MODULE

in
Investment Portfolio
Management

Credits to Nenita Mejorada

 INTRODUCTION

This module is an introduction to Investment Portfolio Management. This contains

concept, information and activities to assess students’ knowledge and understanding in Investment
Portfolio Management. This module is written to discuss and explain basic principles and concepts
of Investment and how to manage investment using Portfolio Management. It also covers
procedure and some basic legal aspects of Portfolio Management. It is designed for college
students taking up Financial Management course.

Investment Portfolio Management is important to study since it is a central part of current

economic, business environment and households. With this, many businesses exposed to the risk
that can affect the operations and profitability of any business. It is the important task of the
Financial Advisers to formulate a policy to control and manage the current finances of every
individual.

Through module, the students can gain a deeper understanding of the core of Investment
Portfolio Management that is essential in the achievement of the business goals and objectives, not
only for the government but also for individuals. This module incorporates worked examples,
relevant exercises and case studies that students will see how concept and principle applies in
practice and can discuss the various issues raised. Students will also acquire and develop essential
knowledge that will improve their competence in all aspects of Financial Management
INTENDED LEARNING OUTCOME
Upon completion of this course, the students should be able to:

ILO 1 Understand investing and the many types of investment vehicles that are available in
today’s investment environment.

ILO 2 Explain the key terms and concepts investments including investment analysis,
portfolio management and its importance in a global perspective.

ILO 3 Understand the basic mechanics of the investment markets, risk and rewards, and types
of investments involved in sound and prudent investing.

ILO 4 Comprehend the financial innovations that have occurred and are expected to occur in
the future.

ILO 5 Know and have comfort to build a diversified investment, calculate individual goals
and objectives and track investments using publications and the media.
 Chapter 1
Introduction

Any person or organization looks forward to better future in terms of income and available
resources despite the onslaught of inflation. These can be realized by making investments.

Investment Management Defined

It refers to the process of defining investment objectives, adopting and executing strategies to
optimize results considering the risks involved, and evaluating performance periodically.

Definition of investment objectives requires the answers to the following:

• What do I intend to achieve in making investments?
• What are the opportunity costs in making investments?
• What are the risks involved? How much risk can I tolerate? what is my appetite for risk?
• How should investible funds be divided among different items of investment?
• Will the investment be short-term or long-term?
• How much is the expected gain?
• What are the intangible benefits expected from a particular investment?
• How much loss can I afford to absorb?
• What are the safeguards to minimize risk?
• What would be the effect on my cash flows?
• If there are periodic cash outlays, where should they come from?
• If there are periodic cash inflows, what should be done with them?

Personal Goal in Investing

When talking about investment, it is not necessarily a matter of continuously accumulating wealth
or being materialistic, rather it should be looked upon as a means of reducing future financial
worries and ultimately, in providing financial and personal independence.
With successful investment management, one can look forward to engaging in activities he is most
interested in and having complete control over how he spends his time.
Investment – refers to assets acquired to realize income and/or earn profit. They are expected to
increase one’s equity or reduce future financial worries.
Investment portfolio – the word portfolio refers to the brief case that is used in carrying
business papers and documents. In business it refers to the aggregate of assets held as
investments.

Change in Purchasing Power of the Monetary Unit due to Inflation

Inflation reduces the purchasing power of the monetary unit so that if inflation rate were 8% what
P100,000 can buy would require P 108,000 after one year. After two years, it would require P
116,640 (or P 108,000 x 108%). In other words the purchasing power of a peso after one year
would be P.9259259 (or 1/1.08).

The figures in eight years would be as follows:

Amount Required to buy
P100,000 worth of goods Value of the Peso
After 1 year (P 100,000 x 1.08) = P 108,000 : (P 100,000/P 108,000) = P 0.925926
After 2 year (P 108,000 x 1.08) = 116,640 : (P 100,000/P 116,640) = P 0.857339
After 3 year (P 116,640 x 1.08) = 125,971 : (P 100,000/P 125,971) = P 0.793832
After 4 year (P 125,971 x 1.08) = 136,049 : (P 100,000/P 136,049) = P 0.735030
After 5 year (P 136,049 x 1.08) = 146,933 : (P 100,000/P 146,933) = P 0.680583
After 6 year (P 146,933 x 1.08) = 158,687 : (P 100,000/P 158,687) = P 0.630170
After 7 year (P 158,687 x 1.08) = 171,382 : (P 100,000/P 171,382) = P 0.583490
After 8 year (P 171,382 x 1.08) = 185,093 : (P 100,000/P 185,093) = P 0.540269
After 9 year (P 185,093 x 1.08) = 199,900 : (P 100,000/P 199,900) = P 0.500249

Rule of 72
It is used in estimating the number of years it would take to halve the purchasing power of the
monetary unit (Bernstein,6). It is arrived at by dividing 72 by the inflation rate. Thus, with an
inflation rate of 8% it would take nine(𝑜𝑟 72/8)2 years to halve the value of the monetary unit.

Do you know the Rule of 72? It's an easy way to calculate just how long it's going to take for your
money to double. Just take the number 72 and divide it by the interest rate you hope to earn. That
number gives you the approximate number of years it will take for your investment to double
 Compound Growth
It refers to the growth in investment portfolio brought about by ploughing back the earnings
therefrom. Thus, interest, dividends and gains become part of the principal based on which future
earnings are realized.
Future value of 1 after n periods. This table is used to determine the future value of an amount
given today.
Future value of an annuity of 1 for n periods. This refers to the accumulated amount of periodic
contributions or additional investments and the earnings thereon as compounded for a number of
years.

Future value of an annuity of P1,000 for 5 years at 10%

(b) (c)
(a) (d)
Year Annual Earnings Total Increase
Annual Savings Portfolio Value
(d x 10%) (a + b)

P P P P
0 1,000 1,000 1,000
1 1,000 100 1,100 2,100
2 1,000 210 1,210 3,310
3 1,000 331 1,331 4,641
4 1,000 464 1,464 6,105
5 0 611 611 6,716
5,000 1,716 6,716
Use of Adequate Information

✓ Investing requires making use of adequate information in making decisions such as those
related to the following questions:
✓ What items of investment must be acquired?
✓ What are the risks involved?
✓ How are the supply and demand for said items of investment?
✓ At what price should they be acquired?
✓ At what price should they acquired of?
✓ In case of sudden decline in prices, how much loss can the investor afford to absorb?

Investable Cash refers to the amount of money that an organization or individual can afford to
keep in some forms of investment for a definite length of period without hampering his day-to-
day operations.
Liquidity Buffer refers to the amount of cash that an entity or individual must have to take care
of unexpected cash requirements.

Forms of Investment
✓ Savings Account. This is lending to the bank cash deposits that can be withdrawn
anytime.

✓ Time Deposit. This lending to the bank for a fixed length of period.

✓ Special Savings Deposit (Premium Savings Account). This earns a rate higher than that
on the ordinary time deposit.

✓ Trust Investments. These are a pooling of investors’ money as evidenced by certificates

issued by trustee banks who are authorized to invest money.

✓ Treasury Bills (T-bills). These are short-term promissory notes issued by the national
government.
 ✓ Commercial Papers. These are interest bearing promissory notes issued by big firms and
are considered a low-risk form of marketable securities.

✓ Mutual funds. These are a pooling of investors’ money by a stock corporation that issues
redeemable shares of stock.

✓ Bonds. These are interest bearing certificates of indebtedness issued by an organization.

✓ Shares of stocks. These are shares in the ownership of corporate entities and are evidenced
by stock certificates.

✓ Derivatives. These are financial instruments the value of which is derived from the value
of other assets.
▪ Option. This refers to the right but not the obligation to buy or sell something at a
specified price and at a specified date or period of time.
▪ Futures contracts. These are forward type contracts wherein buyer and seller are
committed to trade a given asset at set price on a fixed date.

✓ Real Estate. This refers to real property (land and buildings).

✓ Precious Stones and metals. Precious stones generally refers to diamonds, because they
appreciate in value due to their rarity.

✓ Others forms of investment. Other forms of investment may be works of arts and other
collectibles.

Credit rating is an opinion on the financial soundness of an enterprise and its capability to pays
its debts and the corresponding interest. It is used as a tool in determining the degree of risk
involved in making investments and compliments an investor's credit evaluation of a prospective
borrower or issuer of debts securities (commercial papers and bonds).

Short-Term Ratings
PBS 1 (Best Grade): Strongest capability for timely payment of public debt issue on both interest
and principal.
PRS 2 (Better Grade): Above average (strong) capability for payment of public debt issue on both
interest and principal.
PRS 3 (Good Grade): Satisfactory capability for payment of public debt issue on both interest and
principal.
PRS 4 (Fair Grade): Minimal assurance for timely payment of public debt issue on both interest
and principal. Susceptible to near term adverse change due to less favorable financial or economic
condition.
PRS 5 (Doubtful): Capability to pay both interest and principal of public debt issue doubtful.
PRS 6 (Expected to be in default): Payment of interest and principal of public debt issue in default
or expected to be in default upon maturity.

Long-Term Ratings
PRS Aaa: Smallest degree of investment risk. Interest payments are protected by a large or by an
exceptionally stable margin and principal is secured.
PRS Aa: Margins of protection may not be as large as in PRS Aaa issue. Fluctuations of protective
elements may be of greater amplitude or there may be other elements present which make the long-
term risk appear some-what larger than PRS Aaa securities.
PRS A: Have favorable investment attributes and are considered as upper medium grade
obligations.
PRS Baa: Neither highly protected nor poorly secured. Interest payments and principal security
appear adequate for the present but certain
PRS Ba: Judged to have speculative elements. Their future cannot be considered as well assured.
PRS B: Generally lacks characteristics of a desirable investment. Assurance of interest and
principal payments or maintenance of other terms of contract over any long period of time may be
small.
PRS Caa: Poor standing. The issue may be in default or there may be present elements of danger
with respect to principal or interest.
PRS Ca: High possibility of default and has other marked shortcomings.
PRS C: Has extremely poor prospects of ever attaining any real investment standing.
(The foregoing symbols may be further qualified to include a plus (+) or minus (-) sign.)

Risk and Risk Tolerance

Investments involve varying degree of risk or uncertainty. Risk may refer to non.-realization of
expected earnings or loss of capital. Generally, the greater is the degree of risk, the greater is the
opportunity for profit. Thus, investments are considered as a trade-off between safety and profit.
Consequently, one's choice of investments depends on the degree of risk he can be comfortable
with or his risk tolerance.

Diversification in Investments
Diversification as applied to investments refers to spreading investable funds to different
investment items.
Over diversification. This would be going to the extreme of spreading the investable funds to so
many items of investment. Although it minimizes exposure to risk in each item of investment, it
may bring forth the following disadvantages:
▪ Inability of investor to keep track of developments in each item of investment.
▪ Increased transaction costs.
▪ Minimized earnings from the more profitable items of investment.

Factors in Allocating Investable Funds

1. Investor's Cash Needs. This refers to the investor's cash requirements or monthly
operations and planned changes therein as reflected in his cash budget. The cash budget
may therefore be used as a tool in determining when investments may be made and when
the latter should be disposed of.
2. Risk Preference or Tolerance. As stated earlier, this refers to the degree of risk that an
investor can be comfortable with or his appetite for risk. The greater is the risk, the greater
must be the gain. In other words, "win big, lose big”.
3. Financial Limitations. An with so many financial obligations, limited earnings or with
limited resources would prefer to play it safe by put-ting his money in fixed income and
low-risk financial instruments such as time deposit certificates and treasury bills
4. Time Horizon. A time horizon of one year or less is considered short term. If it is for more
than three years, it is long-term. In between, it is Medium term. When the time horizon is
short, the less risky investment vehicles should be chosen.
5. Laddered Investing. This refers to timing investment maturities at staggered dates to jibe
with expected or planned cash outlays. Examples are the following:
Treasury bills, 182 days……….For employees' bonus
Treasury bills, 364 days……… For loan amortization
Bonds, 5 years ………………….For car purchase
Bonds, 10 years……………..... For plant expansion
 6. Market Timing. This refers to buying and selling items of investment ten it is advisable
to do so. In other words, get in and out of the market at the most opportune time.

Offensive and Defensive Investments

Offensive investment is aggressive for it entails more risks but bigger re-ward; Stock investment
is an example.
In the case of defensive investment it entails less risks but smaller re-wards. In most cases, it
brings in fixed amount of income or gain upon sale can be predetermined. Examples are time
deposits, jewelry and real estate.

Investment Mix. This refers to how investable funds are allocated between the different
investment items: The following are examples:
A B C D E
Bank accounts 10% 20% 50% 10% 60%
Trust investments 30 20 — 30 —
Jewelry 10 10 30 10 40
Stocks 20 20 — 50 —
Real estate 30 30 20 — —
100% 100% 100% 100% 100%
Assuming that total investment is P800,000, the breakdown for each column would be as follows:

A B C D E

P P P P P

Bank accounts 80,000 160,000 400,000 80,000 480,000

Trust investments 240,000 160,000 0 240,000 0

Jewelry 80,000 80,000 240,000 80,000 320,000

Stocks 160,000 160,000 0 400,000 0

Real estate 240,000 240,000 160,000 0 0

800,000 800,000 800,000 800,000 800,000

Portfolio Manager
Portfolio Manager is the person or office given the authority to make decisions regarding the
investments of an individual or entity. Portfolio managers are investment decision-makers. They
devise and implement investment strategies and processes to meet client goals and constraints,
construct and manage portfolios, make decisions on what and when to buy and sell investments.
Financial Markets
Financial Markets are the venues for buying and selling financial instruments. They are usually
classified into money markets and capital markets.

Common Investing Mistakes

▪ Failure to make financial plan for the future.
▪ Miscalculating risk tolerance.
▪ Failing to keep sufficient contingency funds.
▪ Jumping on the bandwagon.
▪ Inability to have leverage.
▪ Over-diversification.
▪ Erroneous timing of the market.
▪ Failure to keep a long-term prospective.
▪ Inability to cut losses.

Investment Climate in the Philippines

The Philippines should be considered as an attractive site for investments primarily because it is
customer-rich, it is very resilient and its market is volatile. Its population is more or less 75 million
at the time of this writing, it has weathered so many crises, and investors can take advantage of the
ups and downs. As the old saying goes, "there is opportunity in crisis".

PH investment climate in 2023

https://youtu.be/NCWJtnrkD2A
CHAPTER EXERCISES

Direction: Read the given scenario carefully and answer the question comprehensively.
Support your answer. (Show computations)

1. The items in Mike’s portfolio are as follows:

a. Saving and time deposit …………………………… P 50,000
b. Premium saving account……………………………..200,000
c. Treasury bills, 364, days……………………………..150,000
d. Bonds (2years)……………………………………….100,000
e. Bonds (3years)……………………………………….. 50,000
f. Bonds (8years)……………………………….............200,000
How much liquid asset does Mike have?
a. P50,000
b. P400,000
c. P250,000
d. None of These

2. How much of Mike’s portfolio items (item no.1) are short-term, medium term and long
term respectively.

a. P 50,000 , P500,000 and P 200,000

b. P400,000, P150,000 and P200,000
c. P400,000, P100,000 and P250,000
d. None of the Above
 Chapter 2
Bank Accounts and Credit Securities

Banks Accounts

Bank Accounts may be in the form of savings accounts, time deposits and special savings
deposits or premium savings accounts.

When opening a bank account, the following factors are to be considered;

✓ Minimum balance required.
✓ Interest rate or rates.
✓ Limitations as to withdrawals.
✓ The bank’s reputation.
✓ Insurance.

Current Account is a type of bank account from which withdrawals are made by issuing checks.

Savings Account is a type of bank account wherein deposits thereto and withdrawals therefrom
can be made any time.

Savings Account as First Step in Making Investments. For investment purposes, a savings
account is used to accumulate cash with the intention of transferring part thereof to other types of
bank accounts with higher interest rates.

Example:
A family's monthly net earnings and normal monthly expenses amount to P25,000 and P20,000,
respectively so that it can save P5,000 every month. The family has adopted the policy of
maintaining normal cash requirements for one (1) month in a savings account and transferring to
a time deposit, whatever is the excess. After eight (8) months, the family's savings including
interest amount to P41300 so that P16,300 is transferred to a time deposit account to earn a higher
rate of interest.

Compounding. This refers to non-withdrawal of income earned on an investment so that it

becomes part of the principal in succeeding periods.

Time as an Advantage. Due to the effects, of compounding, the earlier one saves the bigger would
be the future value of his investment.
(refer to pp.63 of “The Secret to Savings and Building your Future”)
Time Deposit is a loan to a bank for a fixed term. Time deposits are evidenced by certificates of
time deposits(CTDs).

Example: A time de-posit of P10,000 is rolled over every month at the rate of 7%. With the 20%
withholding tax, monthly rate must be 1/12 of 5.6% (or 7% x 80%), that is .4667%. Thus, by the
end of one year the time deposit of P10,000 shall have amounted to P10,575 arrived at as follows:
le10,000 x 1.00466712 = P10,575 If a family can save P10,000 every year for five years and
continue to -roll over the amount at the rate of 8% without withdrawing the interest, it would
amount to P63,359, at the end of the fifth year The amount is arrived at as follows.

Future Value (FV) of annual savings of P10,000 for 5 years at 8%

= P10,000. x FV of an annuity of 1 for 5 periods at 8%

= P10,000 x 6.335929*
= P63,359

Time Deposits as Second Step in Investing. This is so because the required minimum balance is
much bigger than that required for savings account.

Special Time Deposits Some banks offer additional time deposit accounts that will earn interest
rates higher than those applied to ordinary time deposits. In some of them, they call the account
Special Savings Deposit (SSD), Special Savings Account (SSA), Mega Savings Account, or
Premium Savings Account.

Trust investment or common trust fund refers to cash entrusted to a trustee bank for investment
in chosen items such as treasury bills, loans, stocks and bonds for the benefit of the designated
beneficiary. The investor is called the trustor or grantor.

Securities are written evidences of ownership , or interest, or participation, in an enterprise, or

written evidences of indebtedness of a person or enterprise. Securities may be bought from the
primary market or the secondary market.

Classifications of Securities Markets

The markets for securities may be classified as follows:

A. Based on maturity of Securities:
• Money market. This refers to the trading of short-term securities. The most
common among them are treasury bills and commercial papers.
 • Capital market. This refers to the trading of long-term securities such as bonds
and shares of capital stock.

B. Based on who is the seller:

• Primary market. The seller is the issuing entity. In other words the proceeds from
sale of securities go to the issuing corporation.
• Secondary market. The seller is a party other than the issuing entity. The proceeds
from sale of securities do not go to the issuing corporation.

Credit Securities are evidences of indebtedness issued by an entity as a vehicle in borrowing

from the public
.
Factors to Consider in Investing in Credit Securities
✓ Interest rate
✓ Date of maturity or call
✓ Value of the security
✓ Yield on the security
✓ Credit rating of the issuing party
✓ Credit rating of the trustee (if any)
✓ Credit rating of the underwriter (if any)

Commercial Papers are promissory notes issued by big firms of unquestionable credit standing
and reputation.

Bond is a certificate of indebtedness with fixed interest rate and maturity date. The written
agreement o bond issues between the issuing party and the bond holder is called Indenture or bond
indenture.

Bonds as Long-Term or Short-Term Investment

✓ Bonds are generally a long-term investment vehicle so that before any party invests
therein, he should see to it that the investment is in track with his financial plans.

✓ Bonds may be a short-term investment when they are listed in the stock exchanges so
that a bondholder can sell his holdings anytime he wants to.

Classifications of Bonds

A. As to the issuing party

1. Government bonds — issued by a government unit.
2. Commercial bonds — issued by a private corporation.
 B. As to security:
1. Mortgage bonds — secured ty lien on real property
2. Equipment trust bonds — secured by equipment of the company:
3. Collateral trust bonds — secured by securities invested in by the issuing company.
4. Debenture bonds — secured by all of the free assets of the issuing company so that in effect
they are not secured by any specific asset.

C. As to maturity of principal:
1. Straight bonds - the entire principal will mature at one time.
2. Serial bonds - the principal matures in installments.
3. Convertible bonds - they can be exchanged for other of the company at the option of the
bondholder.
4. Callable or redeemable bonds - they can be called, redeemed or retired by the issuing company
before maturity date.
5. Non-callable or non-redeemable bonds - they are not subject to calls or redemption before
maturity date.

D. As to transferability:
1. Bearer bonds — they can be transferred to other parties by mere delivery because 'bondholders
are not registered in. the books .of the issuing entity.
2. Coupon bonds —interest coupons are attached to the bond certificates and interest is paid to
the
3. Registered bonds — they are registered in the books of the issuing entity so that they can be
transferred to other parties only upon surrender of the bond certificate to the issuing entity or its
transfer agent.

Registered bonds may be further classified into:

a. Registered as to principal only.
b. Registered as to both principal and interest.

In addition to the foregoing, there are zero coupon bonds and junk bonds.

Zero coupon bonds are those on which there is no periodic payment of interest.

Junk bonds are high yielding bonds issued by companies with very low credit rating so that there
is higher risk from default in the payment of interest and principal.
Bond Quotations; Premiums and Discounts

Bonds are quoted in terms of percentages of par or face value.

Thus, if bonds with par value of P50,000 were quoted at 98, it means they are selling at 98% of
par value or for P49,000. If the quotation were 105, they are selling for P52,500 for 105% of
P50,000). - - - Premium

Bonds are selling at a premium when they are quoted at more than 100% of their par value.
If they are selling at less than par or face value, they are selling at a discount. In case P80,000
bonds are quoted at 103, the premium is 3% of 80,000 or P2,400. If they were quoted at 96, the
discount is equal to 4% of P80,000 or P3,200.

Effective Rate on Short-Term Bond Investment

When an investor has no intention of holding on to bonds beyond one year, the yield thereon is
computed by dividing the annual interest by purchase cost.

Example: An investor buys 8% P100,000 bonds for P95,000. He intends to sell them before the
end of the year. The effective rate may be arrived at as follows:

Effective rate = P8,000/P95,000 = 8.42%

It may be noted that the effective rate is higher because the bonds are purchased at a discount

Bonds as Long-Term Investment; Yield and Bond Value

Yield on bonds refers to the effective rate at which an investor is earning on his investment. It is
also used to refer to the increase in value of an investment.

Bond value refers to the price at which investors would be willing to buy so that they can realize
their desired yield on or rate of return from the investment.

The following formula applies:

Bond value = Present value of annual interest + Present value of redemption price at maturity
date

Effects of Purchase Price on Bond Yield

✓ Bonds Acquired at Face Value.

✓ Bonds Acquired at a Discount.
 ✓ Bonds Acquired at a Premium.
Bonds Acquired at Interest Date and Between Interest Dates

When bonds are acquired at interest date, the price paid applied to the bonds only because all the
interest due on the bonds have already been paid by the company.

Example: Assume that in the given example, Jose Llamas acquires the bonds on March 1, 2002.
Inasmuch as the preceding interest date is January 1, 2002, interest for two months have accrued
on the bonds. The computations are as follows:
Payment applied to bonds:
Payment made (P100.000 .10 x1.01) P1,010,000
Less
Interest accrued on bonds (P 1,000,000 x 8% x 2/2) 13,333
Payment applied to bonds P 996,667

Gain or loss from Bond Investment

The computation for bond yield in the preceding sections are made based on assumption that bonds
are to be held on up to maturity date. Bonds command lower prices when the bank prime interest
rate is high and vice-versa.

Government Securities are debt instruments issued by the government. All government securities
are considered risk-free because they are fully guaranteed by the national government.

Treasury bills (T-bills) are government securities that mature in less than a year. They are offered
in three terms namely, 91, 182 and 364 days to banks and eligible dealers who in turn offer them
to the public, the secondary market. The interest applied is slightly lower than the official rate. The
differential rate is called the spread which accrues to the dealers. The minimum investment for
treasury bills is P100,000 unless they fall under the Small Investors Program (SIP) in which
case, minimum investment is P5,000 .

Discount on, and Purchase Price of GST-Bills. GST-bills are issued at a discount and are
redeemed at face value so that the increment in value is the yield or interest earned by the investor.
The computations for purchase price and discount are as shown below.

Per formula given by the Bureau of Treasury:*

𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒 𝑥 360
Purchase price (PP) = 360 + (𝑅𝑎𝑡𝑒 𝑥 𝑇𝑒𝑟𝑚)
or
𝐹𝑉 𝑥 360
PP = 360 +(𝑅 𝑥 𝑇)
Discount = Face Value — Purchase Price
Illustrative Problem

Treasury bills of P200,000 for 91 days are bought by a bank at the average rate of 13.5%. On the
same day, they are sold to an investor at 12.75%. The purchase prices and discounts to both the
dealers and the investors are computed below.

For the bank or eligible dealer:

P200,000 x 360 P72,000,000
𝑃𝑃1 = 360 + (.135 x 91) = = P193,400
372.285
𝐷1 = P200,000 - 193,400 =P 6,600

For the investor:

P200,000 x 360 𝑃72,000,000
𝑃𝑃2 = 360 + (.1275 x 91) = = P193,755
371.6025
𝐷2 = P200,000 - 193,400 = P 6,245

The same figure' s for purchase price (PPI and PP2) may also be arrived at as follows
considering that the future value is equal to the face value of the treasury bills.
Future value= Face value
Face value = Purchase price + Interest
= Purchase price + (Pur. price x rate x time*)

Face value = P + (Prt)

Therefore,
Face value
Purchase price = 1+(1 x r x t)

For the Dealer

𝐹𝑉
• 𝑃𝑃1 = 1+(𝑟 𝑥 1)
P200,000
• 𝑃𝑃1 = 1 + (.135 x 91/360)
P200,000
• 𝑃𝑃1 = 1.034125 = P193,400

For the Investor

𝐹𝑉
• 𝑃𝑃2 = 1+(𝑟 𝑥 1)
P200,000
• 𝑃𝑃2 = [1 + (.1275 x 91/360)]
P200,000
• 𝑃𝑃2 = 1.0322292 = P193,755
Treasury bonds are government securities that mature beyond one year. At the time of this writing
there are five (5) maturity periods for T-bonds, namely, two (2) years, five (5) years, seven (7)
years, ten (10) years and twenty (20) years. Treasury bonds are classified into regular bonds,
progress bonds, ERAP bonds and small denominated (SDT) bonds. Minimum investment in T-
bonds is P100,000 unless they fall under the SIP in which case, it is P5,000.

Small Investors Program (SIP) is one instituted by the Bureau of Treasury to sell Small
Denominated treasury Bills (SDT-Bills), SDT-Bonds and US Dollar Savings Bonds to improve
the affordability of the.se securities to small savers. It is aimed at deepening the capital market of
the country by expanding the base of the investors it government securities and subsequently, allow
the government to lower interest rates.

CHAPTER EXERCISES

Direction: Read the given scenario carefully and answer the question comprehensively.
Support your answer.

1. Considering you’re a financial adviser. A family has approached you for advice on how
their funds of P10,000,000 should be invested. What question would you ask them before
you give any comment? Why? Explain your side.

2. How would you apply the contents of this chapter to your own finances? Explain
 Chapter 3
Stocks

INVESTMENT IN STOCKS

In more advanced countries, stock investment is an indispensable source of income for both the
private sector and the government. In the Philippines, there has been a general misconception
about stock investment perhaps because of lack of adequate information and its non-inclusion in
the educational curricula.
Although stocks are just one of the investment vehicles, some management books generally refer
to stocks when it comes to investments.

Stock investment refers to acquisition of shares of stocks of other corporations to realize profit
upon their sale and for periodic income (in the form of dividends).

A share of stock is a unit of ownership in a corporation so that stock investment is in effect an

investment in a portion of the equity in a corporation. Thus, it is generally in the form of common
stock which carries with it the right to vote and to share in corporate earnings after providing for
preferred stock.

Classifications of Stocks

Stocks may be classified based on the :

I. Rights Of Stockholders
II. Nature Of Business The Corporation Is Engaged In,
III. Risk And Potential For Earnings
IV. Market Capitalization
V. Marketability
VI. Citizenship of Investors.

I. Rights of Stockholders

Common stock. This represents the basic ownership in a corporation. It carries with it the right to
vote on corporate matters, shares in profits after providing for the shares of preferred stock therein,
and absorbs corporate losses before any portion thereof is charged to preferred stock. The
percentage of ownership in a corporation is measured based on common shares owned.

Preferred stock. This refers to that portion of owners' equity that enjoys preferences over common
stock. These may be in the distribution of earnings and/or distribution of assets in case of
liquidation. Preferred stock as to dividends may be further classified into cumulative, participating,
and cumulative and participating.

II. Nature of Business

Nature of Business Stocks are classified as banks and financial services, industrial and
commercial, mining and oil. These classifications are modified to separate banks from financial
services and to subdivide industrial and commercial into communications, power and energy,
transportation services, holding firms, and hotel, recreation and other services.

III. Risk and Earnings Potential

Blue Chips. These belong to large companies which have a long record of earnings and dividend
payments. They are also known as value stocks. Although returns are moderate, they are low-risk
and are dependable.
Examples : are San Miguel Corp., PLDT, MERALCO and Ayala Corp. Investment in this kind
of stocks is called value investment.

Growth Stocks. These belong to corporations with growth rate faster than that of the-general
economy. The growth may be in terms of revenue, net income and productive assets. At the time
of this writing.
Example: Globe Telecom with its fast increasing subscribers and consequently, revenue. An-
other is Fil-invest land, Inc. with its increasing land bank.

Cyclical Stocks. Their earnings and prices move with the changes in the national economy.
Examples : are those of corporations engaged in high-cost real estate (Ayala land Corp.) and in
recreation and amusements (BW Resources).

Defensive Stocks. Their earnings are not affected so much by changes in the economy. Tiny
belong to corporations engaged in foods and public utilities.
Examples: San Miguel Corp., Jollibee Corp., MERALCO, PLDT and Globe Telecom.

Speculative Stocks. These belong to companies that are not yet operating profitably but are
expected to do so in the future. At the time of this writing.
Examples : Omico Corp. and Island Mining Corp.

IV. Market Capitalization

Market Capitalization refers to the total market value of shares of stock listed in the stock
exchanges. Accordingly, stocks are classified as first liners, second liners and third liners.
Examples : first liners are San Miguel Corporation and Philippine Long Distance Telephone Co,
For second liners, some of these are MUSIC Corporation, IONICS, and Filinvest land, Inc.
For third liners, Omico Corp., Fairmont (formerly, BW Resources, Inc.) and Atlas Mining Corp.

Market Capitalization. Market capitalization refers to the market value of the total number of
shares outstanding of a corporation. It is computed as follows:

Market capitalization = No. of shares outstanding x Market value per share

It is used as a basis in determining the required investment to acquire a desired percentage of

ownership and the sufficiency of the number of shares for the stock to be heavily traded.
Examples: The following data are given on A Corp. and B Corp.:

A Corp B Corp.

No. of shares outstanding 1,000,000 20,000,000

Market value per share P800 P10

Market capitalization P800,000,000 P200,000,000

V. Marketability

In relation to marketability of stocks, they are classified as listed or un-listed depending on whether
they are listed in the stock exchange or not.

Marketability of Stocks. A stock investor prefers to buy shares that he can easily dispose of
should he need cash so that he buys publicly listed stocks or those listed in the stock exchange.
However, there are listed shares that are not often traded because there may be buyers but there
are no sellers and vice-versa. This is partly attributable to the low market capitalization of the
corporation.

VI. Citizenship of Investor

Stocks are classified into Class A and Class B.

Class A may be bought by Filipinos only. Foreign investor re allowed to buy Class B only due to
the prohibition for foreigners to own more than 40% equity in a Philippine corporation. Thus,
Class B stocks of a corporation should not exceed 40% of its total number of common shares
outstanding.
The restriction applies to foreign investors so that a Filipino citizen can buy both Class A and Class
B stocks. In case the holder of Class B stock decides to sell his holdings but there is no buyer, they
may be sold as Class A.

Stock Values

Stocks have par value, book value, net asset value, and market value share.
❑ Par value is the nominal value assigned to a share as appearing on the stock certificate. It
is the minimum amount at which a share of stock may be originally issued.
❑ Book value is the value of a stock based on the value of stockholders' equity per books of
accounts. The stockholders' equity per books is equal to assets at book value minus
liabilities.
❑ Net asset value of a stock is based on the current value of assets minus liabilities. It is
arrived at as follows:
Asset at current values — Liabilities
Net asset value per share = No. of outstanding shares of common stock
❑ Market value of a stock is its current market price. It is the closing price in the day-to-day
trading in the stock exchange. It is affected by supply and demand and goes up and down
depending on the market situation as affected by economic, political and corporate
developments.

Parties Involved in Stock Investment

The parties involved in a stock investment are the :

I. Stock Market,
II. Stock Broker and Dealer,
III. Stock Clearing Office,
IV. Stock Transfer Office
V. Investor.

I. Stock Market

Stock market is where stocks are bought and sold. These may be done in the stock exchange or in
the over-the-counter market.

a.) Stock Exchange. Stock exchange is an organization that facilitates the trading of stocks,
warrants and other securities listed therein. As defined in the Revised Securities Act (RSA) an
exchange is an organized marketplace or facility that, brings together buyers and sellers and
executes trades of securities and/or commodities.
 Securities that are listed in the stock exchange are called publicly listed securities and must have
conformed to criteria as promulgated by its board of governors.

Role of the Stock Exchange in the Economy

The stock exchange plays a major role in an economy. A well-managed stock exchange benefits
the economy as follows:
✓ It increases foreign investments because foreign or global investors are encouraged to
invest in listed profitable corporations.
✓ It enables business entities to raise additional capital.
✓ It provides the government with additional revenue.
✓ It gives Filipinos more faith in their future because of the investment vehicles a stock
exchange provides and also because of the combined effects of the above given advantages
from having a reliable stock exchange.

b.) Over-the-counter (OTC) market refers to trading of securities that are not listed in the stock
exchange. The securities traded are usually those of corporations that are relatively new, those
intending to concentrate their ownership to relatively few stockholders, corporations that have not
yet qualified for public listing and those that are making their initial public offering (IPO) through
the brokers.

The volume of over-the-counter trading is relatively thin. This is due to the fact that securities
traded therein are not readily marketable because the broker still has to look for buyers or seller in
case an investor desires to sell or buy securities. Daily results of over-the-counter trading are not
published.

II. Stockbroker and Stock Dealer

A stockbroker is an individual or company duly licensed by the SEC to participate in trading in

the stock exchange. He should have an adequate understanding of securities, financial statements,
periodic reports, and basic economic theory.

A stock dealer is one who buys and sells stocks for his own account. He may be a stock broker or
one who trades through a stockbroker. His gain or loss from his stock trading depends on his ability
in choosing the stocks to buy and in determining when to sell them.

III. Clearing House

The clearinghouse is the entity wherein inter broker payments and transfers of stocks are coursed
through so that each broker does not have to deal directly with all the others. At present, the
clearing houses of the Makati and Mandaluyong stock exchanges are RCBC and the Security
Clearing Corp. of the Philippines (SCCP).
 IV. Stock Transfer Agent

The stock transfer office of a corporation takes care of the transfer of stocks (covered by stock
certificates) from the name of the seller to that of the buyers. It maintains a complete list of the
corporation's stockholders and the number of shares each has. It takes charge of notifying
shareholders of stock rights and mailing dividend checks and stock certificates.

How Stock Investment is effected

An investor places an order to his stockbroker for the stocks of his choice at the desired price. In
case the broker is able to buy the stocks for him, he issues a Purchase Confirmation to the
investor to inform the latter of such purchase. If the investor desires to leave the stocks purchased
in the books of the broker, the latter have them under a street certificate.

A street certificate is one issued in the name of the stockbroker for the account of his clients. The
investor can easily have his shares sold by calling up his broker. A soon as they are sold, the broker
issues a Confirmation of Sale to the investor.

The broker remits to the investor the net proceeds on or after the due date which is the third day
from the date of sale.

Minimum Board Lot and Allowed Price Fluctuations

Minimum board lot refers to the least quantity that can be purchased de-pending on market price
of a stock and the minimum investment that an investor in stock must have. At the time of this
writing, they‘ are as follows:

Price Ranges Fluctuations Minimum Board Lot

0.0010 - 0.0024 P 0.0002 1,000,000

0.0026 - 0.0050 0.0002 1,000,000

0.0055 - 0.0100 0.0005 1,000,000

0.0110 - 0.0250 0.0010 100,000

0.0260 - 0.0500 0.0010 100,000

0.0525 - 0.1000 0.0025 100,000

0.1050 - 0.2500 0.0050 10,000

0.2600 - 0.5000 0.0100 10,000

0.5100 - 1.0000 0.0100 10,000

Price Ranges Fluctuations Minimum Board Lot

1.0200 - 2.5000 0.0200 1,000

2.5500 - 5.0000 0.0500 1,000

5.1000 - 10.0000 0.1000 1,000

10.2500 - 25.0000 0.2500 100

25.5000 - 50.0000 0.5000 100

50.5000 - 100.0000 0.5000 100

101.0000 - 250.0000 1.0000 10

 252.5000 - 500.0000 2.5000 10

505.0000 - UPWARD 5.0000 10

Transaction Costs for stock investments are the broker's commissions on both "buy" and "sell"
transactions, sales tax on sales, charges for the Phil. Center Depository, the clearing house and the
documentary stamps. Upon purchase of stock, an investor is charged for stockbroker's commission
of store or less 15% of the purchase cost plus 10% VAT based on the commission, charges by tile
Philippine Center Depository and the clearing house totaling more or less L10 of 1% and
documentary stamps of P1.50 for every P200 of par value.

Break-even Price (BEP)

Considering the transaction costs involved in stock investments, selling stocks at a few fluctuations
above purchase cost does not ensure a profit. The break-even price for stocks before documentary
stamps may be computed using a divisor arrived at as follows:

Purchase cost before commission 1.00000

Commission of 1.5% + VAT pf 10% .01650

PCD and clearing house charges .00100

Purchase cost with commissions 1.01750

Divided by –

Equivalent percentage based on selling .97750

price [1— (1.65% commission with VAT +
.5% sales tax + .1% PCD and clearing
house charges)
Multiplier to arrive at BEP 1.04092
Based on the foregoing, stocks bought at P5.20 should be sold at P5.412788 (or P5.20 x 1.04092)
plus documentary stamps to be able to avoid a loss. This is proven as follows:

Selling price at BEP (before doc. stamps)

P 5.412788
Less:

Broker's commission (1.5%) + VAT

.089311
Sales tax (.5%) .027064

PCD and Clearing house charges (.1%)

.005413 .121788
Purchase cost after commission
P5.291000
Purchase cost before commission
P5.200000
Add:

Broker's commission (1.5%) + VAT P.08580

PCD and clearing house charges (1%) .00520 .091000

Purchase cost after commission P5.291000

The Exchange Composite Index

The Philippine stock exchange composite index is a weighted aggregative index based on a
basket of the common stocks of 30 listed corporations. It serves as a measure of the exchange
performance and is used as a tool in analyzing trends in the market. It is often referred to as a
barometer of a nation's economic progress.

Price Volatility The volatility of prices refers to the speed at which prices go up and down. The
more volatile a market is, the bigger are the potential profits and losses on the short-term. An
aggressive stock trader would buy on "lows" and sell on "highs" while a conservative investor
would prefer to hold on to his shares as long-term-investment.
Technical Rebound And Correction; Price Support And Resistance

Technical rebound - occurs when prices go up after going down for a number of days. Technical
correction is the opposite. In other words, there is a technical correction when in the absence of
negative news about a corporation, the market price of its stock goes down after going up for a
number of days.

Example: The market price of X stock went .down from P35 to P25 for three consecutive days.
On the fourth day, the price goes up to P29 despite the lack of any good or positive news about the
company. The increase in price is considered a technical rebound. If the price continues to go up
(to say, P37) and then goes down on the fourth day (to sap P32), the price decline is considered a
technical correction in the absence-of negative news about the corporation.

Price Band refers to the range within which the price of a stock may change in one day’s trading.
It has been set at 60% to 150% of the previous day s closing price. In other words, a stock's price
may increase by not more than 50% and may decline by not more than 40% of the previous day's
market price.

Example: The market price of XYZ stock on October 1st was at P50. On the next trading day,
October 2nd, there is an increase in the demand for the stock so that the market price goes up
abruptly. However, once the price reaches P75 for 150% of P50), the exchange will not allow it to
go up further.

Why Prices Fluctuate

Prices fluctuate in a stock market because their behavior is affected by supply and demand. When
a stock price has gone up significantly, investors resort to "profit-taking" and then wait for the
prices to go down so they can re-purchase the stock at lower price. Another cause of price
fluctuation is the length of period given to stock traders to pay their accounts.

Oversold or Overbought. When the price of a stock has gone down so low, they are said to be
oversold so that it is time to buy. The lowest price at which a seller is willing to sell or at which
there would be more buyers than sellers is called the price as oil.

Price support refers to the lowest price that a stock can command. In other winds, it is the price
at which buyers exceed sellers so that the tendency of the price is to go up. In the given example,
the price support for X stock is P25 because after reaching this level, it rebounds to P29. The price
went down so much so that the stock is considered oversold and it is time for the buyers to come
in.

Price resistance refers to the highest price that a stock can command. It is the price at which sellers
exceed buyers so that the tendency of-the market Price is to go down. In the given example, the
first price resistance is P35 and the second, P37. When market price has gone up so much, the
stock is considered overbought so that it is time to sell it.

The Domino Effect

The Domino effect as observed in stock investment refers to the similar price behavior of other
stocks as brought about by the price behavior or another.

Example is a stock of a corporation that has experienced a significant financial setback.

Timing the Market

The practice of buying "low" and selling “high” is called timing the market. This can applied to
stocks that are in play. Stocks being in play are those that go up and down within a period of one
or two weeks.

Down averaging refers to lowering average unit cost by buying more at lower prices.

Example: On February 8, Ben bought 300,000 shares of GHI Corp. stock for P .06 per share.
Thereafter, the market price continued to go down so that Ben decided to buy gradually as follows:
February 12 200,000 shares @ P.05
February 18 400,000 shares @ .04

In buying gradually at. lower prices, Ben was able to lower his average cost per share to P .0489
arrived at as follows:
300,000 shares @ P .06……………...P 18,000
200,000 shares @ P .05……………...P 10,000
400,000 shares @ P .04………………P16,000
Total cost of 900,000 shares P 44,000

Average unit cost = P44,000/900,000 shares = P .0489

Price Averaging. Some investors do not keep track of price changes. Instead, they buy regularly
regardless of whether the prices are low or high. They benefit also from this practice because the
average cost per share would not be so high but neither would it be too low. This practice is adopted
by regular savers for long-term investment.

Index Investing

Some investors buy index stocks when the composite index is low and then sell them when it has
gone high enough. Index stocks are those included in the computation of the composite index.
Effects of Stock Dividend on Market Price

When stock dividend is declared by a corporation, there are four dates involved.

Date of Declaration. This _is relevant in the analysis of financial statements because it is as of
this date that the corporation has to recognize the transfer from retained earnings to an account
that will ultimately be an addition to capital stock.

Date of Record. This refers to the cut-off date in determining whose names appear in the stock
and transfer book of the corporation and are therefore entitled to the stock dividend.

Date of Ex-dividend Trading. This refers to the date on which the stock is to be traded ex-
dividend or as separated from the stock dividend.

Date of Issuance. This is relevant for a stock investor because of the additional shares he is
receiving and the effect of the additional shares on the market price of the stock.

Effects of Stock Splits

Stock Splits are changes in par value of corporate stock bringing about the corresponding
changes in the number of shares outstanding and market value per share. It may be split-up or
split-down (or reverse split).

Split-up this refers to a reduction in par value per share to bring about an increase in the-number
of outstanding shares and the proportionate decrease in the market value per share.

Split -Down (or Reverse Split). This refers to raising the par value per share and consequently
reduces the number of shares outstanding and raises, the Market value per share.

Stockbroker's Inability to Execute a Client's Orders

Sometimes, a buyer or a seller is unable to buy or sell even if his bid or offer is equal to market
price. The reason for this is that there may not be enough shares being sold or bought at said
price. To illustrate, the following data on MOP common stock are given:
 Sellers Buyers

No. of shares Price/shr. No. of shares Price/shr.

400,000 P 11 150,000 P 10

300,000 10 30,000 9

50,000 9 350,000 8

120,00 8 500,000 7

Comparing the sellers' offers and the buyers' bids, there is no buyer at P11 and there is no seller
at P7. There are more stocks being offered at P10 and P9 compared with the bids so that the
day's trading would result in the following:
150,000 shares at 10
30,000 shares at P 9
120,000 shares at P 8

The day's closing price would be P8 and shall be considered as the stock's market price. It may be
noted that the other "buy" orders at P8 are not carried out because of lack of more sellers at this
price. Assuming that in addition to the given offers a shareholder has to sell 300,000 shares on the
same day, he should be willing to sell 230,000 shares at P8. The remaining 70,000 shares cannot
be sold at this price because of lack of additional buyers at ?8. Unfortunately, when buyers become
aware that some-body has to sell at any price during the day, they might further reduce the bid
Price to as low as the floor level for market prices which is 60% of the previous day's market.
price.

Bases in Investing in Stocks

Investing in stocks may be based either on technical analysis or on fundamental analysis.

Investing Based on Technical Analysis. Trading is based on price trends and the attitude of
investors toward a specific stock. The investor keeps track of price changes and may even go to
the extent of using graphs. He buys at the "lows" and sells at the "highs".
Investing Based on Fundamental Analysis. This is also called value investing because it is based
on the value of the underlying corporation which is measured in terms of book value, net asset
value, earnings per share and price-earnings ratio.

Stock Market Analysts' Recommendations

When the recommendation is strong buy, it means that there is likelihood that the price will go up
in the immediate future, say within three or six months. When it is accumulate, it roust be gradual
acquisition of shares due to favorable factors that will tend to prop up the price.

"Buy on Rumor, Sell on News"

Oftentimes, an uninitiated investor buys a stock upon learning through the media of something
good about a company (such as acquisition of another company and realization of bigger profits).

Nature of Instructions to Stockbrokers

When an investor places his "buy" or "sell" order with his stockbroker, he may give the exact price
at which to buy or to sell.

Good Till Canceled (GTC) Order

Good till canceled order is one that is to be observed from day to day until it is carried out or until
the investor cancels it. Stockbrokers consider a GTC, order as valid liar a period of one week only.

Stop Loss Order

Stop loss order refers to an investor's order to sell his shares if prices go below a certain level in
order to minimize his loss. This is done when prices are going down at a very fast rate and are
therefore expected to go down further.

Buying on Margin
Buying on margin means that an investor buys stocks but does not fully pay for them. The amount
of liability he incurs is called the margin.

Greed and fear

Greed and fear are an investor's weaknesses in making decisions as to when to buy or sell stocks.
Greed as applied to stock investment refers to an investor's desire to sell at much higher prices to
the extent that he is unable to sell when prices have reached the resistance level.

Stock Investment Based on Age

Some investment advisers recommend investing in stocks based on age. That is, the older a person
is, the smaller must be the percentage of his investment in stocks.
Zero-Based Line of Thinking
An investor should always subject his investments to periodic review to determine possible
revisions in their composition in order to optimize the investment mix.

Time Horizon and Risk

Stock investment may be short-term, medium-term or long-term or a combination of these three
depending on the kind of stocks chosen for a portfolio and the investor's ability to anticipate
higher prices for the said stocks.

Minimizing Risk in Stock Investments

✓ Do Your Homework
✓ Diversify Your Stock Investments
✓ Beating the Market
✓ Know when it is advisable to cut losses
✓ Remain focused on long term objectives

CHAPTER EXERCISES

Direction: Read the given scenario carefully and answer the question comprehensively.
Support your answer.
1. How may an investor minimize risk from stock investment? Explain

2. Obtain newspaper clippings in the trading result for the first and last trading day in a
month. Compare the volumes and prices of at least ten stocks and estimate the gain or
loss of an investor who bought those stocks on the first trading day. Show pictures as
proof.
 Chapter 4
Mutual Fund

Mutual Funds

When a small investor cannot decide as to what kind of equity and debt securities to invest in, he
would prefer to invest in an optimum combination thereof. However, with his limited funds and
lack of expertise in, or time for investment management, he would prefer to combine his resources
with those of other investors and delegate the task of investing and managing the investment to
one of them who may be qualified to do so. This practice gave rise to the existence of investment
companies some of which are classified as mutual funds.

Investment Company Defined

An investment company is defined in the Investment Company Act or ICA (Republic Act 2629,
June, 1960) as “ any issuer which is or holds itself out as being engaged primarily or proposes to
engage primarily, in the business of investing, reinvesting or trading in securities". It may
therefore be defined also as a stock corporation that pools money from numerous investors by
issuing its shares and investing the pooled funds in accordance with its objectives and policies.

An investment company should not be confused with an investment house because the latter, as
defined in PD 129, refers to an enterprise engaged in the underwriting of securities of other
corporations. Underwriting is the act or process of guaranteeing the distribution and sale of
securities of any kind issued by another corporation.

Classifications of Investment Companies

An investment company may either be an open-end or a closed-end company. An open-end
company is also known as mutual fund.
Open-end company or mutual fund. It is an investment company that continuously issues its
redeemable shares, and stands ready to redeem them back at net asset value per share (NAVPS)
should investors decide to pull out their investments.

Closed-end companies. It is an investment company that issues a limited number of non-

redeemable share so that they are listed in the stock exchange to provide liquidity to its
shareholders.

Open-End Company or Mutual Fund

Inasmuch as an open-end company or mutual fund is an open-end investment company, it may
also be defined as a stock corporation that pools investors' money by continuously issuing
redeemable shares of stock, investing the proceeds in a portfolio of securities and undertaking to
redeem its shares at their net asset value. Consequently, the number of its outstanding shares
fluctuates depending on the issuances and redemptions everyday.

Each share in a mutual fund represents a proportionate part of every portfolio security of the fund
and shares in its earnings accordingly.

Right of Redemption. Right redemption is unique on the part of investors in a mutual fund
because the latter stands ready to pay for any share returned by its shareholders. The fund is
required by law to pay for redeemed 'shares within seven banking days from date of redemption
request.

Waiver of Pre-emptive Right. Pre-emptive right as defined in the preceding chapter refers to a
stockholder's right to subscribe to new issuance of the shares of stock of an investee corporation.
Inasmuch as new shares are Issued on a continuing basis by a mutual fund, it would be
impracticable to require shareholders to buy new shares every time there are issuances. Thus, the
SEC's implementing rules for the ICA require mutual funds to provide for a waiver of pre-emptive\
rights in their Articles of Incorporation.

Mutual Fund, a Long-Term Investment

Investment in a mutual fund is a long-term investment with holding preferably of more than three
years. There may be highs and lows in its performance and on a long-term basis, positive results
in some years may more than offset performance during bearish periods.
Differences Between Open-End and Closed-End Companies

Open-End Companies Closed-End Company

Number of shares offered Unlimited. Limited.

for sale:

Outstanding number of Variable. Fixed.

shares:

Listing in the stock Not Listed. Listed.

exchange:

Purchase price on the At net asset value per At initial offering

part of investors: share plus fee. price and thereafter, at market
price plus commission.

Sales price on the part of At net asset value At market price less
investors : per share minus commission and tax.
back-end sales load*
or commission and
VAT.
Mutual Funds and Common Trust Funds

Mutual Fund Common Trust Fund

Issuing entity: Investment company. Trust department of a bank

Instruments issued: Common shares. Units of participation.

Primary government Securities and Bangko Sentral ng Pilipinas

regulatory body: Exchange (BSP)
Commission

Are assets required to be held Yes. No.

by an independent custodian?

Minimum investment P5,000 P100,000

required:

Are they subject to full Yes. No.

disclosure requirement?

Are they subject to give No. No.

prospectus to investors?

Are they subject to reserve Yes. Yes. Just like bank deposits, they
requirements? are subject to reserve
requirements.
Net Asset Value per Share of Mutual Funds

When investing in mutual funds, the price paid per share is equal to its, net asset value plus fee.
Net asset value refers to the excess of assets at current value over liabilities.

Mutual funds compute for their net asset value per share (NAVPS) on a daily basis and have
them published in at least two newspapers. Accordingly, all mutual fund expenses are accrued on
a daily basis se that these may be reflected on the daily NAVPS. The practice of computing for
net asset value per share every trading day after the close of the stock market at mid-day called
forward pricing (Hall, 103). On a per share basis, it is computed as follows:

Assets −Total Liabilities

Net asset value per share = No. of shares outstanding

ASSET
Cash and near cash items (time deposits and money market P
placements) 350,000
Stock investments at market prices at which they were last traded)
35,500,000
Bond investments (at market prices at which they were last traded) 50,200,000

Interested receivable 50,000

Dividends receivable 35,000

Total assets at current value P 86,135,000

 Liabilities

Payables — management fees (accrued on a daily basis) P 90,000

Payables — purchase of investments 80,000

Payables — redemptions 50,000

Accrued expenses (custodial fees, audit fees, etc). 15,000

Total liabilities P 235,000

Net assets P 85,900,000

Number of shares outstanding 500,000

Net asset value per share P 171.80

With NAVPS equal to .P171.80 as of a particular date, it is-the used as the basis in pricing all
shares issued or redeemed on the same date.

Investor's Transaction Costs

A mutual fund charges fees to investors and they are classified as follows:

a.) Sales fee (or front-end load). This is a charge made based on NAVPS of share issued to
investors. It has the effect of increasing purchase cost per share.

b.) Redemption or exit fee (deferred sales load or back-end load). This is charged to the
investor upon redemption of his shareholdings. It reduces net proceeds from redemption
on the part of the investor.

c.) Reinvestment fee. This is charged to the investor upon reinvestment of his earnings from
the mutual fund. In most cases, this is not charged anymore by the fund.

d.) Value Added Tax (VAT). This is computed at 10% of fees charged. It is generally
included in the fee percentage when the latter is based on the public offering price.
A mutual fund that charges fees on transactions with investors is called a Load fund, while a fund
that does not make these charges is called a no-load fund. All mutual funds in the Philippines are
load funds.
`

Offering and Redemption Prices

Sales Fee (Front-end load) Based on Issue Price. Issue price is considered as equal to 100% so
that the equivalent percentage of NAVPS must be (1-Sales fee %) of offering price. The offering
price is therefore arrived at as follows:

Net asset value per share

Public offering price (POP) = 1 — Front - end load or fee rate

Assuming that, the NAVPS as of February 5, 2002 is P171.80 and that front-end load rate is 3%
(including VAT), the day's offering price is arrived at as follows:

P171.80 P171.80
Offering price (POP) = = = P177.11
1-3% 97%

The sales charge rate is arrived at as follows:

POP — NAVPS P177.11 — 171.80
Sales charge % = = = 3.09% %
POP P171.80

It may be noted that the rate arrived at is higher than 3% when it is based on the public offering
price (POP).

• Sales Fee (Front-end load) Based on NAVPS. NAVPS is equal to 100(7( so that offering
price must be equal to (1 + Sales fee %) of NAVPS. Using the given example, the offering
price and the sales charge rate are arrived at as follows:

Public offering price (POP) = P171.80 x (1+ 3%). P176.95

POP — NAVPS P176.95 — 171.80

Sales charge = = = 3%
NAVPS P171.80

Redemption Price. This is equal to the NANTS on date of redemption request minus
redemption fee.

Assume that the NAVPS on date of redemption is P180 and the fund charges redemption fee of
2%. The computation for net proceeds must be as follows:

NAVPS on redemption date P 180.00

Less — Redemption fee and VAT (2% x P180) + 10% 3.96
Net proceeds P 176.04
Comparing net proceeds upon redemption of P176.04 and purchase cost of P177.11, it may appear
that there is a loss of F1.07. However, there may have been distribution of earning's in between.
The computation for gain or loss is taken up later in this chanter.

Earnings from Mutual Funds

Investors earnings from mutual funds may be in the nature of:

(a) distribution of dividends earned on its stock investments,
(b) distribution of interest earned on the funds investments in debt securities.
(c) distribution of funds capital gains on its investments and ;
(d) the investor's capital gain or his gain from sale of his shareholdings in the fund.

Example: Oscar Quintus bought 200 shares of a fund's shares for P103 each. During the holding
period of three years, the fund earnings raised the NAVPS to P120. Thereafter, it distributed
earnings subject to automatic reinvestment and Oscar was given 20 additional shares. Said
distribution resulted in a decline in NAVPS to P109.

The increase in value of Oscar's investment is arrived at as follows:

Current investment value (220 shares x P109) P 23,980
Purchase Cost (200 shares x P103) 20,600
Increase in investment value P 3,380

Mutual Fund Operating Expenses

Mutual fund operating expenses consist primarily of management fees, selling and distribution
expenses, smaller fees such as the fees of the fund custodian, transfer agent and external auditor.

Classifications of Mutual Funds

A.) Based on charging of fees:

1. Load funds. They charge fees to investors upon sale and redemption of shares.

2. No-loads funds. They do not charge fees to investors upon sale or redemption of shares.

B.) Based on securities invested in:

1. Equity or Stock funds. They invest primarily in shares of stock.

a) Equity income funds. They are after current income so that they invest primarily in
stocks that regularly declare relatively high dividends.
 b) Growth funds. They invest in growth stocks or those which have sales, earnings and
market share growing at rates higher than the average company or the economy.

c) Aggressive growth funds. They invest primarily in smaller and younger companies
wherein there is more potential for growth but which are subject to greater volatility in
prices and therefore can result in bigger profit but entail greater risk.

d) Index funds. They invest in stocks that are included in the market index.

e) Global stock funds. They invest in stocks in different countries.

2. Bond funds. Their investment is primarily in bonds.

a) Government bond fund. Their primary investment is in government bonds.

b) Commercial bond fund. They invest primarily in bonds issued by private

corporations.

3. Balanced (or hybrid) funds. Their investments are primarily in stocks and bonds.

4. Money market funds. Their primary investment is in short-term money market

instruments such as treasury bills, commercial papers, banker's acceptances, and negotiable
certificates of deposit.

Another term often used in relation to funds is value fund, This refers to the investment practice
of buying quality securities the market prices of which for some reasons have dropped to attractive
levels.

Advantages in Investing in Mutual Funds

Investing in mutual funds is undertaken for the following advantages:

▪ Professional management. Mutual funds hire full-time investment managers,

strategists and analysts who are better qualified in choosing and managing
investments.
▪ Diversification of investments. A mutual fund invests in different kinds of
securities.
▪ Smaller investable cash requirements . Direct investments in different securities
require significant amount of investments.
▪ Liquidity of investment. Investment in mutual funds can be readily converted into
cash because of the redemption right of the shareholders.
▪ Relative safety of investment. Mutual funds are closely regulated by the sec in
enforcing the Investment Company Act and its implementing rules.
 ▪ Lower purchase cost. Mutual fund investments entail lower acquisition cost due
to its greater purchasing power and the brokers' tiered basis of charging
commissions.
▪ Convenience. Mutual fund shares can be bought directly from a fund or through a
broker, bank or agent, by mail, over the phone and over the internet.

Safe Features of Mutual Funds

The Investment Company Act or ICA of 1960 and the implementing rules adopted by the SEC
provide for safety features for the protection of the investing public. Among these are given below.

▪ Required capitalization. Investment companies are required to have at least P50M

subscribed and paid-in capital. The significant amount of capital required provides
the fund with greater purchasing power, liquidity and ability to survive economic
crises.
▪ Common stock with voting rights only. Only common shares with voting rights
can be issued by mutual funds. This implies that fund shares of stock participate in
the fund earnings on equal basis and that all shareholders have a voice on matters
that must be presented to them for approval.
▪ Required liquidity. The SEC requires that at least 10% of the fund should be
invested in liquid/semi-liquid assets in the form of short-term government securities
(such as treasury bills and certificates of indebtedness issued by the BSP) the
servicing and repayment of which are fully guaranteed by the government.
▪ Unallowed investments. An investment company is not allowed to sell securities
short or invest in any of the following:
1. Margin purchase of securities
2. Commodity futures contracts
3. Precious metals
4. Unlimited liability investments
▪ Custody of securities and investments. Sec. 16 of the ICA requires every registered
investment company to place and maintain its securities and similar investments in the
custody of a local commercial bank of good repute or a company which is a member of a
securities exchange.
▪ Waiver of pre-emptive right. This implies that shareholders need not worry about dilution
of their proportionate interest in the fund's net assets and earnings which may arise from
their failure to exercise their rights while other shareholders do.
▪ Bonded employees. Any officer or employee having access to securities or funds is
required to be bonded by a reputable fidelity insurance company against larceny and
embezzlement.
▪ Limitation on expenses. As provided in Sec. 15 of the ICA, expenses of an investment
Company shall not exceed ten percent (10%) of its total investment fund or total net worth.
▪ Limited debt and borrowings. An asset coverage of 300% is required for all the fund's
debts and borrowings.
 ▪ Disclosure requirements. In addition to annual and quarterly reports required by the SEC,
investment companies are required to submit monthly reports to the SEC on the following:
▪ Number of shares sold during the month and the total amount receives from sale
thereof.
▪ Number of shares redeemed during the month and total amount thereof.
▪ No. of shares outstanding at the beginning and end of the month.
▪ The percentage of shares owned by Filipinos.
.
Fund Prospectus

A fund prospectus is a document whereby it informs a prospective investor of its important

features such as:
✓ its investment objectives and policies,
✓ the securities held in the fund, the custodian of its funds and securities,
✓ its investment manager,
✓ its transfer agent,
✓ fee structure,
✓ the purchase and redemption procedures, and
✓ investment risks.

Measuring Mutual Fund Performance

The performance of a mutual fund may be measured by using the total return approach. The
formula for total return is as follows:
NAVPS, end + Distributed Earnings — NAVPS, beg.
Total return = NAVPS, beg

Using the given example wherein purchase cost is P177.11 and net proceeds upon redemption
amount P176.04 and assuming that the fund distributed earnings amounting to P22 per share, the
increase in investment value is arrived at as follows:

Net proceeds upon redemption P 176.04

Distributed earnings per share 22.00
Purchase cost (177.11)
Increase in value of investment P 20.93
Percentage (P20.93/P177.11) 11.8%

If the holding period is nine (9) months, the effective rate of increment in investment value would
be 15.73% or [11.8%/(9/12].

In case there is reinvestment of earnings from the mutual fund, the amount no reinvested should
he substituted for distributed earnings.
Based on Total Value of Investment. Instead of using NAVPS, an investor may use the total
value of his investment in a mutual fund in determining the unrealized return on his investment.
Example: An investor bought 10 shares of a mutual fund at P118. After nine months, the number
of Isis shares has increased to 12 shares because of automatic reinvestment of earnings. The year-
end NAVPS is P104.

The computation is as follows:

Investmentvalue, end + Distributed earnings + Investment value, beg.
Total return =
Investment value, beg.
(12 shares x P104) + PO-(10 shares x P118)
= (10 shares x P118
1,248- 1,180 P68
= = 𝐴 = 5.76%
P1,180 P1,180

With 5.76% return in nine months, the effective rate of investment value increment must be 7.68%
[or 5.76%/(9/12)].

Risk in Mutual Fund Investments

As in any kind of investment, there is no assurance that an investment in a mutual fund will always
result in an increase in its value. Sometimes, redemption price may even be lower than purchase
cost.

Mutual Fund Companies in the Philippines

At the time of this writing the mutual fund companies operating in the Philippines are the
following:

Abacus Growth Fund Far East Fund Philam Fund

All Asia Fixed Income Fund First Galleon Family Philam Strategic Growth Fund
Fund
All Asia Fund First Private Fund Phil equity Fund

Ayala Life Fixed Income GSIS Mutual Fund United Fund

Fund

Citisec Growth and Income Mutual Fund Co. of the Sunlife of Canada Prosperity
Fund Phil. Balanced Fund
ECC Growth and Income Pacific Fund Sunlife of Canada Prosperity
Fund Bond Fund
How Does One Invest in a Mutual Fund?

Anybody interested in mutual funds may call up the offices of the fund itself and request for a
prospectus.

After going over its contents, he may interview the manager in charge for additional information.
In case he decides to go on with his investment, lie will be required by the fund's salesman to fill
up an Investment Application Form and signature cards.

Upon receipt of his check, the salesman issues a Provisional Receipt and the payment is turned
over to the fund's custodian.

As soon as the check is cleared, the custodian issues a Confirmation Receipt or Official Receipt
to the investor.

The investor may request for his Stock Certificate which he may expect to receive within fifteen
days.

Fund Aspects to be Looked Into

Aside from the investment objectives and policies as contained in a prospectus, an investor
should look into some aspects of mutual funds as given below to be better assured of relative
safety and profitability of his investments.

A. Level of transaction costs and mutual fund operating expenses.

B. Track record of mutual funds.
C. Tack record of fund managers.
D. Periodic Performance of Mutual Funds.
✓ Suspend all additional investments in mutual funds leaving the money already
invested therein.
✓ Make additional investments to take advantage of price declines.
✓ Sell all his shareholdings and realize his loss.

Procedure for Redemption

When an investor wants to have his shareholdings redeemed by the mutual fund, he informs the
fund's salesman of his intention to do so. The latter would then ask him to fill up a Redemption
Request Form. If he received a stock certificate for his investment, he would be required to endorse
(by affixing his signature at the back) and surrender it. The fund is expected to pay the investor
within seven (7) banking days from the time the redemption request is received by the fund and in
most cases, they are able to do it in two or three days.
CHAPTER EXERCISES

Direction: Read the given scenario carefully and answer the question comprehensively.
Support your answer.
1. Differentiate open-end and closed-end investment companies.

2. What are the advantages and risk in investing in a mutual fund? Explain
 Chapter 5
Real Estate

REAL ESTATE

Real estate has been it favorite long-term investment vehicle because it appreciates in value with
the passage of time and as the saying goes, "people come and go but the land is always there".

Real estate refers to land and all permanent improvements thereon including buildings. It may be
agricultural, industrial, commercial, residential or in the form of rental units.

Advantages and Disadvantages

As in the case of other forms of investment, real estate investment has its advantages and
disadvantages. The advantages are the following:
✓ It is a hedge against inflation. The price of land in the Philippines, in general increases
steadily.
✓ It is one of the few finite investments. Land available for development is limited.
✓ It is one of the basic necessities of man. Real estate includes housing and shelter is one of
the basic needs of man.
✓ It is a tangible asset and can be directly controlled by the owner. As such, it provides a
visible evidence of the investor's financial status.
✓ It can be used in financing. It is generally acceptable as collateral in obtaining loans.
✓ It can provide periodic income when leased out.

Example : Real property costing P500,000 is sold for P1,250,000 or 250% after eight (8) years.

The gain must be P750,000 or P93,750 per annum arrived at as follows:

Annual gain = (P1,250,000 — 500,000)/8 yrs. = P93,750
Rate of gain = P93,750/P5011 000 = 18.75%
With an annual earnings rate of 18.75%, the investment may be considered as very at considering
the prevailing interest rates on time deposits

Investing in real estate is a hedge against inflation because it appreciates in value. In some cases,
its appreciation is even ahead of the inflation rate. The appreciation or increase in value is due to
a combination of factors such as inflation itself and the increasing demand for real estate.

The disadvantages of real estate investment are the following:

✓ It requires a number of years to realize profit on the investment.

✓ It is immovable so that it is not easily transferred from one party to another.
✓ Mortgaging real property requires certain procedures adopted by lending institutions such
as credit investigation, property appraisal and maintenance of required deposits (in the case
of banks).
 ✓ Upon death of the investor, real property automatically forms part of his estate which is
subject to inheritance tax.
✓ It involves big amount so that it is impractical to dispose of it in case the investor is in need
of small amount of additional capital.
✓ Its price is adversely affected in times of crisis. In case of chaos or war, it cannot easily be
disposed of.

Carrying Cost of Real Estate

The costs incurred in holding on to an investment in real estate consist of costs incidental to
ownership thereof such as property taxes, cost of regular inspection of the property, cost of
normal maintenance and insurance. In decision making, opportunity cost of capital is included in
the Computations.

Opportunity Cost Of Capital. This refers to the earnings that could be earned in other forms of
investment but which are foregone by the investor by choosing one form of investment.
Example: Real estate investment of P500,000 brings in annual rental in-come of P52,000.
Interest on time deposit is 7%. The opportunity cost and differential income are arrived at as
follows:
Opportunity cost of capital = P500,000 x 7% = P35,000
Differential income =P52,000 - 35,000 = P17,000

Factors Considered in Real state Acquisition

In acquiring real estate, an investor should look into the factors that contribute to increase in
market value of the property such as the following:

✓ Location.
✓ Frontage and shape of the land.
✓ Drainage and sewerage system.
✓ Width of streets.
✓ Elevation.
✓ Possible exploration.
✓ Clean title.
✓ Encumbrances.
✓ Improvements.
✓ Financing.
✓ Prospects.
Real Property with Building or House

In case there are improvements included in the acquisition of real estate such as a building, house
or warehouse, the buyer should consider the possible use thereof and the estimated cost of
immediate repairs or even demolition.

Example: Three houses are available for sale and the following data are given:
E S T I M A T E D

Price Quoted Cost of Repairs Selling Price Holding Period

Property A P 250,000 P30,000 P450,000 5 yrs.

Property B 120,000 20,000 300,000 4 yrs.

Property C 320,000 60,000 500,000 6 yrs.

Which investment would result in-the highest margin per annum? The computations would be as
follows: Selling Total Holding Gross Margin Price Cost Period per annum

Selling price Total cost Holding period Gross margin per annum

Property A ( P450,000 — 280,000 ) /5 yrs. P 34,000

Property B ( 300,000 — 140,000) /4 yrs. 40,000

Property C ( 500,000 — 380,000 ) /6 yrs. 20,000

Earnest Money Deposit

When an investor is interested in acquiring a property which has just been offered to him, he may
give the seller an earnest money deposit equal to a certain percentage of selling price. It may be in
the form of a check or promissory note.
Constructing a House or Building

When constructing a building or house on real property, building plans depend on the particular
market it is intended for and the amount of funds available. To minimize construction costs, the
investor should exercise control in the different stages.

Efficient Use of Land Space.

In building or house construction, land should be efficiently used to provide for parking space or
garage, land scaping, future conversion into rental units or multifamily residence, and for future
expansion. When there are two lots, it would be wasteful to construct a house at the middle of the
total area. If the owner really wants to do so, he may see to it that should the need arise, he can
easily have a wall constructed on the boundary line at the middle.

Market Conditions for Real Property

The market conditions for real property vary depending on the demand and supply. It may either
be a buyers market or a sellers' market depending on who has the greater advantage:

✓ Buyers' Market. This exists when buyers are at an advantage. Demand is low so
that buyers are able to avail of discounts and deferred payment plans for extended
periods.
✓ Sellers' Market. This exists when sellers are at an advantage,. Demand exceeds
supply so that sellers can charge high prices often on cash basis or for shorter terms.
✓ Buyer's or Sellers' Market? In determining market conditions, an investor may
consider the trend in construction, occupancy rates, loan availments for real
property acquisitions and interest rates.

Diversification in Real property Investment

A wise investor spreads his investable funds for real estate among the different classes under this
category. This is done to be assured that he realizes profit, from the sale of some of them and in
the case of rental units, to be assured of a steady source of cash inflow.

Conformity

Conformity as applied to real estate refers to whether the property con-forms to what is normal or
standard in a specific locality. It includes conformity to city or municipal requirements and zoning'
policies. It can enhance the value of property.
Occupancy rate

Occupancy rate refers to th4 proportion of real estate that brings in revenue based on the total
capacity. It may be expressed in terms of number of units, months, revenue or income producing
area.

Example: The following data are given on an apartment building:

No. of units…………………….…………...........…0
Total revenue based on100% occupancy…......P50,000
Total floor area………………………………..2,000 sq. m.
No. of units occupied on the average…………..8
Total revenue realized………………………...P38,000
Total floor area occupied, average……………700 sq. m.
No. of months occupied in one year…………..11

The occupancy rate may be stated as follows:

Based on number of units: 8/10 = 80%
Based on total revenue: P38,000/P50,000 = 76c/
Based on floor area occupied: 1,700/2,000 sq. m= 85%
Based on number months occupied: 11/12 months = 92%

Occupancy rate is the opposite of vacancy rate so that if the occupancy rate is 80%, the vacancy
rate must be 20%.

Appraisal of Real Estate

Upon receipt of an application for a mortgage on real estate, the lender subjects the property to an
appraisal or an estimate of its market value to determine the amount that may be granted as-loan.
This is done to be assured that said loan would be fully secured in terms of the market value of the
property. The estimated market value may be arrived at based on a study of the market, current
and potential income, and on replacement cost.

Estimating Market Value Based on a Study of the Market

In estimating market value of property based on a study of the market, the appraiser takes into
consideration conformity or how the property fits with other properties in the same neighborhood,
the recent selling price for similar property in the locality, and the physical condition of the subject
property.
Estimating Market Value Based on Current and Potential Income

Based on current and potential income, market value of property is estimated using a gross rental
multiplier (GRM). GRM is the quotient between prices of recently sold properties and the rental
income realized therefrom. The average GRM is subsequently applied on the estimated rental
income from the subject property to arrive at its estimated market value.

Example: An appraiser is estimating the market value of an apartment building from which annual
rental income has been estimated at P300,000. In going over recently sold apartment buildings in
the locality, the appraiser has accumulated the following data:

Recently Sold Selling price Annual Rental income

Property A P 300,000 P45,000

Property B 1,200,000 250,000

Property C 800,00 160,000

The average gross rental multiplier is arrived at as follows:

Selling price Annual rental income Gross Rental

Multiplier
Property A P 300,000 ÷ P45,000 6.67

Property B 1,200,000 ÷ 250,000 4.8

Property C 800,000 ÷ 160,000 5.0

16.47

Average gross rental = 16.47/3 = 5.49

multiplier

The average gross rental multiplier is then used in arriving at the estimated market value of the
subject property as follows:
Estimated market value of subject property
Selling Price x GRM
= P300,000 x 5.49
= P1,647,000

If the property has some defects, the subject property may be assigned a lower value say,
P1,500,00.0.
If it is relatively new, a premium may be added instead.

Using Capitalization Rate. capitalization rate may, also be, used in estimating market, value of
property. The rate is derived from the net income from properties being sold in the neighborhood
and their selling prices. it is subsequently applied on the property being appraised. The formulae
are as follows:

Capitalization rate = Net income/Market price

Market price for subject property = Net income/Capitalization rate

Example: Property A is on the market for P2,000,000. Annual net income derived therefrom is
P260,000. The appraiser is estimating the market value of property B from which annual net
income of P310,000 can be realized. The computations are as follows:

Capitalization rate = P260,000/1'2,000,000 = 13%

Estimated market value of property B = P310,000/13% = P2,384I,615

If property B is of a more advantageous location, the appraiser may assign a market value of say
P2,700,000 on the subject property. On the other hand, if the occupancy rate is expected to decline
or the market conditions favor buyers, the market value may be adjusted downward to say,
P2,200,000 or even P2,000,000.

Estimating Market Value Based on Replacement Cost

Sound Value is equal to -replacement cost-new minus the corresponding accumulated

depreciation.
Physical obsolescence refers to obsolescence arising from physical features4due to expensive
internal systems resulting in high utility costs or recurring high maintenance costs with all these
resulting in a de-cline in potential rental income therefrom.
Locational obsolescence refers to obsolescence arising from changes in zoning and uses of
property, and property designs for a market that has ceased to exist.
Functional obsolescence is a form of obsolescence arising from changes in systems and uses of a
property to the extent that subject property becomes out of date.
Example: A three-year old building being appraised can be constructed at the total current cost
,P5,000,000. The building is expected to be useful for 20 years. Considering the age of the building,
the appraiser arrives at his estimate as follows:

Replacement cost-new P 5,000,000

Depreciation for three years (P5.000,000 x 3/20) 750,000
Sound value P4,250,000

If the building has not been properly maintained so that immediate re-pairs and cosmetic
maintenance are estimated at P500,000, the estimated Market value may go down to P3,750,000.
However, if the. property has become more valuable because of new improvements introduced by
the local government, the value may be readjusted upward to say. P5,000,000.

Financing Real Estate Acquisitions

When the real estate to be acquired is used as collateral for loans be obtained, it is called leveraged
acquisition. In some cases, the investor obtains a bridge loan. A bridge loan is one that is
temporarily granted using another property as collateral so that upon consummation of the
purchase of the second property, the latter becomes the collateral and the first property is freed of
the lender's lien.

Example: An investor has P2,000,000 . The following real properties are being sold to him.
Cost Annual Cash Inflow Selling Price after 5 yrs.
(5 yrs.)
Property A P2,000,000 P 300,000 P 3,000,000

Property B 1,000,000 130,000 1,600,000

Property C 800,000 150,000 1,300,000

Totals P 3,800,000 P 580,000 P 5,900,000

If the investor decides to invest his entire capital in Property A, his gain from the investment would
be as follows:

Selling price after 5 years P3,000,000

Total annual cash inflows (P300,000 x 5. yrs.) 1,500,000
Total cash inflows P4,500,000
Less — Cost 2,000,000
Gain P2,500,000
Assume that the investor decides to acquire all the three properties by Raving the balance of
P1,800,000 financed at a certain rate so that the total annual cash inflow is just enough to take care
of the periodic amortizations ; of the five-year p including interest. At the end periods his profit
must be 3,900,000 arrived at as follows:

Total selling price after 5 years P5,900,000

Initial cost (P3,800,000 less financed portion of P1,800,000) 2,000,000
Profit P3,900,000

Interest Charges and Periodic Amortization

Interest is the amount charged by a lender to a borrower for the use of his money and is quoted
on an annual basis. Amortization, as applied to loans, races to the In payments to be made which
is applied to interest and principal.
Oftentimes, the buyer is misled by salesmen who convince him to buy "without interest, he just
have to pay a certain amount periodically". The total interest to be paid is the difference between
the total of the payments to be made and the cash price of the property.
Thus, if cash price and ten (10) annual amortizations were P 500,000 and P 88,492, respectively,
total interest charges must amount to P384,920 arrived at as follows:

Total interest charges = Total amortizations - Cash price

= (P 88,492 x 10) - 500,000
= 384,920

To arrive at the interest rate, look for the quotient between cash price and periodic amortization in
the present value of an annuity table considering the number of payment periods. In this case, the
quotient is 5.65022303 (or P500,000/ P 88,492 .
On table IV (line 10), it falls under 12%. This is proven in the following schedule.
SCHEDULE OF PAYMENTS

Period (A) Annual (B) Applied to (C) Applied to (D) Balance

amortization interest-(d) X principal (A) - of principal
12% (B)
0 P 500,000

1 P 88,492 P 60,000 P 28,492 471,508

2 88,492 52,581 31,911 439,597

3 88,492 52,752 35,740 403,856

4 88,492 48,463 40,029 363,827

5 88,492 43,659 44,833 318,995

6 88,492 38,279 50,213 268,782

7 88,492 32,254 56,238 212,544
8 88,492 25,505 62,987 149,557
9 88,492 17,947 70,545 79,012
10 88,493 9,481 79,012 0
884,921 384,921 500,000
Interest rate is 18%
Year Payments Applied to Applied to Balance of
interest principal principal

P P P P
2,500,000
Down 500,000 500,000 2,000,000
payment
First 639,556 360,000 279,556 1,720,444
Second 639,556 309,680 329,876 1,390,568
Third 639,556 250,302 389,254 1,001,314
Fourth 639,556 180,237 459,319 541,995
Fifth 639,554 97,559 541,995 0
3,697,778 1,197,778 2,500,00

Interest rate is 20%

Applied to Applied to Balance of

Year Payments
interest principal principal

P P P P
2,500,000
Down
500,000 500,000 2,000,000
payment
First 668,759 400,000 268,759 1,731,241
Second 668,759 346,248 322,511 1,408,730
Third 668,759 281,746 387,013 1,021,717
Fourth 668,759 204,343 464,416 557,301
Fifth 668,761 111,460 557,301 0
3,843,797 1,343,797 2,500,00
In the given example, the annual amortizations and total interest charges vary as follows:
Annual Difference Total Interest Charges Difference
Amortization
At 16% P610,819 P1,054,094

P(28,737) P(143,684)

At 18% 639,556 1,197,778

(29,203) (146,19)

At 20% 668,759 1,343,797

In the foregoing tabulation, periodic amortization ranges from P610,819 to P 668,759. If the
annual cash inflow from the investment is expected to amount to P611,000, it would not be self-
liquidating at rates higher than 16%. It implies that the investor must have other sources of funds
to meet the difference.

Additional down payment of P500,000; instead rate is 16%

Applied to Applied to Balance of
Year Payments
interest principal principal

P P P P
2,500,000
Down 500,000 500,000 2,000,000
payment
500,000 500,000 1,500,000
First 458,114 240,000 218,114 1,281,886
Second 458,114 205,102 253,012 1,028,886
Third 458,114 164,620 293,494 735,379
Fourth 458,114 117,188 340,453 394,926
Fifth 458,114 63,661 394,926 0

3,290,570 790,570 2,500,00

Investor’s Equity

An investor's equity in his investments is equal to the difference between the Market value of the
latter minus any creditor’s lien in the property.
Referring to the schedule of payments on page 120, it may be noted that at the end of the third year
(under 16% interest), it is P980,505 only. If at this point in time, the market value of the property
were P3,250,000, the investor's equity in the property is computed as follows:
Investor's equity = Market value of property - Creditor's lien
= P3250,000 — 980,505
= P2,269,495

The investor's equity increases with the passage of time because of the increase in market value of
the mortgaged real property. The reverse would hold true in times of depressed real estate prices.

Making Use of Investor's Equity. There are financing companies that are willing to extend loans
based on an investor's equity in real estate. This gives rise to a second mortgage on the property
which usually bears a much higher interest rate and with greater safety margin because the
mortgage has second priority only in the liquidation of the investor's property in case of insolvency.
Refer to the example on page 120 (interest rate of 16%).

Refinancing refers to obtaining a new loan to cancel an old on. This is usually done to take
advantage of a lower rate of interest on the new loan and/ or a longer term. If there are two or more
old loans, the weighted average interest thereon is compared with the new interest rate.

Example: The outstanding loans are as follows:

Loan Balance Interest

Rate
Loan A P 80,000 12%

Loan B 120,000 10%

P 200,000

The weighted average interest rate is computed as follows:

Loan A P 80,000/P200,000 x 12% = 12%
Loan B P120,000/P200,000 x 10% = 10%

Weighted average interest rate = 10.8%

If interest rate on a new loan is lower than 10.8%, it would be worth refinancing the old loans.

Payment Acceleration

Payment (or Mortgage) Acceleration refers to malting additional payments in order to reduce
the balance of the principal, increase the borrower's equity and shorten the payment period.
Assume that the investor accelerates payments by P100,000 for the first and second years and
interest is 16%. The schedule of payments would be as follows:

With mortgage acceleration of P100,000 for the first two years; interest is 16% .
Year Payments Applied to Applied to Balance of
interest principal principal

P P P P
2,500,000
Down 500,000 2,000,000
payment
First 600,000 320,000 290,819 1,709,181
100,000 100,000 1,609,181
Second 610,819 257,469 353,350 1,255,831
100,000 100,000 1,155,831
Third 610,819 184,933 425,886 729,946
Fourth 610,819 116,791 494,028 235,917
Fifth 273,664 37,747 35,917 0
2,916,940 916,940 2,500,00

Advantages and Disadvantages of Payment Acceleration

The advantages are:

✓ It reduces the total interest charges and consequently, the real acquisition cost of
the property.
✓ It enables the borrower to take hold of the title to property earlier and subsequently
make use thereof in raising additional capital to finance other ventures.
The disadvantages are:
✓ By reducing interest charges, the borrower forfeits himself of the tax benefit
therefrom inasmuch s interest is deductible for income tax purposes.
✓ It increases the borrower's opportunity cost, that is, the benefits he may derive from
the use of the amount involved in other forms of investment.
Equity in the mortgaged property cannot be sold nor can it be withdrawn

Easing the Financing Burden

Assuming that an investor proceeds with the financing of his acquisition, what are his options to
ease the financial burden arising from the loan? He may opt to lengthen or shorten the payment
period depending on his liquidity. The loan may be rolled over, that is renegotiating the loan based
on the balances the principal. This prolongs the payment period although the interest rate may be
different. Once the borrower's finances improve, he may negotiate fora buy down mortgage interest
rate whereby an acceleration of payments is made subject lower interest rate.

Net income; Net Cash Flow

Net income from real property refers to the excess of periodic rental income over the related
operating expenses and periodic interest charges. The 'operating expenses that are deducted include
charges even if they do not re-quire cash outlay such as depreciation. Net cash flow is the
difference between periodic collections and the related periodic cash outlays. The computations
are illustrated below.

Example: The following are given on a piece of real estate (land with an apartment building
thereon). A loan of P800,000 was obtained on which the investor pays annual amortization of
P150,000 including interest.

Contract price upon acquisition:

• Land ……..P500,000
• Apartment building 700,000
Estimated life, 20 years

For the year 2001:

• Rental income 200,000

Operating expenses including

• depreciation of P35,000 .................... 85,000
• Interest charges on mortgage ............ 65,000
• Income tax rate…. 25%
Net income and net cash flow for the year 2001 are computed as follows:
Rental income………………………………………………….P 200,000 P 200,000
Operating expenses ……………………………………..…. (85,000)
(P85,000 — Depreciation, P35,000)………………….......... (50,000)
Interest charges………………………….……………………. (65,000) (65,000)
Income before income tax……………………………………... P 50,000
Net cash inflow before income tax ………………………… P 85,000
Income tax (P50,000 x 25%)………………………………… (12,500) (12,500)
Net income………………………………………………....... P 37,500
Net cash inflow after income tax…... ………………………. P 72,500

It may be noted that depreciation expense of P35,000 (on depreciable cost of P700,000/20 years)
is deducted in computing for net income but not in computing for net cash flow. However, the tax
benefit therefrom is reflected in the computations because income tax is computed based on net
income.

The net cash inflow may also be arrived at by adding back depreciation to net income as follows:
Net cash Wow = Net income, P37,500 + Depreciation, P35,000
= P72,500

Comparing the net cash inflow after income tax of P 72,500 with the amortization on principal of
P85,000 (that is annual amortization on the loan of P150,000 minus interest charges of P65,000),
there is a negative difference of P12,500.The investor has to pay this from his other sources of
funds. If he wants to avoid paying the deficiency, he may opt to raise rental rates and/or adopt cost
cutting measures to reduce his operating expenses. The required increase in revenue or reduction
in operating expenses would be P16,667 (or P12,500/(1.25%) because of the 25% income tax.

Rate of Return on Investment

The rate of return on investment in real property is estimated by dividing annual net income by
purchase cost. Assuming that net income of P80,000 is realized from a property costing
P1,250,000, rate of return on investment must be 6.4%, (or P80,000/P 1,250,000).
The P12,500 deficiency in cash flows may also be arrived at as follows:

Net cash inflow P 72,500

Add back: Interest charges 65,000
P137,500
Annual Amortization 150,000
Deficiency P 12,500
Payback Period and Time Adjusted Rate of Return

Payback period is the length of period it takes to recover investment. Thus, it is based on purchase
cost and annual cash inflow from the particular investment.
Time adjusted rate of return is the rate at which an investment is earning or the rate which equates
the present value of net cash returns with the investment.

Example: An apartment building is constructed on land owned by the investor. The following data
are given on a property:
Construction cost……………..P380,300
Annual cash inflow……………P 50,000
Estimated life……………………15 years

The payback period for the apartment building and the time adjusted rate of return are arrived at
as follows:
Payback period = Investment/Annual cash inflow
=P380,300/P50,000
=7.606 years

Time for adjusted rate of return: Locate the payback period (7.606) as the factor in the present
value of an annuity table on line 15 periods.

A Landlord's Problems

Investing in rental units or even in residences for rent entails some problems for the landlord. These
may be in the nature of difficulty in making collections, bad debts, excessive cost of repairs and
maintenance, and property damage caused by tenants.

Screening Prospective Tenants. To minimize problems in dealing with tenants, the landlord
should exercise extreme care in screening prospective tenants. The following are some of the
indications that tenant problems may arise:
a. Unwillingness to fill out written application or information sheets.
b. Inability to name any landlord as reference.
c. Referrals to landlords who cannot be contacted.
d. Inability to pay the required deposit or undertaking to pay the same in installments.
e. No means of livelihood such as a job or self-employment but with exceptionally high income.
f. Too large a family for the rental unit.
g. Over-aggressive pressure exerted on the landlord to move in much earlier than the landlord
would prefer.
h. An attempt to barter services for a portion of the rental.
i. No bank account.
Application forms should he signed and references should be checked with the intention of
determining the paying habits of the applicant.
Deposit Policies. A landlord should see to it that an applicant makes the required deposit ranging
from one to three months rental.

CHAPTER EXERCISES

Direction: Read the given scenario carefully and answer the question comprehensively.
Support your answer.
1. Real estate is a favorite long term investment vehicle. Explain

2. Market conditions for real estate vary. It may be sellers or buyers’ market. How will
these affect an investor’s decision to buy and sell? Explain

3. An investor who is interested in acquiring rental units should be familiar with problems
inherent in dealing with tenants so that he may be in a position to minimize them. Explain
 Chapter 6
Precious Metals and Gemstones

PRECIOUS METALS AND GEMSTONES

Precious metals and gemstones have been a popular investment vehicle specially in Asian
countries and on the part of those who are constantly moving from one country to another. Asians
have a special fondness for them because precious metals and gemstones have enabled them to
survive hard times most specially when the super powers waged their wars on our shores. Another
reason for this is the presence of many gold deposits and mines in our country. For some, precious
metals and stones provide a security blanket because wherever they go, they have something
valuable that can be a source of funds for emergencies. It has been written that one of the
moneymen of a European king carried emeralds and diamonds in his pocket to be in a position to
bail out the latter whenever the need therefor arose.

Precious Metals and Gemstones Defined

Precious metals are platinum, gold and silver. The term gemstones refers to stones with value.
Precious metals and gemstones are usually acquired by investors In the form of jewelry. In the
case of gold, it is also acquired as an investment in the form of coins and bullions.

Precious Metals and Gemstones as an Investment Vehicle; Risks

Investments are made in precious metals and stones because they are portable stores of value with
steady increase in prices. Stones with value are called gemstones.

Risks Involved. These are losses from theft or robbery and temporary-decline in prices. Loss from
theft can be minimized by safekeeping items of jewelry in safety deposit boxes in banks.

Platinum

Platinum is a grayish white metallic element that is soft, dense, very ductile and malleable and
with a high tensile strength. It has been used in jewelry, dentistry, X-ray equipment, medical and
surgical instruments and heating units.

Platinum is much more expensive than gold because of its rarity and expensive usage.
Platinum is different from white gold because the latter is gold mixed with nickel, zinc and copper.
Upon application of nitrate acid, platinum remains while white gold turns yellow.
Gold-Defined
Gold is a metallic chemical element that is soft, malleable and ductile so that it is an excellent
conductor of heat and electricity.
Production of Gold is extracted by mining companies and is recovered from its contaminants by
washing and filtering. If it is imbedded in a vein of another mineral, it is mechanically recovered
by power shovels, drilling and blasting.

Uses of Gold. For centuries, gold was widely used as money and as a base for monetary systems.
From the 1870's to the late 1970's, it was being used as a monetary standard. At present, gold is
part of Central Bank reserves.

Pure gold is very soft and resistant to sulfide formation no that it is mixed with silver to produce a
soft and ductile alloy that is useful for electrical contacts.

Yellow, White and Red (or Rose) Gold

Pure gold is too soft so that other metals are added to make it durable. To produce the different
colors of gold, the following are added:
▪ Yellow gold — silver and copper in equal proportion
▪ While gold — nickel, zinc and copper (65:25:10)
▪ Red co rose gold — copper and sometimes a small quantity of silver
The mixture of two or more metals is called an alloy.

Fineness or Purity of Gold

The proportion of gold is an alloy is stated in terms of fineness or karat (k). Fineness is expressed
in terms of points or percentage while karat is stated based on pure gold being equal to 24 karats.
Thus, a fineness of 100% is equal to 24 karats so that a 12 karat gold must have 50% for fineness
(or 12/24).

Estimating Value of Gold

Gold is quoted in the market per troy ounce. A troy ounce is equal to 31.1 grams. Thus, if the
market quotation were $300 and the peso viz-a-viz the dollar were P45, market value per gram is
computed as follows:
Market value per troy ounce in pesos = $300 x P45 = P13,500
P13 500
Market value per gram = = P434.08
31.1grams

The number of troy ounces is usually converted into grams because the latter is often used in
weighing jewelry. Bullions are weighed in kilos (or 1,000 grams).

Estimating Value of Gold Content of an Alloy. This can be done when the fineness and weight
of the alloy is given. The estimated quantity of gold is arrived at by multiplying them and the
product is then multiplied by the market value per gram.
Example: A gram of gold has market value of P400. How much must be the value of 10 grams
of 18 karat gold?
The computations would be as follows:
18
Fineness of 18 k. gold = 24= .75
Value of gold content = 10 grams x .75 x P400 = P3,000
The estimated value of the gold content of a piece of jewelry may serve as a starting point in
determining the value of the jewelry. Other factors to con-sider are craftsmanship and stones
included, if any.

Gold Bullions are in bar forms and per US standard, the alloy consists of 90% pure gold and
10% copper. trading in bullions is allowed by the Bangko Sentral ng Pilipinas (BSP).

Silver is a white metallic element, ductile and malleable, having the highest electrical an thermal
conductivity of any substance.

Precious Stones
The stones that are with value or gemstones are diamond, ruby, sapphire and emerald with the
diamond as the most valuable.

Carat. The weight of gemstones is measured in carats and equivalent of a carat is:
One (1) carat (ct) = 200 milligrams = 1/5 gram
The carat is subdivided into points with one point equal to 1/100 (or .01) of a carat. Thus stones
may be described as .3, .2 or .75-carat and 2.0 or 3.0 carats.

Diamond is crystallized carbon and the hardest substance ever known. It is used in jewelry and
in industries as an abrasive and in cutting tools

Four C's In Determining Value of Diamonds

In determining the value of a diamond, an investor has to considerer
✓ carat weight
✓ clarity
✓ color
✓ cut

Carat. Diamond weight is expressed in carats (ct.) with one carat being equal to .2 gram. Carats
are expressed in points so that a 1/4 carat is stated as .25 ct. or 25 points and a 1/2 carat as .5 ct
or 50 points.

Clarity. This refers to the extent to which a diamond's quality is free of inclusions. These are
traces o non-crystallized carbon that are like nature's fingerprints, thus making each diamond
unique.

The following descriptions are used in the grading scale for diamonds:
 ✓ Flawless; internally, flawless
✓ Very, very small inclusions (not visible to the naked eye)
✓ Very small inclusions (not visible to the naked eye)
✓ Small inclusions (not visible to the naked eye)
✓ Inclusions (visible to the, eye)

A diamond is considered flawless if it is without surface characteristics or internal inclusions.

Color. The colors of diamonds range from the totally colorless to light yellow and they are graded
accordingly.

Cut. This refers to the arrangement of a diamond’s facets and is due to the skills of a master cutter.
A good cut brings out more sparkle because the diamond is better able to handle light thereby
creating more brilliance. The conventional round brilliant consists of 58 facets

Diamond as Investment

Diamonds are worth investing in because of the steady increase in their prices. This is due to the
constant demand therefor and the controlled production on the part of the big diamond mining
companies.
Pearls A pearl is a nacre encrusted matter produced within the shell of some species of mollusks
and is used as a gem. As such it is the only gem that conies from the sea and made by a living
process. A genuine pearl is produced by putting a grain of mother of pearl in a sea pearl oyster.

Pearls as Investment
Pearls are considered as an investment because of the increasing demand them. This is due to the
fact that one can always wear pearls and look smart without being called a “show-off.

CHAPTER EXERCISES

Direction: Read the given scenario carefully and answer the question comprehensively.
Support your answer.
1. What are the industrial uses of platinum, gold and silver? Cite examples

2. How are pearls produces? Why are pearls a favorite part of one’s jewelry collection?

3. What are the valued determinants of diamonds? Explain each.

 Chapter 7
Personal Finance

PERSONAL FINANCE
There have been so many anecdotes of great men who are not able to attain or maintain financial
and personal independence in their old age and even die poor. On the other hand, there are vendors
and rank-and-file employees who are able not only to provide for their old age but also for their
children as well. Regardless of a person's chosen endeavor, he should be careful in the handling of
his finances.

Personal Finance Defined

❑ Personal finance refers to managing the financial resources of an individual and his family
to improve their equity and maintaining sufficient liquidity in the process.
❑ Equity or net assets refers to the excess of the total market value of assets owned over
total obligations.
❑ Liquidity refers to the relative amount of cash and assets that are readily convertible into
cash based on the amount of disbursements to be made.

Different Levels of Wealth

Wealth measurement is based on one's equity considering what an individual wants to achieve. In
the Philippine context, we have our own values, customs and traditions.

✓ Levels I: A family or an individual is able to meet its (his) periodic target savings goal and
has adopted sufficient safety nets to ensure sufficient cash inflow and medical care in case
of accidents and to ensure the continued education of the children or dependents.
✓ Level II: Portfolio must have reached that level at which periodic earnings there-from
equal the periodic target savings goal thereby bringing about an in-crease in portfolio value
equal to double the latter.
✓ Level III: Portfolio must have reached that level at which the periodic earnings therefrom
approximate the saver's current living cost.
✓ Level IV: Portfolio must have reached that level at which the annual earnings therefrom is
sufficient to cover the saver's living cost based on his desired lifestyle and as adjusted for
inflation.
✓ Level V: Portfolio value has reached that level at which earnings therefrom can sustain
more than saver's annual living costs based on his improved lifestyle so that he can set up
trust funds for the benefit of his children, buy another house, set up more scholarships and
contribute bigger amounts to charity.

Success in Personal Finance

The keys to success in personal finance are frugality, vision and safety nets.
✓ Frugality. This refers to living below our means so that savings may be effected. In being
frugal, we have to save, save and save.
 ✓ Vision. This refers to foresight or the ability to look far into the future. It entails short-term
and long-term planning.
✓ Safety Nets. These are buffers or protections from losses of property and income. These
may be in the form of investment portfolios, insurance policies and retirement or pension
funds.

Why Save?
Savings can never be overemphasized. Unfortunately, there are so many among us who can easily
be waylaid by aggressive advertisements for luxury goods and the desire to "keep up with the
Joneses".

We should save for the following reasons.

✓ Savings provide liquidity buffer.
✓ Savings provide a person with the capacity to make investments as the opportunity
therefor arises.
✓ Savings provide leverage.
✓ Savings attract lenders.
✓ Savings promote self-confidence.

Target Savings Goal

Target savings goal (TSG) refers to how much should a person save monthly or annually in order
to accumulate a desired amount at as a certain point in the future.

Example: Pedro Orbe, a 26-year old employee can live comfortably on P300,000 per annum. He
is intending to retire at the age of 50 and would like to know how much should lie save annually
(aside from the effect of compounded growth of the portfolio) so that he can maintain his
standard of living even after retiring from his job. Inflation rate is 6% and average return on
portfolio is 10%.

The computations would be as follows:

Length of period of accumulation: 50 — 26 years = 24 years
Future value of an annuity of 1 for 24 years at 10% = 97.34705943
Number of years P300,000 should double: 72/6 = 12 yrs.
Required annual income from portfolio after 24 years: (P300,000 x 2 x 2) = P1,200,000
P 1,200,000
Required portfolio value after 24 years = = P12,000,000
10%
P12,000,000
Target savings goal = 97.34705943 = P123,270
Characteristics and Habits for Success in Personal Finance

People who have been successful at wealth building (PSWB) have more or less similar
characteristics and habits. To emulate them, we should: be enthusiastic about life, have a passion
for what we do and see to it that our work in some ways help others and improve this world.

✓ have patience and stick to our long-term vision.

✓ have time to make good educated decisions.
✓ have discipline and not bother about social climbing.
✓ save every month.
✓ avoid debt.
✓ shop before we buy.
✓ buy quality used cars instead of brand new ones.
✓ take care of what we own.
✓ maintain a basic understanding of the investment vehicles and their markets.
✓ adopt corrective measures.
✓ dare to discipline our children and teach them the value of money.

Passion for Life

In general, people successful in wealth building (PSWB) have sincere enthusiasm about life. They
are optimistic and resilient. They do not dwell too long on losses, mistakes and frustrations.
✓ PSWBs maintain healthy sleeping hours to be ready to meet the challenges of a new day.
✓ PSWBs are positive thinkers.
✓ PSWBs value relationships.
✓ PSWBs are conscious of their physical, emotional and spiritual well-being.

Patience and Long-Term Vision

In wealth building, expect failures from time to time. They should not di-vert one's vision from his
long-term goal. The saying “opportunity knocks only once” does not apply because opportunities
will continue to present themselves if only we can discern their existence and take advantage
thereof.

The long-term vision of an individual includes adopting safety nets which are taken up in another
section of this chapter.

Take Time to Make Good Educated Decisions

➢ PSWBs are very good decision makers.
➢ Educated decisions are based on facts and evaluation of possible outcomes.
➢ PSWBs adopt zero-based thinking. In zero-based thinking, one ask himself the following
question: "If I have zero non-cash resources in my portfolio, would I buy what I actually
have?
Have Discipline, Do Not Bother about Social Climbing
➢ PSWBs do not try to "keep up with the Joneses" and are happy living within or even
below their means.
Save Every Month
➢ Savings may be considered as one's payments to himself. Thus, it should be the number
one item in our budget no matter how small the amount may be. As the saying goes, “pay
yourself first before spending".
Avoid Debt
➢ Debt is easy to go into but it is very expensive because of the compounded interest charged
thereon. Assume that you buy P3,000 of consumable items on credit with monthly interest
of 3% on any unpaid balance at the end of each month.

Shopping Before Buying

Shopping before buying gives us the chance to avoid impulse buying and to corn pare prices and
quality of goods.

Buy Quality Used Cars Instead of Brand New Ones

PSWBs in general, prefer to buy quality used cars instead of brand new ones to reduce requisition
cost and consequently, the corresponding commission.

Take Care of What We Own

Regular maintenance of what we own can reduce cash outlays for major repairs and even
replacements.

Maintain a Basic Understanding of Investment Vehicles and their Markets

PSWBs, being aware of the fact that investments make their money earn more money, keep
themselves aware of the changes in the nature of investment vehicles available and the
corresponding expected earnings and risks involved

Systematically Plan and Measure Results; Adopt Corrective Measures

PSWBs have the habit of making plans regarding their financial resources weekly, monthly,
quarterly and annually.
Starting on Personal Finance
To start on personal finance, we must first know our financial position and then determine how to
improve it. The following need to be done:
✓ Prepare your personal balance sheet.
✓ Analyze current income.
✓ Analyze current spending habits.
✓ Estimate income required to cover expenses.
✓ Make projections showing the increased amount of future expenses as brought about by
inflation.
✓ Estimate your target portfolio value.
✓ Estimate monthly and annual total savings goals (TSG).
Analyzing and Improving Current Income
What are the sources of income? For an employee, there would be his salaries, Inmost, and perhaps
additional income from a sideline. If the wife is also working, consider the earnings of both.
Additional income may also include interest, dividends and income from a buying and selling
venture. In most cases, an employee feels that he is unable to maximize his income.

Objects of Expenditures
Expenditures are outlays of cash and noncash assets for goods and services. Objects of
expenditures may be in the form of expenses and assets and some of the latter nay be in the form
of investment.
Expenses. These are expenditures or diminution in assets that provide cur-rent benefits only.
Examples are food, depreciation and travel expenses.
Asset. It is anything of future value.
Examples are appliances, cars, house, jewelry and real estate.
Investment. It is an asset that is expected to result in future earnings.
Examples are jewelry, real estate and stocks.

Control of Expenditures
Control &expenditures refers to the keeping track of actual expenditures, n determining whether
they are in accordance budgets and promptly adopting corrective measures. Thus, in controlling
expenditures, the following need to be borne in mind:
a. Know first what you spend for and how much.
b. Determine what expenditures are not necessary.
c. Set the limit for expenditures on a daily, weekly, bi-monthly and monthly bases. .
d. Prepare a family budget and make every member aware of the limits set for expenditures they
can make.
e. Compare budgeted with actual figures so that corrective measures may be adopted.

A family adopt control measures fur major objects a expenditures. Examples are the following:
✓ Food
✓ Clothing
✓ Light and Power.
✓ Water.
✓ House Repairs and Maintenance.
✓ Recreation.
✓ Entertainment.
✓ Cars.
✓ Travel.
Use of Money Envelopes
Adherence to budgets may be enhanced by using money envelopes for the different recurring
expenditures. There may be envelopes for children, daily allowances, food, newspapers and
medical expenses. The amounts set aside for other expenditures In, be deposited into a current
account.

Current Account: A Control Tool for Disbursements

A current bank account is one from which withdrawals are made issuing checks. It is advisable for
an individual or family to maintain a current. account to control disbursements such as those for
water, light and power, telephone and amortizations on loans.

The advantages of a current or checking account are enumerated below.

✓ It reduces the temptation to make use of the amounts deposited with the checking account
for impulse buying inasmuch as they cannot be disbursed right away.
✓ If lost by collectors, a "stop payment" order may be mode for checks issued and
replacements may be made thereafter.
✓ Checks issued and subsequently returned can serve as evidence of payment.
✓ Checkbooks can serve as records of disbursements.

Year-End Balance Sheet

✓ An individual should prepare his year-end balance sheet and compare the game with his
beginning balance sheet to determine where improvements were made or where
weaknesses lie.
Financial Goals and Corresponding. Portfolio Items
✓ Financial goals are set considering the effects of inflation.
✓ Example: Down payment of 40% is to be made on a P400,000 car two years hence. With
an% inflation rate of 6%, the car must cost P450,000 two years after so that the 40% down
payment must be budgeted at P180,000. Saving may then be effected so that including
interest, they would amount to P180, after two years.

It is Never Too Late

It has been said that employees and professionals work for money while investors and businessmen
make their money earn more money. However, employees and professionals can also be investors
while still working at their own jobs or professions.

Insurance
As a safety net, an individual should have life and disability policy. This is preferably obtained at
an early age when he cannot afford to leave his family without a bread-earner or to suffer from
loss of income in case of disability.
Fire insurance policies on properties should be maintained at all times regardless of the stage of
wealth that an individual or family is in. The reasons for this are as follows:
✓ Premiums on fire insurance policies may be considered insignificant when
compared to the amount of loss from fire.
 ✓ Loss from fire and the subsequent loss of income from properties affected can
totally wipe out one's accumulated wealth.

An Individual's Sources of Financing

It is always advisable for an individual to be aware of the possible of financing in case of need.
Among them are the credit unions, pa installment houses, SSS/GSIS, banks, low interest credit
cards, and neighborhood lender.

Credit Cards
❑ A credit card is one that enables the holder thereof to credit. It is often referred to as "plastic
money".
❑ A credit card is issued by a credit card company upon approval of the application filed by
the prospective cardholder.
❑ A credit card does not indicate that the holder thereof is rich. Rather, it is an evidence that
he is credit worthy.
❑ A credit card is for the convenience of the holder. Instead of carrying more than enough
cash around it is much safer to carry a credit card in order to take advantage of special sales
offers and sales promotions.

"Never Retire" Philosophy

❑ Philosophy, as defined by Webster, is a "wise composure in dealing with problems".
Individuals generally look forward to their retirement years so that they expect to enjoy
their retirement pays and monthly pensions.
❑ Under the "never retire" philosophy, we should continue to improve our skills' or
knowledge so that we may be ready to accept challenges in other jobs or undertakings even
beyond the age of 60 or 65.
❑ Never retire poop!, (NRP) try to learn more about other jobs or ventures. One way of doing
this is by developing hobbies which would prove to be a source of income later on. Another
is by going into ventures wherein inborn talents can be utilized.

Invest in yourself
To be successful at personal finance, we should invest in ourselves by developing our personality,
improving our competency in our chosen endeavors and by learning other skills which may prove
to be beneficial in the future.

How successful are you in Wealth Accumulation?

In applying personal finance, an individual tries to accumulate. Wealth while attending to the needs
of his family and improving the life of others. He may be a prodigious accumulator of wealth
(PAW), average accumulator of wealth (AAW) or an under accumulator of wealth (UAW)
depending on whether he has accumulated more or less than what he should have. The following
formula is given;
Standard for Accumulated Wealth Excluding Inheritance:

{(Age x Annual pre - tax earnings (excluding inheritance)}

10

Example: Dante Ramos is 50 years old and has an annual pre-tax income of P400,000 including
rental income of P120,000 from an inherited apartment building valued at P2,000,000. His total
equity at present is P4,500,000 including inheritance.

Based on the foregoing formula, the accumulated wealth of Dan. Ramos ought to be P1,400,000
excluding inheritance. This is arrived at as follows:
50 𝑦𝑒𝑎𝑟𝑠 𝑥 (𝑃400,000 −120,000)
= P 1,400,000
10

Limitations in Using the Standard

The standard as given may serve . benchmark towards which an individual should strive to save
and invest but should not I.. strictly observed because of the following limitations:

✓ All individual's earnings fluctuate. Earnings may abruptly go up or down due to shifts in
means of livelihood.
✓ One, equity may be affected by the financial assistance he extends to members of his
family. The word family in the Philippine context includes parents, brothers and sisters,
uncles, aunts, first cousins, and in some cases, even loyal members of the household staff.
✓ The composition asses is not reflected in the standard. One's equity may qualify him to be
a PAW but ho may not be in a position to enjoy life as he should if be lacks liquid assets.

The “Die Broke" Philosophy

The die broke philosophy refers to accumulating wealth at an early age, living well and distributing
wealth leaving just enough resources to meet financial requirements in old age. It implies that an
individual should have zero estate upon interment.

The die broke philosophy encourages an individual to enjoy life by maintaining his desired
lifestyle provided he can have enough for his own needs in his old age and for those of his family.

Wills and Personal Trusts

❑ A will is a legal document wherein an individual states how property should be distributed
upon his death.
❑ Living will. This is a document which is also called a letter of instruction wherein one sets
forth his wishes as to what should be done with him in case he becomes profoundly ill or
irreversibly incompetent.
❑ A personal trust is a legal arrangement whereby a person who owns financial resources
entrusts them to a second party for safekeeping and management for the benefit of the
designated beneficiary or beneficiaries..
 ❑ Living trust. It is a personal trust wherein benefits, are enjoyed by the designated
beneficiary during the lifetime of the trustor.
❑ Testamentary trust. This is one created by a will.
❑ Life insurance trust. This refers to one that is created out of life insurance proceeds for
the benefit of the policy holder’s designated beneficiary.
❑ Estate settlement trust. This refers to one wherein the trustee is appointed as executor of
a will.

CHAPTER EXERCISES

Direction: Read the given scenario carefully and answer the question comprehensively.
Support your answer.
1. What are the keys to success in personal finance? Explain Each.

2. What characteristics and habit for success in personal finance have not yet been acquired by
you? How do you plan to acquire them?

3. Joseph Reyes, a 26 year old employee is earning P15,000 a month. Being single, he lives with
his parents and drives his car to and from his office of employment. He intends to get married
before reaching the age of 35. What advice would you give to Joseph as personal finance
advocate?