Republic of the Philippines

President Ramon Magsaysay State University

College of Accountancy and Business Administration
(Formerly Ramon Magsaysay Technological University)
Iba, Zambales, Philippines
Tel/Fax No.: (047) 811-1683

FINANCIAL MANAGEMENT
Module 5

FINANCIAL MARKETS AND

INSTITUTIONS

Name:
Course/Year and Section:
Instructor:
Date:

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 Republic of the Philippines
President Ramon Magsaysay State University
College of Accountancy and Business Administration
(Formerly Ramon Magsaysay Technological University)
Iba, Zambales, Philippines
Tel/Fax No.: (047) 811-1683

College/Department College of Accountancy and Business Administration

Course Code AE 19
Course Title Financial Management
Place of the Course in the
Program
Semester & Academic Year First Semester AY 2020-2021

Introduction

A firm’s primary financial goal is to maximize long-run shareholder value.

Shareholder value is ultimately determined in the financial markets. If financial managers are
to make good decisions, they must understand how these markets operate. In addition,
individuals make personal investment decisions so they too need to know something about
financial markets and the institutions that operate in those markets.

Intended Learning Outcomes

When the students finish this module, they should be able to do the following:
1. Identify the different types of financial markets and financial institutions
2. Explain how these markets and institutions enhance capital allocation.
3. Explain how the stock market operates, and list the distinctions between the different
types of stock markets.
4. Explain how the stock market has performed in recent years.
5. Discuss the importance of market efficiency, and explain why some markets are more
efficient than others.
6. Develop a simple understanding of behavioral finance..

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Discussion

Businesses, individuals, and governments often need to raise capital. For example,
CBD Company forecasts an increase in the demand for electricity in the Philippines, so it will
build a new power plant to meet those needs. CBD’s bank account does not contain the 1
billion necessary to pay for the plant, the company must raise this capital in the financial
markets.
On the other hand, some individuals and firms have incomes that exceed their current
expenditures so they have funds available to invest. For example, Mr. A has an income of
36,000, but her expenses are only 30,000. That leaves him with 6,000 to invest.
People and organizations with surplus funds are saving in order to accumulate funds
for some future use. Members of a household might save to pay for their children’s education
and the parents’ retirement, while a business might save to fund future investments. Those
with surplus funds expect to earn a return on their investments, while people and
organizations that need capital understand that they must pay interest to those who provide
that capital.
In a well-functioning economy, capital flows efficiently from those with surplus
capital to those who need it. This transfer can take place in the three ways:
1. Direct transfers of money and securities occur when a business sells its stocks or
bonds directly to savers, without going through any type of financial institution.
The business delivers its securities to savers, who, in turn, give the firm the money
it needs. This procedure is used mainly by small firms, and relatively little capital
is raised by direct transfers.
2. Transfers may also go through an investment bank (IB). An underwriter facilitates
the issuance of securities. The company sells its stocks or bonds to the investment
bank, which then sells these same securities to savers. The businesses’ securities
and the savers’ money merely “pass through” the investment bank. However,
because the investment bank buys and holds the securities for a period of time, it
is taking a risk—it may not be able to resell the securities to savers for as much as
it paid. Because new securities are involved and the corporation receives the sale
proceeds, this transaction is called a primary market transaction.
3. Transfers can also be made through a financial intermediary such as a bank, an
insurance company, or a mutual fund. Here the intermediary obtains funds from
savers in exchange for its securities. The intermediary uses this money to buy and
hold businesses’ securities, and the savers hold the intermediary’s securities. For
example, saver deposits dollars in a bank, receiving a certificate of deposit; then
the bank lends the money to a business in the form of a mortgage loan. Thus,
intermediaries literally create new forms of capital—in this case, certificates of
deposit, which are safer and more liquid than mortgages and thus better for most
savers to hold. The existence of intermediaries greatly increases the efficiency of
money and capital markets.

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FINANCIAL MARKETS

Different financial markets serve different types of customers or different parts of the
country. Financial markets also vary depending on the maturity of the securities being traded
and the types of assets used to back the securities.

TYPES OF MARKETS
1. Physical asset markets versus financial asset markets. Physical asset markets (also
called “tangible” or “real” asset markets) are for products such as wheat, autos, real
estate, computers, and machinery. On the other hand, financial asset markets deal with
stocks, bonds, notes, and mortgages.
2. Spot markets versus futures markets. Spot markets are markets in which assets are
bought or sold for “on-the-spot” delivery (literally, within a few days). Futures
markets are markets in which participants agree today to buy or sell an asset at some
future date.
3. Money markets versus capital markets. Money markets are the markets for short-
term, highly liquid debt securities. Capital markets are the markets for intermediate-
or long-term debt and corporate stocks. There is no hard-and-fast rule, but in a
description of debt markets, short-term generally means less than 1 year,
intermediate-term means 1 to 10 years, and long-term means more than 10 years.
4. Primary markets versus secondary markets. Primary markets are the markets in
which corporations raise new capital. Secondary markets are markets in which
existing, already outstanding securities are traded among investors.
5. Private markets versus public markets. Private markets, where transactions are
negotiated directly between two or more parties, are differentiated from public
markets, where standardized contracts are traded on organized exchanges.

Other classifications could be made, but this breakdown shows that there are many
types of financial markets.

FINANCIAL INSTITUTIONS
1. Investment banks traditionally help companies raise capital. They (1) help
corporations design securities with features that are currently attractive to investors,
(2) buy these securities from the corporation, and (3) resell them to savers.
2. Commercial banks are the traditional “department stores of finance” because they
serve a variety of savers and borrowers.
3. Financial services corporations are large conglomerates that combine many
different financial institutions within a single corporation. Most financial services
corporations started in one area but have now diversified to cover most of the
financial spectrum.
4. Credit unions are cooperative associations whose members are supposed to have a
common bond, such as being employees of the same firm.
5. Pension funds are retirement plans funded by corporations or government agencies
for their workers and administered primarily by the trust departments of commercial

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 banks or by life insurance companies. Pension funds invest primarily in bonds, stocks,
mortgages, and real estate.
6. Life insurance companies take savings in the form of annual premiums; invest these
funds in stocks, bonds, real estate, and mortgages; and make payments to the
beneficiaries of the insured parties.
7. Mutual funds are corporations that accept money from savers and then use these
funds to buy stocks, long-term bonds, or short-term debt instruments issued by
businesses or government units.
8. Exchange Traded Funds (ETFs) are similar to regular mutual funds and are often
operated by mutual fund companies.
9. Hedge funds are also similar to mutual funds because they accept money from savers
and use the funds to buy various securities. Mutual funds (and ETFs) are registered
and regulated by the Securities and Exchange Commission (SEC), while hedge funds
are largely unregulated.
10. Private equity companies are organizations that operate much like hedge funds, but
rather than purchasing some of the stock of a firm, private equity players buy and then
manage entire firms.

STOCK MARKET
PHYSICAL LOCATION STOCK EXCHANGES
Physical location exchanges are tangible entities. Each of the larger exchanges
occupies its own building, allows a limited number of people to trade on its floor, and has an
elected governing body—its board of governors.

OVER-THE-COUNTER (OTC) AND THE NASDAQ STOCK MARKETS

OTC operates as auction markets—buy and sell orders come in more or less
simultaneously, and exchange members match these orders. Today these markets are often
referred to as dealer markets. A dealer market includes all facilities that are needed to conduct
security transactions, but the transactions are not made on the physical location exchanges.
Brokers and dealers who participate in the OTC market are members of a self-
regulatory body known as the Financial Industry Regulatory Authority (FINRA), which
licenses brokers and oversees trading practices. The computerized network used by FINRA is
known as NASDAQ, which originally stood for “National Association of Securities Dealers
Automated Quotations.” It started as a quotation system, but it has grown to become an
organized securities market with its own listing requirements.

MARKET FOR COMMON STOCK

Some companies are so small that their common stocks are not actively traded. They
are owned by relatively few people, usually the companies’ managers. These firms are said to
be privately owned, or closely held, corporations and their stock is called closely held stock.
On the other hand, the stocks of most large companies are owned by thousands of investors,
most of whom are not active in management. These companies are called publicly owned
corporations, and their stock is called publicly held stock.

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TYPES OF STOCK MARKET TRANSACTIONS
1. Outstanding shares of established publicly owned companies that are traded: the
secondary market.
2. Additional shares sold by established publicly owned companies: the primary market.
3. Initial public offerings made by privately held firms: the IPO market.

DEFINITION OF TERMS:
1. Market price: The current price of a stock.
2. Intrinsic value: The price at which the stock would sell if all investors had all
knowable information about a stock.
3. Equilibrium price: The price that balances buy and sell orders at any given time.
4. Efficient market: A market in which prices are close to intrinsic values and stocks
seem to be in equilibrium.
When markets are efficient, investors can buy and sell stocks and be confident that they
are getting good prices. When markets are inefficient, investors may be afraid to invest and
may put their money “under the pillow,” which will lead to a poor allocation of capital and
economic stagnation. From an economic standpoint, market efficiency is good.

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 Republic of the Philippines
President Ramon Magsaysay State University
College of Accountancy and Business Administration
(Formerly Ramon Magsaysay Technological University)
Iba, Zambales, Philippines
Tel/Fax No.: (047) 811-1683

Student Name:___________________ Email Address:_________________

Course/Year:_____________________ Mobile Number:________________

Kindly answer the questions and submit your answers to my email address
[email protected] on _____________________.

Define each of the following terms:

a. Spot markets; futures markets

b. Money markets; capital markets
c. Primary markets; secondary markets
d. Private markets; public markets
e. Derivatives
f. Investment banks (IBs); commercial banks; financial services corporations
g. Mutual funds; money market funds
h. Exchange traded funds; hedge funds; private equity companies
i. Physical location exchanges; over-the-counter (OTC) market; dealer market
j. Closely held corporation; publicly owned corporation

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