FINANCIAL MARKETS BY Mrs Belen Apostol FINANCIAL MARKETS

FINANCIAL MARKETS BY: Mrs. Belen Apostol

FINANCIAL MARKETS • Brings together individuals and firms who want to borrow money with those who want to lend. • Provide a permanent venue for savers and borrowers, and which render financial services whenever required by their customers. • Expedite the creation and trading of financial instruments.

Direct Credit Market Funds SURPLUS SPENDING UNITS Households Business Firms Government Funds Intermediation Market DIRECT FINANCING Private placements Brokers Dealers Investment Bankers Channels for Funds and Financial Instruments in the Financial Market Primary Securities Secondary Securities INDIRECT FINANCING BY FINANCIAL INTERMEDIARIES Commercial Banks Savings & Loans Associations Mutual Savings Banks Credit Unions Insurance companies Finance companies Mutual Funds Money Market Funds Primary Securities Funds DEFICIT SPENDING UNITS Households Business Firms Government Primary Securities Funds Direct Credit Market

Benefits of Financial Markets The operation of financial markets offer advantages which covers the following: 1. Funds are directed to DSUs which can use them most efficiently DSUs that can use borrowed funds in the most productive manner can afford to pay higher interest rates. For this, they have an edge in the bidding for loanable amounts. Big and small business firms compete for the use of the funds made available by the financial market. Interest rates becomes higher and it motivates savers to save more to have more funds for lending

Benefits of Financial Markets 2. Liquidity is provided to savers Without financial market, savers lend directly to borrowers. They wait for the maturity date of the loan before they get their money back. Lenders could not get their money even if they need it before the maturity date. Thru financial markets, the financial instruments issued to lenders could be converted to cash before the maturity date by endorsement or sale.

Why firms Invest and Borrow • Quantity discounts for bulk purchases granted by suppliers; and • Additional revenues from sales.

Methods by which Financial Markets transfer funds 1. Direct Finance 2. Indirect Finance Direct Finance – lending by ultimate borrowers with no intermediary. The SSU gives money to the DSU in exchange for financial claims on the DSU. The claims issued are called direct claims and are typically sold in direct credit markets such as the money or capital markets. - provides SSUs with a venue for saving with expected return. DSUs are provided with a source of funds for consumption or investment. (increases the efficiency of the financial market)

Direct Financing Disadvantages 1. There are few DSUs which can transact in the direct market because the denominations of securities sold are very large (millions of pesos) 2. It is difficult to match the requirements of SSUs and DSUs in terms of denomination, maturity and other factors.

Methods of Direct Financing 1. Private placements 1. Brokers and dealers; and 1. Investment brokers

Methods of Direct Financing Private placement – selling of securities by private negotiation directly to insurance companies, commercial banks, pension funds, large-scale corporate investors, and wealthy individual investors Broker – an intermediary between buyers and sellers but does not take title to the securities traded Dealer – one who is in the security business acting as a principal rather than an agent. The dealer buys for his account and sells to customer from inventory. He makes profits by selling his inventory of securities at a price higher than the acquisition cost. Investment banker – provides financial advice and underwrites and distributes new investment securities

Indirect Finance • Also called financial intermediation – refers to lending by an ultimate lender to a financial intermediary that then relends to ultimate borrowers • Includes commercial banks, mutual savings banks, credit unions, life insurance companies, and pension funds.

INDIRECT FINANCE FINANCIAL INTERMEDIARIES Funds Lenders – Savers 1. Households 2. Business Firms 3. Government 4. Foreigners FINANCIAL MARKETS Funds Borrowers - Spenders 1. Business Firms 2. Government 3. Households 4. Foreigners DIRECT FINANCE Transfer of Funds From Lenders to Borrowers

Classification of Financial Markets 1. 2. 3. 4. 5. 6. 7. 8. Primary market Secondary market Money market Capital market Bond market Stock market Mortgage market Consumer credit market 9. Auction market 10. Negotiation market 11. Organized market 12. Over-the-counter market 13. Spot market 14. Futures market 15. Options market 16. Foreign exchange market

Primary Market • A financial market in which newly issued primary and secondary securities are traded for the first time • Investors who buy these new issues are supplying funds to DSUs which issue securities • Large corporations needing large amount of funds usually tap the primary market through bond issuance.

Secondary Market • Existing financial securities are traded • SSUs which bought new securities from the primary market may sell the same to the secondary market anytime they wish to change their portfolios before maturity dates. (provides liquidity to the SSUs with securities held) • When banks buy Treasury Bills from the Banko Sentral they do so in consideration of their clients who buy the T- Bills from them and which forms a solid secondary market.

Money Market • A financial market on which debt securities with an original maturity of one year or less are traded. Long- term securities may also be traded in the money market if they have six months or less left to maturity. Banks like Land Bank of the Philippines perform money market functions.

Money Invested PRIMARY MARKET: New Issues The Flow of Funds and Securities in Primary and Secondary Markets Investment Bankers and Private Placement New Funds New Common Stock and Bond Certificates Household Sector New Stock and Bond Certificates Money Common Stock and Bond Certificates Money Stock Exchanges and Over-the-Counter Market SECONDARY MARKET: Seasoned or Existing Issues Business Sector

Capital Market • Trading is undertaken for securities with maturity of more than one year. Banks that bid for two year Treasury bonds are considered part of the capital market. • The capital market is subdivided into three parts: 1. The bond market 2. The stock market; and 3. The mortgage market

Bond Market • The market for debt instruments of any kind. • It operates through a system of dealers using a telecommunications network, rather than in a single physical location for trading. Dealers include giant banking firms located around the world.

Stock Market • The common and preferred stocks issued by corporations are traded. It has two components: 1. the organized exchanges 2. less formal over-the-counter markets • There are many organized exchanges throughout the world like New York and London Stock Exchanges. In the Philippines, stocks are openly traded in the Philippine Stock Exchange.

Stock Market • The companies whose stocks are traded in the Philippine Stock Exchange are classified into the following categories: 1. Banks 2. Financial service 3. Communication 4. Power and energy 5. Transportation services 6. Construction and other related products 7. Food, beverages, and tobacco 8. Holding firms 9. Manufacturing, distribution and trading 10. Hotel, recreation, and other services 11. Bonds, preferred stocks and warrants 12. others

Mortgage Market • Deals with loans on residential, commercial, and industrial real estate and farmland • The mortgage market is composed of various financial institutions. • This may be derived from a review of advertisements in newspapers where financial institutions invite interested parties to buy foreclosed properties. • Banks, National Home Mortgage Finance Corporation, Government Service Insurance System (GSIS), and Social Security System (SSS) grant mortgage loans secured by house and lot collaterals.

Consumer Credit Market • Involved in auto, appliances, education, and travel loans. • A no. of financing institutions extend auto and salary and various personal loans to consumers Auction Market • Trading is conducted by an independent party according to a matching of prices on orders received to buy and sell a particular security • Stocks are sold to the highest bidder on the trading floors

Auction Market • At the Philippine Stock exchange, buyers of securities make their bids and prospective sellers make their offer. • Bids and offers stipulate both price and volume and are handled by the trader. • Trader – an agent of the auction market • Offers are ranked from the lowest price up; bids from the highest price down. Bids and offers are matched with one another. If there is a match, trade is consummated. Buyers and sellers do not directly trade with one another, but through a trader • E. g. Philippine Stock Exchange

Negotiation Market • Buyers and sellers of securities negotiate with each other regarding price and volume, either directly or through a broker or dealer. • Securities that are not frequently traded and which are in large volumes may not be readily accommodated in the auction market for lack of time to receive sufficient orders. This situation is remedied by the negotiation market where the buyers and sellers are given sufficient time to locate one another and to revise either price or volume in order to clear the market. • The Philippine government, negotiates with institutions like the World Bank for loans intended for various projects.

Organized Market • A financial market with fixed trading rules. • It is situated at a central location in the financial district which trading is generally conducted by auction. • The Philippine Stock Exchange is an example of organized market where common and preferred stocks, bonds and warrants are sold • Stock exchanges have specifically designated members • Board – elected governing body • Members have seats in the exchange, which are bought and sold. • The seat gives the holder the right to trade on exchange • The board of governors of the Philippine Stock Exchange is composed of 15 members

Over-the-Counter Market • Consists of large collection of brokers and dealers, connected electronically by telephones and computers that provide for trading in unlisted securities. • All securities not traded in the stock exchange are traded over the counter • The over-the-counter market consists of facilities, namely: 1. Relatively few dealers who hold inventories or over-thecounter securities and act as a securities market. 2. The many brokers who act as agents in bringing these dealers together with investors; and 3. The computers, terminals and electronic networks that provide communications link between dealers and brokers

Spot Market • Securities are traded for immediate delivery and payment. • The spot price is the feature of the spot market and which is actually the price paid for a security that will be delivered on the spot immediately. • Immediately may mean one or two days to one week depending on the facilities used or the tradition in the area. • An alternative to the futures market

Futures Market • Contracts are originated and traded that give the holder the right to buy something in the future at a price specified by the contract. • Futures market used to operate in the Philippines but it was dissolved because of some difficulties. • The Bankers Association of the Philippines has recommended key reforms in government regulations that will pave the way for the resumption of futures trading in the country.

Options Market • One where stock options are traded • Stock option – a contract giving the owner the right to either buy or sell a fixed number of shares of a stock (usually 100) at any time before the expiration date at a price specified in the option. • Options contracts may cover items like gold and Treasury bonds. Options are traded in organized securities exchanges like the Philippine Stock Exchange. • One purpose of the options market is to make possible for investors who wish to reduce the risk of losing money due to price changes in the future. • For instance, an importer purchasing goods to be paid in foreign currency may avoid the risk of a sharp rise in the foreign exchange rate by buying an options contract

Foreign Exchange Market • People buy and sell foreign currencies • Composed of the following: 1. Banks located throughout the world buying and selling foreign monies, in the form of foreign currencies and deposits in foreign banks; 2. Foreign exchange dealers; and 3. Currency exchanges catering mostly to tourists and are found in the downtown areas, airports and railroad stations in major tourist centers.

Homework • Why is knowledge of financial markets an important requirement in business finance?