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CAPITAL MARKETS
OVERVIEW OF MARKET PARTICIPANTS AND FINANCIAL
INNOVATION
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Learning Objectives:
1. Enumerate participants in financial markets.
2. Explain the business of financial institutions
3. Describe what financial intermediary is.
4. Discuss how financial intermediary provide economic functions.
5. Describe the nature of the management of assets and liabilities by financialintermediaries.
6. Explain how different financial institutions use cash outlay of their liability
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ISSUER AND INVESTORS
• Financial intermediaries, An entity that acts as
the middleman between two parties in a financial transaction.
• Regulators – regulates
certain aspects of financial markets.
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• Various entities issue financial assets,both debt
instruments and equity instruments and various
investors purchase these financial assets
• It is common for an entity to both issue a
financial asset and at the same time invest in a
different financial asset.
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CLASSIFICATION OF ENTITIES
Central Governments
Agencies of Central Governments
Municipal Governments
Supranationals
Nonfinancial Businesses
Financial Enterprises
Households
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• Central governments borrow funds for a wide
variety of reasons.Debt obligations issued by
central governments carry the full faith and
credit of the borrowing government.
• Funds are raised by the issuance of debt
obligations called Treasury Securities.
• Two type of government agencies in the USA
are Federally Related Institutions and
Government Sponsored Enterprises.
• In most countries municipalities raise funds in
the capital market.
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• Supranational Institution:is an organizationformed by two or more central government throughinternational treaties.
An international organization, or union, whereby member states transcend national boundaries
or interests to share in the decision-making and vote on issues pertaining to the wider grouping
• Two example of supranational institution areInternational Bank for Reconstruction andDevelopment popularly referred to as World Bank and American Development Bank
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• Financial intermediaries include depository
institutions(commercial banks,savings and loan
associations) who acquire bulk of their funds by
offering their liabilities to the public mostly in
form of deposit.Others are discussed another
chapters.
• Some subsidiaries of nonfinancial business
provide financial services.These financial
institutions called captive finance companies.
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A subsidiary whose purpose is to provide financing to customers buying the parent company's product. Captive finance companies can range in size from mid-sized entities to giant firms, depending on the size of the parent company. Their range of services can also vary widely, from basic card services to full-scale banking. A captive finance company can be a source of significant profits for the parent organization.
• Examples of captive finance companies;
oGeneral Motor Acceptance Corporations (a subsidiary of General Motors)
oGeneral Electric Credit(a subsidiary of General Electric)
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DEFINITION OF 'CAPTIVE FINANCE
COMPANY'
Transform financial assets acquired through the market constitute theminto a different and more widely preferable ,type of asset,which becomestheir liability.This function is performed by financialintermediaries.(most important type of financial institution)
Exchange financial assets on behalf of consumers.
Exchange financial assets on their own account.
Assist in the creation of financial assets for their customers and then sellthose financial assets to other market participants.
Provide investment advice to other market participants.
Manage the portfolios of other market participants.
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Financial businesses more popularly referred
to as financial institutions provide one or more
of the following services:
ROLE OF FİNANCİAL INTERMEDİARİES
• Financial intermediaries play the basic role of the basic role of
transforming financial assets that are less desirable for a large part of
the public into other financial assets-their own liabilities-which are
more widely preferred by the public.This transformation involves at
least one of the four economic functions;
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ROLE OF FİNANCİAL INTERMEDİARİES
I. Providing maturity intermediation
II. Risk reduction via diversification
III. Reducing costs of contracting and information
processing
IV. Providing a payments mechanism
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I. Maturity intermediation:by issuing its own
financial claims the commercial commercial
bank in essence transforms a longer-term asset
into a shorter –term one by giving the borrower
a loan for length of time sought and the
investors/depositor a financial asset for the
desired investment horizon.This is called
maturity intermediation.
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II. This economic function of financial intermediaries-transforming
more risky assets into less risky ones-is called
diversification.Even though individual investors can do it on their
own,they may not be able to to it as cost effectively as a financial
intermediary,depending on the amount of funds they want to
invest.Attaining cost effective diversification in order to reduce
risk by purchasing the financial assets of a financial intermediary
is an important economic benefit for financial markets.
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III. REDUCING THE COSTS OF CONTRACTING AND INFORMATION PROCCESING
Investors purchasing financial assets mustdevelop skills necessary to evaluate an investment. Those skills are developed, investors can apply themwhen analyzing specific financial assets forpurchase.
Investors who want to make a loan to a consumer or business need to write loan contract. Although some people may enjoy devoting leisuretime to this task, most of us find leisure time to be in short supply and compensation for sacrificing it. The form of compensation could be a higher returnobtained from an investment.
In addition to the opportunity cost of time toprocess the information about the financial asset, the cost of this information must also be considered. All these costs are informationprocessing costs.
The costs of writing loan contracts arereferred to as contracting costs. Anotherdimension to contracting costs is the cost of enforcing terms of loan agreement.
IV. PROVIDING A PAYMENTS MECHANISM
The previous three economic functions may not be immediately
obvious. This last one should be. Most transactions made today are not
with cash. Payments are made using checks, credit cards, debit cards and
electronic transfers of funds. Financial intermediaries provide these
methods for making payments.
At one time, noncash payments were restricted to checks.
Payment by credit card was also at one time the exclusive domain of
commercial banks, but now other depository institutions offer this
service. Debit cards are offered by various financial intermediaries.
A debit card differs from a credit card in that a bill
sent to credit cardholder periodically (usually once a month)
requests payment for transactions made in the past. With a
debit card, funds are immediately withdrawn from thepurchaser’s account at time transaction takes place.
The ability to make payments without cash is critical
for financial market. In short, depository institutions
transform assets that cannot be used to make payments into
other assets.
OVERVIEW OF ASSET/LIABILITY
MANAGEMENT FOR FINANCIAL
INSTITUTIONS
To understand why managers of financial institutions
invest in particular types of financial assets and types of investment
strategies employed. It is necessary to have a general information of
asset/liability problem.
For example, depository institutions seek to generate
income by difference between return that they earn on assets and
cost of their funds. This difference is referred to as spread.
THE NATURE OF LIABILITIES
Liability Type Amount of Cash
Outlay
Timing of Cash
Outlay
Type I Known Known
Type II Known Uncertain
Type III Uncertain Known
Type IV Uncertain Uncertain
TYPE I LIABILITY
Both amount and timing are known. For example, depository
institutions know amount that they are committed to pay on maturity date
of a fixed rate deposit, the depositor does not withdraw funds prior to the
maturity date.
TYPE II LIABILITY
The amount of cash outlay is known, but timing of cash outlay is
uncertain. Life insurance policy can be an example for this liability. The
most of basic many types of life insurance policy provides that, for annual
premium, this company agrees to make a specified payment to
beneficiaries upon the death of insured.
TYPE III LIABILITY
Timing is known, but amount is uncertain, such as when a
financial institution has issued an obligation in which the interest rate
adjust based on some interest rate benchmark.
Depository institutions, for example, issue liabilities called
certificates of deposit with a stated maturity. The interest rate paid need
not to be fixed over life of deposit but may fluctuate.
.
TYPE IV LIABILITY
Both amount and timing are uncertain. Home insurance
policy is an example. Whenever damage is done to an insured asset, the
amount of payment that must be made is uncertain.
LIQUIDITY NEEDS
Because of uncertainty about the timing and the amount of the cash outlays, a financial institution must be prepared with sufficent cash to satisfy itsobligations.
Also keep in mind that our discussion of liabilities assumes that the entitythat holds the obligation against the financial institution may exercise itsright to change the nature of deposit, perhaps incurring some penalty.
For example;
In the case of a certificate of deposit,
the depositor may request the withdrawal
of funds prior to the maturity date.
•The deposit-accepting institution will grant this request, but assess an early withdrawal penalty.
•Certain types of investment companies give shareholders the right to redeem their shares at any time.
•Some life insurance products provide a cash-surrender value that allows the policyholder to exchange the policy for a lump sum payment at specified dates.
•Some life insurance products also offer a loan value.
• In addition to uncertaintyabout the timing and amountof the cash outlays, and thepotential for the depositor orpolicyholder to withdrawcash early or borrow againsta policy, a financialinstitution is alsoconcernedwith possible reduction in cash inflows.
• In the case of a depository institution, it means
the inability to obtain deposits.
• For insurance companies, it means reduced
premiums because of the cancellation of policies.
• For certain types of investment companies, it
means not being able to find new buyers for
shares.
İn the Philippine
Setting.....
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Elements of the Financial System
1. Financial Claims- these are the money and the rights to receive money under specific circumstances. (ex: debt and equity)
2. Financial Institutions – they areprivate or government organizations whoseassets consists primarily of claims orincomes primarily derived from dealing inand/or performing services in connectionwith claims. (commonly known as FinancialIntermediaries)
Elements of the Financial System
3. Financial Markets – serves as a means
of bringing the forces of demand and
supply of financial claims.
-is a market in which people and entities can
trade financial securities, commodities and
other fungible items of value at low
transaction costs and at prices that reflect
supply and demand
Elements of the Financial System
4. Government Agencies – Monetary policies are formulated by the Monetary Board of the Central Bank.
CENTRAL BANKS- supervises and regulates the banking institutions and other financial insitutions. It controls money, credit and banking operations in the country.
Elements of the Financial System
The Bangko Sentral ng Pilipinas (BSP) is the
central bank of the Republic of the Philippines. It
was established on 3 July 1993 pursuant to the
provisions of the 1987 Philippine Constitution and
the New Central Bank Act of 1993. The BSP took
over from the Central Bank of Philippines, which
was established on 3 January 1949, as the
country’s central monetary authority. The BSP
enjoys fiscal and administrative autonomy from the
National Government in the pursuit of its mandated
responsibilities.
Elements of the Financial System
Objectives
The BSP’s primary objective is to maintain price
stability conducive to a balanced and
sustainable economic growth. The BSP also
aims to promote and preserve monetary
stability and the convertibility of the national
currency.
Elements of the Financial System
Objectives
The BSP’s primary objective is to maintain price
stability conducive to a balanced and
sustainable economic growth. The BSP also
aims to promote and preserve monetary
stability and the convertibility of the national
currency.
Elements of the Financial System
Responsibilities
The BSP provides policy directions in the areas of money, banking and
credit. It supervises operations of banks and exercises regulatory powers
over non-bank financial institutions with quasi-banking functions.
Under the New Central Bank Act, the BSP performs the following
functions, all of which relate to its status as the Republic’s central
monetary authority.
Liquidity Management. The BSP formulates and implements monetary
policy aimed at influencing money supply consistent with its primary
objective to maintain price stability.
Currency issue. The BSP has the exclusive power to issue the national currency. All notes and coins issued by the BSP are fully guaranteed
by the Government and are considered legal tender for all private and public debts.
Elements of the Financial System
Responsibilities (Continuation)
Financial Supervision. The BSP supervises banks and exercises regulatory powers over non-bank institutions performing quasi-
banking functions.
Management of foreign currency reserves. The BSP seeks to maintain
sufficient international reserves to meet any foreseeable net
demands for foreign currencies in order to preserve the international
stability and convertibility of the Philippine peso.
Determination of exchange rate policy. The BSP determines the
exchange rate policy of the Philippines. Currently, the BSP adheres to
a market-oriented foreign exchange rate policy such that the role of
Bangko Sentral is principally to ensure orderly conditions in the
market.
Other activities. The BSP functions as the banker, financial advisor and official depository of the Government, its political subdivisions
and instrumentalities and government-owned and -controlled
corporations.
Elements of the Financial System
5. Laws and Policies – laws and
regulations are made on money ,
credit and banking to ensure
monetary stability and economic
growth.
The Philippine Financial Institutions
Financial Institutions
- A body corporate that , as part of its normal activities
takes money on deposit and makes advances of money and
Does do under regulatory regime, governed by the central bank (or its equivalent) of the country in which it operates.
FUNCTIONS OF THE FINANCIAL
INSTITUTIONS
1. Investigation and credit analysis –Loan Applications are properly evaluated to ensure the efficient use of credit and to protect the savings of individuals as well as to minimize the risk of nonpayment of loans.
2. Matching the supply and demand for funds – Financial institutions are money brokers.
FUNCTIONS OF THE FINANCIAL
INSTITUTIONS
3. Provisions for Liquidity – through their brokerage function, they provide an organized market, the investor can find a buyer for his debt or ownership claims.
4. Provides payment system – the transfer of goods and services has become convenient, faster and economical.
Structure of the Philippine Financial
System
• Banking Institutions:
1. Private Banking Institutions
a. Commercial Banking Institutions
– expanded commercial banking/universal
banking
– ordinary commercial banks
b. Thrift Banks
– savings and mortgage banks
– private development banks
– stock savings and loan associations
c. Rural Banks
Structure of the Philippine Financial
System
•Banking Institutions:
2. Government Banking Institutions
a. Development Bank of the Philippines (DBP)
b. Land Bank of the Philippines (LBP)
•Non-Bank Financial Institutions
1. Private Non-Banking Institutions
a. Investment Houses-An investment
house, or investment bank, works primarily for
corporations and governments. These banks
help raise money for their clients through debt
and stock offerings.
b. Investment Companies
Structure of the Philippine Financial
System
•Non-Bank Financial Institutions
1. Private Non-Banking Institutions
a. Investment Houses
b. Investment Companiesc. Financing Companiesd. Securities Dealer/Brokerse. Non-Stock savings and loan associationsf. Buildings and loan associationsg. Pawnshopsh. Lending Investorsi. Pension Fund Managersj. Trust companies/ departmentsk. Insurance Companiesl. Credit cooperatives
Structure of the Philippine Financial
System
•Non-Bank Financial Institutions
2. Government Non-Banking Institutions
a.Government Service Insurance System (GSIS)
b. Social Security System
Structure of the Philippine Financial
System
Depository Institutions to Non-
Depository Institutions
• Depository Institutions – banks that accepts deposits –
contribute to the economy by lending much of the money
saved by depositors.
• Non-Depository institutions - which are financial
intermediaries that cannot accept deposits but do pool
the payments in the form of premiums or contributions of
many people and either invest it or provide credit to
others.
Multinational Banks in the Philippines
Citibank
Deutsche Bank
HSBC
JP Morgan Chase
Prebon
Price-WaterHouse-Coopers
THANK YOU…
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