P1_Financial-System-part1finmarket1.pptx

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1. The financial system

2. OVERVIEW FINANCE is the application of economic principles to decision-making that involves the allocation of money under conditions of uncertainty provides the framework for making decisions as to how those funds should be obtained and then invested.

3. OVERVIEW FINANCE The theoretical foundations for finance draw from the field of economics and, for this reason, finance is often referred to as financial economics . The tools used in financial decision-making, however, draw from many areas outside of economics: financial accounting , mathematics , probability theory , statistical theory , and psychology

4. OVERVIEW SPECIALTY AREAS FINANCE Capital markets and capital market theory Financial management Investment management

5. OVERVIEW CAPITAL MARKETS AND CAPITAL MARKET THEORY focuses on the study of the financial system, the structure of interest rates, and the pricing of risky assets. The financial system of an economy consists of three components: (1) financial markets; (2) financial intermediaries; and (3) financial regulators.

6. OVERVIEW CAPITAL MARKETS AND CAPITAL MARKET THEORY Financial Systems and Roles Structure of Interest Rates Derivative Instruments Valuation of Assets

7. OVERVIEW FINANCIAL MANAGEMENT sometimes called business finance or corporate finance the specialty area of finance concerned with financial decision-making within a business entity. primarily concerned with investment decisions and financing decisions within business organizations

8. OVERVIEW INVESTMENT MANAGEMENT Other terms commonly used to describe this area of finance are asset management , portfolio management , money management , and wealth management specialty area within finance dealing with the management of individual or institutional funds

9. FINANCIAL SYSTEM is an organized and regulated structure where an exchange of funds takes place between the lender and the borrower It supplies the necessary financial inputs for the production of goods and services, in turn, promote the well-being and standard of living of people in the country.

10. FINANCIAL SYSTEM the financial system consisting of a variety of institution, markets, and the instruments which are related in a systematic manner and provide the principal means by which savings are transformed into instruments .

11. FINANCIAL SYSTEM SIGNIFICANCE OF FINANCIAL SYSTEM 1. To attain economic development, financial systems are important since they induce people to save by offering attractive interest rate. These savings are then channelized by lending to various business concerns which are involved in production and distribution. 2. It helps in monitor corporate performance 3. It links savers and investors. This process is known as capital formation 4. It helps in lowering the transaction cost and increase returns which will motivate people to save more 5. It helps government in deciding monetary policy

12. FINANCIAL SYSTEM 3 COMPONENTS Financial Markets Financial Intermediaries Financial regulators

13. FINANCIAL SYSTEM ASSETS any resource that is expected to provide future benefi ts and, hence, has economic value. 2 Types: Tangible Intangible

14. FINANCIAL SYSTEM ASSETS Tangible Assets depends on its physical properties Examples: Buildings, aircraft, land, and machinery

15. FINANCIAL SYSTEM ASSETS Intangible Assets represents a legal claim to some future economic benefits The value of an intangible asset bears no relation to the form, physical or otherwise, in which the claims are recorded

16. FINANCIAL SYSTEM FINANCIAL ASSETS / INSTRUMENTS intangible assets where typically the future benefits come in the form of a claim to future cash. It can be referred to as securities including stocks and bonds

17. FINANCIAL SYSTEM FINANCIAL ASSETS / INSTRUMENTS Two parties involved: Issuer - party that has agreed to make future cash payments Investor - party that owns the financial instrument and therefore the right to receive the payments made by the issuer

18. FINANCIAL SYSTEM INVESTOR ISSUER

19. FINANCIAL SYSTEM FINANCIAL ASSETS / INSTRUMENTS Two principal economic functions: they allow the transference of funds from those entities who have surplus funds to invest to those who need funds to invest in tangible they permit the transference of funds in such a way as to redistribute the unavoidable risk associated with the cash flow generated by tangible assets among those seeking and those providing the funds.

20. FINANCIAL SYSTEM FINANCIAL INSTRUMENTS They are legal contracts or indentures specifying the amount of the transaction and the terms and conditions for repayment . It can be classified by the type of claims that the investor has on the issuer. Debt Instruments Equity Instruments

21. FINANCIAL SYSTEM DEBT INSTRUMENTS the issuer agrees to pay the investor interest plus repay the amount borrowed also referred to as an instrument of indebtedness , can be in the form of a note , bond , or loan

22. FINANCIAL SYSTEM EQUITY INSTRUMENTS specifies that the issuer pay the investor an amount based on earnings, if any, after the obligations that the issuer is required to make to investors of the firm’s debt instruments have been paid. Example: Common Stocks and Preferred Stocks

23. FINANCIAL SYSTEM DIFFERENCES IN FINANCIAL INSTRUMENTS 1. Denominations – financial instruments vary in denominations from one hundred peso to billions of pesos 2. Maturity - financial instruments also differ in the terms of maturity, such as demand deposits which are short-term and bonds that have maturity of more than one year

24. FINANCIAL SYSTEM DIFFERENCES IN FINANCIAL INSTRUMENTS 3. Claim against Issuer – financial instruments may be categorized into two types: Ownership Claims Investors can convert their ownership claims into cash, his options are: a) to “sell” his share to an interested buyer b) to get his share of the proceeds of the company through dividends Debt Claims These are liabilities of the issuing companies which must be settled on given dates. Interest is the amount paid for the use of borrowed funds. The settlement of debt claims take priority over those of ownership claims.

25. FINANCIAL SYSTEM DIFFERENCES IN FINANCIAL INSTRUMENTS 4. Collateral – all financial instruments are collateralized by the revenue generated by the issuing borrower. Debt claims may be collateralized by specific assets. Ownership claims have residual but unlimited claim on the company’s earnings after other claims have been satisfied. 5. Terms to Repricing – interest rates paid by the companies on borrowed funds may change before maturity.

26. FINANCIAL SYSTEM DIFFERENCES IN FINANCIAL INSTRUMENTS 6. Marketability – financial instruments may differ in terms of whether they are highly marketable or not. The cost of trading them on the secondary market before maturity is an important factor of marketability. Factors that can lower cost of trading a financial instrument: When the issuer of the instrument is well-known, information cost tends to be lower When the amount of the issue is large, there are lower search and transaction costs When the instruments have few unique characteristics, the costs of analyzing and monitoring are lower

27. FINANCIAL SYSTEM DIFFERENCES IN FINANCIAL INSTRUMENTS 7. Forms of interest payment – (a) by coupons; (b) by a periodic addition to the principal amount 8. Options – options consist of the following types: Call options – permit the issuer to redeem the instrument before maturity Put options – permit the investor to sell back to the issuer before maturity Convertibility options – permit the investor to convert from one instrument to another.

28. FINANCIAL SYSTEM DIFFERENCES IN FINANCIAL INSTRUMENTS 9. Currency – financial instruments may also differ in terms of their currency denomination. Most are denominated in pesos, while a few are in dollars and other currencies.

29. 3 COMPONENTS Financial Markets Financial Intermediaries Financial regulators FINANCIAL SYSTEM: COMPONENTS

30. FINANCIAL MARKETS FINANCIAL MARKETS a market where financial instruments are exchanged (traded) Three major economic functions: Price Discovery Liquidity Reduced Transaction Costs

31. FINANCIAL MARKETS Price Discovery the interactions of buyers and sellers in a financial market determine the price of the traded asset determine the required return that participants in a financial market demand in order to buy a financial instrument

32. FINANCIAL MARKETS Price Discovery signals how the funds available from those who want to lend or invest funds will be allocated among those needing funds and raise those funds by issuing financial instruments

33. FINANCIAL MARKETS Liquidity provide a forum for investors to sell a financial instrument and is said to offer investors This is an appealing feature when circumstances arise that either force or motivate an investor to sell a financial instrument

34. FINANCIAL MARKETS Reduced Transaction Cost Search Cost – Explicit costs include expenses that may be needed to advertise one’s intention to sell or purchase a financial instrument; implicit costs include the value of time spent in locating a counterparty to the transaction.

35. FINANCIAL SYSTEM: COMPONENTS Reduced Transaction Cost Information Cost –costs associated with assessing a financial instrument’s investment attributes.

36. FINANCIAL INTERMEDIARIES Financial entity in order to limit the conditions that make it difficult for lenders or investors of funds to deal directly with borrowers of funds in financial markets. Examples: depository institutions, insurance companies, regulated investment companies, investment banks,

37. FINANCIAL INTERMEDIARIES The role of financial intermediaries is to create more favorable transaction terms than could be realized by lenders/investors and borrowers dealing directly with each other in the financial market How? obtaining funds from lenders or investors lending or investing the funds that they borrow to those who need funds.

38. INVESTOR ISSUER FINANCIAL INTERMEDIARIES FINANCIAL INTERMEDIARY

39. FINANCIAL INTERMEDIARIES Other services: Facilitating the trading of financial assets for the financial intermediary’s customers through brokering arrangements. Facilitating the trading of financial assets by using its own capital to take a position in a financial asset the financial intermediary’s customer want to transact in.

40. FINANCIAL INTERMEDIARIES Other services: Assisting in the creation of financial assets for its customers and then either distributing those financial assets to other market participants. Providing investment advice to customers. Manage the financial assets of customers. Providing a payment mechanism.

41. FINANCIAL INTERMEDIARIES SERVICES PERFORMED BY FINANCIAL INTERMEDIARIES A. Services Benefiting Suppliers of Funds : Monitoring costs —Aggregation of funds in an FI provides greater incentive to collect a firm’s information and monitor actions. The relatively large size of the FI allows this collection of information to be accomplished at a lower average cost (economies of scale). Liquidity and price risk —FIs provide financial claims to household savers with superior liquidity attributes and with lower price risk. Transaction cost services —Similar to economies of scale in information production costs, an FI’s size can result in economies of scale in transaction costs. Maturity intermediation —FIs can better bear the risk of mismatching the maturities of their assets and liabilities. Denomination intermediation —FIs such as mutual funds allow small investors to overcome constraints to buying assets imposed by large minimum denomination size.

42. FINANCIAL INTERMEDIARIES SERVICES PERFORMED BY FINANCIAL INTERMEDIARIES B. Services Benefiting the Overall Economy : Money supply transmission —Depository institutions are the conduit through which monetary policy actions impact the rest of the financial system and the economy in general. Credit allocation —FIs are often viewed as the major, and sometimes only, source of financing for a particular sector of the economy, such as farming and residential real estate. Intergenerational wealth transfers —FIs, especially life insurance companies and pension funds, provide savers with the ability to transfer wealth from one generation to the next. Payment services —The efficiency with which depository institutions provide payment services directly benefits the economy.

43. FINANCIAL INTERMEDIARIES TYPES: Commercial banks — depository institutions whose major assets are loans and whose major liabilities are deposits. Commercial banks’ loans are broader in range, including consumer, commercial, and real estate loans, than are those of other depository institutions. Commercial banks’ liabilities include more non-deposit sources of funds, such as subordinate notes and debentures, than do those of other depository institutions. Thrifts — depository institutions in the form of savings associations, savings banks, and credit unions. Thrifts generally perform services similar to commercial banks, but they tend to concentrate their loans in one segment, such as real estate loans or consumer loans.

44. FINANCIAL INTERMEDIARIES TYPES: Insurance Companies— financial institutions that protect individuals and corporation (policyholders) from adverse events. Life insurance companies provide protection in the event of untimely death, illness, and retirement. Property casualty insurance protects against personal injury and liability due to accidents, theft, fire, and so on. Securities firms and investment banks — —financial institutions that help firms issue securities and engage in related activities such as securities brokerage and securities trading.

45. FINANCIAL INTERMEDIARIES TYPES: Finance Companies— financial intermediaries that make loans to both individuals and businesses. Unlike depository institutions, finance companies do not accept deposits but instead rely on short- and long-term debt for funding. Mutual Funds— financial institutions that pool financial resources of individuals and companies and invest those resources in diversified portfolios of assets.

46. FINANCIAL INTERMEDIARIES TYPES: Hedge Funds— financial institutions that pool funds from a limited number (e.g., less than 100) of wealthy (e.g., annual incomes of more than $200,000 or net worth exceeding $1 million) individuals and other investors (e.g., commercial banks) and invest these funds on their behalf, usually keeping a large proportion (commonly 20 percent) of any upside return and charging a fee (2%) on the amount invested. Pension Funds— financial institutions that offer savings plans through which fund participants accumulate savings during their working years before withdrawing them during their retirement years. Funds originally invested in and accumulated in a pension fund are exempt from current taxation.

47. FINANCIAL INTERMEDIARIES Flow of Funds in a World in FIs

48. FINANCIAL REGULATORS Most governments throughout the world regulate various aspects of financial activities because they recognize the vital role played by a country’s financial system.

49. FINANCIAL REGULATORS The degree of regulation varies from country to country. Regulation takes one of four forms: Disclosure regulation Financial activity regulation Regulation of financial institutions Regulation of foreign participants

50. FINANCIAL REGULATORS Disclosure Regulation requires to provide on a timely basis financial information and non-financial information that would be expected to affect the value of its security to actual and potential investors. Governments justify disclosure regulation by pointing out that the issuer has access to better information about the economic well being of the entity than those who own or are contemplating ownership of the securities

51. FINANCIAL REGULATORS Financial Activity Regulation Rules about traders of securities and trading on financial markets The SEC has is in charged with the responsibility of monitoring the trades that corporate officers, directors, as well as major stockholders, execute in the securities of their firms.

52. FINANCIAL REGULATORS Regulation of Financial Institutions form of governmental monitoring that restricts their activities.

53. FINANCIAL REGULATORS Government Regulation of Foreign Participation involves the imposition of restrictions on the roles that foreign firms can play in a country’s internal market and the ownership or control of financial institutions

54. FINANCIAL REGULATORS FINANCIAL REGULATORS IN THE PHILIPPINES Bangko Sentral ng Pilipinas (BSP) Bureau of Treasury ( BTr ) Securities and Exchange Commission (SEC) Insurance Commission (IC) Department of Finance (DOF) Philippine Deposit Insurance Corporation (PDIC)

55. FINANCIAL REGULATORS Bangko Sentral ng Pilipinas (BSP) Monetary and Economics Sector is mainly responsible for the operations/activities related to monetary policy formulation, implementation, and assessment Financial Supervision Sector is mainly responsible for the regulation of banks and other BSP-supervised financial institutions, as well as the oversight and supervision of financial technology and payment systems​ Currency Management Sector is mainly responsible for the forecasting, production, distribution, and retirement of Philippine currency, as well as security documents, commemorative medals, and medallions Corporate Services Sector is mainly responsible f​or the effective management of corporate strategy, communications, and risks, as well as the BSP's human, financial, technological, and physical resources to support the BSP's core functions​

56. FINANCIAL REGULATORS BURUEA OF TREASURY ( BTr ) - As principal custodian of government funds, the Bureau of the Treasury ( BTr ) is responsible for ensuring the sufficiency of Government financial resources including the active management and investment of excess funds.

57. FINANCIAL REGULATORS SECURITIES AND EXCHANGE COMMISSION (SEC) - is the agency of the Government of the Philippines responsible for regulating the securities industry in the Philippines. In addition to its regulatory functions, the SEC also maintains the country's company register.

58. FINANCIAL REGULATORS INSURANCE COMMISSION (IC) - The purpose of insurance commissioners is to maintain fair pricing for insurance products, protecting the solvency of insurance companies, preventing unfair practices by insurance companies, and ensuring availability of insurance coverage.

59. FINANCIAL REGULATORS DEPARTMENT OF FINANCE (DOF) Formulate goals, action plans and strategies for the Governments resource mobilization effort; Formulate, institutionalize and administer fiscal and tax policies; Supervise, direct and control the collection of government revenues; Act as custodian of, and manage all financial resources of Government Manage public debt; Review and coordinate policies, plans and programs of GOCCs; Monitor and support the implementation of policies and measures on local revenue administration; Coordinate with other government agencies on matters concerning fiscal, monetary, trade and other economic policies Investigate and arrest illegal activities such as smuggling, dumping, illegal logging, etc. affecting national economic interest

60. FINANCIAL REGULATORS PHILIPPINE DEPOSIT INSURANCE CORPORATION (PDIC) is authorized to issue regulations to implement its Charter, conduct bank examinations and investigations to assess financial safety and soundness of banks and their adherence to banking and deposit insurance rules and regulations, and extend financial assistance to eligible distressed banks.