Mindanao State University

College of Business Administration and Accountancy

Department of Accountancy

Chapter 1

Introduction to Financial Market

Written Report in ACT171

(Financial Markets)

Submitted by:
Disoma, Norhata S.
Goling, Hafsa A.
H. Carim, Muslimah D.

Submitted to:
Prof. Sittie Ayesha Ote, CPA

Section A2
June 2024
What is Financial Market?
Financial Markets include any place or system that provides buyers and sellers the
means to trade financial instruments, including bonds, equities, the various international
currencies, and derivatives and others. Financial markets act as an intermediary between
providers of funds and users of funds. It helps the savers to become investors in their
capacity. Thus it also helps private and public institutions to raise money to expand their
business or to carry on projects and infrastructure.

What is Financial System?

A financial system is a group of financial institutions and financial markets that
creates financial instruments and financial services. It efficiently transfers the funds from
one party to another party. These parties consist of savers, investors, intermediaries,
financial instruments, lenders, and the users of funds. The financial system serves as a
channel to transfer funds from individual, private, or public companies, and government
agencies who want to borrow money.
The Basic Functions of the Financial System

1. Promote Savings Functions

2. Payment Function
3. Protection Against Risks Functions
4. Means to Wealth Function
5. Provide Liquidity Function
6. Credit Facility Function

The Philippine Financial System

Economists view that the highly developed and dynamic economic system would
be impossible without an equally sophisticated financial system. The economic system is
involved in the aspect of producing goods and services, while the financial system
interacts in a variety of ways to create and to manage credit facilities including the
supplying of money and much- needed financial instruments.
A financial system may be defined as the diversified financial activities being
performed by the different economic units whose activities are so closely related to each
other taking into account the use of money, credit, and different instruments associated
with money. The different economic units are the financial institutions: banks and non-
banks, business organizations, and individuals.

Classification of the Financial System in the Philippines

The Philippines has a comprehensive banking system encompassing various types
of banks, from large universal banks to small rural banks and even non-banks.
Universal Bank
Provides financial service conglomerates that combine investment banking,
commercial banking, development banking, and insurance to encompass a wider variety
of service. It has the authority to exercise as a commercial bank, the power of an
investment house and the power to invest in non-allied enterprises. Like all other
financial institutions, universal bank are under the supervision of the Bangko Sentral ng
Pilipinas.

Some of Local Universal Banks:

 Government-owned
1. Al-Amanah Islamic Investment Bank of the Philippines
2. Development Bank of the Philippines
3. Land Bank of the Philippines
 Private-owned
1. BDO Unibank, Inc.
2. China Banking Corporation
3. Metropolitan Bank and Trust Company
4. Philippine National Bank
5. Union Bank of the Philippines.

Commercial Bank
In terms of capitalization, commercial bank is next to universal bank. Common
functions of commercial banks are:
a. Accept drafts and Issue letters of credit,
b. Discount and negotiate promissory notes, drafts, bills of exchange, and other
evidence of debt,
c. Accepts and create demand deposits,
d. Receive other types of deposits and deposit substitutes,
e. Buy and sell foreign exchange and gold or silver bullion,
f. Acquire marketable bonds and other debt securities, and
g. Extend credit, subject to such rules as the Monetary Board may promulgate.

Examples of commercial banks:

1. BDO Private Bank, Inc.
2. Maybank Philippines, Inc.
3. Robinsons Bank Corporation.
Thrift Bank
These banks are primarily concern with the mobilization of savings and loans, and
provide short-term working capital, medium and long-term financing, and diversified
financial and allied services for their chosen market and constituencies especially for the
small and the medium enterprise and individuals (RA 7906- Thrift Act of 1995)
Examples of Thrift Banks:
1. Allied Savings Bank
2. Bank One Savings and Trust Corporation
3. BPI Direct Savings Bank

Cooperative Bank
it is a retail and commercial bank organized on a cooperative basis. Cooperative
banking, just like a thrift bank, accepts deposits and provides loans to individuals to
undertake ventures using principles of the cooperative. It is carried out by credit unions,
mutual savings bank, building societies and cooperatives. Cooperative banking is
common to barangays, farmers, and even in the workplace.

Examples of Cooperative Bank:

1. One Network Bank
2. CARD Bank, Inc.
3. Metro South Cooperative Bank

Islamic Bank
Islamic Banking has the function and purpose of conventional banking. However,
adhering to Islamic law and ensuring fair play are the core of Islamic banking. Islam
forbids lending money for interest. The basic principle of Islamic banking is based on risk-
sharing which is component of trade rather than risk-transfer which is seen in
conventional banking. Islamic banking introduces concepts such as profit sharing,
safekeeping, joint venture, cost plus and leasing.

Government Banks
Is a financial institution controlled by the government. This kind of bank plays a
special role in the economic development of one country.

Investment Bank
It is an enterprise whose function is to underwrite securities of another person or
enterprise, including securities of government and private companies. It also provides
planning, consultancy, fund management, and raising funds through equity financing and
borrowings.
Investment companies
These companies are engaged in the buying and selling securities. Most often, the
trust is engaged in the business of investing the pooled capital of investors in financial
securities. The way of conducting their business is either through a closed-end fund or an
open-end fund. An open-end, also known as a mutual fund, does not have restrictions
on the number of shares the fund will issue. These are redeemable anytime and on a day-
to-day basis. It has no fixed amount of paid-in capital. If demand is high enough, the
fund will continue to issue shares no matter how many investors are there. Open-end
funds also allow the investors to buy back shares anytime they wanted.

Securities Dealers/Brokers
Securities Dealers are companies that buy and sell stocks of other companies to
resell them for a profit. They do not receive commission since they are generating profits
based on their trading. Securities Brokers are individuals or firms engaged in the buying
and selling of stocks for commission.

Insurance companies
These are companies that provide insurance in case of loss to the insured
individuals and firms. They transfer the risk of a loss, from one entity to another in
exchange for payment called premium. Insurance is the most basic way of handling risk
and many investors are still into it as a way of risk management. They are using insurance
to hedge against any possibility of financial loss. Insurance may take the form of life,
health, real estate, fire, accident and even credit cards.

Credit Unions
These are composed of member-owned producers and consumers. They are
operated to promote thrift, short-term credit at competitive rates, and provide other
financial services to its members. Most credit unions provide services to support
community development or sustainable international development on a local level.

Pawnshops
They are financial institutions that cater to financing to relativity low-income
individuals. Borrowing requires collateral to guarantee payment. Collateral may take the
forms of rings, necklaces, earrings, gadgets, and any small valuable items.

Financial Intermediary
Financial Intermediary brings together the users and the providers of funds
without having them meet face to face. For this reason, they are also known as an
indirect form of funds channeling. It provides advantages to the providers of funds, and
they are:
 1. Financial Intermediaries hire people who are highly qualified to assess risky
investments.
2. Financial Intermediaries knows how to diversify
3. It has a cost advantage of economies of scale.
4. It helps reconcile conflicting interest of the users and lenders of funds. Normally,
lenders would like to lend their money for the short term while the borrowers
would like it long-term, so it can provide liquidity.
5. Financial Intermediaries give savers liquidity.

Financial market
It is a mechanism where buyers and sellers participate in the trade of financial
assets such as stocks, bonds, currencies and derivatives. Unlike financial intermediaries, it
is not a source of funds but a link to provide a forum in which suppliers of funds and
demanders of loans/investments can transact business.

Money market
This is a market intended for short-term placements. The placement usually takes
one year or less to mature. The money market exists to the fact that people or firms alike
are looking for temporary investment where their idle funds can be placed and earn an
additional income. To some extent, some companies are looking for short-term financing
to support the firm’s seasonal needs. With the presence of money market, this situation
can be easily resolved to meet the temporary needs of the providers and users of funds.

Money market instruments

There are many money market instruments traded in the market. Some of them are:
 Negotiable Certificate of Deposit. It is a time deposit where the investor and the
bank agree on the term of placement. The amount in consideration for this kind
of security is considerably higher than the regular time deposit.
 Commercial paper. It is an unsecured promissory note with a fixed maturity of 1
to 270 days. Commercial paper is a money-market security issued by a high credit
rating companies to raise money to meet short term obligations.
 Repurchase Agreement. It is a financial instrument in which one party sells a
financial instrument to another party at a specified price with a commitment to
repurchase the financial instrument at a fixed amount agreed at a specified date,
 Treasury bills. It is an obligation by the national government. The interest is
normally higher than the savings and time deposit. T-bills are issued through a
competitive bidding process at a discount form par; the return expected by the
investor is through capital appreciation.
 Banker’s Acceptance. It is a bank draft where the bank is required to pay the
holder a specified amount on a specified date. It has a maturity of 90 days from
 the date of issue, but can be extended up to 10 days. People who invested in bank
draft expect a capital appreciation.

Capital market
The money market is for short-term financial instruments while the capital market
is more for long-term financial instrument. Included in the capital market are issuance of
securities and long-term obligations by business and government agencies.

There are two important element of capital market;

1. Organized Security Exchange. A securities exchange operates under the rules and
regulations formulated by an exchange. Investors actively trading on the exchange
are aware of the rules and conduct trades accordingly. In the Philippines, the most
active security exchange is the Philippine Stock Exchange.
 Philippine Stock Exchange, Inc is a private organization that provides and
ensures a fair, efficient, transparent, and orderly market for the buying and
selling securities.
2. Over-the-counter markets. It is involve in the buying and selling of financial
instrument but not in organized security exchanges, these are stocks of
corporations that were registered and licensed by the Securities and Exchange
Commission to sell stocks, which were not being traded in the PSE to the public.

Types of capital market:

1. Primary Market - It is a venue where firms and government agencies raise money
using issuing financial instruments like stocks or bonds for the first time. The proceeds
from the new issues go directly to the issuer. Once the securities are sold to the public
for the first time, it is called an initial public offering (IPO).

Players in the Primary Market

a. Issuers - These are the public or private corporations. Funds are raised using public
issues, rights issues, or through private placements.
b. Financial instruments - These are the instruments purchased by the investors. These
may take the forms of bonds, equities, and warrants.
c. Financial Intermediaries - These are the financial institutions that facilitate the
issuance of securities. Examples are universal banks and investment banks.
d. Investors - Individuals or firms who have excess funds and are willing to invest in
the securities offered.

2. Secondary Market - It is also called the aftermarket. It is the place where financial
instruments already issued are traded. The secondary market provides for the first
owner of the issued securities to be sold to the market. In the secondary market, the
 securities are sold by the investor to another investor for profit or cutting loss. The
gain or loss is based on the trading price of the instrument in an organized market
such as the PSE. It is also in the secondary market where the current market price of
the instruments is determined.

Other Examples of Financial Markets

1. Bond market - It is a place where long-term debt instruments are issued by firms and
government agencies to raise money. It is also a market where the participants are
buying and selling bonds.
2. Interest rate and bond price have an inverse relationship. When the interest rate is
high, the price of the bond is low, and when the interest rate is low, the price of the
bond is high.
3. Commodity market - It is a place where raw or commodities are traded. The
commodities are traded on regulated commodities exchanges where they are bought
and sold in standardized contracts. Forward contracts and futures contracts are
normally used in executing exchanges in this kind of market.
4. Stock market - It is a place where publicly listed stocks are bought and sold. If the
firm would like to raise money in the form of stocks, they normally go to an
investment banker to facilitate the selling. This is in the form of an Initial Public
Offering (IPO) where the stocks are sold for the first time to the general public.
5. Derivatives market - This provides instruments to manage financial risk. The market
can be divided into two: exchange-traded derivatives and over-the-counter
derivatives.
6. Foreign exchange market - Banks normally have this as one of their functions. It is a
global decentralized or over-the-counter (OTC) market for the trading of currencies.
This market determines foreign exchange rates for every currency. It includes all
aspects of buying, selling, and exchanging currencies in the current or determined
prices.

Efficient Market Hypothesis (EMH)

It is a hypothesis that serves as one of the foundations of modern finance theory.

It states that the stock prices already reflect all available information in the market and
this information is immediately available to the investing public. This hypothesis also
describes that the market is perfect and nobody should benefit from the fluctuation of
the prices.

In a book written by Gitman (2006), he stated that EMH, which is the basic
theory describing the behavior of such a “perfect" market, specifically states that;
1. Securities are typically in equilibrium, which means that they are fairly priced and
that their expected returns equal their required returns.
2. At any point in time, security prices fully reflect all public information available about
the firm and its securities, and these prices react swiftly to new information.
3. Because stocks are fully and fairly priced, investors need not waste their time trying
to find and to capitalize on mispriced securities.

The efficient markets theory was first proposed by the French mathematician,
Louis Bachelier in 1900 in his Ph.D. thesis “The Theory of Speculation" describing how
prices of commodities and stocks varied in markets. The efficient-market hypothesis has
been forgotten for several years not until it emerged as a prominent theory in the mid-
1960s when empirical studies were made by famous economists and mathematicians
during that time.

Eugene Francis Fama is most often thought of as the father of the efficient-market
hypothesis. It is Fama who proposed the following three types of market efficiency:

1. Strong-form - It is a concern with all information sets, including private

information, are incorporated in price trends and it states no monopolistic
information can entail profits. In other words, insider trading cannot make a
profit in the strong-form market efficiency world.
2. Semi-strong form - It requires that all public information is reflected in prices
already, such as companies’ announcements or annual earnings figures.
3. Weak efficiency - It is saying that the information set is just historical prices, which
can be predicted from historical price trends; thus, it is impossible to profit from it.

International Financial Market

The Philippine financial market and financial institutions have been developing
good ties with other countries around the world. International debts and equity markets
are those markets that do not only issue debts and equities in their respective countries
but also in other parts of the world. Maintaining good tie-ups with other countries helps
to grow the economy of one country. Financing the needs of one country, at times are
not enough to support government and private projects. At times, they have to come up
with borrowings or issuing equities abroad to serve as additional support for financing.