Chapter 3:

Financial Instruments

Rowegin G. Carloman BSBA FM 4

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Financial Instruments are any type of asset that can be traded
by investors, whether it's a tangible entity like property or a
debt contract.

TYPES OF FINANCIAL INSTRUMENT

- Money Market Instrument
- Capital Market Instrument

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MONEY MARKET INSTRUMENTS
- are short term securities, its either paper or electronic evidences of
debt dealt in the money markets. It is also issued by the government and
corporation needing short-term funds. Examples of Money Market
Instrument are:
Cash Management Bills - are short-term bills which is government-issued
securities with maturities of less that 91 days, specifically 35 days or 42
days which have shorter maturities than T-Bills.
Treasury Bills (T-Bills) - are are short-term secure investments issued by
the Bureau of the Treasury with 91-days, 182-days and 364-days maturities.

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Bankers Acceptance - is a time draft issued by a bank payable to a seller of goods
which also drawn on and accepted by the bank.

Time Draft issued by a bank in order for the bank to pay a specified amount of
money to the bearer of the time draft on a given date.

Letters of Credit - is a written commitment to pay, by a buyer's or importer's bank.

Commercial Letter of Credit - a bank-issued document that ensures a supplier

to a company gets paid for the goods and services it provides

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Certificates of Deposit (CD) - is a receipt issued by a commercial
bank for the deposit of money. It is a time deposit with definite
maturity date (of up to 1 year) and definite rate of interest.

Negotiable Certificates of Deposit - is a bank-issued time deposit that

specifies an interest rate and maturity date and is negotiable.

Repurchase Agreements - are legal contracts that involve the actual

sale of securities by a borrower to lender with a commitment on the
part of the borrower to repurchase the securities at the contract price.

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Money Market Deposit Accounts (MMDAs) - are PDIC-insured
deposit accounts that are usually managed by the banks or
brokerages and can be a convenient place to store money that is
used for upcoming investments.

Money Market Mutual Funds (MMMFs) - are investment funds that

pool funds from numerous investors and invest in a money market
instruments offered by investment companies.

Mutual Fund is an investment company that pools the funds of

many individual and institutional investors to form a massive asset
base.
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Classification of Mutual Funds:
1. Growth funds - invest in assets that are expected to reap large capital gains
(generally equity securities)
2. Income funds - invest in stocks that regularly pay dividends and in notes and bonds
that regularly pay interest
3. Balanced funds - combine the features of both growth funds and income funds
4. Sector funds - invest in specific industries as health care, financial services,
utilities, extractive industries
5. Index funds - invest in a basket of securities that make up some market index as the
S&P 500 index of stocks
6. Global funds -invest in securities issued in many countries providing diversification

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Certificate of assignment - is an agreement that transfers the
right of the seller over a security cover of assignment is an
agreeing security carries a promise to the certain sum security
in favor of the buyer.

Certificate of participation - is an instrument that entitles the

holder to a proportionate equitable interest in the securities
held by the issuing firm or an entitlement to a pro rata share in
a pledged revenue stream, usually lease payments.

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CAPITAL MARKET INSTRUMENTS - As stated, these long-term
instruments are basically either equity securities or debt securities.

Capital market instruments include corporate stocks, mortgages,

corporate bonds, treasury securities, state and local government
bonds, US government agency securities, and non-negotiable bank,
and consumer loans and leases.

Classification of Capital market instruments:

1. Non-negotiable/non-marketable instruments
2. Negotiable/marketable instruments

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Non-negotiable or non-marketable instruments in the capital markets are
the following:

1. Loans - are direct borrowings of deficit units from surplus units like
banks. They can be short-term or long-term.
2. Leases - are rent agreements. The owner of the property is called the
lessor and the one who is renting and using the property is the lessee.
3. Mortgages - are agreements where a property owner borrows money
from a financial institution using the property as a security or collateral
for the loan.
4. Lines of Credit - is a bank's commitment to make loans to regular
depositors up to a specific amount.

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Negotiable or Marketable Instruments in the capital markets are the following:
1. Corporate Stocks - are the largest capital market instruments. Stocks are
evidences of ownership in a corporation. The holders are called shareholders or
stockholders.
Shares of stock may be classified as:
A. 1. Par value shares
2. No par value shares
B. 1. Common shares
2. Preferred shares
a. As to assets
b. As to dividends
i. Cumulative
ii. Non-cumulative
iii. Participating
iv. Non-participating
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Par value shares are shares where the specific money value is shown on
the face of the stock certificate and fixed in the Articles of Incorporation.

No par value shares are shares without any money value appearing on the
face of the stock certificate.

If a corporation issues only one class of stock it is called Common Stock

(or Ordinary Shares) - issued to business owners and other investors as
proof of the money they have paid into a company.

Preferred Shares are a special type of share where dividends are paid to
shareholders prior to the issuance of common stock dividends.

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Preferred Shares as to assets upon liquidation mean that the shares shall be
given preference over common shares in the distribution of the assets of the
corporation in case of liquidation.

Preferred Shares as to dividends refer to shares with preferential rights to

share in the earnings of the corporation, that is, the owners thereof are entitled
to receive dividends before payment of any dividend to the common stock is
made.
1. Cumulative preferred shares – are entitled to receive all passed
dividends in arrears.
2. Non-cumulative preferred shares – are not entitled to passed
dividends or which are called dividends in arrears for cumulative shares.

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 3. Participating preferred shares –are entitled to the portion of
the dividends that may be left over after the common shares have
received dividends at the same rate as the preferred for the current
year, in addition to the prescribed dividend.

4. Non-participating preferred shares – are entitled to a fixed

amount of rate of dividend only, say 10% or 8% or 12%.

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Types of Dividends

1. Cash Dividend - are dividends distributed in the form of cash.

2. Stock Dividend – are dividends given out to stockholder in the
form of the company’s own shares.
3. Property Dividend – are the form of non-cash assets of the
company distributed as dividends to stockholders.
4. Scrip Dividend – are deferred cash dividends and is like
promissory notes that will be paid by the company in cash.

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Bonds - are debt instruments issued by private companies and government
entities to borrow large sum of money that no single financial institution may
be willing or able to lend.

Corporate Bonds - are certificates of indebtedness issued by corporations

who need large amount of cash. Bond agreements are called bond indentures.
Bonds are classified as follows:
1. As to security:
a. Secured Bonds – are collateralized either by mortgages or other
assets.
b. Unsecured Bonds – also called debenture bonds, do not have any sort
of guarantee.

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2. As to interest rate:
a. Variable rate bonds - are bonds whose interest rate fluctuates and
changes when the market rates change.
b. Fixed rate bonds - have rates that are fixed as stated in the bond
indenture.

3. As to retirement:
a. Putable bonds - are bonds that can be turned in and exchanged for
cash at the holder's option.
b. Callable/redeemable bond - is bond in which the issuer has the right to
call the bond for retirement for a price determined at the time the bond is
issued.
c. Convertible Bonds – can be exchanged for common stocks.
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4. Other classification
a. Income bonds - are bonds that pay interest only when the
interest is earned by the issuing company.
b. Indexed or purchasing power bond - Popular in Brazil,
Israel, Mexico, and a few other countries plagued by high rates of
inflation is the indexed or purchasing power bond.
c. Junk bonds - are speculative, below-investment grade,
high-yielding bonds.

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Treasury Bonds – a long-term investment which are government securities that
mature beyond one year.

Retail Treasury Bonds (RTBs) – are like T-Notes, but are usually longer in
maturity (10 years and above).

Floating Rate Notes (NRTs) – in which interest payments rise and fall are
based on discount rates for 13-week bills.

Municipal Bonds - refers to a type of debt security issued by local, county, and
state governments. They are commonly offered to pay for capital expenditures,
including the construction of highways, bridges, or schools.
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Two varieties of Municipal Bonds:
1. General Obligation Bonds (GO) are issued to raise immediate capital to cover
expenses and are supported by the taxing power of the issuer.
2. Revenue Bonds - are issued to fund infrastructure projects and are supported
by the income generated by those projects.

Long-term Negotiable Certificates of Deposit - indicating an amount of bank

indebtedness with a designed maturity. LTNCDs are high-yielding,
negotiable deposit instruments covered by Philippine Deposit Insurance
Corporation (PDIC) up to Php500,000.00. The tenor is typically five years.
Mortgage-Backed Securities - is an investment similar to a bond that
consists of a bundle of home loans bought from the banks that issued
them.

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 Thank you for listening!

“That in all things, God may be glorified!”

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