Credit Instruments

Requirements of an Effective Financial System Role of Financial Intermediaries Structure of Financial Intermediaries

What is credit instrument?

A credit instrument refers to a promise, or order, to pay a definite or determinable sum of money to bearer, or to a specified person or his order. Simply Defined as: A document which gives evidence of a credit obligations resulting for a past transaction which sets forth the responsibility of the debtor to his creditor.

Classes of Credit Instrument

Investment Credit Instrument Commercial Credit Instrument

Bonds
Short-term Notes Stock

Promise to Pay
Orders to Pay

Investment Credit Instrument (BONDS) Bonds

are the promises to pay the principal as well as the interest to its holder at a certain specified time indicated in the instrument. Bonds represent certificates of indebtedness on the part of the corporation which issued them.
May be issued by: Government Business Corporation

Generally indicated on the face of certificates

Credit Instrument Bonds

VARIETY OF BONDS
1. The character of security
2. The provisions governing the payment of

interest and the repayment of principal 3. The purpose for which they are issued 4. The nature of the issuer

Credit Instrument Bonds

CLASSES OF BONDS
1. Nature of the Issuer government, municipal, corporate, industrial, etc. 2. Nature of Security mortgage, collateral, trust, debenture, guaranteed, income, etc. 3. Maturity long-term, short-term, etc. 4. Termination (payment and redemption) convertible, redeemable, serial, sinking fund, etc. 5. Form of Instrument coupon, registered. 6. Purpose refunding, construction, development, equipment, etc.

Credit Instrument Bonds

CLASSIFICATION OF BONDS
Coupon Bonds

-have interest coupons attached. Principal is payable

to the bearer, and interest is payable upon surrender of the coupons. Because title passes without endorsement, these bonds are also called bearer bonds.

Registered Bonds
-have the name of the owner on the face of the instrument and cannot be transferred without endorsement. Interest checks are mailed to the holder on record. Registered bonds are registered as to principal only, and the attached coupons are payable to the bearer.

Credit Instrument Bonds

RETIREMENT OF BONDS
Corporate bonds may be retired through: CONVER SION- exchanging a new security usually a preferred stock, for the outstanding issue. REDEMPTION - repayment of cash REFUNDING - replacing the outstanding bonds with another issue of later maturity, with perhaps some alternations in the provision and rate of interest.

Credit Instrument Bonds

TWO COMMON REDEMPTION PLANS

SINKING FUNDS PROVISION IN THE INDENTURES - stipulating that a certain sum is to be set aside each year out of earnings, the appropriation to be used either to retire outstanding bonds immediately or to be invested and used to a certain bonds at maturity. ISSUANCE OF A SERIAL BOND a portion of the bonds mature each year so that a substantial portion, if not all, of the bonds may be retired at the end of the loan period.

Credit Instrument SHORT-TERM NOTES

SHORT-TERM NOTES
May appear similar to bonds - bonds are held to mean long-term debt obligation which are issued to the general public.

Notes
has always signified obligation maturing within comparative

short period of time. (five years and, moreover, having limited number of holders) The term and provision of the debt obligations in notes are set forth in the documents itself while those in bonds are indicated in the separate instrument known as the indenture

Credit Instrument SHORT-TERM NOTES

In some instances Short-term notes are issued purposely in order to retire a bond issue pending a more permanent solution to the financial problem of the corporation. Short-term notes may be used to pay off bank loans that have become due at time when an adequate amount of cash in the corporation is not available.

Credit Instrument Stocks

STOCKS

Represent permanently investment capital of a

corporation contributed by the owners termed as stockholders which are evidenced by certificates.
The owner of the stocks does not directly own any of

the property of the issuing corporation.

A stock is an evidence of the investment involving a

certain sums of money, an evidence that is transferable to third parties in such a way that the holder may, in normal times, obtain immediate cash through that sale of said stock.

Credit Instrument STOCKS

Share of Stocks
Represents the owners right to a certain portion of

the assets of corporation upon liquidation and to certain shares of the profits after prior claims have been paid. To facilitate the transfer of these rights, the corporation issues a stock certificate to the stockholder.

Certificate of Stock
An evidence of the fact that the holder is the owner of

a share, or a number of shares, of stock.

Credit Instrument STOCKS

Common

Types of Stocks

Residual claimant, receiving only that portion of the corporate income which remains after all other claimants have been satisfied. There is no fixed rate of earnings on common stocks.
Preferred

May be referred as to assets or as to dividends, or both. Holders of preferred stocks have a right to fixed dividend which is secondary to that of interest on all classes of bonds and notes.

Credit Instrument

Commercial Credit Instrument (Promises to Pay)

Promises to Pay

Book Accounts Bank Deposits Promissory Notes

CREDIT INSTRUMENT Promises to Pay

Book Accounts open book account

Is considered as the oldest forms of credit

In the majority cases, it is nothing more than a series of entries in the ledger of the creditor, showing that, in specific place, the debtor received certain kinds of goods involving specific amounts of money for which payment has not been made then at the time of purchase.

CREDIT INSTRUMENT Promises to Pay

Unfortunately, this documentary

evidence being in the hands of retail has, on occasions, precipitated misunderstanding between him and his customer owing to the disagreement as to the exact amount involved in purchase previously made on credit.

CREDIT INSTRUMENT Promises to Pay

Economic Standpoint
1. The seller is compelled to act as a banker for the buyer 2. The capital value of the merchandise remains tied up for the

duration of the life on the credit term

3. There is lack of sharply defined time for the payment of

accounts. This circumstances has served as a source of business friction between the parties concerned.

*Serious Objections to use open book account both from the economic as well as ethical viewpoint. Dwight E. Beebe et. al

CREDIT INSTRUMENT Promises to Pay

Ethical Standpoint

1. The door for litigation is left wide open owing to the

fact the seller has only his book account as evidence of the transaction as already indicated in passing.
2. The ratio of returned goods is quite high involving sales

under the book account

3. The collections are slow, and losses arising from bad

debts are evidently considerable magnitude.

CREDIT INSTRUMENT Promises to Pay

Bank Deposits
The greater bulk of circulating medium of exchange comes

in the form of bank deposits.

This may be in the form of demand deposits which are

subject to withdrawal upon demand through the use of checks, or may be withdrawn only upon due notice of such intention in advance.
The Bank Deposits are fundamentally not unlike open book

accounts arising out of commercial transactions.

CREDIT INSTRUMENT Promises to Pay

Promissory Notes
- is a written promise of one person to pay another a definite sum of money at a certain future time. - is a very simple type of commercial instrument as well as one in common use in the field of consumer and personal credit.

CREDIT INSTRUMENT Promises to Pay

Negotiable Promissory Notes

Negotiable promissory notes may, by endorsement, be discounted, sold, used as collateral and otherwise disposed of in the finance markets.

Non-negotiable Promissory Notes

Non-negotiable Promissory notes do not in any way enjoy such flexibility. As such, the holders of the same must have to retain them in their possession until their maturity.

CREDIT INSTRUMENT Promises to Pay

Advantages
Promissory notes serve as excellent evidence of credit

transactions which cannot be disputed.

It serves as effective instrument for the enforcement of

payment of obligation.
For negotiable type: They are readily transferable by

endorsement and delivery, which makes them perform similar functions to those of medium of exchange.(likewise used as collateral to secure loans from banks)

CREDIT INSTRUMENT Promises to Pay

Shortcomings
The desire on the part of a number of buyers to purchase

goods on cash basis in order to take advantage of discounts has militated against promissory notes.
Settlement of obligations by the use of promissory notes

for numerous and frequent purchase is time consuming, cumbersome impractical.

Adjustments are sometimes easily made when no written

evidence of the debts is used.

CREDIT INSTRUMENT Promises to Pay

One-Name Note Single-Name Note

Promissory note is signed by only one individual.

Two-Name Note
Promissory note signed by two person. The second individual likewise become responsible for the payment of the loan obligation in case of failure on the part of the maker of the instrument.

CREDIT INSTRUMENT Orders to Pay

Orders to Pay
In contrast with promises to pay which involves a maker and a payee, orders to pay generally speaking involves three parties, namely:

ORDER

PAYMENT

DRAWER

DRAWEE

PAYEE

1. The Drawer, that is, the party ordering that payment be made 2. The Drawee, the party ordered to make payment 3. The Payee, the party to whom payment is to be made

CREDIT INSTRUMENT Orders to Pay *When the drawer orders that payment be made to himself (or to cash), the drawer and the payee are the same person.

The instrument is payable to bearer:

a. When it is expressed to be so payable b. When it is payable to a person named therein, or bearer c. When the name of the payee does not purport to be the name of any person (check payable to the order of or cash or bills payable or order)

CREDIT INSTRUMENT Orders to Pay

Checks
Checks may be defined as a written order drawn by a depositor upon a bank directing it to pay on demand a specified sum of money to the bearer or to the order of some person or corporation named on the face of the checks the amount against his deposit account.

CREDIT INSTRUMENT Orders to Pay

Open Checks
Open check is one without crossing. It does not have to be presented through a banking account. These checks are known under the popular term order or bearer checks.

Crossed Checks
Crossed check cannot be presented to the bank for cash payment.. It may be easily recognized and distinguished by the presence of two parallel lines appearing on the top left hand corner of the check. Its use affords a distinct advantage over that of an order or bearer check in that, in the event of loss, its recovery is quite possible since it cannot be cashed for payment.

CREDIT INSTRUMENT Orders to Pay

Certified Check
Certified check is a check which has been certified by the

bank official with respect to the sufficiency of funds covering the amount indicated on the face on the instrument. It is commonly used in commercial transactions where the payee would like to be assured of receipt of payment. It is intended as a guarantee that the check will not bounce. The word certified or its equivalent is stamped on the pace of the check with the accompanying signature of the bank official making the certification.

CREDIT INSTRUMENT Orders to Pay

Cashiers Check
Cashiers check is the banks order to pay drawn upon itself and signed by the cashier, payable to the person or firm designated by the depositor. This is commonly used at present instead of certified checks.

Post-dated Checks
Post-dated checks are checks issued by the drawer showing future date. Such instrument cannot be paid before the date it bears nor will it be acceptable for deposit.

Stale Checks
A check which is not presented to the bank for cash payment nor deposited to payees account after six months from the date it bears . As such, it becomes necessary for the payee to request his drawer to issue a new check to replace the stale one.

CREDIT INSTRUMENT Orders to Pay

Special Checks
Counter Checks
Checks used to withdraw funds of the depositor when his check booklet has been exhausted.

Voucher Checks
Checks that has the accompanying voucher for purpose of keeping an accurate record of the amounts and purposes for which the checks have been received.

Travellers Check
It is a form of check that is not drawn on any particular bank but is payable anywhere throughout the world.

CREDIT INSTRUMENT Orders to Pay

Advantages(uses)
a. Safety and convenience
Keeping large amounts of money in ones home involves numerous risk like the possibility of theft, destruction by fire, and others. Currency that is stolen is difficult to trace or recover. The use of checks eliminates such risk

b. Stop-Payment
The payment may be stopped by the maker because the check has been lost or for various other reasons. Death of a depositor automatically stops payment of his check out standing, cancels and delegated authority to sign his check and seal his deposit.

CREDIT INSTRUMENT Orders to Pay

c. Odd-Amounts
Business transaction involving odd amounts often times give rise to certain degree of inconvenience

d. Receipt
Checks may serve as a receipt covering any transaction. They represent permanent evidence of the fact that payment has been actually made.

e. Large amounts
It may be stated that carrying big amounts of money subjects the individual to great dangers. The use of checks eliminates such risk and danger.

CREDIT INSTRUMENT Orders to Pay

Limitations

We can hardly conceive of the payment of a can of evaporated milk or a kilo of rice by means of checks. Checks cannot be used as a medium of exchange in transactions involving the immediate delivery of goods between people, who do not know one another, as in purchases from the retail store. Checks are not legal tender. It is a matter of policy on the part of the business establishment whether to accept them or not. Unless checks are carefully written, they can be forged and amounts raised.

CREDIT INSTRUMENT Orders to Pay

Bills of Exchange Draft

Draft is simply defined as an order drawn by one party who is drawer directing a second party, who is drawee, to pay a third party who is the payee, a specified sum of money at a certain determinable date.

CREDIT INSTRUMENT Orders to Pay

Classifications

1. Date of payment
Demand or Sight Draft the amount indicated on the instrument is payable upon demand or sight. Time Draft Payment is to be made only after a lapse of certain stipulated time. Time drafts may cover 60 days, 90 days or 120 days.

2. Character of the Drawee

Bank Draft The drawee is a bank. It is an order written by one bank, directing a second bank to pay a certain sum of money to order of the person named in the draft. Commercial Draft The drawee is a business concern. It is an order written by one person or business concern directing another to pay a certain sum of money to the person to the person or concern named in the draft, or to his order

CREDIT INSTRUMENT Orders to Pay

3.

Place Where The Parties Reside Domestic Draft The parties reside in the country. Foreign Draft The parties resides in a foreign country.

4. Whether the Drafts are Accepted or Not

Ordinary Draft Accepted Draft accepted Draft may be subdivided into trade acceptance and bank acceptance. Trade Acceptance arises when the purchaser or importer of the good accepts his obligations to the seller or exporter by writing the word accepted on the face of the time draft. Bank acceptance is a draft drawn upon a bank by a depositor or borrower, payable to a third party and accepted by the drawee.

CREDIT INSTRUMENT Orders to Pay

5. Whether Draft are Free or Documented

Documented Draft When no documents are required to be attached together with the draft accompanied by the required shipping documents. This is very important especially in international trade.

Finance
-deals with the principles, institutions, instruments, and procedures involved in making payments of all types in our economy. Includes: Those for goods and services which are bought for cash and those which are bought on credit and paid later. Payments when intangible claims such as stocks and bonds, are purchased. Finance is concerned with making available for investment in business and government money that has been saved.

Requirements of an Effective Financial System

1.

The financial system must provide an efficient medium for exchanging goods and services.
The financial system must take it possible for the creation of capital on a scale large enough to met the demands of the nations economy.

2.

3.

The financial system should provide markets and procedures for the transfer of claims to wealth, such as promissory notes and shares of ownership(stocks) in a business, and for the conversion of claims into cash.

ROLE OF FINANCIAL INTERMEDIARIES

To pool the savings of lending customers. To invest these funds financially on the basis of careful

investigation.
To diversify risk to degree unattainable for individual

investors.
To transform short-term into long-term funds through an

expedient and careful staggering of maturity dates.

To perform insurance and trust functions.

Financial Institution
May be defined as: an organization through which funds in the form of money or claims in money are assembled and transferred from those individuals and firms having a surplus of economic goods (as represented by such funds) to other individuals and firms whose needs for funds exceed their existing supply

 Enable individuals to borrow for the purchase

of durable consumer goods, to meet emergency credit needs, and to invest in land, houses, both new and old.
Assist in meeting the borrowing needs of government. Most of all, they assist business enterprises in financing current output and in acquiring funds needed for modernization and growth.

Financial Markets
Embraces the flow of funds as a whole in the national economy. It is where the borrowers and lenders or investors of funds, i.e., lending and borrowing, are regulated and where the price of funds, that

is, the interest rate, is determined.

The Philippine Financial System

CATEGORIES:
Banking institution
Non-Banking Financial Intermediaries Non-Bank Thrift Institution

Banking Institution
-are entries authorized by the Central Bank of the Philippines to engage regularly in lending of funds obtained from the public through the receipt of deposits of any kind.

Commercial Banks A commercial bank is any corporation which accepts or creates demand deposits subject to withdrawal by checks. Thrift Banks They are banking institutions organized primarily to encourage deposits.

Kinds of Thrift Banks

a. Private Development Banks any bank organized in accordance with the Private Development Banks Act, with the primary purpose of promoting agriculture and industry and at the same time place within easy reach of the people the medium and long-term credit facilities at reasonable cost, to finance the socio-economic programs of the government and to meet the needs of capital of Filipino entrepreneur.

b. Savings and Mortgage Banks Any corporation authorized by the Central Bank of the Philippines for the purpose of accumulating savings deposits and investing them together form of security, or in loans for personal finances and long-term financing for home building and home development.

c. Stock Savings and Loan Association Any corporation authorized to engage in the business of accumulating the savings of its members or stockholders, and using such accumulations together with its capital, for loan and/or investment in securities of productive enterprises or in securities of the Government, on any of its political subdivisions, instrumentalities or corporation.

Rural Banks The primary purpose of this bank is to promote and expand the rural economy in an orderly and effective manner, by providing the people of their rural communities with the means of proving and facilitating their productive activities and to encourage cooperatives. Specialized Government Banks These are government controlled Banks organized for specific purpose(s) in accordance with their respective charters.

 Development Bank of The Philippines

the purpose of this bank is to provide long-tem credit facilities for the rehabilitation, development, and expansion of agriculture and industry, the reconstruction of property damaged by war, the broadening and the diversification of the national economy, and to promote the establishment of private development banks in the provinces and cities.

 Philippine Amanah Bank its purpose is to provide credit, commercial, development and savings banking facilities at reasonable term to the people of primarily Muslim province in Mindanao. Operates under the Islamic concept of banking called mudraba
Land Bank of the Philippines its purpose is to provide timely and adequate financial support in all phases involved in the execution of needed agrarian reform.

Offshore Banking Units (OBUs) Is any branch, subsidiary, or affiliate of a foreign banking corporation that can conduct banking transactions in foreign currencies involving the receipt of funds principally from external sources and the subsequent utilization of said funds for undertaking inside of outside the country.

Non-Banking Financial Intermediaries

Persons or entities whose principal function include the

lending, investing or placement of funds or evidences of indebtedness or equity deposited with them, acquired by them, or otherwise coursed through them either for their own or for the account of others.
*QUASI-BANKING FUNCTIONS(QBF) borrowing of funds, for the borrowers own account, through the issuance, endorsement, or acceptance of debt instruments of any kind other than deposits, from 20 or more lenders at any one time, for purposes of relending or purchasing of receivables and other obligations.

Kinds of Non-Banking Financial Intermediaries

o Investment Houses

engages or purport to engage in the underwriting of securities of another person or enterprise, including securities of the government and its instrumentalities. They are considered the sophisticated type of non-bank financial intermediaries and is the largest group in the non-bank sector in terms of assets.
o Financing Companies

any corporation/ partnership organized for the purpose of extending credit facilities to consumers and to industrial, commercial, or agricultural enterprises

o Security Dealer/Broker
-A SECURITY DEALER is one who buys and sells securities of another or acquire securities for the purpose of reselling or offering them for sale to the public, or otherwise dealing or trading in securities for profit. They do not receive commission but income or loss is derived from trading, that is, difference in buying and selling price of securities.

- A SECURITY BROKER is a person engaged in the business of effecting transactions in securities for the account of others. He is a go-between in arranging for a buyer to meet a seller of security and when the transaction is completed, he earns a commission.

o Investment Company

Any issuer which is or holds itself out as being engaged primarily or proposes to engage, in the business of investing, re-investing or trading in the securities may be described as an investment company.
KINDS . Open-ended or Mutual Fund offering for sale or has outstanding redeemable securities of which it is the issuer Close-ended Company organized as a holding company whose shares are not redeemable.

o Funds Manager

Refers to the juridical or natural persons engaged in all forms of administration of property, or money or its equivalent, for the benefit of the owner or a third person.
o Lending Investor

A person who makes a practice of lending money for themselves or others. They use their own capital for the purposes of extending all types of loans, generally shortterm, oftentimes without collateral. When they charge interest rates in excess of what the law allows, they become what are known as usurious money-lenders or loan-sharks As such, their activities become anti-social.

o Pawnshop

A pawnshop refers to a person or entity engaged in the business of lending money on personal property delivered as security.
o Money Broker

A money broker is a financial intermediaries engaged in the business of money broking, i.e., and matching borrower with lender or buyer with seller, at an agreed rate and taking no trading position.

Non-Banking Thrift Institution

These thrift institutions which are organized as non-bank entities without any banking or quasi-banking function, are of two kinds, namely:
1. Mutual Building and Loan Associations 2. Non-Stock Savings and Loan Associations

o Mutual Building and Loan Associations

Any corporation whose capital is required or is permitted to be paid by the stockholders in regular, equal periodic payments and whose purpose is to accumulate the savings of its stockholders, to repay to said stockholders their accumulated saving and profits.
o Non-stock Savings and Loan Association Any

association engaged on the business of accumulating the savings of its members and using such accumulations for loans to its member-depositors.

Principal Sources of Funds

Capital Contributions These are the original paid in

capital of stockholders/members and in addition payments of subscriptions/ instalments, if any.

Deposits There are three kinds of deposits, namely;

savings, time and demand deposits, which are true in commercial banks, some thrift banks and some rural banks, while other banks can only service and accept savings and time deposits.
Rediscounting of Notes This refers to the borrowings

from the Central Bank against eligible loan papers offered as collateral.

 Borrowings from domestic and Foreign Sources

Banks and non-bank financial intermediaries may also borrow from other institution, domestic or foreign depending on its funds requirements.
Deposit substitute liabilities

This refers to the method of borrowing that nonbank financial intermediaries with QBF may engage, such as the issuance, endorsement, or acceptance of debt instruments of any kind, other than deposits.