Chapt

er1.TheFi
nanci
alI
nst
it
uti
onsandSt
ockFi
nanci
ng

Fundsar
erai
sedbyf
inancecompani
esj
ustl
i
keanyot
hercor
por
ati
on,by
i
ssui
ngst
ocksandbonds,bor
rowi
ngf
rom t
hebanksandsel
l
ingt
hei
rcommer
cial
paper
.Al
lthesear
etheser
vicespr
ovi
dedbyt
heCapi
tal
Mar
ket
.

Fi
nance,asat
erm,hasbeendef
inedbysev
eralaut
hor
sinv
ari
ousway
s,
Bannockandot
her
sdef
inef
inanceas:
“
thepr
ovi
sionofmoneywhenandwher
erequi
red,
”
Webst
er,
ont
heot
herhand,
decl
arest
hat
“
fi
nancei
sthesci
enceofmanagi
ngmoney
,onei
therapr
ivat
eorpubl
i
cscal
e.”
“
fi
nancei
sthatadmi
nist
rat
ivear
eaorsetofadmi
nist
rat
ivef
unct
ionsi
nan
or
gani
zat
ionwhi
chhast
odowi
tht
hemanagementoft
hef
low ofcashso
t
hatt
he or
gani
zat
ion wi
l
lhav
ethe means t
o car
ryouti
ts obj
ect
ive as
sat
isf
act
ori
l
yaspossi
bleandatt
hesamet
imemeeti
tsobl
i
gat
ionasi
tfal
l
s
due.
”

Fi
nance compani
es ar
ethose whi
ch ar
e engaged i
n maki
ng shor
tand
i
nter
medi
atet
erm i
nst
all
mentl
oans t
o consumer
s,f
act
ors off
inance busi
ness
r
ecei
vabl
esandf
inancet
hesal
eofbusi
nessandf
arm equi
pment
.Fundsar
erai
sed
byf
inancecompani
esj
ustl
i
keanyot
hercor
por
ati
on,byi
ssui
ngst
ocksandbonds,
bor
rowi
ngf
rom t
hebanksandsel
l
ingt
hei
rcommer
cial
paper
.

Thr
eeTy
pesofFi
nanceCompani
es
1.Sal
esFi
nanceCompani
es–ar
efi
rmsspeci
ali
zi
ngi
nthepur
chasef
rom r
etai
l
ersof
t
hei
nst
all
mentr
ecei
vabl
esar
isi
ngoutofr
etai
lsal
esofaut
omobi
l
es,appl
i
ances,
dur
abl
egoodsont
hei
nst
all
mentpay
mentpl
an.

2.Busi
nessorCommer
cialFi
nanceCompani
es–Busi
nessorcommer
cialf
inance
compani
esl
enddi
rect
lyt
oawi
dev
ari
etyofbusi
nesses,
mai
nlyofsmal
landmedi
um
si
ze.Shor
t-
ter
mloansar
egr
ant
edbyt
hist
ypeoff
inancecompani
esagai
nstt
he
secur
it
yofassi
gnedaccount
srecei
vabl
e,i
nvent
ory
,andequi
pment
.

1
3.Per
sonalFi
nanceCompani
es–Fi
nancecompani
eswhi
char
eengagedpr
inci
pal
l
y
i
n per
sonall
oans ar
e cal
l
ed per
sonalf
inance compani
es. Thei
rloan por
tfol
i
o
howev
er,mayi
ncl
ude mi
scel
l
aneous busi
ness l
oans and commer
cialaccount
s
r
ecei
vabl
eloans.

Al
soi
ncl
udedi
s,

I
nsur
ancecompani
espr
ovi
deast
abl
esour
ceofshor
t-
ter
mfunds.A l
ookatt
he
pl
acementact
ivi
ti
esoft
hei
nsur
ancei
ndust
ryi
nthePhi
l
ippi
nespr
ovi
desacl
uet
oit
s
i
mpor
tanceasasour
ceoff
undi
ng.I
nsur
ancecompani
esi
not
herpar
tsoft
hewor
ld
al
sopr
ovi
dear
eadysour
ceoff
undi
ngf
orpr
ivat
ebusi
ness.

St
ockFi
nanci
ng
Whensal
esofst
ockar
esol
dtor
aisef
undsf
ort
hel
ong-
ter
m f
inanci
ng
r
equi
rement
soft
hef
ir
m,t
hismeansi
scal
l
edst
ockf
inanci
ng,t
heobj
ectofst
ock
f
inanci
ngi
stoi
ncr
easeequi
tycapi
tal
.Lar
geandsmal
lfi
rm achi
evet
hisbysel
l
ing
shar
esofst
ock. Publ
i
cut
il
it
yfi
rmsi
nthePhi
l
ippi
nes,f
ori
nst
ancef
inancet
hei
r
ex
pansi
onbyst
ockf
inanci
ng.Thecapi
talr
equi
rement
soft
hef
ir
m consi
stoft
hree
aspect
s:shor
t-
ter
m,i
nter
medi
ate-
ter
m,andl
ong-
ter
m.

Thel
ong-
ter
m capi
talr
equi
rement
soft
hef
ir
minv
olv
edt
heaccumul
ati
onof
v
aluesorf
ixedasset
s.Att
heor
gani
zat
ionalst
age,
thef
ir
m wi
l
lrequi
ref
undsf
ort
he
acqui
si
ti
onofpl
antandequi
pment
,fur
nit
ureandf
ixt
ureset
c.Af
teracer
tai
nper
iod,
managementmaydeci
det
oexpandi
tsact
ivi
ti
es,acqui
reanexi
sti
ngf
ir
m,r
efi
nance
i
tsownoper
ati
ons,
oror
gani
zenewv
ent
ures.

Capi
tal
Stock
Thei
nter
estoft
heowner
sinacor
por
ati
oni
scal
l
edcapi
tal
stock.I
tisdi
vi
ded
i
ntoshar
es,
wit
heachshar
erepr
esent
ingapor
ti
onoft
het
otal
owner
shi
pint
erest
.

Thecapi
talst
ockappear
ingi
nthef
ir
msBal
anceSheeti
snomi
nalandi
s
di
ff
erenti
nit
schar
ter
. Apor
ti
onoft
heaut
hor
izedst
ockwhi
chhasbeeni
ssuedand
sol
di edi
scal
l ssuedst
ock.Thosewhi
char
enoty
eti
ssuedar eduni
ecal
l ssuedst
ock.

Ther
ear
etwopr
imar
ysour
cesofl
ong-
ter
mfi
nanci
ng,

2
1.Sal
eofSt
ocks
2.Sal
eofBonds

Cl
assesofCor
por
ateSt
ocks
1.CommonSt
ock
2.Pr
efer
redSt
ock

CommonSt
ocki
sthatcl
assofst
ocki
ssuedbyal
lcor
por
ati
onsandwhi
ch
r
epr
esent
sther
ealequi
tycapi
tal
.Ithasar
esi
dual
clai
m(af
terdebthasbeenpai
d)t
o
ear
ningsandasset
sandwhi
chcar
ri
est
her
iskofbusi
nesssuccessorf
ail
ure.

Char
act
eri
sti
csofCommonSt
ock:

1.Commonshar
ehol
der
shav
ether
ightt
ovot
einshar
ehol
der
smeet
ings
wher
e maj
ori
ssues such as mer
ger
s and acqui
sit
ions ar
e deci
ded The
i
nvest
or'
sabi
l
ityt
oinf
luencedeci
sionsdependsont
henumberofshar
es
owned,t
hegener
alr
ulebei
ngoneshar
eonev
ote.Howev
er,mosti
nvest
ors
t
endt
obepassi
veandsi
gnpr
oxyf
ormsaut
hor
izi
ngamemberoft
heboar
dof
di
rect
orst
ovot
eont
hei
rbehal
f.Suchact
iont
endst
odepr
ivet
hei
nvest
or
f
rom di
rectpar
ti
cipat
ioni
nrunni
ngt
hecompany
'saf
fai
rs.

2.Fr
om t
hef
ir
m'sper
spect
ive,
commonst
ocksr
epr
esentaper
manentsour
ce
off
inanci
ng,si
ncet
heyar
enotr
edeemabl
eandt
hecompanyi
sunderno
obl
i
gat
iont
opaydi
vi
dends,
eveni
npr
ofi
tabl
eyear
s.

3.Thei
ssuanceofcommonshar
esr
educest
her
ati
oofdebti
nthecompany
's
capi
talst
ruct
ure,i
ncr
easi
ngt
hedebtcapaci
tyoft
hef
ir
m,i
e,
,i
tincr
easest
he
f
ir
m'sabi
l
ityt
oobt
aindebti
nthef
utur
ewhenneeded,ot
hert
hingsr
emai
ning
const
ant

4.Commonst
ockcanbei
ssuedi
npar
tl
ypai
dfor
m.Thi
soccur
swhent
he
i
ssueronl
yrequi
resapr
opor
ti
onoft
hepr
oceedsoft
hei
ssueoft
heshar
eto
bepai
dati
ssue,t
her
estbecomi
ngpay
abl
eatcer
tai
nspeci
fi
eddat
esi
nthe
f
utur
e.

5.Commonst
ocki
sgener
all
yregi
ster
edi
nthenameoft
hepur
chaserandi
s
t
her
efor
epr
otect
edagai
nstl
osst
hrought
hef
torf
ir
e.Somet
imesshar
esar
e

3
 i
ssued i
n bear
erf
orm,wher
e no r
egi
steri
s mai
ntai
ned and phy
sical
possessi
onoft
heshar
ecer
ti
fi
cat
eisr
equi
redaspr
oofofowner
shi
p.Bear
er
i
nst
rument
smi
ghtbeat
tract
ivet
oinv
est
orswho woul
dli
ket
o mai
ntai
n
anony
mit
yfort
axr
easons.

7.Commonst
ockhol
der
sar
egr
ant
edv
oti
ngr
ight
ssi
ncet
heyar
epar
towner
s
oft
hei
ssui
ngcompany
.Howev
er,
somecompani
eshav
emor
ethanonecl
ass
ofcommonst
ock,onecl
asshav
ingt
her
ightt
ovot
eandt
heot
hernothav
ing
t
her
ightt
ovot
eandr
efer
redt
oasnon-v
oti
ngshar
es.

Pr
efer
redSt
ocki
sthatcl
assofst
ockwhi
chhasacl
aim onasset
sbef
ore
commonst
ock,
int
heev
entt
hatt
hef
ir
misdi
ssol
vedandi
tal
sohasapr
iorcl
aimt
o
di
vi
dendsupt
oaspeci
fi
edamountorr
ate.

Char
act
eri
sti
csofPr
efer
redSt
ock:
1.St
ockev
eni
fiti
spr
efer
red,doesnotcont
ainanypr
omi
seofr
epay
mentof
t
heor
igi
nal
inv
est
ment
;andasf
arast
heshar
ehol
der
sar
econcer
ned,
thest
ock
i
saper
manenti
nvest
mentf
ort
hel
i
feoft
hecompany
.

2.Thebenef
itofi
ssui
ngpr
efer
redst
ocksi
sthatt
heyshar
ethesamef
eat
ures
asabondbutwi
tht
headv
ant
aget
hatt
hef
ir
m canski
pthepr
omi
seddi
vi
dend
i
ntheev
entoff
inanci
aldi
ff
icul
ty.Fur
ther
mor
e,si
ncepr
efer
redst
ocksdonot
hav
evot
ingr
ight
stheydonotcausedi
l
uti
oni
nthecont
rol
oft
hecompany
.

3.Onedi
sadv
ant
agei
sthatunl
i
kecouponpay
ment
sonbonds,di
vi
dendsar
e
pai
dfr
om af
tert
axpr
ofi
tsandt
her
efor
edonotl
essent
het
axpay
abl
e.

4.The second di
sadv
ant
age r
elat
ivet
o bondsi
sthat
,inv
est
orsconsi
der
pr
efer
redshar
est
ober
iski
eranddemandahi
ghery
iel
dbef
oret
heywi
l
linv
est
i
nthem.

5.Thecostoff
undsr
aisedt
hrought
hei
ssueofpr
efer
redst
ocksi
shi
ghert
han
t
hecostoff
undsf
rom bondi
ssues.

Par
ti
cul
arcl
assesofpr
efer
redst
ockcani
ncl
ude:

1)par
ti
cipat
ingpr
efer
redst
ock;

4
 2)r
edeemabl
epr
efer
redst
ock;
and

3)conv
ert
ibl
epr
efer
redst
ock.

Cl
assesofPr
efer
redSt
ock

1.Par
ti
cipat
ingpr
efer
redst
ockgi
vest
hest
ockhol
der
stheabi
l
ityt
orecei
ve
l
argerdi
vi
dendsi
nper
iodswher
ethei
ssuergener
atessubst
ant
ialpr
ofi
ts.The
pr
efer
red st
ockhol
der
s can onl
yrecei
ve upon l
i
qui
dat
ion i
ts shar
e af
ter
cr
edi
tor
shav
ebeenpai
d.

2.Redeemabl
e pr
efer
red st
ock gi
ves t
he i
ssuert
he abi
l
ityt
orepayt
he
pr
efer
redst
ockhol
der
satpar
ti
cul
arpoi
nts.Ther
edempt
ioni
snotr
equi
red,
and
i
fthei
ssuerwasi
nfi
nanci
aldi
ff
icul
tyi
twoul
d beunabl
etor
edeem t
he
pr
efer
redst
ock.
3.Conv
ert
ibl
epr
efer
redst
ocki
spr
efer
redst
ockwher
ethest
ockhol
derhast
he
opt
iont
oconv
erti
ntoaspeci
fi
ednumberofor
dinar
yshar
es.Unt
ilconv
ersi
on,
t
hepr
efer
redst
ockhol
derwi
l
lrecei
vepr
efer
reddi
vi
dendsandhav
enov
oti
ng
r
ight
s.Af
terconv
ersi
on,t
hest
ockhol
derwi
l
lbeacommonst
ockhol
derand
gai
nvot
ingr
ight
s.

I
nvest
menti
nBonds
Bondsr
epr
esentdebtcl
aimsi
ssuedi
nret
urnf
orbor
rowi
ngbycor
por
ati
ons
andgov
ernment
s.
Abondi
sacont
ractbet
weent
hei
ssuer(
thebor
roweroff
unds)andt
hebuy
er
(
thel
enderori
nvest
oroff
unds)oft
hebond.Undert
hiscont
ract
,thesecondbuy
er
l
endsacer
tai
nsum t
othei
ssuer
,whoagr
eest
orepayt
hepr
inci
palandagr
eedupon
i
nter
estatspeci
fi
eddat
es.Thecont
ractmaycont
ainot
hercondi
ti
onst
opr
otectt
he
l
endersuchaspl
edgi
ngcer
tai
nasset
sascol
l
ater
al,
inwhi
chcaset
hebondi
scal
l
ed
amor
tgagebondorsecur
edbond.
Bondsi
ssuedbycor
por
ati
onsandbusi
nessesar
ecal
l
edCor
por
ateBonds,
whi
l
ethosei
ssuedbyt
hegov
ernmentar
eei
t edTr
hercal
l easur
yBonds(
T-Bonds)or
Tr
easur
yNot
es(
T-Not
es)
.
Gov
ernmentbondswi
thmat
uri
ti
esbet
ween1and10y
ear
sar
egener
all
y
cal
l
edT-
not
eswhi
l
ethosewi
thmat
uri
ti
esl
ongert
han10y
ear
sar
ecal
l
edT-Bonds.

5
Thr
eeel
ement
schar
act
eri
zeabond.
1.Themat
uri
tyoft
hebond,
whi
chi
ndi
cat
est
het
imeper
iodoft
hel
oan.
2. Thef
acev
alueorparv
alueoft
hebond.Thi
sindi
cat
est
hepr
inci
pal
amount
3.Thebor
roweragr
eest
orepayatmat
uri
ty.

Bondscanhav
eav
ari
etyoff
eat
ures,
someofwhi
char
edescr
ibedbel
ow:
1.Fi
xedv
s.Fl
oat
ingI
nter
est
.Fi
xedr
atebondspayaf
ixedper
cent
ageoft
he
parv
alueoft
hebondatr
egul
ari
nter
val
s(nor
mal
l
yev
ery6mont
hs)
.Fl
oat
ing
r
ate bonds on t
he ot
herhand pay v
ari
abl
erat
es ofi
nter
estwhi
ch i
s
det
ermi
nedbymar
keti
nter
estr
ates(
suchas6mont
hLI
BOR)att
het
imeof
t
heper
iodi
cpay
ment
.Af
loat
ingr
atebondpr
ovi
despr
otect
ionagai
nsti
nter
est
r
ater
isk.Bondswi
thaf
loat
ingr
ateofi
nter
estar
eof
tenr
efer
redt
oasf
loat
ing
r
atenot
es.

2.Mor
tgageBondsv
s.Unsecur
edBonds.Amor
tgagebond,orabondwi
tha
f
ixedchar
ge,hasaspeci
fi
cassett
hatcol
l
ater
ali
zest
hel
oanandi
sther
efor
e
l
essr
iskyf
ort
hei
nvest
or.Somet
imes,t
hei
ssueroft
hebondof
fer
sthe
i
nvest
orsamor
egener
alf
orm ofsecur
it
yov
ert
heasset
soft
hei
ssueratt
he
t
ime-t
hisi
sknownasa'
fl
oat
ingchar
ge'
.Ift
hei
ssuerf
ail
stomaket
he
r
equi
redpay
ment
sont
hebond,t
hei
nvest
orsar
eabl
etot
akepossessi
onof
t
hespeci
fi
edassetorasset
sanduset
hem t
orecoupt
hemoneydue.I
n
cont
rastt
othef
ixedorf
loat
ingchar
gebonds,ani
nvest
ori
nanunsecur
ed
bondi
sonl
yagener
alcr
edi
torandmayst
andt
olosehi
smoneyi
ntheev
ent
t
hecompanyf
acesf
inanci
aldi
str
ess.

3.Asset
-backed secur
it
ies.Somebondsar
eissued t
ofi
nancepar
ti
cul
ar
act
ivi
ti
esandar
epr
ovi
dedwi
thsomef
orm ofsecur
it
yagai
nstt
heasset
sthat
t
heact
ivi
ti
esgener
ate.Anexampl
emi
ghtbeabondi
ssuet
ofi
nancet
he
const
ruct
ionofat
ollbr
idge,wher
ethemoneyt
oser
viceandr
epayt
hebond
i
spr
ovi
dedbyt
het
ollr
ecei
pts,oncet
hebr
idgei
sinoper
ati
on.Ther
ear
e
numer
ousot
herexampl
esofasset
-backedsecur
it
iessuchasbondsi
ssued
byf
inanci
ali
nst
it
uti
onsbackedbycr
edi
t-
car
drecei
vabl
esandbondsi
ssued
byl
ocal
aut
hor
it
iesbackedbypar
kingf
ines.

6
 4.Conv
ert
ibl
eBonds.Conv
ert
ibl
ebondsar
ecor
por
atebondst
hatgi
vet
he
buy
ert
heopt
iont
oexchanget
hei
rbondsf
oraspeci
fi
ednumberofshar
esi
n
t
hecompany
.Forex
ampl
eaconv
ert
ibl
ebondwi
thaconv
ersi
onr
ati
oof5
i
mpl
i
est
hatt
hebondhol
dermaychooset
oexchangehi
sbondf
or5shar
esof
st
ock.Bondhol
der
scompar
ethev
alueoft
hebondagai
nstt
heconv
ersi
on
v
aluet
odeci
deonwhent
oconv
ertt
oshar
es.

Exer
cises

1.Li
stt
hegoal
soff
inancecompani
esi
nbusi
nessor
gani
zat
ions.
2.Whati
sthecr
it
eri
aoft
hegov
ernmentf
oracompanyt
obeabl
etosel
l
/
i
ssuebondsandst
ocks?(
Doar
esear
chf
rom t
hei
nter
net
/websi
tes)
3.Pr
epar
eaLi
sti
ngofCompani
esi
nthePhi
l
ippi
nest
hathasout
standi
ng
BondandSt
ockI
ssues(
Doar
esear
chf
rom t
hei
nter
net
/Websi
tes)
.

Wr
it
eTr
uei
fthest
atementi
scor
rectorFal
sei
sthest
atementi
sincor
rect
.
_
___
_1. Bondpr
icesmov
einv
ersel
ytoi
nter
estr
ates.Thi
smeanswhen
i
nter
estr
atesgoup,
bondpr
icesgoupt
oo.
_
___
_2.The pr
ice ofa bond i
sthe pr
esentv
alue off
utur
e pay
ment
s
di
scount
edatt
hecouponr
ate.
_
___
_3.I
nmostbonds,
thecouponr
ate,
theparv
alueandt
het
ermt
omat
uri
ty
ar
efi
xedov
ert
hel
i
feoft
hebondcont
ract
.
_
___
_4.They
iel
dofabondv
ari
eswi
thchangesi
nint
erestr
ates.
_
___
_5.Thehi
ghert
hecouponr
ate,
thel
owert
hebondpr
icev
olat
il
it
y.
_
___
_6.Shor
tter
m bondshav
egr
eat
erpr
icer
iskcompar
edt
olongt
erm
bonds.
_
___
_7.Abondsel
l
satadi
scountwhent
hemar
ketr
ateofi
nter
esti
sabov
e
t
hebond’
sfi
xedcouponr
ate.
_
___
_8.Pr
icer
iski
sofnoconcer
ntot
hei
nvest
orunt
ilt
hebondi
shel
dto
mat
uri
ty.
_
___
_9.Ther
iskofi
nter
estr
atechangescausi
ngt
hemar
ketpr
iceofabond
t
ori
se orf
all
,resul
ti
ng i
n gai
nsorl
ossesf
oran i
nvest
ori
sknown as
r
einv
est
mentr
isk.
_
___
_10.I
nli
qui
dat
ion,pr
efer
redshar
ehol
der
sar
eent
it
ledt
othei
ssuepr
ice
oft
hei
rpr
efer
enceshar
espl
usaccumul
ateddi
vi
dendsbef
oreot
hercr
edi
tor
s

7
hav
ebeenpai
d.

Chapt
er2.Fi
nanci
alI
nst
rument
s

8
 Fi
nanci
ali
nst
rumenti
sacombi
nat
ionofchar
act
eri
sti
cssuchaspr
omi
sed
y
iel
d,l
i
qui
dit
y,mat
uri
ty,secur
it
yand r
isk. The pr
ocess off
inanci
ali
nnov
ati
on
i
nvol
vescr
eat
ingnewi
nst
rument
sandt
echni
queunpacki
ngandr
ebi
ndi
ngt
hesame
char
act
eri
sti
csi
ndi
ff
erentf
ashi
ont
osui
ttheconst
ant
lychangi
ngneedsoft
he
i
ssuer
sandt
hei
nvest
ors.

Capi
tal
Mar
ketI
nst
rument
s
Thei
nst
rumentusedbyt
hecor
por
atesect
ort
orai
sef
undsar
esel
ect
edon
t sofi
hebasi )inv
est
orpr
efer
encef
oragi
veni
nst
rumentandi
i
)ther
egul
ator
y
f
ramewor
k,wher
eundert
hecompanyhast
oissuet
hesecur
it
y,i
nvest
orpr
efer
ences
v
arywi
tht
hei
rat
ti
tudet
owar
dri
skandt
hei
rinv
est
mentgoal
sandi
nvest
menthor
izon.
Thecor
por
atesect
orandf
inanci
ali
nvest
menti
nst
it
uti
onshav
ebeeni
ssui
ngnew
i
nst
rument
stoat
tr
acti
nvest
ors.Howev
er,t
hei
nst
rument
susedi
sst
il
lver
ynar
row.
Theat
tr
act
ionoft
hei
nst
rument
sforbot
hthecor
por
atesect
orandt
hei
nvest
orl
i
es
na)t
i hei
nvest
orget
sar
easonabl
eret
urndur
ingt
hei
nit
ialy
ear
sand,b)t
hei
ssue
i
nvol
vesl
owerpostt
axcostofcapi
tal
ther
ebyi
ncr
easi
ngi
tsl
i
qui
dit
y.

Capi
tal
Mar
ketI
nst
rument
s
Ar
efi
xedi
ncomeobl
i
gat
ionst
hatt
radei
nthesecondar
ymar
ket
,whi
chmeans
y
oucanbuyandsel
lthem t
oot
heri
ndi
vi
dual
sori
nst
it
uti
ons.

Cl
assi
fi
cat
ionofCapi
tal
Mar
ketI
nst
rument
s
1.Hy
bri
dInst
rument
sar
ethosewhi
char
ecr
eat
edbycombi
ningt
hef
eat
ureof
equi
tywi
thbond,
pref
erenceandequi
ty.
Exampl
e:Debent
ures,
War
rant
s,Secur
edPr
emi
um Not
es
2.Pur
eInst
rument
sar
eequi
tyshar
es,pr
efer
enceshar
esanddebent
ures,
bonds whi
ch wer
eissued wi
tht
hei
rbasi
c char
act
eri
sti
cs i
ntactwi
thout
mi
xi
ngf
eat
uresofot
hercl
assesofi
nst
rument
s.
3.Der
ivat
iveI
nst
rument
sar
econt
ract
swhi
chder
ivet
hei
rval
uesf
rom t
he
v
alueofoneormor
eofot
herasset
s.Someoft
hemostcommonl
ytr
aded
der
ivat
ivesar
efut
ures,
for
war
d,opt
ionsandswaps.

FourCat
egor
iesofCapi
tal
Mar
ketI
nst
rument
s
1.Tr
easur
ySecur
it
ies–al
lissuedbyt
hegov
ernmenti
tmaybebi
l
l,not
esor

9
 bonds.
2.Gov
ernmentAgency Secur
it
ies – sol
d by v
ari
ous agenci
es oft
he
gov
ernmentt
osuppor
tspeci
fi
cpr
ogr
amsbutar
enotdi
rectobl
i
gat
ionoft
he
t
reasur
y.
3.Muni
cipal
Bonds-i
ssuedbyl
ocal
gov
ernmentent
it
iesorgener
alobl
i
gat
ions
orr
evenuebonds.
4. Cor
por
ate Bonds 0 f
ixed i
ncome secur
it
ies i
ssued by i
ndust
ri
al
cor
por
ati
ons,publ
i
c ut
il
it
y cor
por
ati
ons t
oinv
esti
n pl
ant
,pr
oper
ty and
equi
pment
.

Fi
xedI
ncomeI
nvest
ment
s
Hav
eacont
ract
ual
l
ymandat
edpay
mentschedul
e.Thei
rinv
est
mentcont
ract
pr
omi
sespeci
fi
cpay
ment
satapr
edet
ermi
nedt
ime,al
thought
hel
egalf
orcebehi
nd
t
hepr
omi
sev
ari
esandt
hisaf
fect
sthei
rri
sksandr
equi
redr
etur
ns.

I
nvest
orswhoacqui
ref
ixedi
ncomesecur
it
ies(
exceptpr
efer
redst
ock)ar
e
r
eal
l
ylender
stoi
ssuer
s.Speci
fi
cal
l
yyoul
endsomeamountofmoney
,thepr
inci
pal
,
t
othebor
rower
.Inr
etur
nthebor
rower
,ty
pical
l
ypr
omi
set
omakeper
iodi
cint
erest
pay
ment
sandt
opaybackt
hepr
inci
pal
att
hemat
uri
tyoft
hel
oan.

Equi
tyI
nst
rument
s
The r
etur
ns ar
e notcont
ract
ual
. I
tis dependentupon t
he company
’s
successes and pr
obl
ems.Ei
theri
tcan r
ecei
ve hi
gh r
ates orr
etur
n orl
osses
(
commonst
ockhol
der
s).

Equi
tyShar
es
Equi
tyshar
escommonl
yref
err
edt
oasor
dinar
yshar
eal
sor
epr
esent
sthe
f
orm off
ract
ionalowner
shi
pin whi
ch a shar
ehol
der
,as a f
ract
ionalowner
,
under
takest
hemaxi
mum ent
repr
eneur
ialr
isksassoci
atedwi
thabusi
nessv
ent
ure.
Thehol
derofsuchshar
esi
sthememberoft
hecompanyandhasv
oti
ngr
ight
s.
Equi
tyshar
eshav
ether
ightt
oshar
ethepr
ofi
tsoft
hecompanyi
nthef
orm of
di
vi
dends(
cash)andbonus.

Cumul
ati
vePr
efer
enceShar
es

10
 I
nthi
sty
pe di
vi
dend i
spay
abl
e ev
eryy
earbecomesa f
ir
stcl
aim whi
l
e
decl
ari
ngdi
vi
dendbyt
hecompany
.Incaset
hecompanydoesnothav
eadequat
e
pr
ofi
torf
orsomer
easont
hecompanydoesnotwantt
opaypr
efer
encedi
vi
dends,
it
get
saccumul
atedf
orbei
ngpai
dsubsequent
ly.Suchar
rear
sofdi
vi
dendswi
l
lbe
car
ri
edf
orwar
dandpai
doutoft
hepr
ofi
tsoft
hesubsequenty
ear
sbef
oret
he
pay
mentofequi
tydi
vi
dend.

Non-
Cumul
ati
vePr
esenceShar
e
I
tdoesnothav
ether
ightt
ocl
aimf
orcumul
ati
vedi
vi
dends.I
fnodi
vi
dend
wasdecl
aredt
hent
hehol
dercannotcl
aim any
mor
e.

Conv
ert
ibl
ePr
efer
enceShar
es
Thi
sty
peofpr
efer
enceshar
eincl
udesar
ightf
orconv
ert
ingt
hem i
ntoequi
ty
shar
esatt
heendofaspeci
fi
edper
iod. Thi
sshar
esar
esomet
imescal
l
edquasi
equi
tyshar
es.I
thasv
ari
ousr
ight
ssuchasv
oti
ngr
ight
s,hi
gherdi
vi
dend,bonuses
i
ssueet
c.

Debent
uresi
ncl
udedebent
urest
ocks,bondsandanyot
hersecur
it
iesofacompany
whet
herconst
it
uti
ngachar
geont
heasset
soft
hecompanyornot
.

Debent
urei
sadocumentev
idenci
ngadebtoracknowl
edgi
ngi
tandany
documentwhi
chf
ulf
il
lsei
theroft
hesecondi
ti
onsi
sadebent
ure.
Thei
mpor
tantf
eat
ureofadebent
urear
e:
1.I
tisi
ssuedbycompanyasacer
ti
fi
cat
eofi
ndebt
edness.
2.I
tusual
l
yindi
cat
est
hedat
eofr
edempt
ion and al
so pr
ovi
desf
ort
he
r
epay
mentofpr
inci
pal
andpay
mentofi
nter
estatspeci
fi
eddat
eordat
es.
3.I
tusual
l
ycr
eat
esachar
geont
heunder
taki
ngort
heasset
soft
hecompany
.
I
nsuchcase,
thel
ender
sofmoneyt
othecompanyenj
oybet
terpr
otect
ionas
secur
edcr
edi
tor
s.

Debent
uresar
eissuedont
hef
oll
owi
ngf
orms:
 Nakedandunsecur
eddebent
uresdonotcar
ryanychar
geont
heasset
sof
t
hecompany
.

11
 Secur
eddebent
uresar
esecur
edbyamor
tgageoft
hewhol
eorpar
toft
he
asset
soft
hecompany
.
 Redeemabl
edebent
uresar
eredeemabl
eonexpi
ryofcer
tai
nper
iod.
 Per
pet
ualdebent
uresar
eissuedsubj
ectt
oredempt
iononspeci
fi
edev
ent
s
whi
chmaynothappenf
orani
ndef
ini
teper
iod.
 Bear
erdebent
uresar
epay
abl
etobear
erandt
ransf
erabl
ebymer
edel
i
ver
y.
 Regi
ster
eddebent
uresar
epay
abl
etot
her
egi
ster
edhol
der
swhosename
appear
sont
hedebent
urescer
ti
fi
cat
e.

Exer
cises.
TEST1.Dowhati
srequi
redont
hef
oll
owi
ng:
1.St
atet
hebasi
sofsel
ect
ingCapi
tal
Mar
ketI
nst
rument
sforCompani
es.
2.Whatar
etheChar
act
eri
sti
csofCapi
tal
Mar
ketI
nst
rument
s?
3.Whatar
ethedi
ff
erentt
ypesofshar
es?Howdoesi
trepr
esentowner
shi
pin
t
hecompany
?

TEST2.Doar
esear
chf
rom t
hei
nter
netandanal
yzet
heTr
easur
yBondi
n
t
ermsoft
hef
oll
owi
ng:
a.t
ypeofsecur
it
y(secur
edorunsecur
ed)
b.t
ransf
erabi
l
ity
c.t
ypeofi
nter
estr
ate
d.modeofr
edempt
ion

TEST3.Answert
hequest
ioncompr
ehensi
vel
y.
1.Whatar
etheadv
ant
agesofi
nvest
ingi
ntheCommonSt
ock
2.Whatar
etheadv
ant
agesi
ninv
est
ing i
nthecor
por
atebondsoft
he
company
?
2.Compar
ether
etur
nsofabondandacommonst
ock.

12
 Chapt
er3.TheFi
nanci
alMar
ket

Ev
erymoder
neconomyi
sbasedonasoundf
inanci
alsy
stem whi
chhel
psi
n
pr
oduct
ion,capi
talandeconomi
cgr
owt
h.Byencour
agi
ngsav
ingshabi
ts,mobi
l
izi
ng
sav
ingsf
rom househol
dsandot
hersegment
sandal
l
ocat
ingsav
ingsi
ntopr
oduct
ive
usagesuchast
rade,commer
ce,manuf
act
ureet
c.Thi
schapt
erwi
l
lpr
ovi
deabr
oad
ov
erv
iew ofoneoft
hecomponent
soft
hef
inanci
alsy
stem whi
chi
stheCapi
tal
Mar
ket
,it
spur
pose,t
hef
inanci
alasset
sthatar
etr
adedt
her
ein,andsomeoft
he
char
act
eri
sti
csofawel
l
-funct
ioni
ngmar
ket
s.

Rol
eandObj
ect
ivesoft
heFi
nanci
alMar
ket

A pr
oduct
iveeconomyr
equi
resf
ir
mst
o pr
oducegoodsandser
vicesf
or
consumpt
ion,
andt
hesef
ir
msneedr
esour
ces.I
tist
hef
inanci
almar
kett
hatl
i
nkst
he
r
esour
ceneedsoft
hesef
ir
mswi
tht
hepeopl
ewi
l
li
ngt
o pr
ovi
det
henecessar
y
r
esour
ces:
int
hef
orm ofi
nvest
ment
s.

Thef
inanci
almar
kethav
etwomaj
orcomponent
s,t
hemoneymar
ketandcapi
tal
mar
ket
.

Fi
nanci
alMar
ket

MoneyMar
ket Capi
tal
Mar
ket

Secur
it
iesMar
ket Ot
herFor
ms

OfLendi
ng/
Bor
rowi
ng

Pr
imar
yMar
ket Secondar
yMar
ket
Fi
g1.Fi
nanci
alMar
ket

Thef
inanci
alsy
stem exi
stst
ofaci
l
itat
ethedesi
gn,sal
eandexchangeoff
undsand
f
inanci
ali
nvest
ment
s.Thi
sexchangesy
stem t
akesoneoft
wof
orms:di
rectand
i
ndi
rect
.

 I
n di
rectexchange f
inanci
ng sy
stem,bor
rower
s(i
ssuer
s)sel
lsecur
it
ies
di
rect
lyt
olender
s(buy
ers)
.Thebor
rower
sincl
udecent
ralgov
ernment
s,l
ocal

13
 gov
ernment
s,andcor
por
ati
ons.Lender
sont
heot
herhand,
incl
udei
ndi
vi
dual
s,
f
inanci
alandnon-
fi
nanci
ali
nst
it
uti
onsandot
hergov
ernment
s.

 I
nindi
rectexchange(
fi
nanci
ng)sy
stems,f
inanci
ali
nst
it
uti
onssuchasbanks
f
aci
l
itat
ethet
ransf
eroff
undsbet
weenbor
rower
sandl
ender
s,bybor
rowi
ng
f
rom t
hel
ender
sandt
henpr
ovi
dingt
hef
undst
otheul
ti
mat
ebor
rower
s.Such
f
inanci
ali
nst
it
uti
ons ar ed i
e cal
l nter
medi
ari
es and t
hey i
ncl
ude banks,
i
nsur
ancecompani
esandmut
ual
funds.

I
tshoul
dbenot
icedt
hatf
inanci
alsy
stem i
sli
nkedst
rongl
ytot
heeconomi
c
sy
stem.Ther
oleoft
hef
inanci
alsy
stem i
nthi
srespecti
stof
aci
l
itat
epr
oduct
ion,
empl
oymentandconsumpt
ion.

Cl
assi
fi
cat
ionsofFi
nanci
alMar
ket
s

1.THEMONEYMARKET
Themoneymar
keti
sthatsegmentoft
hef
inanci
almar
keti
nwhi
chshor
t
t
erm f
inanci
alasset
s(secur
it
ieswi
thl
esst
hanoney
eart
o mat
uri
tysuchas
gov
ernmentt
reasur
ybi
l
ls,bankcer
ti
fi
cat
esofdeposi
ts,et
c.)ar
etr
aded.Most
t
radesi
nthi
smar
keti
sinl
argesi
zes,
gener
all
yofonemi
l
li
ondol
l
ars(
int
heUS)or
mor
e,andt
her
efor
eout
sidet
hescopeofsmal
ltomedi
um i
nvest
ors.I
ndi
vi
dual
s,
howev
er,
canpar
ti
cipat
eint
hismar
kett
hroughmoneymar
ketmut
ual
funds.

Mar
ketmaker
ssuchasl
argecommer
cialbanks,
broker
agef
ir
ms,
andmoney
mar
ketdeal
ersf
aci
l
itat
etr
adi
ng ofsecur
it
ies i
nthe moneymar
ket
.Br
oker
s
pr
imar
il
yactasi
nter
medi
ari
esbybr
ingi
ngt
oget
herpot
ent
ial
buy
ersandsel
l
ersand
char
geacommi
ssi
onf
ort
hei
rser
vices.Deal
ersont
heot
herhandhav
eanact
ive
posi
ti
onsi
nthesecur
it
iest
hatt
heydeali
n,byst
andi
ngr
eadyt
obuy(
att
hebi
d
pr
ice)andt
osel
l(att
heaskpr
ice)dependi
ngont
heneedsoft
hecl
i
ent
.

Someoft
hemor
eimpor
tantmoneymar
ketsecur
it
iesar
e:
Tr
easur
yBi
l
ls(
TBS)
.

Cer
ti
fi
cat
esofDeposi
ts(
CDs)
.

Commer
cial
Paper
.

Banker
s'Accept
ances.

Repur
chaseAgr
eement
s(Repos)
.

14
2.THECAPI
TALMARKET
The capi
talmar
keti
sthatsegmentoft
he mar
keti
n whi
ch l
ong t
erm
f
inanci
alasset
s(secur
it
ies wi
th mor
ethan one y
eart
o mat
uri
ty such as
gov
ernmentandcor
por
atebonds,
stocks,
etc.
)ar
etr
aded.Thecapi
talmar
ket
scan
besubdi
vi
dedi
ntot
wo:
Thepr
imar
ymar
ketandt
hesecondar
ymar
ket
.
Funct
ionsoft
heCapi
tal
Mar
ket
:
Themaj
orobj
ect
ivesofcapi
tal
mar
ketar
e:

 Tomobi
l
izer
esour
cesf
ori
nvest
ment
s

 Tof
aci
l
itat
ebuy
ingandsel
l
ingofsecur
it
ies

 Tof
aci
l
itat
ethepr
ocessofef
fi
cientpr
icedi
scov
ery

 To f
aci
l
itat
e set
tl
ement of t
ransact
ions i
n accor
dance wi
th t
he
pr
edet
ermi
nedt
imeschedul
es.
Tr
adi
ngi
ntheCapi
tal
Mar
ket
Secur
it
iesMar
ket–r
efer
stot
hemar
ket
sfort
hosef
inanci
ali
nst
rument
s,cl
aims,
or
obl
i
gat
ionst
hatar
ecommonl
yandr
eadi
l
yav
ail
abl
eforsal
e.
Secur
it
iesMar
kethast
woi
nter
-dependentsegment
s,f
ort
henewi
ssues(
pri
mar
y)
mar
ketandt
hest
ock(
secondar
y)mar
ket
.

1.ThePr
imar
yMar
ket(
auct
ion-
typemar
ket
)
Thepr
imar
ymar
keti
sthatpar
toft
hemar
keti
nwhi
chi
ssueofnew secur
it
iesi
s
car
ri
edout
,of
tenr
efer
redt
oast
henewi
ssuesmar
ket
.Int
hepr
imar
ymar
ket
,fi
rms
andot
heror
gani
zat
ionsr
aiset
hef
undst
heyneedbyi
ssui
ng(
sel
l
ing)l
ong-
ter
m
secur
it
iessuchasst
ocksandbondst
opot
ent
iali
nvest
ors.Howev
er,t
hei
ssuance
andmar
ket
ingofsecur
it
iesi
saspeci
ali
zedt
askcommonl
yunder
takenbyspeci
al
f
inanci
ali
nst
it
uti
onscal
l
edi
nvest
mentbanks.

Thei
nvest
mentbanki
ssi
mpl
yani
nter
medi
arybet
weenpr
ospect
ivei
nvest
orsi
na
secur
it
y,andt
hei
ssui
nguni
t.Thei
ssueofnew secur
it
iesbyt
hei
nvest
mentbank
canei
therbeona'
fi
rm commi
tment
'basi
sinwhi
chcaset
hebankguar
ant
eest
he
sal
eoft
hesecur
it
ies,orona'
bestef
for
ts'basi
s,wher
eunsol
dsecur
it
iesar
e
r
etur
nedt
othei
ssui
ngcompany
.

15
I
nor
derf
ort
hei
nvest
mentbankt
ocar
ryouti
tsr
olepr
oper
ly,i
thast
oaddr
essf
our
f
unct
ions:
(
1)Thef
ir
stf
unct
ioni
sanadv
isor
yfunct
ion,whi
chent
ail
spr
ovi
dingadv
icet
oit
s
cl
i
ent
sregar
ding t
hesi
zeand pr
ici
ng oft
hei
ssue,i
tspr
opert
imi
ng,and
av
ail
abi
l
ityofot
herf
inanci
ngal
ter
nat
ives.

(
2)Theadmi
nist
rat
ivef
unct
ioni
stheact
ualpr
ocessofi
ssui
ngt
hesecur
it
yandi
ts
r
egi
str
ati
on.Thi
sinv
olv
essat
isf
yingv
ari
ousl
egalandr
egul
ator
yrequi
rement
s
setdownbyt
hest
ockmar
ketadmi
nist
rat
or,andSecur
it
iesandExchange
Commi
ssi
on(
SEC)i
ntheUS

(
3)Theunder
wri
ti
ngf
unct
ion,
wher
ethei
nvest
mentbankpur
chasest
hesecur
it
ies
f
rom t
he i
ssui
ng f
ir
m and t
hen r
e-sel
l
sthem t
othe publ
i
c.I
naf
ir
m
commi
tmentar
rangement
,thei
nvest
mentbankpay
sinadv
ancet
het
otal
val
ue
oft
hequant
it
yitunder
wri
test
othesecur
it
yissuer
.Ot
heral
ter
nat
ivest
othi
s
f
ir
m commi
tmentexi
stwher
ethei
nvest
mentbank'
srol
echanges.I
nthecase
oft
hebest
-ef
for
tsal
ter
nat
ive,t
hei
nvest
mentbankeragr
eest
ohel
pthei
ssuer
sel
l
sthei
ssuet
othepubl
i
cforanagr
eed•uponcommi
ssi
on,andt
heunsol
d
secur
it
iesar
eret
urnedt
othei
ssui
ngf
ir
m.

(
4)Thedi
str
ibut
ionf
unct
ion,whi
chi
sthei
nvest
mentbank'
sef
for
tint
heact
ual
mar
ket
inganddi
str
ibut
ionoft
hei
ssuet
othepubl
i
c.

I
nthepr
imar
ymar
ket
,ther
ear
eanumberofr
egi
ster
eddeal
ers(
Aut
hor
ized
Per
sons)
,whoar
eli
censedt
ohel
pcompani
esi
ssuenewsecur
it
ies.Regul
ati
ons
l
aiddownbyt
heCapi
talMar
ketAut
hor
it
yspeci
fyt
hemaxi
mum andmi
nimum
numberofshar
est
hati
ndi
vi
duali
nvest
orscansubscr
ibef
or.I
ncaseofexcess
demand,
shar
esar
edi
str
ibut
edonapr
orat
abasi
sinpr
opor
ti
ont
othenumberof
shar
esor
igi
nal
l
ydemanded.

2.Secondar
yMar
ket(
negot
iat
ion-
typemar
ket
)
Thi
ster
msr
efer
stot
hemar
ketdeal
i
ngwi
tht
her
esal
eandpur
chaseof
secur
it
iesorot
hert
it
lest
opr
oper
tyorcommodi
ti
es.Exampl
esar
ethesecondar
y
mor
tgagemar
ket
s,wher
ehol
der
sofmor
tgageswhoneedf
undscandi
sposeoft
hei
r
hol
dingsbef
oremat
uri
ty.Anot
heri
sthesecondar
yst
ockmar
keti
nvol
vedi
npr
ivat
e

16
pl
aci
ng and deal
i
ngs among br
oker
s,mer
chantbanks and ot
herper
sons and
i
nst
it
uti
ons.

Secur
it
iest
radedout
sideoft
heor
gani
zedexchangest
akepl
acei
nthe“
over
-
t
he-
count
er”or“
off
-boar
d”mar
ket
.TheOTCmar
keti
spr
ovi
dedbydeal
erswhoar
e
r
eadyt
obuyorsel
lpar
ti
cul
arsecur
it
iesatcer
tai
npr
ices. OTC t
ransact
ionsar
e
car
ri
edoutbydi
recti
nqui
ri
esandnegot
iat
ionsamongt
hedeal
erst
hrought
heuseof
mai
l
,tel
ephone,
tel
egr
aph,
tel
ety
peorot
herf
ormsofcommuni
cat
ion.

Thedeal
ersi
ntheOTCmar
ketof
tenactaspr
inci
pal
s,i
.e.t
heybuyandsel
lfor
t
hei
rownaccount
sint
ransact
ionswi
thcust
omer
sandot
herdeal
ers.Thedeal
er
act
ual
l
ytakest
it
let
othesecur
it
iesheacqui
resandheei
therhol
dst
hem asi
nvent
ory
orsel
l
sthem i
mmedi
atel
y.

Secondar
ytr
adi
ngcant
akeoneoft
wof
orms:exchanget
radi
ngorov
ert
he
count
ert
radi
ng.I
nanexchanget
radi
ngst
ruct
ure,
anexchangeov
erseest
het
radi
ng,
andmakessur
ethati
tcompl
i
eswi
thi
tsr
egul
ati
ons.

TheNew Yor
kSt
ockExchange(
NYSE)i
sagoodexampl
e,wher
eal
ltr
ader
s
conv
ergeatonephy
sicall
ocat
ionf
ort
hebuy
ingandsel
l
ingofsecur
it
ies.I
ndi
vi
dual
i
nvest
orswi
shi
ngt
obuyorsel
lasecur
it
yont
heNYSEcont
actamemberoft
he
ex
changewhowi
l
lexecut
ethet
radeont
hei
rbehal
f.Theexchangeset
sthev
ari
ous
r
ulesandr
egul
ati
onst
hatgov
ernhow andwhent
radi
ngt
akespl
aceandwi
l
lal
so
pr
ovi
det
hei
nfr
ast
ruct
uret
omoni
torandset
tl
eal
ltr
ades.

OVER-
THE-
COUNTERMARKER(
OTC)

Tr
ansact
ionst
hatt
akepl
aceout
sidet
heexchangesar
esai
dtooccuri
nthe
Ov
ert
heCount
er(
OTC)mar
ket
.Theset
ransact
ionst
akepl
aceatnospeci
fi
csi
ngl
e
l
ocat
ion,of
tenoccur
ri
ngt
hroughcommuni
cat
ionnet
wor
ks,compr
isi
ngt
elephone
l
i
nes,comput
ert
ermi
nal
s,andot
herel
ect
roni
cfaci
l
iti
es,whi
chconnectbr
oker
s,
deal
ersandi
nvest
ors.

Deal
ersquot
ethepr
icesatwhi
cht
heyar
ewi
l
li
ngt
obuyandsel
lvar
ious
secur
it
iesont
henet
wor
k.I
nvest
orsi
nter
est
edi
ntr
adi
ngcanei
therexecut
etr
ades

17
di
rect
lyort
hroughabr
okercont
act
ingadeal
eront
hei
rbehal
f.

TheOTC mar
ket
,howev
er,hasnomechani
sm t
ost
opshar
pincr
easesor
decl
i
nesi
nsecur
it
ypr
ices,
whi
chmayoccurduet
othet
empor
aryi
mbal
ancebet
ween
suppl
yanddemand.I
ntheor
gani
zedexchangemar
ket
s,suchi
mbal
ancescanbe
t
ackl
edbyt
heexchangehal
ti
ngt
radi
ngi
nacer
tai
nsecur
it
y,t
oal
l
ow addi
ti
onal
buy
ersorsel
l
erst
orest
oreequi
l
ibr
ium t
othemar
ket
.Somemar
ket
susecei
l
ingsand
upperl
i
mit
sfordai
l
ysecur
it
ymar
ketpr
icemov
ement
s.
Thesecondar
ymar
keti
sbestdescr
ibedasanauct
ionmar
ket
,wher
einv
est
orsent
er
t
hequant
it
iesandpr
icesatwhi
cht
heywi
sht
obuyorsel
l
.

Exer
cises.

1.Descr
ibehowt
heFi
nanci
alSy
stem i
sli
nkedt
otheeconomyofacount
ry.Whydo
y
out
hinkt
her
eisaneedf
orCapi
tal
Mar
ketbot
hbyi
nvest
orsanduser
soff
unds.

2.Whatar
ethef
inanci
alpr
oduct
sandser
vicesoft
het
wot
ypesofmar
ket
-money
mar
ketandcapi
tal
mar
ket
?

3.Howi
str
adi
ngconduct
edi
naPr
imar
yMar
ket
?

4.Howi
str
adi
ngconduct
edi
naSecondar
yMar
ket
?

TEST2.Wr
it
eTr
uei
fthest
atementi
scor
rectandFal
sei
fthest
atementi
sincor
rect
.

_
___
___
__1.The moneymar
ket
s ar
e a col
l
ect
ion ofmar
ket
s,each t
radi
ng a
di
sti
nct
lydi
ff
erentf
inanci
ali
nst
rumenti
nacent
ral
exchangemar
ket
.
_
___
___
__2.Deal
ersandbr
oker
sbuysecur
it
iesf
ort
hei
rownposi
ti
onsandsel
lfr
om
t
hei
rsecur
it
yinv
ent
ori
eswhenat
radet
akespl
ace.
_
___
___
__3.Themoneymar
ket
sar
ewhol
esal
emar
ket
sar
ewhol
esal
emar
ket
i
nvol
vei
nlar
get
ransact
ions.
_
___
___
__4.Forl
argecor
por
ati
ons,commer
cialpaperi
smor
eexpensi
vebuti
sa
mor
eassur
edal
ter
nat
ivet
obankbor
rowi
ng.
_
___
___
__5.Commer
cialpaperi
smor
eli
kel
ytobepl
aceddi
rect
lybyl
argef
inanced
compani
es.

18
_
___
___
__6.Themosti
mpor
tanteconomi
cfunct
ionofmoneymar
keti
stopr
ovi
de
anef
fi
cientmeansf
oreconomi
cuni
tst
oadj
ustt
hei
rli
qui
dit
yposi
ti
ons,
meani
ngt
he
abi
l
ityt
oaccesst
ofundswhenneeded.
_
___
___
__7.Consumer
smostof
tenhav
eonl
yindi
rectaccesst
othemoneymar
ket
t
hroughcommer
cial
banks.
_
___
___
__8.Themoneymar
keti
sadeal
ermar
ket
,notanexchange,andhasno
speci
fi
clocat
ion.
_
___
___
__9.Moneymar
ketbor
rower
sar
esmal
linnumbercompar
edt
omoney
mar
ketl
ender
s.
_
___
___
__10.Tr
easur
yNot
esar
econsi
der
edr
isk–f
reewi
thl
i
ttl
epr
icer
iskbecause
t
heyar
eguar
ant
eedbyt
hegov
ernment
.
_
___
___
__11.Commer
cialbanksar
ethemaj
ori
ssuerandi
nvest
orofmoneymar
ket
secur
it
ies.
_
___
___
__12. A negot
iabl
ecer
ti
fi
cat
eofdeposi
tisabankdeposi
tthatcanbe
t
radedi
nthesecondar
ymar
ketbef
orei
tsmat
uri
ty.
_
___
___
__13.Deal
ersbr
ingbuy
erandsel
l
ert
oget
her
,br
oker
smakesamar
ket
.
_
___
___
__14.Resi
dual
clai
msar
ebasi
cowner
shi
pcl
aimsi
nacor
por
ati
on.
_
___
___
__ 15. Pr
imar
y capi
talmar
ket secur
it
ies pr
ovi
de mar
ket
abi
l
ity and
possi
bil
i
tiesf
ori
nvest
orst
oal
tert
her
iski
nessoft
hei
rpor
tfol
i
os.

Chapt
er4.TheSecur
it
iesMar
ket

19
Secur
it
iesMar
ket
Secur
it
iesr
efert
oincomey
iel
dingpapert
radedont
hest
ockexchangeorsecondar
y
mar
ket
s.Av
eryessent
ial
char
act
eri
sti
cofasecur
it
yisi
tssal
abi
l
ity
.

Ty
pesofSecur
it
y.Ther
ear
ethr
eemai
nty
pesofsecur
it
y
1.Fi
xedi
nter
est–consi
sti
ngofdebent
ures,
pref
err
edst
ocks,
andbonds
i
ncl
udi
ngal
lgov
ernmentsecur
it
ies;
2.Var
iabl
eint
erest–consi
sti
ngofcommonst
ocksandbonds,
aswel
las
pr
efer
redst
ockswi
thpar
ti
cipat
ingf
eat
ure;
and
3.ot
her
s–l
i
kebi
l
lsofexchangeandassur
ancepol
i
cies.

Secur
it
iesconsi
stoft
hef
oll
owi
ng:
1.bonds
2.debent
ures
3.not
es
4.ev
idenceofi
ndebt
edness
5.shar
esi
nacompany
6.pr
e-or
gani
zat
ioncer
ti
fi
cat
esorsubscr
ipt
ions
7.i
nvest
mentcont
ract
s
8.cer
ti
fi
cat
eofi
nter
estorpar
ti
cipat
ioni
napr
ofi
tshar
ingagr
eement
9.col
l
ater
alt
rustcer
ti
fi
cat
es
10.v
oti
ngt
rustcer
ti
fi
cat
es
11.equi
pmentt
rustcer
ti
fi
cat
es
12.cer
ti
fi
cat
esofdeposi
tforasecur
it
y
13.cer
ti
fi
cat
eofassi
gnment
s
14.r
epur
chaseagr
eement
s
15.pr
opr
iet
aryornon-
propr
iet
arymember
shi
pcer
ti
fi
cat
es
16.commodi
tyf
utur
escont
ract
17.t
ransf
erabl
est
ockopt
ions
18.pr
e-needpl
ans
19.pensi
onpl
ans
20.l
i
fepl
ans

20
 21.j
ointv
ent
urecont
ract
s
22.ot
hersi
mil
arcont
ract
sandi
nvest
ment
s

TheSecur
it
iesMar
ket
The pr
imar
y di
str
ibut
ion ofcor
por
ate secur
it
ies af
fect
sthe abi
l
ity oft
he
cor
por
ati
on t
o di
spose oft
he r
emai
ning i
ssues i
nthe secondar
y mar
ket
s. The
component
s oft
he secur
it
ies mar
ket
s pl
ay an i
mpor
tantr
olei
nthe subsequent
di
str
ibut
ionofsecur
it
ies.Suchmar
ketcomponent
swi
l
lbedi
scussedi
nthi
stopi
c.

TheSt
ockExchange
Thest
ockexchangei
samar
keti
nwhi
chsecur
it
iesar
eboughtandsol
d.Ther
e
ar
est
ockexchangesi
nmostcapi
talci
ti
esoft
hewor
ld,aswel
lasi
nlar
gestpr
ovi
nci
al
ci
ti
es. Themostnot
abl
eint
hisexchangesar
etheNew Yor
kSt
ockExchange,t
he
Amer
icanSt
ockEx
changeandt
heLondonSt
ockExchange.Thest
ockexchangesar
e
pr
imar
il
yor
gani
zedt
oser
vet
hei
rownl
ocal
stockmar
ket
s.
Thosewhocanpar
ti
cipat
eint
het
radi
ngar
ethoseLi
stedCompani
es.I
tmeanst
hat
t
hese t
ype of compani
es hav
e sound f
inanci
alper
for
mance and t
hei
r mar
ket
capi
tal
i
zat
ionqual
i
fiest
osel
lsecur
it
iesi
nthemar
ket
.

Mar
ketSt
yles

1.Or
derDr
ivenMar
ket
s

I
nanor
derdr
ivenmar
ket
,pot
ent
ialbuy
ersandsel
l
ersofsecur
it
iesi
ndi
cat
e
howmanysecur
it
iest
heywantt
obuyorsel
landatwhatpr
ice.

The t
radi
ng sy
stem br
ings buy
ers and sel
l
erst
oget
her wher
ethei
r
r
equi
rement
smat
ch.Mostoft
hemaj
orst
ockmar
ket
sar
oundt
hewor
ldoper
ate
somef
orm ofor
derdr
ivent
radi
ngsy
stem,suchast
heNewYor
kSt
ockExchange
andt
heLondonSt
ockExchange.

2.Quot
eDr
ivenSy
stem

Asmal
lnumberofst
ockexchangesoper
ateaquot
edr
ivensy
stem.

I
naquot
edr
ivensy
stem,t
heexchangeenabl
esf
inanci
ali
nst
it
uti
onst
oact
asmar
ketmaker
s.Mar
ketmaker
sar
eobl
i
gedt
opr
ovi
det
wo-
wayquot
est
obuy

21
andsel
lpar
ti
cul
arsecur
it
iest
hroughoutt
hest
andar
dmar
kethour
s.I
nor
dert
o
gener
atepr
ofi
t,t
hemar
ketmakerwi
l
lquot
eal
owerpr
icet
obuyt
hesecur
it
ies(
the
bi
d pr
ice)
,and ahi
gherpr
icet
o sel
lthesecur
it
ies(
theof
feraskpr
ice)
.The
di
ff
erencebet
weent
hepr
icesi
sof
tenr
efer
redt
oast
hebi
d-of
feraskspr
ead.

Thekeyadv
ant
aget
hatt
hequot
edr
ivensy
stem of
fer
sov
ert
heor
derdr
iven
sy
stem i
stheabi
l
ityt
otr
adet
hroughoutt
het
radi
ngday
. Thi
sisbecauset
he
mar
ketmaker
sar
eobl
i
gedt
oquot
epr
icesandbeabl
etot
radei
natl
eastaset
mi
nimum numberofsecur
it
ies.I
nanor
derdr
ivenmar
ket
,li
qui
dit
ycoul
ddr
yup,i
f
t
her
ear
enoor
der
stobuy(
ort
osel
l
).

Thedi
sadv
ant
ageoft
hequot
edr
ivensy
stem i
sthati
nvest
orsar
eef
fect
ivel
ypay
ing
f
ort
hepr
ovi
sionofl
i
qui
dit
ythr
ought
hebi
d-of
ferspr
ead,compar
edt
otheor
der
dr
ivensy
stem wher
etheor
der
sar
emat
ched.

I
nbot
htheor
derdr
ivenandquot
edr
ivenmar
ket
s,f
ir
mscanacti
ntwo
capaci
ti
es–agentorpr
inci
pal
.Af
ir
m act
ingasagentsi
mpl
yar
rangest
het
radeon
behal
foft
hecl
i
ent
,char
gingacommi
ssi
on.Fi
rmsact
ingaspr
inci
palact
ual
l
ybuy
orsel
lsecur
it
iest
hemsel
ves,suchasmar
ketmaker
sinquot
edr
ivenmar
ket
s.
Cl
ear
ly,
fir
mst
aki
ngpr
inci
palposi
ti
onst
akegr
eat
err
iskst
hant
hoseact
ingasi
nan
agencycapaci
ty.
Exer
cises.

1.St
atet
her
easonswhycompani
eswoul
dseekf
undi
ngf
rom t
heCapi
tal
Mar
ket
?
2.I
dent
if
yTy
pesofSecur
it
iesandst
atei
tsnat
ureofi
nvest
ment
.
(
a.wher
eisi
ttr
aded?pr
imar
yorsecondar
ymar
ketb.f
ixedi
nter
estor
v
ari
abl
eint
erestear
ningi
nvest
ment
)
Ex.I
nsur
ance,
tradedi
npr
imar
yandsecondar
ymar
ket
,fi
xedi
nter
est
3.Whati
saSt
ockExchangeandwhocanpar
ti
cipat
eint
heTr
adi
ng?
4.St
atet
headv
ant
agesanddi
sadv
ant
agesofOr
derDr
ivenMar
ketandQuot
e
Dr
ivenSy
stem.

Wri
teTr
uei
fthestatementi
scorr
ectandFal
seift
hestat
ementi
sincorr
ect
.
1.Commer
cialpapersar
elong-
ter
m bondinst
rument
swheresecuri
tyIhel
d
ov
ert
heasset
soft
hei
ssuer
.

22
2.At
ransact
ionaccounti
sademanddeposi
taccounti
nwhi
cht
heowneri
s
ent
it
led t
orecei
ve hi
s orherf
unds on demand whi
ch t
ransf
ersl
egal
owner
shi
poff
undst
oot
her
s.
3.Sav
ings account
s ar
eint
erestbear
ing account
sfori
ndi
vi
dual
s and
par
tner
shi
pswi
thl
i
mit
edwi
thdr
awal
off
unds.
4.Bor
rowedf
undsar
ety
pical
l
yshor
tter
m bor
rowi
ngsbycommer
cialbanks
f
rom t
hecapi
tal
mar
ket
s.
5.Loan capi
talr
efer
stol
ong t
erm not
es and debent
ures t
hatcan be
conv
ert
ibl
eint
ocommonst
ock.
6.Shar
ecapi
tal
theaccumul
atedpor
ti
onoft
hebank’
spr
ofi
tthathasnotbeen
pai
doutt
oshar
ehol
der
sordi
vi
dends.
7.Ther
oleoff
inanci
alsy
stem i
stot
ransmi
tinf
ormat
ionbet
weensav
ersand
bor
rower
s.
8. The f
inanci
alsy
stem i
s compr
ised off
inanci
almar
ket
s,i
nsur
ance
compani
esandcent
ral
banks.

Chapt
er5.Regul
ati
onsi
ntheFi
nanci
alMar
ket

23
 Thegov
ernmentf
ocusesoni
ncr
easi
ngt
het
ranspar
encyandef
fi
ciencyi
nthe
secondar
ymar
ket
.Itensur
est
hatt
hepr
imar
ydi
str
ibut
ionofcor
por
atesecur
it
ies
whi
chaf
fect
stheabi
l
ityoft
hecor
por
ati
ont
odi
sposeoft
her
emai
ningi
ssuesi
nthe
secondar
ymar
ket
s.Thecomponent
soft
hesecur
it
iesmar
ket
spl
ayani
mpor
tant
r
olei
nthesubsequentdi
str
ibut
ionofsecur
it
ies.

Regul
ati
oni
ntheFi
nanci
alMar
ket
TheFi
nanci
alMar
keti
swher
etr
adi
ngofst
ocksar
emade.I
tcanei
therbei
n
t
hePr
imar
yMar
ketort
heOv
er-
the-
count
erMar
ket
.Iti
simpor
tantt
oensur
esmoot
h
wor
kingofcapi
talmar
ket
,asi
tist
hear
enaf
ort
hepl
ayer
sassoci
atedwi
tht
he
economi
cgr
owt
hoft
hecount
ry.

TheCapi
talMar
keti
nter
medi
ari
esar
evi
tall
i
nkbet
weeni
nvest
or,i
ssuerand
r
egul
ator
.Theobj
ect
iveoft
hesei
nter
medi
ari
esi
sto smoot
hen t
hepr
ocessof
i
nvest
mentandt
oest
abl
i
shal
i
nkbet
weent
hei
nvest
orsandt
heuser
soff
unds.

Cor
por
ati
onsandgov
ernment
sdonotmar
kett
hei
rsecur
it
iesdi
rect
lyt
othe
i
nvest
ors.I
nst
eadt
heyhi
ret
heser
vicesoft
hemar
keti
nter
medi
ari
est
orepr
esent
t
hem t
othei
nvest
ors.

TheSecur
it
iesandExchangeCommi
ssi
oni
ssuer
ulesandr
egul
ati
onst
o
i
mpl
ementt
heSecur
it
izat
ionActof2004.Ot
herbr
anchesi
nthegov
ernmentt
hat
f
aci
l
itat
est
radi
ngofSecur
it
iesar
ePhi
l
ippi
neDeposi
tor
yExchangeandBur
eauof
Tr
easur
y. The gov
ernment
’s goali
sto achi
eveal
eveloff
inanci
alsect
or
dev
elopmentcompar
abl
etoi
tsnei
ghbor
ingcount
ri
es.Thegov
ernmentneededt
o
r
est
orei
nvest
orconf
idence,becauseot
herv
ulner
abi
l
iti
escont
ri
but
edt
oincr
eased
sy
stemi
cri
skandv
olat
il
it
y.

Ef
fi
ciencyandLi
qui
dit
yoft
heSecur
it
iesMar
ket

24
 Thegov
ernmentf
ocusedoni
ncr
easi
ngt
ranspar
encyandef
fi
ciencyi
nthe
secondar
ymar
ketandpr
ovi
dingf
orani
ncr
easedv
ari
etyofi
nvest
mental
ter
nat
ives.

Whenbuy
ingorsel
l
ingsecur
it
ies,t
heser
vicesoft
hef
oll
owi
ngmi
ddl
emenwi
l
l,most
of
tenber
equi
red:
1.Br
okeri
sanyper
sonengagedi
nthebusi
nessofef
fect
ingt
ransact
ionsi
n
secur
it
iesf
ort
heaccountofot
her
sbutdoesnoti
ncl
udeabank.
2.Deal
eri
sanyper
sonengagedi
nthebusi
nessandsel
l
ingsecur
it
iesf
orhi
s
ownaccount
,thr
oughabr
okerorot
her
wise,butdoesnoti
ncl
udeanyper
son
i
nsof
arashebuy
sorsel
lsecur
it
iesf
orhi
sownaccount
,ei
theri
ndi
vi
dual
l
yor
i
nsomef
iduci
arycapaci
ty,
butnotasapar
tofar
egul
arbusi
ness.
3.Sal
esmani
ncl
udesev
erynat
uralper
son,ot
hert
hanadeal
er,empl
oyedor
appoi
ntedoraut
hor
izedbyadeal
er,i
ssuerorbr
okert
osel
lsecur
it
iesi
nany
manner
.

Thef
oll
owi
ngar
eamongt
hemar
keti
nter
medi
ari
es:
1.Mer
chantBanker
s – any per
son engaged i
nthe busi
ness ofi
ssue
managementbymaki
ngar
rangement
sregar
dingsel
l
ing,buy
ing,subscr
ibi
ng
t
osecur
it
iesoract
ingasmanager
/consul
tant/
adv
isororr
endi
ngcor
por
ate
adv
isor
yser
vices.
2.Under
wri
ter
s–aper
sonwhoengagei
nthebusi
nessofunder
wri
ti
ngofan
i
ssueofsecur
it
iesofabodycor
por
ate.
Under
wri
ti
ng i
san ar
rangementwher
ecer
tai
n par
ti
esassur
ethei
ssui
ng
companyt
otakeupshar
esorot
hersecur
it
iest
oaspeci
fi
edext
enti
ncase
t
hepubl
i
csubscr
ipt
iondoesnotamountt
otheexpect
edl
evel
s. Fort
his
pur
poseanar
rangementwi
l
lbeent
eredi
ntobet
weent
hei
ssui
ngcompany
andt
heassur
ingpar
tysuchast
hebank,
thebanker
,br
okerorot
herper
son.
3.Sy
ndi
cat
es–ar
egi
ster
edi
nter
medi
arywhoi
sper
mit
tedt
ocar
ryont
he
act
ivi
tyoft
heunder
wri
ter
.Thesy
ndi
cat
emember
sar
eappoi
ntedt
ocol
l
ect
t
heent
ir
ebi
dfor
ms.Thesy
ndi
cat
emembersubmi
tst
hebi
dwi
thchequet
o
t
hebanker
sandhav
epr
ooft
hatt
hebi
damountwaspai
d.
4.Tr
ust
ees–at
rust
eeofaTr
ustDeed.I
nmostcases,car
rysecur
it
iesf
or
t
hei
nvest
orsf
oraf
ee.
5.Cust
odi
ans–aper
sonwhocar
ri
esont
hebusi
nessofpr
ovi
dingcust
odi
al

25
 ser
vicest
othecl
i
ent
.Thecust
odi
ankeepst
hecust
odyoft
hesecur
it
iesof
t
hecl
i
entsuchasadmi
nist
erandpr
otectt
heasset
soft
hecl
i
ent
.
Thet
ypeofor
dert
hatani
nvest
orpl
acest
hroughhi
sbr
okercanv
ary
wi
thr
espectt
osi
ze,
timi
ng,
pri
ce,
andmet
hodofexecut
ion.

Cust
omer
scanei
therpl
aceabuyor
derorasel
lor
derwi
thhi
s\herbr
oker
.The
numberofshar
esi
nanor
deri
sgener
all
y100shar
esormul
ti
plesof100andi
s
cal
l
edar
oundl
otor
der
.

Or
der
stobuyorsel
llesst
han100shar
esar
ecal
l
edoddl
otor
der
s.Oddl
ot
or
der
sincurahi
ghert
ransact
ioncostf
ort
wor
easons;f
ir
st,t
hecommi
ssi
onper
secur
it
yinoddl
otor
der
sexceedst
hatf
orr
oundl
otor
der
s.

Second,anoddl
otdi
ff
erent
iali
susual
l
yadded(
orsubt
ract
ed)i
nthecaseof
buy
ing(
orsel
l
ing)oddl
otshar
es

Ty
pesofOr
der
s
Forabr
okert
oexecut
eacl
i
ent
'
sor
deref
fect
ivel
yhemustr
ecei
vespeci
fi
c
andcl
eari
nst
ruct
ions.Thesei
nst
ruct
ionsar
econv
eyedi
nthef
orm ofdi
ff
erentt
ypes
ofor
der
s.

1.Mar
ketOr
der
Mar
ketor
deri
stheeasi
estt
ypeofor
deracust
omercanpl
ace.Undera
mar
ketor
der
,ani
nvest
oraskst
hebr
okert
oexecut
ether
equi
redt
ransact
ionas
qui
ckl
yaspossi
ble,
andatt
hebestpr
iceav
ail
abl
eint
hemar
ket
,lowestpr
icei
n
t
hecaseofabuy(
i.
e.att
hel
owestaskpr
ice)andt
hehi
ghestpr
icei
nthecase
ofasel
l(i
.eatt
hehi
ghestbi
dpr
ice)
.Becauset
heor
derspeci
fi
esonl
ythe
quant
it
yandnott
hepr
ice,
thedeal
isusual
l
yexecut
edwi
thi
naf
ewmi
nut
es.

2.Li
mitor
der
I
ncaseofl
i
mitor
der
sthei
nvest
orspeci
fi
esbot
hthequant
it
yandt
hepr
ice
atwhi
chhei
swi
l
li
ngt
obuyorsel
lasecur
it
y.Thus,t
hebr
okerdoesnot
hingbut
wai
tst
osei
zet
heoppor
tuni
tywhent
hemar
ketpr
iceoft
hest
ockr
eachesorf
all
s
bel
owt
hespeci
fi
edpr
icei
nthecaseofal
i
mitbuyor
der
.Al
ter
nat
elyi
nthecaseofa
l
i
mitsel
lor
derwai
tsf
ort
hepr
icet
oreachorexceedt
hel
i
mitsel
lpr
ice.Li
mitor
der
s
mayormaynotbeexecut
edi
mmedi
atel
y.Usual
l
ythei
nvest
orwi
l
lspeci
fyt
he

26
per
iodoft
imef
orwhi
cht
hel
i
mitor
deri
stobekeptal
i
ve.Adayl
i
mitor
deri
skept
act
ivet
hrought
het
radi
ngday
,butwi
l
lbecancel
l
edi
fnotexecut
edbyt
heendof
t
het
radi
ngday
.

3.Fi
l
lorKi
l
lOr
der
A'
fi
llorki
l
l'or
deri
sat
ypeofl
i
mitor
der
.Ina'
fi
llorki
l
l'l
i
mitor
dert
he
i
nvest
ori
srequest
ing al
i
mitor
dert
o bewi
thdr
awn i
fitcannotbeexecut
ed
i
mmedi
atel
y.

4.St
opl
ossOr
der
St
opl
ossor
der
sar
esi
mil
art
othel
i
mitor
derdescr
ibedabov
e,exceptt
hat
t
het
radei
snott
obeexecut
edunl
esst
hest
ockhi
tsapar
ti
cul
arpr
ice.Unl
i
ket
he
l
i
mitor
derhowev
er,ast
opl
osssel
lisex
ecut
edwhent
hest
ockpr
icehi
tsor
decl
i
nesbel
owt
hepar
ti
cul
arpr
ice,
andast
opl
ossbuyi
sexecut
edwhent
hest
ock
pr
icehi
tsorex
ceedst
hepar
ti
cul
arpr
ice.Ast
henamesuggest
stheseor
der
sar
e
i
ntendedt
oli
mitt
hel
osst
othei
nvest
or.Ast
opor
derbecomesamar
ketor
der
oncet
hest
oppr
icei
sreached,
somet
imespr
icescanf
allsor
api
dlyt
hatt
hebr
oker
maybeunabl
etoexecut
ethesel
latP95andwi
l
lbeobl
i
gedt
osel
latapr
icebel
ow
P95.

5.St
op-
li
mitOr
der
Thest
op-
li
mitor
dert
ackl
est
heuncer
tai
ntyaboutt
hepr
iceatwhi
cht
he
t
radewi
l
lbeexecut
edi
nast
opor
derbycombi
ningt
hef
eat
uresofast
opor
derwi
th
al
i
mitor
der
s.Forexampl
e,i
fani
nvest
orhas1,
000shar
est
hatwer
eboughtatP50
each,andf
ear
sasuddendecl
i
nei
npr
ice,hecani
ssueast
op-
li
mitor
deratapr
ice
ofP49st
op,P47l
i
mit
,Thi
smeanst
hatt
hebr
okershoul
dst
artt
hesel
l
ingpr
ocess
whent
hepr
icedr
opst
oP49orl
ess,
butmaynotsel
lforl
esst
hanP47.

Gener
all
yinv
est
orsbuyshar
esi
ntheant
ici
pat
ionofapr
icei
ncr
easei
nthe
f
utur
e.I
fani
nvest
orhowev
erant
ici
pat
esadecl
i
nei
nthepr
ice,
thei
nvest
orcansel
l
t
heshar
est
oday(
bor
rowi
ngt
hem v
iahi
sbr
oker
)pl
anni
ngt
opur
chaset
hem i
nthe
f
utur
etor
epl
acet
hebor
rowedshar
es.Suchat
ransact
ioni
st medashor
er tsal
e.

Thei
nvest
orwi
l
lreapapr
ofi
tonl
yift
hepr
icef
all
sandt
hebor
rowedshar
es
ar
epur
chased atal
owerpr
ice.Thei
nvest
ori
srequi
redt
oal
sopayanydi
vi
dends

27
t
hatt
heshar
epay
sdur
ingt
heper
iodt
hatt
heshar
esar
ebor
rowed.St
ockexchange
r
egul
ati
onsonl
yper
mitshor
tsal
est
otakepl
aceaf
terposi
ti
vechangesi
nthest
ock
pr
ice(
upt
ick)
,inor
dert
oav
oidexcessi
vespecul
ati
onagai
nstt
hest
ock.

Mostr
egul
ati
onsr
equi
ret
hepr
oceedsf
rom shor
t•sal
est
obekepti
nan
accounti
nthe i
nvest
or'
sname.Thebr
okermayaskt
heshor
t-
sel
l
ert
okeepacash
mar
ginorsui
tabl
ecol
l
ater
alagai
nstl
ossesi
fst
ockpr
icesr
ise,

Ex e:Asanexampl
ampl e,consi
dert
heshor
tsal
eof100shar
esatt
hecur
rentmar
ket
pr
iceofP50.
Thebr
okerexecut
est
heshor
tsal
eandr
equest
sa50% i
nit
ialmar
gin
f
rom t
hei
nvest
or.(
Thei
nvest
ori
s,t
her
efor
e,r
equi
red t
o pr
ovi
decash orcash
equi
val
entcol
l
ater
alwor
thP2500)
.Ift
hest
ockpr
icef
all
stoP30,t
hei
nvest
orcan
pur
chaset
he100shar
esand'
cov
er'hi
sshor
tposi
ti
onbyr
epl
aci
ngt
he100shar
es
bor
rowed,andgener
ateapr
ofi
tofP2,
000.But
,ift
hepr
icegoesupt
oP70,t
he
br
okermayaskt
hei
nvest
ort
odeposi
tcashmar
ginorbuyshar
est
orepl
acet
heones
shor
tsol
d,l
eadi
ngt
oal
ossofP2000f
ort
hei
nvest
or.

Exer
cises.

TEST1.Dowhati
srequi
redont
hef
oll
owi
ng:
1.Doar
esear
chf
rom t
hei
nter
netaswhatl
awsandr
egul
ati
onsar
epr
otect
ing
t
hei
nvest
orsi
nthePhi
l
ippi
nes.
2.Li
stt
hef
unct
ionsoft
hemi
ddl
emenofsecur
it
ies?
 Br
oker
 Sal
esman
 Deal
er
3.Expl
ainbr
ief
lyt
her
oleandr
esponsi
bil
i
tiesofi
nter
medi
ari
es.

TEST 2.Choosethecorr
ectanswerf
oreachoft
hef
oll
owi
ngquest
ions.
Writ
ethelet
terbefor
ethenumber.

1- Fi
nanci
almarketshavethebasi
cfuncti
onof
(
a)Br i
ngi
ngtogetherpeoplewi
thfundstolendandpeoplewhoneedfunds.
(
b)Assuringthattheswingsi
nthebusinesscy cl
earel
esspr
onounced.
(
c) Assur
ingthatgover
nmentsneednev erresortt
opri
nti
ngmoney.
(
d)Bot h(
A)and( B)oftheabove.

2-Whi
choft
hef
oll
owi
ngst
atement
saboutt
hechar
act
eri
sti
csofdebtandequi
ty

28
 ar
et r
ue?
(a)Theycanbot hbelong-ter
mf inanci
alinst
ruments.
(b)Theybot hi
nvolv
eacl ai
m ont heissuer’
sincome.
(c) Theybothenabl
eacor porat
iont orai
sefunds.
(d)Al l
oftheabove

3-Whichoft
hefol
lowingarelong-
termfinanci
ali
nst
rument
s?
(
a)Anegotiablecert
if
icateofdeposit
(
b)Abanker ’
sacceptance
(
c) Agover
nmentTr easuryBond
(
d)Agov er
nmentTr easuryBil
l

4-Whichoft
hefollowingareshor
t-
ter
mf i
nanci
ali
nst
rument
s?
(
a)Anegot iablecert
if
icat
eofdeposi
t
(
b)Abanker ’sacceptance
(
c) AgovernmentTr easur
yBond
(
d)Bot haandboft heabove

5-Whichoft
hef ol
lowi
ngi nst
rument
sisnott
radedi
namoneymar
ket
?
(
a)Banker sacceptances
(
b)Gov ernmentTreasuryBil
l
s
(
c) RepurchaseAgreements
(
d)Longt erm Bonds

6-Whichoft
hef oll
owinginst
rument
saret
radedi
nacapi
tal
mar
ket
?
(
a)gov er
nmentagencysecur i
ti
es
(
b)Negot iablebankCDs
(
c) Repurchaseagreements
(
d)Commer ci
alPapers

7-TheNewYor kStockExchangeispri
mar
il
y
(a)Asecondar ymarket.
(b)Anorganizedauctionmarket
.
(c) Anov
er-t
he-countermar
ket.
(d)Both(a)and(b)arecorr
ect.

8 -Whichofthefollowingar eexamplesofapr i
marymarkettr
ansact
ion?
(a)Listedcompanyi ssuesadditi
onalsock.
(b)Acompanyi ssuesnewbonds.
(c) Aninvestoraskshi sbrokertopur
chase1,000sharesofSABI
Ccommon
st
ock.
(d)Both( a)and( b)arecorrect.

9 -AnI
nit
ial
Publ
i
cOf
fer
ingi
nwhi
cht
heunder
wri
terpur
chasest
he

29
 sharesf
rom theissui
ngfir
m andt akest
her
iskofsel
l
ingt
he
sharest
othepubl i
cisknownas:
(a)Af i
rm commi tmentunderwri
ting
(b)Anegot i
atedunderwrit
ing
(c) Abesteffor
tsunderwri
ting
(d)Acompet i
ti
veunderwri
ting

10-Thecustodianofani nvestorshar
eshasresponsi
bil
i
tyf
oral
lthef
oll
owi
ng
except:
(a)Keepi nginv
est mentsaf e
(b)Col l
ecti
ngdividends
(c) Exchangeratemov ementscont
rol
(d)Vot i
ngonbehal fofi nvest
ors

11-Whichofthef ol
lowingref
erst
osel
l
ingst
ockbor
rowedf
rom anot
heri
nvest
or?
(a)ASt op-lossorder
(b)AMar gintr
ade
(c) AShor tsal
e
(d)ALimi torder

12 -Fi
nancial
mar ketshavethebasi
cf uncti
onof
(
a)Br i
ngi
ngt ogetherpeoplewi
thfundst ol
endandpeoplewhoneedfunds.
(
b)Assur i
ngthatt heswingsi
nthebusinesscy cl
earel
esspr
onounced.
(
c) Assuri
ngthatgov er
nmentsneednev erresortt
opri
nti
ngmoney.
(
d)Bot h(A)and( B)oftheabove.

13 -Whi
chofthefol
lowingarel
ong-t
ermfi
nanci
ali
nst
rument
s?
(
a)Anegotiabl
ecer t
if
icat
eofdeposit
(
b)Abanker’sacceptance
(
c) Agover
nmentTr easur
yBond
(
d)Agov er
nmentTr easur
yBil
l

14 -Whi
chofthefol
lowingareshor
t-
termf
inanci
ali
nst
rument
s?
(
a)Anegotiabl
ecer t
if
icat
eofdeposit
(
b)Abanker’sacceptance
(
c) Agover
nmentTr easur
yBond
(
d)Bothaandboft heabove

15 -Whi
chofthef ol
lowinginstr
ument
sisnott
radedi
namoneymar
ket
?
(
a)Banker sacceptances
(
b)Gov er
nmentTr easuryBill
s
(
c) Repur
chaseAgr eement s
(
d)Longt erm Bonds

16 -Whi
choft
hef
oll
owi
ngi
nst
rument
sar
etr
adedi
nacapi
tal
mar
ket
?

30
 (
a)U. S.governmentagencysecur
it
ies
(
b)Negot iablebankCDs
(
c) Repurchaseagreements
(
d)Commer ci
alPaper
s

17 -TheNewYor kStockEx changeispr

imar
il
y
(
a)Asecondar ymarket.
(
b)Anor ganizedauctionmar ket
.
(
c) Anover-t
he-countermar ket
.
(
d)Bot h(a)and(b)arecor r
ect.

18-Whichofthefollowingar eexamplesofapr i
marymarkettr
ansact
ion?
(a)List
edcompanyi ssuesadditi
onalsock.
(b)Acompanyi ssuesnewbonds.
(c) Ani
nv estoraskshi sbrokertopur
chase1,000sharesofcommonstock.
(d)Both( a)and( b)arecorrect.

19-Thecustodianofani nvestorshar
eshasresponsi
bil
i
tyf
oral
lthef
oll
owi
ng
except:
(a)Keepi nginv
est mentsaf e
(b)Col l
ecti
ngdividends
(c) Exchangeratemov ementscont
rol
(d)Vot i
ngonbehal fofi nvest
ors

20-Whichofthef ol
lowingref
erst
osel
l
ingst
ockbor
rowedf
rom anot
heri
nvest
or?
(a)ASt op-lossorder
(b)AMar gintr
ade
(c) AShor tsal
e
(d)ALimi torder

31
 Chapt
er6.Ri
skandRet
urnTheor
ies

I
nthepur
sui
tofanyobj
ect
ive,onehast
oreckonwi
thr
isk.I
ndi
vi
dual
s
andf
ir
msmustf
acet
hepr
ospectofei
thergai
ningorl
osi
ngi
nthei
rinv
est
ment
s.
Forev
eryt
ransact
ionmadeacor
respondi
ngamountofr
iski
spr
esent
,yetev
en
wi
thsuchuncer
tai
nti
es,
busi
nessesmov
eon.TheFact
orst
obeconsi
der
edar
e
t
hoset
hatcont
ri
but
etoanasset
’st
otalr
isk.Becausemostoft
hei
nvest
ors
hav
eapor
tfol
i
oofi
nvest
ment
s,i
tisnecessar
ytoconsi
derhowt
omeasur
ethe
r
iskofanassetwheni
tisapar
tofal
argepor
tfol
i
oofasset
s.Ther
iskt
hat
pr
evai
l
swhen asseti
spar
tofa di
ver
sif
ied por
tfol
i
oisr
efer
red t
o asi
ts
sy
stemat
icr
isk.

I
nvest
mentRi
sks
I
nvest
menti
sthecur
rentcommi
tmentofmoneyf
oraper
iodoft
imei
n
or
dert
oder
ivef
utur
epay
ment
sthatwi
l
lcompensat
ethei
nvest
orf
or:
1.t
het
imeoff
undsar
ecommi
tt
ed,
2.t
heexpect
edr
ateofi
nfl
ati
ondur
ingt
hist
imeper
iod,
and
3.t
heuncer
tai
ntyoft
hef
utur
epay
ment
s.

Thesummat
ionoft
het
hreecomponent
si edt
scal
l her
equi
redr
ateof
r
etur
n.
Thi
sist
hemi
nimum r
ateofr
etur
nthaty
oushoul
dacceptf
rom t
hei
nvest
ment
t
ocompensat
eyouf
ordef
err
ingconsumpt
ion.

Thei
nvest
orcanbeani
ndi
vi
dual
,agov
ernment
,apensi
onf
und,ora
cor
por
ati
on. I
nvest
ment
s i
ncl
udes al
lty
pes such as i
nvest
ment
s by
cor
por
ati
onsi
npl
antandequi
pmentandi
nvest
ment
sbyi
ndi
vi
dual
sinst
ocks,
bonds,
commodi
ti
esorr
eal
est
ate.

I
nvest
ori
str
adi
ngaknowndol
l
aramountt
odayf
orsomeexpect
edf
utur
e
st
ream ofpay
ment
sthatwi
l
lbegr
eat
ert
hant
hecur
rentdol
l
aramountt
oday
.

32
 Measur
eofRet
urnandRi
skofI
nvest
ment

Thepur
poseofCapi
talMar
ket
sist
obr
ingt
oget
heri
nvest
orswhowantt
o
i
nvestsav
ingswi
thcompani
esorgov
ernment
swhoneedcapi
talt
oexpandor
t
ofi
nancebudgetdef
ici
ts.Thecostoff
undsatanyt
ime(
thei
nter
estr
ate)i
s
t
hepr
icet
hatequat
est
hecur
rentsuppl
yanddemandf
orcapi
tal
.
 Thef
ir
stmeasur
eist
hehi
stor
icalr
ateofr
etur
nonani
ndi
vi
duali
nvest
ment
ov
ert
het
imeper
iodt
hei
nvest
menti
shel
d(t
hati
sit
shol
dingper
iod)
.
 Nextconsi
derhow t
omeasur
etheav
eragehi
stor
icalr
ateofr
etur
nforan
i
ndi
vi
duali
nvest
mentov
era numberoft
ime per
iods.(
mont
hly
,semi
-
annual
l
y,annual
l
yet
c.)
 Thet
hir
dsubsect
ionconsi
der
stheav
erager
ateofr
etur
nforapor
tfol
i
oof
i
nvest
ment
s.(
per
cent
ageorr
ateofi
ncr
ease)

Whenwei
nvest
,wedef
ercur
rentconsumpt
ioni
nor
dert
oaddt
oourweal
th
sot
hatwecanconsumemor
eint
hef
utur
e.Ther
efor
e,whenwet
alkabouta
r
etur
noni
nvest
ment
,wear
econcer
nedwi
tht
hechangei
nweal
thr
esul
ti
ng
f
rom t
hisi
nvest
ment
.Thi
schangei
nweal
thcanei
t ocashi
herbeduet nfl
ows,
suchasi
nter
estordi
vi
dends,orcausebyachangei
nthepr
iceofanasset
(
posi
ti
veornegat
ive)
.
Ri
sksi
nInv
est
ment

Ri
skmaybedef
inedast
hev
ari
abi
l
ityi
npossi
bleout
comesofanev
entbased
onchance.

Met
hodsofHandl
i
ngRi
sks
1.Ri
skmaybeav
oided
2.Ri
skmayber
etai
ned
3.Hazar
dmayber
educed
4.Lossmayber
educes
5.Ri
skmaybeshi
ft
ed;
and
6.Ri
skmayber
educed.

Ani
nvest
orwhopur
chasesbondsf
acesr
isksf
rom av
ari
etyofsour
ces.These
i
ncl
udei
nfl
ati
onr
isk,
def
aul
tri
sk,
li
qui
dit
yri
skandi
nter
estr
ater
isk.

33
1.I
nter
estRat
eRi
skorPr
iceRi
sk
Themar
ketpr
iceofabondi
sinv
ersel
ypr
opor
ti
onalt
othel
evelofi
nter
est
r
ates.Wheni
nter
estr
atesf
all
,bondpr
icesi
ncr
easeandconv
ersel
ywhen
i
nter
estr
atesr
ise,
bondpr
icesdecr
ease.Asi
nter
estr
atesf
luct
uat
erandoml
y
i
ntheeconomy
,thebondwi
l
lexper
iencer
andom pr
icemov
ement
s.Thi
s
r
andom v
ari
ati
oni
npr
icei
ster
medpr
icer
isk.
Bondi
nvest
orst
her
efor
eexper
iencepr
icegai
nswheni
nter
estr
atesf
alland
suf
ferpr
icel
osseswheni
nter
estr
atesr
ise.

2.I
nfl
ati
onRi
sk
I
nfl
ati
onr
iski
srel
atedt
otheconceptofi
nter
estr
ater
iskdi
scussedabov
e.As
i
nfl
ati
oni
ncr
easessodoi
nter
estr
ates,whi
cht
henaf
fect
sbondpr
ices.Whi
l
e
mostf
inanci
alasset
sar
einf
luencedbyi
nfl
ati
on,bondsar
eaf
fect
edmost
sev
erel
y.

3.Li
qui
dit
yRi
sk
Al
i
qui
dsecur
it
ymar
keti
swher
eani
nvest
ori
sabl
etosel
lasecur
it
yatshor
t
not
icewi
thouthav
ing t
o of
ferasubst
ant
ialpr
icedi
scountA mar
ketf
or
secur
it
iest
hatar
eact
ivel
ytr
adedt
endt
obel
i
qui
dBondmar
ket
s,especi
all
y
cor
por
atebondmar
ket
stendt
obet
hinwi
thi
nfr
equentt
radi
ng.Bondhol
der
s
wi
shi
ngt
osel
linsuchmar
ket
smayhav
etoof
ferapr
icedi
scountand
t
her
efor
esuf
feral
osst
oat
tractbuy
ers.

4.Def
aul
tRi
sk
Whenacor
por
ati
ont
hatbor
rowsf
undsbyi
ssui
ngbondsi
sunabl
etomake
t
hepr
omi
sedi
nter
estandpr
inci
pal
pay
ment
s,t
hebondi
ssai
dtobei
ndef
aul
t.
Thel
i
kel
i
hoodt
hatabondhol
dermayl
osehi
smoneyt
hroughsuchnon-
pay
menti
ster
meddef
aul
tri
sk.Whi
l
egov
ernmentbondsdonotsuf
ferf
rom
t
hispr
obl
em (
becauset
heycanul
ti
mat
elyi
ncr
easet
axesorsi
mpl
ypr
int
moneyt
orepayt
hebonds)
,al
lcor
por
atebondshav
esomeamountofdef
aul
t
r
isk,
albei
tinv
ary
ingdegr
ees.

Di
vi
dends
Theneti
ncomeofacor
por
ati
onmaybedi
str
ibut
edt
othest
ockhol
der
sint
he

34
 f
orm ofdi
vi
dends.Ther
ear
eti
meshowev
erwhent
hei
ncomei
snotdecl
ared
asdi
vi
dends.I
nst
ead,i
tisr
etai
nedi
nthecompany
’scof
fer
sforusei
nsome
ofi
tscapi
talf
inanci
ngr
equi
rement
s.Thi
sisr
epor
tedas“
ret
ainedear
nings”
i
nthecompany
’sBal
anceSheet
.

Ty
pesofDi
vi
dends

Compani
es hav
e been known t
o paydi
vi
dends ei
theras a cash
di
vi
dend,
int
hef
orm ofst
ockr
epur
chase,
orasast
ockdi
vi
dend.Thef
ir
stt
wo
ar
eequi
val
entway
sofdi
str
ibut
ingcasht
otheshar
ehol
der
,whi
l
ethel
astdoes
notr
epr
esentanact
ual
cashdi
str
ibut
ion.

1.CashDi
vi
dends
Cashdi
vi
dends,
ast
henamei
mpl
i
esi
swhent
hecompanydi
str
ibut
escash
f
rom ear
nedpr
ofi
tst
oit
sshar
ehol
der
s.Si
ncest
ocksar
eact
ivel
ytr
adedi
nthe
mar
kett
hecompanymustknowt
owhom t
hedi
vi
dendshast
obesent
.Ther
eis
usual
l
yat
imel
ag(
afew weeks)bet
weendecl
arat
ionandpay
mentofcash
di
vi
dends.
A decl
ared di
vi
dend becomes a l
i
abi
l
ityoft
he cor
por
ati
on,and si
nce
pay
menti
sgener
all
yrequi
redv
erysoon,i
susual
l
ycl
assi
fi
edascur
rentl
i
abi
l
ity
.
Soont
hedecl
arat
iondat
e,t
her
etai
nedear
ningaccounti
sdecr
easedbyt
he
amountoft
hedecl
areddi
vi
dendandacur
rentl
i
abi
l
ityofequalmagni
tudecal
l
ed
di
vi
dendspay
abl
eiscr
eat
ed.

Themar
ketv
alueoft
heshar
efal
l
sbyt
heamountoft
hedi
vi
dendont
he
dat
eofr
ecor
d.Ani
nvest
orhol
dingashar
eont
her
ecor
ddat
eisent
it
ledt
othe
di
vi
dend,whi
l
eani
nvest
orbuy
ingt
heshar
eont
hef
oll
owi
ngdayi
snot
.The
pr
iceont
hef
oll
owi
ngdayi
sther
efor
egoi
ngt
obel
esst
hant
hepr
iceont
heday
bef
orebyt
heamountoft
hedi
vi
dend.Themar
ketpr
iceont
her
ecor
ddayand
ear
li
eri
scal
l
edt
hecum di
vi
dendpr
icewhi
l
ethepr
iceaf
ter
war
dsi
scal
l
edt
heex
-di
vi
dendpr
ice.
2.St
ockRepur
chase
St
ock r
epur
chase i
s consi
der
ed as an al
ter
nat
ivet
o cash di
vi
dends.
Repur
chasi
ngst
ocksachi
evet
hesameout
comeofdi
str
ibut
ingcasht
othe
shar
ehol
der
s.Ar
epur
chaseandacashdi
vi
dendar
ethesamet
hingi
nawor
ld
wi
thoutt
axesand t
ransact
ioncost
s.Howev
er,i
nther
ealwor
ldt
her
eisa

35
 di
ff
erence i
ntax t
reat
mentoft
he t
wo al
ter
nat
ives.I
nar
epur
chase,a
shar
ehol
derpay
scapi
talgai
nst
axes(
nor
mal
l
ylowert
hanor
dinar
ytaxr
ates)on
t
hesal
ewhi
l
edi
vi
dendsar
etaxedasor
dinar
yincomeatahi
ghert
axr
ate.

Compani
esgi
vemanyr
easonsf
orr
epur
chasi
ngt
hei
rst
ock,ot
hert
hant
he
pr
efer
ent
ialt
axt
reat
mentment
ionedabov
e.Thesei
ncl
udet
hebel
i
ef,ont
he
par
tofmanagement
,thatt
hest
ocki
sunder
val
ued.Somecompani
eschoose
t
her
epur
chaseal
ter
ati
vei
nanat
temptt
oboostt
hei
rear
ningspershar
e(EPS=
Ear
nings/
Numberofshar
es)
,si
ncer
epur
chaser
educest
henumberofshar
es
out
standi
ng (
the denomi
nat
or) wi
thoutaf
fect
ing ear
nings as much (
the
numer
ator
).

3.St
ockDi
vi
dend
I
nast
ockdi
vi
dend,
shar
ehol
der
sar
egi
vennewshar
esi
nst
eadofcash.For
exampl
e a 10% st
ock di
vi
dend i
mpl
i
es t
hatf
orev
ery10 shar
es hel
dthe
shar
ehol
derwi
l
lrecei
veonenewshar
easadi
vi
dendNot
ethatast
ockdi
vi
dend
hasnosubst
ant
iveef
fectont
hef
ir
m si
ncenocashf
lowsar
einv
olv
ed.Thet
otal
v
alueoft
hef
ir
mther
efor
eshoul
dnotchange.Howev
ert
hei
ncr
easei
nthe
numberofshar
esout
standi
ngwi
l
lreducet
hemar
ketpr
icepershar
e.

4.St
ockSpl
i
t

Asi
nthecaseofast
ockdi
vi
dend,somecompani
esmaychooset
ospl
i
t
t
hei
rshar
esi
nanat
temptt
obr
ingt
hepr
icepershar
etoacomf
ort
abl
elev
el
al
l
owi
ng wi
deri
nvest
orpar
ti
cipat
ion.I
na3f
or1st
ockspl
i
t,t
hecompany
r
epl
aceseachol
dshar
ewi
tht
hreenewshar
es.

Ani
nvest
orhol
ding100shar
esbef
oret
hespl
i
twi
l
lrecei
veanaddi
ti
onal
200shar
es,
tot
akehi
shol
dingt
o300shar
es.Justasi
nthest
ockdi
vi
dendcase
al
lpost
-spl
i
tval
uesmustchangeexact
lyi
npr
opor
ti
ont
othespl
i
t.

Forexampl
ethebookv
aluepershar
ewi
l
lfal
lbyat
hir
d,aswi
l
lear
ningsper
shar
eandt
hemar
ketpr
icepershar
e.

Di
vi
dendPol
i
cyi
nPr
act
ice

36
 Compani
espr
efert
omai
ntai
nar
elat
ivel
yst
abl
elev
elofdi
vi
dends,onet
hat
pr
efer
abl
ygr
owsov
ert
ime.Fr
equentchangesi
ndi
vi
dendscangi
veconf
li
cti
ng
si
gnal
stoshar
ehol
der
sont
heper
for
manceoft
hef
ir
m.

Forexampl
e,when a company
's ear
nings i
ncr
ease,managementmay not
aut
omat
ical
l
yrai
set
hedi
vi
dend.Onl
ywhenmanagementi
sconf
identt
hatt
he
i
ncr
easedear
ningswi
l
lbesust
ainedi
nthef
utur
ewi
l
ltheyi
ncr
easet
hedi
vi
dend.

Var
ioust
ypesofdi
vi
dendpol
i
ciest
hathav
ebeenobser
vedi
ncl
ude:

1.St
abl
edol
l
arpershar
epol
i
cy:Manycompani
esuseast
abl
edi
vi
dend-
per
-
shar
epol
i
cy.Ast
abl
epol
i
cyt
endst
obel
ookeduponf
avor
abl
ybyi
nvest
ors,
asi
t
i
mpl
i
esal
ow-
ri
skcompany
.
2.Const
antdi
vi
dend-
pay
out
-r
ati
opol
i
cy:Wi
tht
hispol
i
cyaconst
antper
cent
age
ofear
ningsi
spai
douti
ndi
vi
dends.Becauseneti
ncomev
ari
es,di
vi
dendspai
d
wi
l
lal
sov
aryusi
ngt
hisappr
oach.
3.Acompr
omi
sepol
i
cy:Acompr
omi
sebet
weent
hepol
i
ciesofast
abl
eri
yal
amountandaper
cent
ageamountofdi
vi
dendsi
sforacompanyt
opayal
ow
r
iyal
amountpershar
epl
usaper
cent
agei
ncr
ementi
ngoody
ear
s.
4.Resi
dual
-di
vi
dendpol
i
cy:Wi
tht
hiski
ndofpol
i
cyt
heamountofear
nings
r
etai
neddependsupont
heav
ail
abi
l
ityofi
nvest
mentoppor
tuni
ti
esi
napar
ti
cul
ar
y
ear
.Di
vi
dendspai
drepr
esentt
her
esi
dualamountf
rom ear
ningsaf
tert
he
company
'si
nvest
mentneedsar
eful
fi
ll
ed.

Exer
cises.

TEST1.Dowhati
srequi
redont
hef
oll
owi
ng:

1.St
atet
her
easonswhyani
nvest
orput
shi
smoneyi
nthecapi
tal
mar
ket
?

2.Lookf
rom t
hei
nter
netanexampl
eofacompanyanddoar
esear
chast
o

howandwhatt
ypeofdi
vi
dendsar
edi
str
ibut
edt
oit
sst
ockhol
der
s.

TEST2.Cl
assi
fyt
heTy
pesofRi
sksont
hef
oll
owi
ngI
nvest
ment
sast
o

a.l
owr
isk b.moder
ater
isk C.hi
ghr
isk
Wr
it
ethecor
rectanswer(
let
ter
)bef
oret
henumber
.

1.Bonds 6.Peert
opeerl
endi
ng

37
 2.BankDeposi
ts 7.Hi
ghYi
eldBonds

3.St
ocks 8.Der
ivat
ives

4.Mut
ual
Funds 9.Gol
d/Pr
eci
ousSt
ones

5.Real
Est
ate 10.Ant
iques

TEST3.Wri
teTr
uei
fthest
atementi
scor
rectandFal
sei
fthest
atementi
s
i
ncorr
ect
.

1.A decl
ared di
vi
dend becomesal
i
abi
l
ityoft
hecor
por
ati
on,and si
nce
pay
menti
sgener
all
yrequi
red v
erysoon,i
susual
l
ycl
assi
fi
ed ascur
rent
l
i
abi
l
ity
.

2.Ther
equi
redr
ateofr
etur
niswhati
stobeaccept
edf
rom t
hei
nvest
mentt
o
compensat
efr
om post
ponementofconsumpt
ion.

3.Thepur
poseofCapi
talMar
ket
sist
obr
ingt
oget
heri
nvest
orswhowantt
o
i
nvestsav
ingswi
thcompani
esorgov
ernment
swhoneedcapi
talt
oexpandor
t
ofi
nancebudgetdef
ici
ts.

4.Repur
chasi
ngst
ocksachi
evet
hesameout
comeofdi
str
ibut
ingcasht
othe
shar
ehol
der
s.

5.Ani
nvest
orhol
dingashar
eont
her
ecor
ddat
eisent
it
ledt
othedi
vi
dend,
samewi
tht
hei
nvest
orbuy
ingt
heshar
eont
hef
oll
owi
ngday
.

6.Compani
eschooset
ospl
i
tthei
rshar
esi
nanat
temptt
obr
ingt
hepr
iceper
shar
etoahi
gherv
alue.

7.Thei
ncr
easei
nthenumberofshar
esout
standi
ngwi
l
lal
soi
ncr
easet
he
mar
ketpr
icepershar
e.

8.As i
nter
estr
ates f
luct
uat
erandoml
yint
he economy
,the bond wi
l
l
exper
iencer
andom pr
icemov
ement
s.

9.Whenwei
nvest
,wedef
ercur
rentconsumpt
ioni
nor
dert
oaddt
oourweal
th
sot
hatwecanconsumemor
eint
hef
utur
e.
10.Asi
nfl
ati
oni
ncr
easessodoi
nter
estr
ates,
whi
cht
henaf
fect
sbondpr
ices.

38
 Chapt
er7.Fi
nanci
alI
nnov
ati
onandPor
tfol
i
oManagement

Ani
nvest
orneedst
ounder
standt
hedi
ff
erencesamongi
nvest
ment
ssot
hey
canbui
l
dapr
oper
lydi
ver
sif
iedpor
tfol
i
othatconf
ormst
othei
robj
ect
ives.Thati
s
t
oseekt
oacqui
reagr
oupofi
nvest
ment
swi
thdi
ff
erentpat
ter
nsofr
etur
nov
er
t
ime.I
fchosencar
eful
l
y,suchpor
tfol
i
osmi
nimi
zer
iskf
oragi
venl
evelofr
etur
n
becausel
ow ornegat
iver
atesofr
etur
nonsomei
nvest
ment
sdur
ingaper
iodof
t
imear
eof
fsetbyabov
e-av
erager
etur
nonot
her
s.Thegoali
stobui
l
dabal
anced
por
tfol
i
oofi
nvest
ment
swi
thr
elat
ivel
yst
abl
eov
eral
lrat
esofr
etur
n.

Fi
nanci
alI
nnov
ati
ons
Fi
nanci
ali
nnov
ati
onhasbeenacont
inuousandi
ntegr
alpar
tofgr
owt
hoft
he
capi
talmar
ket
s. Av
ari
etyoff
act
orssuchasi
ncr
easedi
nter
estr
ate,v
olat
il
it
y,
f
requencyoft
axandr
egul
ator
ychangeset
c.hav
est
imul
atedt
hepr
ocessof
f
inanci
ali
nnov
ati
on.

Equi
typor
tfol
i
osar
econst
ruct
edusi
ngquant
it
ati
vemet
hods. Comput
ers
anal
yzer
elat
ionshi
psbet
weenst
ocksandmar
ketsect
orst
oident
if
yunder
val
ued
st
ocks.Quant
it
ati
vescr
eensandf
act
ormodel
sar
eusedt
oconst
ructpor
tfol
i
osof
st
ockswi
thsuchat
tri
but
esasl
ow P/
E(pr
iceperear
ningr
ati
os)l
ow pr
ice/
book
r
ati
os,smal
lcapi
tal
i
zat
ions,orhi
ghdi
vi
dendy
iel
dthosenegl
ect
edbyanal
ysi
sor
st
ockswhoser
etur
nsar
est
rongl
ycor
rel
atedwi
theconomi
cvar
iabl
essuchas
i
nter
estr
ates.

Met
hodsofDi
ver
sif
icat
ion

Di
ver
sif
icat
ionenabl
esi
nvest
orst
oreduceorr
emov
einv
est
mentspeci
fi
cri
sk.By
ef
fi
ci
ent
lydi
ver
sif
yingt
hei
nvest
ment
shel
dinani
nvest
or'
spor
tfol
i
o,t
hei
nvest
or
canmi
nimi
zer
iskf
oragi
vent
argetl
evelofr
etur
n.I
nthef
oll
owi
ngsect
ion,
wewi
l
l
l
ookathow t
hecor
rel
ati
onofr
etur
nsf
rom i
nvest
ment
simpact
sthedegr
eeof
di
ver
sif
icat
ion.Combi
ningasset
sthatar
enegat
ivel
ycor
rel
ated(
i.
e.t
endt
omov
e
i
nopposi
ngdi
rect
ions)wi
l
lmaxi
mizet
hebenef
it
sofdi
ver
sif
icat
ion.

39
1.Mut
ual
FundsI
nvest
ment

The adv
entofmut
ualf
unds has expanded t
he abi
l
ityofi
ndi
vi
dual
sto
par
ti
cipat
einf
inanci
almar
ket
s.Amut
ualf
undi
samechani
sm bywhi
chaf
ir
m
col
l
ect
smoneyf
rom al
argenumberofi
ndi
vi
duali
nvest
orst
ofor
m apool
,whi
ch
cant
henbei
nvest
edi
nvar
iousf
inanci
ali
nst
rument
s.Fundsponsor
spur
sue
speci
fi
cobj
ect
ivest
osat
isf
ytheneedsoft
hei
ndi
vi
duali
nvest
orsbyof
fer
ing
f
unds wi
th di
ff
erentr
isk char
act
eri
sti
cs and exposur
eto di
ff
erentki
nds of
secur
it
ies.I
ntheUSal
one,wel
lov
er2,
500mut
ualf
undsexi
stal
l
owi
ngi
ndi
vi
dual
i
nvest
orst
ochoosespeci
fi
cfundst
osui
tthei
rinv
est
mentneeds.

ADVANTAGESOFMUTUALFUNDI
NVESTI
NG

Mut
ual
fundspr
esentanumberofadv
ant
agest
othei
ndi
vi
dual
inv
est
or:

Pr
ofessi
onal
fundmanagement
.
Di
ver
sif
icat
iont
hroughpool
i
ng,
alt
houghi
ndi
vi
dual
smi
ghtbei
nvest
ingsmal
l
amount
s.
Lowert
ransact
ioncost
s,si
ncet
hef
undmanager
str
adel
argequant
it
iesof
secur
it
ies.
Theabi
l
ityt
ochoosef
undst
hathav
eaf
ocust
hatmat
chest
heobj
ect
ivesoft
he
i
nvest
or.

Byf
art
he gr
eat
estadv
ant
age f
ort
he smal
linv
est
ori
s di
ver
sif
icat
ion and
pr
ofessi
onalmanagement
,whi
chi
sdi
ff
icul
ttoachi
evewi
tht
hel
i
mit
edf
unds
av
ail
abl
etot
het
ypi
cal
inv
est
or.

'
2.Tr
easur
yBi
l
ls,whi
chr
epr
esentshor
t-
ter
m bor
rowi
ngbyt
hegov
ernmentt
o
f
inancei
tsbudgetdef
ici
ts. Thesebi
l
lsar
eissued wi
thdi
ff
erentmat
uri
ti
es,
i
ncl
udi
ng4weeks(
30day
s),13weeks(
90day
s),26weeks(
180day
s),and52
weeks(
oney
ear
).Thef
ir
stt
hreemat
uri
tyt
ypesar
eissuedonceaweek,on
Monday
s,wi
tht
he13weekbi
l
lsbei
ngi
ssuedt
hemost
.

Tr
easur
ybi
l
lsar
esol
datadi
scountf
rom nomi
nal
val
ueorparv
alue(
i.
e.,
ata
pr
icel
esst
hant
henomi
nalv
alue)
.Ani
nvest
orpur
chasi
ngt
hebi
l
lrecei
vest
he

40
nomi
nalv
alueatmat
uri
ty,t
hedi
ff
erencebet
weent
henomi
nalv
alueandt
he
di
scount
edv
aluer
epr
esent
ingt
hei
nter
estont
hei
nvest
ment

3.Bondsar
eusedt
ofi
nancedev
elopmentpr
oject
sint
heCount
ry,andt
hey
usual
l
y hav
emat
uri
ti
esbet
weent
woandt
eny
ear
s.Theyar
enon-
cal
l
abl
e,wi
th
f
ixedorf
loat
ingr
atest
hatar
epai
dsemi
-annual
l
y.

Si
mil
art
oTr
easur
ybi
l
ls,
bankscanr
e-sel
lthebondst
ogov
ernmentagenci
es
and cor
por
ati
ons,ot
herbanks,ot
hermut
ualf
unds i
n a count
ry,and l
ocal
i
nvest
ors.

Bondmar
ket
shav
eal
sobecomemor
eint
ernat
ionali
nnat
ure.Abor
rowercan
choose t
oissue bondsi
n di
ff
erentcur
renci
esand i
n di
ff
erentcount
ri
es.A
Eur
obondi
sabondi
ssuedi
nacount
rybutdenomi
nat
edi
naf
orei
gncur
rency
.

Exampl
e:ZCor
pisaut
hor
izedt
oissue10bondswi
thf
acev
alueofP10,
000on
Januar
y01,2020 Thebondswi
l
lmat
ureaf
ter5y
ear
sandi
nter
esti
spay
abl
e
annual
l
yev
er y1st.Thi
yJanuar smeanst
hatani
nvest
ormaybuyatl
eastone
bondandt
hatheshal
lbepai
dannuali
nter
estofP80r
egar
dlessoft
hei
ssue
pr
iceandt
hatonmat
uri
tydat
e,Januar
y1,2026,heshal
lbepai
dthef
acev
alue
ofP10,
000perbond.Uponi
ssuanceofal
lthebonds,t
het
otalbondl
i
abi
l
ityof
t
he cor
por
ati
on shal
lbe P1,
000,
00 (
or100 xP10,
000)and annuali
nter
est
pay
ment
smustt
otal
P80,
000.

4.St
ocks maybedi
vi
dedi
ntot
woormor
ecl
assest
oat
tractdi
ff
erentki
ndsof
i
nvest
ors. They may di
ff
erwi
thr
egar
ds t
ovot
ing r
ight
s,pr
efer
ences i
n
di
str
ibut
ionofdi
vi
dendsandi
nthel
i
qui
dat
ionpr
ocessandt
ocer
tai
nrest
ri
cti
ons.
Thepr
inci
palcl
assesofcapi
talst
ockar
ecommonandpr
efer
red.

St
ockDi
vi
dendsr
efer
stoear
ningsdi
str
ibut
ioni
nthef
orm ofshar
esofcapi
tal
st
ock.I
tent
ail
snodi
minut
ioni
nthef
inanci
alr
esour
cesofacor
por
ati
onf
ori
tis
mer
elyat
ransf
erf
rom r
etai
nedear
ningst
ocapi
tal
stock.

Cl
assesofShar
es:Shar
esofst
ockmaybecl
assi
fi
edasparv
alueandno-
par

41
v
alueshar
es:
ParVal
ueShar
es.Theyhav
especi
fi
cmoneyv
alueasst
atedi
nthear
ti
clesof
i
ncor
por
ati
onandi
nthest
ockcer
ti
fi
cat
es.Theobj
ect
ivei
stosett
hemi
nimum
pr
iceatwhi
cht
heshar
esshoul
dor
igi
nal
l
ybei
ssued.
No-
parVal
ue Shar
es. No speci
fi
c moneyv
alue i
s st
ated i
nthe ar
ti
cles of
i
ncor
por
ati
onandi
nthest
ockcer
ti
fi
cat
es. Theyhav
eto bef
ull
ypai
dupon
subscr
ipt
ionandt
heconsi
der
ati
onshoul
dnotbel
esst
hanP5.

5.For
eignExchangei
str
adedi
naf
orei
gnexchangemar
ketf
orcur
renci
es.The
demandsi
deoft
hismar
keti
ncl
udespeopl
eandent
it
ieswhohol
dsomeot
her
cur
rencybutwantt
obuydol
l
arsorpeopl
eandent
it
ieswhowantt
obuycur
renci
es.

ExchangeRat
ear
esi
mpl
yanot
herpr
iceofmoney
,si
mil
art
oint
erestr
ates.I
tis
somet
imesdi
ff
icul
ttot
hinkofmoneyashav
ingapr
ice,
butt
hati
swhatexchange
ar
e:t
hepr
iceofonecur
rencyi
nter
msofanot
hercur
rency
.

Suppl
yint
heFor
eignCur
rencyMar
ket
Thesesel
l
ersofapar
ti
cul
arcur
rencyi
ncl
udet
hef
oll
owi
ng:
1.Domest
icconsumer
s
2.Domest
ici
nvest
orst
hatwantt
omakef
orei
gni
nvest
ment
s
3.For
eignf
ir
mssel
l
ingl
ocal
l
y
4.Domest
ict
our
ist
sheadedabr
oad
5.Cent
ral
Banks

Por
tfol
i
oManagement
Oneoft
hemaj
oradv
ancesi
nthei
nvest
mentf
iel
d dur
ing t
hepastf
ew
decadeshasbeent
her
ecogni
ti
ont
haty
oucannotcr
eat
eanopt
imum i
nvest
ment
por
tfol
i
obysi
mpl
ycombi
ningnumer
ousi
ndi
vi
dualsecur
it
iest
hathav
edesi
rabl
e
r
isk-
ret
urnchar
act
eri
sti
cs.Speci
fi
cal
l
y,i
thasbeenshownt
hatani
nvest
ormust
consi
dert
her
elat
ionshi
pamongt
hei
nvest
ment
stobui
l
danopt
imum por
tfol
i
o
t
hatwi
l
lmeeti
nvest
mentobj
ect
ives.

Mar
kowi
tzPor
tfol
i
oTheor
y–dev
elopedbyHar
ryMar
kowi
tz(
1952–1959)who
der
ivedt
heexpect
edr
ateofr
etur
nofapor
tfol
i
oofasset
sandanexpect
edr
isk

42
measur
e.

TheMar
kowi
tzModeli
sbasedonsev
eralassumpt
ionsr
egar
dingt
hei
nvest
ment
behav
ior
:
1.I
nvest
orsconsi
dereach i
nvest
mental
ter
nat
ive asbei
ng r
epr
esent
ed bya
pr
obabi
l
itydi
str
ibut
ionofexpect
edr
etur
nsov
ersomehol
dingper
iod.
2.I
nvest
ors maxi
mize one per
iod expect
ed ut
il
it
y,and t
hei
rut
il
it
y cur
ves
demonst
rat
esdi
mini
shi
ngmar
ginal
uti
l
ityofweal
th.
3.I
nvest
orsest
imat
ether
iskoft
hepor
tfol
i
oont
hebasi
soft
hev
ari
abi
l
ityof
expect
edr
etur
ns.
4.I
nvest
orsbasedeci
sionsol
elyonexpect
edr
etur
nandr
isk,
sot
hei
rut
il
it
ycur
ves
ar
eaf
unct
ionofexpect
edr
etur
nandt
heexpect
edv
ari
anceofr
etur
nsonl
y.
5.Foragi
venr
iskl
evel
,i
nvest
orspr
eferhi
gherr
etur
nst
olowerr
etur
ns.Si
mil
arl
y
f
oragi
venl
evel
ofexpect
edr
etur
n,i
nvest
orspr
eferl
essr
iskt
omor
eri
sk.

Exer
cises.
TEST1.Dowhati
srequi
redont
hef
oll
owi
ng:
1.Whydoi
nvest
orshol
ddi
ver
sif
iedpor
tfol
i
os?St
atet
her
easons.
2.Pr
ovi
deFour(
4)Met
hodsofDi
ver
sif
icat
ion.St
atehowani
nvest
orear
ns
f
rom t
hesemet
hods.
3.Howcanr
iskbemi
ti
gat
edi
nMar
kowi
tzPor
tfol
i
oTheor
y?
TEST2.Doar
esear
chf
rom t
hei
nter
net
/websi
te
Gi
veanexampl
eofFi
nanci
alI
nnov
ati
onsi
nter
msof
:
a.Sav
ingsandDeposi
ts
b.MoneyTr
ansf
er/Remi
tt
ances
c.LongTer
mInv
est
ment

43
 Chapt
er8.Der
ivat
iveMar
ket
sandSecur
it
ies

As wi
th anyf
inanci
alpr
oduct
s,a der
ivat
ivet
ransact
ions hav
e speci
fi
c
t
ermi
nol
ogyt
hatmustbeunder
stoodi
nor
dert
ouset
hisi
nst
rument
sef
fect
ivel
y.
Foreachoft
heder
ivat
ivear
rangement(
for
war
dcont
ract
,cal
lopt
ion,
putopt
ion)an
i
nvest
orcanent
eri
ntoat
ransact
ionsei
thert
hel
ongposi
ti
on(
thebuy
erort
heshor
t
posi
ti
on(
thesel
l
er)
.

Der
ivat
iveMar
ket
s
Thegr
owt
hoft
hemar
keti
nwhi
chder
ivat
ivesecur
it
iesar
ecr
eat
edand
ex
changedhasbeennot
hingshor
torphenomenal
.Thel
astf
ewdecadeshav
eseen
t
heemer
genceofcont
ract
stot
radesuchf
undament
alpr
oduct
sasagr
icul
tur
al
commodi
ti
es,
preci
ousmet
als,
cur
renci
es,
commonst
ockandbonds.
Ther
ear
eev
ender
ivat
ivest
otr
adehy
pot
het
icalunder
lyi
ngasset
s(e.
g.opt
ionsand
f
utur
escont
ract
)aswel
lasacombi
nat
ionder
ivat
ivessuchasopt
ioncont
ract
sthat
al
l
owt
hei
nvest
ort
odeci
deatal
aterdat
etoent
eri
ntoaf
utur
econt
racti
nvol
vi
ng
anot
hersecur
it
ytr
adeorcommodi
ty.

UseofDer
ivat
ivesi
nPor
tfol
i
oManagement
Bey
ondt
heuni
quer
isk-
rewar
dpr
ofi
l
est
heyof
ferasst
andal
onei
nvest
ment
,
der
ivat
ives al
so ar
e used wi
del
ytor
est
ruct
ure exi
sti
ng por
tfol
i
os ofasset
s.
Ty
pical
l
y,t
hei
ntentoft
hisr
est
ruct
uri
ngi
stomodi
fyt
hepor
tfol
i
osr
isk.

Ader
ivat
ivei
nst
rumenti
sonef
orwhi
cht
heul
ti
mat
epay
offt
othei
nvest
or
dependsdi
rect
lyont
hev
alueofanot
hersecur
it
yorcommodi
ty.I
nthesamewayas
t
he under
lyi
ng asset
s,an i
nvest
orbel
i
evi
ng t
hata cer
tai
n common st
ockwi
l
l
i
ncr
easei
nval
uecanbenef
itf
rom ei
therapur
chaseoft
hest
ockdi
rect
lyoran
opt
iont
opur
chaset
hatst
ockatapr
edet
ermi
nedpr
ice.

Howder
ivat
ivesar
eused,
li
esi
nthei
rabi
l
ityt
omodi
fyt
her
iskandexpect
ed
r
etur
nchar
act
eri
sti
csofexi
sti
ngi
nvest
mentpor
tfol
i
os.
Opt
ionsand f
utur
esal
l
ow i
nvest
orst
o hedge(
orev
eni
ncr
ease)t
her
iskofa

44
col
l
ect
ionofst
ocksi
nway
sthatgof
arbey
ondt
hedi
ver
sif
icat
ionr
esul
ts.

TwoTy
pesofDer
ivat
ives
1.For
war
dandFut
uresCont
ract
2.Opt
ionCont
ract
s

Exampl
eofaFor
war
dCont
ract
:
Acal
lopt
iongi
vest
heownert
her
ightt
opur
chaseanunder
lyi
ngsecur
it
y,
suchasast
ockorabondataf
ixedpr
icewi
thi
nacer
tai
namountoft
ime.Sot
he
opt
ion’
sul
ti
mat
eval
uecanbesai
dtodependon-andt
husder
ivef
rom-t
hatoft
he
ot
herasset
.Si
mil
arl
y,af
orwar
dcont
ractt
osel
labondf
oraf
ixedpr
iceataf
utur
e
dat
ewi
l
lseei
tsv
aluet
othei
nvest
orr
iseorf
allwi
thdecr
easesori
ncr
easesi
nthe
mar
ketpr
iceoft
heunder
lyi
ngbond.
Suppose t
hatt
wo i
nvest
ors agr
ee atDat
e0(
present
)to
t
ransf
erabondf
rom onepar
tyt
otheot
heratt
hef
utur
eDat
e
T.Thet
wopar
ti
esmustagr
eeatwhi
chbondandhowmuch
ofi
tist
obeexchanged,t
hedat
eandl
ocat
ionatwhi
cht
his
exchangewi
l
ltakepl
ace,andt
hepr
iceatwhi
cht
hebondwi
l
l
beboughtandsol
d.So,
thet
ermst
hatmustbeconsi
der
edi
n
f
ormi
ngaf
orwar
dcont
ractar
ethesameast
hosenecessar
y
f
orabondt
ransact
iont
hatset
tl
edi
mmedi
atel
y(i
.
e.aspot
mar
kett
ransact
ion)wi
tht
woexcept
ions.
Fi
rst
,the set
tl
ementdat
e agr
eed t
oint
he cont
racti
s
pur
posef
ull
ysett
obei
nthef
utur
e.
Second,t
he cont
ractpr
ice – whi
ch wi
l
lrepr
esentas t
he
f
orwar
dpr
icesetatDat
e0f
oracont
ractt
hatmat
uresatDat
e
T-i
susual
l
ydi
ff
erentf
rom t
hepr
evai
l
ingspotpr
icebecause
oft
hedi
ff
erentt
imef
ramesi
nvol
ved.

For
war
dCont
racti
sthemostbasi
cder
ivat
ivepr
oductav
ail
abl
e.Af
orwar
d
cont
ractgi
ves i
ts hol
derbot
hthe r
ightand t
he f
ullobl
i
gat
ion t
o conducta
t
ransact
ioni
nvol
vi
nganot
hersecur
it
yorcommodi
ty–t
heunder
lyi
ngasset–ata

45
pr
edet
ermi
nedf
utur
edat
eandatapr
edet
ermi
nepr
ice.

Thef
utur
edat
einwhi
cht
het
ransact
ioni
stobeconsummat
edi
scal
l
edt
he
cont
ract
smat
uri
ty(
orexpi
rat
iondat
e,whi
l
ethepr
edet
ermi
nedpr
iceatwhi
cht
he
t
radet
akespl
acei
sthef
orwar
dcont
ractpr
ice.Not
icet
her
emustal
way
sbet
wo
par
ti
es(
somet
imescal
l
edcount
erpar
ti
es)t
oaf
orwar
dtr
ansact
ion,t
heev
ent
ual
buy
er(
orl
ongposi
ti
on)whopay
sthecont
ractpr
iceandr
ecei
vest
heunder
lyi
ng
secur
it
y,andt
heev
ent
ualsel
l
er(
orshor
tposi
ti
on)whodel
i
ver
sthesecur
it
yfora
f
ixedpr
ice.

For
war
dandSpotMar
ket
s
For
war
dcont
ract
sar
enotsecur
it
iesi
nthet
radi
ti
onalsense,t
heyar
emor
e
appr
opr
iat
elyv
iewedast
radeagr
eement
snegot
iat
eddi
rect
lybet
weent
wopar
ti
es
f
orat
ransact
iont
hati
sschedul
edt
otakepl
acei
nthef
utur
e.

Feat
uresofaFor
war
dCont
ract

 For
war
d Cont
ract
sar
enegot
iat
ed i
ntheov
er-
the-
count
ermar
ket
. Thi
s
meanst
hatFor
war
dCont
ract
sar
eagr
eement
sbet
weent
wopr
ivat
epar
ti
es-
oneofwhi
chi
sof
tenader
ivat
ivei
nter
medi
ary
,suchasabank-r
athert
han
t
radedt
hroughaf
ormal
exchange.

 For
war
dcont
ract
sar
ecompl
etel
yfl
exi
ble,t
heycanbewhat
everanyt
wo
mut
ual
l
yconsent
ingcount
erpar
ti
esagr
eet
o.

 For
war
dCont
ract
smaynotr
equi
recol
l
ater
al;i
nst
ead,t
hel
ongandshor
t
posi
ti
onssomet
imest
rusteachot
hert
ohonorr
espect
ivecommi
tment
sat
Dat
eT.

 I
nFor
war
dCont
ract
s,l
ackofcol
l
ater
almeanst
hatf
orwar
dcont
racti
nvol
ve
cr
edi
t(ordef
aul
t)r
isk,whi
chi
soner
easonwhybanksar
eof
tenmar
ket
maker
sint
hesei
nst
rument
s.

 For
war
dCont
racti
sthati
tisof
teni
l
li
qui
d,meani
ngt
hati
tmi
ghtbedi
ff
icul
t
orcost
lyf
oracount
erpar
tyt
oexi
tthecont
ractbef
orei
tmat
ures.I
ll
i
qui
dit
y
i
sreal
l
y a by
-pr
oductoft
he cont
ract
’sf
lexi
bil
i
ty because t
he mor
e
speci
fi
cal
l
ytai
l
oredanagr
eementi
stot
heneedsofapar
ti
cul
ari
ndi
vi
dual

46
 t
hel
essmar
ket
abl
eitwi
l
lbet
osomeoneel
se.

Fut
uresCont
ractt
ryt
osol
vet
hispr
obl
em byst
andar
dizi
ngt
het
ermsoft
he
agr
eement(
e.g.expi
rat
iondat
e,i
dent
it
yandamountoft
heunder
lyi
ngasset
)and
hav
ingbot
hpar
ti
est
radet
hroughacent
ral
i
zedmar edaf
ketcal
l utur
esexchange.
Fut
urePr
ice–i
sanal
ogoust
othef
orwar
dcont
ractpr
iceandatanyt
ime
dur
ingt
hel
i
feofacont
ract
,issetatal
evelsucht
hatabr
andnew l
ongorshor
t
posi
ti
onwoul
dnothav
etopayani
nit
ial
premi
um.

Opt
ionCont
ract
Anopt
ioncont
ractgi
vesi
tshol
dert
her
ight–butnott
heobl
i
gat
ion–t
o
conducta t
ransact
ion i
nvol
vi
ng and under
lyi
ng secur
it
y orcommodi
ty ata
pr
edet
ermi
nedf
utur
edat
eandatapr
edet
ermi
nedpr
ice.

Thesel
l
eroft
heopt
ionmustper
for
m onhi
ssi
deoft
heagr
eementi
fthe
buy
erchoosest
oexer
ciset
heopt
ion.Thust
heobl
i
gat
ionoft
heopt
ionmar
keti
s
i
nher
ent
lyone-
sidedbuy
ersundert
het
ermsoft
heagr
eement
.Asaconsequence,
t
wodi
ff
erentt
ypeofopt
ionsar
eneededt
ocov
eral
lpot
ent
ialt
ransact
ions:acal
l
opt
ion–t
her
ightt
obuyt
heunder
lyi
ngsecur
it
y-andputopt
ion–t
her
ightt
osel
lthe
sameasset
.

Opt
ionCont
ractTer
ms
Twopr
icesar
eimpor
tanti
nev
aluat
inganopt
ionposi
ti
on.Theexer
ciseor
st
ri
ki
ngpr
icei
sthepr
icet
hecal
lbuy
erwi
l
lpayt
o–ort
heputbuy
erwi
l
lrecei
ve
f
rom t
heopt
ionsel
l
eri
ftheopt
ioni
sexer
cised.

Theexer
cisepr
icei
stoanOpt
ionwhatt
hecont
ractpr
icei
stoaFor
war
d
Agr
eement
.
Thesecondpr
iceofi
nter
esti
swhatt
heopt
ionbuy
ermustpayt
othesel
l
erat
Dat
e0t
o acqui
ret
hecont
racti
tsel
f.To av
oidconf
usi
on,t
hissecondpr
icei
s
t
ypi
cal
l
yref
err
edt
oast
heOpt
ionPr
emi
um.
Abasi
cdi
ff
erencebet
weenopt
ionsandf
orwar
dsi
sthatanopt
ionr
equi
res

47
t
hisupf
rontpr
emi
um pay
mentf
rom buy
ert
osel
l
erwhi
l
ethef
orwar
dor
dinar
il
ydoes
not
.
Opt
ionTr
adi
ngMar
ket
Opt
ionst
radebot
hinov
er-
the-
count
ermar
ket
sandont
heexchange.When
exchanget
raded,
justt
hesel
l
eroft
hecont
racti
srequi
redt
opostamar
ginaccount
becausehei
stheonl
yoneobl
i
gat
edt
oper
for
m ont
hecont
ractatal
aterdat
e.Al
so
Opt
ionscanbebasedonawi
dev
ari
etyofunder
lyi
ngsecur
it
ies,i
ncl
udi
ngf
utur
es
cont
ract
sorot
heropt
ions.

Exer
cises.
Dowhati
srequi
redont
hef
oll
owi
ng:
1.Whatt
ypeofi
nvest
menti
str
adedi
ntheder
ivat
ivemar
ket
?
2.Gi
veanexampl
eofaFut
ureCont
ractasaDer
ivat
ive. St
atehow t
he
i
nvest
orear
nsf
rom t
hist
ransact
ion.(
Doar
esear
chf
rom t
hei
nter
net
)
3.Gi
veanexampl
eofanOpt
ionsCont
ractasaDer
ivat
ive.St
atehow t
he
i
nvest
orear
nsf
rom t
hist
ransact
ion.(
Doar
esear
chf
rom t
hei
nter
net
)

Ref
erences

48
Capi
tal
Mar
ketAut
hor
it
y,2012.Ki
ngFahdNat
ional
Libr
aryCat
alogi
ng-
in-
Publ
i
cat
ion
Dat
a.

Capi
tal
Mar
ketandSecur
it
iesLaws,
(2015)
.

Medi
na,
R.G.(1988)
.Busi
nessFi
nance.RexBookst
ore.

Rei
l
ley
,F.
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