Chapter 9: Foreign Exchange Market

● Trading of currency and bank deposits denominated in particular currencies

takes place in the foreign exchange market.
● Transactions conducted in the foreign exchange market determines the rates at
which currencies exchanged, which in turn determine the cost of purchasing
foreign goods and financial assets.
● Firms that do business internationally must be concerned with exchange rates.
● Constant change in exchange rates causes problems for financial managers as
the change in relative purchasing power between countries affects imports and
exports, interest rates and other economic variables.
● International Monetary Fund (IMF) administers the exchange rate system.
● Exchange rates are important because they affect the relative price of domestic
and foreign goods.
● Factors influencing exchange rates are Inflation, Interest rates, Balance of
payments, Government intervention and other factors.
● If exchange rate was set too high, it tends to create a deficit in a particular
country's balance of payments.
● If exchange rate was set too low, it tends to create a surplus in a particular
country’s balance of payments.
● Two kinds of Foreign Exchange Rate Transactions namely, Spot Transactions
and Forward Transactions.
● Factors that would affect exchange rates in the long run namely, Relative Price
Levels, Trade Barriers, Preferences for Domestic Versus Foreign Goods, and
Productivity.

Devaluation- refers to the adjustment in which currency was made cheaper with
respect to the dollar.
Upvaluation or revaluation- refers to when a currency became more expensive with
respect to the dollar.
Forex Market or Foreign Exchange Market- Provides service to individuals,
businesses, and governments who need to buy or sell currencies other than the used in
their country.
Exchange rate- simply the price of one country’s currency expressed in terms of
another country’s currency.
Inflation- It tends to deflate the value of a currency.
Interest rates- The higher the interest returns in a particular country as compared to
others, the investors may be attracted that would result to increased demand for that
country’s currency.
Balance of payments- Is used to refer to a system of accounts that catalogs the flow of
goods between the residents of two countries.
Government intervention- Through intervention, the central bank of a country may
support or depress the value of its currency.
Other factors- Factors that may affect exchange rates are political and economic
stability, extended stock market rallies and significant declines in the demand for major
exports.
Managed Float- Is the current method of exchange rate determination.
Floating rates- It permits adjustments to eliminate balance of payments’ deficits or
surpluses.
Theory of Purchasing Power Parity (PPP)- It states that exchange rates between any
two currencies will adjust to reflect changes in the price levels of the two countries.
Spot Transactions- Are those which involve immediate exchange of bank deposits.
Spot Exchange Rate- Is the exchange rate for the spot transactions.
Forward Transactions- It involves the exchange of bank deposits at some specified
future date.
Forward Exchange Rate- Is the exchange rate for the forward transaction.
Direct quote- It indicates the number of units of the home currency required to buy one
unit of the foreign currency.
Indirect quote- It indicates the number of units of foreign currency that can be bought
for one unit of the home currency.
Cross rate- Is the indirect computation of the exchange rate of one currency from the
exchange rates of two other currencies.
Forward rates (for a currency)- Is the exchange rate at which the currency for future
delivery is quoted.
Forward Market Transaction- Is the trading of currencies for future delivery.
Relative Price Levels- A rise in a country’s price level causes its currency to
depreciate.
Trade Barriers- Increasing this would causes to appreciate a country’s currency in the
long run.
Preferences for Domestic Versus Foreign Goods- Increased demand for a country’s
exports causes appreciation of currency in the long run while increased demand for
imports causes a domestic currency to depreciate.
Productivity- As a country becomes more productive its currency appreciates in the
long run.
Foreign Exchange Risk- Refers to the possibility of a drop in revenue or an increase in
cost in an international transaction due to a change in foreign exchange rates.

Avoidance of Exchange Rate Risk in Foreign Currency Markets

1. The firm may hedge its risk by purchasing or selling forward exchange contracts.
2. The firm may choose to minimize receivables and liabilities denominated in
foreign currencies.
 3. Maintaining a monetary balance between receivables and payables denominated
in a particular foreign currency avoids a net receivable or net liability position in
that currency.
4. Using of Trigger Pricing
5. A firm may seek to minimize its exchange rate risk through diversification.
6. A speculative forward contract does not hedge any exposure to foreign currency
fluctuation as it creates the exposure.

Chapter 10: Mortgage Markets and Derivatives

Mortgage- Refers to a long-term loan secured by real estate.

Fully Amortized- It means that the payments will pay-off the outstanding indebtedness
by the time the loan matures.
Conventional Mortgages- These are originated by banks or other mortgage lenders
but are not guaranteed by government or government controlled entities.
Insured Mortgages- These mortgages are originated by banks or other mortgage
lenders but are guaranteed by either the government or government-controlled entities.
Fixed-rate Mortgages- The interest rate and the monthly payment do not vary over the
life of the mortgage.
Adjustable-Rate Mortgages (ARMs)- Is tied to some market interest rate and therefore
changes over time.
Graduated-Payment Mortgages (GPMs)- These mortgages are useful for home
buyers who expect their incomes to rise.
Growing Equity Mortgage (GEMs)- The payments will initially be the same as on a
conventional mortgage.
Shared Appreciation Mortgages (SAMs)- The lender lowers the interest rate in the
mortgage in exchange for a share of any appreciation in the real estate.
Equity Participating Mortgage (EPM)- Through this, an outside investor shares in the
appreciation of the property.
Second Mortgages- These are loans that are secured by the same real estate that is
used to secure the first mortgage.
Reverse Annuity Mortgages (RAMs)- The borrower does not make payments against
the loan and continues to live in his home.
Mortgage Interest Rates- How much and from whom to borrow.
Loan Terms- Protect the lender from financial loss.
Collateral- Real estate being financed and be pledged as security.
Down Payment- Pay portion of the purchase price.
Private Mortgage Insurance- An insurance policy that guarantees to make up any
discrepancy between the value of the property and the loan amount.
Borrower Qualification- Lender will determine whether the borrower qualifies for it.
Mortgage-backed security- Is a security that is collateralized by a pool of mortgage
loans.
Derivatives- Are financial instruments that derive its value on contractually required
cash flows from some other security or index.
Derivatives for hedging- To protect against cost fluctuations by fixing a price for a
future deal in advance.
Derivatives for speculation- To buy or sell an asset in the hope of generating profit.

Characteristics of the Residential Mortgage

● Mortgage Interest Rates
● Loan Terms
● Collateral
● Down Payment
● Private Mortgage Insurance (PMI)
● Borrower Qualification

Three Important Factors that affect the interest rate on the loan
1. Current long-term market rates
2. Term or life of the mortgage
3. Number of Discount Points Paid

Types of Mortgage Loans

● Conventional Mortgages
● Insured Mortgages
● Fixed-rate Mortgages
● Adjustable-Rate Mortgages (ARMs)
● Graduated-Payment Mortgages (GPMs)
● Growing Equity Mortgage (GEMs)
● Shared Appreciation Mortgages (SAMs)
● Equity Participating Mortgage (EPM)
● Second Mortgages
● Reverse Annuity Mortgages (RAMs)

Securitization of Mortgages
Several Problems face by Intermediaries
● Mortgages are usually too small to be wholesale instruments.
● Mortgages are not standardized.
● Mortgage loans are relatively costly to service.
● Mortgages have unknown default risk.

Impact of Securitized Mortgage on the Mortgage Market

 ● Mortgage-backed securities have been growing in popularity in recent years as
institutional investors look for appreciative investment opportunities.
● Securitized mortgage are low-risk securities that have higher yield than
comparable government bond and attract funds from around the world.

Benefits that can be derived from Securitized Mortgage

● It reduced the problems and risks caused by regional lending institutions’
sensitivity to local economic fluctuations.
● Borrowers now have access to a national capital market.
● Investors can enjoy the low-risk and long-term nature of investing in mortgages
without having to service the loan.
● Mortgage rates are now more open to national and international influences.

Characteristics of Derivatives
A derivative is a financial instrument:
● Whose value changes in response to the change in a specified interest rate,
security price, commodity price, foreign exchange rate, index of prices, credit
rating, or similar variable.
● Requires no initial net investment or little net investment relative to other types of
contracts that have a similar response to changes in market conditions.
● That is settled at a future date.

Typical Examples of Derivatives

● Future Contracts- An agreement between seller and a buyer that requires the
seller to deliver a particular commodity at a designated future date, at a
predetermined price.
● Forward Contracts- It calls for delivery on a specific date.
● Options- It gives its holder the right either to buy or sell an instrument.
● Foreign Currency Futures- The foreign loans denominated in the currency of
the lender.
● Interest Rate Swaps- These are contracts to exchange cash flows as of a
specified date or series of specified dates.

Chapter 11: Internationalization of Financial Markets

New York Stock Exchange- Largest in the world in terms of market capitalization.
Toronto Stock Exchange- Stock exchange in Canada.
Japan Exchange Group (JPX)- The largest exchange in Asia.
Exchange of Hong Kong- Largest stock exchange in China in terms of market value of
its outstanding shares.
London Stock Exchange- Largest stock exchange in Europe.
Deutsche Borse- Stock exchange based in Frankfurt, Germany.
Internationalization of Financial Markets- Leading the way to a more integrated world
economy in which flows of goods and technology between countries are more
commonplace.
Cross-Border Measure- Another way of measuring the growth of finance.
Foreign bonds- The traditional instruments in the international bond market.
Lower inflation- Erodes the value of financial assets and increases the value of
physical assets.
Pensions- Significant change in pension policies occurred in many countries starting
1990s.
Stock and bond market performance- During 1990s and in the period before 2008,
many countries’ stock and bond markets performed well.
Risk management- Derivatives and Asset-backed securities whose basic purpose is to
redistribute risk.
Investors- The driving force behind financial markets.
Individuals- Owns a small proportion of financial assets.
Institutional Investors- Are responsible for most of the trading in financial markets.
Mutual funds- Are investment companies that typically accept an unlimited number of
individual investments.
Hedge funds- Can accept investments from only a small number of wealthy individuals
or big institutions.
Insurance companies- The most important type of institutional investor.
Pension funds- Aggregate the retirement savings of a large number of workers.
Algorithmic traders- Also known as high-frequency trading, where it has expanded
dramatically in recent years as a result of increased computing power.
Eurocredits- Is the market for floating-rate bank loans whose rates are tied to LIBOR.
Eurobond Market- Eurobond is an international bond underwritten by an international
syndicate of banks.
Foreign Bond Market- Foreign bonds are international bonds issued in the country in
whose currency the bond is denominated.

Factors Affecting the Long-Run Trends of Increased Financial Market Activity

● Lower inflation
● Pensions
● Stock and bond market performance
● Risk management
● The Investors

Categories of Investors
● Individuals
● Institutional Investors
Types of Institutional Investors
● Mutual funds
● Hedge funds
● Insurance companies
● Pension funds
● Algorithmic traders

International Credit Markets

● Eurocredits
● Eurobond Market
● Foreign Bond Market

Chapter 12: Financial Institutions and Intermediaries

Financial Institution- Is a company engaged in the business of dealing with financial

and monetary transactions.
Financial Intermediary- Is a financial firm, such as bank that borrows funds from
savers and lends them to borrowers.
Commercial banks- Are the most important intermediaries as it plays a key role in the
financial system.
Universal bank- Provides a large array of services including those of commercial banks
and investment banks.
Insurance Companies- Specialize in writing contracts to protect their policyholders.
Pension Funds- Is a financial intermediary that invests contributions of workers and
firms in stocks, bonds and mortgages.
Investment Intermediaries- Are financial firms that raise funds to invest in loans and
securities.
Investment Banks- They differ from commercial banks in a way that they do not take in
deposits.
Mutual Funds- These financial intermediaries allow savers to purchase shares in
portfolio of financial assets.
Close-end mutual funds- It issues a fixed number of nonredeemable shares.
Open-end mutual fund- It issues share that investors can redeem each day after the
markets close for a price tied to the NAV.
Hedge Funds- Are financial firms organized as a partnership of wealthy investors.
Finance Companies- Are non-bank financial intermediaries that raise funds through
sales of commercial paper and other securities.
Consumer finance companies- These companies makes loans to enable consumers
to buy cars, furniture and appliances, to finance home improvement and refinance
household debts.
Business finance companies- These companies are engaged in factoring that is,
purchasing at a discount the accounts receivable of small business firms.
Sales finance companies- These companies are affiliated with department stores and
companies that manufacture and sell high-priced goods.
Money Market Mutual Funds- These are relatively new financial institutions that have
the attributes of a mutual fund but also function to some extent as a depositing
institution.

Two Channels where financial system matches savers and borrowers

● Financial Markets
● Banks and other financial intermediaries

Types of Services offered by Universal bank:

● Deposit accounts such as checking and savings
● Loans and credit
● Asset and wealth management
● Buying and selling securities
● Financial and investment advice
● Insurance products

Types of Pension Plans

● Defined contribution plan
● Defined benefit plan

Chapter 13: Basics of Commercial Banking

Commercial banking- It takes deposits from savers and making loans to households
and firms.
Balance Sheet- Where bank’s sources and uses of funds are summarized.
Asset- Is something of value that an individual or firm owns.
Liability- Is something that an individual or a firms owes.
Bank Capital- Is the difference between the value of the bank’s assets and the value of
its liabilities.
Bank’s net interest margin- The difference between the interest it receives on its
securities and loans and the interest it pays on deposits and debt, divided by the total
value of its earning assets.
Return on Assets (ROA)- An expression for the bank’s total profit earned per peso of
assets and usually measured in terms of after-tax profit.
Reserves and Other Cash Assets- The most liquid asset that banks hold which
consists of vault cash- cash on hand and in bank or deposits at other banks.
Securities- Are liquid assets that banks trade in financial markets.
Loans Receivable- Loans are illiquid relative to marketable securities and entail greater
default risk and higher information costs.
Other Assets- Includes banks’ physical assets such as computer equipment and
buildings.
Demand or Current Account Deposits- Bank offer savers demand or current account
deposits, which are accounts against which depositors can write checks.
Nondemand Deposits- Savers use only some of their deposits for day to day
transaction.
Borrowings- Banks often have more opportunities to make loans than they can finance
with funds they attract from depositors.
Return on Equity (ROE)- This is after-tax profit per peso of equity or bank capital.
Liquidity Risk- The possibility that a bank may not be able to meet its cash needs by
selling assets or raising funds at a reasonable cost.
Credit Risk- The risk that borrowers might default on their loans.

Bank Assets
● Reserves and Other Cash Assets
● Securities
● Loans Receivable
● Other Assets
Loans Receivable
● Loans to businesses
● Consumer loans
● Real estate loans
Bank Liabilities
● Demand or Current Account Deposits
● Nondemand Deposits
● Borrowings

Management of Bank Assets

● Banks must simultaneously seek highest returns possible on loans and
securities, reduce risk and make adequate return provisions.

Management of Bank Liabilities

● Heavy dependence on demand deposits as sources of bank funds.
● Non-reliance on overnight loans and borrowing from other banks to meet their
reserve needs.

Management of Bank Capital

● Banks manage the amount of capital they hold to prevent bank failure and to
meet bank capital requirements set by the regulatory authorities.
Managing of Bank Risk
● Managing Liquidity Risk
● Managing Credit Risk
● Managing Interest-Rate Risk
● Reducing Interest-Rate Risk

Managing Credit Risk

● Diversification Investors
● Credit-Risk Analysis
● Collateral
● Credit Rationing
● Monitoring and Restrictive Covenant
● Long-term Business Relationships

Managing Interest-Rate Risk

● Banks experience interest-rate risk if changes in market interest rates cause a
bank’s profit or its capital to fluctuate.

Reducing Interest-Rate Risk

● Bank managers can use a variety of strategies to reduce their exposure to
interest-rate risk.

Chapter 14: Expanding the Boundaries of Banking

Off-balance-sheet activities- It does not affect the bank’s balance sheet because they
do not increase either the bank’s assets or its liabilities.
Loan commitments- A bank agrees to provide a borrower with a stated amount of
funds during a specified period of time.
Standby letters of credit- The bank commits to lend funds to the borrower to pay off its
maturing commercial paper.
Loan sales- Is a financial contract in which a bank agrees to sell the expected future
returns from an underlying bank loans to a third party.
Trading activities- Banks earn fees from trading in the multibillion dollar markets for
futures, options and interest-rate swaps.
Industry coverage groups- Established to have separate groups within the bank each
having expertise in specific industries or market sections such as technology or health
care.
Financial products groups- Provide investment banking financial products such as
IPOs, M&As, Corporation restructuring and various types of financing.
Bulge Bracket Banks- Are the major international investment banking firms with easily
recognizable names.
Middle-Market Banks- Occupy the middle position between smaller regional
investment banking firms and massive bulge bracket investment bank.
Regional boutique banks- The smallest of the investment banks both in terms of firm
size and deal size.
Elite boutique banks- They are more likely to offer restructuring and asset
management services.

Investment Banks
● They offer distinct financial services, dealing with larger and more complicated
financial deals than retail banks.

Role of Investment Banks

● Corporate Advising
● Brokerage division

Typical divisions within investment banks:

● Industry coverage groups
● Financial products groups

Types of Firms Engaged in Investment Banking

● Bulge Bracket Banks
● Middle-Market Banks
● Boutique Banks

Boutique Banks
● Regional boutique banks
● Elite boutique banks

Areas of Business
● Brokerage- such as Proprietary trading, Acting as a broker, and Research.
● Corporate Advising- such as Bringing companies to market, Bringing
companies together and Structuring products.

How Investment Banks Make or Lose Money

● Making Money- They receive fees in return for providing advice, underwriting
services, loans and guarantees and etc.
● Losing Money- Trading division of a bank may make the wrong decisions and
end up losing the bank money.
Chapter 15: An Update on the Philippine Banking and Insurance Industries

Outlook on the banking system remains positive given:

● Robust macroeconomic performance
● Adequate liquidity
● Rising capital buffers and opportunities presented by the growing economy and
technological innovations.

Financial Soundness of the Philippine Banking Sector

● The assessment is mainly conducted to identify potential problems that may lead
to vulnerability in the financial sector and contribute to a financial crisis.

The BSP Financial Soundness Indicators

● Capital adequacy
● Asset quality and earnings
● Profitability, Liquidity, and Sensitivity to market risk

Foreign Currency Deposit Unit

● This system showed strong growth in which the liquidity was firm in view of the
significant investments in financial assets that help smoothen out the process of
withdrawals of foreign currency deposits from the system.

Trust Operations
● The Philippines Trust Industry’s assets was stable in 2018 due to expansion in
the stock of financial assets, mostly investment in equities despite market
volatility.

Three Core Strengths

● The banking industry’s strong capital position.
● The banks’ ample liquidity buffers which enable banks to withstand short-term
liquidity shocks.
● Expanding the assets of banks on the back of increasing deposit liabilities.

Chapter 16: Financial System Regulators- Part 1

Monetary Board- Exercises the powers and functions of the BSP such as the conduct
of monetary policy and supervision of the financial system.
Governor- Is the chief executive officer of the BSP and is required to direct and
supervise the operations and internal administration of the BSP.
Deposit Insurance- Is essentially the assured amount a bank depositor gets in the
case that the bank cannot fulfill its obligations.
Principal Regulatory Agencies of the Philippine Financial System
● Bangko Sentral ng Pilipinas (BSP)
● Philippine Deposit Insurance Corporation
● Securities and Exchange Commission
● Insurance Commission

Objectives of Financial Institution

● To ensure the soundness of the financial system
● To increase the information available to investors
● To improve control of the financial system

Ensuring the Soundness of the Financial System

● Restrictions on Entry
● Stringent Reporting Requirements
● Restriction on Assets and Activities
● Deposit Insurance
● Limits on Competition
● Restriction on Interest Rate

Primary Objective of the BSP

● The BSP’s primary objective is to maintain price stability conducive to a balanced
and sustainable economic growth.

Responsibilities of BSP
● Liquidity Management
● Currency Issue
● Lender of last resort
● Financial Supervision
● Management of Foreign Currency Reserves
● Determination of Exchange Rate Policy
● Other activities

Bangko Sentral’s Functions as a Fiscal Agent of the Government

● To be the official representative of the government to financial entities.
● To be the depository banker of the government.
● To be the financial adviser of the government.
● To manage public debts.

A Deputy Governor heads each of the BSP’s operating sector as follows:

● Monetary and Economics Sector
 ● Financial Supervision Sector
● Currency Management Sector
● Corporate Services Sector

Instruments of Central Bank Actions

● Control of legal reserve requirement
● Control of discount and rediscount
● Open market operation
● Control of collateral required on bank loans
● Imposition of portfolio ceiling
● Minimum capital ratio
● Margin requirements for Letter of Credit
● Moral suasion

Functions of PDIC
● Deposition Insurance
● Risk Mitigation
● Receivership and Liquidation

Covered by PDIC Deposit Insurance

By Deposit Type
● Savings
● Special Savings
● Demand/Checking
● Time Deposits
● Negotiable Order of Withdrawal
By Deposit Account
● Single
● Joint account
● Account “By”, “In Trust For” or “For the Account of” another person
By Currency
● Philippine Peso
● Foreign Currencies considered as part of BSP’s International reserves

Not covered by PDIC Deposit Insurance

● Investment products such as bonds and securities, trust accounts and other
similar instruments.
● Deposit accounts of transactions that: are unfunded, fictitious or fraudulent;
constitute and or emanate from unsafe and unsound banking practices; and are
determined to be proceeds of an unlawful activity as defined in the Anti-Money
Laundering Act (AMLA).
Chapter 17: Financial System Regulators- Part 2

Securities and Exchange Commission (SEC)- responsible for regulating the

securities industry in the Philippines and also maintains the country’s company register.

Vision
By 2022, SEC is the champion of investor protection; the judicious administrator of an
automated, reliable and secured company registration and information systems; and the
progressive overseer of a robust and inclusive capital market in the ASEAN and Asia-
Pacific Region.

Mission
We develop and regulate the capital market and company registration; promote good
corporate governance; empower investors, corporators, and entrepreneurs; and
facilitate access to financial products and resources.