CHAPTER 5

Credit risk – the risk that the borrower was not able to repay its obligation. It also affects the valuation of
accounts receivable.
Loanable funds theory – it assumes that it is ideal to supply funds when the interests are high and vice
versa. It was introduced by Knut Wicksell in 1900s.
Liquidity preference theory – the interest rates are dependent on the preference of the household
whether they hold or use it for investment.
Tenor of the investment – defines the riskiness of the repayment of debt; the longer, the higher.
Expectation theory – the interest rates are driven by the expectation of the lender or borrowers in the
risks of the market in the future.
Pure expectations theory – based on the current data and statistical analysis to project the behavior of
the market in the future.
Biased expectation theory – there are other factors that affect the term structure of the loans as well as
the interest to be perceived moving forward.
Liquidity premium – the adjustment or increase on the interest rate.
Liquidity theory – another theory under the biased expectation theory
Preferred habitat theory – does not only consider the liquidity but the risk premium as well but
disregarding the consensus of the market on the future interest rates.
Market segmentation theory – this theory assumes that the drive of the interest rates are the savings and
investment flows.
Philippine Dealing Systems (PDS) Group – an organized market that was formed out of the financial
distress in 1997. It manages or operates electronic trading and settlement platforms in the PDSFE
markets, and performs key post-settlement functions for the Debt and Equity markets through its
electronic Depository, Registry and Custody services.
Philippine Dealing and Exchange Corporation (PDEx) – provides a centralized infrastructure for
trading, clearing, and settlement of fixed income securities, which ensures price discovery, transparency,
and investor protection.
Philippine Depository and Trust Corporation (PDTC) – acts as depository, registry, and intermediary
of participants for all kinds of securities or financial instruments and provides value-added services such
as collateral management for repurchase transactions.
Philippine Securities Settlement Corporation (PSSC) – the entity responsible for matching, clearing,
and settlement of transactions.
Default risk – arise on the inability to make payment consistently.
Liquidity risk – identified by ensuring the business to be capable of meeting all its currently maturing
obligation. It focuses on the entire liquidity of the company or its ability to service its current portion of
their debt as it comes due.
Legal risk – dependent on the covenants set and agreed in between the lenders and the borrowers. It will
arise only upon the ability of any of the parties to comply with the covenants of the contract.
Market risk – the impact of the market drivers to the ability of the borrowers to settle the obligation. It is
classified as a systematic risk.
Spot rates – the interest rate or yield available or applicable for a particular time.
Hedge rate – means the weighted average fixed rate determining the series of payments to be made by
the sellers under each outstanding hedge transaction.
Forward rates – normally contracted rates that fixed the rates and allow a party to assume such risk on
the difference between the contracted rate and the spot rate.
Swap rate – another contract rate where a fixed rate exchange for a certain market rate at a certain
maturity.
London Interbank Offered Rate (LIBON) – used to benchmark interest rates which is used as reference
for international banks to borrow.
Credit ratings – affects the confidence level of the investors to countries or companies. It is determined
by companies that are recognized globally that objectively assigns or evaluates countries and companies
based on the riskiness of doing business with them.
Standard and Poor’s Corporation (S&P) – an American financial services corporation founded in 1941
by Henry Varnum Poor in New York, USA.
Moody’s Investors Services – a credit rating company particularly on debt securities established in 1909
in New York, USA.
Fitch rating – the third credit rating agency. It was founded in 1914 in New York, USA and was owned
by Hearst.
Hearst – global information and services company.
DBRS – was established in 1976 in Toronto, Canada and was considered the fourth largest ratings agency.
CARE Ratings – started its operation in 1993 based in India. It was based in Mumbai with partners in
Brazil, Portugal, Malaysia, and South Africa.

CHAPTER 6
Financial market – a forum or market that enables suppliers and demanders of funds to make
transactions.
Debt Securities Market – is the financial market where the debt instruments or securities are transacted
by suppliers and demanders of funds.
Debt instrument – is a paper or electronic obligation that enables the issuing party to raise funds by
promising to repay a lender in accordance with terms of a contract.
Debt security – refers to a debt instrument, such as a government bond, corporate bond, certificate of
deposit (CD), municipal bond or preferred stock, that can be bought or sold between two parties and has
basic terms defined.
Notional amount – amount borrowed
Money market debt securities – debt securities with maturities of less than one year.
Capital market debt securities – debt securities with maturities of longer than one year.
Corporate bond – issued by corporation; usually used for a long-term debt instrument that provide a
maturity of at least one year.
Government bond – issued by national government; provides the face value on the agreed maturity date
with periodic interest payments.
Municipal bond – issued by local governments to fund their projects.
Mortgage bond – locked in by the pledge of particular assets.
Asset-backed bond (ABS) – a financial security collateralized by a pool of assets such as loans, leases,
credit card debt, royalties or receivables.
Collateralized Debt Obligation (CDO) – a structured financial product that pools together cash flow-
generating assets and repackages this asset pool into discrete tranches that can be sold to investors.
Coupon rate – also known as interest rate; It is the fixed return that an investor earns periodically until it
matures.
Current or Market Price – may be purchased a bond at par, below par, or above par.
Bond valuation – a technique for determining the theoretical fair value of a particular bond.
Zero-coupon bond – makes no annual or semi-annual coupon payments for the duration of the bond.
Credit spread – the risk premium.
Yield curve – the term structure of interest rates when graphed.
Benchmark spot rate curve – also known as benchmark zero-coupon rate curve; a term structure that is
used to value bonds of issuers of the same credit quality.
Traditional valuation approach – discount every cash flow of a bond by the same interest rate.
Arbitrage free valuation approach – views each security as the same package of cash inflows, with
each cash flow viewed as a zero-coupon bond and each cash flow discounted at its own unique discount
rate.
Lattice model – used to value callable bonds and putable bonds.
Monte Carlo simulation model – used to value mortgage-backed securities and certain types of asset-
backed securities.