMENTS
 Examples of real assets;
 Valuable pieces of jewelry  Securities mature in more than one year
 Machines are traded in the capital market.
 Physical assets that may be
traded in a hard market FINANCIAL DERIVATIVES
 Are “manufactured” by stock market or
 Forms of financial instrument, a value of
any financial institution
which is derived from another
 Affected by inflation or decreasing
instrument.
purchasing power of money
 Example: stock option
 Manufactured here means that the
 Stock is the base and option would be
stock market creates assets traded that
its derivative
are intangible.
 It is tradable financial instrument based
FIVE INVESTMENT ASSETS or INVESTMENT on an asset’s underlying value.
CLASSES that are traded in the market
Money Coin, pieces of
1. Stocks stamped metal used
2. Bonds as a trading medium;
any currency used in
3. Currencies (considered financial asset)
the same way
4. Real estate Cash Money on hand
5. Commodity (considered real asset) Capital market The markets for
longer-term loanable
funds
Debentures An instrument issued
as evidence of a
borrower’s debt to a
lender. These are used
by companies to raise
finance repaid over
the long term
PROCESS OF INVESTMENT
 Portfolio management, building the
collection or set of assets
 Allocation of assets, splitting of the
portfolio into five or less types of
investment classes
 Construction decision, choosing from
the top-down or bottom-up approaches
in portfolio management.
TOP-DOWN PORTFOLIO MANAGEMENT
 Tries to allocate assets by country or
region, as well as the type of asset
BOTTOM-UP PORTFOLIO MANAGEMENT
 Looking at specific company/ies then
investing in it, with the tendency of
investing in just one country and/or one
class.
INVESTMENT MANAGEMENT
 Involves channeling of funds by means
of financial intermediaries, transferring
and scheduling of risks, appropriation of
the investment class, and managing
ownership of funds.
 Ownership and management exist in a
separation concept and deal with
agency issues, of principal and agent
roles.
 In order to mitigate the issues, there
must be good corporate governance in
place and regulated by the government
or state.
CORPORATE GOVERNANCE
 Is the examination of the control of a
company as exercised by its directors.
THREE FACTORS OF A COMPETITIVE MARKET
1. How risk and return are optimized
2. How efficient is the investment market
3. How appropriate is the style of
investment, whether active, passive, or
a combination
In the economy, ASSETS ARE PLOTTED BY
THESE PLAYERS / KEY PLAYERS IN THE
FINANCIAL SYSTEM
 FIRM; Business issuing securities (debt
and equity) or financial instruments
 HOUSEHOLD; the ones who lend and
borrow from financial intermediaries
 GOVERNMENT; the one that never
overfunds and is considered always in a
shortage
 FINANCIAL INTERMEDIARIES; the one
that positions between the debtors and
the creditors. Example: banks, mutual
funds, pension funds, and insurance
companies.
FINANCIAL SYSTEMS IN ECONOMIC
DEVELOPMENT
FLOURISH SAVINGS AND INVESTMENT
RELATIONSHIP
 Provides facilities for individual and firm
savings. More savings and investments,
 there is more production of goods and
services.
DEVELOP LABOR AND EMPLOYMENT
 More manufacturing companies can
boost their working capital, thereby,
they are able to employ more
individuals for their production.
GROWTH IN CAPITAL AND SECURITIES MARKET
 Capital markets issue debenture and
shares to public and other fund
institutions that are expecting good
returns from their fixed assets like
machinery and equipment.
 Short-term loans – help in the
continuity of the business and trade
 Foreign exchange market – help address
transactions that involve foreign
currencies, help raise funds for these
companies, and support the forex
requirement of some companies who
are dealing with other countries.
TRADE DEVELOPMENT
 Advance business, both domestically
and internationally, allows capital goods
to be sold through hire purchases and
instalment schemes.
INFRASTRUCTURE AND TECHNOLOGY
DEVELOPMENT
 Countries that are not dependent on
natural resources such as oil and gas,
financial institutions allow issuance of
letters of credit, finance them, and even
offer to discount some financial
instruments like bills.
 Economic liberalization – a set of policy
establishing development banks and
merchant banks to raise funding for
infrastructure buildings.
 Venture capitalist – allow companies
with investable funds to invest in highly
risky information and technology
businesses or promote other new
ventures.
UPHOLD FISCAL POLICY
 The existence of a worthy financial
system in one country helps in the
control of inflation, recession, and even
depression through a sound policy on
finance
 Regulated by BSP
 Laws and other legislation may be
enforced to mitigate the risks of
unwanted and speculative transactions.
Examples:
R.A 3765: An Act to Require the
Disclosure of Finance Charges in
Connection with Extensions of Credit
R.A 6426: An Act Instituting a Foreign
Currency Deposit System in the
Philippines, and For Other Purposes
R.A 3591 – An Act Establishing the
Philippine Deposit Insurance
Corporation, among others
ATTRACT FOREIGN INVESTMENT
 Vigorous financial systems in one
economy entice potential investors in
various sectors and provide more
production opportunities and
investment prospects that can lead to
economic growth and development.
FOSTER ECONOMIC INTEGRATION
 Forming economic integration tends to
have a common investment, trade
practice, and even legislation.
  One common currency is practices, just
like the EU
BALANCE REGIONAL DEVELOPMENT
 Provide various concessions and stock
ownership plans (SOPs) that eventually
help avoid political risks in regions.
Equitable interest rates offered in
various places would discourage
mitigation from rural to urban areas.
SUSTAIN MACROECONOMIC BALANCE
 Having a good financial system allows
balance in the industrial, agriculture,
and service sectors, ensuring that
contributors to the national income
benefit from the financial resources.
EQUITY MARKET PRICES
Returns = Today’s Price / Yesterday’s Price
1. Average return – used to smooth out
variations in a fund’s return
n
∑ return
l
n managed by these institutions to meet the
2. Variance of Return – measure of the
average variability (spread) of prices
3. Standard Deviation of Return
CHAPTER 9
FINANCE AND DEVELOPMENT
Financial Systems
 Transform short-term liabilities into
long-term assets.
 For example, demand deposits can be
transformed into long-term loans
FINANCE
 The driver of sustainability
 However, to achieve sustainability
through finance, it is necessary to
rebuild and adapt the financial
system to the specifics of
sustainable development
MODERN FINANCIAL SYSTEMS
 Can be described as one-dimensional,
focusing on ensuring the economic
security of transactions
ROLE OF FINANCES
(1) LINK THE SAVERS AND INVESTORS.
Financial institutions such as banks, bond
markets, or stock markets link the savers
and borrowers of the economy.
Organizations offering financial services,
specifically banks, building society, finance
company, or credit union.
Supply of savings coming from “savers” like
households, firms, and other venture
capitalists save up or invest money that are
demand for such savings by borrowers such
as firm, entrepreneurs, or even households
The concept of venture capital basically
benefits start-up business entrepreneurs to
develop new products. Since it is a start-up
business, this can be a very risky investment
to the point of losing the entire investment.
(2) SCREEN AND MONITOR INVESTMENTS
Venture capitalist normally screen new
ideas, evaluate the viability of the business,
and solicit investments for these.
Apart from screening function of finance, it also
monitors the daily activities of financial assets
that are traded in the market.
(3) SMOOTHEN CONSUMPTION
It can be the savings for retirement, or it
can be a mortgage like a car loan or
education loan. Financial system help us
borrow and save money to acquire these
assets without waiting for many years to
come.
(4) MANAGE RISK
According to Pan and Fan, in view of the
stability of the banking system, considering
shadow banking, interbank lending, and
complex relationships between banks, there is a
need for concentrated interbank network
structure that is easier to increase the
probability and degree of risk contagion.
SHADOW BANKING
- credit intermediation of channels
funding from depositors to investors
through a range securitization and
secured funding techniques and may
cause systematic financial risks and
arbitrage risks.
(5) MANAGEMENT OF PAYMENT SYSTEM
It is easier with the use of mobile devices. In a
study by Su-Chang et al. in 2019, due to
smartphones being more popular and the
wireless network infrastructure improving, it
positively affects customers’ satisfaction in
terms of mobile payment usage intention.
FINANCIAL DEVELOPMENT
 Key role in sustainable economic
growth and development
 Essential for reducing income inequality
FINANCE AND GOVERNANCE
 There must be a sound legal system
 The issue of insecure property rights in
a firm
 Effective corporate governance
 Directors of public companies are
accountable for their actions to the
company shareholders
 The Philippine Code encourages a
governance body to put in place
policies, programs, and procedures to
encourage employees to actively
participate in the realization of the
company’s goal and management.
Furthermore, the country opted for the
predominant “comply” or “explain”
approach promoted by Organization of
Economic Cooperation and
Development (OECD) principles that
combine voluntary compliance with the
mandatory disclosure of the company
situation. Companies thus do not have
to comply with all the code provisions
necessarily but indicate and explain
their reason for noncompliance.
MICROFINANCE
 Range of financial products (loans,
saving/cheque accounts, insurance,
etc.) focused on low-income individuals
who have generally been overlooked by
traditional financial service providers.
 They have been neglected by or denied
access to mainstream financial
institutions because of the perceived
risk or relatively low balances/high
transaction accounts to maintain.
 The poor usually are subject to low,
irregular, and unpredictable income
 flows and their needs vary from time to  ROSCAs are common in developing
time. countries and among migrant groups in
 The usual pecuniary (or in-kind) are developed countries.
sourced from family, friends, or  ROSCAs version in different countries;
remittances.
 It is available as well, like the rotating INDIA Chit fund
NIGERIA AND Susus
savings and credit association (ROSCAs),
GHANA
microlenders, store credit, and money
WEST AFRICA Tontines
lenders. BOLIVIA Pasanaku
 Directly related to the economic growth CHINA Hui
of a country. If the economic growth is INDONESIA Arisan
high, the development of financial PHILIPPINES Paluwagan
sector positively influences the activity
of microfinance sector.
TWO COMMON TYPES OF ROSCAs
MICROCREDIT
1. Random ROSCA – Regular paluwagan, a
 These are ways of improving access of fund is formed by contributions of those
the poor to a variety of financial who agreed on the microsavings and
services, including microsavings and every agreed time, they would take the
microinsurance. pooled amount.
 Does not require collateral. 2. Auction ROSCA – bid is tendered by
 May be borrowed one time or on a those who want to pool their money. It
recurring basis allow those with urgent needs to
 Interest are high as much as 35% or receive funds earlier than those with
higher less urgent needs. However, the bid
 Proponent: Muhammad Yunus, PhD, amount will be deducted from the total
believing that poor people will repay amount to be received by the members
loans given the opportunity to of ROSCA.
commercialize their ideas, making
ISLAMIC FINANCE
microcredit a viable business model.
 Well-functioning Islamic financial
MICROSAVINGS
system promotes economic growth.
 The idea of pooling resources is not new  Study made by Suseno et al.
in terms of savings for Filipinos.
MOST SIGNIFICANT INFLUENCES OF
 Group of cooperation is inevitable as
FINANCIAL INCLUSION IN ISLAMIC
well as the desire to help
BANKING COUNTRIES
 Ex: rotating savings and credit
association (ROSCAs) – all participants a.) Macroeconomic factors
contribute to a common fund and take b.) Level of employment
turns to receive a return. c.) GDP per capita
  Do not SIGNIFICANTLY INFLUENCE
FINANCIAL INCLUSION
a.) Information technological
advancement
b.) Corruption
 Islamic financial model has its
foundation and origin in the Koran and
in the sunna. Its application is bound by
a conventional body of rules and
regulations as well as the historical,
social, and economic context of the
country in which the model has been
implemented.
 In the Philippines, there is synergy
between Islamic finance and the
development of Halal tourists products
as a way to sustainable tourism and
eventually contribute to the economic
growth and development of the
country.
 Halal means literally, that which is
permitted or prescribed, primarily
refers to dietary restrictions that
Muslim are expected to follow. Halal
products are in great demand by
consumers all over the world.
CHAPTER 10
FOREIGN TRADE
 Started toward the end of seventeenth
century
ADAM SMITH
 In 18th century, he wrote a book, The
Wealth of Nations, the time of
liberalism emphasized the role of
specialized production to supply the
highly increasing demand for
consumptions.
DAVID RICARDO (1772-1823)
 A classical economist best known for his
theory on wages and profit, the labor
theory of value, the theory of
comparative advantage, and the theory
of rents.
 Comparative advantage, wherein each
country specializes in a particular
product or set of products and import
everything else for consumption.
 Due to comparative advantage, it
pushes international trade.
 A country has a comparative advantage
in the production of goods and services
if that particular country can produce
the same at a lower opportunity cost
than other countries.

 Exchange of goods and services

between countries.
 Dynamics of trade are highly
complicated due to risk involved. But
the reward of reap when it is a success.

HISTORY OF FOREIGN TRADE

MERCANTILISM

 Valued balance of trade, exports given

to a foreign country must, at any time,
exceed the imports, if not equal.