Jenelyn D.

Dela BSBA 3B

Introduction to International Business Trade Reviewer

Module 1
International business -refers to the trade of goods, services, technology, capital and/or knowledge across national
borders and at a global or transnational scale. It involves cross-border transactions of goods and services between
two or more countries. Transactions of economic resources include capital, skills, and people for the purpose of the
international production of physical goods and services such as finance, banking, insurance, and construction.
International business is also known as globalization.
Multinational companies have investment in other countries, but do not have coordinated product offerings in each
country. More focused on adapting their products and service to each individual local market. A multinational
corporation (mnc) or multinational enterprise (mne) is a corporation enterprise that manages production or delivers
services in more than one country. It can also be referred to as an international corporation.
Global companies have invested and are present in many countries. They market their products through the use of the
same coordinated image/brand in all markets. Generally, one corporate office that is responsible for global strategy.
Transnational companies are much more complex organizations. They have invested in foreign operations, have a
central corporate facility but give decision-making, r&d and marketing powers to each individual foreign market.
The size of the international business should be large in order to have impact on the foreign economies. Most of the
multinational companies are significantly large in size. In fact, the capital of some of the mncs is more than our annual
budget and gdps of the some of the african countries. International markets present more potentials than the domestic
markets. This is due to the fact that international markets are wide in scope, varied in consumer tastes, preferences
and purchasing abilities, size of the population, etc.
Here the first two marketing and sourcing-constitute the basic strategies that encompass a firm’s initial considerations.
Essentially, management is answering two questions: to whom are we going to sell what, and from where and how will
we supply that market? We then have a series of input strategies – labor, management, ownership, and financial.
They are in their efforts to develop their own business plans. As an obligation addressed essentially to the query, with
what resources are we going to implement the basic strategies? That is, where will we find the right people,
willingness to carry the risk, and the necessary funds? A second set of strategies legal and control respond to the
problem of how the firm is to structure itself of implement the basic strategies, given the resources it can muster.
Influences and goals of international business
Companies engage in international business to:
Expand sales: companies’ sales are dependent on (a) the consumers’ interest in their products or service and (b) the
consumers’ willingness and ability to buy them. The number of people and the extent of their purchasing powers are
higher for the world as a whole than for a single country.
Acquire resources: manufacturers and distributors also look for foreign capital, technologies and information that they
can use at home, to reduce their costs. Sometimes, a company operates abroad to acquire something not readily
available in the home country so as to improve its product quality and differentiate itself from competitors, potentially
increasing market share and profits.
Minimize risk: companies seek out foreign markets to minimize swings in sales and profits arising out of business
cycle recessions and expansions which occur differently in different countries.
Problems of international business
What make international business strategy different from the domestic are the differences in the marketing
environment. The important special problems in international marketing are given below:
Political and legal differences: the political and legal environment of foreign markets is different from that of the
domestic. The complexity generally increases as the number of countries in which a company does business
increases.
Cultural differences: the cultural differences, is one of the most difficult problems in international marketing. Many
domestic markets, however, are also not free from cultural diversity.
Economic differences: the economic environment may vary from country to country.
Differences in the currency unit: the currency unit varies from nation to nation. This may sometimes cause problems of
currency convertibility, besides the problems of exchange rate fluctuations. The monetary system and regulations may
also vary.
Differences in the language: an international marketer often encounters problems arising out of the differences in the
language. Even when the same language is used in different countries, the same words of terms may have different
meanings. The language problem, however, is not something peculiar to the international marketing.
Differences in the marketing infrastructure: the availability and nature of the marketing facilities available in different
countries may vary widely.
Trade restrictions: a trade restriction, particularly import controls, is a very important problem, which an international
marketer face.
High costs of distance: when the markets are far removed by distance, the transport cost becomes high and the time
required for affecting the delivery tends to become longer. Distance tends to increase certain other costs also.
Differences in trade practices: trade practices and customs may differ between two countries.
Module 2
Why do nations trade? A nation trades because it expects to gain something from its partner. One may ask whether
trade is like a zero-sum game, in the sense that one must lose so that another will gain. The answer is no, because
though one does not mind gaining benefits at someone else’s expense but no one wants to engage in a transaction
that includes a high risk of loss. For trade to take place both nations must anticipate gain from it.

In other words, international trade is a positive sum game. There are basically two sets of theories of international
trade: the classical trade theories, explaining how inter-country trade takes place; and theories of international trade,
explaining inter-country investment in manufacturing and service activities and the management of these activities.
Theory of mercantilism (1500-1700) - mercantilism became popular in the late seventeenth and early eighteenth
centuries in western europe and was based on the notion that governments (not individuals who were deemed
untrustworthy) should become involved in the transfer of goods between nations in order to increase the wealth of
each national entity. Wealth was defined, however, as an accumulation of previous metals, especially gold

The concept of mercantilism incorporates two fallacies. The first was the incorrect belief that old or precious metals
have intrinsic value, when actually they cannot be used for either production or consumption. Thus, nations
subscribing the mercantilism notion exchanged the products of their manufacturing or agricultural capacity for this
non-productive wealth. The second fallacy is that the theory of mercantilism ignores the concept of production
efficiency through specialisation. Instead of emphasizing cost-effective production of goods, mercantilism emphasises
sheet amassing of wealth with acquisition of power.

Neo-mercantilism corrected the first fallacy by looking at the overall favourable or unfavourable balance of trade in all
commodities, that is, nations attempted to have a positive balance of trade in all goods produced so that all exports
exceeded imports. The term “balance of trade” continues in popular use today as nations attempt to correct their trade
deficit positions by increasing exports or reducing imports so that outflow of goods balances the inflow.

Theory of economic development - the trade structure is also sought to be explained in terms of scale economies.
According to this theory, there is a relationship between the size of the internal market and average unit cost of
production and export competitiveness.

Rostow’s stages of economic growth theory - a more recent and applicable theory of economic development was
provided in the 1960s by walter w. Rostow, who attempted to outline the various stages of a nation’s economic growth
and based his theory on the notion that shifts in economic development coincided with abrupt changes within the
nations themselves. He identified five different economic stages for a country – traditional society, preconditions for
take-off, take off the drive to maturity, and the age of high mass consumption.

Stage 1: traditional society- rostow saw traditional society as a static economy, which he likened to the pre-1700s
attitudes and technology experienced by the world’s current economically developed countries. He believed that the
turning point for these countries came with the work of sir isaac newton, when people began to believe that the world
was subject to a set of physical laws but was malleable within these laws. In other words, people could effect change
within the system of descriptive laws as developed by newton.

Stage 2: preconditions for take-off - rostow identified the preconditions for economic take-off as growth or radical
changes in three specific, non-industrial sectors that provided the basis for economic development:
Stage 3: take-off- the take-off stage of growth occurs, according to rostow, over a period of twenty to thirty years and
is marked by major transformations that stimulate the economy.

Stage 4: the drive to maturity - within rostow’s scheme, this stage is characterised as one where growth becomes self-
sustaining and a widespread expectation within the country. During this period, rostow believes that the labour pool
becomes more skilled and more urban and that technology reaches heights of advancement.

Stage 5: the age of mass consumption - the last stage of development, as rostow sees it, is an age of mass
consumption when there is a shift to consumer durables in all sectors and when the populace achieves a high
standard of living as evidenced through the ownership of such sophisticated goods as automobiles, televisions and
appliances.

Theory of absolute advantage

Principle of absolute advantage - adam smith was the first economist to investigate formally the rationale behind
foreign trade. In his book, wealth of nations, smith used the principle of absolute advantage as the justification for
international trade. According to this principle, a country should export a commodity that can be used at a lower cost
than can other nations.

Principle of relative advantage - one problem with the principle of absolute advantage is that it fails to explain whether
trade will take place if one nation has absolute advantage for all products under consideration.

Theory of comparative advantage - this question was considered by david ricardo, who developed the important
concept of comparative advantage in considering a nation’s relative production efficiencies as they apply to
international trade. In ricardo’s view, the exporting country should look at the relative efficiencies of production for both
commodities and make only those goods it could produce most efficiently.

Factor endowment theory - the eli heckscher and bertil ohlin theory of factor endowment addressed the question of
the basis of cost differentials in the production of trading nations. They posited that each country allocates its
production according to the relative allocates its production according to the relative proportions of all its production
factor endowments – land, labour and capital on a basic level, and, on a more complex level, such factors as
management and technological skills, specialised production facilities, and established distribution networks.

Human capital approach theory - this theory, which is also sometimes known as skills theory of international trade, has
been advocated by a number of economists, especially becker, kennen and kessing. Whereas the factor proportions
theory considers labour as a homogenous factor, however, it is not so in the real world. In fact, for export of
manufactured goods, the skill level of labour is very important determinant.

Identical preferences theory - this theory is based on the role of demand as an explanatory variable used by linder. A
domestic industry can flourish and reach commercially optimal level of production if the domestic demand is large
enough.

Strategic trade theory - with the dramatic growth in trade in the last few decades, and the growth in the role of mnes in
international trade, there has been a resurgence of interest in taking a fresh look at theories of international trade. In
the last two decades, a new set of models has come into being, using the perspectives of game theory and theories of
industrial organisation. While there is no one overarching model, this broad collection of theories and ideas has come
to be known as “strategic trade theories”.

Modern investment theory - other theories explain investing overseas by firms, as a response to the availability of
opportunities not shared by their competitors, that is, to take advantage of imperfections in markets and only enter
foreign spheres of production when their comparative advantages outweigh the costs of going overseas.

International product life cycle theory - the international product life cycle theory puts forth a different explanation for
the fundamental motivations for trade between and among nations. It relies primarily on the traditional marketing
theory regarding the development progress, and life span of products in markets. This theory looks at the potential
export possibilities of a product in four discrete stages in its life cycle.

The international product life cycle (iplc) theory developed and verified by economists to explain trade in a context of
comparative advantage describes the diffusion process of an innovation across national boundaries. The life cycle
begins when a developed country having a new product to satisfy consumer needs wants to exploit its technological
breakthrough by selling abroad.

Stage 0 – local innovation: stage 0 depicted as time 0 on the left of the vertical importing/ exporting axis, representing
a regular and highly familiar product life cycle in operation within its original market. Innovations are most likely to
occur in highly developed countries because consumers in such countries are affluent and have relatively unlimited
want. Stage 1 – overseas innovation: as soon as the new product is well developed, its original market well cultivated,
and local demand adequately supplied, the innovating firm will look to overseas market in order to expand its sales
and profits. Thus this stage is known as “pioneering or international introduction” stage.

Stage 2 – maturity: growing demand in advanced nations provides an impetus for firms there to commit themselves to
starting local production, often with the help of their governments’ protective measures to preserve infant industries.
Thus, these firms can survive and thrive in spite of the relative inefficiency.

Stage 3 – worldwide imitation: this stage means tough times for the innovating nations because of its continuous
decline in exports. There is no more new demand anywhere to cultivate.

Stage 4 – reversal: not only must all good things end, but misfortune frequently accompanies the end of a favourable
situation. The major functional characteristics of this stage are product standardisation and comparative disadvantage.
The innovating country’s comparative advantage has disappeared, and what is left is comparative disadvantage.

Module 3
Social and cultural environment - though society and culture do not appear to be a part of business situations, yet they
are actually key elements in showing how business activities will be conducted, what goods will be produced, and
through what means they will be sold to establishing industrial and management patterns and determining the success
or failure of a local subsidiary or affiliate.

Elements of culture - there are too many human variables and different types of international business functions for an
exhaustive discussion about culture. The main elements of culture are:

Attitudes and beliefs: the set of attitudes and beliefs of a culture will influence nearly all aspects of human behaviour,
providing guidelines and organisation to a society and its individuals.

Attitudes towards time: everywhere in the world people use time to communicate with each other. In international
business, attitudes towards time are displayed in behaviour regarding punctuality, responses to business
communication, responses to deadlines, and the amount of time that is spent waiting in an outer office for an
appointment.

Attitude towards work and leisure: people’s attitudes towards work and leisure are indicative of their views towards
wealth and material gains. These attitudes affect the types, qualities and numbers of individuals who pursue
entrepreneurial and management careers as well.

Attitude towards achievement: in some cultures, particularly those with high stratified and hierarchical societies, there
is a tendency to avoid personal responsibility and to work according to precise instructions received from supervisors
that are followed by the latter

Attitudes towards change: the international manager must understand what aspects of a culture will resist change and
how the areas of resistance differ among cultures, how the process of change takes place in different cultures and
how long it will take to implement change.

Attitude towards job: the type of job that is considered most desirable or prestigious varies greatly according to
different cultures.

Cultural dimension - the influences of the religious, family, educational and social systems of a society on the business
system comprise the cultural dimension of our picture. Because cultural attitudes vary so much among countries, it is
harder to find general patterns here than for the economic dimension.

2. Technological environment - pervasive are diversified in scope, technological changes affect many parts of
societies. These effects occur primarily through new products, processes, and materials. The technological segment
includes the institutions and activities involved with creating new knowledge and translating that knowledge into new
outputs, products, processes and materials.

Internet - a technology with important implications for business in the internet sometimes referred to as “the
information superhighway.” The internet is a global web of more than 25,000 computer networks. It provides a quick,
inexpensive means of global communication (i.e. With strategic alliance partners) and access to information.

Modems - modems are important for connecting personal computers to phone lines that help gain access to the
internet. The technology in the manufacture of modems has advanced rapidly. Their speed may only be curtailed by
the limits of conventional phone lines.

Satellite imaging - another new technology that is gaining rapid popularity is satellite imaging. Several aerospace
companies have invested up to $1 billion in corporate earth imaging systems.

3. Economic environment - perhaps the most important characteristic of the international market environment is the
economic dimension. With money, all things (well, almost all!!) Are possible. Without money, many things are
impossible for the marketer.

Economic systems - there are three types of economic systems: capitalist, socialist, and mixed. This classification is
based on the dominant method of resource allocation: market allocation, command or central plan allocation, and
mixed allocation, respectively.

Market allocation/economy - a market allocation system is one that relies on consumers to allocate resources.
Consumers “write” the economic plan by deciding what will be produced by whom. The role of the state in a market
economy is to promote

Command allocation/economy- in a command allocation system, the state has broad powers to serve the public
interest. These include deciding which products to make and how to make them. Consumers are free to spend their
money on what is available, but state planners make decisions about what is produced and, therefore, what is
available. Because demand exceeds supply, the elements of the marketing mix are not used as strategic variables.
Mixed system - there are, in reality, no pure market or command allocation systems among the world’s economies. All
market systems have a command sector and all command systems have a market sector; in other words, they are
“mixed”. In a market economy, the command allocation sector is the proportion of gross domestic product (gdp).

The international economic system - several factors have contributed to the growth of the international economy post
world war ii. The principal forces have been the development of economic blocs like the european union (eu) and then
the “economic pillars”– the world bank (or international bank for reconstruction and development to give its full name),
the international monetary fund (imf) and the evolution of the world trade organisation from the original general
agreement on tariffs and trades (gatt).

Income and purchasing power parity around the globe - when a company charts a plan for global market expansion, it
often finds that, for most products, income is the single most valuable economic variable. After all, a market can be
defined as a group of people willing and able to buy a particular product.

The key economic issues that influence international business are discussed below:

1. Inflation- is the pervasive and sustained rise in the aggregate level of prices measured by an index of the cost of
various goods and services. Inflation results when aggregate demand grows faster than aggregate supply- essentially,
too many people are trying to buy too few goods, thereby creating demand that pushes prices up faster than incomes
grow.

2. Unemployment- the unemployment rate is the number of unemployed workers divided by the total civilian labor
force, which includes both the unemployed and those with jobs.

3. Debt- debt, the sum total of government’s financial obligations, measures the state’s borrowing from its population,
from foreign organizations, from foreign governments, and from international institutions.

4. Income distribution- gni or ppp, even weighted by the size of the population, can misestimate the relative wealth of
a nation’s citizens. Uneven income distribution is not a problem of poorer nations.

5. Poverty- a related but separate issue concerns poverty- the state of having little or no money, few or no material
possessions, and little or no resources to enjoy a reasonable standard of life. In many parts of the world, workers and
consumers struggle for food, shelter, clothing, and clean water, health services, to say nothing of safety, security, and
education.

6. The balance-of payments the balance of payments (bop), officially known as the statement of international
transactions, records a country’s international transactions that take place between companies, governments, or
individuals. Managers use the bop as a comprehensive indicator of a country’s economic stability.

4. Political environment - majority of the mncs have to face complex political environmental problems because they
must cope with the politics of more than one nation. That complexity forces mncs to consider three types of political
environment: foreign, domestic and international.

Let us know some more about political environment, discussed in following subsections.

1. Political systems- in order to appraise the political environment of a country, the knowledge of the form of
government of that country is essential. Basically, the government can be classified into two categories –
parliamentary (open) or absolutist (closed).

2. Political risks defined- political risk, sometimes called “sovereign risk,” has several elements. First, it is found
whenever a government prevents a private sector debtor from repaying its obligations. Second, it occurs when the
foreign government is itself a debtor and defaults on its own obligations due to its own volition. Third, political risk is
present when a government repossesses the assets of a private entity (sometimes referred to as “confiscation,” or
“expropriation

3. Political risk analysis- there are a number of political risks which are to be faced by international marketers. The
risks, which the marketers face from the host government, are: confiscation is the process of a government’s taking
ownership of a property without compensation. Nationalisation involves government ownership and it is the
government that operates the business being taken over.

4. Indicators of political instability - to assess a potential marketing environment, a company should identify and,
evaluate the relevant indicators of political difficultySocial unrest- social disorder is caused by such underlying
conditions as economic hardship, internal dissension and insurgency, and ideological, religious, racial, and cultural
differences.

Attitudes of nationals- an assessment of the political climate is not complete without an investigation of the attitudes of
the citizens and government of the host country. The nationals’ attitude toward foreign enterprises and citizens can be
quite inhospitable.
Policies of the host government- unlike citizens’ inherent hostility, a government’s attitude toward foreigners is often
relatively short-lived. The mood can change either with time or change in leadership, and it can change for either the
better or the worse. The impact of a change in mood can be quite dramatic, especially in the short run.

Jenelyn D. Dela BSBA 3B

Credit and Collection Reviewer

Module 1

Barter is defined as exchange of goods for other goods without the use of any medium of exchange. Barter system is
prevalent at an early stage of man’s economic life when the wants were very limited in number.

Adam smith in his book entitled “wealth of nations”, entertained the belief that money originated in man’s rational effort
to meet the necessity of finding some medium of exchange.

Raw materials are turned into finished products which provide not only gainful employment among the country’s labor
force but also contribute to the increase in, what economists call, the multiplier effect.

One of the unique features of our business system is that it operates to a large extent on promises, called credit.
Business firms sell to consumers on credit and buy from other businessmen on credit. The word credit comes from the
latin credere which means “to trust.”

Nature – credit is akin to a two-way street. The sale of a good or service on the basis of deferred payment gives rise to
the existence of a credit transaction involving two parties, the creditor and the debtor. For every debtor, there is
creditor and vice versa. The creditor, as a seller of goods or services on credit, has both the moral and legal right to
demand of his debtor to pay the obligation when due.

Credit is held to refer to “an entry in the books of a bank showing its obligations to a customer,” that is, for the deposits
made by latter. In bookkeeping, credit is “an entry showing that the person named has a right to demand something
but not necessarily money.” The term credit may refer to a credit instrument, that is, a document which serves to
evidence the existence of a business transaction anchored on trust. The use of credit and its importance the use of
credit especially in the business world is so common that, by way of compliment, it is generally called as “the lifeblood
of business.”

Advantages of credit

 credit facilitates and contributes to the increase in wealth by making funds available for productive purposes.

 credit saves time and expense by providing a safer and more convenient means of completing transactions.

 credit helps expand the purchasing power of every member of the business community – from producer to the
ultimate consumer.  credit enables immediate consumption of goods thereby providing for an increase in material
well-being.

 credit helps expand economic opportunities through education, job training and job creation.

 credit spreads progress to various sectors of the economy.  credit makes possible the birth of the new industries.

 credit helps buying become more convenient for customers.

Disadvantages of credit

 credit, at times, encourages speculation.  credit also tends to contribute to extravagance and carelessness on the
part of people who obtain it.

 because of credit, many entrepreneurs resort to over expansion. Failure to generate expected income can only
cause a collapse which affects the nation’s economy.

 owing to the observation that business can be expanded or contracted rapidly through the use of credit,
businessmen are not only susceptible but eventually succumb to an air of confidence and pessimism. Credit causes
one businessman to be dependent upon others.

The costs of credit are: 1. Interest 2. Credit and collection overhead expenses 3. Bad debts or risk.

2 common and distinct types of credit: a. Credit for merchandise sold b. Cash or bank loan
Cash discount a percentage deducted from the purchase price if the buyer pays within the specified time shorter than
the credit period. In the examples 2% and 1% cash discount period the number of days after the beginning of the
credit period during which the cash discount is available. In this case, 10 days and 15 days are the cash discounts
period the debtor, or the user of merchandise credit under this 2/10 n/30 scheme, have the option of paying within 10
days to avail of a 2% discount, or wait for the entire 30 days, and forgo the discount.

How credit affects prices increases and decreases in credit affect prices in very much the same way as increases and
decreases in the supply of money.

Module 2

Consumer credit consumer credit also called consumption credit is that kind of credit extended to consumers in order
to facilitate the process of consumption. This type of credit exists in those cases where an individual acquires funds
intended for personal consumption or enjoyment in return for a promise to make appropriate payments in the future.

Two basic types of consumer credit (based on method of payments) a. Closed-end credit -a onetime loan repaid in
equal payment in a specified period of time. B. Open-end credit – continuous loan &billed periodically for at least
partial payment.

Retail credit is a typical example of consumer credit, which is held synonymous with one another, as with personal
credit, the use of which is obtained through charge account and instalment credit?

Replevin when an article is sold under an instalment contract, and there buyer later fails to live up to his part of the
contract, the seller, in order to protect himself from loss, has the right to repossess the article. The legal action
necessary is usually referred to as possession or repliven, from the old french; replevin means warrant (“re” meaning
bank and “plevir” signifying pledge.)

Installment credit is when you borrow a specific amount of money from a lender and agree to pay off the loan in
regular payments of a fixed over a specified time period. Examples: home mortgages, car loans and student loans

Mercantile credit mercantile credit, sometimes also called as commercial credit, which may be described as that type
of credit which one businessmen may extend to another when selling goods on time for resale of commercial use, is a
characteristic feature of our modern economy.

Commercial bank credit bank credit refers solely to the credit given by commercial banks to businessmen instead to
assist them in the operation of their business.

Revolving credit a revolving credit is a combination of the charge account and the installment plan. As has been
pointed out by some authors, this type of credit has developed out of the popular 91-day charge account.

Investment credit investment credit is utilized by a business organization for the purchase of fixed assets or to carry
minimum business operations.

Credit classified according to purpose may be known as: agricultural credit. Export credit, industrial credit, commercial
and real estate credit.

Agricultural credit consist of those loans which are intended for the acquisition of fertilizers, pesticides, seedlings, and
any instruments, machinery and other movable equipment used in the production, processing, transformation,
handling or transportation of agricultural products.

Commodity loans since most agricultural product are produced annually and are harvested and available for the
market within the span of transportation, storage, financing and marketing. Many such commodities are stored in cold
storage warehouse which store the perishable goods.

Export credit credit in some form and to some extent is always involved in all sort of transaction for which cash is not
paid on or before shipment of goods out of the country.

Industrial credit is intended to financing needs of industries like logging, fishing, manufacturing and others, and which
involves big amounts of money. Generally speaking, as may be expected, the maturity of this type of credit is long
term.

Commercial credit this type of credit, which is sometimes termed as mercantile credit, has already been indicated in a
foregoing discussion.

Real estate credit when credit is purposely for construction, acquisition, expansion or improvement of real estate
properties, it is termed as real estate credit. This type of credit was extended previously by the defunct rehabilitation
finance corporation which was expressly established to assist in the rehabilitation program of the government.

Classes and kinds of credit according to maturity

Base on maturity, credit may be classified as: short, medium, or intermediate, and long term.

Short-term credit is payable within one year from the date of acquisition. This type of credit usually covers the
purchase of consumers’ goods. The so-called character loan falls under this type.

Medium or intermediate term credit range from one year to five years in maturity. This is usually given for the number
or purposes, like the financing of improvements on a firm or industry.

Long-term credit which are intended from five years up. This type of credit covers those loans intended for investment
purposes.

Government or public credit public credit is a branch or a form of credit in general and, as such, is subject to rules and
principles that govern the use of all credit.

Module 3

Credit institutions, in general, perform the following functions: (1) to pool the savings of the lending customers, (2) to
invest these funds financially on the basis of careful investigation and analysis of credit, (3) to diversify risk to a degree
unattainable for individual investors, (4) to transform short term into long term funds through an expedient and careful
staggering of maturity dates, and (5) to perform insurance and trust functions.

A financial intermediary is an entity that acts as the middleman between two parties in a financial transaction, such as
commercial bank investment bank, mutual fund, or pension fund.

Types of financial intermediaries

Banks: the central and commercial banks are the most well-known financial intermediaries simplifying the lending and
borrowing process, along with providing various other services to its customers on a large scale.

Credit unions: these are the cooperative financial units which facilitate lending and borrowing of funds to provide
financial assistance to its members.

Non-banking finance companies: a nbfc is a financial company engaged in activities such as advancing loans to its
clients at a very high rate of interest.

Stock exchanges: the stock exchange facilitate the trading of securities and stocks, and in every trading activity, it
charges the brokerage from each party which is its profit.

Mutual fund companies: the mutual fund organizations club the amount collected from various investors. These
investors have identical investment objectives and risk-taking ability. The funds are then collectively invested in the
securities, bonds, and other investment options, to ensure a capital gain in the long run.

Insurance companies: these companies provide insurance policies to the individuals and business entities to secure
them against accident, death, risk, uncertainties and default. For this purpose, they accept deposits in the form of
premium, which is pooled into profitable investments to gain returns. The insured person can claim the money in case
of any mishap as per the agreement.

Financial advisers or brokers: the investment brokers also collect the funds from various investors to invest it in the
securities, bonds, equities, etc. The financial advisers even provide guidance and expert opinions to the investors.
Investment bankers. These banks specialize in services like initial public offerings (IPO), other equity offerings,
proving for mergers and acquisitions, institutional client’s broker services, underwriting debts, etc. As a result of
constant mediation, between the investor or public and the companies issuing securities.

Escrow companies: it is a third party acting as an intermediary and responsible for getting all the conditions fulfilled at
the time of loan provided by one party to the other for the real estate mortgage.

Pension funds: the government entities initiate a pension fund. A certain amount is deducted from the salary of the
employees each month.

Building societies: these financial intermediaries are similar to the credit unions, owned and facilitating mortgage loans
and demand deposits to its members.

Collective investment schemes: under this scheme, the various investors with common investment objective come
together to pool their funds and collectively invest this amount into a profitable investment option.

Advantages of financial intermediaries

The financial intermediaries are as crucial to the economy as the blood is to the body. Some of its significant benefits
are discussed below:
 low risk: the involvement of intermediaries reduces the risk of fraudulent, default and even capital loss for the lender.

 convenience: exchange becomes suitable for the investor as well as the borrower. Since both, the parties do not
need to invest time and money in searching for each other. Instead, they have to approach the intermediary for the
purpose.

 economies of scale: the cost involved in the lending and borrowing of funds like analysing credit position, operational
expenses and cost of paperwork decreases to a large extent.

 financial specialization: these organizations or companies specialize in fund management and investing activities
providing better returns to the investors and easy loans to the borrowers.

 greater liquidity: the financial intermediaries like banks allow investors or depositors to withdraw their amount at any
point of time, as per their requirement.

 safe investment: for the investor’s point of view, financial intermediaries are considered to be more trustworthy and
reliable than lending money directly to an individual to yield interest.

Drawbacks of financial intermediaries

Everything has two phases, one is positive, and the other is negative. As we already know that financial intermediaries
operate for profits, they are not charitable institutions; the following are some of its disadvantages:

Low returns on investment: the ultimate aim of the financial intermediaries is to earn a profit and therefore, they
usually provide a low rate of interest on the investment made by the depositors.

Opposing goals: the goals of the investors and the financial intermediaries may not complement each other, and
therefore the objective of one may not be achieved.

Fees and commissions: these intermediaries impose charges, expenses and commission on the financial assistance
they provide to their customers.

False opportunities: sometimes, the financial intermediaries come up with the investment opportunities which
guarantee high potential returns with the hidden risk involved in it.

High interest on loans: these financial intermediaries charge a high rate of interest on the loan provided to the
borrowers to earn a profit.

Appliance companies their main source of investible funds (used to grant credit installment buyers) is owner’s equity –
the owner’s capital funds.

Self-financing. The installment sales of appliance companies and car dealers are either self-financed or not. A self –
financing company is the seller of the merchandise and also the lender it will accept the credit application, approve it,
and release the unit being purchased. In finance terms. It carries its own receivables.

Pawnshop - pawnshop business is defined by the bsp as “the business of lending money on personal property that is
physically delivered to the control and possession of the pawnshop operator as loan collateral (bsp circular no. 938).
The primary document used in a pawnshop is the pledge. The borrower called the pledger, signs a document, called
the pledge which includes the terms and conditions of the loan, and either in the same page, or in the back of the
pledge, a promissory note is signed by borrower. As evidence for the receipt of the property offered as security, the
pawnshop is required to issue a “pawn ticket” to the borrower.

Commercial establishments of the significance to the continued functioning of a credit economy are commercial
establishments, as may be gauged by the kind and amount of credit that they grant. To mention a few, we have: retail
stores, department store, and supermarkets.

Pledging of account receivables pledging is a practice in which a company uses money it expects from customers –
that is, customer receivables as collateral for a loan.

Factoring of account receivables factoring of account receivables is the practice of transferring the ownership of
accounts receivable to a company specialized in receivables collection, in exchange of immediate cash. In other
words, the company that originally owns the receivables sell them to another company called “factor” and receives
immediate cash.

The sale of these accounts are either on with or without recourse basis. In a “with recourse “ transaction, f the account
turns out to a bad debt, the factoring company will charge it back to the seller of the account. In other words, non-
payment is the seller’s responsibility. The opposite is true for a “without recourse” sale.
Social security system (sss). Is a state run, social insurance program in the philippines to workers in the private,
professional and informal sectors? Sss is established by virtue of republic act no. 1161, better known as the social
security act of 1954. This law was later amended by republic act no.8282 in 1997.

Government service insurance system (gsis) like the social security system, the gsis was the product of need – the
need to protect employees against unforeseen contingencies in the future.A ffords protection to employees of the
government owned or controlled corporations. This agency provides loan to members.

Jenelyn D. Dela BSBA 3B

TQM (Productions and Operations Management) Reviewer

Production management - the application of management principles to the production part of the company. Involves
planning, organizing, directing, and controlling the production process. Ultimate goal is to convert raw materials into
finished products. Production management - is about managing activities related to production only

Operations management - deals with the supervision, design, and planning of business operations. Main objective is
to enhance the quality of business operations, focusing on successfully turning inputs into outputs in the most efficient
manner. Operation management - is about the management of overall business operations which includes production
and post-production stages.

There are three basic functions of business organizations namely: finance, operations, and marketing.

A supply chain is the sequence of organizations—their facilities, functions, and activities—that are involved in
producing and delivering a product or service.

There are three basic business strategies: • low cost. • responsiveness. • differentiation from competitors.

Productivity is an index that measures output (goods and services) relative to the input (labor, materials, energy, and
other resources) used to produce it. It is usually expressed as the ratio of output to input,

Productivity = units produced / input used Labor productivity formula productivity = units produced/ labor-hours used

Multi-factor formula productivity = output / labor + material + energy + capital + miscellaneous productivity

Formula Productivity growth = current productivity – previous productivity /previous productivity times 100

Productivity growth is the increase in productivity from one period to the next relative to the preceding period
what is quality? In technical usage, quality can have two meanings:

(1)the characteristics of a product or service that bear on its ability to satisfy stated or implied needs; and

(2)a product or service free of deficiencies.

Dimensions of quality for manufactured products a customer looks for:

• performance • features •reliability • conformance • durability

Dimensions of quality for manufactured products a customer looks for:

• serviceability • aesthetics • safety • other perceptions

Dimensions of quality for a service a customer looks for: • time and timeliness • completeness • courtesy •
consistency

Dimensions of quality for a service a customer looks for: • accessibility and convenience • accuracy •responsiveness

Two categories: •cost of achieving good quality (a.k.a. Cost of quality assurance) • prevention costs • appraisal costs

Cost poor-quality (referred to as cost of not conforming to specifications) • internal failure costs • external failure costs

Quality tools

Process flowcharts - a process flowchart is a diagram of the steps in a job, operation, or process. It enables everyone
involved in identifying and solving quality problems to have a clear picture of how a specific operation works and a
common frame of reference.

Symbol Name Function

 Start / end An oval represent a start or end point.

Arrows A line is a connector that shows relationship between the representative shapes.

Input / output A parallelogram represent input or output.

Process A rectangle represent process.

Decision A diamond indicates a decision.

Cause-and-effect diagrams - also called as fishbone diagram. A graphical description of the elements of a specific
quality problem and the relationship between those elements. Used to identify the causes of a quality problem so it
can be corrected.

Check sheet/ check list - check sheets are frequently used in conjunction with histograms, as well as with pareto
diagrams. A check sheet is a fact finding tool used to collect data about quality problems. A typical check sheet for
quality defects tallies the number of defects for a variety of previously identified problem causes. When the check
sheet is completed, the total tally of defects for each cause can be used to create a histogram or a pareto chart.

Histogram - a histogram is the most commonly used graph to show frequency distributions. It looks very much like a
bar chart. When do we use histograms? • when the data are numerical. • when you want to see the shape of the
data’s distribution, especially when determining whether the output of a process is distributed approximately normally.
• when analysing whether a process can meet the customer’s requirements.

Pareto analysis - is a method of identifying the causes of poor quality. It was devised in the early 1950s by the quality
expert joseph juran. Pareto analysis is based on juran’s finding that most quality problems and costs result from only a
few causes. Pareto analysis is a simple technique for prioritizing possible changes by identifying the problems that will
be resolved by making these changes. By using this approach, you can prioritize the individual changes that will most
improve the situation.

Pareto analysis uses the pareto principle – also known as the "80/20 rule" – which is the idea that 20 percent of
causes generate 80 percent of results. With this tool, we're trying to find the 20 percent of work that will generate 80
percent of the results that doing all of the work would deliver.

Step 1: identify and list step 2: identify the root cause of each problem step 3: score problems step 4: group problems
together by root cause. Step 5: add up the scores for each group step 6: take action • now you need to deal with the
causes of your problems, dealing with your top-priority problem, or group of problems.

When to use a scatter diagram • when you have paired numerical data. • when your dependent variable may have
multiple values for each value of your independent variable.

Interpreting control charts • processes are variable may it be in manufacturing or service industry • reason for this is
the sources of variation in all processes • 2 major sources of variation: • common cause variation - is the inherent
variation in the process due to the way it was designed and is managed; can be reduced only by fundamentally
changing the process • special cause variation - caused by things that don't normally happen in the process;
employees closest to the process have the responsibility for finding and removing (if possible) special causes of
variation.

Interpreting control charts - a process is in statistical control if only common cause variation is present. How do we
know if only common cause variation is present or if there are also special causes of variation present? The only way
to determine this is through the use of a control chart.

“in control” control charts

If a control chart does not look similar to the one beside, there is probably a special cause present.

Points beyond the control limit

A special cause is present in the process if any points fall above the upper control limit or below the lower control
limit. Action should be taken to find the special cause and permanently remove it from the process. If there is a point
beyond the control limits, there is no need to apply the other tests for out of control situations.

The zone tests are valuable tests for enhancing the ability of control charts to detect small shifts quickly

The zones are called zones a, b, and c. There is a zone a for the top half of the chart and a zone a for the bottom half
of the chart.

A special cause exists if two out of three consecutive points fall in zone a or beyond. The test is applied for the zone a
above the average and then for the zone a below the average.
A special cause exists if four consecutive points fall in zone b or beyond. This test is applied for zone b above the
average and then for zone b below the average.

A special cause exists if seven consecutive points fall in zone c or beyond. The test should be applied for the zone c
above the average and then for the zone c below the average.

Stratification occurs if two or more processes (distributions) are being sampled systematically.

The test for stratification involves the use of the zones but is applied to the entire chart and not one-half of the chart at
a time.

Stratification (a special cause) exists if fifteen or more consecutive points fall in zone c either above or below the
average.

Test for mixtures - a mixture exists when there is more than one process present but sampling is done for each
process separately.

A mixture (a special cause) is present if eight or more consecutive points lie on both sides of the average with none of
the points in zone c.

Rule of seven tests

•these tests are often taught initially to employees as the method for interpreting control charts (along with points
beyond the limits).

• the tests state that an out of control situation is present if one of the following conditions is true:

• seven points in a row above the average • seven points in a row below the average

• seven points in a row trending up, or • seven points in a row trending down

Inventory is the “stock” of all the items used in an organization for the purpose of selling in the market. Inventory
answers the question “how much do we have on hand?” (murray, 2019).

Purposes of inventory

• to maintain independence of operations. • to meet variation in product demand.

• to allow flexibility in production scheduling. • to provide a safeguard for variation in raw material delivery time.

• to take advantage of economic purchase order size.

Inventory planning includes creating forecasts to determine how much inventory should be on hand to meet consumer
demand. Inventory control is the process by which managers count and maintain inventory items in the business.

Inventory as an important asset inventory is considered to be one of the most important assets of a business. Its
management needs to be proactive, accurate and efficient. The primary objective in terms of holding inventory is to
ensure that customer service targets can always be met without compromising cash flow or running out of stock.
When customers cannot purchase what they need, when they need it, they often cease to be customers.

Functions of inventory

1. To meet anticipated customer demand 2. To smooth production requirements 3. To decouple operations

4. To reduce the risk of stock outs 5. To take advantage of order cycles 6. To hedge against price increases

7. To permit operations 8. To take advantage of quantity discounts

Inventory cost

1. Holding (or carrying) costs 2. Setup (or production change) costs 3. Ordering costs 4. Shortage costs

Economic order quantity the question of ‘how much to order?’ can be determined by using an economic order quantity
(eoq) model. Economic order quantity is an inventory management technique that is used to identify the fixed order
size that will minimize the sum of the annual costs of holding inventory and ordering inventory.

Economic order quantity eoq assumes that the relevant costs of inventory can be divided into order costs and carrying
costs.

• order costs are the fixed clerical costs of placing and receiving an inventory order.
• carrying costs are the variable costs per unit of holding an item in inventory for a specific period of time.

• the eoq model analyzes the trade-off between order costs and carrying costs to determine the order quantity that
minimizes the total inventory cost.

2 DS
The formula for eoq is: 𝑄= √
H
Where: q = eoq units d = demand in units (typically on an annual basis) s = order cost (per purchase order) h =
holding costs/carrying cost (per unit, per year)

Jenelyn D. Dela BSBA 3B

Risk Management Reviewer

Overview

Risk - stochastic deviation from expected cash flows. The volatility of returns leading to “unexpected losses,” with
higher volatility indicating higher risk. The volatility of returns is directly or indirectly influenced by numerous variables,
which we called risk factors, and by the interaction between these risk factors.

Risk ▪ uncertainty ▪ financial loss ▪ deviation of a parameter from its target value ▪ random negative deviations of
financial variables from previously defined reference values of asset position

Characteristics of risk ▪ randomness (stochastic, probabilistic) ▪ negative deviations ▪ financial ▪ ideally measurable ▪
randomness (stochastic, probabilistic) ▪ negative deviations ▪ financial ▪ ideally measurable

Types of risk

Market risk - the risk that changes in financial market prices and rates will reduce the value of a security or a portfolio.

Interest rate risk - the risk that the value of a fixedincome security will fall as a result of an increase in market interest
rates

Equity price risk - ▪ the risk associated with volatility in stock prices

Foreign exchange rate risk - arises from open or imperfectly hedged positions in particular foreign currency
denominated assets & liabilities leading to fluctuations in profits or values as measured in a local currency.

Commodity price risk - the number of market players having direct exposure to the particular commodity is quite
limited, hence affecting trading liquidity which in turn can generate high levels of price volatility

Credit risk - the risk of an economic loss from the failure of a counterparty to fulfill its contractual obligations, or from
the increased risk of default during the term of the transaction

Liquidity risk - comprises both: a) “funding liquidity risk” and b) “trading liquidity risk”

Funding liquidity risk - relates to a firm’s ability to raise the necessary cash to roll over its debt; to meet the cash,
margin, and collateral requirements of counterparties; and to satisfy capital withdrawals

Trading liquidity risk - often simply called liquidity risk. Is the risk that an institution will not be able to execute a
transaction at the prevailing market price because there is, temporarily, no appetite for the deal on the other side of
the market

Operational risk - refers to potential losses resulting from a range of operational weaknesses including inadequate
systems, management failure, faulty controls, fraud, and human errors; in the banking industry, it’s also often taken to
include the risk of natural & man-made catastrophes (e.g., earthquakes, terrorism) and other nonfinancial risks

Legal and regulatory risk - closely related to operational risk, as well as to reputation risk. In the derivative markets,
legal risks - arise when a counterparty/investor, loses money on a transaction & decides to sue the provider firm to
avoid meeting its obligations.

Regulatory risk is the potential impact of a change in tax law on the market value of a position

Business risk - refers to the classic risks of the world of business, such as uncertainty about the demand for products;
▪ or the price that can be charged for those products; ▪ or the cost of producing and delivering products
Strategic risk - refers to the risk of significant investments for which there is a high uncertainty about success and
profitability ▪ it can also be related to a change in the strategy of a company vis-à-vis its competitors

Reputation risk - can be divided into two main classes: ❑ the belief that an enterprise can and will fulfill its promises to
counterparties and creditors; ❑ and the belief that the enterprise is a fair dealer and follows ethical practices

Systemic risk - ▪ in financial terms, it concerns with the potential for the failure of one institution to create a chain
reaction or domino effect on other institutions and consequently, threaten the stability of financial markets and even
the global economy.

Risk management - the identification, evaluation, and prioritization of risks followed by coordinated & economical
application of resources to minimize, monitor, and control the probability or impact of unfortunate events or to
maximize the realization of opportunities

It is a continuous process

1. Identify 2. Assess 3. Evaluate 4. Control and monitor

Risk managemnt process

Risk identification (which risk does have an impact on the company?)

Risk assessment (how much do these risk affect the company?)

Risk management (how do i deal with the relevant risk?)

Risk control (how well the risk has been handled?) (what needs to be changed?)

Risk communication (which information must be communicated?)

Modigliani and miller theorem – capital structure does not create value to the firm under perfect capital markets.

Two types of financial risk: 1.Market risk 2. Credit risk

Topic 1

What is bank? The word “bank” originates from the italian word banco. This is a desk or bench, covered by a green
tablecloth that was used several hundred years ago by florentine bankers. The traditional role of banks has been to
take deposits and make loans. Two types of bank Commercial and Investment Banking.

Commercial banking involves, among other things, the deposit-taking and lending activities we have just mentioned.

Commercial banking can be classified as retail banking or wholesale banking.

1. Retail banking, as its name implies, involves taking relatively small deposits from private individuals or small
businesses and making relatively small loans to them.
2. Wholesale banking involves the provision of banking services to medium and large corporate clients, fund
managers, and other financial institutions. Both loans and deposits are much larger in wholesale banking than
in retail banking. Sometimes banks fund their lending by borrowing in financial markets themselves.
Investment banking is concerned with assisting companies in raising debt and equity, and providing advice on
mergers and acquisitions, major corporate restructurings, and other corporate finance decisions. Investment banking
main activity is raising debt and equity financing for corporations or governments. This involves originating the
securities, underwriting them, a then placing them with investors.

Methods of raising debt or equity

Private placement-the securities are sold to a small number of large institutional investors, such as life insurance
companies or pension funds, and the investment bank receives a fee.

Public offering- securities are offered to the general public.

Best efforts- the investment bank does as well as it can to place the securities with investors and is paid a fee that
depends, to some extent, on its success.

Firm commitment- the investment bank agrees to buy the securities from the issuer at a particular price and then
attempts to sell them in the market for a slightly higher price. It makes a profit equal to the difference between the
price at which it sells the securities and the price it pays the issuer. If for any reason it is unable to sell the securities, it
ends up owning them itself.

Advisory services - investment banks offer advice to companies on mergers and acquisitions, divestments, major
corporate restructurings, and so on. Valuation, strategy, and tactics are key aspects of the advisory services offered
by an investment bank.

Securities trading banks often get involved in securities trading, providing brokerage services, and making a market in
individual securities. In doing so, they compete with smaller securities firms that do not offer other banking services.

The risks facing banks - capital is now required for three types of risk: credit risk, market risk, and operational risk.

Credit risk is the risk that counterparties in loan transactions and derivatives transactions will default. This has
traditionally been the greatest risk facing a bank and is usually the one for which the most regulatory capital is
required.

Market risk arises primarily from the bank’s trading operations. It is the risk relating to the possibility that instruments in
the bank’s trading book will decline in value.

Operational risk which is often considered to be the biggest risk facing banks, is the risk that losses are created
because internal systems fail to work as they are supposed to or because of external events.

Insurance companies and pension plans - the role of insurance companies is to provide protection against adverse
events. The company or individual seeking protection is referred to as the policyholder. The policyholder makes
regular payments, known as premiums, and receives payments from the insurance company if certain specified
events occur. Insurance is usually classified as life insurance and nonlife insurance, with health insurance often
considered to be a separate category.

Life insurance in life insurance contracts, the payments to the policyholder depend at least to some extent on when
the policyholder dies. Different types of life insurance

Term life insurance (sometimes referred to as temporary life insurance) lasts a predetermined number of years. If the
policyholder dies during the life of the policy, the insurance company makes a payment to the specified beneficiaries
equal to the face amount of the policy. If the policyholder does not die during the term of the policy, no payments are
made by the insurance company.
Whole life insurance (sometimes referred to as permanent life insurance) provides protection for the life of the
policyholder. The policyholder is required to make regular monthly or www.rasabourse.com insurance companies and
pension plans 49 annual payments until his or her death. The face value of the policy is then paid to the designated
beneficiary.
Variable life insurance given that a whole life insurance policy involves funds being invested for the policy holder, a
natural development is to allow the policyholder to specify how the funds are invested. Variable life (vl) insurance is a
form of whole life insurance where the surplus premiums discussed earlier are invested in a fund chosen by the
policyholder.
Universal life universal life (ul) insurance is also a form of whole life insurance. The policyholder can reduce the
premium down to a specified minimum without the policy lapsing. The surplus premiums are invested by the insurance
company in fixed income products such as bonds, mortgages, and money market instruments. The insurance
company guarantees a certain minimum return, say 4%, on these funds.
Variable-universal life (vul) insurance blends the features found in variable life insurance and universal life insurance.
The policyholder can choose between a numbers of alternatives for the investment of surplus premiums.
Endowment life insurance lasts for a specified period and pays a lump sum either when the policyholder dies or at the
end of the period, whichever is first. There are many different types of endowment life insurance contracts
Group life insurance covers many people under a single policy. It is often purchased by a company for its employees.
The policy may be contributory.
Annuity contracts many life insurance companies also offer annuity contracts. Where a life insurance contract has the
effect of converting regular payments into a lump sum, an annuity contract has the opposite effect: that of converting a
lump sum into regular payments.

Longevity risk is the risk that advances in medical sciences and lifestyle changes will lead to people living longer.
Increases in longevity adversely affect the profitability of most types of annuity contracts (because the annuity has to
be paid for longer), but increase the profitability of most life insurance contracts.

Mortality risk is the risk that wars, epidemics such as aids, or pandemics such as spanish flu will lead to people living
not as long as expected.
Property-casualty insurance - property insurance provides protection against loss of or damage to property (from fre,
theft, water damage, etc.). Casualty insurance provides protection against legal liability exposures.

Health insurance - health insurance has some of the attributes of property-casualty insurance and some of the
attributes of life insurance. It is sometimes considered to be a totally separate category of insurance.

Two key risks facing insurance companies;

1. Moral hazard is the risk that the existence of insurance will cause the policyholder to behave differently than he or
she would without the insurance.
2. Adverse selection is the phrase used to describe the problems an insurance company has when it cannot
distinguish between good and bad risks. It offers the same price to everyone and inadvertently attracts more of the
bad risks. To lessen the impact of adverse selection, an insurance company tries to find out as much as possible
about the policyholder before committing itself.
Reinsurance - is an important way in which an insurance company can protect itself against large losses by entering
into contracts with another insurance company for a fee, the second insurance company agrees to be responsible for
some of the risks that have been insured by the first company.

Pension plans are set up by companies for their employees. Typically, contributions are made to a pension plan by
both the employee and the employer while the employee is working. When the employee retires, he or she receives a
pension until death. There are two types of pension plans: defined benefit and defined contribution.

1. Defined benefit plan, the pension that the employee will receive on retirement is defined by the plan. Typically
it is calculated by a formula that is based on the number of years of employment and the employee’s salary in
the event of the employee’s death while still employed, a lump sum is often payable to dependents and a
monthly income may be payable to a spouse or dependent children. Sometimes pensions are adjusted for
inflation. This is known as indexation.
2. Defined contribution plan the employer and employee contributions are invested on behalf of the employee.
When employees retire, there are typically a number of options open to them. The amount to which the
contributions have grown can be converted to a lifetime annuity.
Mutual funds - mutual funds, exchange-traded funds (etfs), and hedge funds invest money on behalf of individuals and
companies. The funds from different investors are pooled and investments are chosen by the fund manager in an
attempt to meet specified objectives.
Types of open-end funds

Money market mutual funds invest in interest-bearing instruments, such as treasury bills, commercial paper, and
bankers’ acceptances, with a life of less than one year.

Long term funds.

Bond funds - invest in fixed-income securities with a life of more than one year.

Equity funds - invest in common and preferred stock. The most popular so far.

Hybrid funds - invest in stocks, bonds, and other securities.

Index fund are funds designed to track a particular equity index such as the philippine stock exchange index.

Active or passive management when buying a mutual fund or an etf, an investor has a choice between a passively
managed fund that is designed to track an index such as the psei and an actively managed fund that relies on the
stock selection and timing skills of the fund manager. Actively managed funds tend to have much higher expense
ratios.

Regulation the funds must file a registration document with the sec. Full and accurate financial information must be
provided to prospective fund purchasers in a prospectus. There are rules to prevent conflicts of interest, fraud, and
excessive fees.

Late trading- brokers collude with investors and submit new orders or change existing orders after cut-off time of 4pm.
For various reasons, an order to buy or sell is sometimes not passed from a broker to a mutual fund until later than 4
p.m.

Market timing- this is a practice where favored clients are allowed to buy and sell mutual funds shares frequently (e.g.,
every few days) and in large quantities without penalty.

Front running occurs when a mutual fund is planning a big trade that is expected to move the market. It informs
favored customers or partners before executing the trade, allowing them to trade for their own account first.
Directed brokerage involves an improper arrangement between a mutual fund and a brokerage house where the
brokerage house recommends the mutual fund to clients in return for receiving orders from the mutual fund for stock
and bond trades.

Hedge funds are different from mutual funds in that they are subject to very little regulation. This is because they
accept funds only from financially sophisticated individuals and organizations. “hedge fund” implies that risks are being
hedged.

Topic 2

Derivatives are financial instruments with a value derived from underlying assets, such as tangibles like commodities,
intangibles like interest rates, or cash instruments like stocks and bonds.

Classifications of derivatives:

Swap - deal between two parties to exchange or series of future cash flows or liabilities from two different financial
instrument.
Futures - standardized contracts similar to forward traded of exchanges. In which two parties agree that one party will
purchase an underlying asset from the other party.
Forward - customized contract between two parties to buy or sell an asset at a specified future date.
Option - form of derivatives that give one party the right but not the commitment to buy or sell an underlying asset from
or to another party at an agreed price over a certain period.
Options are popular derivatives that give one party the right to buy or sell an underlying asset at an agreed price over
a certain period. Call options give the holder the right to buy a stock, while put options give the holder the right to sell a
stock. An option contract exists between the option buyer/holder and option writer/seller, who charges a fee called
option premium. Options are categorized as american and european options, with american options being exercised
before maturity and european options only at maturity. Options contracts mitigate downside risks without foregoing
upside potential, making them a preferred choice over other derivative instrument.

Fixed income securities are investment instruments that provide a fixed return or income to their holders at regular
intervals until maturity. These securities include bonds, treasury bills, notes, and certificates of deposit. Fixed income
securities are issued by governments, corporations, and other organizations to finance their operations or projects.

Security bank is one of the banks here in the philippines that offers fixed income securities. Security bank offers
treasury bills, retail treasury bonds, fixed rate treasury notes, peso corporate bonds, dollar sovereign bonds, and dollar
corporate bonds.

Fixed income derivatives are financial instruments whose value is based on the performance of fixed income
securities, such as bonds and treasury bills

Equity markets are financial markets where stocks, shares, or other equity instruments are traded. Equity refers to
ownership in a company, and in the equity markets, investors can buy and sell ownership in publicly traded
companies.

Currency markets as markets where one currency is exchanged for another at a negotiated exchange rate. Currency
markets are financial markets where currencies of different countries are traded. Currency markets, also known as
foreign exchange (forex) markets, facilitate the exchange of one currency for another.

Commodity markets as markets where commodities such as gold, oil, and agricultural products are traded.

Topic 3

Market risk?
The uncertainly associated with any investment decision is called market risk or systematic risk. Market risk is the
possibility for an investment value to decrease due to changes in market such as fluctuations in interest rates,
currency exchange rates, commodity prices or market movements. This risk is inherent in all investments and caused
by external factors that are beyond the control of the investor.
Characteristics of market risk
Market risk is unpredictable- market risk are caused by factors that beyond an investor control such as changes in
economic condition, geopolitical events and natural disasters. These events can be difficult to predict.
Affect a wide range of assets- market risk can affect a wide range of assets including stocks , bonds, commodities,
currencies and real estate.
A type of systematic risk- which means they affect the entire market or a particular segment of the market. Systematic
cannot be diversified away through asset distribution.
Can lead to significant losses- it can lead t significant losses to investors particularly if they are heavily in a separate
assets or sector.

Market risk can be manage - but market risk cannot be eliminated entirely they can be manage through diversification,
hedging and other risk management techniques. Investors can also limit their exposure to market risk by carefully
selecting investments and monitoring their portfolios.

Different types of market risk

Equity risk- is the financial risk involved in holding equity in a particular investment. Equity risk is a type of market risk
that applies to investing in shares.

Interest rate risk- a risk that arises for bond owners from fluctuating interest rate.
Is the risk that changes in rates will affect the value of fixed income investments such as bonds.
Currency risk- is the risk in changes in foreign exchange rates will affect the value of investments denominated in
foreign currencies. This risk is particularly relevant for investors who hold investments in foreign markets or who invest
in multinational companies.

Commodity risk- is the threat or price fluctuations of a raw material for commodity producers, a decrease in raw
material prices is going to hurt, because they’re going to receive less money for the raw material that they’re providing.
Is the risk that the value of investments in commodities such as gold, oil or agricultural products will fluctuate due to
changes in supply and demand or geopolitical events.

Systematic risk- it refers to the risk inherent to the market or market segment. Systematic risk also known as
undiversifiable risk, volatility risk, or market risk affects the overall market not just a particular stock or industry.
Is the risk that affect the entire market or a particular segment of the market.

Unsystematic risk- a risk that are not shared with a wider market or industry. Unsystematic risk are often specific to an
individual company, due to their management, financial obligations, or location. Unlike systematic risk, unsystematic
risk can be reduced by diversifying one’s investments.
How to manage market risk

Diversification- is one of the most effective ways to manage market risk by spreading investments across different
assets classes sectors and geographic regions investors can reduce their exposure to any single risk factor.
Asset allocation- involves determining the appropriate mix of investments based on a investors risk tolerance time
horizons and financial goals by balancing different type of assets investors can reduce their exposure to market risk
while still achieving their desire level of return.
Hedging- involves using financial instruments such as options features or swaps to protect against potential losses for
example an investor may purchase put options on a stock to hedge against a decline in its value.
Stop loss orders- an order to sell a security once it reaches or certain price this can help to limit potential losses in the
event of the market downturn.
Active management- involves regularly monitoring and adjusting a portfolio in response to changing market conditions.
Maintain a long- term perspective- it’s important to remember that market functions are a moral part of investing by
maintaining a long term perspective and focusing on long term financial goals investors can avoid making impulsive
decision based on short term market volatility.
Advantages of market risk
•potential for higher returns market risk is often associated with a higher potential return investors who are willing to
accept higher levels of risk may be able to earn higher returns than those who only invest in low risk investment.
•liquidity market risk is typically associated with investments that are publicly traded such as stocks and bonds this
investments are generally more liquid than private investment meaning that investors can buy and sell them quickly
and easily.
•transparency publicly traded investments are subjects to regulatory oversight and reporting requirements this means
that investors have access to a walls of information about their investments including financial statement earnings
reports and analysis ratings.

Disadvantages of market risk

•losses the most obvious disadvantages of market risk is potential losses when market conditions change investments
can lose value and investors may not be able to recover their initial investments.
•complicity investing in a stock market can be complex and it requires a high level of financial literacy and knowledge
of market trends this can make it difficult for in experience investors to make informed decisions.
•volatility market risk is often associated with high levels of volatility meaning that investments can experience large
fluctuation in value over short periods of time. This can make it hard for investors to predict the prospective value of
time this can make it hard for investors to predict the prospective value of their investments.
Topic 4

Investment risk - the degree of uncertainty and/or potential financial loss inherent in an investment decision.

Types of investment risk

1. Inflation risk
 The tendency for prices to increase over time.m
 The effects on investment - future dollars (your investment) will not have as much buying power.
 2. Longevity risk
 The risk of outliving your savings.
 The effect on investment - the length of retirement is undetermined, making it tough to know how
much money you'll need.
3. Market risk
 The risk of loss due to financial market performance.
 The effect on investment - stock vary from day-to-day and year-to-year, which can have a negative
effects on investments.
4. Investment rate risk
 The risk to savings and loan rates it interest rates change.
 The effect on investment - for money you want to grow (investments), interest rate increases are
generally positive.
5. Credit risk
 The risk of default by the issuer of the bond.
 The effect on investment - bondholders may not be paid the promised interest or the full principal.
Risk management

 Is a crucial process used to make investment decision.

 The analysis of an investment's returns compared to its risk with the expectation that a greater degree of risk
is supposed to be compensatedby a higher expected return.
The following are the investment risk techniques by risk management;

1. Standard deviation 2. Sharpe ratio 3.beta 4.value at risk (var) 5. Conditional value at risk (cvar)
The standard deviation is commonly used to measure the historical volatility associated with an investment relative to
its annual rate of return. Most useful in conjunction with an investment's average return to evaluate the dispersion from
historical results
Sharped ratio - measures investment performance by considering associated risks. Most useful when evaluating
differing options. This measurement allows investors to easily understand which companies or industries generate
higher returns for any given level of risk.

Beta - measures the amount of systematic risk an individual security or has relative to the entire stock market. The
market is always the beta benchmark an investment is compared to, and the market always has a beta of one. Most
useful when comparing an investment against the broad market.

Value at risk (var) - is a statistical measurement used to assess the level of risk associated with a portfolio or
company. The var measures the maximum potential loss with a degree of confidence for a specified period. Most
useful when wanting to assess a specific outcome and the likelihood of that outcome occurring.

Conditional value at risk (cvar) - is another risk measurement used to assess the tail risk of an investment. Used as an
extension to the var, the cvar assesses the likelihood, with a certain degree of confidence, that there will be a break in
the var.it seeks to assess what happens to investment beyond its maximum loss threshold. This measurement is more
sensitive to events that happen at the tail end of a distribution.

R-squared - is a statistical measure that represents the percentage of a fund portfolio or a security's movements that
can be explained by movements in a benchmark index. Most useful when attempting to determine why the price of an
investment changes. It's a byproduct of a financial model that clarifies what variables determine the outcome of other
variables.

Topic 5

Credit risk refers to possibility of a borrower failing to meet their financial obligations. This may result in losses for the
lender or investor.

Types of credit risk

Default risk is the most common type of credit risk, referring to the likelihood of a borrower failing to repay their debt in
full. This can result in losses for the lender or investor, especially if the borrower is unable to make any repayments.

Spread risk arises from fluctuations in the credit spread, which is the difference between the interest rate on a risky
debt instrument and a risk-free debt instrument.
Downgrade risk refers to the possibility of a borrower’s credit rating being downgraded by a credit rating agency. A
downgrade can negatively impact the borrower’s cost of borrowing and the market value of their outstanding debt.

Recovery risk is the uncertainty surrounding the amount that can be recovered from a borrower in the event of a
default. This risk can be influenced by factors such as the quality of the collateral and the legal framework governing
debt recovery.

Credit risk strategy

Credit risk from lending money to someone : This is the risk that the borrower will not pay back the loan.

Credit risk from borrowing money: This is the risk that the lender will not be able to get the money back from the
borrower.

Credit risk from investing in a company: This is the risk that the company will not be able to pay back the investment.

Factors of credit risk

Factors influencing credit risk - Credit risk can be influenced by a variety of factors, including borrower-specific factors
and macroeconomic factors.

Borrower-specific factors, such as creditworthiness, financial performance, and industry sector, play a significant role
in determining credit risk.

Macroeconomic factors, such as economic conditions, interest rates, and the regulatory environment, can also
influence credit risk.

The industry sector in which a borrower operates can also impact credit risk. Certain industries may be more
susceptible to economic downturns, regulatory changes, or other factors that can negatively affect borrower’s ability to
repay their

The regulatory environment can also impact credit risk. Financial institution must comply with various regulations and
standard related to credit risk management, such as the basel accords and international financial reporting standards
(ifrs).

What is managing credit risk?

Credit risk management refers to measuring and mitigating the risks associated with the lent amount and being aware
of the bank’s reserves to be used at any given time. Risk management here involves facilitating proper decisions-
making of lenders or banking institutions.

Credit risk management involves examining a series of steps on ensure the amounts are lent to reliable hands. The
lenders are expected to evaluate the loan applications from borrowers thoroughly. In addition, they must ensure that
borrowers can make monthly payments in the future.

Credit risk steps

1. Evaluate 2. Validate 3. Monitor 4. Leverage 5. Advanced 6. Prepare

Proper credit risk environment - Is essential for any financial institution or lender. It encompasses a well-structured
framework of policies, procedures and practices that are geared towards evaluating, managing and mitigating the risk
associated with lending money.

Effective credit granting process - Is a structured and meticulous approach employed by lenders to asses and approve
loans for borrowers.

Efficient administrative system - Forms the backbone of any well-functioning organization. It encompasses
meticulously organized set of process, protocols and tools that collectively facilitate seamless operations.

Accurate supervising - Is the cornerstone of effective management within any organization. It involes the precise
oversight of tasks projects or personal ensuring that they align with established objectives.

Deploying apt control in place - Is a critical aspects of organization management, involving the strategic
implementation of measures to mitigate risks and ensure smooth operation. This begins with a through risk
assessment, identifying potential vulnerabilities across financial, operational, regulatory and cyber security domains.

Topic 6
What is Business Operation? Business operations refer to the activities and tasks that organizations use to produce
goods and services. Business operations is a broad term that describes everything that happens within a company to
keep it running and earning money. Business plans often include a section dedicated to operations.

Operations management is the process that generally plans, controls and supervises manufacturing and production
processes and service delivery. Operations management involves overseeing business activities to attain objectives,
enhance productivity, and optimize profitability. Operations management is the management of your employees and
resources.

Operational Risk is a form of risk that involves system mistakes, human interference, inaccurate information or other
technical issues

TYPES OF OPERATIONAL RISK

1. People Risk - The risk of financial losses and negative social performance related to inadequacies in human
resources. This encompasses the inability to attract, manage, motivate, develop, and retain competent resources
and often results in human errors, fraud, or other unethical behavior, both internal and external to the institution.
2. Process Risk - The risk of financial losses and negative social performance related to failed internal business
processes within every aspect of the business. This include product design flaws and internal project failures.
3. Systems Risk - The risk of financial losses and negative social performance related to failed internal systems.
This encompasses inter-branch connectivity, management information and core banking systems, information
technology systems, power backup systems, and other technical systems.
4. External Events Risk - The risk of financial losses and negative social performance related to the occurrence of
external events typically outside of an MFI’s control. This encompasses both natural disasters and as well as
man-made events.
5. Legal and Compliance Risk - The risk of financial losses and negative social performance related to non-
compliance with internal and external regulations and laws. This encompasses non-compliance with microfinance
regulations, anti-money laundering (AML) requirements, tax laws, human resources laws, mandatory vehicle
registration, internal codes of ethical conduct, and other regulations.
Seven (7) categories of operational risk

Basel II, a set of international banking regulations, lays out seven categories of operational risk.

Internal Factors and Fraud - several internal factors and activities may lead to internal fraud within the organization.
These acts are done with the intention of fraud, misappropriate property, etc., and involve an internal party.

External Fraud - third parties commit external frauds intending to defraud or misappropriate property. Such acts may
cause loss to the organization.

Losses Relating to Clients, Products, and Practices of Business - such risks comprise losses resulting from
unintentional non-fulfillment of orders and Professional obligations. This category includes improper business and
market practices .
Employment Practices and Hazards - an organization faces risks with regard to activities that are inconsistent with
health, safety, and labor laws.
Risks due to Damage to Physical Asset - a business faces a risk of damages to its physical assets from natural
disasters and calamities, terrorism and vandalism, etc.
Business Disruption - there may be business disruption due damages to software or hardware, power failures, etc.
Risks related to Execution, Delivery, and Processing - there may be operational risks arising out of a failure in the
processing of transactions or from processes and producers going wrong.

Key Five-Step Process to Manage Operational Risk

1. Risk Identification - Identifying operational risks in the context of the organization’s objectives and goals is the
natural first step to risk mitigation and reduction.
2. Risk Assessment - After all the operational risk identified, evaluate them based on the potential harm and
likelihood of occurrence.
3. Risk Measurement and Mitigation - In this stage, compare the cost of risk control to the cost of potential risk
exposure. Then choose how to mitigate the risk.
4. Control Implementation - Implement the necessary controls to mitigate or minimize the risk.
5. Risk Monitoring and Reporting - Monitor the risks continuously to determine whether there are any changes to
their prevalence and severity. Your original list of identified risks should be reviewed and updated on regular
basis.

Another way to manage Operational Risk are the following;

1. Proactive Management for Risk Identification - The management should be proactive so as to correctly
recognize, predict, and prepare in advance for such operational risks and hazards.
2. Brainstorming Sessions - A common method to identify risk is to conduct the “Brainstorming sessions”. A proper
flow of ideas from all management levels can help tackle such risks.
3. Audit on the Basis of Risk - It is an effective tool to check and verify the effectiveness of the organization’s
framework for risk management. Identification of any loopholes and shortcomings can help in their removal and
cure.
4. Risk Map - A risk map can also help identify the probability of occurrence of an event. It can assess the damage
the event can cause in the organization on such occurrence. Every probable event can then put into a risk
category.

Jenelyn D. Dela BSBA 3B

Social Responsibility and Good Governance Reviewer