Republic of the Philippines
PALAWAN STATE UNIVERSITY
College of Business and Accountancy
Puerto Princesa City
P412─INVESTMENT PORTFOLIO MANAGEMET
CHAPTER 3—THE FINANCIAL MARKET
A. FINANCIAL INSTRUMENTS
Financial instruments are assets that can be traded.
They can also be seen as packages of capital that
may be traded. Most type of financial instruments
provide an efficient flow and transfer of capital all
throughout the worlds investors.
TYPES AND FUNCTIONS
SHARES
A unit of ownership interest in the
corporation or financial asset. While owning shares
in a business does not mean that the shareholder has
direct control over the business’s day-to-day
operations, being shareholder does entitle the
processor to an equal distribution in any profits, if
any declared in the form of dividends. The two main
types of shares are common shares and preferred
shares.
BONDS
A debt investment in which investment
loans money to an entity (corporate or
governmental) that borrows the funds for a defined
period of time at a fixed interest rate. Bonds are used
by companies, municipalities, states and U.S and
foreign governments to finance a variety of projects
and activities
DERIVATIVES
A security whose price is dependent upon or
derived from one or more underlying assets. The
derivatives itself is merely contract between two or
more parties. Its value determined by fluctuation in
the underlying assets. The most common underlying
assets include stocks, bonds, commodities,
currencies, interest rates and market indexes.
FUTURES
A financial contract obligating the buyer to
purchase an asset (or the seller to sell an asset), such
as physical commodity or a financial instrument, at a
predetermined future date and time. Future contracts
detail the quality and quantity of the underlying
asset; they are standardized to facilitate trading on a
futures exchange some future contracts may call for
physical delivery of asset, while others are settled in
cash.
B. THE FINANCIAL PARTICIPANTS AND
THEIR FUNCTIONS
1.) BANKS
Banks participate in the capital market and money
market. Within the capital market, banks take active
part in the bond markets. Banks may invest in equity
and mutual funds as a part of their fund
management. Banks take active trading interest in
the bond market and have certain exposures to the
equity market also. Banks also participate in the
market as the clearing houses.
2.) PRIMARY DEALERS (PD’s)
PD’s deal in government securities both in
primary and secondary markets. Their basic
responsibility is to provide two-way quotes and
act as market makers for government securities
and strengthen the government securities
market.
3.) FINANCIAL INSTITUTIONS (FI’s)
FI’s provide/lend long term funds for
industry and agriculture. FI’s raise their
resources through long-term bonds from
financial system and borrowings from
international financial institutions like
International Finance Corporation (IFC), Asian
Development Bank (ADB), International
Development Association (IDA), International
Bank for Reconstruction and Development
(IBRD), etc.
4.) STOCK EXCHANGES
Stock exchange is duly approved by the
Regulators to provide sale and purchase of
securities by “open cry” or “on line” on behalf
of investors through brokers. The stock
exchanges provide clearing house facilities for
netting of payments and securities delivery.
Securities traded in stock exchanges include
equities, debt and derivatives.
5. BROKERS
Only brokers approved by
Capital Market Regulator can operate on stock
exchange. Brokers perform job for
intermediating between buyers and seller of
securities. They help build up order book, price
discovery, and are responsible for a contract
being honoured. For their services, broker earn a
fee known as brokerage.
6.) INVESTMENT BANKERS (Merchant
Bankers)
These are agencies/organizations regulated and
licensed by SEBI, the capital market regulator. They
arrange raising of funds through equity and debt
route and assist companies in completing various
formalities like filling of the prescribed document
and other compliances with the regulators.
7. FOREIGN INSTITUTIONAL INVESTOR
(FII’s)
FII’s are foreign based funds authorized by Capital
Market Regulator to invest in countries equity and
debt market through stock exchanges. They are
allowed to repatriate sale proceeds of their holdings,
provided sales have been made through an
authorized stock exchange and taxes have been paid.
FII’s enjoy de-facto capital account convertibility.
8. CUSTODIANS
Custodians are organization which are allowed to
hold securities on behalf of costumers and carry out
operations on their behalf. They handle both funds
and securities of Qualified Institutional Borrowers
(QIBs) including FII’s. They are supervised by the
Capital Market regulator.
9. DEPOSITORIES
Depositories hold securities in demat (electronic)
form, maintain accounts of depository participants
who, in turn, maintain accounts of their costumers.
On instruction of stock exchange clearing house,
supported by documentations, a depository transfers
securities from buyers to sellers’ account in
electronic form.
C. THE FINANCIAL MARKET AND
ECONOMY
1.) THE INFORMATIONAL ROLE OF
FINANCIAL MARKETS
Stock prices reflect investors’ collective
assessment of a firm’s current performance and
future prospects. When the market is more
optimistic about the firm, its share price will
rise. Higher price makes it easier for the firm to
raise capital and therefore encourages investment.
2.) CONSUMPTION TIMING
an economy are earning more than they currently
wish to spend.
for example, retirees, spend more than they
currently earn.
The One way is to “store” your wealth in financial
assets. In high-earnings periods, you can invest your
savings in financial assets such as stocks and bonds.
In low-earnings periods, you can sell these assets to
provide funds for your consumption needs.
3.) ALLOCATION OF RISK
Virtually all real assets involve some risk
When Ford builds its auto plants. for example, it
cannot know for sure what cash flows those plants
will generate.
This allocation of risk also benefits the firms that
need to raise capital to finance their investments.
When investors are able to select security types with
the risk-return characteristics that best suit their
preferences, each security can be sold for the best
possible price.
4.) SEPARATION OF OWNERSHIP AND
MANAGEMENT
Businesses are owned and managed by the same
individual. This simple organization is well suited to
small businesses and, the most common form of
business
organization before the Industrial revolution.
D. FINANCIAL MARKET PARTICIPANTS
There are two basic financial market participant
categories: Investor vs. Speculator and
Institutional vs. Retail
Action in financial markets by central banks is
usually regarded as intervention rather than
participation.
INVESTOR VS. SPECULATOR
Investor
An investor is any party that makes an
Investment. The term has taken on a specific
meaning in finance to describe the particular
types of people and companies that regularly
purchase equity or debt securities for financial
gain in exchange for funding an expanding
company. Less frequently the term is applied to
parties who purchase real estate, currency,
commodity derivatives, personal property, or
other assets.
Speculation
Speculation
In the narrow sense of financial speculation,
involves the buying, holding, selling, and short-
selling of stocks, bonds, commodities,
currencies, collectibles, real estate, derivatives
or any valuable financial instrument to profit
from fluctuations in its price as opposed to
buying it for use or for income via methods such
as dividends or interest. Speculation represents
one of three market roles in western financial
markets, distinct from hedging, long term
investing and arbitrage. Speculators in an asset
may have no intention to have long term
exposure to that asset.
INSTITUTIONAL VS. RETAIL

Institutional investor
An institutional investor is an investor, such as a
bank, insurance company, retirement fund, hedge
fund, or mutual fund, that is financially sophisticated
and makes large investments, often held in very
large portfolios of investments. Because of their
sophistication, institutional investors may often
participate in private placements of securities, in
which certain aspects of the securities laws may be
inapplicable.

Retail
A retail investor is an individual investor
possessing shares of a given security. Retail
investors can be further divided into two categories
of share ownership.
1.) A Beneficial Shareholder is a retail investor who
holds shares of their securities in the account of a
bank or broker, also known as “in Street Name.” The
broker is in possession of the securities on behalf of
the underlying shareholder.
2.) Registered Shareholder is a retail investor who
holds shares of their securities directly through the
issuer or its transfer agent. Many registered
shareholders have physical copies of their stock
certificates.
In the United States, as of 2005 about 57 million
households owned stocks, and in total, individual
investors owned 26% of equities.