KNOWING THE PHILIPPINE FINANCIAL MARKET

A Guide for Investors

Investors Primer I: The Philippine Financial Market

Table of Contents

Part I The Investment Scenario

1. What is an investment?
2. What is the Investment Process?
3. Who are the Participants in the investment process?
4. What are the different types of investments?
5. What is the life of an investment?
6. What is the importance of investing?
7. What are the rewards of investing?

Part II The Financial Market

1. What are the money and capital markets?

2. What are the primary and secondary markets?
3. What is a stock market and stock exchange?
4. What is the over-the-counter market?
5. What are the advantages of the stock market?
6. Who are the players in the stock market?

Part I The Investment Scenario

1. What is an investment?

An investment is any vehicle into which funds can be placed with the expectation that
they will generate positive income and/or their value is preserved or increased.

2. What is the Investment Process?

The overall investment process is the mechanism for bringing together suppliers
(those having extra funds) with demanders (those needing funds). Normally, suppliers
or savers and demanders or issuers are brought together through a financial institution
or a financial market although there are instances, such as property transactions,
where buyers and sellers directly deal with one another. Financial institutions are
organizations through which the savings of individuals, corporations and governments
are channeled into loans or investments. Example of financial institutions is banks,
investment houses, mutual funds, pension funds and insurance companies. Financial
markets provide the legal and tax framework/environment that bring together
suppliers and demanders of funds to make safe and quick financial transactions, often
though intermediaries such as organized securities exchanges.

Suppliers or savers may transfer their funds through financial markets, financial
institutions, or directly to the demanders or issuers. Financial institutions can also
participate in the investment process either as suppliers or demanders of funds.
The financial markets consist of two parts, namely, the money market and the capital
market. The money market deals with short-term investments while the capital market
is for long-term investments. A more thorough discussion about these markets can be
found in Part II.

3. Who are the Participants in the investment process?

The three key participants in the investment process are government, business and
individuals. They can either be a demander or supplier of funds.

Government
Both local and national government need large amounts of money. Funds are needed
to finance capital expenditures like long-term infrastructure projects – road building,
schools and hospitals through the issuance of different types of long-term debt
securities. Also, government needs to fund operating costs that keep it running.
Normally these funds are sourced from taxes and fees collections. In cases where the
operating expenditures exceed government revenues or if government receipts are not
yet available to meet government payments, government resorts to borrowing funds
by issuing short-term debt securities. If government has temporary idle cash, it
sometimes makes short-term investments to earn positive returns. As such,
government becomes suppliers of funds.

Business
Most businesses require big sums of money to support operations in both the long
term and short-term. On the short-term, funds are used to meet operating cost like
financing inventory and accounts receivables. Long-term needs of businesses are
concentrated on seeking funds to develop products, build plants and buy equipment.
Financing these needs require businesses to issue a variety of debt and equity
securities. Like government, business firms also supply funds if they have excess
cash. At the same time, they are both net demanders of fund since they demand more
funds than they supply.
Individuals
We are more familiar of the fact that people need money, in the form of loans, to buy
property like cars and houses. Yet individuals supply funds to help meet the needs of
both government and businesses through deposits in savings accounts, purchases of
debt or equity securities, buy insurance or various types of property. As a group,
individuals are net suppliers of funds; they put money into the financial system than
they take out.

4. What are the different types of investments?

Investors can either be individual or institutional.

Individual
Individual investors personally handle their funds to meet their financial goals.
Earning interest from idle funds, ensuring the family’s security and building a
retirement fund are some reasons why the individual investor invests.

Institutional
People with large sums of money for investment or who are too busy or lack expertise
for investment decisions often hire an institutional investor. Institutional investors
commonly know as fund managers, are investment professionals paid to manage the
funds of others using their expertise and sophistication in both investment knowledge
and method. Aside from rich individuals and professional investors include financial
institutions and large non-financial corporations. Individual investors trade in large
amounts of securities to earn high returns that can be used as additional sources of
interest payments (for banks) and benefits to policyholders or beneficiaries (for
insurance companies).

5. What is the life of an investment?

There is a wide range of investment vehicles available to the investor such as

securities, mutual funds, property and others.

Securities
Securities are investments that represent evidence of debt or ownership interest in a
business or other assets. Bonds and stocks are the most frequently used types of
securities.
Investment in securities represents either a debt or an equity interest. Debt represents
funds borrowed in exchange for receiving interest income and the promise that the
loan will be repaid at a given future date. Bonds and commercial papers are example
of debt securities. Equity represents a current ownership interest in a specific business
or property. Typically, an investor obtains an equity interest in a business by buying
securities collectively known as stocks (i.e., common, preferred and convertible
preferred).

Debt securities are similar to bank loans, in that the corporation promises to pay the
face value on the maturity date together with interest payments at regular intervals.
But unlike a bank loan, bonds and commercial papers are represented by certificates,
which are handed over to the buyer who becomes the holder of the certificates. In this
way, stocks are also similar to debt securities – a stock certificate is issued – but differ
in a way that the issuing company does not have the obligation to pay interest to the
holder or repay the face value of the stock.

The investor also has a choice, of which type of securities to invest in depending on
such considerations like cost, rate of return, risk involved and taxes to be paid.

Short-term investment
Examples of short-term investment vehicles are deposit accounts, Treasury bills (T-
bills), commercial papers, certificates of deposit, promissory notes and the like. The
maturity of all these instruments is under one year. These instruments are suitable for
temporarily investing idle funds and earning a return, usually interest. Generally, they
are popular to conservative investors because they carry little or no risk at all. They
are highly liquid since they can be easily converted to cash with little or no loss in
value, thus, enabling the investor to quickly obtain funds to meet unexpected
obligations or shift to more attractive investment opportunities.

Common stock
Buying a share of common stock is in fact buying a share of a business. An individual
who owns shares in, say Petron or PLDT has an ownership interest in that company
and is called a stockholder or shareholder. The he holds are evidence of ownership in
the corporation. The percentage or proportion of ownership depends on how many of
the company’s shares he owns.

For example, 1000 shares of common stock in a corporation that has 100,000
outstanding shares represent 1,000/100,000 ownership interest. This means you have a
one percent ownership interest in the company’s plant, its building, its inventories
and, last but not the least, its management. You own one percent in everything that the
company has or may have in the future. This type of ownership is also referred to as
having equity in a company; hence, stocks are also called equity securities.

Fixed-income securities
Common examples of fixed-income securities are bonds, preferred stocks and
convertible securities. These groups of investment vehicles offers a fixed periodic
return and are quite popular investments during periods of high interest rates since
investors like to have guaranteed high returns.

Bonds
Are long-term debt instruments that offer the holder a known interest return along
with a return of the bond’s face value (the value stated on the face of the certificate) at
maturity (usually 20 years). Bonds are commonly issued by corporations and
governments.

Preferred stocks
Represent an ownership interest in a firm and like common stocks, has no maturity
date. It has however a specific dividend rate. This dividend payment has preference
ove stock dividends paid to common stockholders. Aside from the dividends it pays,
investors buy preferred stocks for the possibility of earning capital gains from its sale.

Convertible security
Is a special type of fixed-income obligation (bond or preferred stock) with a feature
permitting the investor the benefit of earning fixed income such as interest (for bonds)
or dividends (for preferred stocks), while offering the potential of capital gains (like
common stocks)

Mutual funds
A mutual fund is the commonly used name for an investment company, which pools
the money of many investors into a large fund. It is managed by a financial
professional, called an investment adviser or fund manager. who invest this large
accumulation of funds into a large portfolio of securities, such as debt and equity
securities, and other financial instruments.

Property
Investments in property can either be in real property or tangible personal property.

Real estate
This term usually refers to raw land, buildings and that which is permanently affixed
to the land such as residential homes, commercial property (condominiums, office and
apartment buildings), and the like. Returns normally received from this form of
investment are in the form of capital gains, rental income, etc.

Tangibles
Examples of tangibles include gold, precious metals and gemstones, along with
collectible items such as artwork, antiques, coins and stamps. Investors purchase these
in anticipation of price increases.

6. What is the life of an investment?

The life of an investment can either be short or long-term. Sort-term investments

usually mature within one year while long-term investments have longer maturities,
like bonds, or with no maturity at all, like common stocks.

7. What is the importance of investing?

Investing is the process of placing funds in selected investment vehicles with the
expectation of generating positive income and/or preserving and increasing their
value.

The availability of funds in the economy largely influences its growth and continuity.
A cyclical interdependence dictates the flow of funds that are needed to finance the
activities of government, business firms, even individuals. For instance, if fewer
individuals save their money in financial institutions, supply of funds for investments
or borrowings will decline. A shortage in funds for housing loans will result to fewer
houses being bought. Corollary, fewer houses being bought will mean fewer people
being employed to build houses and lower demand for construction materials. This
would also affect the demand for consumer goods such as appliances, furniture and
fixtures, which would in turn affect the sales of the manufacturers of these goods.
Lower sales translate to lower taxes and lower income to be used for business
expansion.

8. What are the rewards of investing?

It must be noted that for the investment process to run smoothly, the suppliers of
funds must be sufficiently compensated by the demanders of funds in exchange for
the risk involved in supplying the funds.

Returns or rewards form investing are in the form of current income or increase in
value. An example of earning current income is placing money in a savings account
that would give periodic (usually quarterly) interest payments or insurance policy that
offers dividends. On the other hand, investing ina piece of property entails
expectations of an increase in its value between the time it was bought and the time it
will be sold.

Part II The Financial Market

1. What are the money and capital markets?

Financial markets are classified into the money market and the capital market. The
money market is where short-term funds are raised through the buying and selling of
short term debt securities such as commercial papers. The capital market is where
long-term funds are raised through the bond market, which deals with long-term debt
securities such as bonds, the stock market which deals with equity securities or stocks.

2. What are the primary and secondary markets?

Basically, it is in the capital market, called the stock market, where an investor can
buy and sell stocks. This market consists of the primary market or secondary market,
depending on whether the securities were sold by the company itself or by an existing
shareholder(s).

Primary market
In the primary market, new shares are issued and sold to the investing public for the
first time. It is where capital is actually raised by the company selling stock directly to
investors typically through an initial public offering. For instance, if San Miguel
Corporation decides to sell a new stock to raise equity funds, it will be a primary
market transaction. Since it is the first time the company has sold stock to the public,
it is called an initial public offering (IPO). The proceeds of the sale go to San Miguel
Corporation, the issuing company. Investors who have subscribed to the IPO have
provided the company with the necessary funds to continue its operation and
expansion, and become part owners of the company.

An underwriter or investment banker assists the issuer of a new security in setting the
offering price and in marketing the securities to the public. The investment bankers
serves as a middleman in the transfer of funds between the company in need of capital
and the public, and facilitates the issuance of shares.
There is occasionally a secondary offering in the primary market. This means that the
shares of stock being offered were previously issued but is being offered to the public
for the first time by a large or controlling shareholder. As such, the selling stockholder
gets the proceeds of the sale.

Secondary market
The secondary market is where securities can be bought and sold after they have been
issued to the public in the primary market. Thus, if you decide to buy existing shares
of San Miguel Corporation, you cannot buy them directly from the issuing company
anymore since they have all been sold to the investing public during the initial public
offering.

So, how can you avail of San Miguel shares when the IPO has been completed?
Investors can only buy these shares from existing shareholders who are willing to sell
their shares. When they do so, it is a secondary market transaction. The proceeds from
this transaction don not go to the issuing corporation; instead they go to the investor
who sold his shares.

The secondary market is where the original shareholders sell their shares to other
investors. An investor can only make a profit when he can sell his shares at a price
higher that the purchase price. This market gives a continuous reflection of the value
of securities (prices) at some point in time according to the best available information.

Secondary markets include the stock exchange and the over-the-counter (OTC)
market.

3. What is a stock market and stock exchange?

There are differences in their definition but real concept of a stock exchange and stock
market remains constant. Simply defined, a stock market is an organized activity
involving the buying and/or selling of securities done within a stock exchange.

In a fundamental sense, a stock exchange brings buyers and sellers together. It is an

organization whose function is to facilitate the purchase and sale of stocks and other
securities. It is a market where investors can buy and sell securities after they have
been offered in the primary market.

Remember that the stock exchange is not a capital raising mechanism. As part of the
secondary market, it is only adjunct to the capital raising market or primary market. It
is merely a place or means where existing shareholders can sell their shares to those
who are ready to buy.

The stock exchange and the stock market facilitate the flow of savings into
investments by providing a ready market for the resale of securities. The inflow of
funds in the stock market is one efficient way of directing a needed resource (in this
case, money) into a growing economy. As such, the stock exchange plays a key role in
economic development by providing a centralized environment that brings together
the demanders and suppliers of funds to make secure and fast transactions.

4. What is the over-the-counter market?

Stocks of corporations not listed and therefore not traded in the stock exchange but
registered and licensed by the Securities and Exchange Commission for sale to the
public are only available in the so-called over-the-counter (OTC) market. This market
is not a specific organization but another way of trading securities. OTC transactions
are carried out by direct inquiries and negotiations among the buyers and sellers
through the use of mail, telephone, telegraph, Teletype, or other forms of
communications.

5. What are the advantages of the stock market?

The stock market is a better market for the trading of securities as opposed to the OTC
because of the following:

Most accessible market

Through the offices of member firms located everywhere, even in the provinces,
stocks are available to millions of people.

Ready market
With a simple phone call, an investor can buy and sell stock, virtually within minutes.
Market transactions are done swiftly, conveniently and at a fair price.

Liquidity of the market

Hundreds of different stocks are available to thousands of buyers and sellers and can
readily be turned into cash due to the large number of market players. The OTC
market is generally much thinner or less liquid which makes it more difficult to sell at
a certain time in a failing market due to lack of buyers.

Operates in full public view

Transactions and price data are readily available through newspapers, radio, television
and information networks. Unlike the stock exchange, the over-the-counter stock
prices are not published daily in the newspapers, which makes it more difficult for an
investor to keep track of his investment.

6. Who are the players in the stock market?

Investors are the ones who buy and sell securities in the hope of receiving dividend
income and making a profit through capital appreciation. These buyers and sellers are
not the only players in the stock market. Other persons or institutions ensure that the
stock market is a readily accessible, efficient, orderly and transparent market. These
are:
Stockbroker
Anyone who wishes to buy shares of stocks or bonds must have a stockbroker. He acts
as an agent or middleman between the investor and other buyers/sellers. As an
intermediary, the stockbroker executes orders for clients, purchasing or selling the
stocks on the stock exchange. He is the only person or corporation authorized and
licensed by the Securities and Exchange Commission to trade in securities. They are
commonly known as members, member-brokers, or member-firms of the Philippine
Stock Exchange.

Stock exchange
This is the organization that oversees the transactions of the buyers and sellers placed
through the member-brokers. Its professional management ensures that the market is
efficient, fair, transparent and orderly by enforcing its rules and regulations.

Transfer agent
When shares are purchased and transferred from the seller to the buyer, the transaction
should be recorded in the stock books of every listed company which record the
complete shareholdings of each stockholder of the company. But most companies
have his record keeping done by a separate agency, called the transfer agent. Thus,
when a transaction has been done, the details are kept in a ledger or record book by
the company’s transfer agent. As such, the transfer agents maintains the ledgers for
each issuer company showing the name and address of, and the number of shares held
by each registered stockholder. Another function of a transfer agent, which is either a
commercial bank or trust company, is to cancel old certificates, issue new certificates
and change the name of the certificates into the buyer’s name when the shares have
been sold.

Clearing House
When a transaction has been made, the seller – through his stockbroker – has to
deliver the stock certificate to the buyer who in turn orders his stockbroker to pay for
the shares purchased. This seems to be an easy process. But considering the thousands
of transactions executed everyday and the nearly 200 stockbrokers involved, broker-
to-broker payments and delivery of certificates would become complicated. To
facilitate transactions and make the market more orderly, all payments by all
stockbrokers are done to a centralized institution, called the clearinghouse. Thus, all
stockbrokers will make payments to and receive payments from the clearinghouse for
purchases and sales they have made for their clients. At the same time, all stock
certificates will be delivered to and obtained from this central institution.

Listed company
A corporation that offers and lists its shares in the stock exchange is called a listed
company or issuer. A listed company is also known as a publicly owned company in
view of the fact that its shares were sold to the investing public. These are the
companies that raised their required funds through such issuance of securities to the
public. The capital raised provides the company with the necessary funds to be
invested in business facilities and equipment. An issuing company becomes a listed
company, whose shares are traded in the stock market, after it has met the strict listing
requirements imposed by the stock exchange.