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Module 2. Sources of Funds. Framework. Framework. What is an investment?. An asset or property right acquired for profit Risks:. Liquidity Risk. Market Risk. Inflation Risk. Credit Risk. General investment classes. Savings deposits Time deposits Life insurance policies Bonds

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Module 2

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module 2

Module 2

Sources of Funds

what is an investment
What is an investment?
  • An asset or property right acquired for profit
  • Risks:

Liquidity Risk

Market Risk

Inflation Risk

Credit Risk

general investment classes
General investment classes
  • Savings deposits
  • Time deposits
  • Life insurance policies
  • Bonds
  • Money market placements
  • Houses, apartments and building ownership
  • Land ownership
  • Business ownership
  • Education and training
  • Foreign exchange investments
  • Precious tangibles
financial markets
Financial markets
  • What is a financial market?
  • Offers and sales occur in two distinct ways
    • Primary market
    • Secondary market
  • Financial institutions such as banks act as intermediaries
financial markets1
Financial Markets

Money Market

Capital Market

Forex Market

Derivatives Market

  • Debt
  • Equity
  • Tbills
  • Tnotes
  • CPs
  • BAs
  • Spot
  • Forward
  • Options
  • Swaps
  • Futures
  • Structured Products

Money Market vs. Capital Market

  • Short-term
  • Government bonds
  • Large denominations
  • Institutional investors
money market instruments
Money market instruments
  • Government raises money by selling notes to the public
  • Investors buy the bills at a discount from the stated maturity value. At maturity, the investor will get the face value.
  • Notes: longer-term and may give periodic interest

Treasury Bills and notes

  • A time deposit
  • May not be withdrawn on demand
  • The bank pays interest and principal at maturity
  • Usually insured by government insurance (PDIC)

Certificates of deposit

  • Large, well-known companies may issue debt instead of borrowing from banks
  • Usually pays interest and gives back the principal upon maturity

Commercial papers

  • Starts with an order to a bank by a bank’s customer to pay a sum of money at a future date (similar to post-dated check)
  • When the bank endorses the order for payment as “accepted,” it assumes responsibility for ultimate payment to the holder of the acceptance.
  • The acceptance may be traded in secondary markets like any other claim on the bank.

Banker’s acceptance

money market instruments1
Money market instruments
  • The dealer sells government securities to an investor on an overnight basis, with an agreement to buy back those securities the next day at a slightly higher price.
  • The increase in the price is the overnight interest.
  • The dealer thus takes out a one-day loan from the investor, and the securities serve as collateral.
  • Reverse repo: mirror image of a repo


Demand loans

  • Mechanism used by banks to adjust their daily reserve positions
  • Interbank borrowing and lending

Term loans

  • Loans to banks for a definite period of time
types of transactions
Types of transactions

Repurchase agreement

Straight sale

- Direct sale to an investor up to maturity date

Ex: A dealer bought a Meralco CP on Jan 1 2008 to mature on May 31 2008 with a 15% interest p.a. Supposing on April 6, a client went to the dealer and said he has excess funds up to May 31 (45 days). The dealer sold the note to the client at 13% p.a. On the maturity date, the client received the principal plus the corresponding interest. The bank earned 2% on the transaction.

- Repurchase (RP) – the commercial bank sells to the central bank using securities as collateral.

- Reverse repurchase (RRP) – the commercial bank lends to the central bank and the central bank gives securities as collateral.

features of good investments
Features of good investments
  • Safety of the value of the investment
  • Saleable investments
  • Stability of income
  • Taxes
how are loans made
How are loans made?

Find prospective loan customers

Evaluate financial condition

Evaluate character and sincerity of purpose

Assess possible loan collateral and sign the loan agreement

Make site visits and evaluate credit record

Monitor compliance with loan agreement and other customer service needs

what makes a good loan
What makes a good loan?


Is the borrower creditworthy?

Can the loan agreement be properly structured and documented?


Can the lender perfect its claim against the assets or earnings of the customer?




Is the borrower creditworthy?

6 C’s of Lending


  • Well-defined purpose for requesting credit
  • serious intention to repay


  • Authority to request the loan
  • Minors, corporations


  • Ability to generate enough cash to repay the loan


Is the borrower creditworthy?

6 C’s of Lending

  • Does the borrower have adequate net worth or own enough quality assets to support the loan?



  • Recent trends in borrower’s line of industry
  • Changes in law and regulation could adversely affect the borrower
  • Loan request meets the lenders and regulatory authorities standard for loan quality



Can the loan agreement be properly structured and documented?


  • Loan agreement must meet borrower’s needs for funds with a comfortable repayment schedule
    • Lend less or more money over a longer or shorter period than requested
  • Must protect the lender and those the lender represents
  • Process of recovering lender’s funds must be carefully spelled out in a loan agreement


Can the lender perfect its claim against the

assets or earnings of the customer?

Reasons for taking collateral

  • If the borrower cannot pay, the pledge fo collateral gives the lender the right to seize and sell those assets designated as loan collateral, using the proceeds of the sale to cover what the borrower didn’t pay back.
  • Gives physical advantage over the borrower (borrower feels more obliged to repay the loan)


Can the lender perfect its claim against the

assets or earnings of the customer?

Personal guarantees and pledges made by the business owners

Resources on customer’s B/S

Expected profit, income

or cash flow

and collateral pledged

or consignors of the loan

Common types of collateral

  • Accounts receivables
  • Factoring
  • Inventory
  • Real property
  • Personal property
  • Personal guarantees

Amount owned = Loan P+I –deposits

Safety zones surrounding loaned funds

types of business loans
Self-liquidating inventory loans

Working capital loans

Interim construction financing

Security dealer financing

Retailer and equipment financing

Asset-based loans (AR financing, factoring and inventory financing)

Syndicated loans

Term loans to support the purchase of equipment, rolling stock and structures

Revolving credit financing

Project loans

Loans to support acquisitions of other business firms

Types of business loans

Short-Term Loans

Long-Term Loans

what do banks look for in fs
What do banks look for in FS?
  • Historical analysis
    • What are the trends in costs and profit?
  • Financial ratio analysis
    • Ability to control expenses
    • Operating efficiency in using resources to generate sales
    • Marketability of product line
    • Coverage that earnings provide over financing costs
    • Liquidity position, indicating availability of ready cash
    • Track record of profitability
    • Financial leverage
    • Contingent liabilities
  • Comparison with industry performance
the 4 basic questions
The 4 basic questions
  • How liquid is the firm?
  • Is management generating adequate operating profits on the firm’s assets?
  • How is the firm financing its assets?
  • Are the owners (stockholders) receiving an adequate return on their investment?
what is the time value of money
What is the time value of money?
  • A dollar today is worth more than a dollar in the future.
  • WHY?
    • Because a dollar can be invested today and earn interest for the future
    • Because a dollar today can be eroded by inflation
    • TVM = Opportunity cost
simple interest
Simple Interest
  • Suppose you place $100 in a savings account that pays 6% interest per year. How much interest will you get at the end of 1 year? How much total money will you get at the end of 1 year? At the end of 5 years?

Formula Toolbox:

Interest Payment = Principal x Rate x Time

Time = actual no of days /360 days

compound interest
Compound Interest
  • Suppose you place $100 in a savings account that pays 6% interest per year. How much interest will you get at the end of 1 year? How much total money will you get at the end of 1 year? At the end of 5 years?

Formula Toolbox:

Future Value (FV) = PV*(1+i)n

Present Value (PV) = FV*(1+i)-n

present value and future value
Present Value and Future Value
  • If we place $1,000 in a savings account paying 5% interest compounded annually, how much will our account accrue in 10 years?
  • If we invest $500 in a bank where it will earn 8% compounded annually, how much will it be worth at the end of 7 years?
  • How many years will it take for your initial investment of $7,753 to grow to $20,000 if it is invested at 9% compounded annually?
  • If you like to buy a new laptop that will cost P20,000 10 years from now, at what rate should you invest your savings of P11,167?
  • Fred Moreno has found an institution that will pay him 8% p.a. interest compounded quarterly on a P10,000 deposit. If he leaves his money in this account for 24 months, how much will money will he have at the end of 1 year? At the end of 2 years?
  • How much will he have at the end of 2 years if the interest rate is 8% p.a. compounded semi-annually? Compounded monthly?
making interest rates comparable
Making interest rates comparable
  • Future Value (FV) = PV*(1+i/m)n*m
    • m = number of times per year that the interest is compounded
    • N = number of years
  • Effective annual rate for compounding: (1+i/m)m - 1
  • Continuous compounding: PV x ei*n
  • Joseph is a friend of yours. He has plenty of money but little financial sense. He received a gift of 12,000 for his recent graduation band is looking for a bank in which to deposit the funds. BPI is offering an account with an annual interest rate compounded 2.85% semi-annually, while PSbank offers an account with a 2.75% annual interest compounded monthly. Calculate the value of the two accounts at the end of one year and recommend to Joseph which account he should choose.

Formula Toolbox:

  • Annuities are equal amounts of payments occurring for a consecutive time periods (amortization payments)
  • What is the present value of a 10 year $1,000 annuity discounted back to the present at 5%?
  • A perpetuity is an annuity that continues forever; that is, for every year from its establishment it pays the same dollar amount.
  • Example: preferred stock that yields a constant dollar dividend indefinitely

Formula Toolbox:


PP = constant dollar amount provided by the perpetuity

i = annual interest or discount rate

  • (Comprehensive present value) You are trying to plan for retirement in 10 years and currently you have $100,000 in savings account and $300,000 in stocks. In addition, you plan to add to your savings by depositing $10,000 per year in your savings account at the end of each of the next five years and then $20,000 per year at the end of each year for the final five years until retirement.
      • Assuming your savings account returns 7% compounded annually and your investment in stocks will return 12% compounded annually, how much will you have at the end of 10 years? Ignore taxes.
      • If you expect to live for 20 years after you retire, and at retirement you deposit all of your savings in a bank account paying 10%, how much can you withdraw each year after retirement (20 equal withdrawals beginning one year after you retire) to end up with a zero balance at death?
  • How many years would it take for your investment to grow fourfold if it were invested at 16% compounded semi-annually?
  • (Comprehensive present value) You found the woman of your dreams and she agreed to marry you in 5 years. You currently have Php 150,000 in savings and P15,000 in stocks. You have deposited your savings in a TD yielding 6.5% semi-annually, while the expected rate of return of your stock is 9.75%. To save for the wedding, you vowed to deposit Php 50,000 per year for the next five years at a bank deposit yielding 5.25%.
    • How much money can you spend in your wedding?
    • If your wedding planner told you that the cost of your dream wedding is php 875,000, how much should you save each year (in a deposit yielding 5.25%) to be able to afford your wedding?