BASIC

FINANCE
Principles of money, credit
and banking
 The financial sector is composed of two important segments: Financial markets and
institutions.

 Financial markets are individuals and firms with SURPLUS FUNDS. • Surplus –
excess or an amount such as money that is more than the amount needed.

  Expenditures – an amount of money that is spent on something; expenses

Individuals and firms who want to borrow money are brought together with those who
want lend in the financial markets.
1. SSUs – Surplus Spending Units DSUs – Deficit Spending Units

2. Direct Financing - Private placements - Brokers - Dealers - Investment bankers Deficit Spending Units -
Households - Business Firms - Government Indirect by Financial Intermediaries - Commercial Bank - Savings
and Loans - Finance Companies, etc. Surplus Spending Units - Households - Business Firms - Government
Intermediation Market

3. Security – is fungible, negotiable financial instrument that holds some type of monetary value. An instrument
of investment in the form of a documents (as a stock certificate or bond) providing evidence of its ownership.

  2 types of security
• Equity security, such as partnership. Ex. Stock certificate
• Debt security, such as money borrowed must be repaid w/ terms that stipulates the size of the loan, interest rate
and maturity date.
4. Financial markets, just like any market, operate in the demand and supply funds. DSUs that can
use borrowed funds in the most productive manner can afford to pay higher interest rates.

5. Liquidity – the capability of covering current liabilities quickly. This arrangement forces lender to
WAIT for MATURITY date of the loan before he gets his money back.

6.Ways to stimulate savings 1. Denomination (size) intermediation - secondary securities can be

made available in a wide range of denominations, from a few hundred pesos to many millions of
pesos.

7.Ways to stimulate savings 2. Maturity intermediation – savers are concerned about the length of the
time of their savings will be invested. It is also an investment term that describes a bank’s long-term
lending of funds borrowed for a short-term investment.
8. Ways to stimulate savings 3. Credit-risk intermediation – when primary securities are offered for a sale,
individual SSUs may not be too eager to buy because of their limited access to credit information.

9.Ways to stimulate savings 4. Interest rate sensitivity – some types of primary securities are subject to
changes in market interest rates. Many SSUs are averse/opposed to such interest rate risk. The SSUs are
given a choice of secondary security with a wide range of interest sensitives.

10. Ways to stimulate savings 5. Foreign currency intermediation – when SSUs buy primary securities stated
in foreign currencies, they assure the risk that the value of the foreign currencies may change through time.

11. Ways to stimulate savings 6. Higher net interest rates – when SSUs undertake actual search for DSUs
issuing primary securities, they do so with higher search and transaction costs. This is so because of the
difficulties involved in identifying DSUs, determining the credit quality of securities offered and locating the
offices where the DSUs are located.
12. Ways to stimulate borrowings 1. Denomination (size) intermediation – in selling securities, financial
intermediaries are able to acquire a pool of funds which enable them to buy primary securities in a wide
range of denominations. This arrangement relieves the DSUs in the searching for SSUs which are willing
to lend the exact amount they need.

13. Ways to stimulate borrowings 2. Maturity intermediation – In the absence of financial intermediary,
borrowers will have a hard time looking for direct lenders who will match the maturity period they require.
This problem is eliminated under the financial intermediation arrangement because the intermediary can
create secondary securities in any maturity.

14. Ways to stimulate borrowings 3. Interest rate sensitivity intermediation – many borrowers are averse to
the risk of interest rate increases. a) Intermediaries can sell secondary securities to a variety of lenders w/
different preferences for interest change periods.

15. Ways to stimulate borrowings b) Intermediaries are better able to assume and manage interest rate risk,
so they just perform the service.