LECTURE 3

PRIMARY MARKET
The Primary Market is where securities are created. It’s in this market that firms sell new stocks
and bonds to the market for the first time. An initial Public Offering, or IPO, is an example of a
primary market. In the primary market, sell new stocks and bonds to the public. The primary market
is where securities are created, while the secondary market is where those securities are traded by
investors.
The primary market is a part of the capital market. It enables the government, companies, and
other institutions to raise additional funds through the sale of debt and equity related securities. For
example, primary market securities can be notes, bills, government bonds, and stocks of companies.
ENTITIES IN THE PRIMARY MARKET
1. Company – The company issues securities for the first time in the primary market. This process is
known as Initial Public Offering. Since the securities are sold for the first time, the primary market is
known as the New Issue Market.
2. Underwriter – The underwriter decides the sale price of the new issue securities. Financial
institutions such as investment banks, insurance companies, etc offer underwriting services. Also,
the underwriter facilitates and monitors the new issue offering. Hence, underwriting is an entire
process of raising capital by selling new stock to investors through IPO
3. Investors – They are the purchasers of the new security in the primary market.

The company issues the securities to its investors. The issue can be in the form of a public issue,
private placement, rights or bonus issue. Once the company receives the money, it issues the
certificate to the investor. The certificate can be issued at face value, premium value or par value.
When the issue closes, securities are traded in the secondary market. The trading in the secondary
market can happen on the stock exchange.
The company that offer securities are looking for expanding their business operations funds their
business targets, or increase their physical presence across the market.

FUNCTION OF PRIMARY MARKET

The key function of Primary Market is to facilitate capital growth by enabling individuals to convert
savings into investments. It facilitates companies to issue new stocks to raise money directly from
households for business expansion or to meet financial obligations.
PRIMARY DISTRIBUTION OF SECURITIES
Primary distribution refers to the sale of a new security, public reception to new issue is still
unknown factor, hence great care is required when an initial issue has to be distributed that even
well established companies take precautions in marketing a new issue through experienced
institutional security dealer (5 best stock brokers in the Philippines: First Metro Sec Pro., COL
Financial, BDO Securities, BPI Trade, Philstocks). Primary distribution is mostly done via the
investment bankers, private placement, or direct sale by a company to individual investors. New
issues are never traded through the security exchanges.
The Secondary Market is created for seasonal securities. These are securities which have passed the
test of public acceptance. They are being traded by original holders. The security exchanges are the
principal secondary market for the public offering of seasonal securities.
The choice of the distribution method will be between selling through expert middlemen and direst
private disposal by the issuer. A corporation usually resorts to an investment house which may
underwrite the security by itself or as part of an underwriting syndicate or merely act as an agent in
a selling group. Underwriter is a bank of financial institution that pledges to buy all the unsold
shares in an issue of new shares. Underwriter syndicate is a temporary group of bans and broker-
dealers who come together to sell new offerings of equity or debt securities to investors.
THE INVESTMENT HOUSE
An investment or bank is an intermediary between the sources of capital, the investors, and its
users, the business firm. The primary business of the investment house is the marketing of financial
instruments. Its broader role encompasses investment and consultancy services.
In the performance of its functions, an investment banker may find itself in the position of creditor,
investor, agent or consultant. It is called a bank because it is a financial institution that acquires
funds for business use, however it does not accept money deposits. It acts as depository of financial
instruments acquired either on an agency basis or through outright purchase.
Most corporations do not raise long-term capital frequently. The activities of working capital
management go on daily, but attracting long-term capital involves huge sum of money and this
situations considered the importance and expertise of an Investment banker.
Definition of Investment Banker
The investment banker is a financial specialist involved as an intermediary in the merchandising
of security. He or she acts as a middle person by facilitating the flow of savings from those
economic units who wants to invest to those units that want to raise funds. The investment banker
work in an investment banking firm or an investment banking house.
Investment House in the Philippines:
1. RCBC CAPITAL
2. AB CAPITAL AND INVESTMENT CORPORATION (Asian Bank)
3. CLSA EXCHANGE CAPITAL, INC
4. INVESTMENT AND CAPITAL CORPORATION
5. ORTIZ JM AND COMPANY INCORPORATED
6. STATELAND INCORPORATED
COMPETITIVE BIDDING
The primary distribution of new issues follows some general pattern. The marketing of securities
may be done through formal negotiations between the investment banker and the issuer or through
competitive bidding. Under the competitive bidding, the issue is auctioned by the company and
awarded to the highest bidder. A common practice is for a group of investment bankers to form a
syndicate. This is a group participation in a certain issue. The members of the syndicate may agree
among themselves as to the price they are going to bid. This is determined after considering the
estimated selling price to the public and the “spread” of gross profit, of the syndicate. There is a
separate agreement that governs the relationship of the individual members. The agreements
covers all aspects of the transactions including the liability of each in the event of any breach of
contract.
NEGOTIATED DISTRIBUTION:
Most issuers prefer to negotiate with particular investment house who have their confidence, whose
ability and integrity they could depend on. As in the case of competitive bidding, negotiations may
be made with only one investment banker or with a syndicate. The investment banker who conducts
the preliminary arrangements with the issuer is called “originator”
There are three functions of investment banker.
1.Underwriting
The term underwriting is borrowed from the field of insurance. It means assuming a
risk. The investment banker assume the risk of selling security issue at a satisfactory price. A
 satisfactory price is the one that generates profit for the investment banking house. Some
economic units will actually purchase the financial claims of borrowing units and sell them at a
higher price to investors, this process is called underwriting.
The procedure goes like this. The managing investment banker and its syndicate will buy a
security issue from a corporation in need of funds. The syndicate is a group of another investment
banker who are invited to help buy and resell the issue. The managing house is the investment-
banking firm that originated the business because its corporate client decided to raise external
funds. On a specific day, the firm that is raising capital is presented with a check in exchange with
the securities being issued. At this point investment-banking syndicate owns the securities. The
corporations has its cash and proceed to use it. If the price of the newly issued security falls below
that paid to the firm by the syndicate, the syndicate will suffer a loss. Its objective is to sell the new
issue to the investing public at a price per security greater than its cost.
There are three major variations of local underwriting agreements: on firm basis, on stand-by, or on
a best effort basis.
An underwriting agreement is said to be on firm basis, if the investment house agrees to
purchase the issue from the corporation. The investment banker or the syndicate takes all the risks
in the disposal of the security. The issuing company is assured of cash payment at the specific
period agreed upon.
An example of an underwriting agreement on a firm basis through a syndicate is the public
offering of the 8% debenture bonds of Northern Motors, Inc. Three investment houses agreed to
purchase the bonds outright in the following corporations: CCP Securities Corporation, the syndicate
manager, P2 million; Bancom Development Corporation P1 million; and Private Development
Corporation of the Philippines, P 500,000. Likewise, the CCP securities Corporation was the sole
underwriter on firm basis of the Cummins Diesel Sales and Service Corporation 12% guaranteed
bonds worth P1,000,000.
In a stand-by underwriting agreement, the investment banker agrees to purchase whatever
portion of the issue will be left unsold after the offering period. This type is frequently used in the
stock issue where outstanding stockholders may exercise their preemptive rights. The portion of the
stocks that will not be subscribed by the stockholders is bought by the investment banker.
A best effort basis is more of a selling agreement than an underwriting contract. The investment
house merely pledges to exert its best efforts to sell the securities. There is no assurance as to how
much will be sold and when the cash will forthcoming to the company.
SPREAD The originator conducts investigations on the feasibility of an issue before the drawing of
the underwriting contract. Both the present and future financial positions of the company and the
viability of the project for which the funds to be raised will be invested and the projection of market
conditions are explored. The investment banker has to determine its gross profit or spread. The
spread will be determined by the amount of risk involved, the extent of selling campaign necessary
and the bargaining positions of the parties (the issuer and the investment house)
2. DISTRIBUTION OF SECURITIES
Once the syndicate owns the securities, it must get them into hands of the ultimate investors.
This is the distribution or selling functions of investment banking. The investment banker may have
different branches with dealers involved in the selling effort. The syndicate can be viewed as
wholesaler of security and dealers are retailers of security.
The arrangement with the investment house may either be outright purchase of the issue in full
or in part or merely on a selling agency, which is the best effort, basis.
Prospectus. A prospectus is a primer on a security issue. It has a detailed description of its
features and includes factual information on the operations and financial position of the issuing
company. In some jurisdictions, the distribution of a prospectus to potential buyers is compulsory in
the initial public offering of a security. The purpose is to acquaint buyers with the nature of the
issue. The manager of the selling group furnishes the prospectus to dealers and brokers subsequent
to the filing of the registration statement but before the offering date.
Offering Period. As soon as the required registration has been approved by the SEC, the offering
period starts. Personal offers are present to dealers with complete information as to offering price
and sales commission. Underwriters are particularly concerned with selling the issue quickly as
possibly to avoid any unfavorable changes in the market price.
3. Advising
The investment banker is an expert in the issuance and marketing securities. A sound
investment house must be aware of prevailing market conditions and can relate those
conditions to the particular security that could be sold at a given time. Business conditions may
include the future interest. The investment banker may advice the firm to issue in a proper
timing to avoid the higher yield that are forthcoming. The banker can analyze the firm’s capital
structure and make recommendations as to what general source of capital should be issued, at
this point the banker is invited to sit with the board of directors to observe corporate activity
and make recommendations in a regular basis.
 LECURE 4
SECONDARY MARKET
SECURITIES AND EXCHANGE COMMISSION: an independent government agency which supervises the
securities market, oversees the operation of the PSE and its members, and ensures compliance with the
provisions of the securities act. Also issues the rules and regulations subject to the approval by the
Monetary Board.

HISTORY

The SEC was created by Congress of the Philippines in 1936 as part of the Securities Act
(Commonwealth Act No. 83). This occurred just after the United States Congress created the United
States Securities and Exchange Commission. The first commissioner of the SEC was Ricardo
Nepomuceno. The SEC was not in operation during the Japanese occupation of the Philippines, but was
restored in 1947.

FUNCTIONS

Major Function include: Registration of securities, analysis of every registered security, evaluation of the
financial condition and operations of applicants for security issue.

FUNCTIONS OF SEC DEFINED IN Section 5 of the Securities Regulation Code

Supervision of over all registered business entities in the country, including suspensions and revocations
of their registration.
Policymaking with regard to the market insecurities.
Control over and approval of security registration statements
Power to investigate violations of securities laws and to impose sanctions for such violations.
Power to issue subpoenas, punish for contempt, and issue cease and desist orders in furtherance of its
law enforcement mission.
PHILIPPINE STOCK EXCHANGE

A self-regulatory organization with the authority to police its ranks through the Compliance and
Surveillance Group (CSG)

The PSE is a private non-profit and non-stock organization created to provide and maintain a fair,
efficient, transparent and orderly market for the purchase and sale of securities such as stocks,
warrants, bonds, options and others.

THE ROLE OF THE PSE

-The PSE bring together companies which aim to raise capital through the issue of new securities
-Companies have an easier access to their funds through the listing of their share in the stock exchange.
It is easier to raise new capital through initial public offering if listed in Exchange.
-PSE plays a vital role in the financing of productive companies that uses the funds for further expansion
that is essential for the economic growth.
-The PSE facilitates the selling and buying of the issued stocks and warrants.
-It provide suitable market for trading securities to individuals and organization who want to invest their
savings and excess funds.
-The PSE is committed to protect the interest of the investing public. Develop and maintain an efficient,
fair, orderly and transparent market.

EFFICIENT MARKET – Orders are executed and transactions are settled in the fastest possible way.
-Fully automated machine is installed. Installation of trading terminal outside metro manila to
encourage provincial investors
FAIR MARKET – PSE assures that no investor will have undue advantage over another market player in
manipulating prices and engaging into insider trading.
-Insider trading is the act of buying and selling a particular stock based on certain privileged information
which is not available to the public, this is illegal and prohibited by the PSE.

MARKET TRANSPARENCY – I is an assumption that investor can only make informed and intelligent
stock information about the particular stocks he wants to buy.
The PSE required the listed companies to disclose timely, complete and accurate material
information to the exchange and the public regularly.

UNIT TRADING
For the convenience in making and executing orders, the exchanges establishes a unit of trading
called board or round lot. Board lot means buying or selling the securities in an established amount. The
PSE establishes board lots on the basis of respective price ranges, for example, with an offering price for
shares from P0.01 to P0.024 centavos the board lot is 20,000 shares; for the P50 to P100 price range per
share, the board lot is 10 shares. That is, orders for stocks prices from one centavo to .025 centavos
should always be in terms of 20,000 shares, and for the P50 to P100 price, in terms of ten shares.

BUYING AND SELLING ORDERS - The order to buy or sell may either be at the market price basis or a
limit order. The market price order is easier to execute because the broker will buy or sell at whatever
price the security is being traded at the order is made. The limit order specifies a maximum order price
to buy at not more P10, it means that that the broker is instructed to buy at P10 or less. A broker
ordered to sell at no less than P10 could sell the security only at any price at over P10.
Trading in the exchange is a continuing auction sale. (The PSE is open Monday through Friday
from 9:30 am to 12:45 pm Philippine Standard Time. The PSE does not close for lunch, there is typically
less liquidity during the middle of the day. Most trading happens near the beginning and the end of the
day. Market resumes 1:30 PM and Pre close 3:17 PM)
Brokers with buy orders compete with each other in purchasing the stocks at the lowest bid
price. Bid price is the price the buyer is willing to pay for a certain security. Brokers compete with each
other in selling the stocks at the highest asked price. Asked price is the price at which the security is
offered for sale.
It is evident that exchanges do not fix price of securities on their floors. The market price is
dictated by supply and demand conditions and the continuous bargaining between buyers and sellers.
There are many factors that influence stock price; discovery of oil, world price of copper, available
reports on a company etc.

However, the PSE controls price behavior imposing minimum fluctuations for each security in
accordance with its respective range. Quotations mat not fail below nor rise beyond 20% of the last
sales price. To illustrate; minimum fluctuations allowed for securities within the price range of P50 to
P100 per share is P1. Shares for P100 may not be quoted above P101 nor below P99. Or if the last sales
price is P100 the subsequent quoted price may not rise above P120.

JOLLIBEE FOOD CORPORATION

Feb 10, 1021 12:52 pm PHST
Market Open P185.50

Previous Close: P184.90

Open : P185.00
Day Range: P184.90 – P187.00
52 Wk Range P91.10 - P211.00
Market Value P202.7B

MARGIN TRADING – An investor may pay in full for the security he buys or he may just put up a portion
of the purchase price. Margin trading refers to the purchase of securities where the buyer only pays a
part of the purchase price with the balance usually advance by the broker, payable at specified future
time. Thus an investor Mr. X may buy P5,000 worth of stock and pays only P2,500 to the broker. The
balance is payable at a later date. The margin payment is commonly expressed in percentage. In our
example, the buyer Mr. X puts up 50% of the purchasing price. The broker advances the money for the
unpaid balance P2,500 to the seller of the security. Mr. X then owes the his broker the amount
advanced on which the broker may charge interest. The broker keeps the security purchased as a
collateral.

STOP LOSS ORDER – The authority of the broker to sell the purchased security at a target price is
contained in a stop loss order. However the broker is no obliged to wait until the specified price is
reached since the order is usually issued by the investor to protect himself against loss in a highly
fluctuating market. The broker is given the discretion I determining the best price at which to sell even if
the target price is not reached.

Government and Financial Institution

Government financial assistance in the past has been mostly for the acquisition and
maintenance of fixed assets. This shift in the government’s financial policy could partly be attributed to
the growing awareness of the government to the importance of working capital in the operation of a
firm and the partially of the World Bank in Financing SME’s.

Sources of Government Financing

Government advances for working capital needs are mostly to provide for fixed or permanent
working capital needs are mostly to provide for fixed or permanent working capital and to extent
working capital financing to small and medium scale businesses. Landbank of the Philippines and Rural
Banks are the primary source of financing.

Secondary market simply represent trading in already existing financial claims. If you buy your brother’s
Meralco common stock, you have made a secondary market transaction. Secondary market reduce the
risk of investing in financial claims. Should you need cash, you can liquidate your claims in the
secondary market.

Financial intermediaries are financial institutions which include commercial banks, savings and loan
association, credit unions, life insurance companies, and mutual funds. Financial institutions has
common characteristics: they offer their own financial claims of other economic unit. These latter
claims can be called indirect securities, to economic units with excess savings. The proceeds from
selling their indirect securities are then use to purchase the financial claims of other economic units.
These latter claims can be called as direct securities.

Examples:
A mutual fund might sell a mutual fund shares (their indirect security) and purchase the
common stock (direct securities) of some major corporations.
A life insurance companies sell life insurance policies and purchases huge quantities of
corporate bonds. Financial intermediaries thereby involve many small savers in the process of capital
formation.
Another financial intermediary are private pension fund. In comparison to insurance
companies, first, private pension funds have grown at a much faster rate than insurance company,
second, a greater proportion of the financial asset mix of the pension funds is devoted to corporate
stocks and bonds. Third, the pension funds invest more heavily in corporate stocks than they do in
corporate bonds.

Movement of Savings
1. The direct transfer of funds – Here the firm seeking cash sells its securities directly to savers
(investors) who are willing to purchase them in hopes of earning a reasonable rate of return.
New business formation is a good example as the new business ay go directly to a saver or
group of savers called venture capitalists. The venture capitalist will lead funds to the firm
or take an equity position in the firm if they feel the product or service the new firm hopes
to market will be successful.
2. Indirect transfer using the investment banker – The managing investment-banking house
will form a syndicate of several investment bankers. The syndicate will buy the entire issue
 of securities from the firm that is in need of financial capital. The syndicate will then sell the
securities at a higher price than it paid for them of the investing public (the savers). Note
that second method of transferring savings, the securities being issued just pass through the
investment-banking firm. They are not transformed into a different type of security.
3. Indirect transfer using the financial intermediary. This system operates in life insurance and
pension funds. The financial intermediary collect the savings f individuals and issues its own
(indirect) securities in exchange of the savings. The intermediary then uses the funds
collected from the individual savers to acquire the business firm (direct) securities, such as
stocks and bonds.

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