Chapter 2 players in the market

CAPITAL MARKETS

OVERVIEW OF MARKET PARTICIPANTS AND FINANCIAL

INNOVATION

1

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

2

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.

3

• 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.

4

CLASSIFICATION OF ENTITIES

Central Governments

Agencies of Central Governments

Municipal Governments

Supranationals

Nonfinancial Businesses

Financial Enterprises

Households

5

• 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.

6

• 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

7

• 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.

8

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)

9

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.

10

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;

11

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

12

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.

13

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.

14

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.....

28

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)


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


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.


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.


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.


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.


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.


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.


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


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


System


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


System


2. Government Non-Banking Institutions

a.Government Service Insurance System (GSIS)

b. Social Security System


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…

48

Education

Chapter 2 players in the market