Chapter 3

FINANCIAL
INSTRUMENTS
 1 Learn about the different money
market instruments and the
different capital markets
2 Be familiarized with the different
government-issued securities dealt with
the money market.
Learning 3 Be knowledgeable about the negotiated
(non-negotiated capital market and the
Objectives instruments dealt with the said market.

4 Different types of corporation-issued stocks

and the different types of corporation-
declared dividends to stockholders will be
discussed.
  are financial contracts between
interested parties. They can be created,
traded, modified and settled.
Financial  Association of Chartered Certified

Instruments Accountants (ACCA)

“A financial instrument is any contract
that gives rise to a financial asset of one
entity and a financial liability or equity
instrument of another entity.”
 1. Cash
Instruments
Cash instruments are those whose value

Types of is determined directly by the markets.

• Securities
Financial • Loans/Deposits

Instruments 2. Derivative Instruments

Derivative instruments are those which
derive their value from the value and
characteristics of one or more underlying
entities.
  In Finance, they are classified as
to their term or maturity date.
Short Term > Money Market
Long Term > Capital Market
Financial  In Accounting, they are classified

Instruments as current or non current assets.

Both Finance and Accounting classify short term
securities as short term. But for long term
securities, what finance treats as long term can be
treated in accounting as short term.
MONEY MARKET
INSTRUMENTS
  Short term securities
Money  They are paper or electronic

Market evidences of debt dealt in the

money markets.
Instruments  Issued by the Bureau of
Treasury
 1 Cash Management Bills
2 Treasury Bills
3 Banker’s Acceptance

Money 4 Letter’s of Credit

5 Negotiable Certificate of
Market 6 Deposit
Money Market Deposit Account
7 Money Market Mutual Funds
Instruments 8 Repurchase Agreements
9 Certificate of Assignment
10 Certificate of Participation
11 Eurodollor CDs and Eurocommercial
Cash Management Bills

 Government-issued securities with

maturities of less than 91 days.
 Backed up by the full taxing power of
the issuing government.
 Treasury Bills
(T-Bills)
2 Types of Government Securities
1. Treasury Bills
2. Treasury Bonds
 Issued by the Bureau of Treasury with 91-day, 182-day, and
364 day maturities.
 Sold through government securities dealers (GSEDs)
 Zero coupon securities
 Sold at a discount
 Discount yield or margin (sole source of returns)
 They do not earn interest
 Banker’s Acceptance

 It is a time draft issued by a bank payable to a seller of goods

 The accepted draft may be readily sold in an active market.
 Time Draft – issued by a bank is an order for the bank to pay a
specified amount of money to the bearer of the time draft on a
given date.
 Sight draft – order to pay immediately.
 Letters of Credit

 It is a contractual agreement between a bank, known

as the issuing bank, on behalf of the buyer (drawer),
authorizing another bank, the correspondent bank,
known as the advising or confirming bank, to make
payment to the beneficiary (seller).
 Negotiable Certificate of
Deposits

Certificate of Deposit – is a receipt issued by a commercial

bank for the deposit of money. It is a time deposit with a definite
maturity date and a definite rate of interest.
Negotiable Certificate of Deposit – is a bank-issued time
deposit that specifies an interest rate and maturity date is
negotiable.
It is also a bearer instrument.
 Money Market Deposit
Accounts

 MMDA’s are PDIC insured deposit accounts that are

usually managed by banks or brokerages and can be a

convenient place to store money that is to be used for

upcoming investments or has been received from the

sale of recent investments.

 Money Market Mutual
Funds

 MMMF’s are investment funds that pool funds from

numerous investors and invest in money market

instruments offered by investment companies.

Mutual Fund – is an investment company that pools

funds.
 1 Stock Funds/Equity Funds
- invest primarily in shares of stock

4 Basic Types 2 Balanced Funds

- invest both in shares of stock and
debt instruments

of MMMF’s 3 Bond Funds

- invest in long term debt
instruments
4 Money Market Funds
- invest purely in short term debt
instruments
Mutual 1 Growth Funds
- invest in assets that are expected to
reap large capital gains

Funds can 2 Income Funds

- invest in stocks that regularly pay dividends and
in notes and bonds that regularly pay interest.

be 3 Balanced Funds
- Combine the features of both growth funds
and income funds

classified 4 Sector Funds

- invest in specific industries
5 Index Funds
as: - invest in a basket of securities

6 Global Funds
- invest in securities issued in many countries
providing diversification
 Repurchase Agreements

 Repurchase Agreements are legal contracts that involve

the actual sale of securities by a borrower to the lender

with a commitment on the part of the borrower to

repurchase the securities at the contract price plus a stated

interest charge at a later date.

 Repurchase Agreements

 Overnight RP’s
- It matures in a day.
 Term RP’s
- Have a maturity greater that 1 day
 Certificate of Assignment

 Certificate of Assignment is an agreement that transfers the right of the seller

over a security in favor of the buyer.

 The underlying security carries a promise to pay a certain sum of money on a

fixed date like a promissory note.

 Allows the buyer to hold the security as a guaranteed source of repayment.

 Certificate of Participation

 Certificate of Participation is an instrument that gives the

buyer a share in a security that promises to pay a certain sum
of money on a fixed date or a type of financing where an
investor purchases share in the lease revenues of a program or
municipality.
 Eurodollar CD’s

 Eurodollar Certificate of Deposits or

Eurodollar CD’s are dollar-denominated,

negotiable, large-time deposits in banks

outside the United States.

 CAPITAL
MARKET
INSTRUMENTS
Capital  Capital market instruments are
long terms instruments that are
Market basically either equity securities

Instruments or debt securities.

 1 Non-negotiable/Non-marketable
Instruments

A Loans
Capital
Leases
Market B

Instruments C Mortgages

D Lines of Credit
  Loans are direct borrowing of
A Loan deficit units from surplus units

s
like banks.
  Leases are rent agreements.

 Lessor

B Leases
- Owner of the property

 Lessee
- One who is renting and using
the property
 * Types of Lease
 Operating Lease

- Lessor shoulders all expenses and

lessee pays a fixed regular amount

B Leases monthly.
 Financing Lease or Capital Lease

- Lessee shoulders all expenses of

the property.
- Lease-to-own contracts

• Lessee pays a big initial down payment.

  Mortgages are agreements where
a property owner borrows money
C Mortgage from a financial institution using
the property as a security of
collateral for the loan.
  Line of credits is a bank’s
commitment to make loans to
regular depositors up to a specific

Lines of amount.

D  Personal Lines of Credit

Credit - for households and can be used for

home renovation.
 Commercial Lines of Credit

- are for businesses and can be used

for current and short-term purposes.
 Negotiable/Marketable
2
Instruments

Capital A Corporate Stocks

Market B Bonds

Instruments C Long-Term Negotiable Certificates o

Deposit

D Mortgage-Backed Securities
  Corporate stocks are the largest
capital market instruments.
 Stocks
- evidences of ownership in a
Corporat corporation.
A
e Stocks - are the shareholders or stockholders.
 Holders

 Share of Stocks
- intangible evidence of ownership
 Stock Certificate
- tangible evidence of ownership
  Stocks are by nature long-term
and they do not have maturity
dates.
 Capital stock of a company is
divided into shares and each share

Corporat is denominated in the currency of

the country where the company is
A located.
e Stocks  Domestic Companies
- Incorporated in the countries where
they are located.
 Foreign Corporation
- These are foreign companies with
offices in the country.
 1 Par Value Shares
Shares of
stocks may 2 No Par Value Shares

be classified 3 Common Shares

as: 4 Preferred Shares

  are shares where the specific
Par Value money value is shown on the face
1
Shares  May be issued at:
of the stock certificate.

 Premium
  are shares without any money
value appearing on the face of the

No Par stock certificate.

 Corporation Code provides that

2 Value no par value shares may not be

Shares issued less than five pesos per

share.
 may be assigned with a stated
value and without stated value.
 Common  if a corporation issues only one
3
Shares class of stock, it is called common
stock (ordinary shares)
  shares with preferential rights

Preferred  Preferred Shares as to Assets

4 - Shares shall be given preference
Shares over common shares in distribution
of the assets of the corporation in
case of liquidation.
  Preferred Shares as to Dividends

- shares with preferential rights to

Preferred share in the earnings of the

4 corporation.
Shares - entitled to receive dividends before
payment of any dividend to the
common stock is made.
  Passed Dividends

Preferred - all dividends not declared by the

4 Board of Directors in a given period.

Shares  Dividends in Arrears

- unpaid passed dividends.
  Cumulative Preferred Shares
- Entitled to receive all passed

Preferred dividends in arrears.

4  Non-cumulative Preferred Shares

Shares - not entitled to passed dividends or
which are called dividends in arrears for
cumulative shares. They only receive
dividends that are currently declared
  Participating Preferred Shares
- entitled not only to the stipulated
dividend, but also to the share with

Preferred the common stock in the dividends

4 that may remain.
Shares  Non-participating Preferred Shares
- Entitled to a fixed amount or rate of
dividend only.
Dividends 1 Dividends out of earnings

can be 2 Liquidating
Dividends
classified as:
  Cash Dividends
- dividends distributed in the form of
cash
Dividends  Stock Dividends
- dividends given out to stockholders
1 out of in the form of the company’s own

Earnings  Unissued Common Stock

shares.

- authorized capital stock that has not

been fully paid. Stock certificates have
not been issued.
 Dividends  Property Dividends

- form of non-cash assets of the

1 out of company distributed to stockholders.

Earnings Scrip
 Dividends
- are deferred cash dividends.
 Liquidatin  Liquidating Dividends are dividends

2g representing return of capital paid by

companies in the extractive industry.

Dividends
 Liquidatin  Liquidating Dividends are dividends

2 g
representing return of capital paid by
companies in the extractive industry.

Dividends
  are debt instruments issued by
private companies and government

B Bonds entities to borrow large sum of

money.
 They earn a fixed rate of interest ,
which issuers pay at regular
intervals.
  is issued by a national government and is
denominated in the country’s own
Government currency.

Bond  Bonds issued by national

governments in foreign currencies
are normally referred to as
SOVEREIGN BONDS.
  are certificates of indebtedness issued by
corporations who need large amount of

Corporate cash.
 Bonds have specific interest rates and

Bonds maturity dates and most corporate

bonds are long-term bonds.
 Bond agreements are called BOND
INDENTURES.
 1.As to security:
 Secured Bonds
Bonds can -are collateralized either by
mortgages or other assets
be classified  Unsecured Bonds

as follows: -also called debenture bonds . They

do not have any sort of guarantee.
 2. As to interest rate:

Bonds can
 Variable Rate Bonds
-are bonds whose interest rate
fluctuates and changes when the
be classified market rates change.

as follows:  Fixed Rate Bonds

-have rates that are fixed as
stated in the bond indenture.
 3. As to retirement:

Bonds can
 Putable Bonds
-bonds that can be turned in and
exchanged for cash at the holder’s

be classified option.
 Callable/Redeemable Bonds
-bonds in which the issuer has the right
as follows: to call the bond for retirement.
Convertible Bonds
-can be exchanged for common
stocks and usually carry lower
interest rates.
 3. Other classification:

Bonds can
 Income Bonds
-are bonds that pay interest only when
the interest is earned by the issuing

be classified company.
 Indexed or Purchasing Power Bond

as follows: -the interest rate paid on these bonds

is based on an inflation index.
 Junk Bonds
-are speculative, below-investment
grade, high-yielding bonds.
  Issued by the treasury of the country
concerned.
Treasury
Bonds
 Are government securities which
mature beyond one year.

 T-notes could be over 1-to10-year

notes.
  They are direct and unconditional

Retail obligations of the national government

that primarily cater to the retail market
or the end-users.
Treasury  They are issued to mobilize savings and
encourage retail investors to purchase
Bonds(RTB long–term papers.

s)  Are like T-notes, but are usually longer

in maturity (10 years and above)
Floating  Interest payments rise and fall are
Rate based on discount rates for 13-week T

Notes(FRNs
Bills.

)
  Are
Fixed Rate direct and unconditional
obligations of the national government.
Treasury
Notes(FXTN  They are interest bearing and carry a
term of more than one year.
s)
Treasury  Their interest rates are generally higher
than the interest rates on Treasury Bill
Notes and  They are subject to interest rate
Treasury fluctuations and changes

Bonds  Are usually issued to fund the national

debt and other national expenditures
  State and local governments must

Municipal finance their own capital investment

projects. So local governments usually
Bonds issue Municipal bonds in financing
their projects.
Two  General Obligation Bonds
-are issued to raise immediate capital
to cover expenses and are supported
varieties of by the taxing power of the issuer.

Municipal  Revenue Bonds

-are issued to fund infrastructure

Bonds: projects and are supported by the

income generated by those projects.
 Long-  Are negotiable certificates of deposit
with a designated maturity or tenor
Term
C Negotiable
beyond 1year

 LTNCDs are covered by deposit

Certificate insurance with the Philippine Deposit

s of Insurance Corp. (PDIC) up to a

maximum amount of P500,000 per
Deposit depositor.
 Mortgag  These are securities backed up by
D
e-Backed standard
mortgages.
million block group of

Securitie
s
THANK YOU!