Financial markets play a vital role in connecting individuals and firms with surplus funds (savers) to those with a need for funds (borrowers). They do this through the issuance and trading of financial instruments. There are various types of financial markets that facilitate the exchange of different financial assets, including primary markets for new issues, secondary markets for existing assets, money markets for short-term debt, and capital markets for longer-term debt and equity. Financial markets provide important benefits such as directing funds to their most productive uses, providing liquidity to savers, and stimulating both savings and borrowing.

1. CHAPTER 4
FINANCIAL MARKETS
The financial sector is composed of two important segments: financial markets and
institutions. Financial markets perform a vital function in the operation of the overall financial
system. Why and how this is so shall be the subject of this chapter.
WHAT ARE FINANCIAL MARKETS
There are lots of individuals and firms with surplus funds. This actually means that their
current expenditures are smaller than their current incomes. To many of them, the surplus funds
need to be invested.
At the same time, there are people and firms whose need for funds are greater than their
current incomes. They need a reliable source of loanable funds.
Individuals and firms who want to borrow money are brought together with those who
want to lend in the financial markets. These markets provide a permanent venue for savers and
borrowers, and which render financial services wherever required by their customers. These
services are made possible by the financial markets through expediting the creation and trading of
financial instruments (securities).
Figure 4.1 shows an illustration of how funds and securities are channeled to and from the
SSUs and DSUs in the financial markets.
BENEFITS OF FINANCIAL MARKETS
The operation of financial markets offer advantages which covers the following:
1. Funds are directed to DSUs that can use them most efficiently;
2. Liquidity is provided to savers.
Financial markets, just like any market, operate in the demand and supply of funds. DSUs that
can use borrowed funds in the most productive manner can afford to pay higher interest rates.
Because of this, they have an edge in the bidding for loanable funds. Higher interest rates will then
motivate savers to save more so they will have more funds for lending.
An additional benefit provided by financial market is liquidity. Without the intervention of
financial markets, savers will directly lend to borrowers. This arrangement forces the lender to
wait for maturity date of the loan before he gets his money back. The lender will be at a great
disadvantage if he happens to need the loaned amount before maturity. This problem is eliminated
when financial markets are tapped. This happens because financial instruments are issued to
lenders, which in turn, can be converted to cash even before maturity, by endorsement or sale.

2. Exhibit 4.1
CHANNELS FOR FUNDS AND SECURITIES IN THE FINANCIAL MARKET
Direct
Credit
Market Primary
Securites
Funds
Primary Funds
Securities
Secondary Primary
Securities Securities
Funds Funds
Intermediation Direct credit
Market Market
DIRECT PLANNING
Private placements
Brokers
Dealers
Investment bankers
SURPLUS SPENDING
UNITS
Households
Business Firms
Government
DEFICIT SPENDING
UNITS
Households
Business Firms
Government
INDIRECT FINANCING
BY FINANCIAL
INTERMEDIARIES
Commercial banks
Savings & Loans
Mutual savings banks
Credit unions
Insurance companies
Pension funds
Finance companies
Mutual funds
Money market funds

3. HOW FINANCIAL MARKETS STIMULATE SAVINGS AND BORROWINGS
By using financial intermediaries, financial markets stimulate savings and borrowings.
There are various ways of achieving these.
Ways to Stimulate Savings
When financial intermediaries issue secondary securities to the general public, they motivate
SSUs to save. This is achieved in six ways which are as follows:
1. Denomination (size) Intermediation – Secondary securities can be made available in a
wide range of denominations from a few hundred pesos to many millions of pesos. To open
an account with a savings bank for instance, will only require an amount as low as one
hundred pesos. Some intermediaries, however, specialize in issuing large denomination.
2. Maturity Intermediation – Savers are concerned about the length of time their savings
will be invested. Dealing with financial intermediaries, however, eliminates the problem
because the savers can choose from secondary securities issued by the intermediaries in
maturities of from one year to more than a hundred years. Securities such as stocks have
no maturity and their life is co-terminus with the life of issuing DSU. Banks accept deposits
that may be withdrawn in one or few days. Educational plan companies sell contracts that
mature when the beneficiaries of the SSUs reach college age.
3. Credit- Risk Intermediation – When primary securities are offered for sale, individual
SSUs may not be too eager to buy because of their limited access to credit information.
Financial intermediaries, however, have better ways of identifying and later screen out poor
credit risk. These intermediaries will then issue secondary securities that are based on
primary securities bought and previously identified as good risk. This form of intervention
minimizes the efforts of SSUs in credit screening.
Also, the advantage of diversification is brought by financial intermediation. This is
achieved by pooling the funds obtained through the sale of secondary securities and
purchasing a wide variety of different primary securities. When losses, occur, only a few
of the primary securities will be affected because of the benefits brought by diversification.
The effect on the secondary securities issued will be negligible.
4. Interest Rate Sensitivity Intermediation – Some types of primary securities are subject
to changes in market interest rates. Many SSUs are averse to such interest rate risk. This is
remedied by the issuance of secondary securities by financial intermediaries. The SSUs are
given a choice of secondary securities of a given maturity with a wide range of interest
sensitivities.
5. Foreign Currency Intermediation – When SSUs buy primary securities stated in foreign
currencies, they assume the risk that the value of the foreign currency may change through
time. This risk is transferred to the financial intermediary which buys foreign currency
denominated primary securities and then sells secondary securities stated in local currency.

4. 6. Higher Net Interest Rates – When SSUs undertake actual search for DSUs issuing
primary securities, they do so with higher search and transaction costs. This is so because
of the difficulties involved in identifying DSUs, determining the credit quality of securities
offered, and locating the offices where the DSUs are located.
When SSUs buy secondary securities from financial intermediaries, the search and
transaction costs are much lower. When deducted from the gross interest rates, the lower
costs will yield higher net interest rates.
Ways to Stimulate Borrowings
Financial intermediaries stimulate borrowings in six ways. They are as follows:
1. Denomination (size) Intermediation – In spelling secondary, securities, financial
intermediaries able to acquire a pool of funds which enable them to buy primary
securities in a wider range of denominations. This arrangement relieves the DSUs in
searching for ‘SSUs which are willing to lend the exact amount they need.
When one wants to borrow from a financing company the amount of P19,689 to finance
the purchase of a sewing machine, he can borrow that exact amount. Borrowing the
same amount directly from an SSU would be difficult.
2. Maturity Intermediation – In the absence of a financial intermediary, borrowers will
have a hard time looking for direct lenders who will match the maturity period they
require. This problem is eliminated under the financial intermediation arrangement,
because the intermediary can create secondary securities in any maturity. Because of
this flexibility, financial intermediaries can accommodate the maturity requirements of
DSUs who sell their primary securities to them.
3. Interest Rate Sensitivity Intermediation – Many borrowers are averse to the risk of
interest rate increases. The financial intermediary can accommodate this kind of
borrowers by buying their primary securities with a sufficiently wide variety of interest
change periods for every maturity. This is made possible by two factors: (1)
intermediaries can sell secondary securities to a variety of lenders with different
preferences for interest change periods, and (2) intermediaries are better, able to assume
and manage interest rate risk, so they just perform the service.
4. Foreign Currency Intermediation – When DSUs sell primary securities in foreign
currency denomination, it is difficult to find an SSU that will accommodate the sale.
On the other hand, financial intermediaries can buy those types of securities with the
use of two options: (1) they may issue secondary securities denominated in foreign
currencies, and (2) they may assume the exchange rate risk between the time the
security is purchased and the time, it matures.
A case in point is the plan of the Philippine government to issue a yen- denominated
bond to cover budget deficits for the year 2000.
If the plan pushes through, the Philippine government will be a beneficiary of
foreign currency intermediation service provided by financial intermediaries.

5. 5. Lower Net Interest Cost – When DSUs deal directly with SSUs, the search and
transaction costs are higher. Because financial intermediaries are easier to locate, the
denomination and maturity of securities they issue can be tailored to need, and their
credit evaluation is quick and efficient, DSUs are more attracted to deal with them.
When the lowered search and transaction costs are added to the interest cost, the overall
effect will be a lower net interest cost for the borrowing DSU.
6. Information and Assistance Services – Financial intermediaries provide information,
expert assistance, and other services in addition to financing. This is especially
important when DSUs are dealing with foreign markets since they are provided with
information on legal, tax and financial requirements in those areas.
CLASSIFICATION OF FINANCIAL MARKETS
Financial markets are of various kinds.
1. Primary market
2. Secondary market
3. Money market
4. Capital market
5. Bond market
6. Stock market
7. Mortgage market
8. Consumer market
9. Auction market
10. Negotiation market
11. Organized market
12. Over-the-counter market
13. Spot market
14. Futures market
15. Options market
16. Foreign exchange market
Primary Market
A financial market on which newly issued primary and secondary securities are traded for
the first time is called primary market. Investors who buy these new issues are supplying funds to
DSUs which issue the securities.
When Globe Telecom made its plan to issue $200 million worth of debt notes to finance
the continuous expansion of its cellular and fixed-line network, it considered tapping the primary
market for the bonds issuance.

6. Secondary Market
A secondary market is that financial market through which existing financial securities are
traded. SSUs which bought new securities from the primary market may sell the same to the
secondary market anytime they wish to change their portfolios before maturity dates. As such, the
secondary market provides liquidity to the SSUs with securities held.
When banks buy Treasury bills from the Bangko Sentral, they do so in consideration of
their clients who buy the T-bills from them and which forms a solid secondary market. Exhibit 4.4
shows the flow of funds and securities in the primary and secondary markets.
Money Market
The money market is that financial market on which debt securities with an original
maturity of one year or less are traded. Long-term securities may also be traded in the money
market if they have six months or less left to maturity.
The money market was the financial: market tapped for sale of treasury bills in June 1999
amounting to P1 billion for the 91-day T-bill, P1.5 billion for the 182 day, and P2 billion for the
364 day T-bills.
Apart from their other functions, financial institutions like the Land Bank of the Philippines
perform money market functions.
Capital Market
The capital market is that portion of the financial market where trading is undertaken for
securities with maturity of more than one year.
When some banks bidded for the two-year Treasury bonds offered at P3 billion, they are
part of the capital market.
The capital market is subdivided into three parts:
1. the bond market
2. the mortgage, market, and
3. the stock market.
Bond Market
The market for debt instrument of any kind is called the bond market. The involvement of
large companies like the Dutch banking giant ABN AMRO in the issuance of 10 year bond is an
indication that the bond market is very active. ABN AMRO lead managed the issue of the bonds
by Electricity Generating Authority of Thailand. The bonds are valued at $300 million and
guaranteed by the world bank’s international Bank for Reconstruction and Development.

7. Stock Market
The stock market is that financial market where the common and preferred stocks issued
by corporations are traded. When the Social security system (SSS) bought 25.2 million shares of
stock of the Union bank valued at P460 million, the sale was a stock market transaction.
The stock market has 2 components: (1) the organized exchange, and (2) the less formal
over-the-counter markets.
There are many organized exchanges throughout the world like the New York and the
London stock exchanges. In the Philippines, stocks are openly traded in the Philippine Stock
Exchange. The companies whose stocks are traded in the Philippines Stock Exchange are classified
as follow:
1. banks
2. financial service
3. communication
4. power and energy
5. transportation services
6. construction and other related products –
7. foods, beverages, and tobacco
8. holding firms
9. manufacturing, distribution and trading
10. hotel, recreation, and other service
11. bonds, preferred and warrants
12. others
Mortgage Market
The mortgage is that portion of the financial market which deals with loans on residential,
commercial, and industrial estate, and on farmland. Universal and commercial banks tapped the
mortgage by extending real estate loans amounting to P717.68 billion for the year ended June
2014.
Among the banks that deal with mortgage market are: Bank of the Philippine islands, the
Philippine National Bank, and Philippine Saving Bank, which offer low home interest.
Various financial comprise the mortgage market. This may be derived from a review of
advertisements in newspapers where financial institutions are inviting interested parties to buy
foreclosed properties (see Exhibit 4.3). the real and other acquired assets of the Philippine National
Bank valued at P7.5 billion is an indication that the bank is also an active participant of the
mortgage market.
The National Home Mortgage Finance Corporation (NHMFC) is another component of the
mortgage market that grants mortgage loans, secured by house and lot collateral.

8. Consumer Credit Market
The market involved in loans an autos, appliances, education, travel, etc. is referred to as
an the consumer credit market. As there are millions of consumers tapping the credit market, a
number of financing institutions caters to the credit needs of these consumers needing credit.
An example of a personal loan offered to these in need is shown in Exhibit 4.4.
Auction Market
The auction market is one where trading is conducted by an independent third party
according to a matching of prices on orders received to buy and to sell a particular security. Stocks
are sold to the highest bidder, on the trading floors.
At the Philippine Stock Exchange, buyers of securities make their bids and prospective
sellers make their offer. Bids and offers stipulate both price and volume and are handled by the
trader, an agent of the auction market.
Offers are ranked from the lowest price up; bids from the highest price own. Bids and offers
are matched with one another. If there is a match, trade is consummated. Buyers and sellers do not
directly trade with one another, but through the trader.
An example of an auction market is the Philippine Stock Exchange.
Negotiation Market
When buyers and sellers of securities negotiate with each other regarding price and volume,
either directly or through a broker or dealer, they are engaged in the financial market called
negotiation market.
Securities that are not frequently traded and which are in large volumes may not be readily
accommodated in the auction market for lack of time to receive sufficient orders. This situation is
remedied by the negotiation market where the buyers and sellers are given sufficient time to locate
one another and to revise either price or volume in order to clear the market.
An example of a negotiation market in action is when the World Bank (WB) issued to the
Philippine Government an invitation to negotiate for a loan intended for the implementation of the
P10.6 billion Bus Rapid Transit (BRT) project in Cebu City.
Organized Market
The organized market is that financial market with fixed trading rules. It is situated at a
central location in the financial district in which trading is generally conducted by auction. Another
name for organized markets are exchanges like the Philippine Stock Exchange and the Australian
Stock Exchange. Common and preferred stocks, bonds, and warrants are sold at the Philippine
Stock Exchange.

9. Stock exchanges has specifically designated members, and has an elected governing body
– the Board Members have seats in the exchange which are bought and sold. The seat gives the
holder the right to trade on the exchange. The board of governors of the Philippine Stock Exchange
is composed of 15 members.
Over-the-Counter Market
The over-the-counter market is that market consisting of a large collection of brokers and
dealers, connected electronically by telephones and computers, that provides for trading in unlisted
securities. All securities not traded in the stock exchange for one reason or another are traded over-
the-counter. The over-the-counter market consists of facilities namely,
1. relatively few dealers who hold inventories of over the counter securities and act as a
securities market.
2. the many brokers who act as agents in bringing these dealers together with investors, and
3. the computers, terminals, and electronic networks that provide a communications link
between dealers and brokers.
Spot Market
When securities are traded for immediate delivery and payment, the market referred to is
the spot market. The spot price is the feature of the spot market and which is actually the price
paid for a security that will be delivered on the spot or immediately. The term “immediately” may
actually mean one or two days to one week depending on the facilities used or the tradition in the
area. Spot market is an alternative to the futures market.
Futures Market
Futures market is that market where contracts are originated and traded that give the holder
the right to buy something in the future at a price specified by the contracts.
For some time in the past, there was a futures market operating in the Philippines, but it
was dissolved because of some difficulties. As its importance cannot be discounted, the Bankers
Association of the Philippines recommended key reforms in government regulations that will pave
the way for the resumption of futures trading in the country.
Option Market
The options market is one where stock options are traded. A stock option is a contract
giving the owner the right to either buy or sell a fixed number of shares of a stock (usually 100) at
any time before an expiration date at a price specified in the option.
Options contracts may cover items like gold and treasury bonds. Options are traded in
organized securities exchanges like the Philippine Stock Exchange.

10. One purpose of the options market is to make possible for investors who wish to reduce
the risk of losing money due to price changes in the future. For instance, an importer purchasing
goods to be paid in foreign currency may avoid the risk of a sharp rise in the foreign exchange rate
by buying an options contract.
Foreign Exchange Market
The foreign exchange market is the market where people buy and sell foreign currencies. This
market is composed of the following:
1. banks throughout the world buying and selling foreign monies, in the form of foreign
currencies and deposits in foreign banks;
2. foreign exchange dealers; and
3. currency exchanges catering mostly to tourist and are found in the downtown area, airports
and railroad stations in major tourist centers.

11. New Funds
Money Invested
New Common
Stocks and bond
certificates
New Stock and
Bond Certificates
Money
Common Stocks and
Bond Certificates
Common Stocks and
Bond Certificates
Exhibit 4.2
THE FLOW OF FUNDS AND SECURITIES IN PRIMARY
AND SECONDARY MARKETS
PRIMARY MARKETS: NEW ISSUES
SECONDARY MARKETS: SEASONED OR EXISTING ISSUES
Investment Bankers and
Primary Placement
Business
Sector
Household
Sector
Stock Exchanges and
Over-the-Counter-
Markets

12. Exhibit 4.3
AN EXAMPLE OF AN ADVERTISEMENT OF A MORTGAGE MARKET SELLING
FORECLOSED MORTGAGES
PNB PROPERTY AUCTION up to 40%
discount
Cagayan, Isabela, Quirino & Nueva Viscaya
Properties
August 28,2014 Thursday 2:00 PM The Hotel Andrea
Don Jose Canciller Ave.
Cauayan City, Isabela
ISABELA
Item 2 - Residential lot with improvements
Title ID: 20492/20493
Lot Area: 2,750 sq. m.
Floor Area: 352 sq. m. (whouse) 144 sq. m. (Main Bldg.)
TCT-86886/86887 Lot 180-A-New-3-A & 180-A-New-3-B
Barrio of Nampicuan, Purok 2, Aurora Isabela
Market Price: 550,000.00
Min. Bid Price: 530,000.00
Item 3 - Vacant lot
Title ID: 14909
Lot Area: 628 sq. m.
TCT: 340231
Lot 13 Blk. 1 Purok 6
Bo. San Antonio, Burgos, Isabela
Market Place: 109,900.00
Min. Bid Price: 99,000.00
Item 4 - House and Lot
Title ID: 18287
Lot Area: 400 sq. m.
Floor Area: 99 sq. m.
TCT: 322994
Lot No. 3-B-4 National Road, Masigun East, Burgos Isabela
Market Price: 140,000.00
Min. Bid Price: 110,000.00
From an advertisement, The Philippine Star, August 2, 2014.
page B-3. Partial listing only.

13. Exhibit 4.4
AN EXAMPLE OF AN ADVERTISEMENT OF
A PERSONAL LOAN
SHOP NOW,
GET BILLED LATER
PNB CREDIT CARDS
Zero % Affordable payment plan
Pay for your child's back to school needs
after 3 months*!
Getting your children ready for school time is new
easier on the packet!
Whether it's uniforms, school supplies, or other
things your children may need, use your
PNB Credit Card to pay with 0% installment
at your choice of 3, 6, 9, 12, or 24-month terms.
*To be billed starting on the 3rd statement/cut-off.
0% interest is for selected items and terms.
Promo runs from May 15 - July 31,2014.
Terms and conditions apply.
Source: PNB Flyer, 2014.
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