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L2: FM, insti, instr
MAS2: Financial Markets, Institutions, and Instruments
| Term | Definition |
|---|---|
| financial system | - plays the key role in the economy - stimulates economic growth - influence economic performance of the actors that affects the economic welfare |
| 3 main components of the financial system | 1. financial instruments 2. financial intermediaries 3. financial markets |
| asset | - any resource expected to provide future benefits - possesses economic value |
| two categories of asset | 1. tangible 2. intangible |
| financial asset | - financial instruments/securities - intangible assets - provide future benefits in the form of a claim to future cash - e.g. savings, stocks |
| any transaction related to financial instrument includes two parties: | 1. the issuer 2. investor |
| key economic functions of financial assets | - transferring funds - redistributing risks |
| financial market | - transfer of financial instrument - where financial instruments are traded - facilitates the flow of funds to finance investments by corporations, governments, and individuals |
| financial market | 1. price discovery 2. liquidity 3. reduction of transaction cost |
| price discovery | - transaction bet. buyers and sellers of financial instruments in a financial market to determine the price of traded asset |
| liquidity | - provides an opportunity for investors to sell a financial instrument at its fair market value at any time |
| reduction of transaction cost | - when financial market participants are charged/bear the costs of trading a financial instrument |
| key attributes determining transaction costs | 1. asset specifity 2. uncertainty 3. frequency of occurence |
| transaction costs | 1. cost of search and information 2. cost of contracting and monitoring 3. cost of incentive problems |
| cost of search and information | explicit cost: e.g. broker implicit cost: e. g. time na ginugol mo |
| cost of contracting and monitoring | - makes sure that the terms in the contract are followed |
| cost of incentive problems | - mga itinatago para mas maging maganda |
| participants in financial markets | 1. public investors 2. brokers 3. dealers 4. credit rating agencies |
| financial markets | 1. internal market 2. external market |
| internal market | - national market 1. domestic market 2. foreign market |
| domestic market | - where issuers domiciled in the country - issue securities then traded |
| foreign market | - where securities are sold and traded outside of the country of issuers |
| external market | - international market/ offshore market/ euromarket |
| money market | - includes financial instruments that have a maturity or redemption date that is one year or less at the time of issuance - e.g. treasury bills, commercial paper, time deposit |
| capital market | - long-term financial instruments issued by corporations and governments are traded |
| 2 types of capital market securities | 1. equity 2. debt |
| equity | - represent ownership interest - no maturity - issued by corporations, and those that represent indebtedness - advantage for investors: high return - disadvantage: high risk |
| debt | - issued by corporations and by the state and local governments - advantage to investors: low risk - disadvantage: low return |
| cash market | - spot market - market for the immediate purchase and sale of a financial instrument |
| derivative market | - cotract - provide for price discovery and risk transfer for securities, commodities, and currencies - contracts called derivative instruments are traded are traded |
| primary market | - first issuance of financial instrument - where securities are created - new securities (stocks, bonds) are issued and solf for the first time - done usually through initial public offerings(IPO) |
| secondary market | - financial instruments are resold among investors - already issued securities are bought and sold by investors |
| classification of secondary markets | 1. stock exchanges 2. over-the-counter market |
| stock exchanges | - central trading locations where financial instruments are traded |
| over-the-counter market | - generally where unlisted financial instruments are traded - stock that are not trading on stock exchange |
| financial market regulation | - aimed to ensure the fair treatment of participants - aims of regulation is to ensure business disclosure of accurate information for investment decision-making - regulatory framework has to provide the equal access to disclosures by companies |
| financial institution | - intermediary that channels the savings of individuals, businesses, and governments into loans or investments |
| roles of financial institutions | 1. create 2. facilitate 3. assist 4. provide 5. manage |
| create | - create more favorable transactions that could be realized by lenders and borrowers dealing directly with each other in the financial market |
| facilitate | - facilitating the trading of financial assets of the customers through brokering arrangements |
| assist | - assisting in the creation of financial assets for its customers and the distributing those financial assets |
| provide | - providing investment advice to customers - provide payment mechanism |
| manage | - manage financial assets of customers |
| broad types of financial institution | 1. depository 2. non-depository |
| depository institutions | 1. commercial banks 2. saving institutions 3. credit unions |
| commercial banks | - most dominant depository institution - serve surplus units by offering a wide variety of deposit accounts - transfer deposited funds to deficit units by providing direct loans or purchasing debt securities - e.g. BDO |
| saving institutions | - thrift institutions - include savings and loan associations and savings banks |
| credit unions | - nonprofit - restrict their business to credit union members who share a common bond (such as common employer or union) |
| other depository institutions | 1. central banks (BSP) 2. retail banks (PNB) 3. universal banks (Metrobank) 4. large banks (Bangko de Oro) 5. community banks (RCBC) 6. online banks (Maya) |
| non-depository institutions | 1. finance companies 2. mutual funds 3. securities firms 4. issuance companies 5. pension funds |
| finance companies | - obtain funds by issuing securities and then lend the funds to individuals and small businesses |
| mutual funds | - sell shares to surplus units and use the funds received to purchase a portfolio of securities - dominant in non-depository financial institution when measured in total assets |
| securities firms | - provide a wide variety of functions in financial markets - act as brokers/ dealers - provide underwriting and advising services |
| insurance companies | - provide individuals and firms with insurance policies that reduce financial burden associated with death, illness, and damage to property |
| pension funds | - provide an efficient way for individuals to save for their retirement - manage the money until the individuals withdraw the funds from their retirement accounts |
| roles of financial instruments | 1. raising capital 2. facilitating transactions 3. income generation 4. risk management 5. price discovery |
| raising capital | - businesses and government can raise capital through financial capital through financial instruments |
| facilitating transactions | - buying, selling, and managing assets |
| income generation | - financial instruments offer investors various income streams - through interests, capital gains, dividends) - certificate of deposits |
| risk management | - financial instruments enables the management and reduction of financial risks |
| price discovery | - financial instruments play a role in discovering an asset's price |
| category of financial instruments | 1. non-tradables 2. non-transferrables 3. securities 4. derivatives |
| non-tradable | - instruments that cannot be easily bought or sold in secondary markets - e.g. private equity |
| non-transferrable | - instruments that cannot be transferred from one party to another |
| derivatives | - instruments that have values determined from underlying assets - e.g. interest rates, currency, bonds, stocks, and stock indexes |
| examples of derivatives | 1. swaps 2. options |
| swaps | - agreement to exchange one security for another with the intent of altering the security terms to which each party individually is subjected |
| options | - give buyers the right, but not the obligation, to buy or sell an underlying asset at an agreed price and date |
| securities | - tradable financial assets - represent some form of ownership or creditor relationship - equity-based or debt-based |
| debt-based instruments | - reflect a loan the investor made to the issuing entity |
| short-term debt-based instruments | - maturity of one year or less - e.g. treasury bills, commercial papers, certificate of deposits |
| treasury bills | - low interest rates - very low risk of default since the government assures that these will be paid |
| commercial papers | - promissory notes issued by financial institutions or large firms - short maturity period - secured only by the reputation of the issuer |
| certificate of deposits | - time deposit - savings account that holds a fixed amount of money for a fixed period of time - bank pays interest |
| medium-term debt-based instruments | - have maturity of more than one year but less than 10 years - notes and floating rate |
| notes | - legal document representing a loan made from an issuer to a creditor or an investor |
| floating rate notes | - debt securities with interest payments that vary periodically based on a reference interest rate |
| long-term debt-based instruments | - maturity of over ten years - e.g. corporate bonds and mortgage-backed securities |
| corporate bonds | - corporations - maturities over ten years |
| mortgage-backed securities | - debt securities collateralized by a mortgage or a collection of mortgages |
| equity-based instruments | - reflects ownership of the issuing entity - returns from equity instruments come from either dividends or stock price appreciation - e.g. common stock |
| common stock | - class of stock that represents equity ownership in a corporation |
| instruments that can be viewed as mix debt and equity | 1. preferred stock 2. convertible bond |
| preferred stock | - fixed income instrument - investor is only entitled to receive a fixed contractual amount |
| convertible bond | - allows the investor to convert debt into equity under certain circumstances |
Created by:
tabeeelll
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