Chapter 1: Financial System and Financial Markets Flashcards
(151 cards)
1
Q
Life-blood of the company
A
Financial System
2
Q
Ensure that profit and wealth is maximized
A
Financial System
3
Q
Sources of Wealth
What are the Origin of Wealth?
A
- Entrepreneurship - Profit
- Capital - Interest
- Labor - Salaries Wages
- Land - Rent
4
Q
Composed of network of inter-related systems of financial markets, intermediaries and services
A
Financial System
5
Q
Came from the French word “finer” which means “to end and settle a debt”
A
Finance
6
Q
Permits an efficient method to move funds between entities who have funds and entities who need funds
A
Financial System
7
Q
Serve as regular, time-efficient and cost effective link between fund providers and fund demanders
A
Financial System
8
Q
What are the two types that funds can flow?
A
Direct and Indirect Financing
9
Q
In this route, the borrower-spenders borrow and deal directly with suppliers or lenders through selling financial instruments (or securities).
A
Direct Financing
10
Q
Represent claims on the future income or assets of the borrower
A
Financial Instruments
11
Q
Borrowers recognize financial instruments as?
A
Liabilities
12
Q
Lenders recognize financial instruments as?
A
Asset
13
Q
Buying stocks directly from a company is also considered as?
A
Direct Financing
14
Q
In this route, the borrowing activity between both parties still happens though indirectly through the intervention of a financial intermediary.
A
Indirect Financing
15
Q
Elements of the Financial System
- (Who are the players?)
They are individuals or corporation that who be needing financial support for them to start their business, fund for their working capital, or planned expansion.
A
Demanders
16
Q
Elements of the Financial System
- (Who are the players?)
They are individuals or corporation who are in other side of the system that are willing to provide and/or has excess wealth and are looking for opportunity to keep it growing. These are people or investors that are willing to extend financial support with interest.
A
Suppliers of Fund
17
Q
Elements of the Financial System
- (How will the exchange occur?)
Are special types of financial entities that act as a third party to facilitate the borrowing activity between lenders and borrowers.
A
Financial Intermediaries
18
Q
They gather funds from lenders and redistribute it to borrowers through an investment vehicle like loans.
A
Financial Intermediaries
19
Q
The lenders and borrowers do not even know who the ultimate individual or firm is who provided or demanded for the funds. They only need to have access to the financial intermediary to enjoy the benefits of the financial transaction.
True or False?
A
True
20
Q
Elements of the Financial System
- (What will be used?)
Are medium of exchange of contractual obligation of a party, where such contract can be traded.
A
Financial instruments
21
Q
These can be tangible or intangible.
A
Financial instruments
22
Q
What are the two types of Financial Instruments?
A
(1) Cash
(2) Derivative financial instruments.
23
Q
Contract where a party recognizes it as an asset while the party treats it as a liability. (IFRS)
A
Financial instruments
24
Q
Elements of the Financial System
- (Where will it be traded?)
This is the venue where suppliers and buyers of financial instruments meet.
A
Financial Markets
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For cash financial instruments, where financial market are they exchanged?
Money Market
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For derivative financial instruments, where financial market are they traded?
Capital Market
28
Elements of the Financial System
5. (How it is controlled?)
It is the governance body that is ensuring the transactions that occur within the financial systems comply with the laws and regulations imposed on the entities as well as the elements that play within the system.
Regulatory environment
29
Financial systems are normally regulated by central banks
True or False?
True
30
Channels or places where funds and financial instruments such as stocks, bonds and other securities are exchanged between willing individuals and/or entities.
Financial Market
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Includes the existing mechanisms and conventions to facilitate transfer of funds and/or financial instruments between market participants.
Financial Market
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Intend to establish a consistent, efficient and cost-effective bridge between fund providers and fund demanders.
Financial Market
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Who are the participants in the financial markets includes ultimate lenders and borrowers?
(1) households
(2) governments and businesses
(3) financial intermediaries
(4) brokers and dealers
(5) regulators
(6) fund managers
(7) financial exchanges
34
What is the main economic function of financial markets?
To serve as a channel to transfer excess funds
from fund providers to fund demanders.
35
Financial markets also provide additional options to lenders and borrowers
Fund providers may?
(a) deposit funds in banks
(b) buy primary or secondary securities or lessen their debt through purchasing existing securities.
36
Fund demanders may?
(a) issue new securities
(b) sell currently- owned financial instruments in
the financial market to obtain funds.
37
What are the three major economic functions of a Financial Market?
Price Discovery
Liquidity
Reduction in transaction costs
38
Refers to the interaction between buyers and sellers in the financial market in order to come up with the price of traded financial instrument.
Price Discovery
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Price is set at the level wherein the buyers are willing to buy, and sellers are willing to sell. The agreement between the two parties is important in determining the price of the financial instrument.
True or False?
True
40
Usually, the providers of funds in the financial market determine the required return for a financial instrument. This is the minimum rate of return that they are willing to accept to purchase a financial instrument.
True or False?
True
41
Is an important feature especially when there are circumstances that push investors to sell a financial instrument
Liquidity
42
Without liquidity, an investor is forced to hold onto a financial instrument up until such time that conditions in the agreement happen that will permit the disposal of the instrument (e.g. conversion) or the issuer is contractually obligated to pay for the instrument.
True or False?
True
43
For debt instruments, this pertains to?
For equity instruments?
Maturity date
Voluntary or involuntary liquidation
44
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All types of financial markets offer different degrees of liquidity.
True or False?
True
46
Is the last function of a financial market.
> these are the costs incurred when two parties trade a financial instrument.
Reduction in transaction costs
47
What are the two types of Transaction costs?
1. Search Cost
2. Information cost
48
These are costs incurred to look for financial instruments that can be purchased or sold by a party.
Search costs
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Type of search cost that are expenses needed to advertise intent to purchase or sell a financial instrument.
Explicit search cost
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Type of search cost that include the value of time consumed to look for a counterparty for the transaction.
Implicit Search
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Are costs related to evaluating investment characteristics of a financial instrument.
Information costs
52
Types of Financial Markets
1. Based on Instruments Traded
Short term securities are normally traded in the?
Money Market
53
Long term securities are classified under the?
Long Term
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Is the sector of the financial system where financial instruments that will mature or be redeemed in one year or less from issuance date are traded.
Money Market
Specifically, money markets cater to fund demanders who need short-term funds from fund providers who have excess short-term funds. Short-term is defined as one year or less.
55
Once money market securities are issued, they are traded in the?
Secondary Market
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Money markets are not exclusive for short-term investors. Long- term investors also need the money market as they tend to use this market to meet their short-term liquidity needs.
True or False?
True
57
Money Market serve as the conduit to efficiently transfer large amounts of money from fund providers to fund demanders for short maturity terms quickly and at a cheap cost from the parties involved.
True or False?
True
58
A market instruments that usually offer an investment opportunity that yields a higher return than just mere holding of cash (which generates zero interest).
Money Market
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They are very liquid and can be easily convertible to cash and have very little default risk because of the associated short maturity term.
Money Market
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What are the common examples of Money Market?
(a) Treasury Bills
(b) Commercial Papers
(c) Certificates of Deposits
(d) Repurchase Agreement and Bankers' Acceptances.
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Where financial instruments issued by governments and corporations that will mature beyond one year from issuance date (long-term) are traded.
Capital Market
62
Long-term financial instruments encompass financial instruments that have maturity dates of?
Longer than one year and perpetual securities (with no maturity).
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Capital Market securities are classified into two:
(1) debt
(2) equity (which represent ownership interest).
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Market that are expected to be a liquid market where fund demanders can interact with potential investors to acquire external financing resources.
Capital Market
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Types of Financial Markets
2. Based on Market Type
In this market, supplier of funds is called lenders while in another market they are called buyers
Primary Market, Secondary Market
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Types of Financial Markets
2. Based on Market Type
In this market, borrowers are the demanders of funds while in another market they are called sellers
Primary Market, Secondary Market
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Is a type of financial market wherein fund demanders such as corporations or government agencies raise funds through new issuances of financial instruments e.g. bonds and stocks.
Primary Market
New issuances of financial instruments are sold to original fund providers (usually households) in exchange for money that the fund demander needs.
68
Primary market securities also include issuance of additional debt or equity securities of an already publicly traded company.
True or False?
True
69
Non-negotiable instruments like mortgage loans, savings deposits and life policies are issued only in primary markets and are not traded in secondary markets.
True or False?
True
70
Usually, primary markets transactions are coursed through investment banks which are financial institutions that act as intermediaries between issuing companies (fund demanders) and potential investors (fund providers).
True or False?
True
71
Provide advice to issuers on matters related to prices of the securities, transaction costs and number of securities to be issued based on their fund needs.
Investment in Banks
They also provide advice on how to present information to attract potential investors to the securities issuance.
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They are responsible for all aspects to ensure proper execution of the issuance: legal and financial exchange requirements, appointments of lawyers and auditors, due diligence, etc. Investment banks also underwrite securities.
Investment Banks
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Investment banks guarantee the price for the securities of the issuing company and then sell these to the general public.
Underwriting
74
Types of Issuance Methods
This occurs when securities are offered for sale to the general public and done through issuing a prospectus (document which contains an offer to the general public to subscribe or purchase securities at a stated price).
Public Offering
75
Private companies who sell shares to the general public for the very first time are deemed to be conducting an?
Initial public offering or IPO
> IPOs are usually done through the help of investment banks
76
Public offering can either be an:
(a) Offer for subscription
> the general public is invited to subscribe to unissued shares of the company.
(b) Offer for sale
> existing shareholders invite potential subscribers to buy a portion of the shares they own. Proceeds from this offer are enjoyed by the existing shareholders, not by the company.
77
This occurs when the issuer looks for a single investor, an institutional buyer or group of buyers to purchase the whole securities issuance instead of offering it to the general public.
Private placement (also called as limited public offer).
78
One variation of a private placement is that an underwriter subscribes to all securities at a certain price and consequently, sells these same securities to a group of investors at a higher price. The difference between these two prices is termed as underwriting spread.
True or False?
True
79
Is usually used for issuance of treasury bills, bonds and other securities issued by the government and are commonly executed exclusively with market makers.
Auction
80
Auction can be done in three methods:
Type of auction where the seller begins the sale at a high price. From that point, the price of the securities is continuously lowered down at specific intervals until the potential buyer agrees to purchase at that price.
Dutch Auction
81
Type of auction where the prospective buyers commence the auction by submitting an initial bid price. Other buyers interested to purchase the securities submit a new bid to top the previous one. The process continues as the price of the securities increases as more interested buyers bid on it. The bidding stops when no other bidders want to top the last bid. The last, highest bid price becomes the price of the securities that the highest bidder should pay.
English Auction
82
Type of auction where bidders submit sealed bids to the sellers. The sealed bids are ranked from highest to lowest price. The number of securities is allocated first to the highest priced bid and follows a descending order. Highest priced bids receive full allocation while lower bids receive allocations distributed pro rata.
Descending price sealed auction (or first-price sealed auction).
83
This method occurs when issuers are open to receive bids for their securities at all times. Issuers maintain the right to accept or reject the bid prices based on how much fund they need, when they need the fund and what is their outlook of the market.
Tap Issue
84
Refers to the market wherein the securities issued in primary market are subsequently traded i.e. resold and repurchased (secondhand).
Secondary Market
85
Buyers in the secondary market include households, businesses and governments who have excess funds while the sellers are the household, businesses and governments who need funds.
True or False?
True
86
When the buyer purchases a financial instrument in the secondary market, funds are transferred to the seller. Transactions in the secondary market usually occur through the help of securities brokers which acts as the facilitator between the seller and the buyer of the security.
True or False?
True
87
The original issuer of the financial instrument is not involved in the subsequent transactions in the secondary market.
True or False?
True
88
Examples of the secondary market include:
(a) foreign exchanges market
(b) futures market
(c) options market.
89
Economic functions of secondary market are:
Price discovery
Liquidity and reduction in borrowing costs
Support to the primary market
Implementation of monetary policy
90
Two Classification of Market Structure
The buyers and sellers propose their price through their brokers who conveys the bid in a centralized location. The price is then matched (securities will be awarded to the buyer with the same offer price as the selling price of the seller) and the transaction is consummated. This is also called the auction market.
Order-Driven Market Structure
91
What are the types of orders there are in a order driven?
(a) Market orders (or at-best orders) orders placed with broker
(b) Limit orders
(c) Day orders
> Orders placed that are only valid until the end of the business day. All orders not executed at the end of day are cancelled and removed from the system.
(d) Good-until-cancelled orders
> Orders placed that remain valid for a sustained period up until the client voluntarily cancels and removes these from the system.
92
This is also called primary dealer markets, professional markets or market-made markets.
Quote-Driven Market Structure
93
In this market structure, the market makers establish a price quote at which the market participants should trade with. The market makers set a bid quote (to buy) and offer quote (to sell).
Quote-Driven Market Structure
94
Bid quote is generally lower than the offer quote. The difference between the bid quote and offer quote, called a spread, represents profit for market makers.
True or False?
True
95
Two Classifications where Financial Instrument are traded:
Are centralized trading locations where financial instruments are purchased or sold between market participants.
Exchange (or formalized)
96
97
Most exchanges are order-driven. Most popular exchanges includes PSE
True or False?
True
98
Is a market where unlisted financial instruments are allowed to be traded, in addition to listed financial instruments. Dealers stationed at various locations who have securities on hand stay ready to sell and buy securities "over the counter" to any party who approaches them and is willing to accept their price.
Over-the-Counter market (or informal)
99
Bonds, loans, spot money and foreign exchange markets are unlisted, hence, are traded in an OTC market.
True or False?
True
100
Types of Financial Markets
3. Based on Country's Perspective
Refers to the market where issuers who are considered residents in a country issue the securities and where these securities are traded afterwards.
Domestic Market
101
Refers to the market where issuers who are not residents of a country can sell or issue securities and subsequently trade.
Foreign Market
102
External market refers to the financial market where securities that have two unique characteristics are being traded:
a. Upon issuance, these securities are offered simultaneously to investors in different countries
b. Securities are issued outside the regulatory jurisdiction of any single country.
103
Examples of external markets include international market and offshore market.
True or False?
True
104
Types of Financial Markets
4. Based on Trading Modality
The buyer and the seller of the securities are brought together by a broker and the trade occurs at that point.
Broker Market
> Ownership of the securities effectively changes on the floor of the exchange through the help of a broker.
> The Philippine Stock Exchange is the sole broker market in the Philippines.
105
The buyer and seller are not brought directly together by a third party. Instead, market makers (dealers who create markets by offering to sell/buy securities at stated ask/bid prices. respectively) execute the sell or buy orders.
Dealer Market
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107
There are two distinct trades that occur in Dealer Market:
(a) Seller sells his securities to a dealer
(b) Buyer buys his securities from a dealer (can be the same dealer of Seller A).
108
Refers to the lowest price that the seller of a security offered for sale is willing to take while the bid price is the highest proposed price that investors are willing to shell out to buy a security.
Ask Price
109
Dealer markets do not have centralized trading floors as compared with exchanges. Instead, dealer markets consist of many market makers that are connected through a mass telecommunications network.
True or False?
True
110
Facilitates indirect financing
Financial Intermediaries and Other Participants
Ex:
(a) depository institutions
(b) insurance companies
(c) pension companies
(d) asset management firms
(e) regulated investment companies and investment banks.
111
What services do Financial Intermediaries and Other Participants provide?
* Trading of financial assets for the customers of the financial intermediary through brokering arrangements
* Trading of financial assets through its own capital by buying a stake in a financial asset that its customers want to transact in
* Formation of financial assets needed by its customers and distribute these to its customers and other market participants as well.
* Investment consultation services to customers
* Financial assets management
* Payment mechanism between merchants and customers.
112
Refers to the risk that liability holders (e.g. depositors for banks) may require cash in exchange of the financial claims they have from the institution. As a result, financial intermediaries always maintain a high level of cash and marketable securities to make sure that they can meet the demand from depositors when the latter requires them to pay.
Liquidity Risk
113
Benefits of Financial Intermediaries are;
1. Acceleration of flow of funds between entities
2. Efficient allocation of funds
- occurs when potential borrowers have more information about the transaction compared to the bank.
3. Creation of money
4. Support in price discovery
* process of setting a price which is acceptable for the buyer and the seller.
5. Improved liquidity for lenders
6. Reduced price risk for lenders
* Price risk means that prices of financial instruments may vary over time.
7. Diversification
* converts more risky assets to less risky assets through sharing of risks.
8. Economies of scale
* occur when fixed costs are optimized per unit as a result of large volume of transactions.
There are two main economies of scale:
(a) Information processing
> cost of acquiring and processing information needed to evaluate purchase
(b) Transaction Cost
9. Risk mitigation
10. Implementation of monetary policy function
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Classification of Financial Intermediaries
Financial intermediaries can be a financial institution which is primarily extending financial support to demanders, while most are going into the exchange of these instruments.
True or False?
True
116
Three classifications of Financial Intermediaries:
Firms that accept cash deposits from individuals, companies and entities. Once the deposit is received, this becomes liability of the depositary institution to the depositor.
Depository institutions
117
Example of Depository Institutions
Raise their funds through offering checking deposit accounts (deposits on which drafts/checks can be written against), savings deposit accounts (deposits that are payable on demand, but checks cannot be written against) and time deposits (deposits that have maturity in fixed terms).
Commercial Banks
118
Raise their funds through offering checking deposit accounts (deposits on which drafts/checks can be written against), savings deposit accounts (deposits that are payable on demand, but checks cannot be written against) and time deposits (deposits that have maturity in fixed terms).
Commercial Banks
119
Primarily mobilized small savings and provide loans at generally longer and easier terms than do commercial banks as they cater to the lower income groups.
Thrift Banks
120
Offering basic financial services such as savings and credit facilities to farmers and small-scale merchants.
Rural Banks
121
Used as a tool to facilitate payment for online purchases. The first recorded transaction is a sale of compact disc using electronic payment via credit card.
E-Wallets
122
They obtain funds at periodic intervals based on an existing contract. Unlike depository institutions, contractual savings institutions can project more accurately how much money they need to pay in the future (in the form of benefits promised).
Contractual Savings Institutions
123
Examples of Contractual Savings Institutions:
Offer services to assume risk or become underwriters of the risk associated with various insurable occurrences. In addition to their role as risk bearers, insurance companies also invest in the financial markets.
Insurance Companies
124
A contract of insurance is an agreement whereby one undertakes for a consideration to indemnify another against loss, damage or liability arising from an unknown or contingent event.
Insurance companies
125
Insurance companies collect premiums (payment made by parties who want to be insured) in exchange for selling protection against potential future risks.
True or False?
True
126
Benefits can be paid via lump sum (one-time payment) or annuity (yearly payments). The beneficiary can be the one who pay the premiums or another party who the payor assigned. Since insurance companies do not know if the insured event will happen or not, they can take advantage of the premiums received by earning return from it by investing the money in the financial market.
True or False?
True
127
Insurance products that are offered by insurance companies include:
a. Life Insurance
b. Health Insurance
c. Property and Casualty Insurance
d. Liability Insurance
e. Disability Insurance
f. Long-term care insurance
g. Structured settlements
h. Financial Guarantee Insurance
128
Collects contributions from employees and uses the money collected to invest in various vehicles with the intention of growing these through the years to be able to pay benefits to the member employees upon their retirement.
Pension Funds
129
Contributions to pension funds are usually deducted immediately from the paycheck of employees and are remitted to pension funds directly by their employers. It is also a common practice that employers shoulder a portion of this contribution. In case contributions are not deducted from their paycheck automatically, employees can opt to pay voluntarily.
True or False?
True
130
Since retirement can be predicted, pension funds have the time to invest in long-term assets. As a result, a large percentage of pension funds investments are placed in stocks and corporate bonds.
True or False
True
131
In the Philippines, the state-run pension funds are:
• Social Security System or SSS (for workers in the private sector)
• Government Service Insurance System or GSIS (for government employees).
132
Pension plans can be classified into two:
The pension fund invests the contributions that they receive in various instruments. If the investments will be profitable, retirement benefits will be high or vice-versa. Ultimately, the retirement benefits will depend solely on the performance of the investment.
Defined contribution plan
133
In this type of plan, the employee will receive a fixed retirement benefit based on their years in service regardless of the performance of the pension fund. If the pension fund performs better and accumulates money greater than the benefit paid, the excess fund remains with the pension fund. However, if the pension fund underperforms and becomes insufficient to pay out the benefits, the firm who owns the plan becomes liable to pay for the difference.
Defined benefit plan
134
0rganizations whose primary objective is to maximize return from investments in various financial instruments to add value for the investors.
Investment Intermediaries.
135
Are are companies that manage funds owned by individuals, companies or the government through buying and selling of financial instruments.
Asset Management Firms
136
Asset Management Firms type of accounts/funds usually handled:
Financial intermediaries that sell shares to the general public in exchange for cash.
Regulated investment companies (RIC)
137
Regulated investment companies (RIC) is divided into two:
Also called indexed funds, are managed to mimic movements in the market index such as the PSE Index.
Passive Funds
138
Are managed by asset management firms with the intention to outperform the index fund via actively trading securities in the fund portfolio.
Active Funds
139
Each share stands for proportional interest in the portfolio of financial instruments managed by the RIC. Each share in the portfolio is valued at Net Asset Value (or NAV). NAV is interpreted to be a per share metric.
True or False?
True
140
Two types of RICS
More commonly known as mutual funds, do not have a fixed number of shares.
Open-end funds
141
Have a fixed number of shares upon its inception and do not issue additional or redeem shares.
Closed-end funds
142
Unlike open-end funds, the market price of the fund's shares may be higher or lower than NAV. Shares that are priced higher than NAV are dubbed as trading at a premium while shares valued lower than NAV are known to be trading at a discount. A brokerage commission fee is paid by investors in closed-end funds to brokers who will transact the purchase or sale on their behalf.
True or False?
True
143
Costs associated with investing in RICs include:
> Shareholder fee or sales charge - one-time charges imposed to investors
> Annual fund operating expense known as expense ratio - covers operating expenses of the fund.
144
Are like mutual funds, but the shares of the portfolio funds trade in an exchange like a regular share offered by a company.
> possess characteristics of both open-ended and closed-ended funds.
Exchange Traded Funds (ETF)
> ETFs are also allowed to place limit orders, stop orders and orders to sell short or at a margin since its shares are directly traded in the secondary market unlike open-end funds.
145
Are developed to cater to sophisticated investors and are usually not subject to the same regulations covering mutual funds.
Are usually organized as a private investment partnership or offshore investment corporation which uses various trading strategies to gain better position in different markets.
Hedge Funds
146
Also called individually managed accounts are distinct funds solely dedicated to an individual or institutional investor. Instead of investing in a shared fund like a mutual fund, a fund can be made that will be based on the specific necessities of a sole investor.
Separately managed accounts
147
Investments done through the fund will suit the specific objectives required by the sole investor. Since these are like "specialized" funds, fees charged for separately managed accounts are typically higher than RICS.
True or False?
True
148
Highly leveraged institutions that have significant influence on how primary and secondary markets work.
> assist entities (individual, corporate, government) in raising money to fund their initiatives.
Investment Banks
149
Activities that an investment bank can offer are as follows:
a. Public offering of securities
b. Private Placement of Securities
c. Trading of securities
d. Advisory services for mergers, acquisitions and financial restructuring
e. Merchant banking
f. Securities finance and prime brokerage service
g. Asset management
h. Research
150
Raise their funds through issuing stocks and bonds or selling commercial papers. Finance companies then lend out the funds to individual consumers (to buy furniture, vehicles, home improvements) and small businesses.
Finance Companies
151
Some non-financial corporations open their own finance companies to assist in selling their main product.
True or False?
True
Example:
Toyota Motor Philippines. Toyota Motor Philippines has a wholly owned finance company known as Toyota Financial Services Philippines that offer car financing solutions for automobiles sold by Toyota
