CHAPTER 2 FINANCIAL ENVIRONMENT
Spot Market
Financial environments – factors and situations
that primarily affect the financial aspects of a
corporation/
Principal factors:
1. Financial Markets
2. Financial Intermediaries
Financial managers acquire funds through equity
financing and debt financing.
I. Different types of markets
A. Financial Markets
1. Stock Market
 A market where equity securities
are being issued and traded.
2. Bond Market
 A market where debt securities are
issued and traded. Also referred to as
fixed-income market because
investors receive fixed interest
payments.
3. Money Market
 A market where short-term debts
(treasury bill) with maturities of one
year or less are used as source of
financing.
4. Capital Market
 A market where long-term debt
(treasury bills and treasury notes)
and equity securities are involved.
B. Other Markets
1. Physical Market
 Also known as real asset or tangible
markets because products involved
are real estate, property plant and
equipment, inventories, etc.
2.
 A market where assets or goods are
sold for and delivered on the spot or
today.
3. Future Market
 a market where future contracts are
sold. A future contract is a contract
that gives the buyer an obligation to
buy an asset at a predetermined price
for a future date.
a. Forward contract – exchange
rate used to value purchase or
sale of foreign currency is a
forward rate. Forward rate is
already determined today.
b. Option contract – value is
derived from the price of an
“underlying” asset. Classified as
call option (option to buy) or
put option (option to sell).
4. Private Market
 A market where negotiation and
agreement takes place personally
between two parties.
5. Public Market
 A market where security or
contracts with standardized
features are being traded and held
by individuals.
II. Financial Intermediaries
1. Mutual Funds (MF)
 The investment company pools
money from investors then invests
these accumulated amount in a
portfolio of securities whether equity
(shares of stock), debt (bonds) or
money market (short term
securities). Investors purchased
shares of the investment company
thereby giving the former the right
to receive dividends.
2. Unit Investment Trust Fund (UITF)
 The investment company sells units
of investment to investors to
accumulate a trust fund. The trust
fund may be invested also in equity,
debt or balance of equity and debt.
Hence, investors own units of
investment not shares of stock.
3. Pension Fund
 These are pooled contributions
from the employees or from the
employers that serves as the
investment plans for the
retirement benefits of the
employees. Accumulated funds
may be invested in shares of
stocks or in mutual fund to
increase amount of pension.
4. Financial Institution
 A kind of financial intermediary that
provide additional financial
services other than pooling and
investing funds.
 Bank – may serve as debtor
and creditor by accepting
cash deposits and providing
loans.
 Insurance company – sells
protection against losses from
fortuitous events
III. Transfer of Securities
 Direct Transfer
The equity securities evidenced by stock
certificates and debt securities by bond
certificates are issued directly to
investors. These investors pay directly
to the issuing company
 Indirect Transfer
The issuing company seeks the aid of
financial institution to easily issue their
securities to investors, thus there is
mediation between the issuer and
investor.
o Indirect transfer through
Investment Bank – securities of
a company are bought by
investment bank or so called
underwriter with the intention
of reselling them to a
prospective investor. No new
form of capital is made.
o Indirect transfer through
Financial Intermediary –
securities are bought by financial
intermediaries without the
intention of reselling it: rather
they will sell their own
securities to new investors. New
form of capital is created.
IV. Stock Market Transaction
Stock Markets are where shares of stocks
of a corporation are sold to new and/or
existing investors.
1. Manila Stock Exchange (est. August 8,
1927)
2. Makati Stock Exchange (est. May 27,
1963)
These 2 were unified forming Philippine
Stock Exchange (est. December 23, 1992
with eight constituent indices:
 PSE Composite Index
 PSE All shares Index
 PSE Holding Firms Index
 PSE Industrial Index
 PSE Financial Index
 PSE Mining and Oil Index
 PSE Property Index
 PSE Services Index
The following are the stock market transaction:
1. Initial Public Offering (IPO) Markets
 Markets where stocks of a closely
held corporation, going public are
offered to the public for the first
 time. They undergo IPO in order to
raise additional capital to finance
their operating and investing
activities. Generally, IPO is
classified as primary market
transaction.
2. Seasoned Offering
 The issuance of additional shares
of stocks of the company after its
first time offering in order to finance
the capital budget or improve capital
structure. This may be done by
family corporations or publicly
listed corporations.
3. Primary Markets
 The issuance of new shares of
stocks to investors through the aid of
investment bankers. Cash proceed
goes to the corporation.
4. Secondary Market
 Involved with the sale of the
outstanding shares to the new or
existing investors. Cash proceed
goes to the selling shareholders.
o Semi-strong form
This level shows that all available public
information is already incorporated in
stock prices. Investors cannot beat the
market solely by analyzing published
financial reports unless they have
information from company insiders.
o Strong form
This level shows that investors cannot
beat the market even with insider
information. Investors in this efficient
market cannot earn high returns.
Stock prices can be classified as:
a. Market value – also known as perceived
value, is the price of the stock which is
currently traded in the market.
b. Intrinsic value – this is the true value of
the stock. This is the price that the willing
buyer will bid and willing seller will ask
provided that all necessary information is
available. This can be estimated using:
o Dividend Discount Model
o Corporate Valuation Model

V. Stock Market Efficiency

Market efficiency – when the stocks market

shows that market prices of stocks are about
equal or close to intrinsic values.

Inefficient Stock Market – stock prices are

considered to be highly overvalued or
undervalued.

Three levels of Efficiency in Efficient Market

Hypothesis (EMH):

o Weak form
This level shows that the information
regarding past or historical prices of a
particular stock is not conclusive in
predicting stock prices. An investor
cannot beat the market by simply
analyzing past stock performance.