Course Code: BAFIN101B
Course Title: Financial Markets
Chapter1:
Development of the Monetary System
Money is a commodity accepted by general
consent as a medium of economic exchange.
It is the medium in which prices and values
are expressed; as currency, it circulates
anonymously from person to person and
country to country, thus facilitating trade and
it is the principal measure of wealth.
BARTER SYSTEM
Barter is the direct exchange of goods or
services— without an intervening medium of
exchange— either according to established
rates of exchange or by bargaining. It is
considered the oldest form of commerce.
Barter is common among traditional
societies, particularly in those communities
with some developed form of market. Goods
may be bartered within a group as well as
between groups, although gift exchange
probably accounts for most intragroup trade,
particularly in small and relatively simple
societies. Where barter and gift exchange
coexist, the simpler barter of ordinary
household items or food is distinguished
from ceremonial exchange (such as a
potlatch), which serves purposes other than
purely economic ones.
ADVANTAGES OF BARTERING
There are a number of reasons why a barter
economy or being able to barter is beneficial.
As mentioned above, there may be times
when cash is not readily available, but goods
or services are.
Bartering allows individuals to get what they
need with what they already own. If, for
example, an individual needs lumber to put
an addition onto their home but lacks funds
to buy the lumber, they may be able to use the
barter system to supply their needs - for
example, exchanging furniture they don’t
need for the needed lumber.
Such a deal, of course, needs to be negotiated
by both parties. It is a reciprocal, mutuallybeneficial arrangement that doesn’t involve
the exchange of cash or another monetary
medium (such as a credit card).
Disadvantages of Bartering
The problem with a barter economy is its
inefficiency. The first potential problem is -
using the example above - the person seeking
lumber may not be able to find a supplier of
lumber who is in need of something the
lumber seeker can provide.
The second potential problem comes with
trying to guarantee their fair exchanges. How
does one calculate, for example, a fair
exchange rate of eggs for a television set?
EVOLUTION OF MONEY
Some of the major stages through which
money has evolved are as follows:
1. Commodity Money - In the earliest
period of human civilization, any
commodity generally demanded and
chosen by common consent was used
as money. Goods like furs, skins, salt,
rice, wheat, utensils, weapons, etc.
were commonly used as money. Such
exchange of goods for goods was
known as “barter exchange”.
2. Metallic Money - With the progress
of human civilization, commodity
money changed into metallic money.
Metals like gold, silver, copper, etc.
were used as they could easily be
handled and their quantity can be
easily ascertained. It was the main
form of money throughout the portion
of recorded history.
3. Paper Money - It was found
convenient as well as dangerous to
carry gold and silver coins from place
to place. So, the invention of paper
money markets was a critical stage in
the development of capital. Paper
money is regulated by the Central
Bank of the country (Bangko Sentral
ng Pilipinas). At present, a very large
part of money consists mainly of
currency notes or paper money issued
by the central bank.
4. Credit Money - The emergence of
credit money took place almost
alongside that of paper money.
People keep a part of their cash as
deposits with banks, which they can
withdraw at their convenience
through cheques. The cheque (known
as credit money or bank money), is
not money itself but performs the
same function.
5. Plastic Money - The latest type of
money is plastic money in the form of
credit cards and debit cards. They aim
at removing the need for carrying
cash to make transactions.
Money has evolved through different
stages according to time, place, and
circumstances.
THE SIGNIFICANCE OF MONEY
Money facilitates both national and
international trade. The use of money as
a medium of exchange, as a store of
value, and as a transfer of value has made
it possible to sell commodities not only
within a country but also internationally.
To facilitate trade, money has helped in
establishing money and capital markets.
There are banks, financial institutions,
stock exchanges, produce exchanges,
international financial institutions, etc.
which operate on the basis of the money
economy and they help in both national
and international trade.
Further, trade relations among different
countries have led to international
cooperation. As a result, developed
countries have been helping the growth of
underdeveloped countries by giving them
loans and technical assistance. This has
been made possible because the value of
foreign aid received and its repayment by
developing countries is measured in
money.
UNFAVORABLE
MONEY
EFFECTS
OF
Money is not an unmixed blessing. Total
dependence or misuse of money may lead
to undesirable and harmful results. In the
words of Robertson, “Money, which is a
source of so many blessings to mankind,
becomes also, unless we can control it, a
source of peril and confusion. “ The
following are the various disadvantages
of money:
1. Instability - A great disadvantage of
money is that its value does not
remain constant which creates
instability in the economy. Too much
money reduces its value and causes
inflation and too little money raises
its value and results in deflation (i.e.,
a fall in the price level). Inflation
distorts the pattern of distribution in
favor of the rich; thus, it makes the
rich richer and the poor poorer.
Deflation, on the other hand, results
in unemployment and hardships for
the working class.
2. Inequality of Income - Money,
through its excessive use and
inflationary effect, creates and widens
the inequalities in the distribution of
income and wealth. This divided
society into ‘haves’ and ‘have-nots’
and led to a class conflict between
them.
3. Growth of Monopolies - The use of
money leads to the concentration of
wealth in a few hands and this gives
rise to monopolies. The growth of
monopolies results in the exploitation
of the workers bringing misery and
degradation to them.
4. Over-Capitalization
Easy
borrowing and lending facilities,
made possible through money, may
lead certain industries to use more
capital than is required. This overcapitalization, in turn, results in overproduction and unemployment.
5. Misuse of Capital - Money, which is
the basis of credit, leads to the
creation of more and more credit
creation. Credit creation, if not
matched by the increase in
production, results in an inflationary
rise in prices.
6. Hoarding - In the materialistic world,
people give undue importance to
money and, instead of utilizing it in
productive activities, may start
hoarding. This would adversely affect
the growth of income, output, and
employment of the economy.
7. Black Money - Money, due to its
storability characteristic, is the cause
of the evil of black money. It provides
people with a convenient way to
evade taxes by concealing their
income. Black money, in turn,
encourages black marketing and
speculative activities.
8. Political
Instability
Wide
fluctuations in prices and business
activities, caused by money, may lead
to political instability. This may result
in a change of government.
9. Moral and Social Evils - In modern
times, moral values have been
sacrificed at the altar of money.
People have become so much moneyminded that they openly indulge in
corrupt practices to satisfy their greed
for money. Money is also the root
cause of thefts, murders, fraud, and
other social evils.
To conclude, the defects of money do not,
however, indicate its elimination. The
advantages of money far exceed its
disadvantages. It is a good servant and a
bad master. What is required is the proper
regulation of money supply through a
wisely formulated monetary policy to
ensure the efficient working of the
economic system and to achieve the
socio-economic objectives of the
economy.
THE FUNCTIONS OF MONEY
The basic function of money is to enable
buying to be separated from selling, thus
permitting trade to take place without the
so-called double coincidence of barter. In
principle, credit could perform this
function, but, before extending credit, the
seller would want to know about the
prospects of repayment. That requires
much more information about the buyer
and imposes costs of information and
verification that the use of money avoids.
THE ATTRIBUTES OF MONEY
1. General Acceptability - An
important quality of money is its
acceptance. Good money requires
acceptance by all without any
hesitation.
2. Portability - Apart from its
acceptance, good money also requires
portability. I people can carry or
transfer money from one place to
another, then it is good money.
3. Durability - Acceptance and
portability aside, the material used to
make money must last for a long time
without using its value.
4. Divisibility - Talking about the
qualities of good money, it is
important
to
remember
the
divisibility of money.
5. Homogeneity - An important quality
of good money. If money is not
homogenous, then transactions will
become uncertain as people would be
unsure of what they are receiving.
6. Cognizability - The ability to
recognize money is critically
important. If money is cognizable,
7. Stability - Of all the qualities of good
money, stability is the most essential
one. The value of money cannot
change for a long period of time and
hence remain stable.
KINDS OF MONEY
The four major types of money:
1. Commodity Money - It is the
simplest kind of money that is used in
barter systems where valuable
resources fulfill the functions of
money. The value of this kind of
money comes from the value of
resources used for the purpose. It is
only limited by the scarcity of
resources. The value of this kind of
money involves the parties associated
with the exchange process. This
money has intrinsic value.
Whenever any commodity is used for
an exchange purpose, the commodity
becomes equivalent to the money and
is called commodity money. There
are certain types of commodities,
which are used as commodity money.
Among these, there are several
precious metals like gold, silver,
copper, and many more. Again, in
many parts of the world, seashells
(also known as cowrie shells),
tobacco, and many other items were
in use as a type of money & medium
of exchange. Ex: gold coins, beads,
shells, pearls, stones, tea, sugar,
metal.
2. Fiat Money - The word fiat means
‘the command of the sovereign”. Fiat
currency is the kind of money which
don’t have any intrinsic value and
can’t be converted into a valuable
resource. The value of fiat money is
determined by government order
which makes it a legal instrument for
all transaction purposes. Fiat money
needs to be controlled as it may affect
the entire economy of a country if it is
misused. Today Fiat money is the
basis of the modern money system.
The real value of fiat money is
determined by the market forces of
demand and supply.
3. Fiduciary Money - It is generally
paid in gold, silver, or paper money.
Cheques and banknotes are examples
of fiduciary money because both are
some kind of token used as money
and carry the same value.
Fiduciary money is generally paid in
gold, silver, or paper money. There
are cheques and banknotes, which are
examples of fiduciary money because
both are some kind of token that is
used as money and carry the same
value.
4. Commercial Bank Money - Demand
deposits are claims against financial
institutions that can be used for the
purchase of goods and services. A
demand deposit account is an account
where funds can be withdrawn at any
time by cheque or cash withdrawal
without giving the bank or financial
institution any prior notice.
Banks have the legal obligation to
return funds held in demand deposits
immediately upon demand (or ‘at
call’). Demand deposit withdrawals
can be performed in person, via
cheques or bank drafts, using
automatic teller machines (ATMs), or
through online banking.
OTHER TYPES OF MONEY

Fractional Money - It is a hybrid
type of money that is partly backed by
a commodity and has a fiat money
transaction purpose. If the commodity
loses its value then Fractional money
converts into Fiat money.

Representative
Money
It
represents a claim on a commodity
and it can be redeemed for that
commodity at a bank. It is a token or
paper money that can be exchanged
for a fixed quantity of a commodity.
Its value depends on the commodity it
backs.


Coins - Metals of particular weight
are stamped into coins. There are
various precious metals like gold,
silver, bronze, and copper whose
coins are already used in human
history. The minting of coins is
controlled by the state.
Paper Money - Paper money doesn’t
have any intrinsic value, as fiat
money, it is approved by government
order to be treated as legal tender
through which value exchange can
happen. Governments print the paper
money according to the requirements
which are tightly controlled as it can
affect the economy of the country.
COINAGE
It means the process of manufacturing
metals into certain shapes to maintain
uniformity in all coins of the same kind.
In the old ages, gold and silver metals
were commonly used as a media of
exchange.
There were many problems in the
transactions of metals. So to remove these
problems the government has taken over
the sole power of coinage money. Now
government converts the metal into
standard coins.
Now a day it is a very easy medium of
exchange and tempering with metallic
currency is very difficult.
KINDS OF COINAGE
1. Free Coinage System - If the people
are allowed to take mental to the mint
for the conversion into standard coins
without limit, it is called the free
coinage system. Before 1993, this
system was prevailing in U.K and
USA.
2. Limited Coinage System - When the
government limits the conversion of
metal into standard coins, it is called
a limited coinage system. The
government keeps in view the
currency requirement of the country.
Government imposes limits on the
free coinage of other metals.
Sometimes the fee is also charged.
The face value is greater than its
original value.
3. Gratuitous Coinage System - When
Govt. does not charge any fee for
minting coins it is called gratuitous
coinage. This system is adopted at a
time when the intrinsic value of
bullion is to be brought at par with its
face value.
4. Non-Gratuitous Coinage System In this system Government charges a
fee for converting metal into coins.
Sometimes, it charges only minting
cost (brassage) and sometimes more
than the cost seignior-age.
5. The Debasement of Coinage
System - When there is a difference
in the face value of a coin fixed by
law and the original value of metallic
it is called debasement.

DETECTING
COUNTERFEIT
BILLS AND COINS
How to Detect Fake Money vs Real
Money in the Philippines

When you know what to look for and
where to look, you can easily
determine fake money vs. real money.
The BSP has come up with a threestep inspection method called FEEL,
LOOK, and TILT. This method is
detailed below together with two
additional handy tips.
 FEEL
In this step, you’re supposed to
feel a note’s tactile cues that will
prove its authenticity. Here are
the things you need to check:



Security
Paper
– The
Philippine banknote should
feel different from the usual
paper. After all, it’s primarily
made of abaca fiber. It
shouldn’t be exaggeratedly
smooth.
Embossed Prints – The note
features embossed elements,
so you’ll feel a variation of
textures across its surface.
Tactile Marks – A few pairs
of congruent lines on either
side of the note are marks that
help visually impaired people
to identify and differentiate
bills. Furthermore, these
marks are a sign that your note
is authentic.

Asymmetric Serial Number – At the
lower left and upper right sides of the
note, you’ll find the serial number.
This should bear one to two prefix
letters and six to seven digits. The
font increases in size and thickness.
See-Through Mark – At the lower
right corner of the note, you’ll notice
a truncated Babaylan script. Hold the
money against the light, and the
truncated part will be visible,
revealing the entirety of the script.
The said script means PILIPINO.
 TILT
Continue your visual inspection by
tilting your money. Doing this will
reveal features that aren’t found on
fake notes.


 LOOK
How can you tell the difference
between real and fake money?
You can tell the difference
between fake money vs real
money by looking at the unique
visual features of a note. Here’s
what you need to check:


Watermark – This is the
“apparition” of the faces
featured on the bill. If you
hold the note under the light,
you’ll see these shadow
images on the right side.
Security Fiber – Security
fibers are the thin yet visible
lines that are randomly
spread on the front and
back of the note. They
should come in blue
and red.


Security
Thread
– For
smaller notes like ₱20 and
₱50, this is the vertical line
that runs across the width of
the bill. This line becomes
visible when you view your
bill against the light. For
larger notes, such as ₱100,
₱200, ₱500, and ₱1,000, the
line appears as a series of
metallic dashes featuring the
note’s value and the text
“BSP.”
Concealed Numerical Value
– At the upper right corner of
the bill, you’ll see a smaller
version of the portrait. Tilt the
note at a 45-degree angle, and
you’ll see the money’s value
over the portrait.
Optically Variable Ink (for
₱1,000 notes) – The money’s
value printed on the lower
right corner of the note should
not be only embossed; its
color should also change from
green to blue when you view
it at different angles. A fake
1000-peso bill doesn’t have
this feature.
Optically Variable Device
Patch (for ₱500 and ₱1,000
notes) – The reflective foil
printed on the left side of the
note’s portrait has a hidden visual
cue. To check if it’s a fake 500
peso bill or not, tilt your ₱500
note. You’ll see an image of the
Blue-naped parrot. For the
₱1,000 note, you’ll see an image
of a clam with the South Sea
pearl.

Enhanced Value Panel (for
₱500 and ₱1,000 notes) – For
newer notes, the numerical
value on the left side of the
bill should have a colorshifting effect.
 Try Damaging the Bill
Rub some water on the paper bill.
If the color smudges and the bill
starts tearing, it could be a sign
that the money you have is fake.
Remember, the notes are not
made of regular paper, so they
shouldn’t come apart even if
they’re exposed to water. Also,
try to scratch the bill. If the
printing smears or shows any sign
of damage, it could be counterfeit.
 Consider the Changes in
Design
From time to time, the BSP
releases new money designs. In
every release, you should pay
attention to the new elements and
features of the notes.
For instance, the 2022 design of
the ₱1,000 note features the
Philippine Eagle instead of the
country’s World War II Heroes.
This new design is part of the
polymer or plastic bills that runs
alongside the existing 1,000 peso
paper banknotes. So, if you
receive a ₱1,000 note featuring
the Philippine Eagle that’s not
printed on polymer, chances are
it’s a fake 1,000 peso bill.



Well-functioning financial markets,
such as the bond market, stock
market, and foreign exchange market,
are key factors in producing high
economic growth.
Financial Institutions are the
institutions that make financial
markets work.
“Financial Institutions are the
intermediaries, that take funds from
the people who save and lend it to
people who have productive
investment opportunities”.
IMPORTANT FUNCTIONS
The economic system relies heavily on
financial resources and transactions, and
economic efficiency rests in a part on
efficient financial markets.
Financial Market consist of:

Agents,
brokers,
institutions,
intermediaries, and transacting
purchases and sales of securities
The many persons and institutions operating
in the financial markets are linked by:
- contracts, communications networks which
form an externally visible financial structure,
laws, and friendships.
The financial market is divided between
investors and financial institutions.
The term financial institution is a broad
phase referring to organizations that act as
agents, brokers, and intermediaries in
financial transactions. Agents and brokers
contract on behalf of others; intermediaries
sell for their own accounts.
Course Code: BAFIN101B
Course Title: Financial Markets
Chapter 2:
Introduction and Overview of Financial
Markets
Financial
intermediaries
purchase
securities for their own accounts and sell their
own liabilities and common stock.
- For example, a stockbroker buys and sells
stocks for us as our agent, but a savings and
loan borrow our money (savings account)
and lends it to others (mortgage loan).
Why study Financial Markets?



Financial markets, such as bond and
stock markets, are crucial in our
economy.
These markets channel funds from
savers
to
investors,
thereby
promoting economic efficiency.
Market activity affects personal
wealth, the behavior of business
firms, and the economy as a whole.
The stockbroker is classified as an agent and
broker, and savings and loans are called
financial intermediaries.
Brokers and savings and loans, like all
financial institutions, buy and sell securities,
but they are classified separately because the
primary activity of brokers is buying and
selling rather than buying and holding an
investment portfolio.
Financial institutions are classified according
to their primary activity, although they
frequently engage in overlapping activities.
2. Capital Market

A capital market is an
institutional arrangement for
the trading of medium and
long-term securities or equity
and debt.
Financial markets are a mechanism for the
exchange trading of financial products within
a policy framework.

They are characterized by a large volume of
transactions and the speed with which
financial resources move from one owner to
the other.
The major purpose of capital
markets is to mobilize longterm savings and finance
long-term investments.

It also provides liquidity with
a mechanism enabling the
investor to sell financial
assets, encourages broader
ownership of productive
assets, lowers the cost of
transactions and information,
and
improves
the
effectiveness
of
capital
allocation by way of a
competitive
pricing
mechanism.

So, it comprises all long-term
borrowings from banks as
well as financial institutions,
borrowings from foreign
markets, and raising of capital
by issuing several securities
such as shares, debentures,
bonds, etc.

The market participants in
capital
markets
are
widespread
and
include
everyone
from
Retail
Investors to Strong Financial
Entities such as Banks and
Mutual Funds.
OVERVIEW
MARKETS
OF
FINANCIAL
They perform the important functions of an
efficient payment the mechanism, providing
information about companies, enhancing the
liquidity of financial claims, transmutation of
financial claims to suit the preferences of
both savers and borrowers, diversification
and reduction of risk, and an efficient source
for capital generation and investment.
Financial Markets consist of two distinct
types of markets –
1. Money Market

The money market is a
market for short-term debt
instruments with maturity
below one year. It is a highly
liquid market where securities
are bought and sold in large
quantities
to
reduce
transaction costs.

Such securities are often riskfree.

Call
money
market,
certificates
of
deposits,
commercial paper, repo, and
treasury bills are the major
instruments of the money
market.



The money market constitutes
a very important segment of
the financial system as it
facilitates the conduct of
monetary policy.
The main investors in the
money market are financially
strong entities such as banks
and mutual funds.
Participation
of
retail
investors is less due to low
returns in comparison to other
markets.
Primary Market
The primary market is also known as the new
issue market. It consists of mechanisms for
the procurement of long-term funds by fresh
issues of shares and debentures.
Secondary Market
The secondary market is also called the stock
market. It provides a ready market for longterm securities. The secondary market has
two components: the over-the-counter (OTC)
market and the exchange-traded market.
TYPES OF FINANCIAL MARKETS
A financial market is a marketplace that
provides an avenue for the sale and purchase
of assets, such as bonds, stocks, foreign
exchange, and derivatives.
Financial markets, from the name itself, are a
type of marketplace that provides an avenue
for the sale and purchase of assets such as:
- bonds, stocks, foreign exchange, and
derivatives
Often, they are called by different names,
including “Wall Street” and “capital market,”
but all of them still mean one and the same
thing.
Simply put, businesses and investors can go
to financial markets to raise money to grow
their business and to make more money,
respectively.
There are so many financial markets, and
every country is home to at least one,
although they vary in size. Some are small
while others are internationally known, such
as the New York Stock Exchange (NYSE)
which trades trillions of dollars on a daily
basis. Here are some types of financial
markets:
1. Stock Market
- The stock market trades shares of
ownership of public companies.
- Each share comes with a price, and
investors make money with the stocks
when they perform well in the market.
- It is easy to buy stocks. The real
challenge is in choosing the right
stocks that will earn money for the
investor.
- There are various indices that
investors can use to monitor how the
stock market is doing, such as the
Dow Jones Industrial Average (DJIA)
and the S&P 500.
- When stocks are bought at a cheaper
price and are sold at a higher price,
the investor earns from the sale.
2. Bond Market
- The bond market
offers
opportunities for companies and the
government to secure money to
finance a project or investment.
- In a bond market, investors buy
bonds from a company and the
company returns the amount of the
bonds within an agreed period, plus
interest.
3. Commodities Market
- The commodities market is where
traders and investors buy and sell
natural resources or commodities
such as corn, oil, meat, and gold.
- A specific market is created for such
resources because their price is
unpredictable.
- There is a commodities futures
market wherein the price of items that
are to be delivered at a given future
time is already identified and sealed
today.
4. Derivatives Market
- Such a market involves derivatives
or contracts whose value is based on
the market value of the asset being
traded.
FUNCTIONS OF THE MARKET
The role of financial markets in the success
and strength of an economy cannot be
underestimated. Here are four important
functions of financial markets:
1. Puts savings into more productive
use. Financial markets like banks
open it up to individuals and
companies that need a home loan,
student loan, or business loan.
2. Determines the price of securities.
Investors aim to make profits from
their securities. However, unlike
goods and services whose price is
determined by the law of supply and
demand, prices of securities are
determined by financial markets.
3. Makes financial assets liquid.
Buyers and sellers can decide to trade
their securities anytime. They can use
financial markets to sell their
securities or make investments as
they desire.
4. Lowers the cost of transactions. In
financial markets, various types of
information regarding securities can
be acquired without the need to
spend.
IMPORTANCE
MARKETS
OF
FINANCIAL
There are many things that financial markets
make possible including the following:
- Financial markets provide a place where
participants like investors and debtors,
regardless of their size, will receive fair and
proper treatment.
- They provide individuals, companies, and
government organizations with access to
capital.
called “transparent” systems of AngloAmerican finance
FINANCIAL MARKET REGULATION
- Financial markets help lower the
unemployment rate because of the many job
opportunities it offers.
DIMENSIONS
MARKETS
OF
FINANCIAL
The first is the extensiveness of
participation in financial markets, ranging
from markets limited to very elite
participation (Continental) to markets with
mass participation.
The second dimension is the structure of
financial intermediation of the financial
market—the complexity of the linkages
between suppliers of capital and users of
capital, bet
The third dimension is the relative
dominance of primary and secondary
financial markets. Primary financial
markets are the site of “new issues” of
securities and literally involve exchanges
between financiers and industrialists.
Secondary financial markets are the site of
trading in already issued shares, and do not
involve the provision of capital to industry
but are rather locations of trading among
financiers.
The fourth dimension is the relative
dominance of investment and speculation.
Market participants who invest buy securities
and hold them to receive interest or
dividends. Market participants who speculate
buy securities to resell at a profit
The fifth dimension is the type of security
that predominates on the market:
debentures versus equity. Debentures (debt)
are bonds and other interest-bearing
securities that provide a fixed return to
investors.
A sixth dimension is an organizational
form of financial securities markets,
ranging from “private associations” For
example, in America government bureaus in
Continental Europe.
A seventh dimension is a form of financial
accounting and the extensiveness of
financial information available to market
participants, ranging from quite “opaque”
information systems like those of Continental
Europe and some Asian economies to the so-
The financial markets are among the most
heavily regulated sectors of the economy.
The most important goals of financial market
regulation are the protection of the individual
(protection of creditors, investors, and
insured persons), system stability and
properly functioning financial markets.
Through the increasing cross-border
integration of financial markets, international
standards have a substantial impact on
financial market regulation. Switzerland is
actively involved in the corresponding
international bodies that draw up these
standards. If the same cross-border rules
apply to everyone, this ultimately strengthens
the competitiveness of the domestic financial
center.
When formulating or revising financial
market regulations, State Secretariat for
International Finance (SIF) pays particular
attention to the following points.

Involvement
of
stakeholders.
Broad-based exchanges with the
industry take place during regular
meetings on general topics and
specific projects. Where appropriate,
customers (e.g. insured persons) are
included in these exchanges.

Cost/benefit analyses. In the case of
new regulatory projects, cost/benefit
analyses are carried out and the
probable economic impact is
evaluated right from the outset (quick
check and regulatory impact
assessment).

Ex post evaluations. Together with
the administration, independent
experts examine whether existing
regulations are effective and whether
there is a need for deregulation or
greater regulation.
OVERVIEW
OF
INSTITUTIONS
FINANCIAL
A financial institution (FI) is a company
engaged in the business of dealing with
financial and monetary transactions such
as deposits, loans, investments, and
currency exchange. Financial institutions
encompass a broad range of business
operations within the financial services
sector including banks, trust companies,
insurance companies, brokerage firms,
and investment dealers.
Virtually everyone living in a developed
economy has an ongoing or at least
periodic need for the services of financial
institutions.
TYPES
OF
INSTITUTIONS
FINANCIAL
1. Central Bank
Central banks are the financial
institutions responsible for the
oversight and management of all
other banks.
The Bangko Sentral ng Pilipinas
(BSP) is the central bank of the
Republic of the Philippines.
In the United States, the central bank
is the Federal Reserve Bank, which is
responsible for conducting monetary
policy and supervision and regulation
of financial institutions.
Individual consumers do not have
direct contact with a central bank;
instead, large financial institutions
work directly with the Federal
Reserve Bank to provide products and
services to the general public.
2. Retail and Commercial Banks
Traditionally, retail banks offered
products to individual consumers
while commercial banks worked
directly with businesses. Currently,
the majority of large banks offer
deposit accounts, lending, and limited
financial
advice
to
both
demographics.
Products offered at retail and
commercial banks include checking
and savings accounts, certificates of
deposit (CDs), personal and mortgage
loans, credit cards, and business
banking accounts.
3. Internet Banks
A newer entrant to the financial
institution market is internet banks,
which work similarly to retail banks.
Internet banks offer the same
products and services as conventional
banks, but they do so through online
platforms instead of brick-and-mortar
locations.
Under internet banks, there are two
categories: digital banks and neobanks. Digital banks are online-only
platforms affiliated with traditional
banks. However, neobanks are pure
digital native banks with no affiliation
to any bank but themselves.
4. Credit Union
A credit union is a type of financial
institution providing traditional
banking services and is created,
owned, and operated by its members.
In the recent past credit unions used
to serve a specific demographic per
their field of membership, such as
teachers or members of the military.
Nowadays, however, they have
loosened
the
restrictions
on
membership and are open to the
general public.
Credit unions are not publicly traded
and only need to make enough money
to continue daily operations. That's
why they can afford to provide better
rates to their customers than
commercial banks.
5. Savings and Loan Associations
Financial institutions that are
mutually owned by their customers
and provide no more than 20% of
total lending to businesses fall under
the category of savings and loan
associations. They provide individual
consumers with checking accounts,
personal loans, and home mortgages.
Unlike commercial banks, most of
these institutions are communitybased and privately owned, although
some may also be publicly traded.
The members pay dues that are
pooled together, which allows better
rates on banking products
6. Investment Banks
Investment banks are financial
institutions that provide services and
act as an intermediary in complex
transactions, for instance, when a
startup is preparing for an initial
public offering (IPO), or in merges.
They can also act as a broker or
financial
adviser
for
large
institutional clients such as pension
funds.
Investment banks do not take
deposits;
instead,
they
help
individuals,
businesses
and
governments raise capital through the
issuance of securities. Investment
companies, traditionally known as
mutual fund companies, pool funds
from individuals and institutional
investors to provide them access to
the broader securities market.
Global investment banks include
JPMorgan Chase, Goldman Sachs,
Morgan Stanley, Citigroup, Bank of
America, Credit Suisse, and Deutsche
Bank. Robo-advisors are the new
breed of such companies, enabled by
mobile technology to support
investment services more costeffectively and provide broader
access to investing by the public.
7. Brokerage Firms
Brokerage firms assist individuals
and institutions in buying and selling
securities among available investors.
Customers of brokerage firms can
place trades of stocks, bonds, mutual
funds, exchange-traded funds (ETFs),
and some alternative investments.
8. Insurance Companies
Financial institutions that help
individuals transfer the risk of loss are
known as insurance companies.
Individuals and businesses use
insurance companies to protect
against financial loss due to death,
disability,
accidents,
property
damage, and other misfortunes.
9. Mortgage Companies
Financial institutions that specialized
in originating or funding mortgage
loans are mortgage companies. While
most mortgage companies serve the
individual consumer market, some
specialize in lending options for
commercial real estate only.
Mortgage
companies
focus
exclusively on originating loans and
seek
funding
from
financial
institutions that provide the capital for
the mortgages.
Many mortgage companies today
operate online or have limited branch
locations, which allows for lower
mortgage costs and fees.
What is the Main Difference between a
Bank and Other Financial Institutions?
The main difference between banks and nonbanking other financial institutions is that the
latter cannot accept deposits into savings and
demand deposit accounts, whereas these are
the core business for banks.
What is a Financial Intermediary?
A financial intermediary is an entity that
acts as the middleman between two parties
generally banks or funds, in a financial
transaction. A financial intermediary may
lower the cost of doing business.
How do Banks make Money?
Commercial banks make money from a
variety of fees and by earning interest from
loans such as mortgages, auto loans, business
loans, and personal loans. Customer deposits
provide banks with the capital to make these
loans
FINANCIAL SYSTEM
A financial system is a set of institutions,
such as banks, insurance companies, and
stock exchanges, that permit the exchange of
funds.
Financial systems exist on firm, regional, and
global levels. Borrowers, lenders, and
investors exchange current funds to finance
projects, either for consumption or
productive investments, and to pursue a
return on their financial assets.
The financial system also includes sets of
rules and practices that borrowers and lenders
use to decide which projects get financed,
who finances projects, and the terms of
financial deals.
Understanding the Financial System
Like any other industry, the financial system
can be organized using markets, central
planning, or some mix of both.
Financial markets involve borrowers,
lenders, and investors negotiating loans and
other transactions.
In these markets, the economic good traded
on both sides is usually some form of money:
current money (cash), claims on future
money (credit), or claims on the future
income potential or value of real assets
(equity).
These also include derivative instruments.
Derivative instruments, such as commodity
futures or stock options, are financial
instruments that are dependent on an
underlying real or financial asset's
performance. In financial markets, these are
all traded among borrowers, lenders, and
investors according to the normal laws of
supply and demand.
In a centrally planned financial system (e.g.,
a single firm or a command economy), the
financing of consumption and investment
plans is not decided by counterparties in a
transaction but directly by a manager or
central planner.
Which projects receive funds, whose projects
receive funds, and who funds them is
determined by the planner, whether that
means a business manager or a party boss.
Most financial systems contain elements of
both give-and-take markets and top-down
central planning.
For example, a business firm is a centrally
planned financial system with respect to its
internal financial decisions; however, it
typically operates within a broader market
interacting with external lenders and
investors to carry out its long-term plans.
At the same time, all modern financial
markets operate within some kind of
government regulatory framework that sets
limits on what types of transactions are
allowed.
Financial systems are often strictly regulated
because they directly influence decisions
over real assets, economic performance, and
consumer protection.
FINANCIAL
COMPONENTS
MARKETS
Multiple components make up the financial
system at different levels. The firm's financial
system is the set of implemented procedures
that track the financial activities of the
company.
Within a firm, the financial system
encompasses all aspects of finances,
including accounting measures, revenue and
expense schedules, wages, and balance sheet
verification.
On a regional scale, the financial system is
the system that enables lenders and
borrowers to exchange funds. Regional
financial systems include banks and other
institutions, such as securities exchanges and
financial clearinghouses.
The global financial system is basically a
broader regional system that encompasses all
financial institutions, borrowers, and lenders
within the global economy. In a global view,
financial systems include the International
Monetary Fund, central banks, government
treasuries, monetary authorities, the World
Bank, and major private international banks.
Course Code: BAFIN101B
Course Title: Financial Markets
Chapter 3:
Determinants of Interest Rate
What is an Interest Rate?
- The interest rate is the amount a lender
charges a borrower and is a percentage of the
principal – the amount loaned. The interest
rate on a loan is typically noted on an annual
basis known as the annual percentage rate
(APR).
The difference between the total repayment
and the original loan is the interest charged.
When the borrower is considered to be low
risk by the lender, the borrower will be
usually charged a lower interest rate. If the
borrower is considered high risk, the interest
rate that they are charged will be higher,
which results in a higher cost loan.
SIMPLE INTEREST RATE
I = PrT
P = I/Rt
An interest rate can also apply to the amount
earned at a bank or credit union from a
savings accounts or certificate of deposit
(CD). Annual percentage yield (APY) refers
to the interest earned on these deposit
accounts.
R
=
I/ptX100
Understanding Interest Rates
Example: If you take out a ₱300,000 loan
from the bank and the loan agreement
stipulates that the interest rate on the loan is
4% simple interest, this means that you will
have to pay the bank the original loan amount
of ₱300,000 + (4% x ₱300,000) = ₱300,000
+
₱12,000
=
₱312,000.
- Interest is essentially a charge to the
borrower for the use of an asset.
Assets borrowed can include cash, consumer
goods, vehicles, and property. Because of
this, an interest rate can be thought of as “the
cost of money” – higher interest rates make
borrowing the same amount of money more
expensive.
Interest rates thus apply to most lending or
borrowing transactions.
Individuals borrow money to:
- purchase homes
- fund projects
- launch or fund businesses
- pay for college tuition
- businesses take out loans to fund capital
projects and expand their operations by
purchasing fixed and long-term assets
For loans, the interest rate is applied to the
principal, which is the amount of the loan.
The interest rate is the cost of debt for the
borrower and the rate of return for the lender.
The money to be repaid is usually more than
the borrowed amount since lenders require
compensation for the loss of use of the money
during the loan period.
The lender could have invested funds during
that period instead of providing a loan, which
would have been generated from income
from the asset.
T = I/Pr (if
monthly,
divide by
twelve)
Simple Interest – Principal x Interest Rate x
Time
The individual that took out a loan will have
to pay P12,000 in interest at the end of the
year, assuming it was only a one-year lending
agreement. If the term of the loan was a 30year mortgage, the interest will be:

Simple Interest = ₱300,000 X 4% X
30 = ₱360,000
A simple interest rate of 4% annually
translates into an annual interest payment of
₱12,000. After 30 years, the borrower would
have made ₱12,000 x 30 years = ₱360,000 in
interest payments, which explains how banks
make their money.
COMPOUND INTEREST RATE
- It is the interest you earn on interest.
It is the addition of interest to the principal
sum of a loan or deposit.
A = Final Amount/Future Value
P = Initial Amount Invested
2,000,000
R = Interest Rate
(68.37615231)
N = Amount of Times that the Investment is
Compounded per Year
P = 29,249.9641
T = Time
I = A-P
Examples:
I = 2,000,000-29,249.9641
1. Investing an original ₱ 1,000 at 5%
compounded annually, how much
would you have after 7 years?
A= ?
P = 1000
R = 0.05
N = annually (1)
T = 7 years
0.05
1(7)
)
1
=1000 (1 +.05/1)^1(7)
=1000(1.407100)
A = 1,407.10
After 7 years of investing at 5% compounded
annually, 1000 became 1,407.10 How about
the interest after 7 years?
A = 1000 ( 1 +
I=A-P
I = 1,407.10-1000
I = 407.10
2. Malou puts ₱ 20,000 in a savings
account paying 8% annual interest
compounded monthly. At this rate
how much money will be in the
account after 10 years?
0.0
12(10
( 1 + 8
) )
12
=20,000(1+.08/12) ^120
A = 44, 392.80
20,00
A =
0
How about the interest after 10 years?
I = A-P
I = 44,392.80-20,000
I = 24,392.8
=
P(68.37615231)
(68.37615231)
Interest after 45 years
I = 1,970, 750.036 after 45 years
4. Sarah wishes to turn her ₱10,000
investment into ₱100,000 in 20 years.
How much interest does she needs to
receive compounded annually to
reach her goal?
100,000=10,000(1+r/1) ^1(20)
100,000
=10,000(1+r/1) ^20
10,000 10,000
1/20 [(1+r)^20] = 10 ^ 1/20
1+r=1.122018454
r=.1.122018454-1
r = 12.2018%
Interest after 20 years
I=A-P
I=100,000-10,000
I = 90,000
5. Martina invest ₱ 50,000 into an index
annuity that’s averaging 8.4%
compounded semi-annually. At this
rate, how many years for her account
to reach ₱1,000,000?
1,000,000=50,000(1+.084/2) ^2t
1,000,000=50,000(1.042) ^2t
1,000,000 =
50,000 (1.042) ^2t
50,000
50,000
(1.042) ^2t=20
Log(1.042)^2t=log 20
3. James wants to have ₱ 2,000,000 for
retirement in 45 years. He invests in a
mutual fund paying an average of
9.5% each year compounded
quarterly. How much should he
deposit into his mutual funds?
2t log (1.042)
=
Log (1.042)
2t= log20
Log (1.042)
2,000,000 = P(1+0.095/4)^4(45)
2,000,000 =P(1+.095/4)^180
2t=72.81455449 / 2
T = 36.41 years
log20
log (1.042)
Interest after 36.41 years
I=A-P
I=1,000,000-50,000
I=950,000
How to Calculate Future Value Lump
Sum?
This is the calculation of the value in the
future of an amount you have today. At a
specific interest rate, you will be able to find
out what it will be at a specific future date.
TIME VALUE OF MONEY AND
INTEREST RATES
As individuals, we often face decisions that
involve saving money for a future use, or
borrowing money for current consumption.
We need to determine the amount we need to
invest, if we are saving, or the cost of
borrowing, if we are shopping for a loan.
As investment analysts, much of our work
also involves evaluating transactions with
present and future cash flows. When we place
a value on any security, for example, we are
attempting to determine the worth of a stream
of future cash flows.
To carry out all the above tasks accurately,
we must understand the mathematics of time
value of money problems. Money has time
value in that individuals value a given
amount of money more highly the earlier it is
received.
Therefore, a smaller amount of money now
may be equivalent in value to a larger amount
received at a future date. The time value of
money as a topic in investment mathematics
deals with equivalence relationships between
cash flows with different dates. Mastery of
time value of money concepts and techniques
is essential for investment analysts.
LUMP SUM VALUATION
A lump sum amount is defined as a single
complete sum of money. A lump sum
investment is of the entire amount at one go.
For example, if an investor is willing to
invest the entire amount available with him in
a mutual fund, it will refer to as lump sum
mutual fund investment.
Lump sum investment is considered as one
way of investing into mutual funds. The other
method being that of systematic investment
plan, popularly known as SIP. Usually lump
sum investments are undertaken by big
players and investors, in stocks especially
those related to assets that are likely to
appreciate in the long term, making the
investment profitable except in cases of high
volatility.
FV = PV (1+r)
n
Where:
FV = Future Value
PV = Present Value
R = interest rate
N = number of compounding period
Note: if there is more than one compounding
year, you divide the interest rate by the
number of compounding per year to get r, and
multiply the number of year by the number of
compounding per year to get n.
Illustration 1. Bunnie deposits ₱20,000 into
a savings account for a period of ten years.
This investment earns 8% interest
compounded annually. Calculate how much
Bunnie will receive in ten years’ time.
FV=PV(1+ r)^n
FV= 20,000 (1+.08) ^10
FV = 43,178.50
Illustration 2. Potchie deposits ₱ 140,000
into a savings account for a period of 15
years.
This
investment
earns
7%
compounded quarterly. Calculate how much
Potchie will receive in 15 years’ time.
FV=PV(1+r) ^n
FV=140,000(1+.07/4) ^ (4)15
FV = 396,454.30
Illustration 3. How much will you have at
the end of 5 years if you invest ₱30,000 with
an interest rate of 3% per annum
compounded semi-annually?
FV= PV(1+r) ^n
FV=30,000 (1+ .03/2) ^2(5)
FV = 34, 816.22
How to Calculate Present Value Lump
Sum?
This is the calculation today of the amount
you will have in the future. At a specific
interest rate, you will be able to calculate
what it is worth today.
PV=FV/ (1+r) ^n
Where:
FV = Future Value
PV = Present Value
R = interest rate
N = number of compounding period
Note: Your Present Value should be less than
your future Value.
Illustration 1
John wants to have ₱120,000 at the end of 10
years, in order to buy a filming camera. He
wants to invest in an account that earns 8%
interest compounded annually. How much
should he invest today in order to achieve this
goal?
companies, to provide regular income to a
client.
An annuity is a reasonable alternative to
some other investments as a source of income
since it provides guaranteed income to an
individual. However, annuities are less liquid
than investments in securities because the
initially deposited lump sum cannot be
withdrawn without penalties.
Upon the issuance of an annuity, an
individual pays a lump sum to the issuer of
the annuity (financial institution). Then, the
issuer holds the amount for a certain period
(called an accumulation period). After the
accumulation period, the issuer must make
fixed payments to the individual according to
predetermined time intervals.
Annuities are primarily bought by individuals
who want to receive stable retirement income
PV = FV/ (1+r) ^n
PV = 120,000 / (1+.08) ^10
TYPES OF ANNUITIES
PV = 55, 583.22
1. Fixed Annuities
Illustration 2
Annuities that provide fixed payments. The
payments are guaranteed, but the rate of
return is usually minimal.
From the previous problem. What will be the
future value if John invest ₱ 55,583.22?
FV = PV(1+r) ^n
2. Variable Annuities
FV = 55,583.22 (1+.08) ^10
Annuities that allow an individual to choose
a selection of investments that will pay an
income based on the performance of the
selected investments. Variable annuities do
not guarantee the amount of income, but the
rate of return is generally higher relative to
fixed annuities.
FV = 120,000
Note: if there is more than one compounding
year, you divide the interest rate by the
number of compounding per year to get r, and
multiply the number of year by the number of
compounding per year to get n.
Illustration 3
John wants to buy a car in 2 years` time. He
wants to know how much he should deposit
into a fixed deposit account offering 11% per
annum, compounded monthly, in order for
him to buy a car worth ₱ 200,000.
PV = FV/ (1+r) ^n
PV = FV/ (1+r/12) ^2x12
PV = 200,000/ (1+ .11/12) ^24
PV = 160,664.70
ANNUITY VALUATION
An annuity is a financial product that
provides certain cash flows at equal time
intervals. Annuities are created by financial
institutions, primarily life insurance
3. Life Annuities
Life annuities provide fixed payments to their
holders until his/her death.
4. Perpetuity
An annuity that provides perpetual cash
flows with no end date. Examples of financial
instruments that grant perpetual cash flows to
its holder are extremely rare.
The most notable example is a UK
Government bond called consol. The first
consoles were issued in the middle of the
18th century. The bonds did not specify an
explicit end date and were redeemable at the
option of the Parliament. However, the UK
Government redeemed all consoles in 2015.
VALUATION OF ANNUITIES
Annuities are valued by discounting the
future cash flows of the annuities and finding
the present value of the cash flows.
Where:
PV = Present Value
C = Cash Flow
N = number of payments
Illustration 1. How much money do you
need to invest now to generate a cash flow of
₱1,000 every year for the next five years,
given an annual interest rate of 6%?
rate of 7%. He wants to receive a cash flow
of ₱5,000 per month for the next 30 years.
How much money does he need to put into an
annuity to generate this cash flow? (Ignore
any fees charged or any bonuses credited by
the insurance company.
*Since it is asking for monthly cash flow, we
are going to modify the formula.
PV = 5000[ 1- (1+.07/12) ^ -12(30)
PV =5000[ 1-(1+.07/12) ^-360
PV = 5000 ( 1-0.123205853 / 0.0058333333
PV = 751, 537.84
PV= 1000 [ 1- (1+0.06) ^-5]
PV = ₱4, 212.36
It is important to understand that the
A thousand peso received one year from
now is worth how much today?
Now let’s see the total amount of money that
the insurance company is paying him and
let’s compare it to the amount of money he
put into in this insurance contract.
The insurance company is paying him ₱ 5000
per month, and there is 12 months per year
and the insurance company will be paying
him for total of 30 years.
PV = 1000/ (1+.06) ^1
PV = 943.3962
A thousand peso received two years from
now is worth how much today?
PV = 1000/(1+.06)^2
PV = 889.9964
A thousand peso received three years from
now is worth how much today?
So in total, over the course of 30 years, the
insurance company will be paying him
₱1,800,000
Let’s calculate his net profit for putting his
money into this contract, no fees included.
₱1,800,000 – 751, 537.84 = ₱ 1,048, 462.16,
this is the amount of money that he’s
receiving in interest over the course of 30
years.
PV = 1000/ (1+.06) ^3
PV = 839.6193
EFFECTIVE ANNUAL RETURN
A thousand peso received four years from
now is worth how much today?
What is an Effective Annual Interest
Rate?
PV = 1000/ (1+.06) ^4
An effective annual interest rate is the real
return on a savings account or any interestpaying investment when the effects
of compounding over time are taken into
account. It also reflects the real percentage
rate owed in interest on a loan, a credit card,
or any other debt.
PV = 792.093
A thousand peso received five years from
now is worth how much today?
PV = 1000/(1+.06)^5
PV = 747.2582
TOTAL=₱4, 212.36
Illustration 2. Timothy wishes to buy an
immediate annuity that offers a fixed interest
It is also called the effective interest rate, the
effective rate, or the effective annual rate
(EAR).
Understanding
Interest Rate
the
Effective
Annual
The effective annual interest rate describes
the true interest rate associated with an
investment or loan. The most important
feature of the effective annual interest rate is
that it takes into account the fact that more
frequent compounding periods will lead to a
higher effective interest rate.
It is usually higher than the nominal rate,
which is stated rate indicated by a financial
instrument that is issued by a lender or
guarantor.
Suppose, for instance, you have two loans,
and each has a stated interest rate of 10%, in
which one compounds annually and the other
compounds twice per year. Even though they
both have a stated interest rate of 10%, the
effective annual interest rate of the loan that
compounds twice per year will be higher.
EAR is used to compare different financial
projects which calculate annual interests
with different compounding periods.
Note: The effective annual interest rate is
important because without it, borrowers
might underestimate the true cost of a loan.
And investors need it in order to project the
actual expected return on an investment,
such as a corporate bond.
Effective Annual Rate Formula
EAR is normally higher than the nominal rate
because the nominate rate quotes a yearly
percentage rate regardless of compounding.
Increasing the number of compounding
periods makes the effective annual interest
rate increase.
It is important to know that an investment that
is compounded annually have an EAR equal
to its nominal rate.
At the end of the year, the client will receive
₱1,000 (1+12.683%)=₱1,126.83 not ₱1,120
(1000*12%)
LOANABLE FUNDS THEORY
The neo-classical theory of interest or
loanable funds theory of interest owes its
origin to the Swedish economist Knut
Wicksell.
Later on, economists like Ohlin, Myrdal,
Lindahl, Robertson and J. Viner have
considerably contributed to this theory.
According to this theory, rate of interest is
determined by the demand for and supply of
loanable funds. In this regard this theory is
more realistic and broader than the classical
theory of interest.
SUPPLY OF LOANABLE FUNDS
The supply of loanable funds is derived from
the basic four sources as savings,
dishoarding, disinvestment and bank credit.
They are explained as:
1. Savings (S):
Savings constitute the most important source
of the supply of loanable funds. Savings is the
difference between the income and
expenditure. Since, income is assumed to
remain unchanged, so the amount of savings
varies with the rate of interest. Individuals as
well as business firms will save more at a
higher rate of interest and vice-versa.
2. Dishoarding (DH):
Dishoarding is another important source of
the supply of loanable funds. Generally,
individuals may dishoard money from the
past hoardings at a higher rate of interest.
Thus, at a higher interest rate, idle cash
balances of the past become the active
balances at present and become available for
investment. If the rate of interest is low
dishoarding would be negligible.
Illustration
Union Bank offers a nominal interest rate of
12% on its certificate of deposit to its client.
The client initially invested ₱1,000 and
agreed to have the interest compounded
monthly for a full year.
EAR = 12.683%
3. Disinvestment (DI):
Disinvestment occurs when the existing stock
of capital is allowed to wear out without
being replaced by new capital equipment.
Disinvestment will be high when the present
interest rate provides better returns in
comparison to present earnings. Thus, high
rate of interest leads to higher disinvestment
and so on.
4. Bank Money (BM):
Banking system constitutes another source of
the supply of loanable funds. The banks
advance loans to the businessmen through the
process of credit creation. The money created
by the banks adds to the supply of loanable
funds.
interest rate at which the demand for money
exactly matches the supply of money. It
indicates that individuals and businesses are
"holding onto" money in the right mix of
assets to keep the right amount of money in
circulation in the economy to satisfy demand
and keep inflation low.
DEMAND FOR LOANABLE FUNDS
Loanable funds theory differs from the
classical theory in the explanation of demand
for loanable funds.
According to this theory demand for
loanable funds arises for the following
three purposes viz.; Investment, hoarding
and dissaving:
1. Investment (I):
The main source of demand for loanable
funds is the demand for investment.
Investment refers to the expenditure for the
purchase of making of new capital goods
including inventories. The price of obtaining
such funds for the purpose of these
investments depends on the rate of interest.
An entrepreneur while deciding upon the
investment is to compare the expected return
from an investment with the rate of interest.
If the rate of interest is low, the demand for
loanable funds for investment purposes will
be high and vice- versa. This shows that there
is an inverse relationship between the
demands for loanable funds for investment to
the rate of interest.
2. Hoarding (H):
The demand for loanable funds is also made
up by those people who want to hoard it as
idle cash balances to satisfy their desire for
liquidity. The demand for loanable funds for
hoarding purpose is a decreasing function of
the rate of interest. At low rate of interest
demand for loanable funds for hoarding will
be more and vice-versa.
3. Dissaving (DS):
Dissaving’s is opposite to an act of savings.
This demand comes from the people at that
time when they want to spend beyond their
current income. Like hoarding it is also a
decreasing function of interest rate.
EQUILIBRIUM INTEREST RATE
Macroeconomics can affect both individuals
and businesses as they operate day to day.
One important macroeconomic concept is
the equilibrium interest rate, which is the
Demand for Money
The demand for money is how much money
is necessary to conduct everyday
transactions, such as paying for goods and
services. It is not merely the amount of
physical money in circulation – these days,
"cash" often refers to any highly liquid
monetary asset, such as money held in a
checking account.
While the individual who has a checking
account may not physically possess the
money in bills and coins, they could easily
take it out of the account and spend that
physical money at a store or transfer it
directly to the store via a debit card. The
amount of money individuals and businesses
need for such everyday use is part of the
demand for money.
FACTORS THAT CAUSE THE SUPPLY
AND DEMAND
FACTORS AFFECTING SUPPLY
In industries where suppliers are not willing
to lose money, supply will tend to decline
toward
zero
at
product
prices
below production costs.
Price elasticity will also depend on the
number of sellers, their aggregate productive
capacity, how easily it can be lowered or
increased, and the industry's competitive
dynamics. Taxes and regulations may matter
as well.
DETERMINANTS OF SUPPLY





Input Costs
Technology and Productivity
Taxes and Subsidies
Producer Future Expectations
Number of Suppliers
Changes in supply determinants will shift the
Supply Curve.
Example:
If Input Costs increase (it costs more to make
a product), then Supply will decrease
(producers have to spend more to make a
product and have to cut back on production).
FACTORS AFFECTING DEMAND
Consumer income, preferences, and
willingness to substitute one product for
another are among the most important
determinants of demand.
Consumer preferences will depend, in part,
on a product's market penetration, since
the marginal utility of goods diminishes as
the quantity owned increases. The first car is
more life-altering than the fifth addition to
the fleet; the living-room TV more useful
than the fourth one for the garage.
DETERMINANTS OF DEMAND






Consumer Income
Consumer Tastes and Preference
Price of Substitute Good
Price of Complementary Good
Number of Buyers
Consumer Future Expectations
Changes in demand determinants will shift
the Demand Curve.
EXAMPLE: If Consumer Income increases
(people have more money), then Demand
will increase (people have more money and
willing to spend more/buy more products).