Introduction To Financial Management

Differentiate the Financial instruments, financial institution and financial markets.

1. Financial Institution : are companies in the financial sector that provide a broad range of business and services including banking, insurance and investment management.

Identify examples of Financial institution/intermediaries:

A. Commercial Banks – Individuals deposit funds at commercial Banks which use the deposited funds to provide commercial loans to firms and personal loans to individual, and purchase debt securities issued by firms or government agencies.

B. Insurance Companies – Individuals purchase insurance ( life, property and casualty and health) protection with insurance premiums. The insurance company’s pool these payments and invest proceeds in various securities until the funds needed to pay off claims by policy holders. Because they often own large blocks of a firm’s stock or bonds, they frequently attempt to influence the management of the firm to improve the firm’s performance, and ultimately, the performance of the securities they own.

C. Mutual Funds – mutual funds owned by investment companies that enable small investor to enjoy the benefits of investing in a diversified portfolio of securities purchased on their behalf by professional investments managers. When mutual funds were money from investors to invest in newly issued debt or equity securities, they finance new investment by firms. Conversely, when they invest in debt or equity securities already held by investors, they are transferring ownership of the securities among investors.

D. Pension Funds – Financial institution that receive payments from employees and invest the proceeds on their behalf.

Other financial institution include pension funds like Government Service Insurance System (GSIS), and Social Security System (SSS), Unit Investments Trust Fund (UITF), Investment Banks and credit unions, among others.

2. Financial Instruments – is a real or a virtual document representing a legal agreement involving some sort of monetary value. These can be debt securities like corporate bonds or equity like shares of stock. When a financial instrument issued, it gives rise to a financial asset on one hand and a financial liability or equity instrument on the other.

A. A Financial Asset is any asset that is:

• Cash
• An equity instrument of another entity.
• A contractual right to receive cash or another financial asset from another entity.
• A contractual right to exchange instruments with another entity under conditions that are potentially favorable (IAS 32.11)
• Examples: Notes Receivable, Loans Receivable, Investments in Stocks, Investments in Bonds

B. A financial liability is any liability that is a contractual obligation:

• To deliver cash or other financial instrument to another entity.
• To exchange financial instruments with another entity that are potentially unfavorable ( IAS 32)
• Examples: Notes Payable, Loans Payable, Bonds Payable

C. An 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 Share Capital
• Identify common examples of Debt and Equity Instruments.

D. Debt instruments generally have fixed returns due to fixed interest rates. Examples of Debt instruments are as follows:

• Treasury bonds and Treasury bills issued by the Philippine government. These bonds and bills have usually low interest rates and have very low risk of default since the government assures that these have been paid.
• Corporate bonds issued by publicly listed companies. These bonds usually have higher interest rates that Treasury bonds. However, these bonds are not risk free. If the company issued the bonds goes bankrupt, the holder of the bonds will no longer receive any return from their investment and even their principal investment has wiped out.

E. Equity 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.

The following are types of equity instruments:

• Preferred stock has priority over a common stock in terms of claims over the assets of a company. This means that if a company has liquidated and its assets have to be distributed, no asset be distributed to common stockholders unless all the claims of the preferred stockholders has given. Moreover, preferred stockholders have also priority over common stockholders in cash dividend declaration. Dividends to preferred stockholders are usually in a fixed rate. No cash dividend given to common stockholders unless all the dividends due to preferred stockholders paid first. (Cayanan,2015)
• Holders of common stock on the other hand are the real owners of the company. If the company’s growth is encouraging, the common stockholders will benefit on the growth. Moreover, during a profitable period for which for which a company may decide to declare higher dividends, preferred stocks will receive a fixed dividend rate while common stockholders receive all the excess.

3. Financial Market – refers to a market place, where creation and trading assets, such as shares, debentures, bonds, derivatives, currencies, etc. take place.

Classify Financial Markets Into comparative groups:

-Primary vs. Secondary Markets

• To raise money, users of funds will go to a primary market to issue new securities ( either debt or equity) through a public offering or a private placement.
• The sale of new securities to the public referred to as public offering and the first offering of stock named an initial public offering. The sale of new securities to one investor or a group of investors (institutional investors) is referred to as a private placement.
• However, suppliers of funds or the holders of the securities may decide to sell the securities that have purchased. The sale of previously owned securities takes place in secondary markets.
• The Philippine stock Exchange ( PSE) is both a primary and secondary market.

-Money Markets vs. Capital Markets

• Money markets are a venue where in securities with short term maturities (1 year or less) are sold. Hey have created because some individuals, businesses, governments, and financial institutions have temporarily idle funds that they wish to invest in a relatively safe, interest bearing asset. At the same time, other individuals, businesses, governments, and financial institutions find themselves in need of seasonal or temporary financing.
• On the other hand, securities with longer term maturities sold in capital markets. The key capital market securities are bonds (long term debt) and both common stock and preferred stock (equity or ownership).

The role of financial managers make financing decisions that require funding from investors in the financial markets.

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