FM 7 - CAPITAL MARKETS

Lesson#5: The Derivatives Market

Futures Contracts Forwards
WHAT IS THE DERIVATIVES AND Contracts
DERIVATIVES MARKET?

• Derivatives Market is a marketplace for are traded in an are only facilitated

exchange privately making
Derivative instruments which are financial
the former less
assets in the form of financial contracts risky than the latter.
whose value is derived or dependent on an
underlying asset, group of assets, or
benchmark. Less risky Risky
• Derivatives are used for Hedging and
Speculating.
Swaps Contracts
• Derivatives move risk from risk-averse to
risk-seekers.
● A swap is a derivative contract
through which two parties exchange
TYPES OF DERIVATIVES INSTRUMENT the cash flows or liabilities from two
different financial instruments.
1. Forwards Contracts ● There are two major types of
2. Futures Contracts swaps
3. Swaps
➢ Interest Rate Swaps (1) Interest Rate Swaps and
➢ Currency Swaps
4. Options Contracts (2) Currency Exchange Swaps
➢ Call Options
➢ Put Options Interest Rate Swaps - is an agreement
5. Interest Rate Caps, Floors, and between two parties to exchange a fixed
Collars interest rate for a variable interest rate
payment.
Forwards and Futures Contracts Currency Exchange Swaps - is sometimes
Similarities: referred to as a cross-currency swap,
involves the exchange of interest and
Forward and Futures Contract is a sometimes of principal in one currency for
derivatives contract or agreement between the same in another currency.
two parties to buy a particular Financial
Assets at a predetermined price and rate
and at a predetermined date.
Differences:
Futures Contracts are traded in an
exchange while Forwards Contracts are
only facilitated privately making the former
less risky than the latter.
 Lesson#6: The Stock Market

WHAT IS THE STOCK MARKET?

Stock Market
Options Contracts ● is one of the two markets included in
the capital markets, it is a
● An options contract is an marketplace for equity instruments in
agreement between two parties to particular stocks.
facilitate a potential transaction on
an underlying security at a preset Stocks
price, referred to as the strike price,
prior to or on the expiration date. ● are equity instruments that represent
● There are two types of options a fraction of ownership over an
contract issuing company.
● There are two general types of
(1) Call Options and stocks:
(1) Common Stock and
(2) Put Options (2) Preferred Stocks
Call Options - gives you the right to buy the
products at a set price, while Common Stocks vs Preferred Stocks

Put Options - gives you the right to sell the

products at the strike price. ● Both Common Stocks and
Preferred Stocks are equity
● The Buyer of an option contract instruments that represent
has the option to execute but is not ownership of a company.
obligated. ● Both Stocks have limited liability, but
these two stocks differ from each
other when it comes to
Interest Rate Caps and Floors (1) Voting Rights,
(2) Returns,
● Interest rate floor is an
agreed-upon rate in the lower range (3) Preemptive Rights,
of rates and
● Interest rate cap is an agreed-upon (4) Dividend Priority.
rate in the upper range of rates
associated with a floating rate loan
product.
● Sometimes this is partnered with FACTORS COMMON PREFERRE
Interest Rate Swaps. STOCK D STOCK
● The combination of the Caps and
Floors are called Collars. Voting With Without
Rights

Returns Volatile Fixed

Preemptive With Without

Rights
 3. Convertible Preferred – preferred
Dividend Last First shares that are convertible to
Priority common stocks.

IN A TRIANGLE, THE TOP TO BOTTOM

4. Participating Preferred – entitled to
ARE THE FF IN ORDER: regular dividends plus additional
after all other dividends are paid in
● Bond Holders exchange for another agreement
with the issuer.
● Preferred Stocks
● Common Stocks
5. Callable Preferred – are preferred
Types of Common Stocks shared that can be bought back by
the issuing company after a
predetermined period.
1. Authorized Stocks – is the
maximum shares of common stock a
company is legally allowed to issue
The Philippine Stock Market

Philippine Stock Exchange

2. Reserve Stocks – Shares of Stocks
that not issued by the company and ● The Philippine Stock Exchange
is kept as a reserve. (PSE) - is the only stock exchange in
the Philippines.
● Considered one of the oldest
3. Issued Stocks – Is the total stocks bourses in Asia, PSE traces its roots
issued or made available for back to the country’s two former
purchase to investors by the bourses
corporation.
– the Manila Stock Exchange
(formed in 1927) and the Makati
Stock Exchange (formed in 1963).
4. Treasury Stocks – Is the shares of – The Manila and Makati bourses
common stock bought back by a were unified in 1992 to form the
corporation. (Retain, Cancel, or PSE.
Reissue)
Philippine Stock Exchange Index

● The PSEi - is the main index of the

5. Outstanding Stocks – Is the total
Philippine Stock Exchange (PSE).
shares of common stocks that are
● It is composed of a fixed basket of
owned by the investors.
30 companies called blue chip
companies, whose selection is
Types of Preferred Stock based on a specific criteria.
● The PSEi provides a snapshot of the
1. Straight Preferred - Entitled to market's overall condition by
regular dividend payments. gauging changes in the stock prices
of select listed companies.

2. Cumulative Preferred – Entitled to

regular dividend and missed
dividends.
 Two ways of making profit in stock Lesson#7: Structures of Interest Rates
market

1. Trading – takes advantage of the Factors that affect and Theories about
market price increase and decrease. interest rate determination
2. Investing – takes advantage of the
company’s performance in WHAT IS INTEREST RATE?
producing profits.
● Interest Rate – is the amount
charged by the creditor to a debtor, it
is expressed as a percentage of the
Trader vs Investor principal value of the loan.
● This can be considered as the cost
Traders - make money by buying and of debt in the point of view of a
selling securities. borrower.
Investors - make profit from dividends or
shares of returns.
Theories about interest rate
determination
Realized vs Unrealized Gain
1. Knut Wicksell’s Loanable Funds
Theory
Unrealized Gains and Losses – are 2. John Maynard Keynes’s Liquidity
theoretical or paper gains. Preference Theory

Realized Gains and Losses – are the

actual gains or losses incurred from buying
and selling of securities. Knut Wicksell
● Swedish Economist
● Dec. 20, 1851, Stockholm.
● May 3, 1926, Stocksund.

Loanable funds theory

Loanable Funds - are all the income that
individuals and organizations have decided
to save and loan out rather than spend on
consumption.
Loanable Funds Theory - explains that the
determinant of market interest rate is
demand and supply.

John Maynard Keynes

● English Economist
● June 5, 1883
● April 21, 1946
 Liquidity Preference Theory Factors that affect interest rate
● Explains that interest rate is 1. Strength of Economy
determined by the preference of 2. Inflation
households and firms to hold money 3. Government Policies and
balances rather than spending those Interventions
funds. Money balances can be in the 4. Supply and Demand of Loanable
form of currency or checking Funds
accounts. 5. Credit or Default Risk
6. Term of Loan

Theories about interest rate

determination Bond Valuation

Features of Bonds and Valuation of

Knut Wicksell’s John Maynard Bonds
Loanable Funds Keynes’s Liquidity
Theory Preference Theory
WHAT ARE THE FEATURES OF A
BOND?
Knut Wicksell John Maynard
Keynes 1. Face Value
2. Coupon Rate
3. Coupon Dates
Swedish Economist English Economist 4. Maturity Date
5. Issue Price
Dec. 20, 1851, June 5, 1883
Stockholm How to compute for the value of a bond?

May 3, 1926, April 21, 1946

Stocksund

Loanable funds Liquidity

theory Preference Theory C = coupon rate
f = Frequency
Loanable Funds - Explains that PAR = Face Value
are all the income interest rate is r = YTM
that individuals and determined by the n = Tenor
organizations have preference of
decided to save households and
and loan out rather firms to hold money
than spend on balances rather Example:
consumption. than spending
those funds. Money
Loanable Funds balances can be in
Theory - explains the form of
that the currency or
determinant of checking accounts.
market interest rate
is demand and
supply.
Lesson#8: Money Market and Deposit accounts and money market
International Market accounts

The Money Markets WHAT ARE DEPOSIT AND MONEY

MARKET ACCOUNTS?
WHAT IS MONEY MARKET?
Deposit accounts - are bank accounts that
Money markets - cover the markets for lets you deposit money and withdraw funds.
This could be:
short-term financial instruments. Debt
instruments are the only short-term (1) interest bearing and,

instruments in the financial markets. (2) non-interest-bearing deposit accounts

Money markets - are characterized by two: 1. Current/ Checking Accounts

2. Savings Accounts
(1) Low-risk and 3. Time Deposit Accounts

Money Market Accounts - are interest

(2) Low-return instruments bearing deposit accounts that have higher
interest rates than regular savings account.
Money market instruments include: Some money market account comes with
checking account function but are less
● Money Market Funds, flexible.
● Money Market Accounts,
Commercial Papers
● Bank Accounts,
● Commercial Papers, WHAT ARE COMMERCIAL PAPERS?
● Banker’s Acceptance, Commercial Papers - is an unsecured,
● Repurchase Agreement (Repo), short-term debt instrument issued by
corporations. It's typically used to finance
● Treasury Bills, and short-term liabilities such as payroll,
accounts payable, and inventories.
● Interbank Call Loans.
Commercial Papers include:
WHAT IS MONEY MARKET FUNDS?
1. Promissory Notes
Money Market Funds - are mutual funds 2. Bank Drafts
who invest the pooled money into the 3. Checks
money market instruments. These 4. Certificate of Deposits
instruments are highly liquid and has a very
short-term PROMISSORY NOTES

Example: Sun Life Prosperity Money Promissory Notes - is a written promise to

Market Fund, Land Bank Money Market pay a certain sum of money to a specified
Fund, China Bank Money Market Fund, person or entity on a specific date or on
Rizal Peso Money Market Fund, BPI Invest demand and is the most common form of
Money Market Fund. commercial paper.
 BANK DRAFTS 1. 91-day,
2. 182-day,
A draft is a written order issued by a bank 3. 364-day.
directing a bank to pay a specified sum of
money to a designated person or entity. T-bills are sold in the secondary market in a
discounted price.
There are two types of drafts
Interbank Call Loans - are credits of one
1. Sight Drafts and bank to another for a period not exceeding
2. Time Drafts four (4) days.

CHECKS

A check is a written order issued by a The International Bond Market

bank’s clients directing a bank to pay a
specified sum of money to a designated WHAT IS INTERNATIONAL BOND
person or entity. MARKET?

The main difference between the two is An international bond is defined as a bond
drafts are guaranteed and checks are not. issued in a country that is not the domestic
country of the issuer.

There are two categories of international

CERTIFICATE OF DEPOSITS bonds:

A certificate of deposit is a type of time 1. Foreign bonds and

deposit offered by banks and other financial 2. Eurobonds
institutions.
FOREIGN BONDS

Foreign Bonds - are international bonds

REPO that are denominated in the currency of the
country where they are issued.
WHAT IS REPURCHASE AGREEMENT?
EUROBONDS
A repurchase agreement (repo) is a form
of short-term borrowing for dealers in Eurobonds - are international bonds that
government securities. In the case of a are denominated in other country’s
repo, a dealer sells government securities to currency.
investors, usually on an overnight basis,
and buys them back the following day at a BOND CREDIT RATING
slightly higher price. That small difference in
price is the implicit overnight interest What is the importance of bond credit
rate. Repos are typically used to raise rating?
short-term capital.
Bond Credit Rating - measures the credit
worthiness of a bond. It can be used as
measurement whether a bond is a good
T-BILLS AND INTERBANK CALL LOANS investment or a bad investment.

WHAT IS TREASURY BILLS AND CALL

LOANS?

Treasury Bill - are government securities

which mature in less than a year. Treasury
bills have three tenors: