Financial Institution,

Financial Instruments &

Financial Market
These questions are related to our
next topic. A finance manager needs
to look for funds to finance the
company. If the company has extra
cash, he/she will make a decision
where to put it.
THE FINANCIAL INSTITUTIONS
The flow of money begins with the depositor who opens
a bank account and earns interest from the account. In
exchange, these funds are lent by the banks to
businesses. They are borrowers who want to start up a
new business, a new product, expand a business, or find
another investment opportunity. When the business earns
profit, the borrower of the funds will pay interest on the
loan, and the depositor receives an interest in his/her
bank account.
The financial institution’s role is to act as a financial
intermediary. A financial intermediary serve as a link
between the depositor who has the money and the
lender who needs money. Financial institutions
include commercial banks, universal banks,
investment banks, investment companies, finance
companies, life and non-life insurance companies,
mutual fund companies, and private equity firms.
Most funds, especially public funds, are
looking for investment opportunities that will
sustain their requirements for about five years
or more, that is, long-term, and this is to
separate certain investor requirements from
fast returns.
FINANCIAL MANAGEMENT is managing
financial matters including analysis of
statements, assessment, or investment
opportunities, which happens before one
starts investing and acquiring funds from
different sources.
The Key Individual Roles
1. The Depositor Who Has the Funds
The depositor is the person who has the
money and puts in a savings account with a bank that
pools this together with the savings from other
depositors. He/she saves money in a bank because
he/she wants to achieve things in life, such as a new
house, a new car or even a small business. His/her
money also earns interest in the bank
2. The Borrower Who Needs the Funds
The borrower is the one who needs funds
and borrows it from a bank. He/she knows
where to use the funds such as starting up a
new business, purchasing new equipment,
expanding his/her business, or investing in
other financial instruments.
FINANCIAL INSTRUMENTS AND
FINANCIAL MARKETS
Financial instruments are the tools that help
a business’ daily operations and help the
finance manager handles his/her cash, his/her
short-term operating requirements, and long-
term business requirements.
Money market instruments are funds
available for a short time (1 year or less than a
year). They are available most of the time and
do not provide very high returns. Table 1 is a
list of the different market instruments and
their characteristics.
The borrower can also use long-term debts for
his/her business needs. However, the interest
rates are higher than money market instruments.
BOND is an example of long-term debt. It is a
security reflecting the debts of a government’s or
business’ debt promising to pay a fixed interest
to the bondholder for a definite time.
A NOTE is another example of long-term debt
that has a longer term than a money market
instrument. Notes are similar to bonds that have
regular interest payments and have a specified
maturity term.
STOCKS are types of security that
represent ownership in a corporation
and a claim on part of the corporation’s
assets and earnings. The two main types
of stocks are common and preferred.
FINANCIAL MARKET
Financial Markets are the meeting places
of suppliers and users of various types of funds
that can make transactions directly.
1. PRIMARY MARKET – refers to
market in which buyers and sellers negotiate and
transact business directly without an intermediary. o
Public offering is the sale of new securities to the
general public and the first offering of stock is
called IPO or Initial Public Offering. o Private
placement is the sale of a new security to a private
or specific buyer.
2. SECONDARY MARKET – refers to financial
market where previously issued securities (such as bond,
notes and shares) are bought and sold.

3. MONEY MARKETS are venues wherein securities

with short-term maturities (1 year or less) are borrowed
or loaned. Capital markets are financial markets for
stocks for a long-term period (one year or longer).
DIFFERENT TYPES OF FINANCIAL
INSTITUTIONS
A financial institution can be a bank or nonbank.
Different kinds of banks:
1. THRIFT BANKS
Thrift banks are deposit-taking financial
institutions that extend credit to the consumer market
that is in the countryside or rural areas.
2. COMMERCIAL BANKS

Commercial banks are mainly deposit-taking

financial institutions that extend credit to the
retail and consumer market, and their
transactions are usually many but small, using
the local currency.
 They collect and secure the funds of the
depositors. Savings and checking accounts provide a
fast and efficient way for bank clients to access their
money and use the money to pay bills and other
short-term investments such as utility bills,
education fees, and other expenses.
They lend money of the depositors to small and
medium businesses in exchange with interest to be
paid regularly for the use of the funds
The interest paid to depositors and the rate
earned from borrowers will pay the banking
cost such as employees’ salaries, office rent,
electricity, and other business-related costs.
3. UNIVERSAL BANKS
Universal banks lend money to multinational
companies. The transactions are larger than
commercial banks and denominated in multi-
currencies not just to the local currency. They are
like commercial banks but mostly their clients are
larger corporations. They also offer other financial
services due to an expanded license to engage with
clients.
4. INVESTMENT COMPANIES
Investment banks provide loans to big
corporations and governments and can raise
funds through bond issuances and initial
public offerings. Investment banks also
provide funds to businesses.
HOW INVESTMENT BANKS RAISED FUNDS
FROM THE PUBLIC:
a. Identify the business who needs financing.

b. Talk and negotiate with the investors the amount needed

to be raised, kind of denominations to use, investment rate
to pay the investing public, and the fee to charge for putting
all the fund raising and lending together.
c. Execute the fund raising once the
agreement is done.

d. Monitor the financial stability of the

issuer and the borrower.

e. Monitor the payments to investor.

The nonbank institutions that raise and lend
funds:
1. LEASING COMPANIES
Leasing companies extend
financing to companies that need
funds for their business. They are not
banks and are not regulated by
central bank
Financial Leasing Companies engage in
financing the purchase of tangible assets. The
leasing company is the legal owner of the goods,
but ownership is effectively conveyed to the
lessee, who incurs all benefits, cost and risk
associated with ownership of the assets.
Lessor is a participant of the lease who takes
possession of the property and provides it as a
leasing subject to the lessee for temporary
possession.

Example: In leasehold estate, the landlord is the

lessor and the tenant is the lessee.
How does leasing company make money?
Lease extensions, renewals, lease rolls,
equipment upgrades and other forms of
continued payments are the most common source
of lessor profitability. Leasing companies
accomplish this goal through carefully contract
provisions.
2. INVESTMENT COMPANIES
Investment companies perform similar
functions as banks in the manner that they can
provide financing to companies or raise funds
through bonds or Initial Public Offerings. They
are regulated by the Securities and Exchange
Commission (SEC)
3. MUTUAL FUNDS
Mutual funds are types of investments or
funds of small investors pooled together and
managed to be able to generate maximum
returns.
4. INSURANCE COMPANIES
Insurance companies sell life and non-life
insurance products that offer security during times of
death, illness, accident, and damage to property.
Individuals buy insurance protection with insurance
premiums. The insurance companies use these
payments to invest in stocks, bonds, real estate, and
mortgages. The proceeds will be the payment to the
insured individual.
5. PRIVATE EQUITY FUNDS

Private equity funds are managed by

private fund managers or investors, allowing
owners to invest more aggressively in the
financial markets
Private equity firms raise money from
institutional investors (pension funds,
insurance companies and family wealth) for
the purpose of investing in private
businesses, growing them and selling them
years later, generating better returns for
investors than they can reliably get from
public.
The Flow of Money and Role of the
Financial Manager
The flow of funds to businesses begins with the
source of funds, the saver or lender, who has the money,
saves, or deposits with the bank of any financial institution.
The financial institutions or banks look for outlets to
increase the money. The businessman need money for
his/her projects, so he/she borrow money from the
depositor. The borrower pays interest.
 The goal of finance is to maximize profit,
so it is expected that the finance manager will
invest the money into new projects or use this
wisely. He / She can use the money to pay the
company’s loan, use for the operation of the
business or put it in investments
WHAT IS A WORTHWHILE BUSINESS?
A worthwhile business is a business that
achieves the objective of financial soundness,
sustainability, competitiveness, and nation-building.
The financial manager's role is to ensure that the
entire cash flow happens and is completed up to
interest payments on the borrowed loan after money
is invested in a worthwhile business.
ACTIVITY:
A. Directions: Identify the following financial
instruments. Write LT if it is a long-term debt and
MM if it is a money market debt.

1. treasury bonds
2. federal agency debt
3. treasury bills
4. commercial papers
5. local government funds 6.

money market funds

7. credit card debt

8. corporate funds
B. Directions: Identify the following financial
institutions. Write B if it is a bank institution and NB
if it is a nonbank institution.
9. leasing companies
10. investment companies
11. thrift banks
12. mutual funds
13. private equity funds
14. commercial banks
15. universal banks
DIRECTIONS: Answer the following questions.
1. Distinguish financial institution from
financial instrument and financial market.
2. Explain the flow of funds within
an organization through and
from the enterprise and the
role of financial manager.