THE FINANCIAL SYSTEM

Module 2 — Quick Reviewer

📌 PART 1: WHAT IS THE FINANCIAL SYSTEM?

Simple Definition: The Financial System is like the PLUMBING of an economy. It moves
money from people who have extra (savers) to people who need it (borrowers/investors).
Without it, savings would just sit idle and businesses couldn't grow.

Two key groups:

• Surplus Units (Savers): People or groups with MORE money than they spend — they supply funds
• Deficit Units (Borrowers/Investors): People or groups who need MORE money than they have — they
demand funds

The 4 Core Parts (Pillars) of the Financial System

Pillar What It Is Real-Life Example

Financial Assets The 'vehicles' that carry money — things Stocks, bonds, bank deposits
(Securities) you can buy/sell/own

Financial Markets The 'meeting places' where assets are Philippine Stock Exchange (PSE)
traded

Financial Institutions The 'middlemen' that connect savers Banks, insurance companies,
and borrowers investment firms

Regulators The 'referees' who make sure the game Bangko Sentral ng Pilipinas (BSP), SEC
is fair

💸 PART 2: HOW DOES CAPITAL FLOW? (3 Ways Money Moves)

Think of these as 3 different ways to send money from a saver to a business that needs it:

Method How It Works Who Holds the Revenue Source

Risk?

1. Direct Transfer Business sells stocks/bonds You (the investor) No middleman fee
straight to you — NO middleman

2. Via Investment Bank Investment bank 'underwrites' — You (the investor) Fees & Commissions
buys the securities first, then sells
to investors

3. Via Financial You deposit in a bank → bank The Bank The Spread (interest
Intermediary (most creates a NEW loan for a earned on loan minus
common) business. Two separate interest paid to you)
transactions.
 🔑 KEY DIFFERENCE: In method 2 (Investment Bank), the SAME security just passes through.
In method 3 (Bank), a BRAND NEW asset (the loan) is created. The bank literally invents new
capital!

🏪 PART 3: TYPES OF FINANCIAL MARKETS (5 Pairs)

Markets are categorized in 5 different ways. Each pair describes a different feature:

Pair Option A Option B

1. Physical vs. Financial Physical: Trade real, tangible things Financial: Trade contracts/paper (stocks,
(land, corn, oil) bonds, notes)

2. Spot vs. Futures Spot: Buy now, get it NOW (like a Futures: Agree today to buy/sell at a set
grocery store) price in the FUTURE

3. Money vs. Capital Money Market: Short-term (< 1 year) — Capital Market: Long-term (> 1 year) —
quick loans, safe investing for growth

4. Primary vs. Primary: FIRST-TIME sale of new Secondary: Resale of already-issued

Secondary securities securities (e.g. PSE)

5. Private vs. Public Private: Deal between two parties, not Public: Open exchanges anyone can
open to public access (NYSE, PSE)

🧾 PART 4: MARKET INSTRUMENTS (The actual 'products' being

traded)

Instruments are the actual financial products bought and sold. They differ by how long before they 'expire':

💵 MONEY MARKET INSTRUMENTS (short- 📈 CAPITAL MARKET INSTRUMENTS (long-

term, < 1 year): term, > 1 year):

1. Treasury Bills — govt borrowing short-term 1. Treasury Notes — govt medium-term bonds
2. Commercial Papers — company short-term 2. Treasury Bonds — govt long-term bonds
IOUs 3. Mortgage Loans — home loans
3. Negotiable Certificates of Deposit (CDs) 4. State & Local Government Bonds
4. Money Market Mutual Funds 5. Corporate Bonds
5. Consumer Credit / Credit Card Debt 6. Stocks (no maturity date!)

⚙️PART 5: THE 3 MAIN FUNCTIONS OF A FINANCIAL MARKET

Function Simple Meaning Analogy

1. Price Discovery The market tells you exactly what Like checking Shopee for the current price
anything is worth RIGHT NOW of a phone

2. Liquidity You can turn your investment into cash Like having an emergency exit — you can
QUICKLY when you need it get out fast
 3. Cost Savings One place to find thousands of Like a mall vs. visiting 100 individual
investment options — saves time & stores
effort

🌟 PART 6: WHY THE FINANCIAL SYSTEM MATTERS (3 Vital

Functions)

Function What It Does Example

Risk Management Insurance and diversification protect you You invest in 10 different stocks instead of
from losing everything 1, so if one crashes, you don't lose all your
money

Liquidity Ensures you can convert investments You sell a stock today to pay an
back to cash quickly when needed emergency hospital bill tomorrow

Efficiency Money flows to the BEST ideas; failing A startup with a great idea gets funding; a
companies lose funding failing company loses investors

🏦 PART 7: FINANCIAL INSTITUTIONS (The Middlemen)

These are the organizations that make the financial system work. Think of them as different types of shops in the
financial 'mall':

Banks & Lending Institutions

Institution What They Do Simple Analogy

Commercial Banks Serve everyone — take deposits, give The SM Superstore of finance — does
loans, financial services everything

Investment Banks Help companies raise capital by The 'launcher' — helps companies go
creating, buying & selling securities public (IPO)

Savings & Loan Focus on savings deposits and home Specialist for home buyers
Associations (S&Ls) mortgage loans

Credit Unions Member-owned cooperatives for people A financial club — members help each
with a common bond (e.g. employees of other
one company)

Investment & Insurance Institutions

Institution What They Do Key Feature

Mutual Funds Pool money from many investors to buy Affordable diversification — even small
stocks, bonds, etc. investors can spread risk

Hedge Funds Like mutual funds but with fewer rules For wealthy/sophisticated investors
and riskier strategies only — high risk, high reward

Exchange-Traded Funds Like mutual funds but traded on stock More flexible than mutual funds —
(ETFs) exchanges like stocks buy/sell any time of day
 Pension Funds Manage retirement savings for Your future retirement money being
employees of companies/government invested now

Life Insurance Companies Collect premiums, invest funds, pay out Protection + investment in one
when policyholder dies or retires package

📱 PART 8: RECENT TRENDS IN THE FINANCIAL SYSTEM

1. Technology (FinTech)
• Third-Party Payment Systems: GCash, PayMaya — pay digitally without a bank
• Trading Software & Robo-Advisors: Algorithms automatically manage your investments
• Crowdfunding: Anyone can raise money directly from the public online (e.g. Kickstarter)
• Platform Lending: Borrow and lend online — no traditional bank needed
• Cryptocurrencies: Digital money (Bitcoin) using blockchain — decentralized and secure

2. Globalization
• Deregulation: Governments are removing restrictions so markets can compete globally
• Cross-border investments: Money now flows freely between countries

3. Derivative Instruments
Derivatives are contracts that derive their value from something else (like stocks or currency). Used to manage
risk or speculate:
• Forward/Futures Contracts: Lock in a price today for a transaction in the future
• Swap Contracts: Two parties exchange financial obligations (e.g. swap a fixed interest rate for a floating
one)
• Option Contracts: The RIGHT (but not obligation) to buy or sell at a set price within a period

🔄 PART 9: THE CAPITAL ALLOCATION PROCESS

Big Idea: Some people have extra money. Some people have great business ideas but no
cash. The Capital Allocation Process is how the financial system connects these two groups
efficiently. Think of it as the irrigation system of the economy — water (money) flows from
where it's abundant to where it's needed most.

Player Their Role

Savers (Households) Supply the capital — they have surplus money

Borrowers (Businesses/Govt) Demand the capital — they need money to grow

Intermediaries (Banks, Funds) Facilitate the movement — they connect savers to borrowers

Markets (PSE, bonds market) The infrastructure where all trading happens
⚡ QUICK CHEAT SHEET — MODULE 2 ESSENTIALS

Term Plain English Meaning

Financial System The whole network (markets + banks + laws) that moves money around
the economy

Surplus Unit Someone with MORE money than they spend — a saver

Deficit Unit Someone who NEEDS more money than they have — a borrower

Financial Asset / Security A paper/digital 'vehicle' for money (stocks, bonds, deposits)

Financial Institution A middleman that connects savers and borrowers (bank, insurance, etc.)

Regulator The referee that sets the rules (BSP, SEC)

Underwriting When an investment bank guarantees a company's new stock/bond sale

The Spread Bank's profit = interest charged on loans MINUS interest paid to
depositors

Spot Market Buy now, get it now

Futures Market Agree now, pay/receive later at a fixed price

Derivative A contract whose value comes from something else (like a bet on a
stock's price)

Crowdfunding Raising money from many people online (no bank needed)

ETF A fund traded on the stock exchange — flexible, diversified

Hedge Fund A high-risk investment fund for wealthy investors with fewer regulations

Deregulation Government removing restrictions to allow freer market competition

🎯 THE BIG PICTURE: The Financial System exists for ONE reason — to make sure money
doesn't sit idle. It channels savings into productive investments, creating jobs, growth, and
wealth for the entire economy. Every bank, stock market, and insurance company is just a
different tool serving this one goal.