Business Finance

Introduction to Financial
Management
(Part - 2)
Prepared by:
Sir Jecho
(Don Jericho Diaz. Baldoza)
TOPICS COVERED
1. Financial System
2. Types of Financial Institutions
3. Types of Financial Markets
4. Types of Financial Instruments
LEARNING COMPETENCIES

The learners should be able to:

1. Prepare a diagram illustrating how the Financial
System works.
2. Define Financial Institutions, Financial Markets, and
Financial Instruments.
3. Identify the types of Financial Institutions,
Financial Markets, and Financial Instruments.
LEARNING COMPETENCIES
The learners should be able to:

4. Explain the flow of funds within an organization –

through and from the enterprise.
Financial System
FINANCIAL SYSTEM
The Financial system
performs the essential
economic function of
channeling funds from
those who are investors
(savers of funds) to
those who need funds
(users of funds).

In other words, the

financial system allows
savers of funds to lend
funds to users of funds.
Credits to: Mr. Jonas Ordaniel
Financial System
Hi! Meet Rose...
Rose is an entrepreneur and investor. She
managed her investments and cash very
well. She has an idle cash and she want to
put her excess cash in some financing
activities that will make her excess cash
grow. What she should do with that cash?
SAVERS OR
SUPPLIERS OF FUNDS
Financial System
Hi! Meet Jack...
Jack is an entrepreneur, and he owned a
small clothing shop. He is planning to
expand his business but does not enough
cash to pay for the expansion. Where can
Jack get the additional funding?

USERS OR
DEMANDERS OF FUNDS
SCENARIO 1
 ROSE JACK
If Rose knows that Jack is in needs of
funds, or if Jack knows that Rose is
willing to invest funds, Rose and Jack
may agree to make a

PRIVATE PLACEMENT

-the sale of a new security

SAVERS OR directly to an investor or USERS OR
SUPPLIERS OF FUNDS group of investors. DEMANDERS OF FUNDS
 Financial System
And since Rose observed that Jack’s
Business has been profitable, Rose is
willing to lend Jack the money since she is
confident that Jack can repay his loan.

Rose is now expecting to be 20% richer

from her lending to Jack, and Jack can
now expand his operations to gain more
profit from his business PRIVATE
PLACEMENT
FINANCIAL SYSTEM
SCENARIO 2
 ROSE JACK
However, if these facts are unknown to them,
Rose and Jack can go to a FINANCIAL MARKET
which is an organized forum that lets Rose, along with
other suppliers of funds, and Jack, along with other
users of funds, meet and make transactions.
Once Rose and Jack have met in the Financial
Market, they can now agree to make a private
placement.
Is and organized forums in
which the suppliers and
users of various types of
SAVERS OR funds can make transactions USERS OR
SUPPLIERS OF FUNDS FINANCIAL MARKET directly. DEMANDERS OF FUNDS
FINANCIAL SYSTEM
SCENARIO 3
 ROSE If Rose and Jack do not want to make an effort to
JACK
find a counterparty in the Financial Markets, Rose
and Jack may go to a FINANCIAL INSTITUTION.
A financial Institution will receive Rose’s supply of funds
and match it with Jack’s demand of funds.
Unlike the Financial Markets were Rose and Jack knows
to whom the fund went and from whom the funds came,
Financial Institutions served as an INTERMEDIARY to
the supplier and users of funds.

-intermediaries that channel

the savings of individuals,
SAVERS OR businesses, and governments USERS OR
SUPPLIERS OF FUNDS into loans or investments. DEMANDERS OF FUNDS
FINANCIAL iNSTITUTION
FINANCIAL SYSTEM
 Financial System
1. How transactions between • Verbal Agreement
suppliers and users of funds • Written Agreement
takes place?
due to the increased need for
security for the performance of
2. How would they prove obligations arising from these
that there was a transaction transactions and due to the
so that the demander or growing size of the financial
users of funds will be able to system, the transfers of funds
repay the supplier on time from one party to another are
and at the right amount? made through FINANCIAL
INSTRUMENTS.
 FINANCIAL
INSTRUMENTS
Financial Instruments
Financial Instruments - is a real or a virtual document
representing a legal agreement involving some sort-of monetary
value (Source: Investopedia - Sharper Insight. Smarter
Investing. | Investopedia (2016)

Financial Instruments are contracts for monetary assets that can

be purchased, traded, created, modified, or settled for.

When a financial instrument is issued, it gives rise to a

financial asset on one hand and a financial liability or equity
instrument on the other. (Corporate Finance Institute)
 Financial Instrument will result to a/an:
FINANCIAL ASSETS FINANCIAL LIABILITY
any asset that is: is any liability that is a contractual
• Cash obligation:
• An Equity instrument of another • To deliver cash or other financial
entity instrument to another entity.
• A contractual right to receive cash or
another financial asset from another Examples: Notes Payable, Loans
entity. Payable, Bonds Payable

Examples: Notes Receivable, Loans

Receivable, Investment in Stocks,
Investment in Bonds.
EQUITY INSTRUMENT
is any contract that evidences a residual interest in the
assets of an entity after deducting all liabilities. (IAS 32)

Examples: Ordinary Share Capital, Preference

 LET’S THINK!
TAKE NOTE!!!
A. Who are the HOLDERS of • When companies are in need of
Financial Assets? funding (users of funds), they either
sell debt securities (or bonds) or
issue equity instruments. The
Savers/Supplier of Funds
proceeds from the sale of the debt
securities and issuance of bonds will
be used to finance the company’s
B. Who are the MAKERS of plans.
Financial Liabilities? • On the other hand, investors buy
debt securities of equity
instruments (supplier of funds) in
Demanders/Users of Funds hopes of receiving returns through
interest, dividend income or
appreciation in the financial asset’s
https://efinancemanagement.com/sources-of-finance/financial-instruments
 TYPES OF
FINANCIAL
INSTRUMENTS
 Financial Instruments
DERIVATIVES -Are Financial Instruments that have values determined from underlying assets, such as
INSTRUMENT interest rates, currency, bonds, stocks, and stock indexes.
-Derivatives are financial instruments that derive their value in response to changes in
interest rates, financial intrument prices, commodity prices, FOREX rates, credit risks,
and indices.
CASH -Cash Instruments include things like deposits and loans, as well as easily transferable
INSTRUMENT securities. This type of intrument is directly influenced by the market, so any market
fluctuations will be directly reflected in the cash asset’s value.
-We can also categorize financial instruments by asset class, depending on whether they are
ASSET debt or equity based.
CLASSES -Debt-based Financial Instruments (Short or Long Term) reflect a loan the investor made to the
issuing entity.
-Equity-based Financial Instruments, on the other hand, reflect ownership on the issuing entity.
-Foreign Exchange (FOREX) are Financial Instruments that are represented on the foreign
market and primarily consist of currency agreements and derivatives.
 Equity-Based Financial Instruments
-Generally have varied returns based on the performance of the issuing company.
-Returns from equity instruments come from either dividends or stock price appreciation.

Preferred Stock has priority over a common stock in Common Stock on the other hand are the real
terms of claims over the assets of a company. owners of the company.
• if a company were to be liquidated and its assets • If the company’s growth is spurring, the
have to be distributed, no asset will be distributed common stockholders will benefit on the
to common stockholders unless all the claims of growth.
the preferred stockholders have been given. • Moreover, during a profitable period for which
• Moreover, preferred stockholders have also a company may decide to declare higher
priority over common stockholders in cash dividends, preferred stock will receive a fixed
dividend declaration. Dividends to preferred dividend rate while common stockholders
stockholders are usually in a fixed rate. No cash receive all the excess.
dividends will be given to common stockholders • Lastly, common stockholders have a voting
unless all the dividends due to preferred rights, a privilege not available to preferred
stockholders are paid first. (Cayanan, 2015) stockholders.
 Debt-Based Financial Instruments
-Generally have fixed returns due to fixed interest rates.
-Debt-based instruments are categorized as Short-Term and Long-Term Debt Instruments:
Short-Term Debt Instrument last or mature for one
year or less. • Commercial Papers - are promisory notes
Cash Equivalents - These are an investment made issued by financial institutions or large firms
that can be easily converted to cash and must be of with short maturity period usually 2 to 30 days
the short term usually with a maturity period of not and not more than 270 days, and is secured only
more than three months or 90 days. They must be of by reputation by the issuer.
the highest liquidity in nature and should be easily • Certificate of Deposits - is a savings account that
sold in the market. holds a fixed amount of money for a fixed period
• Treasury Bonds and Treasury Bills (T-BILLS) - are of time, such as six months, one year, or five
issued by the Philippine government. These bonds years, and in exchange, the issuing bank pays
and bills have usually low interest rates and have interest.
very low risk of default since the government
assures that these will be paid.
 Debt-Based Financial Instruments

Long-Term Debt Instrument last or mature for more than one year.

• Corporate Bonds are issued by publicly listed companies. These bonds usually
have higher interest rates than Treasury bonds.

• However, these bonds are not risk free. If the company which issued the bonds
goes bankrupt, the holder of the bonds will no longer receive any return from
their investment and even their principal investment can be wiped out.
 HOMEWORK:

ANSWER THE TAKE HOME ACTIVITY

#2 TO BE PROVIDED ON THE NEXT
MEETING!
PREPARE FOR A QUIZ
NEXT WEEK!
Business Finance End of
Part - 2
THANKS
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