CHAPTER 13

INTRODUCTION TO INVESTMENTS
 Investment
How various fields view “Investment”:
• Accounting – refers to assets held by the
business for the accretion of wealth through
distribution
• Economics – tangible or physical assets
• Finance – amount of money invested in
financial assets

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 Types of Investments
1. Financial instruments – financial assets to one
party and financial liability or equity to another

Stock – equity instrument

Bond – debt instrument

2. Non-financial instruments

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 Bonds
Bond – an unconditional promise to pay:

a. Specified sum of money at a determinable

future time
b. Periodic interest based on the agreement

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 Bonds
Types of bonds:

1. Term bond – single maturity date

2. Serial bond - series of maturity dates
3. Callable bond – bond that can be redeemed by
the issuing company prior to the maturity date
4. Convertible bond – bond that offer the
bondholder the right to exchange the bonds to
shares of stock prior to maturity date

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 Nominal Rate vs. Effective Interest Rate

Nominal rate
• interest rate that appears on the face of the
bonds
Effective interest rate
• also known as yield to maturity or market
interest rate
• Actual rate of interest that investors earn from
investment in bonds
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 Effective Interest Rate
Three factors that influence the effective
interest rates of the bonds
• Real rate of return
• Inflation premium
• Risk premium – comprised of business risk and
financial risk

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 Valuation of Bonds
How is the market price determined?

PV of principal (PV of lump sum) + PV of interest

payments (PV of ordinary annuity)

= Market Price of the Bond

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 Discount vs. Premium
Discount
• Face value of the bonds > market price
• Nominal rate < the effective interest rate

Premium
• Face value of the bonds < market price
• Nominal rate > the effective interest rate

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 Bondholder vs. Stockholder
Bondholder
• Owner of a debt instrument
• Earns through interest income
• Bonds generally have maturity dates

Stockholder
• Owner of an equity instrument
• Earns through dividends
• Stocks generally do not have maturity dates

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Common Stock vs. Preferred Stock
Common Stock
• Ordinary shares
• Have voting rights

Preferred Stock
• Preferred shares
• Preferred as to dividends and net assets

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 Valuation of stocks
Par value
• Nominal value of the shares
• Usually indicated in the articles of incorporation
• The Corporation Code of the Philippines prohibits
any corporation from issuing shares of stock
below the par value
No-par value
• Shares that do not have par value
• Stocks issued at their stated value should never
be lower than P5.00

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 Valuation of stocks
Stock Price or Current Market Price
• “true” or intrinsic value of the stocks
• Estimated value
• Primarily affected by the true returns on
investment and expected risks

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 Valuation of stocks
Initial Public Offering (IPO)
• The sale of stocks based on their stock price
happens when the corporation goes into
public for the first time
• Stock issuances after the IPO are already
based on the current market value

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 Valuation of stocks
The two stock valuation methods are the
following:
1. Discounted dividend model
2. Constant growth model

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 Discounted Dividend Model
• Estimates the current market value of the
stocks by considering only the expected
divided that may be received

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 Constant Growth Model
• Uses the next year’s dividend D1 = D0 (1+g) as
numerator
• Assumes that dividends of companies will
grow at a constant rate
• May be applied to mature companies or
companies that have been in the market for
several years

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 Undervaluation vs. Overvaluation
Undervalued
• Stock price computed using stock valuation
model > current market value

Overvalued
• Stock price computed using stock valuation
model < current market value

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