Finance -key player in ensuring continuity of operations.
Finance - French 'finer' > to end and settle a debt.
Sources of Wealth
 Entrepreneurship - Profit
 Capital - Interest
 Land - Rent
 Labor - Salaries/Wages
Tools used in financial decision-making - drawn from:
 Mathematics
 Statistics
 Psychology
 Accountancy
Deals in providing quantitative information.
Focuses of capital markets study:
1. Financial System
2. Structure of Interest Rates
3. Pricing of Assets
Financial System
-> Financial system permits an efficient method to move funds between entities who have funds and
entities who need funds.
 Fund providers - have available funds because they spend less than their income
 Fund demanders - have fund shortage because they spend more than their income.
Funds can flow in two routes
 Direct Financing - borrower-spenders borrow and deal directly with lenders through selling
financial instruments.
 Indirect Financing - borrowing activity happens indirectly through the intervention of financial
intermediaries.
-> Transfer of funds allows parties to gain some return.
-> A properly functioning financial system also enhances welfare of individual consumers as they have
immediate access to funds.
Flow back of fund
 Business enterprise - through profit
 Government - through taxes
 Investors - through interest or dividends.
-> Efficient financial markets enhance the economic well-being of all members of the society.
ELEMENTS OF FINANCIAL SYSTEM
1. Lenders and borrowers (who are the players)
o without these two parties, the financial system will not exist.
2. Financial Intermediaries (how will the exchange occur)
o acts as third party to facilitate borrowing activity between lenders and borrowers.
o gather funds from lenders and redistribute to borrowers through investment vehicle
3. Financial Instruments (what will be used)
o medium of exchange of contractual obligation of a party where such contract can be traded.
4. Financial Markets (where will it be traded)
o same with other economic markets where suppliers and buyers of financial instruments
meet.
5. Regulatory Environment (how is it controlled)
o governance body to ensure that the transactions that occur between financial systems
complies with the laws and regulations
6. Money Creation (what is the value it creates)
o used to either be reinvested or earned out of the system flows
7. Price Discovery (how much is created)
o the process of determining or valuing the financial instrument in the market
THE FINANCIAL MARKETS
 channels where funds and financial instruments are exchanged between willing
entities/individuals.
 provide additional options to lenders and borrowers on which form they want their transaction to
be in.
-> exchanging of financial instruments is also known as trading
3 Major Economic Functions of Financial Instruments
1. Price Discovery
o interaction between buyers and sellers in the financial market in order to come up with the
price of the traded financial instrument.
o Price level
 willing to be bought by buyer
 willing to be sold by seller
2. Liquidity
o easy access to a venue where investors can sell their financial instruments for cash
3. Reduction in Transaction Costs
o transaction costs are incurred of parties' transaction to trade a financial instruments.
Two types:
a. Search Cost
 costs incurred to look for financial instruments that can be purchased or sold by a
party
b. Information Cost
 costs related in evaluating investment characteristics of a financial instrument.
 information gathered
a. profitability
b. liquidity
c. stability
d. market value
TYPES OF FINANCIAL MARKETS
Based on Instruments Traded
 Money Market
o short-term security
o sector where financial instruments that will mature or be redeemed in one year or less from
issuance date are traded
o not exclusive for short-term investors. Long-term investors also need it to meet their shortterm liquidity needs.
o offer an investment opportunity that yields a higher return than just mere holding of cash.
o very liquid and easily convertible to cash and has very little default risk
 Capital Market
o financial Instruments issued by governments and corporations that will mature beyond one
year from issuance date are traded.
Based on Market Type


Primary Market
a. Public Offering
 securities are offered for sale to the general public
b. Private Placement
 the issuer looks for a single investor, an institutional buyer or group of buyers to
purchase the whole securities issuance instead of offering it to the general public.
c. Auction
Usually used for issuance of treasury bills, bonds and other securities
 Dutch Auction
Seller begins the sale at a high price
 English Auction
prospective buyers commence the auction by submitting an initial bid price
 Descending Price Sealed Auction
bidders submit sealed bid to the sellers
d. Tap Issue
 issuers are open to receive bids for their securities at all times
Secondary Market
o securities issued in primary market are subsequently traded, resold and repurchased
Economic functions
o Price Discovery
 secondary market provides information about prices of the securities traded which can
influence economic decisions
o Liquidity and Reduction in Borrowing Cost
 secondary market allows active trading which improves liquidity and marketability of
the securities
o Support to the Primary Market
 price discovery helps in giving information that can be helpful in
a. setting prices for new issuances executed in the primary market
b. assessing receptiveness of the market for new issuances
o Implementation of Monetary Policy
 secondary market allows regulators such as BSP to trade securities to influence liquidity
and interest rates set in the financial system
Classification based on Market Structure
o Order-Driven
the buyers and sellers propose their price through their brokers who conveys the bid in
centralized location
 Market orders
deals with the instruction to execute transaction at the prevailing best market price
 Limit orders
orders placed where clients set a price or price range that may be below/above the
existing price
 Day orders
orders placed that only valid until the end of the business day
 Good-until-cancelled orders
orders placed that remains valid for a sustained period up until the client voluntarily
cancels
o Quote-Driven Market Structure
the market makers establish a price quote at which the market participants should trade
with
Based on Where Financial Instruments are Traded
 Exchange
o financial instruments are purchased or sold between market participants
 Over-the-counter
o unlisted financial instruments are allowed to be traded
o can also be done through computers
o market do not have formalized mechanisms to regulate transactions unlike exchanges
Based on Country's Perspective
 Internal or National Market
Financial market operating in a certain country
o Domestic Market
Market where issuers who are considered residents in a country issue the securities and
where these securities are traded afterwards
o Foreign Market
Market where issuers who are not residents of a country can sell or issue securities and
subsequently traded
 External Market
a. Upon issuance, offered simultaneously to investors in different countries
b. Securities are issued outside the regulatory jurisdiction of any single country
Based on Manner of Financial Intermediaries
 In a broker market
o the buyer and the seller of the securities are brought together by a broker and the trade
occurs at that point
 In a dealer market
o the buyer and seller are not brought directly together by a third party. Instead, market
makers execute the sell or buy orders
Reference:
Lascano, M.V., Baron, H.C., and Cachero, A.L. (2019) Fundamentals of Financial Markets.