Financial Market

ACCO 20083
FINANCIAL
MARKETS
Instructional Materials
Compiled by:
Dr. Herbert C. Baron, CPA
Dr. Marvin V. Lascano, CPA
Andrew Timothy L. Cachero, MBA, CPA
Maria Luisa U. Oliveros, CPA
Luzviminda S. Payongayong, CPA
Table of Contents
Module 1 – Financial Systems and the Financial Markets ............................... 2
Module 2 – Financial Regulation .............................................................. 5
Module 3 – Money Market Financial Instruments .......................................... 8
Module 4 – Managing the Credit Risk of the Financial Instrument .................... 19
Module 5 – Debt Securities Market .......................................................... 28
Module 6 – Equity Securities Market ........................................................ 34
Module 7 – International Financial Market ................................................. 40
REFERENCES .................................................................................... 44
APPENDIX: SYLLABUS ON FINANCIAL MARKET
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Module 1 – Financial Systems and the
Financial Markets
Overview:
In commerce, Finance is the application of economic principles to decision-making
that involves the allocation of money under conditions of uncertainty. It provides for the
framework for making decisions as to how those funds should be obtained and then
invested. It is the financial system that provides the platform by which funds are transferred
from those entities that have funds to invest to those entities that need funds to invest.
Finance came from a French word which means settlement of debt. The Financial
systems allow the flow of the funds to those who needs it and those who are willing to
extend or invest. In the system, financial market is a venue where the demanders and
suppliers of funds meet.
Module Objectives:
After successful completion of this module, you should be able to:
• Discuss the Financial Systems and its elements

• Identify the Financial Intermediaries
• Classify the players in the financial markets
Course Materials:
According to Dr. Faure (2013), Financial System is a set of arrangements or
conventions embracing the lending and borrowing of funds by non – financial economic
units and the intermediation of this function by financial intermediaries in order to facilitate
the transfer of funds, to create additional money when required, and to create markets in
debt and equity instruments (and their derivatives) so that the price and allocation of funds
are determined efficiently.
The Elements of Financial System
1. Demanders of Funds
The demanders of fund are the individuals or groups that need financing. They are
those who are in need of additional financing to sustain their business operations
or livelihood for domestic. In commerce, demanders of fund are those who are
willing to do actions to earn more but restricted with financial resources.
2. Supplier of funds
Supplier of funds are players in the system that have excess or willing to invest
their funds in the system with the intent of earning more out of these funds.
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3. Financial Intermediaries
Financial intermediaries don’t have their own funds but acts as channels of
transmitting those funds from the demanders and suppliers of funds. They may be
financial institution, financial markets or through private placement.
a. Financial Institutions. Financial Institutions are entities that aims to collect

or gather funds from the suppliers and in return extend this to the
demanders of fund normally in the form of loans or any interest bearing
instruments. Financial institutions may be generally classified into
commercial banks, investment banks or universal banks.
b. Financial Markets. Financial Markets are arrangers of transactions

between the suppliers and demanders of fund. Financial Market acts as the
middleman or conduit between the parties with the aim to perfect the
exchange. Financial Markets are classified into:
i. Instruments Traded. Financial Markets may be classified according
to the instruments it is trading. Money Market are those who are
trading short term financial instruments that are legally traded e.g.
Treasury Bills, Commercial Papers, Certificates of Deposits,
Repurchase agreement, or Bankers’ acceptances. Another type is
Capital Market which trades equity or debt instruments which are
normally to mature in long term period. These will take the form of
stock markets and bond markets.
ii. Market Type. Financial markets may be classified to the type of

market that trades. If the instrument used to trade are issued first-
hand or original issuance these are called Primary Market. Once
these are traded again the player is now called Secondary Market.
iii. Origination. Financial Markets may be classified according to where

it originated or players are originated. If the transaction is perfected
within the same national boundary this is called Domestic Market
otherwise it is International or Foreign Market.
c. Private Placement. Private placement are intermediaries with a particular,

private or specific individual or entity where the supply and demand of fund
will be taken. For equity trade, these are normally issuance of stocks to pre
selected investors.
Financial intermediaries allow for the acceleration of flow of funds between entities
or players, efficiently allocating funds, creation of money and supports price
discovery.
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4. Regulators
Regulators play an important role in the financial system. They set the framework
and boundaries to protect the interest of the players in the system. The regulators
are the governance body ensures that all complies with the laws, rules and
regulations imposed to them. In the Philippines, the major financial regulator is the
Bangko Sentral ng Pilipinas or BSP. BSP, through its Monetary Board, issues
policies and guidelines where the players in the financial systems must comply.
5. Financial Instruments
Financial Instruments are documents or representation for the exchange. This

represents a specified value. The value maybe agreed by the parties or already
been determined. The financial instruments must adhere to the form which the
laws so require.
Read:
Books, published materials and references on Financial Markets, Financial Management

and Financial Systems.
Activities/Assessments:
1. Essay. What is financial system? Describe how the elements interact with each
other.
2. Select a public listed company, get their audited financial statements. Identify
who are financial intermediaries potentially tapped by the companies if they need
additional financing.
3. Get a list of players in the financial market and classify them into the different
types of financial market.
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Module 2 – Financial Regulation
Overview:
According to the Public Utility Research Center of University of Florida, Regulation
is a process whereby the designated government authority provides oversight and
establishes rules for firms in an industry. A regulatory agency who is the governance body
to ensure compliance to laws, rules and regulation is identified to provide oversight to the
players in the industry.
Financial Regulation ensures that the risks are managed and all parties in the
financial system are protected. This is a type of regulation that imposes standards and
policies to set controls over the market factors that will affect the financial sustainability.
Module Objectives:
• Identify the drivers that will affect the financial sustainability

• Recognize the different financial regulators in the Philippines
• Identify the risk in the Financial Markets
Course Materials:
Financial Regulation is a process of governing in the financial systems to ensure

balance and protection of the interest of all players in the systems. By doing so this
manages the risk that will potentially arise in the financial market system. General form of
risks in the financial systems are:
• Credit Risk. Credit Risk is the probability that the payor will not pay or settle its
obligation.
• Liquidity Risk. Liquidity Risk is the probability to raise sufficient resources to repay
its financial obligation
• Default Risk. Default Risk is the probability that currently maturing portion were not
settled on time.
• Technological Risk. Technological Risk is probability that services will be
interrupted due technological resource limitation.
• Legal Risk. Legal Risk is the probability that new laws, rules and regulation will be
imposed and might affect the ability to sustain its creditworthiness.
Since these risks, among others, may affect the financial operations of the
business or organizations. Laws are created to enforce financial regulations. In financial
markets, these laws, rules and regulations control the following drivers: competitiveness,
market behavior, consistency and stability.
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Competitiveness. Policies were imposed to the financial system to ensure parity
among parties which could drive the following: access to capital, credit and loan term
offerings, support to providers of financing, management of business risks, transaction
costs and tariffs. It must be noted that the main determinant of competition are the main
forces that drives the market i.e. buyers and sellers.
Market Behavior. Financial Regulation sets the parameters to ensure that firms will
comply with the standards and level the playing field. The policies were set to regulate the
information disclosure, advantage over internal information, entry of new players,
minimum capital requirement and minimum governance requirements.
Consistency. The reason why in the field of accountancy consistency is an

important principle because it enables development of reasonable decision. Consistency
plays a key attribute to ensure that the other drivers affecting the results were isolated for
better analysis and at the same time reducing the risk inherent in the results.
Stability. Market Stability is important. Given that market behavior is dependent on

a lot of factors, the risk is very high. Most of the players failed to survive because their
ability to forecast and to mitigate the market risk. In the financial market, the impact of
financial risk is something that the regulatory environment should consider. The regulation
must be able to protect the interest of the clients as well as the companies to enable their
corporate sustainability.
These drivers are among the key factors that were controller or regulated by the
Financial Regulators. In the Philippines, the key financial regulators are: Bangko Sentral
ng Pilipinas, Insurance Commission, Philippine Securities and Exchange Commission and
Board of Investments, among others.
Each financial regulator has specific industry, risk and players in the financial
system that they are tasked to oversee. Particularly for the Bangko Sentral ng Pilipinas
which is a Self-Regulating agency attached to the Department of Finance which is
generally focused on regulating the liquidity management, currency issues, and currency
reserves and exchange rates.
Basically, the financial regulators are focused on controlling the payment systems.
Payment system enables the transfer of funds from a party to another thereby effecting
settlement. Nowadays due to the emergence of financial technology, payment systems
are being automated, but nonetheless, it importance remain to be the same which are:
• Managing safe and real time transaction
• Effective risk management
• Facilitates financial market transactions.
Read:
Republic Act 10607 or the Amended Insurance Code

Republic Act 7653 or the Bangko Sentral ng Pilipinas Charter
Other books and reference on Financial Markets, Risk Management and Financial
Regulation
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1. Illustrate the charters of the Financial Regulators in the Philippines.
2. Tabulate the drivers that affect the financial market and identify the risks that may
arise.
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Module 3 – Money Market Financial
Instruments
Overview:
Financial Instruments are the main vehicle used for transactions in the financial
market. There are two parties involved in the financial instruments – issuer and investors.
Financial Instruments are traded in the Financial Market. Money Market is the type of
financial market where these financial instruments with less than one year tenor are
traded. There are three fundamental characteristics: Sold in large denomination; low
default risk; and mature in one year or less from original issue date. Common types of
money market financial instruments are treasury bills, repurchase agreements or repo,
negotiable certificates of deposits, commercial paper, and banker’s acceptances.
In evaluating money market securities, interest and tenor of the securities before
maturity are the large factors. As the interest increases the value of the securities reduces.
Investors must ensure apples-to-apples comparison among the securities to determine
the value to be used in investing decisions.
Module Objectives:
• Describe the different financial instrument

• Identify the limitations or risk in using each financial instrument
• Describe how financial instruments be valued and treated in financial reports
Course Materials:
Financial Instruments according to Conceptual Framework for Financial Reporting

(2018), an asset is a resource controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity. Assets can be classified
in terms of physicality: tangible and intangible assets. Tangible assets are assets that has
physical properties and can be easily seen, touched or perceived by the five senses.
Intangible assets are identifiable assets that do not have physical substance and usually
represents a legal claim to some future economic benefit. Financial instruments (also
called as financial assets or securities) are basically intangible as future economic benefit
takes form of a claim to cash that will be received in the future. Financial instruments
are the main vehicle used for transactions in the financial market. For the purposes of
presentation in financial statements, financial instruments may be presented under cash
equivalents or investments. Securities that are maturing within 90 days or less are
classified under cash equivalents. Otherwise, they are classified under investments.
There is a minimum of two parties involved in a financial instrument: the issuer;

and the investor. The issuer is the party that issues the financial instrument and agrees
to make future cash payments to the investor. On the other hand, the investor is the party
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that receives and owns the financial instrument and bears the right to receive payments
to be made by the issuer. On an accounting perspective, investors recognize financial
instruments as an asset.
Financial instruments have two main economic purposes:
• Allows transfer of fund from entities with excess funds (investors) to entities who
needs funds (issuer) for business purposes (e.g. to pay for tangible assets).
• Permit transfer of fund that allows sharing of inherent risk associated with the cash
flows coming from tangible asset investment between the issuer and investor.
Usually, the initial investor does not hold on to the instrument up until the time the
issuer can make the payment. In such cases, investors trade their financial securities to
other individuals or institutions who are willing to pay for their claim to future payment.
Financial intermediaries that operate in the financial system demand funds from
“investors” and convert these to various financial assets that the general public is willing
to buy. As a result of these interlinked activities, claims of the final wealth holders generally
differ from the liabilities recognized by the issuers (final demanders of funds).
Money Market
Financial instruments are the primary subject of trading in a money market. The
financial instruments traded in the money market are short-term and highly liquid, that it
can be considered close to being money.
Money market securities have three fundamental characteristics:
• Usually sold in large denominations
• Low default risk
• Mature in one year or less from original issue date. Most money markets
instruments mature in less than 4 months.
Transactions in the money market are not confined to one singular location.
Instead, the traders organize the purchasing and selling of the securities among
participants and closes the transactions electronically. As a result, money market
securities commonly have an active secondary market. An active secondary market
enables individuals / organizations to trade money market instruments to cater to short-
term financial needs. Money market instruments become a flexible tool as individuals /
organizations may invest in these for short-term gains and convert it back to cash quickly
once liquidity need arises. On an accounting perspective, most money market instruments
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are considered as cash equivalents due to the fact that they mature (i.e. cash can be
redeemed) within three months or less from the date of purchase.
Most transactions in the money market are very large, hence, they are considered
as wholesale markets. The required size of the transaction usually averts individual
investors in directly participating in the money market. As a result, dealers and brokers
execute transactions in the trading rooms of brokerage houses and large banks to match
customers (buyers to sellers) with each other. Despite this limitation, individual investors
nowadays can invest in the money market by joining funds that trade mostly using money
market instruments.
A mature secondary market for money market instruments allows the money
market to be the preferred place for firms to temporarily store excess funds up until such
time they are needed again by the organization. Investors who place funds in the money
market do not intend earn high returns for their money. Instead, investors look at the
money market as a temporary investment that will provide a slightly higher return than
holding on the money or depositing it in banks. If investors believe that the prevailing
market conditions do not justify a stock purchase or there might be a possible interest rate
hikes impacting bonds, then they can choose to invest on money market instruments in
the meantime. Holding on to cash is a very expensive option for investors as this does not
generate any return. Any idle cash becomes an opportunity cost to investors by means of
the interest income not earned by holding on to the cash. To reduce opportunity costs,
money markets become a viable option to temporarily invest idle funds.
Investors also plan their strategy to incur the lowest opportunity costs. Investors
want to have an easy source of cash to be able to act quickly if there are available
investment opportunities that come but at the same time do not want to let go of potential
interest income. As a result, they invest on money market securities to achieve these
objectives. Financial intermediaries also use money market instruments to attain
investment requirements or deposit outflows.
On the other hand, money markets offer a least expensive alternative for fund
demanders such as the government and financial intermediaries when they have short-
term fund requirements. Fund demanders need to have funds quickly because the timing
of cash inflows and outflows does not synchronize with each other. For businesses, timing
of cash collections from revenue may not match when the business needs to pay its
operating expenses. For government, collection of revenue only comes at certain points
of the year (tax payment deadlines) but expenses are incurred throughout the year. To
resolve the need for funds as a result of the mismatch, these entities turn to money
markets to obtain funds.
Participants in the money market include the following
• Bureau of Treasury. The bureau sells government securities to raise funds.

Short-term issuances of government securities allow the government to obtain
cash until tax revenues are collected.
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• Commercial banks. Issues treasury securities; sell certificates of deposits and
extends loans; offers individual investor accounts that can be used to invest in
money markets. Banks are the primary issuer negotiable certificates of deposits,
banker’s acceptances and repurchase agreements.
• Private Individual. These private individuals made their investment through

money market mutual funds
• Commercial Non-Financial Institutions. These entities buy and sells money

market securities to manage their cash i.e. to temporarily store excess funds in
exchange of somewhat higher return and obtain short-term funds
• Investment companies. Trade securities in behalf of their clients. Makes a market

for money market securities through maintaining an inventory of financial
instruments that can be bought or sold. Investment companies help maintain
liquidity of money market since they make sure that sellers can easily sell their
securities when the need arises.
• Finance / commercial leasing companies. These companies raise money market

instruments i.e. commercial paper to lend funds to individual borrowers
• Insurance companies. These are companies that invest on money market to

maintain liquidity level in case of unexpected demands most especially for
property and casualty insurance companies.
• Pension funds. Maintain funds in money market as preparation for long-term

investing in stocks and bonds market. Need to maintain liquidity to meet
obligations but since future obligations are likely expected, huge money market
investments are not necessary.
• Money market mutual funds. These funds permit small investors (e.g. individuals)
to invest in the money market by accumulating funds from numerous small
investors to buy large-denomination money market securities.
Common Types of Money Market Financial Instruments
• Treasury Bills – are government securities issued by the Bureau of Treasury

which mature in less than a year. There are three tenors of Treasury Bills: (1) 91
day (2) 182-day (3) 364-day Bills. The number of days is based on the universal
practice around the world of ensuring that the bills mature on a business day.
Treasury Bills are quoted either by their yield rate, which is the discount, or by their
price based on 100 points per unit. Treasury Bills which mature in less than 91-
days are called Cash Management Bills (e.g. 35-day, 42-day). Being government
securities, these are no longer certificated (i.e. scripless) same with the practice in
other countries such as China, Canada and USA. Banks that compose majority of
the Government Security Eligible Dealers (GSED) bid for T-bills in the weekly
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auctions held by the Bureau of Treasury. The banks then resell the T-bills to
investors. Treasury bills can be sold via two methods: auctions or competitive
bidding and noncompetitive bidding.
Treasury bills have virtually zero default risk since the government can always print
more money that they can use redeem these securities at maturity. Risk of
inflationary changes is also lower since the maturity term is shorter. Market for
Treasury bills is both deep and liquid. Deep market means that the market has
numerous different buyers and sellers while liquid market means that securities
can be quickly traded at low transactions costs. Investors prefer to go to a deep
and liquid market such as Treasury bills since there is only little risk that they will
not be able to liquidate the securities when they prefer to.
Government securities, particularly treasury bills, are the safest investment

instrument in the market. Because they are backed by the full taxing power of the
government, they are practically default risk-free. While there may be market risks
owing to changes in interest rates, these are an attractive investment vehicle since
the safety of the investor’s principal is assured. These are also marketable and
highly liquid. They can be traded easily in the secondary market anytime the market
is open. Interest rate is not explicitly stated in the Treasury bill; hence, interest is
not actually paid by the government when they sell this security. Instead, treasury
bills are issued at a discount (meaning lower price than the par value at maturity).
When analyzing investments, investors often try to compare performance of

financial instruments with each other. To address this, most investors look at
percentages to be able to compare returns better. At the point of view of investors,
the discount rate indicates how much return, in %, they can get from a particular
security. The annualized discount rate for a non-interest-bearing security (like
Treasury bill) is described in the equation below.
𝐵𝑣 − 𝐵𝑝 360
𝐸𝑞. 3.1 𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 = ×
𝐵𝑣 𝐷
Bv = Face Value or Market Value
Bp = Purchase Price
D = tenor or period in days
For example, a P1,000 Treasury bill with a 91-day tenor can be purchased at 995.
To compute for the discount rate, we just need to substitute above information in
the formula.
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𝑃 1,000 − 𝑃 995 360
𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 = ×
𝑃 1,000 91
𝑃 5.00 360
𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 = ×
𝑃 1,000 91
𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 = 1.98%
Another variation of the annualized discount rate is what we call the investment
rate. The investment rate portrays a more accurate representation of how much
investor will earn from the security since it uses the actual number of days per year
and the true initial investment in the computation. Eq. 4.2 presents the formula for
the annualized investment rate.
𝐵𝑣 − 𝐵𝑝 365
𝐸𝑞. 4.2 𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑒 = ×
𝐵𝑝 𝑀
Bv = Face Value or Market Value
Bp = Purchase Price
M = number of days to maturity
Using the previous example, the annualized investment rate is
𝑃 1,000 − 𝑃 995 365

𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑒 = ×
𝑃 995 91
𝑃 5.00 365
𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑒 = ×
𝑃 995 91
𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐼𝑛𝑣𝑒𝑠𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑒 = 2.02%
Treasury bills are also known to be very near to the definition of a risk-free asset.
As a result, interest earned on Treasury bills are among the lowest in the market.
Investors may find that earnings from Treasury bills may not be sufficient to cover
for changes in purchasing power brought by higher inflation. Treasury bills are
mostly meant as an investment vehicle to temporarily store excess cash since it
may hardly catch up with inflation.
• A Repurchase agreement (repo) is a financial contract involving two securities

transactions, a sale/purchase of a debt security on a near date and a reversing
purchase/sale of the same or equivalent debt security on a future date.
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Repurchase agreements enable short-term funds to be transferred between
financial or non-financial institutions, usually ranging from one-day to 3 to 14 days.
Some repos can also range from one to three months. Repos are a key component
of the debt securities market that produces short-term cash or securities liquidity
critical to price-making activity of fixed income dealers.
Dealers of government securities commonly use repos to manage liquidity and take
advantage of expected changes in interest rates. Dealers sell their securities to a
bank with an accompanying repo agreement promising to buy the securities back
at a specified future date. Essentially, repos are collateralized loans. Since repos
are collateralized by the accompanying securities, these usually are treated as low-
risk investments with low interest rates.
• Negotiable certificates of deposit are securities issued by banks which records

a deposit made. The certificate indicates the interest rate and the maturity date of
the deposit. Since maturity date is stated in the certificate, negotiable certificates
of deposit are treated as a term security with a specific maturity date. It cannot be
easily withdrawn by the depositor since it is different from a demand deposit
account wherein money can be withdrawn upon demand of depositor. A certificate
of deposit essentially restricts holders from withdrawing funds on demand. The
concept behind CDs is that investors are willing to accept a higher return in
exchange of having no access to liquidity.
Negotiable certificate of deposit is also classified as a bearer instrument. As a

bearer instrument, whoever person or entity which possesses the instrument upon
maturity will receive the principal and interest. This feature allows negotiable CDs
to be purchased and sold between investors. Interest rates of CDs are based on
the outcome of the negotiation between the depositor and the bank. Both parties
should agree on the interest rate of the CD. The interest rates of CDs are usually
at the same level with other money market securities since it carries a low level of
risk.
Investors can buy or sell certificates of deposit up until the instrument’s maturity.
Negotiable CDs may have maturity period between one to four months up to six
months. However, there are lesser demand for CDs with longer maturity. Upon
maturity, the bank shall pay the principal plus the interest to the investor who holds
the CD.
In the Philippines, the BSP allows and regulates the issuance of long-term
negotiable certificates of deposits (LTNCD). LTNCD refers to interest bearing
negotiable certificates of deposit with a minimum maturity of five years. LTNCD
offers a higher return compared to regular time deposit account because of the
long period that depositors will be unable to withdraw the money.
• Commercial Paper - Fundamentally, commercial papers are unsecured

promissory notes. Commercial paper may be short-term or long-term. Short term
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commercial paper means an evidence of indebtedness of any person with a
maturity of three hundred and sixty-five (365) days or less. Long term commercial
paper is an evidence of indebtedness of any person with a maturity of more than
three hundred sixty-five (365) days.
Since commercial papers are unsecured, only large and creditworthy corporations
can issue this security. Lenders will not accept commercial papers from small
companies since they are going to assume high level of risk since this security is
not secured. Commercial papers are issued directly to the buyer and usually, there
is no secondary market for commercial papers. Dealers may redeem commercial
papers if the bearer needs cash, but this seldom happens.
Nonbank corporations like financing companies usually issue commercial papers

and use the proceeds to fund loans that they extend to their clients. Issuers often
maintain line of credits with banks to serve as backup for a commercial paper. The
line of credit is primarily for the benefit of the issuer of the commercial paper. If the
issuer is not able to pay the maturing commercial paper, the bank will lend funds
to the issuer to enable the latter to pay for the commercial paper. The availability
of line of credit reduces the risk associated with commercial papers, hence, this
reduces the interest rate. Banks usually extends the line of credit and agrees to
provide the loan in advance in case there is a need to pay off the commercial paper.
In exchange, the issuer pays of a service charge in exchange of the line of credit.
Issuers of commercial paper agrees to pay the line of credit fee because this is
lower versus paying interest on the commercial paper for an extended period of
time.
Commercial papers may either have a stated interest rate on its face or sold at a
discounted basis. In the Philippines, commercial papers are not required to register
with SEC if they meet the following requirements, otherwise, companies need to
register with SEC first prior to issuing any commercial paper.
➢ Issued to not more than 19 non-institutional lenders
➢ Payable to a specific person
➢ Neither negotiable nor assignable and held on to maturity
➢ Amount not exceeding P50 million.
• Banker’s acceptances refer to an order to pay a specified amount of money to

the bearer on a specified date. Banker’s acceptances are often used to finance
purchase of goods that have not yet been transferred from the seller to the buyer.
Banker’s acceptance is usually offered to importers and exporters. An acceptance
is formed when a draft or a promise to pay is made by the bank’s client and the
bank then ultimately accepts, promising to pay in behalf of the client. The bank’s
acceptance of the draft translates to a promise to pay to whomever party presents
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it to the bank for payment. The client then gives the draft (i.e. banker’s acceptance)
to the vendor to finance the purchase.
Banker’s acceptances are usually payable to the bearer. Hence, this can be
subsequently purchased and sold until it matures. Banker’s acceptances are
usually sold at a discount, similar with Treasury bills. Market dealers also facilitate
the trading of banker’s acceptances by matching prospective sellers and buyers.
Interest rates on banker’s acceptances are usually low since default risk is very
minimal.
Evaluating Money Market Securities
As a finance person, you should be able to understand and evaluate which money
market securities to invest on depending on the purpose of the business. Money market
securities may be evaluated based on the interest rates and liquidity.
Interest rates are very relevant in deciding which money market securities to invest
since this dictate the potential return that can be received from the investment. Interest
rates on money market tend to be relatively low as a result of the low risks associated with
them and the short maturity period. Money market securities have a very deep market;
thus, they are competitively priced. If you would notice, most money market securities
carry the same risk profile and attributes, thus, making each instrument a close substitute
for each other. Hence, if a particular security may have an interest rate that deviates from
the average rate, supply and demand forces in the market would ultimately correct it and
force it back to the average rate.
Liquidity refers to how quick, efficient and cheap to convert a security into cash.
Treasury bills, that have a ready secondary market, are considered to be more liquid than
commercial papers which do not have a developed secondary market. Holders of
commercial papers tend to hold the security until it matures. For this reason, brokers may
charge a higher fee for investors that would want to liquidate its commercial paper since
more effort shall be made to look for potential buyers compared to treasury bills that have
buyers willing to purchase at short notice. Since most money market securities are
typically short-term, money market is often preferred by investors who desire liquidity
intervention – providing liquidity where it did not previously exist.
Valuation of Money Market Securities
Valuation of money market securities is important to determine at what amount an

investor is willing to pay in exchange of a security. In some cases, investors need to give
an amount as a bid to be able to buy securities. Money market securities can be valued
using the present value approach. The interest rate used in the valuation shall reflect the
required return from the instrument based on the investor’s perceived risk. Investors may
also use the prevailing interest rate in the market for the type of security being purchased.
Eq 4.3 presents the valuation formula which is practically present value formula.
16
𝑆𝑏
𝐸𝑞. 3.3 𝑀𝑎𝑟𝑘𝑒𝑡 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 =
(1 + 𝐼)𝑛
Sb = Face value of the security
I = Interest rate
n = Number of Periods
For example, face value of a one-year Treasury bill is at P1,000 with an annual interest
rate of 3%. To compute for the value of the Treasury bill, use the formula above. The
face value which will be received upon maturity is P1,000. The interest rate will be 3%
and the number of periods is 1 (since it has a one-year maturity term)
𝑃1,000
𝑀𝑎𝑟𝑘𝑒𝑡 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 =
(1 + 3%)1
𝑀𝑎𝑟𝑘𝑒𝑡 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 = 𝑃970.87
This means that an investor is willing to pay P970.87 for a P1,000 Treasury bill based on
the risks surrounding the instrument. In absolute terms, the investor will get return of
P29.13 from this investment.
Assume that another P1,000 Treasury bill with maturity term of 90 days with an annual
interest rate of 4% is being evaluated. Assume 360 days. The value of said Treasury bill
is computed as follows:
𝑃1,000
𝑀𝑎𝑟𝑘𝑒𝑡 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 =
(1 + 1%)1
𝑀𝑎𝑟𝑘𝑒𝑡 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 = 𝑃990.10
The annual interest rate should be converted to match the 90-day maturity term. Hence,
annual interest term of 4% shall be multiplied with 90 / 360 to get how much is the interest
rate for the tenor of the security. In this case, the interest rate to be used is 1% which
represents the interest cost associated with the 90 days that the money is held by the
government.
As a general rule, as the interest rate rises, the value of the security becomes lower. This
means that the market risk is increases thus the impact on the value of the securities also
reduces.
Read:
• Treasury Bills in auction/competitive bidding and non-competitive bidding

• Difference of Annualized Discount Rate and Annualized Investment rate.
17
• Securities and Exchange Commission and Bangko Sentral ng Pilipinas
Regulation on the discussed money market financial instruments
• Other books and reference on Financial Markets specifically Money Market
1. Tabulate the common types of money market financial statements and
differentiate.
2. Create a summary of the formulas discussed in this module in three columns.
First column is the Name of the formula, the Formula and last column will be
where to use the formula
3. Get an example document of each of the money market financial instruments
discussed.
18
Module 4 – Managing the Credit Risk of the
Financial Instrument
Overview:
One of the challenges in financing is to ensure the ability of the borrowers to settle
the obligation. The risk involve in financing are: default risk, liquidity risk, and market risk
among others. It is theoretically assumed that the cost of financing is affected by the
availability of loanable funds which is the Loanable Funds Theory and the maturity of the
loans, where the longer the life of the loans the higher the rate is Liquidity Preference
Theory. The three factors that affect the interest rates: (1) industry; (2) risk exposure; and
(3) compensation for the market expectation. Hence, the interest formula will require the
function of default or risk-free rate, inflation and debt premium for the compensation.
In order to mitigate the risk, most businesses hedge forward rates or enter into a
swap rate agreement. It is important for the borrowers and lenders to know what the spot
rate in the prevailing market is and employ certain expectations in the future.
Module Objectives:
• Understand theories relating to credit risk and interests

• Determine how interest rates are computed
• Identify ways to mitigate credit risks and interest rate risks
• Identify the different levels and methods of credit rating of entities
Course Materials:
Credit Risk and Interest Rates
Credit risk is a type of business risk. This is the risk that the borrower may not be
able to repay its obligation. Such risk is included in valuation as a factor to determine the
cost of lending or financing using debt. Credit risk also affects the valuation of accounts
receivable.
Theories related in Setting Interest Rates
According to Fabozzi and Drake, there are two economic theories that drive the
interest rates. These are loanable funds theory and liquidity preference theory. Loanable
funds theory assumes that it is ideal to supply funds when the interests are high and vice
versa. This theory was introduced by Knut Wicksell in 1900s.
On the other hand, liquidity preference theory was introduced by John Maynard
Keynes and states that the interest rates are dependent on the preference of the
19
household whether they hold money or use it for investment. Hence, the longer the term,
the higher the interest rates because investors prefer short-term investments more.
The tenor of the investment also defines the riskiness of the repayment of debt.
The longer the life of the debt, the riskier the repayment; hence, the interest rate is higher.
There are two economic theories that affect the term structure of interest rate. These are
expectations theory and market segmentation theory.
• Expectation Theories
Expectation theories state that the interest rates are driven by the
expectation of the lender or borrowers regarding the risks of the market in the
future. It can either be a pure expectation theory or biased expectation theory.
Both theories understand how interest rate, or the term, should be structured
over time.
Pure expectations theory is based on the current data and statistical
analysis to project the behavior of the market in the future. They all rely on
forward rates or the future interest rates based on their projection on the future
prices. Of course, expectation on the interest rates varies depending on the
perspective and the maturity. For example, Company A needs to finance a
project that will be operated in perpetuity. Company A applied for a loan to
Company B payable for 20 years. The prevailing interest rate at present is 7%.
Based on the current environment, the market seems to worsen in the future.
How will the interest rate behave in the future? With the given information,
Company B must assume a higher rate than 7% since the probability that
Company A may pay in the future is becoming low. The pure expectations shall
be based on the strong estimates based on the uncertainty of the future. The
rates to be agreed should be reasonable enough for both parties otherwise one
will not be fully compensated especially on the part of the lenders. Observed
that the pure expectations theory only relies on the term and not on other
factors.
Biased Expectation Theory includes that there are other factors that
affect the term structure of the loans as well as the interest to be perceived
moving forward. The forward rates will be affected or will be adjusted if the
liquidity of the borrower will be weaker or stronger in the future. The adjustment
or increase on the interest rate is called the liquidity premium. Liquidity
premium increases as the maturity lengthens. This theory is called the liquidity
theory. Another theory under the Biased Expectation Theory is the preferred
habitat theory. This theory does not only consider the liquidity but the risk
premium as well but disregarding the consensus of the market on the future
interest rates. The habitat being referred here is the biased estimate over the
market behavior in the future.
• Market Segmentation Theory

This theory assumes that the driver of the interest rates are the savings
and investment flows. The maturities are segmented depending on how the
assets and liabilities were managed as well as the lenders on how they extend
financing. It is the same with preferred habitat theory however it does not
20
assume that any of the players are willing to shift sector should opportunity to
arise for the asset or liabilities to be retired or lenders to offer higher rates.
Determination of Interest Rate
To determine the appropriate interest rate or rates the following factors should be
considered assuming the cash flows are already been established:
• Interest rates in the industry
• Risk exposure
• Compensation on the market expectation.
In finance, interest can be determined by the function of the risk and the
compensation of the investor on the difference between the risk-free rate and the market
fluctuations (Eq 5.1).
Eq 4.1 𝑖 = (𝑅𝑓 + 𝐷𝑚 )
i = interest
Rf = risk free rate where (Real risk free rate = Rf - inflation)
Dm = debt margin or debt spread or the risk premium
The risk-free rate should the rate that assumes zero default in the market where
this is more or less equivalent to the rates offered by the sovereign. Hence, normal basis
of the risk-free rate is the Treasury bills issued by the republic. In the Philippines, this can
also be referred in the Philippine Dealing Systems or PDS Group.
The risk free rate can be real or excludes the effect of inflation or the exclusion of
the effect of the purchasing power of Philippine Peso. Since the real risk free rate excludes
the inflation, the nominal which is the risk free adjusted for inflation may assume a
compounding effect in the future. Since the BSP is the main supplier of the bank reserves,
it cannot set the real interest rates because it cannot set the inflation expectations. Hence,
it is more appropriate to say the real risk free rate can be determined by deducting the
prevailing inflation.
Let’s illustrate, Morgana Corp. would like to borrow funds from Oberon Financing.
The risk free rate is 6% and the current inflation is 2%. In the following year, the inflation
is expected to grow to 3%. Oberon still finds that the 4% margin remains to be relevant.
How much is the interest rate that Oberon Financing should impose to Morgan Corp.?
𝑖 = (𝑅𝑓 + 𝐷𝑚 )
We know that the risk free rate is nominal hence we have to recalculate to
incorporate the forecasted risk of purchasing power in the future. Hence, the real risk free
rate should be recalculated.
𝑅𝑓𝑟 = (𝑅𝑓 − 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛)
𝑅𝑓𝑟 = 6% − 2%
𝑅𝑓𝑟 = 4%
21
The real risk free rate is 4%, since the repayment will be made in the future, Oberon
should consider the forecasted inflation. Transposing the formula to determine the risk
free rate nominal in the future and incorporate the 3% inflation forecast:
𝑅𝑓 = (𝑅𝑓𝑟 + 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛)
𝑅𝑓 = 4% + 3%
𝑅𝑓 = 7%
Now the nominal risk free rate applicable for the loan is 7%. We can calculate the
applicable return that Oberon Financing need in order to kept them whole by
𝑖 = 7% + 4%
𝑖 = 11%
Therefore, the interest rate that Oberon Financing should charge Morgan is 11%.
Now the question is will this be acceptable to Morgana Corporation? The assessment then
again will be different to the borrower. Morgana should consider if their assessment in the
future that the interest will go worse in the long term then 11% is a good offer. Suppose,
another financing company is offering 9% then Morgana should reconsider. In addition,
Morgana Corporation in the long run should also consider that the interest cost on their
end would also result to tax benefits, if the interest cost is considered as a tax-deductible
expense.
Another way on how to calculate the interest rate is by the function of the market
value, par value and the interest expense paid by debt securities or bonds. Eq 5.2 presents
the formula suggested to determine the interest rate on debt securities.
𝑉−𝑀
𝐼+( )
𝐸𝑞 4.2 𝑖 = 𝑛 𝑥 100%
𝑉+𝑀
2
i = interest rate
I = periodic interest payments
V = par value of bonds
M = market value of bonds
n = term of bonds
To illustrate, Merlin Corporation issued bonds with 10% nominal rate for a
Php1,000 par value bond payable for 20 years. The bonds were sold for Php1,200. How
much is the interest rate of the Merlin bonds in the market?
Using the formula in Eq 4.2 the interest rate of Merlin bonds
1,000 − 1,200
(1,000 𝑥 10%) + ( 20
)
𝑖= 𝑥 100%
1,000 + 1,200
2
−200
100 + ( 20 )
𝑖= 𝑥 100%
2,200
2
22
100 − 10
𝑖= 𝑥 100%
1,100
𝑖 = 0.0818 𝑥 100% = 8.18%
The interest rate in the market is 8.18% which is lower than the nominal rate of
10% for the Merlin Bonds. This means that the same bonds are perceived to be riskier in
the market as compared to the nominal rate. But what if the bonds were sold on a
premium? Note that the market value of the bond is Php1,200 hence there is a premium
on the Php1,000 par value of Php200. This is because the bonds are guaranteed by Merlin
Corporation to earn 10% interest while the market can only provide about 200 bps lower
than market.
On the other hand, the bond sold at a discount expects that the nominal rate of the
instrument or bond of the same class is lower than the market. Assume that Merlin
Corporation issued Php1,000 par value bonds paying Php100 interest every year for 20
years where their bonds were sold at Php950. How much is the rate of cost of debt in the
market?
It can be noted that the difference this time is that the interest is given at Php100
and the bonds market value is Php950 lower than the par value of Php1,000, therefore
there is a discount. The same problem can be solve using Eq 4.2
1,000 − 950
(100) + ( 20
)
𝑖= 𝑥 100%
1,000 + 950
2
50
100 + ( )
𝑖= 20 𝑥 100%
1,950
2
100 + 2.50
𝑖= 𝑥 100%
1,950
𝑖 = 0.1051 𝑥 100% = 10.51%
This time the interest rate is 10.51% higher than the nominal rate of 10%. Given
that the difference is about 51 bps, the market value is discounted by about Php50 only
(Php1,000 – Php950). You may observe that using this formula, interest rates can be
determined depending on how the nominal or guaranteed interest rate fairs with the market
or effective cost of debt.
In commerce, risk is a very important factor to consider that may drives the
business up or down. Risk relates to the volatility of return patterns in the business. Thus,
the challenge on quantifying the risk is imperative for the investors to be able to determine
how much they can keep themselves whole. There are risks that are inherent in every
23
financing transaction. These are default risk, liquidity risk, legal risks, and market risks,
among others.
• Default risk arise on the inability to make payment consistently. Most of the
businesses was able to raise financing on their demands, however their cash
flows projected were not that guaranteed. Basically, the cash flows
management principle is to allow the business to self-liquidate or self-finance.
While, the company is made aware of their periodic obligation but there are still
chances that they may fail to make sure that the funds were available upon
servicing of debt or paying the amortization including interest. This type of risk
may be quantified by determining the probability of the borrower to default in
their payments in the duration of the loan.
• Liquidity risk is identified by ensuring the business to be capable of meeting all

its currently maturing obligation. This is different in default risk. Liquidity risk is
focusing on the entire liquidity of the company or its ability to service its current
portion of their debt as it comes due. In practice, this risk is quantified by
determining the opportunity cost of the lender on the period within which the
borrowers were able to recoup or worst the value there cannot be salvage
because of the ability of the company to be liquid.
• Legal risk is dependent on the covenants set and agreed in between the
lenders and the borrowers. The legal risk will arise only upon the ability of any
of the parties to comply with the covenants of the contract. Normally, the
burden is to the borrower to comply given that the party who is obliged to pay
back is them. The common defaults in the covenants are as follows: (1)
maintaining the financial ratios; (2) significant acquisition or disposal of assets;
(3) repayment of other obligation; or (4) declaration of dividends of any form
without the consent of the lenders.
• Market risk is the impact of the market drivers to the ability of the borrowers to
settle the obligation. Market risk is classified as a systematic risk because it
arises from external forces or based on the movement of the industry. Among
the risks that affects the interest, market risk is the most difficult to quantify.
The experts and analysts can just only set certain parameters to measure it.
Mitigating the Interest Rate Risks
Since there interest rate is dependent on the inflation, tenor and other market risks.
Companies should consider and make reasonable estimates to mitigate these risks.
Commercially, there are measures that the company may consider mitigating the impact
of the interest rates. The movement of the yield maybe normal or increasing, inverted or
declining or flat or constant over time. There different types of interest rates are as follows
needs to be understood in order to know how to mitigate them:
Spot rate is the interest rate or yield available / applicable for a particular time.
Spot rates are already actual rates and are not hedge. When the agreement is a spot rate
24
the applicable interest rate is based on the prevailing market rate at the particular time. It
is important to know the spot rates to be used for establishing market expectation in the
future. Spot rates will be used to mitigate the risk by referring to historical yield vis-à-vis
the forces that occur in those times. For example, a typhoon occurred in the Metro Manila
that causes the prices of the resources to rise because of the scarcity of resources
resulting to increase in interest rates. Upon noting the effect on the spot rates of the
external forces, we will expect in the future that when such incident will recur the spot rates
will increase. Thus, it is incumbent to the supplier of funds to consider quantifying its effect
so that the variability of rates will be managed.
Forward rates are normally contracted rates that fixed the rates and allow a party
to assume such risk on the difference between the contracted rate and the spot rate. It is
a challenge for the financial consultants and economic experts to determine that most
probable rates in the future. The clash will be that the lenders would like a more
conservative rate while borrowers are aggressive or lower as much as possible versus the
expected spot rate in the future.
Another way on how to mitigate the interest rate risk is enter into a swap rate.
Swap rate is another contract rate where a fixed rate exchange for a certain market rate
at a certain maturity. Usually the one used as reference is the LIBOR. For the swap rate,
it is normally the fixed portion of a currency swap.
LIBOR or London Interbank Offered Rate is used to benchmark interest rates

which is used as reference for international banks to borrow. It is calculated using the
Intercontinental Exchange or ICE. The rates issued short term from 1 day up to 1 year and
releasing more than 30 rates based on about five currencies. This is the reason why this
rate is used as the reference for consumer loans across the world.
The correlation of the swap rate and the maturity rate is called the swap rate yield
curve. The curve is useful for countries as reference for the credit risks and for future
decisions.
Credit Ratings
Credit rating affects the confidence level of the investors to countries or

companies. The credit ratings are determined by companies that are recognized globally
that objectively assigns or evaluates countries and companies based on the riskiness of
doing business with them. The riskiness is primarily driven by their ability to manage their
liquidity and solvency in the long run. The higher the grade the lower the default risk
associated to the country or company. These three major rating companies are: Standard
& Poor’s Corporation (S&P); Moody’s Investors Service; and Fitch Ratings.
Although, the credit ratings provided by these companies are just recommendatory
opinion and will serve as reference only and is not an absolutely provide default probability
to the companies.
• Standard and Poor’s Corporation or S&P is an American financial services

corporation was founded in 1941 by Henry Varnum Poor in New York, USA.
25
The company uses data gathered from 128 countries using more than 1,500
credit analysts to assess the creditworthiness to the industry. The credit ratings
provided by S&P were categorized to Investment Grade and Non-Investment
Grade and scaled from AAA to D.
• Moody’s Investors Services or Moody’s is credit rating company particularly on

debt securities established in 1909 in New York, USA. The company gathers
information from more than 130 countries, more than 4,000 non-financial
corporate issues and more than 4,000 financial institutions. The company
employs more than 13,000 across the whole world. Moody’s classify the credit
standing into the ratings from Aaa to C.
• Fitch Ratings. The third credit rating agency is Fitch Ratings. It was founded in
1914 in New York, USA. The company was owned by Hearst. Hearst is a global
information and services company. Fitch provides credit opinions based on the
credit expectations based on the certain quantitative and qualitative factors that
drive a company, they assess based on the credit analysis and intensive
research. They conduct their assessment over more than 8,000 entities around
the globe with 25 different currencies. Fitch same with the other rating agencies
publishes its opinion based on a certain scale of ratings to represents their
opinion from AAA to D.
• There are other credit rating agencies other than the three major like DBRS
and CARE Ratings. Unlike S&P, Moody’s and Fitch, these credit rating
agencies were not located in the United States. DBRS was established in 1976
in Toronto, Canada. The company was considered as the fourth largest ratings
agency. The company observe almost 50,000 securities worldwide. DBRS also
has offices in New York, Chicago, London, Frankfurt and Madrid in Spain. The
rating follows from AAA to C as the least. CARE Ratings started its operation
in 1993 based in India. The company is based in Mumbai with partners in
Brazil, Portugal, Malaysia and South Africa. Other than Mumbai they also have
about 10 regional officers that aims to provide information to investors to serve
as guide as they enter into new investment. They also use AAA as the best
instrument to D as the least.
Read:
Books, published materials and references on Financial Markets: Credit Risk

Management and Credit Rating Agencies.
1. Visit the website of PDS Group and research on its functions and role to debt
market of the Philippines.
2. Visit the websites of the various Credit rating agency discussed and further
understand their process of rating an entities.
26
3. Tabulate each Credit rating agency and differentiate
4. Essay: What are the risks inherent to Financial Instruments and how to mitigate
them?
27
Module 5 – Debt Securities Market
Overview:
Debt Securities Market is the type of financial market in the form of debt
transactions between demanders and suppliers of funds. Debt instrument is legally
enforceable evidence of a financial debt and the promise of timely repayment of principal,
plus any interest. Debt security is a debt instrument however not all debt instruments are
debt securities. Debt securities are different from equity securities as equity securities
represent claims on earnings and assets of a corporation, while debt securities are
investment into debt instruments. The characteristics of a regular bond are coupon rate,
maturity date and current price.
Bond Valuation in Practice essentially is calculating the present value of a bond's
expected future coupon payments. The theoretical fair value of a bond is calculated by
discounting the present value of its coupon payments by an appropriate discount rate. The
discount rate used is the yield to maturity, which is the rate of return that an investor will
get if s/he reinvested every coupon payment from the bond at a fixed interest rate until the
bond matures. It takes into account the price of a bond, par value, coupon rate, and time
to maturity. Discount rate used normally is the risk free or default free rate plus the risk
premium, if applicable. There are 2 approaches in Bond Valuation for option-free bonds:
traditional approach and arbitrage free valuation approach. There are 2 approaches in
Bond Valuation for bonds with embedded options: lattice model and Monte Carlo
Simulation
Module Objectives:
After successful Completion of this module, you should be able to:
• Identify different types of bonds

• Select the bond or debt security investments that will yield higher value
Course Materials:
Debt Securities Market and Debt Instrument
Debt market or Debt Securities Market is the financial market where the debt
instruments or securities are transacted by suppliers and demanders of funds. This
chapter shall focus on this type of financial market.
A debt instrument is a paper or electronic obligation that enables the issuing party
to raise funds by promising to repay a lender in accordance with terms of a contract. Types
of debt instruments include notes, bonds, debentures, certificates, mortgages, leases or
other agreements between a lender and a borrower. These instruments provide a way for
market participants to easily transfer the ownership of debt obligations from one party to
another.
28
A debt instrument is legally enforceable evidence of a financial debt and the
promise of timely repayment of the principal, plus any interest. The importance of a debt
instrument is twofold. First, it makes the repayment of debt legally enforceable. Second, it
increases the transferability of the obligation, giving it increased liquidity and giving
creditors a means of trading these obligations on the market. Without debt instruments
acting as a means of facilitating trading, debt would only be an obligation from one party
to another. However, when a debt instrument is used as a trading means, debt obligations
can be moved from one party to another quickly and efficiently.
Types of Debt Instruments
Debt instruments can be either long-term obligations or short-term obligations.

Short-term debt instruments, both personal and corporate, come in the form of obligations
expected to be repaid within one calendar year. Long-term debt instruments are
obligations due in one year or more, normally repaid through periodic installment
payments.
• Short-Term Debt Instruments

In corporate finance, short-term debt usually comes in the form of revolving
lines of credit, loans that cover networking capital needs and Treasury bills. If for
example, a corporation looks to cover six months of rent with a loan while it tries to
raise venture funding, the loan is considered a short-term debt instrument.
• Long-Term Debt Instruments

Long-term debt instruments in personal finance are usually mortgage
payments or car loans. For example, if an individual consumer takes out a 30-year
mortgage for Php 500,000, the mortgage agreement between the borrower and the
mortgage bank is the long-term debt instrument.
Debt Security
Debt security refers to a debt instrument, such as a government bond, corporate

bond, certificate of deposit (CD), municipal bond or preferred stock, that can be bought or
sold between two parties and has basic terms defined, such as notional amount (amount
borrowed), interest rate, and maturity and renewal date. It also includes collateralized
securities, such as collateralized debt obligations (CDOs), collateralized mortgage
obligations (CMOs), mortgage-backed securities issued by the Government National
Mortgage Association (GNMAs) and zero-coupon securities.
Types of Debt Securities
• Money market debt securities. Money market securities are debt securities with
maturities of less than one year. Money market securities of most interest to individual
investors are treasury bills (T-bills) and certificates of deposit (CDs).
29
• Capital market debt securities. Capital market debt securities are debt securities
with maturities of longer than one year. Examples are notes, bonds, and mortgage-
backed securities.
The Bond Market
Debt market or Debt securities market is also known as bond market is a financial
market in which the participants are provided with the issuance and trading of debt
securities. The bond market primarily includes government-issued securities and
corporate debt securities, facilitating the transfer of capital from savers to the issuers or
organizations requiring capital for government projects, business expansions and ongoing
operations. In the bond market, participants can issue new debt in the market called the
primary market or trade debt securities in the market called the secondary market. These
products are typically in the form of bonds, but they may also come in the form of bills and
notes. The goal of the bond market is to provide long-term financial aid and funding for
public and private projects and expenditures.
Types of Bond Markets
• Corporate Bond. Corporations provide corporate bonds to raise money for

different reasons, such as financing ongoing operations or expanding
businesses. The term "corporate bond" is usually used for longer-term debt
instruments that provide a maturity of at least one year.
• Government Bonds. National governments issue government bonds and
entice buyers by providing the face value on the agreed maturity date with
periodic interest payments.
• Municipal Bonds. Local governments and their agencies, states, cities,
special-purpose districts, public utility districts, school districts, publicly
owned airports and seaports, and other government-owned entities issue
municipal bonds to fund their projects.
• Mortgage Bonds. Pooled mortgages on real estate properties provide
mortgage bonds. Mortgage bonds are locked in by the pledge of particular
assets. They pay monthly, quarterly or semi-annual interest.
• Asset-backed bonds. Also known as asset-backed security (ABS), asset-
back bond is a financial security collateralized by a pool of assets such as
loans, leases, credit card debt, royalties or receivables.
• Collateralized Debt Obligation (CDO). CDO is a structured
financial product that pools together cash flow-generating assets and
repackages this asset pool into discrete tranches that can be sold to
investors.
30
Characteristics of Bonds
The characteristics of a regular bond include:
• Coupon rate. Some bonds have an interest rate, also known as the coupon rate,
which is paid to bondholders semi-annually. The coupon rate is the fixed return
that an investor earns periodically until it matures.
• Maturity date. All bonds have maturity dates, some short-term, others long-term.
When the bond matures, the bond issuer repays the investor the full face value
of the bond. For corporate bonds, the face value of a bond is usually Php 1,000
and for government bonds, face value is Php 10,000. The face value is not
necessarily the invested principal or purchase price of the bond
• Current or Market Price. Depending on the level of interest rate in the

environment, the investor may purchase a bond at par, below par, or above par.
For example, if interest rates increase, the value of a bond will decrease since
the coupon rate will be lower than the interest rate in the economy. When this
occurs, the bond will trade at a discount, that is, below par. However, the
bondholder will be paid the full face value of the bond at maturity even though
he purchased it for less than the par value.
Bond Valuation
Bond valuation is a technique for determining the theoretical fair value of a

particular bond. Bond valuation includes calculating the present value of the bond's future
interest payments, also known as its cash flow, and the bond's value upon maturity, also
known as its face value or par value. Because a bond's par value and interest payments
are fixed, an investor uses bond valuation to determine what rate of return is required for
a bond investment to be worthwhile. Eq 5.1 describe the formula to value a bond.
1 1
Eq 5.1 𝐵𝑜 = 𝐼 × [∑𝑛𝑡=1 (1+𝑟 𝑡 ] + 𝑀 × [(1+𝑟 ]
𝑑) 𝑑 )𝑛
Bo = present value of the bond
I = annual interest paid in dollars
n = number of years to maturity
M = par value in dollars
rd = required return
To illustrate, suppose a 10-year 10% bond with a par value of Php1,000 is traded
in the market. The similar debt instrument is expecting 9% returns in the market. How
much is the value of the bonds?
Using Eq 5.1 the bond is valued at Php 1,064. The value is higher than par and
issued on a premium because the market offers a lower return as compared the
guaranteed returns of 10%.
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10
1 1
𝐵𝑜 = 𝑃ℎ𝑝1,000 𝑥 10% × [∑ 10
] + 𝑃ℎ𝑝1,000 × [ ]
(1 + 9%) (1 + 9%)10
𝑡=1
𝐵𝑜 = 𝑃ℎ𝑝100 × 6.4177 + 𝑃ℎ𝑝1,000 × 0.4244
𝐵𝑜 = 𝑃ℎ𝑝641.77 + 422.41
𝐵𝑜 = 𝑃ℎ𝑝1,064.18
This principle simply states that the bonds can be resold at Php1,064 since this is
perceived by the market to be better off that what is available to everyone else.
A zero-coupon bond makes no annual or semi-annual coupon payments for the

duration of the bond. Instead, it is sold at a deep discount to par when issued. The
difference between the purchase price and par value is the investor’s interest earned on
the bond. To calculate the value of a zero-coupon, we only need to find the present value
of the face value.
Following our example above, if the bond paid no coupons to investors, its value
will simply be the present value of the face value of the bonds i.e. Php422.41. Under both
calculations, a coupon paying bond is more valuable than a zero-coupon bond.
Valuation for a Non-Treasury bond (Adding Risk Premium)
The above valuation assumes a default free rate and thus for a non-Treasury bond,
a risk premium has to be added to the base interest rate (the Treasury rate). The risk
premium is the same regardless of when a cash flow is to be received. This risk premium
is also called constant credit spread. So, for the above, assuming the appropriate risk
premium / credit spread is 100 bps equivalent to 1%, the discount rate to be used should
be 6% i.e. 5% the risk free interest rate (the Treasury rate) + 1% risk premium.
Approaches in Valuation
The above formula can be adjusted based on the approaches in valuation. There
are at least 2 approaches in valuation of bonds. Below are approaches which assumed
option-free bonds.
• Traditional approach. The traditional approach to valuation has been to

discount every cash flow of a bond by the same interest rate (or discount rate).
The cash flows are viewed as default free / risk free, the traditional practice is
to use the same discount rate to calculate the present value of securities and
use the same discount rate for the cash flow for each period. So, suppose that
the yield on a 10-year Treasury trading at par value is 5%. Then, the practice
is to discount each cash flow using a discount rate of 5%. In case of non-
treasury securities, the risk premium has to be added.
• Arbitrage Free Valuation approach. The fundamental flaw of the traditional

approach is that it views each security as the same package of cash flows. For
example, consider a 10-year Philippine Treasury bond with an 8% coupon rate.
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The cash flows per Php 100 of par value would be 19 payments of Php 4 every
6 months and Php 104 for 20 six month periods from now. The traditional
practice is to discount every cash flow using the same interest rate. The proper
way to view the 10-year 8% coupon bond is as a package of zero-coupon
bonds. Each cash flow should be considered a zero-coupon bond whose
maturity value is the amount of the cash flow and whose maturity date is the
date that the cash flow is to be received. Thus, the 10-year 8% coupon bond
should be viewed as 20 zero-coupon bonds. The reason this is the proper way
to value a bond is that it does not allow a market participant to realize an
arbitrage profit by taking apart or “stripping” a security and selling off the
stripped securities at a higher aggregate value than it would cost to purchase
the security in the market. This approach to valuation is referred to as the
arbitrage-free approach.
Valuation of Bonds with Embedded Options
• The lattice model is used to value callable bonds and putable bonds.
• The Monte Carlo simulation model is used to value mortgage-backed securities
and certain types of asset-backed securities.
Read:
Books, published materials and references on Financial Markets, Debt Market.
1. Tabulate the different type of bonds and identify its differences
2. Essay: Discuss each bond valuation method and distinguish its differences and
where and how it should be used.
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Module 6 – Equity Securities Market
Overview:
Equity securities market is the type of financial market wherein equity instruments
are traded between demanders and suppliers of funds. Equity instruments is a legal
agreement which serves as evidence ownership interest in a business. Investors include
equity instruments in their portfolio because of capital appreciation and dividends. The
most common example of equity securities is shares. Shares can be classified in two –
preference shares and ordinary shares. Shares are publicly traded in the stock market.
Stock market is composed of two components – exchanges and over the counters (OTC).
Share valuation can be computed via different methodologies: through dividends (zero-
growth, constant growth, variable growth), free cash flow, book value, liquidation value
and price-earnings multiples.
Module Objectives:
After successful Completion of this module, you should be able to:
• Understand equity instruments and its characteristics

• Distinguish equity from debt
• Understand how shares are valued through different methodologies
Course Materials:
Equity instrument is a type of financial instrument wherein an issuing company decides
to compensate investors at an amount dependent on the future earnings of the company
(like dividends). Equity instrument is a contract that evidences a residual interest in the
assets of an entity after deducting all of its liabilities. Future earnings set aside for these
investors should be after settling all mandatory payments of the business including
financing charges. Shares are example of equity instrument.
Aside from compensation, shares represent ownership in a business. People who own
shares are called shareholders. They physical legal document to evidence shares is called
a stock certificate. Stock certificates specify who own the shares and how many shares
are owned by this shareholder. For equity instruments, the company is the issuer while
shareholders are investors.
Authorized capital stock pertains to the maximum amount or number of shares that can
be issued as shares to investors as documented in the Articles of Incorporation.
Outstanding shares are shares of stocks that are issued to or subscribed by shareholders
(whether fully paid or not). Outstanding shares exclude treasury shares. Treasury shares
are shared bought back by the company from previous shareholders. Only corporations
are allowed to issue shares.
There are two reasons why investors should consider equity instruments:
34
• Capital Appreciation – pertains to the possibility of increase in value of shares often
reflected through its market price. Investors can buy and sell shares in the
secondary market, providing a mechanism that allow trading which influences the
value of shares. However, since market price results from interaction of different
market forces, this can be highly volatile which brings uncertainty to shareholders.
• Dividends – refers to payments distributed by corporation to their shareholders.
The amount of dividend declared is based on the excess earnings of the company
and is approved by the board of directors. Dividends can be in the form of cash,
property (i.e. shares in other companies) or the company’s own shares. Dividend
declaration is primarily based on the current performance of the business though
this the level of declaration can be levelled by businesses to manage expectations
of shareholders.
Comparison between Equity and Debt
Equity Debt
Participation in the Can participate through Does not participate
businesses voting on specific
decisions like election of
board directors
Claim on Assets and Subordinate to debt Prioritized over Equity.
Income
Least priority in terms of Claim of creditors are
asset and income satisfied before distributing
distribution to shareholders.
Type of Financing Permanent Temporary
Maturity Date No maturity date Maturity date is based on

what is stipulated in
contract
Risk and Return Profile Higher risk versus debt; Lesser risk versus equity;
investors expect higher return is limited to interest
returns (through infinite stipulated in agreement
capital appreciation and
dividends)
Impact to Tax Cannot be claimed as tax- Tax-deductible expense for
deductible expense by company
company
Types of Shares
Preference Shares – shares that possess certain characteristics that prioritize them over
ordinary shares. Typically, dividend is already promised to preference shareholder
regardless of business performance. Preference shares generally do not have voting
rights though some corporations can grant this based on their Articles of Incorporation.
Preference share is quasi-debt; the dividend is somewhat like a contractually obligated
35
interest without maturity date of debt agreements. Other features that preference shares
can possess include:
• Cumulative – Dividends that are not paid in previous years (in arrears) should be
paid, together with the current year dividends, prior to dividend distribution to
ordinary shareholders. Non-cumulative preference shares mean that company is
not liable to pay out dividend in arrears.
• Callable – Features which permits corporations to repurchase outstanding
preference shares within a period of time at a set price. This feature allows
corporations to cease commitment to pay required dividends of preference shares
by repurchasing it and is exercised when market conditions deems it reasonable
to do so.
• Convertible – Option given to shareholders to convert preference shares to
ordinary shares.
Ordinary Shares – shares that represent equity in the business. Holders of these are
known as residual owners since they will only enjoy return once claims from creditors and
preference shareholders are satisfied. Ordinary shareholders only receive dividend upon
the discretion of the company’s board of directors and possess voting rights (usually one
vote, one share) to act on specific corporate actions such as issuance of new shares and
election of company directors. Preemptive right - which grants the right to purchase shares
during additional share issuance to protect their stake from dilution – is given to
shareholders. Ordinary shareholders enjoy limited liability i.e. if the company goes under,
they are only liable up to the amount they invest. In recent years, other types of ordinary
shares are developed such as supervoting shares (share with multiple votes) and
nonvoting ordinary shares.
Stock Market
Stock market is the avenue where shares are traded publicly. Stock market can be
physical or virtual. This is composed of exchanges and over the counters (OTC) and can
function as primary or secondary market.
• Exchanges – organized physical venues for trading of shares which are facilitated
by floor traders. Floor traders, often members of brokerage firms, meet at the
exchange and collect bid and ask offers from each other. Through this, they
connect matching deals and execute trade orders coming from their clients or their
own firms.
• OTC market – markets where shares are traded electronically by dealers. Dealers
or also commonly called as market makers create market by linking buy and sell
orders from their clients. They maintain inventory of shares from different
companies that they use to trade in the OTC market to maintain equilibrium
between purchase and sell orders. Profits are earned by dealers via the spread
between bid price and ask price or commission through trading.
• Electric Communications Network – network that directly connects key brokerage
firms and traders. ECN is becoming relevant because of its transparency, cost
effectiveness and quicker execution.
36
• Exchange-traded Funds – these are formed when portfolio containing different
securities is established and a share is traded in the exchange representing the
portfolio. Exchange-traded funds are value based on the market value of the
shares within the portfolio.
Platforms for Capital Markets
• Conventional Brokerage – Brokers sell and buy shares in the exchange in behalf
of their investors, earning commission in the process.
• Online Trading – Digital platforms that investors can use which have lower
commission. Though, investments insights might not be available in the absence
of traditional brokers.
• Mutual Funds – Funds set up by investment companies that brings together money
from different investors and invests the pooled money in different stocks in behalf
of all the investors.
Share Valuation
Dividend-based Valuation
• Zero-growth model – This assumes that dividend will not change in the future and
is used for valuing preference shares.
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 𝑎𝑡 𝑒𝑛𝑑 𝑜𝑓 𝑌𝑒𝑎𝑟 11
𝑆ℎ𝑎𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 =
𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 (%)
Example: Tony Stark estimates that the dividend of Ironman Company, an
established technology producer, is expected to remain constant at P6 per share
indefinitely. If his required return on its stock is 15%, what is the value per share?
𝑃6.00
𝑆ℎ𝑎𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 = = 𝑃40.00
15%
• Constant-growth model – Most popular approach in dividend-based share
valuation which assumes that dividends will increase at a constant rate indefinitely
but always lower than the required rate of return.
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 𝑎𝑡 𝑒𝑛𝑑 𝑜𝑓 𝑌𝑒𝑎𝑟 11
𝑆ℎ𝑎𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 =
𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 (%) − 𝐺𝑟𝑜𝑤𝑡ℎ 𝑅𝑎𝑡𝑒 (%)
Example: ProGo Company, a selfie stick company, assumes that dividend will
grow by 5%. The last dividend declared is at P2.00. Required return is 15%
2.00 𝑥 1.05 2.10
𝑆ℎ𝑎𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 = = = 𝑃21.00
15% − 5% 10%
• Variable growth model – This model assumes that dividend may growth at varying
rates and may go up or down depending on business and economic conditions. In
order to capture the variations in growth in the valuation, these four steps should
be considered.
37
a. Compute for the value of cash dividends based on the estimated growth rate
for each individual year.
b. Compute for the present value of each dividend for each year during initial
growth period.
c. Compute for the value at the end of the initial growth period by using the
expected growth rate until infinity through the constant growth model. Compute
the present value of this value in relation to current year.
d. Add present value computed in Step B & C.
Example: Vicky Company forecasts that dividends of Vir Company will grow by
10% in the next three years and 5% from Year 4 onwards. Required return of Vicky
is 15%. Last dividend received by Vicky Company from Vir Company is P3.00.
Step 1. Dividends for the next 3 years: Y1 = P3.30, Y2 = 3.63 ; Y3 = 3.99
Step 2. Present value during initial growth period
Y1 = 3.30 x 0.8696 = P2.87
Y2 = 3.63 x 0.7561 = P2.74
Y3 = 3.99 x 0.6575 = P2.62
Step 3. Value from Year 4 onwards using constant growth model.
Dividends to be received by Year 4 = P4.19
3.99 𝑥 1.05 4.19
𝑆ℎ𝑎𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 = = = 𝑃41.90
15% − 5% 10%
Present Value by end of Y3 = P41.90 x 0.6575= P27.55
Step 4. Add present value for all years.
Share Value = P2.87 + P2.74 + P2.62 + P27.55
Share Value = P35.78
Other Alternative Valuation Methodologies
• Free Cash Flow – cash flow available to creditors and shareholders after satisfying
all contractual obligations. Free cash flow follows the premise of present value
computation wherein annual free cash flow is discounted using weighted average
cost of capital. Since free cash flows estimates the value of the entire company,
market value of debt and preference shares should be subtracted to arrive at value
of ordinary shares.
• Book Value per Share – value per share based on the exact book value as
recorded in the accounting records. This method does not consider future earning
potential of the firm.
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 −

𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒𝑠 𝑠ℎ𝑎𝑟𝑒𝑠
𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 =
𝑇𝑜𝑡𝑎𝑙 𝑁𝑜. 𝑜𝑓 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑆ℎ𝑎𝑟𝑒𝑠
38
• Liquidation Value per Share – value per share based on the current market value
of assets (assuming it is sold today) and all liabilities (including preference shares)
are fully paid. This method is more realistic compared to book value per share but
does not consider future earning potential of the firm.
• Price/Earnings Multiples Method – share price is computed by using the average

price/earnings ratio of comparable companies in the same industry. This is done
by multiplying the current earnings per share by the P/E multiple.
Hybrid and Derivative Securities
• Hybrid Securities – financial instruments which possess characteristics of both

debt and equity
o Stock purchase warrants – instruments that give bearers the right to
purchase stated number of shares of a company at a given price within a
limited time frame. Warrants are detachable and are often used as
sweeteners to bond issuances.
o Convertible securities – bonds or preference shares that can be converted
to ordinary shares in the future.
• Derivative Securities – securities that are neither debt nor equity but derives
value from underlying asset.
o Options – gives holders chance to purchase (call option) or sell (put option)
a specific asset. Holder can decide whether to exercise the option or not.
Read:
Books, published materials and references on Financial Markets and Equity Market.
1. Research on the Philippine Stock Exchange, its functions and its roles in the
Philippine financial market. Enumerate criteria how companies can list in the
PSE and the disclosure requirements for listed companies.
2. Essay: Discuss each share valuation method and distinguish its differences
and where and how it should be used.
39
Module 7 – International Financial Market
Overview:
International trade is one of the most important factors of growth and prosperity of
participating economies. International financial market exists due to the fact that economic
activities of businesses, governments, and organizations get affected by the existence of
nations. It is a known fact that countries often borrow and lend from each other. This is
also applicable to the investing public residing in these countries. Different concepts are
associated with international financial market such as foreign exchange transactions,
international bonds, foreign direct investment, country risk premium and offshore banking
units.
Module Objectives:
• Describe the background and importance of international financial markets

• Understand how investments are executed in international financial markets and
relevant concepts
Course Materials:
The international financial market is the worldwide marketplace in which buyers
and sellers trade financial assets, such as stocks, bonds, currencies, commodities and
derivatives, across national borders. The international financial market is the place where
financial wealth is traded between individuals (and between countries). It can be seen as
a wide set of rules and institutions where assets are traded between agents in surplus and
agents in deficit and where institutions lay down the rules.
Motives for Investing in International Financial Market
• Economic Conditions – investors think that companies operating in countries with

favorable economic outlook may yield better operating results.
• Exchange Rate Outlook – investors consider investing in currencies they
believe will appreciate as compared to their local currency
• International Diversification – investing in different countries with varying
economic conditions might mitigate overall risk in terms of portfolio management.
History of Foreign Exchange
• Gold Standard – exchange rates were dictated by these from 1876 to 1913.
Every currency is convertible into gold and relative conversion rates dictates the
exchange rate. Gold standard was suspended due to World War I.
• Agreements on Fixed Exchange Rates – an international agreement, known as
Bretton Woods Agreement) established fixed exchange rates between currencies
40
and was in effect from 1944 until 1971. Governments intervene if exchange rates
move 1% higher or lower than the established level.
• Floating Exchange Rates – The existing foreign exchange model. Widely used
currency were permitted to fluctuate based on prevailing market conditions and
restrictions were lifted.
Foreign Exchange Transactions
• Spot Rate – most common type of foreign exchange transaction which signifies
immediate exchange. These transactions happen in the spot market.
• Forward Transactions – forex transactions wherein investors may secure an
exchange rate (known as forward rate) at which it will sell or buy currency during a
specified time period. This is documented via a forward contract and is typically
offered by commercial banks.
• Currency Futures – agreement stipulating standard volume of a specific currency
that will be exchanged on a predetermined settlement date and is usually sold in
exchanges
• Currency Options – instruments that can be used to buy (call option) or sell (put
option) a specific currency based on the discretion of holder. Call options are used
to hedge future payables while put options are used for future receivables.
International Bonds
• Foreign Bonds – Bonds issued by a borrower that has different nationality from
the country where bond is issued. It is denominated in the currency of the country
where bond is issued.
• Eurobonds – Bonds sold in countries other than the nation which uses the
currency. For example, companies in the US offer dollar bonds which are sold in
countries other than US. Characteristics of Eurobonds may include its bearer form,
yearly coupon payments and conversion feature.
Foreign Direct Investments
• Foreign Direct Investment – investments placed by an entity in countries other

than where it is situated. This typically happens when a firm starts a foreign
business operation, acquire foreign assets or buying ownership stake in a foreign
company. FDI is usually made by investors in countries with open economies
equipped with skilled labor force, less red tape and attractive growth prospects.
Primary characteristic of FDI is the exercise of substantial influence in decision
making of an entity. According to Organisation of Economic Co-operation and
Development (OECD), foreign direct investment exists when controlling interest is
established which is equivalent to 10% ownership in a foreign-based company.
This definition is flexible as effective controlling interest may be present with less
than 10% ownership.
o Horizontal direct investment – occurs when the investor starts same type
of business it does in its home country.
41
o Vertical direct investment – occurs when investors has a stake in a
business in a foreign country which is related to its business in the home
country. For example, obtaining ownership in a foreign raw material
supplier.
o Conglomerate investment – investors make an investment in a foreign
company which is unrelated to its business in their home country.
Country Risk Premium
• Country Risk Premium (CRP) - is the additional return or premium demanded by

investors to compensate them for the higher risk associated with investing in a
foreign country, compared with investing in the domestic market. CRP considers
the following factors: political instability, economic risks, sovereign debt burden,
currency fluctuation and adverse government regulations (such as expropriation
or currency controls). Country risk is the primary factor looked at when investing in
foreign markets.
Country risk premium can be estimated through the following methods:
o Sovereign Debt Method - CRP for a particular country can be estimated by

comparing the spread on sovereign debt yields between the country and a
mature market like the U.S.
o Equity Risk Method. In equity risk method, CRP is measured based on the
relative volatility of equity market returns between a specific country and a
developed nation.
Offshore Banking Units

• Offshore banking units - is a financial service unit (normally a branch or subsidiary
of a non-resident bank), which plays an intermediary role between non-resident
borrowers and lenders. It is a bank shell branch, located in another international
financial center. For instance, a London-based bank with a branch located in
Delhi. Offshore banking units make loans in the Eurocurrency market when they
accept deposits from foreign banks and other OBUs. Under law, offshore banking
units (OBUs) are not authorized to take domestic deposits or conduct activity with
local establishments or clients. All trade activity of the offshore banking unit must
be offshore.
Advantages of offshore banking units as compared to onshore bank include the

following:
o Free of regulations and restrictions normally imposed on domestic financial

establishments as it pertains to foreign exchange and sometime tax
concessions and relief packages.
o Activities of an offshore banking unit are not subject to the local restrictions
as there might be on foreign exchange or other banking activities or
regulations.
42
Read:
Books, published materials and references on International Financial Markets
1. Research about World Bank and why is it important to the international financial
market.
2. Essay: Why is international financial market important to investors?
43
REFERENCES
Bangko Sentral ng Pilipinas
Lascano, Baron, Cachero. Fundamentals of Finacial Market
Securities and Exchange Commission
44
APPENDIX: SYLLABUS ON FINANCIAL MARKET
COURSE TITLE : FINANCIAL MARKETS
COURSE CODE : ACCO 20083
COURSE CREDIT : 3 UNITS
PRE-REQUISITE : NONE
COURSE : This course is intended to help students understand the role of financial institutions and markets play in the business environment that students will
DESCRIPTION face in the future. It also helps students to develop a series of applications of principles from finance and economics that explore the connection
between financial markets, financial institutions, and the economy. Students will learn commercial banks, investment banks, i nsurance companies,
mutual funds, the Bangko Sentral ng Pilipinas, and their role of in the economy.
Institutional Learning Outcomes Programs Outcomes Course Outcomes

1. Creative and Critical Thinking Students will be able to gain understanding the how the financial market works and design Upon completion of the course, the
strategies on how to maximize profit and wealth students will be able to:
a. Describe the financial
2. Effective Communication Students will be able to articulate and describe the financial markets in both local and
systems in both local and
international setting that will aid them in making sound recommendation to their future clients
international setting
and/or management
b. Determine the methodologies
3. Strong Service Orientation Students will be able to create opportunities and package service offering. This course will
to assess the risks involve in
enable them to explore alternatives and recommend best approach available for their future
financial markets particularly
clients and/or management
in debt and equity security
4. Passion to Life-Long Learning Students will have a grasp on the fundamentals of financial markets and its play in a larger
trading
picture. This will open and encourage long term exploration and learning about the ins and
c. Identify the agencies that may
outs of the subject.
affect and drive the
5. Sense of Personal and Professional Students must demonstrate a capable manager or an associate, at least, that is seen with
continuous development of
Ethics objectivity and integrity at all times. the financial market structure
6. Sense of Nationalism and Global Students must participate through contributing the skills earned by allowing them to be part d. Apply the skills and
Responsiveness of contributors of growth in the industry through the provision of quality financial management knowledge obtain in
through their knowledge in financial markets in both local and international settings. accounting and financial
7. Community Engagement Students must understand the relevance of the services in the development of their reporting
communities, particularly the advise that they can extend to the stakeholders. e. Create strategies on how to
8. Adeptness in the Responsible Use Students must know how to the use of technology and online platform made available to handle challenges in entering
of Technology maximizing financial capabilities. financial markets
9. High Level of Leadership and Student is expected to form part of the leadership team, advisory at the very least, of the firm
Organization Skills they will engage in the future and make strategic financial directions. The maturity is expected
to be further demonstrated at all times.
DETAILED LEARNING PLAN
WEEK NO. OF RESOURCES/
TOPIC LEARNING OUTCOMES METHODLOGIES ASSESSMENT
NO. HOURS REFERENCES
Class Management The learner will be to: • Lecture and discussion • Copy of the • Summary of
• Introduction to the course • Have an appreciation of the • Manage expectation by syllabus student
• Discussion of the syllabus coverage of the course sharing insights of the • Student ref lection and
1 1 • Classroom policies • Establish order in the class instructor and the students handbook expectation
• Elect class
of f icers,
prepare seat
plan.
Introduction to Financial Af ter the session the student is • Lecture Textbooks • Recitation
Systems and Financial Market expected to: • Case study Instructional • Presentation
• Describe the elements of f inancial Materials • Quiz
• Nature and Importance of systems, particularly the f inancial Online Materials
Financial System market
• Elements of Financial • Describe the importance of f inancial
System market in maximizing f irms prof it and
2 3 • Nature and Importance of wealth
Financial Market • Dif f erentiate the dif f erent types of
• Money Market vs. Capital f inancial markets
Market
• Primary Market vs.
Secondary Market
Financial Regulation Af ter the session, the student is • Lecture Textbooks • Recitation
• Role of regulation in the expected to: • Activity Instructional • Presentation
Financial System • Identif y the drivers that will af f ect the Materials Quiz
• Philippine Financial f inancial sustainability Online Materials
Regulators • Recognize the dif f erent f inancial
3 3 • Drivers of Financial regulators in the Philippines
sustainability • Identif y the risks in the Financial
• Risk in the Financial Market Market
Managing Credit Risk in Money Af ter the session, the student is • Lecture Textbooks • Recitation
Market expected to: • Problem Solving Instructional • Quizzes or
• Credit Ratings • Identif y the dif f erent levels and • Case Study Materials Long Exams
• Credit Inf ormation System methods of rating entities Online Materials
• Cost of Debt • Make recommendation on the
4–6 6 • Managing Liquidity and results of liquidity and solvency
Solvency • Understand how to improve value of
• Valuation of Collaterals collaterals
Financial Instruments Af ter the session, the leaner is expected • Lecture Textbooks • Recitation
• Negotiable Certif icates of to: • Problem Solving Instructional • Quizzes or
Deposit • Describe the dif ferent f inancial • Case Study Materials Long Exams
• Short-Term and Long-Term instrument Online Materials
Commercial Papers • Identif y the limitations or risk in using
• Banker’s Acceptances each f inancial instrument
• Describe how f inancial instruments
7- 8 6 • Treasury Bills, Notes and
be valued and treated in f inancial
Bonds reports
• Repurchase Agreement
• Risk on Trading Financial
Instruments
• Accounting f or Financial
Instruments
9 3 MIDTERM DEPARTMENTAL EXAMINATION

Debt Securities Market Af ter the sessions, the student is • Lecture Textbooks • Recitation
• Types of Long Term expected to: • Problem Solving Instructional • Quizzes or
Securities • Identif y dif f erent types of bonds • Case Study Materials Long Exams
10 – 11 6 • Strategies and Challenges • Select the bond or debt security Online Materials
in Bond Market investments that will yield higher
• Assessing Bond Value value
Equity Securities Market Af ter the session, the student is • Lecture Textbooks • Recitation
• Types of Stocks expected to: • Problem Solving Instructional • Quizzes or
• Rights vs Warrants • Describe the dif ferent types of • Case Study Materials Long Exams
• Types of Market market capitalization Online Materials
12 – 14 9 Capitalization • Determine value of stocks based on
• Stock Valuation (use of the f inancial inf ormation made
Market Value Ratios) available to them
• Optimizing Transaction • Describe the rules and regulations
Costs applicable f or a listed corporation
International Financial Market & Af ter the sessions, the student is • Lecture Textbooks • Recitation
Innovations expected to: • Field Exposure Instructional • Quizzes or
• Nature of International • Describe the dif ferent f actors that • Case Study Materials Long Exams
Financial Market af f ect the strategies in doing Online Materials
• Foreign Direct Investments international f inancial market
• Currency Exchange • Describe the roles of international
15 – 16 6 • Cryptocurrency agencies that may af f ect the
f inancial market
• Country Risk Premium
• Identif y the risk that may af f ect the
• Of f -shore Banking Units f inancial market strategies
• World Bank and
International Finance
Corporation
17 3 FINAL DEPARTMENTAL EXAMINATION

17 52
REFERENCES (Reading Materials)
• CIRC HF 4910 S28 2015, Saunders, Anthony, Financial Markets and institutions, 2015
• CIRC HF 4026 B75 2013, Brigham, Eugene F., Fundamentals of Financial Management, 2013
• CIRC HF 4026 R826 2015, Ross, Stephen A., Financial Management: principles and applications, 2015
• Gitman Lawrence J. and Zutter, Chad J., Principles of Managerial Finance, 13 th edition. 2012
• Lascano, Marvin V., Baron, Herbert C., Cachero, Andrew L., Fundamentals of Financial Markets. 2019
GRADING SYSTEM
Class Standing 70%
Quizzes 70%
Assignments, recitation 10%
Seatwork, files, notebook 10%
Attendance, right conduct 10%
Departmental examination 30%
Total 100%
Final Grade = (1st Grading Period + 2nd Grading Period)

2
ATTENDANCE
The allowed number of absences f or students enrolled in ACCO 20083 with once-a-week meeting is three (3). Request f or excused absences or waiver of absences must be
presented upon reporting back to class. Special examinations will be allowed only in special cases, such as prolonged illne ss. It is the responsibility of the student to monitor
his/her own tardy incidents and absences that might accumulate leading to a grade of “FA,” (Failed due to Absences). It is also his/her responsibility to cons ult with the teacher,
chair or dean should his/her case be of special nature.
ACADEMIC HONESTY
All BSA and BSMA students are expected to be academically honest. Cheating, lying and other f orms of immoral and unethical behavior will not be tolerated. Any student
f ound guilty of cheating in examinations will (at a minimum) receive a grade of 5.0 in the said test.

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ACCO 20083

• Discuss the Financial Systems and its elements

The Elements of Financial System

a. Financial Institutions. Financial Institutions are entities that aims to collect

b. Financial Markets. Financial Markets are arrangers of transactions

ii. Market Type. Financial markets may be classified to the type of

iii. Origination. Financial Markets may be classified according to where

c. Private Placement. Private placement are intermediaries with a particular,

Financial Instruments are documents or representation for the exchange. This

Books, published materials and references on Financial Markets, Financial Management

• Identify the drivers that will affect the financial sustainability

Financial Regulation is a process of governing in the financial systems to ensure

Consistency. The reason why in the field of accountancy consistency is an

Stability. Market Stability is important. Given that market behavior is dependent on

Republic Act 10607 or the Amended Insurance Code

• Describe the different financial instrument

Financial Instruments according to Conceptual Framework for Financial Reporting

There is a minimum of two parties involved in a financial instrument: the issuer;

Financial instruments have two main economic purposes:

Money market securities have three fundamental characteristics:

• Usually sold in large denominations

• Low default risk

Participants in the money market include the following

• Bureau of Treasury. The bureau sells government securities to raise funds.

• Private Individual. These private individuals made their investment through

• Commercial Non-Financial Institutions. These entities buy and sells money

• Investment companies. Trade securities in behalf of their clients. Makes a market

• Finance / commercial leasing companies. These companies raise money market

• Insurance companies. These are companies that invest on money market to

• Pension funds. Maintain funds in money market as preparation for long-term

Common Types of Money Market Financial Instruments

• Treasury Bills – are government securities issued by the Bureau of Treasury

Government securities, particularly treasury bills, are the safest investment

When analyzing investments, investors often try to compare performance of

Bv = Face Value or Market Value

D = tenor or period in days

𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 = 1.98%

Bv = Face Value or Market Value

M = number of days to maturity

Using the previous example, the annualized investment rate is

𝑃 1,000 − 𝑃 995 365

𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐼𝑛𝑣𝑒𝑠𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑒 = 2.02%

• A Repurchase agreement (repo) is a financial contract involving two securities

• Negotiable certificates of deposit are securities issued by banks which records

Negotiable certificate of deposit is also classified as a bearer instrument. As a

• Commercial Paper - Fundamentally, commercial papers are unsecured

Nonbank corporations like financing companies usually issue commercial papers

➢ Issued to not more than 19 non-institutional lenders

➢ Payable to a specific person

➢ Neither negotiable nor assignable and held on to maturity

➢ Amount not exceeding P50 million.

• Banker’s acceptances refer to an order to pay a specified amount of money to

Evaluating Money Market Securities

Valuation of Money Market Securities

Valuation of money market securities is important to determine at what amount an

Sb = Face value of the security

𝑀𝑎𝑟𝑘𝑒𝑡 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 = 𝑃970.87

𝑀𝑎𝑟𝑘𝑒𝑡 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 = 𝑃990.10