FNMNGT 5

CHAPTER 1: OVERVIEW OF THE PHILIPPINE FINANCIAL MARKET

Financial System of a Country

➔ is of immense importance as it portrays the stability as well as sustainability of the
country.
➔ consists of a set of complex and closely interconnected financial institutions, markets,
instruments, services, practices, and transactions.
➔ where the suppliers and users of funds meet
➔ Suppliers
- can be individuals, businesses, institutions, and even the government.
- have available capital through savings and accumulated wealth
- willing to lend their capital for a fee.
➔ Users
- can also be individuals, businesses, institutions, and the government.
- willing to pay a fee for the use of capital to support their financing needs.
➔ includes its banks, securities markets, pension and mutual funds, insurers, market
infrastructures and central bank, as well as its regulatory and supervisory authorities.
- These institutions and markets provide a framework for carrying our economic
transactions and monetary policy
- help channel savings into investment, thereby supporting economic growth.
-
Liberalization of Financial Markets in the 1990s and 2000s
➔ considered to have contributed to the 2007/2008 Global Financial Crisis.

Financial Markets Require:

1. Depth
- Financial institutions and financial markets are a sufficient size.
2. Access
- Reflects the degree to which economic agents use financial services.
3. Efficiency
- financial institutions are able to successfully intermediate financial resources, and
to facilitate transactions.
4. Stability
- refers to low market volatility plus low institutional fragility.

Economic Development
➔ depends on the local financial system, but NOT SOLELY on the local financial system.
➔ Enterprises from one country
➔ can draw on the financial resources of another through Foreign Direct Investment (FDI)
➔ affiliates of multinational enterprises (MNEs) in developing countries can take advantage
of the financial markets in a parent’s (home) high-income country.
➔ MNE affiliates
- less likely to be credit-constrained
 - make greater use of firm-internal funds
- make less use of external funds
- less reliant on local financial institutions

Recent empirical studies show both effects:

1. firms in developing countries benefited from improvements in domestic financial markets
2. MNE affiliates have been less reliant on such improvements.

Problems in Financial Systems

➔ disrupt financial intermediation
➔ undermine the effectiveness of monetary policy
➔ exacerbate economic downturns
➔ trigger capital flight and exchange rate pressures
➔ create large fiscal costs related to rescuing troubled financial institutions.
➔ financial shocks in one jurisdiction can quickly spill across financial sectors and national
borders.
*Resilient financial systems that are well regulated and well supervised are essential for both
domestic and international economic and financial stability.

Financial Intermediation Process

➔ difference in the savings and consumption patterns in the economy gives rise to an
intermediation process to balance the financial system.
➔ Financial markets
- perform the essential economic function of channeling funds from those that have
saved to those that have a shortage of funds.
➔ Financial Intermediaries
- matching lenders with borrowers
- provide continuous facility of capital flow from the surplus savers to deficit savers
in the system.
- Provide services like risk management, liquidity, and information dissemination

Philippine Financial Markets

➔ exchange of assets in the financial system is consummated in specialized financial
markets.
➔ Traditionally, the financial system has only the money market and the capital market.
➔ With the advent of new product offerings and complex financial instruments, the
Philippine financial system can now be subdivided into four major markets:
1. Money Market
● trading in very short-term debt investments.
● investment fund with a portfolio of fixed-income instruments with high
liquidity and short maturity.
● Wholesale level
- involves large-volume trades between institutions and traders.
● Retail level
 - includes money market mutual funds bought by individual
investors
- money market accounts opened by bank customers.
- used by governments and corporations to keep their cash flow
steady, and for investors to make a modest profit.
2. Capital Market
● dedicated to the sale and purchase of long-term debt and equity
instruments.
● composed of primary and secondary markets.
● common capital markets are the stock market and the bond market.
● formal Philippines Capital Market- one of the oldest in Asia.
● Manila Stock Exchange
- established in 1927
- Gold and copper mining stocks dominated trading during the first
five decades of operation
- trade in oil stocks caused a boom in the late 1970s
● rival financial group established a second stock exchange in 1963.
● government induced the two exchanges to merge in 1994 to form the
Philippines Stock Exchange (PSE).
3. Foreign Exchange Market
● also known as forex, FX or the currency market
● an over-the-counter (OTC) global marketplace
● determines the exchange rate for currencies around the world
● Participants are able to buy, sell, exchange and speculate on currencies.
● made up of banks, forex dealers, commercial companies, central banks,
investment management firms, hedge funds, retail forex dealers and
investors.
● Bangko Sentral ng Pilipinas (BSP)
- maintains a floating exchange rate system.
- Exchange rates are determined on the basis of supply and
demand
- ROLE: ensure orderly conditions in the market
● Philippine Dealing System (PDS)
- Where peso-dollar trading among Bankers Association of the
Philippines (BAP) member-banks and between these banks and
the BSP are done
● Philippine Dealing and Exchange Corp. (PDEx).
- an electronic platform
- Used by most of the BAP-member banks which participate in the
peso-dollar trading
- Appointed by BAP as the official service provider for the US Dollar
(USD) / Philippine Peso (PHP) spot trading (which involve the
purchase or sale of the US dollar for immediate delivery, i.e.,
 within one day for US dollars), and Reuters, as the exclusive
distributor of all PDEx data.
- allows nearly instantaneous transmission of price information and
trade confirmations.
- banks which do not subscribe to PDEx can continue to deal
peso-dollar spot transactions via their Reuters Dealing screens.
4. Derivatives Market
● values are derived from other underlying assets (e.g. options and future
contracts)
● Philippine universal and commercial banks
- engaged in derivatives transactions like foreign currency forwards
and foreign currency swaps since the early 1980s.
● Manila International Futures Exchange (MIFE)
- established in 1985
- functioned as the Philippine’s main commodity and derivatives
market.
- offered sugar and soybean futures contracts and then expanded
to coffee and copra.
- first financial futures contract to be traded in 1990 was on
Philippine treasury bills.
- regulated and controlled by SEC.
- closed down in 1997 due to governance issues including fraud
and irregularities done by brokers and officials of the exchange.
● Philippine Dealing and Exchange Corp (PDEx)
- 2005: started as a centralized infrastructure for trading securities
which ensures price discovery, transparency and investor
protection.
- 2008: granted by the SEC a self-regulatory organization (SRO)
status in the Inter-Dealer market, Inter-Professional Market and
coverage of all its members in all markets within the PDEx Trading
Systems.
- 2008: Philippine Stock Exchange and the Philippine Dealing
System Holdings Corporation entered into an agreement to
develop a local derivatives exchange.

Status of and Observations on the Philippine Capital Market

➔ Across the Philippines and Asia’s other emerging economies
- Some $800 billion in investment opportunities go unfilled each year because
capital markets are less reliable than issuers might like.
- Philippines: ambitious goal of increasing its infrastructure spending to 7% of
GDP.
- if the cost of capital in the Philippines were lower and more stable, businesses
would have an easier time raising money to fund new ventures and growth
projects
 - Philippines has capital markets that are not yet as deep as those of several other
Asian emerging economies
- recent report on the capital markets of emerging Asia: Philippines has room to
improve on several important indicators of capital market depth.

CHAPTER 2: Organization and Functioning of Securities Markets

Market
➔ the means through which buyers and sellers are brought together to aid in the transfer of
goods and/or services.
➔ Financial Market
 -where buyers and sellers trade commodities, financial securities, foreign
exchange, and other freely exchangeable items and derivatives of value at low
transaction costs and at prices that are determined by market forces.
➔ need not have a physical location
➔ does not necessarily own the goods and services involved.
➔ can deal in any variety of goods and services.

Characteristics of a Good Market

1. Timely and Accurate Information
● To determine the appropriate price, participants must have timely and accurate
information on the volume and prices of past transactions and on all currently
outstanding bids and offers.
2. Liquidity
● Marketability
- an asset's likelihood of being sold quickly
● asset can be bought and sold quickly at a price close to the prices for previous
transactions (price continuity), assuming no new information has been received.
● Depth
- Required in price continuity
- numerous potential buyers and sellers must be willing to trade at prices
above and below the current market price.
3. Low Transaction Costs
● Internal Efficiency
- Lower costs (as a percent of the value of the trade) include the cost of
reaching the market, the actual brokerage costs, and the cost of
transferring the asset make for a more efficient market.
4. Rapid Adjustment of Prices to New Information
● buyer or seller wants the prevailing market price to adequately reflect all the
information available regarding supply and demand factors in the market.
● External Efficiency/ Informational Efficiency
- prices reflect all available information about the asset.

Primary and Secondary Markets

1. Primary Capital Markets
➔ where governments, municipalities or companies sell new issues of bonds or
shares to raise fresh funds.
➔ where newly issued securities are sold by issuers, and the issuers receive the
proceeds.
➔ Primary Capital Markets Government Bond Issues in the Philippines are:
● Treasury bills
- short term, low-risk investments
- Direct and unconditional obligations by the Philippine government.
● Treasury bonds
- long-term, low-risk instruments
 - direct and unconditional obligations by the Philippine government.
● Corporate debt securities
- debt obligations issued by corporations to raise money in order to
expand their businesses.
- may include senior unsecured bonds/corporate notes and
subordinated notes.
● Foreign currency denominated government bonds
- bonds issued by the Republic of the Philippines and bonds issued
by other countries.
➔ Philippine Retail Treasury Bond (RTB)
- direct and unconditional obligation of the Philippine government
- generally considered a safe and liquid investment opportunity.
- issued by the Bureau of Treasury is one way for the government to raise
needed funds.
- Safe: fully backed by the government
- Liquid: can be traded in the secondary market prior to maturity.
➔ New municipal bond issues are sold by one of three methods:
a. competitive bid
b. Negotiation
c. Private placement
*Two of the methods given require an underwriting function
➢ Underwriting
- performed by both investment banking firms and
commercial banks (for municipal bonds)
- Involve 3 services:
● origination
● risk bearing
● distribution
➔ Corporate bond issues
- almost always sold through a negotiated arrangement with an investment
banking firm that maintains a relationship with the issuing firm.
- issue fixed-income securities to get new capital,
- issue equity securities – generally common stock.
- new stock issues are typically divided into two groups:
1. Seasoned equity issues- new shares offered by firms that already
have stock outstanding.
2. Initial public offerings (IPO)- involve a firm selling its common
stock to the public for the first time.
*New issues (seasoned or IPO­­) are typically underwritten by
investment bankers, who acquire the total issue from the company
and sell the securities to interested investors.
2. Secondary Financial Markets
➔ permit trading in outstanding issues;
➔ stocks or bonds already sold to the public are traded between current and
potential owners.
➔ proceeds from a sale in the secondary market do not go to the issuing unit (the
government, municipality, or company) but, rather, to the current owner of the
security.
➔ Provides liquidity to the individuals who acquired these securities.
➔ primary market benefits greatly from the liquidity provided by the secondary
market because investors would hesitate to acquire securities in the primary
market if they thought they could not subsequently sell them in the secondary
market.
➔ important to those selling seasoned securities
➔ New issues of outstanding stocks or bonds to be sold in the primary market are
based on prices and yields in the secondary market.
➔ IPOs are priced based on the prices and values of comparable stocks or bonds in
the public secondary market.
➔ Secondary Markets for bonds
- distinguishes among those issued by the federal government,
municipalities, or corporations.
- major market makers: banks and investment firms.
- included two major segments: security exchanges and an
over-the-counter (OTC) market.
➔ Secondary Equity Market is usually been broken down into three major
segments:
● major national stock exchanges
● regional stock exchanges
● over-the-counter market
➔ Securities Exchange
- major national stock exchange and regional stock exchange
- Both only differ in size and geographic emphasis.
- Alternative Trading Systems: they can differ in their trading systems.
➔ Pure Auction Market
- where potential buyers and sellers submit bid and ask prices to an
independent party who matches orders.
- Price-driven: investor who offers to pay the most will be the buyer, and the
investor willing to accept the lowest price will be the seller.
➔ Dealer market
- where dealers make a market in stocks (quoting bid-ask prices) and are
willing to take positions on their own books.
- Provides liquidity.
➔ Call vs. Continuous Markets
● Call Markets
- trading for individual stocks takes place at specified times.
 - intent is to gather all the bids and asks for the stock and attempt to
arrive at a single price where the quantity demanded is as close
as possible to the quantity supplied.
- Generally used during the early stages of development of an
exchange when there are few stocks listed or a small number of
active investors/traders.
● Continuous Market
- trades occur at any time the market is open.
- priced either by auction or by dealers.
- Dealer market: willing to buy or sell for their own account at a
specified bid and ask price.
- Auction Market: enough buyers and sellers are trading to allow the
market to be continuous; another investor available and willing to
sell stock.
➔ National Stock Exchanges
- Two U.S. securities exchanges are generally considered national in
scope:
a. The New York Stock Exchange (NYSE)
b. American Stock Exchange (AMEX).
- Outside the US:
a. Tokyo Stock Exchange,
b. Stock Exchange of Thailand,
c. Philippine Stock Exchange.
- considered national because of the large number of listed securities, the
prestige of the firms listed, the wide geographic dispersion of the listed
firms, and the diverse clientele of buyers and sellers who use the market.
➔ Divergent Trends –New Exchanges and Consolidations
● 1st Trend
- creation of a number of new stock exchanges around the world in
emerging economies (e.g. China, Russia, Sri Lanka, Poland,
Hungary, and Peru)
● 2nd Trend
- Toward consolidation of existing exchanges in developed
countries through mergers, partnerships, or strong affiliations.
➔ Regional Exchanges
- typically have the same operating procedures as the national exchanges
in the same countries
- differ in their listing requirements and the geographic distributions of the
listed firms.
- Two main reason for existing:
a. provide trading facilities for local companies not large enough to
qualify for listing on one of the national exchanges.
 b. regional exchanges in some countries list firms that also list on
one of the national exchanges to give local brokers who are not
members of a national exchange access to these securities.
➔ Over-the-Counter Market
- decentralized market
- market participants trade stocks, commodities, currencies or other
instruments directly between two parties and without a central exchange
or broker.
- do not have physical locations; trading is conducted electronically.
- very different from an auction market system.
- typically less transparent than exchanges and are also subject to fewer
regulations.
- Because of liquidity, may come at a premium
➔ Third Market
- describes OTC trading of shares listed on an exchange
- investment firm that is not a member of an exchange can make a market
in a listed stock.
- success or failure of the third market depends on whether the OTC
market in these stocks is as good as the exchange market and whether
the relative cost of the OTC transaction compares favorably with the cost
on the exchange
➔ Fourth Market
- trading is direct institution-to-institution trading without using the service of
broker-dealers
- Avoiding both commissions, and the bid-ask spread.
- Trades are usually done in blocks.