CAPITAL MARKETS

Certificate of Assignment

Certificate of assignment is an agreement that transfers the right of the seller over a security in favor of
the buyer. The underlying security carries a promise to pay a certain sum of money on a fixed date like a
promissory note. The arrangement allows the buyer to hold the security as a guaranteed source of
repayment. The buyer has the option to force the liquidation of the underlying security to ensure
repayment.

For example, ABC Corporation owns certain securities, say T-bills worth $100,000. ABC Corporation goes
to a bank and borrows money corresponding to the amount of the T-bills, that is, #100,000. ABC
Corporation executes a certificate of assignment assigning the right over of the T-bills to the bank. The
maturity and amount of the loan need to match the maturity and amount of T-bills. When the maturity
date comes, ABC Corporation will pay the bank $100,000 that it borrowed and get back the cancelled
certificate of assignment.

Certificate of Participation

Certificate of participation is an instrument that entitles the holder to a proportionate equitable interest
in the securities held by the issuing firm or an entitlement to a pro rata share in a pledged revenue
stream, usually lease payments. The lessor assigns the lease and the payments to a trustee, which then
distributes the payments to the certificate holders. The transaction is between the buyer and the original
issuer of the security. A dealer issues the certificate of participation. The dealer's liability is to vouch for
the integrity of the original security rather than to repay the loan if the issuer defaults. The certificate of
participation is a useful instrument when the original security is in a large denomination and when there
are a few buyers.

For example, DEF Corporation issued a promissory note for $300 million to a bank. The bank later sold #5
million of this instrument to RST Company, Inc. The bank will issue a certificate of participation in DEF's
promissory note to RST Company, Inc. The bank's certificate of participation does not make the bank
liable in case DEF Corporation defaults on its note.

Eurodollar CDs and Eurocommercial Papers

The US dollar has been an international medium of exchange. Foreign governments and financial
institutions, like banks, hold a store of funds denominated in US dollars outside of the United States.
Moreover, US corporations conducting international trade often hold US dollar deposits in foreign banks
overseas to facilitate expenditures of their companies and branches or offices in these foreign countries.
These dollar-denominated deposits held offshore in US bank branches overseas and in other foreign
banks are called Eurodollar deposits and the market in which they trade is called the Eurodollar market.
Eurodollar certificate of deposits or Eurodollar CDs are dollar-denominated, negotiable, large-time
deposits in banks outside the United States. Similarly, Eurocommercial papers (EuroCPs) are issued in
Europe by dealers of commercial papers without involving a bank. They are negotiable commercial
papers dealt with in the European markets. The Eurocommercial rate is generally about one-half to one
percent above the LIBOR rate. Foreign commercial paper markets are new and small relative
The income earned in money market mutual funds varies based on the performance of the underlying
investments. However, because these investments are fairly safe, they do not pay high returns although
the yields are a bit higher than on money market deposit accounts.

Both money market deposit accounts and money market mutual funds are simply places to keep your
money for the short term. They are not good places to put your money for the long-term. Because they
earn so little, parking long-term assets in a money market guarantees that you will lose buying power to
inflation. If you are parking cash while you figure out where to better invest it, a money market mutual
fund might be the better choice because you could then easily transfer those assets into a fund with the
same company with a single phone call or click of the mouse.

MMMFs are open-ended mutual fund that invest in commercial paper, banker's acceptances, repurchase
agreements, government securities, certificates of deposit, and other highly liquid and safe securities,
and pay money market rates of interest. Open-end mutual fund shares are bought and sold on demand
at their net asset value (NAV), which is based on the value of the fund's underlying securities and is
calculated at the end of every trading day. Investors buy shares directly from a fund. Closed-end mutual
funds (CEFs) have a fixed number of shares and are traded among investors on an exchange. CEFs may
trade at a discount or premium to their NAV. If the market price of a CEF is greater than its NAV, it will be
traded at a premium. If the market price is less than its NAV, it will be traded at a discount. A CEF is not
required to buy back its shares from investors upon request (Wellsfargofunds.com). Like stocks, their
share prices are determined according to supply and demand, and they often trade at a wide discount or
premium to their NAV.

Launched in the middle 1970s, MMMFs became popular in the early 1980s when interest rates and
inflation soared. Management's fee was less than 1% of an investor's assets; interest over and above that
amount was credited to shareholders monthly. In the US, the fund's NAV normally remained a constant
$1 per share-only the interest rate went up or down. Such funds, like MMDAs usually offered check-
writing privileges. In 2008, the government created a temporary money fund insurance program,
guaranteeing share prices if the fund's NAV fell below $1 a share. In addition, some funds were covered
by private insurance.

Many money market funds are part of fund families. This means that investors can switch their money
from one fund to another and back again without charge. Money in an asset management account
usually is automatically swept into a money market fund until the account holder decides where to
invest it next.
MMMFS sell their shares to raise cash, and by pooling the funds of large numbers of small savers, they
can build their liquid assets portfolios. In the US, one can start an account with merely $1,000, which
makes it suited for small businesses and even individuals. These funds offer liquidity and offer return the
same way as purchasing the marketable securities directly.

The growth of MMDA market retarded the growth of MMMF market. MMDA was actually designed by
the government as a step to save small depository institutions that were threatened by the fast
development of MMMF market. There is always a very close competition between these two markets.

Money Market Mutual Funds

Money market mutual funds (MMMFS) are investment funds that pool funds from numerous investors
and invest in money market instruments offered by investment companies. A mutual fund is an
investment company that pools the funds of many individual and institutional investors to form a
massive asset base. The assets are then entrusted to a full-time professional fund manager who
develops and maintains a diversified portfolio of security investments. In the Philippines, there are
currently four basic types of mutual funds- stock, balanced, bond, and money market funds. Stock
funds/Equity funds invest primarily in shares of stock. Balanced funds invest both in shares of stock and
debt instruments combining the features of both the growth funds and the income funds. Bond funds
invest in long-term debt instruments of governments or corporations. Money market funds invest purely
in short- term debt instruments. As of September 30, 2010, there are a total of 43 mutual funds in the
country. (PIFA.com)

More comprehensively, mutual funds can be classified as:

1. Growth funds - invest in assets that are expected to reap large capital gains (generally equity
securities)
2. Income funds - invest in stocks that regularly pay dividends and in notes and bonds that
regularly pay interest
3. Balanced funds - combine the features of both growth funds and income funds
4. Sector funds-invest in specific industries as health care, financial services, utilities, extractive
industries
5. Index funds - invest in a basket of securities that make up some market index as the S&P 500
index of stocks
6. Global funds - invest in securities issued in many countries providing diversification.

People who buy shares of a mutual fund are its owners or shareholders. They are portfolios of liquid
investment with low default risk. They are investment pools that buy safe, short- term securities, such as
T-bills, CDs, and commercial papers. MMMFs allow small investors to invest in money market
instruments. MMMFs provide investors with check-writing capacities, just like MMDAs and thus may be
viewed as an alternative to bank deposits. Unlike MMDAs, MMMFs are not insured by the government.
Wholesale MMMFS cater to institutional investors setting high minimum investment levels, for instance,
$50,000. Others are known as retail MMMFs with minimum investments within the reach of most
individuals. Some MMMFs specialize in investing in T-bills only, while others invest in a variety of money
market instruments.

Secondary markets for CDs exist. In Asia, CDs market has grown rapidly in the past decade, despite that it
is relatively small and illiquid compared to its counterparts in Europe and the United States. In the
Philippines, banks like Union Bank, BDO, and HSBC offer CDs. In the US, the heart is found in New York
City. CDs are more heterogeneous than T-bills. T-bills have similar rates, maturity periods, and
denominations; more variety is found in CDs. This makes it harder to liquidate large blocks of CDs
because a more specialized investor is much needed. Securities dealer who "makes" the secondary
market in CDs mainly trades in million units. Smaller denominations can be traded, but will bring a
relatively lower price. Income received from CDs is subject to taxation at all government levels. In recent
years, CD yields have been above those available on bankers' acceptances. (Keown et al. 1998)

Banks issue negotiable CDs to attract additional funds to make additional loans or to counteract the
restrictive effect of deposit withdrawals. Banks began issuing negotiable CDs, I which were not subject to
statutory interest rate ceilings, in an effort to halt the withdrawal of deposits. When central banks adopt
restrictive policies, commercial banks issue negotiable CDs increasing the outstanding supply of these
marketable securities. Negotiable CDs are held by lenders with a need for temporary investment outlets
for large amounts of fund typically at P1M or more. The primary buyers of negotiable CDs are
corporations, money market mutual funds, government institutions, charitable organizations like PCSO,
and foreign buyers.

Repurchase Agreements

Repurchase agreements are legal contracts that involve the actual sale of securities by a borrower to a
lender with a commitment on the part of the borrower to repurchase the securities at the contract price
plus a stated interest charge at a later date. A repurchase agreement is usually a short-term loan (often
overnight) from a corporation, state or local government, or other large entity that has idle funds to a
commercial bank, securities dealer, or other financial institution. They were created by brokerage houses
and popularized by commercial banks. A reverse repurchase agreement or reverse repo is an agreement
involving the purchase of securities by one party to another with the promise to sell them back at a
given date in the future. Therefore, from the point of view of the seller of the security, the transaction is
a repurchase agreement and from the point of view of the buyer, the transaction is a reverse repo.

Repurchase agreements are closely associated with the functioning of the interbank call loan market in
the Philippines and the federal funds market in the US. In an interbank loan market or Fed funds
transaction, the bank with excess reserves sells fed/reserve funds for one day to the purchasing bank.
The next day, the purchasing bank returns the fed/reserve funds plus one day's interest reflecting the
fed/reserve funds rate. Since there is a credit risk exposure to the selling bank in that the purchasing
bank may not be able to repay the fed/ reserve funds the next day, the selling bank may seek collateral
backing for the one-day loan of fed/reserve funds. In a repo transaction, the funds-selling bank receives
government securities as collateral from the funds-purchasing bank. That is, the funds-purchasing bank
temporarily exchanges securities for cash. The next day, this transaction is reversed; the funds-
purchasing bank sends back the fed/reserve funds borrowed plus interest at the repo rate; in return, it
receives or repurchases its securities used as collateral in the transaction.

RPs are free from interest rate ceilings and are not subject to reserve requirements as long as the
collateral are GS. The contract price of the securities that makes up the arrangement is fixed for the
duration of the transaction. Anyone who buys an RP is protected from market price fluctuations
throughout the contract period. This makes it a sound alternative investment for funds that are freed up
for only very short periods of time. The collateral used most frequently in these transactions is a
government-issued security like a T-bill. The borrower provides the lender collateral in the form of GS
making the loan free of default. However, it has poor marketability because it is a two-party agreement,
but it is self-liquidating within a few days.

RPs can be overnight RPs or term RPs. Overnight RPS mature in a day. Term RPs have a maturity greater
than 1 day. The difference between overnight RPs and term RPs is the same difference between demand
deposits and time deposits. Term RPs are one way of avoiding the interest rate ceilings on time deposits.
Assume that an investor invests overnight or over the weekend. The investor is concerned that T-bill
prices will fall before they are sold. The investor can always find a bank or dealer willing to sell the
desired number of T-bills and commit to buying them back later at a specified price. The purchase and
sale prices are set to guarantee the investor a profit.

If the interest rates fall or remain unchanged during the day(s) the investor holds the T-bills, the rate of
profit on the repo will be slightly less than the rate that the investor could have earned by buying and
selling T-bills in the open market. This difference and the fee charged for the transaction constitute the
bank's or dealer's profit. However, if interest rates rise, the investor still gets the guaranteed profit and
the bank or dealer absorbs the loss. This change in the interest rates constitutes the risk in repos. (Shetty
et al. 1995)

In another case, a large corporation with a million or more in funds that is not needed for a few days
"buys" a large block of GS from a major bank. The bank agrees to repurchase the securities on the date
the corporation needs the funds at a price sufficiently above the price the company paid for the
securities to provide a rate of return about one-quarter of one percent below the current federal funds
rate. Thus, rather than holding large checking account balances, which earn no interest, the corporation
makes a safe, convenient investment at a competitive yield. Banks, dealers, and others who borrow in
this market find it a useful source of funds. Because aggressive management of cash positions by
corporations, state, and local governments, and other large organization has become widespread, RP
market has grown dramatically in the past 25 years.
Money Market Deposit Accounts

Money market deposit accounts (MMDAs) are PDIC-insured deposit accounts that are usually managed
by banks or brokerages and can be a convenient place to store money that is to be used for upcoming
investments or has been received from the sale of recent investments. They are very safe and highly
liquid investments, typically paying higher interest than regular savings accounts but lower than money
market mutual funds. They are also called money market accounts. MMDAs usually offer check-writing
privileges. MMDAs are insured by the Philippine Deposit Insurance Corporation (PDIC) up to $500,000
per person, per bank. As long as the balance in the account remains below the insurance limit, every bit
of principal and interest earned on the account is 100% guaranteed.
Banker's Acceptances

Banker's acceptance is a time draft issued by a bank payable to a seller of goods. It is drawn on and
accepted by the bank. Before acceptance, the draft is not an obligation of the bank; it is merely an order
by the drawer to the bank to pay a specified sum of money on a specified date to a named person or to
the bearer of the draft just like an ordinary check. Upon acceptance, which occurs when an authorized
bank employee stamps the draft "accepted" and signs it, the draft becomes a primary and unconditional
liability of the bank. If the bank is well known and enjoys a good reputation, the accepted draft may be
readily sold in an active market (LaRoche 1998). The bank substitutes its own creditworthiness for that of
the drawer that makes banker's acceptances marketable instruments.

Time draft issued by a bank is an order for the bank to pay a specified amount of money to the bearer of
the time draft on a given date. It is different from sight draft, which is an order to pay immediately. A
bank check is a sight draft.

Letters of Credit

Banker's acceptances are generally used with the purchase of goods or services either domestically or
internationally. In these cases, the buyer has its bank issue a letter of credit (L/C) on its behalf in favor of
the seller. For imports, an international letter of credit is opened; for local purchase, a domestic letter of
credit is opened. A commercial letter of credit is a contractual agreement between a bank, known as the
issuing bank, on behalf of the buyer (drawer), authorizing another bank, the correspondent bank known
as the advising or confirming bank, to make payment to the beneficiary, the seller. The issuing bank, on
the request of the buyer, opens the letter of credit. The issuing bank makes a commitment to honor
drawings made under the credit. The beneficiary is the seller of goods or services. Essentially, the issuing
bank replaces the buyer as the payor.

The letter of credit states that the bank will accept the seller's time draft if the seller presents the bank
with shipping documents that transfer title on the goods to the bank. The bank notifies the seller of the
letter of credit through a correspondent bank in the case of exports in the exporter's country. When the
goods have been shipped, the seller presents its time draft and the specified documents to the accepting
bank's correspondent, which forwards them to the accepting bank. If the documents are in order, the
accepting bank takes them, accepts the draft, and discounts it for the exporter. At this point, the
transaction is complete from the exporter's point of view; it has shipped the goods, turned over title to
them, and received payment. The responsibility of the buyer is to the issuing bank, which the buyer has
to pay for the entire amount of the transaction including any necessary charges and fees.

Through a letter of credit, the bank substitutes its own promise to pay for the promise of one of its
customers. By substituting its promise, the bank reduces the seller's risk, facilitating the flow of goods
and services through international markets. If the seller becomes concerned about the soundness of the
bank issuing the letter of credit, the seller may ask his own bank to issue a confirmation letter in which
that bank guarantees against foreign bank default. A confirmation letter transfers the payment obligation
to the guaranteeing/confirming bank from the originating/issuing bank.
Negotiable Certificates of Deposit

Certificate of deposit (CD) is a receipt issued by a commercial bank for the deposit of money. It is a time
deposit with a definite maturity date (of up to one year) and a definite rate of interest. CD stipulates that
the bearer is entitled to receive annual interest payments at the rate indicated in the certificate, together
with the principal upon maturity of the certificate. They are not ordinarily redeemed prior to maturity,
but in the early 1960s, a secondary market was established in which CDs in denominations of $100,000
or more can be traded prior to maturity. That was when the so-called negotiable certificates of deposit
were born (Thomas 1997). They are not the regular certificates of deposits or time deposits held by
depositors in banks, which are not marketable.

Negotiable certificate of deposit is a bank-issued time deposit that specifies an interest rate and maturity
date and is negotiable. It is a short-term, 2 to 52 weeks, and of a large denomination, #100,000,
$500,000, and 1M. The normal round lot trading unit among dealers is $1 million. It is a bearer
instrument, that is, payable to whoever holds the CD when it matures. Therefore, it is important that the
owners must take good care of them because when lost, the one who found it can claim payment.
Negotiable CDs are more risky than T-bills. When CDs mature, the owner receives the full amount
deposited plus the earned interest.

even if the security is a 10-year bond, but the intention of the company is to sell it as the need arises and
not wait for its maturity, the security is classified as current or short-term. On the other hand, if the
intention of the company is to hold the securities until the maturity or to hold on to them for regular
dividend income or interest income, then the securities are reported under non-current assets as long-
term investment. For the purposes of this book, we will follow the classification in finance. The
clarification in the foregoing is intended to help accounting students in studying finance.

MONEY MARKET INSTRUMENTS

Money market instruments are short-term securities. They are paper or electronic evidences of debt
dealt in the money markets. Only debt securities are short-term. Equity securities are long-term and
belong to the capital market. Money market instruments are issued by the government and corporations
needing short-term funds. Government securities are generally issued by the Bureau of the Treasury. The
details on the securities issued by the Philippine government discussed in this book are all from the
Treasury.gov.ph, the official website of the Philippine Treasury.

Cash Management Bills

Cash management bills are government-issued securities with maturities of less than 91 days, specifically
35 days or 42 days. They have shorter maturities than T-bills. Government securities (GS) are
unconditional obligations of the government issuing them, backed up by the full taxing power of the
issuing government. As such, they are theoretically default-free. Investing in these bills affords security
and liquidity to investors.

Treasury Bills (T-Bills)

Treasury bills (T-bills) are issued by the Bureau of the Treasury with 91-day, 182-day, and 364-day
maturities. The odd number of days is to generally ensure that they mature on a business day. Like
Treasury bonds (T-bonds), they are sold only through government securities eligible dealers (GSEDS),
dealers authorized by the government to sell T-bills. Transactions are done through bidding online.

The Philippine government issues two types of government securities: Treasury bills, which are short-
term, and T-bonds, which are long-term. T-bills are zero coupon securities because they have no coupon
payments (interest payment) and only have face values. They are sold at a discount, which means that
their purchase price is less than their face value. This difference between their purchase price and their
face value is the sole source of their return generally referred to as discount yield (dy) or margin. They do
not earn interest.

They are generally quoted either by their yield rate, which is the discount or by their price based on 100
points per unit. The yield is the increment or interest on an investment. Relative to government
securities, it is the discount earned on T-bills or the coupon paid to the holder of T-bonds. Both the
discount and the coupon are expressed as a percentage of the value of the GS on a per annum basis.
Conventionally, the yields in longer-dated or termed GS are higher than the yields in shorter-termed GS.
The image on the next page is a sample of the Philippine government's latest offerings of T-bills dated
April 6, 2016.a
EXPERIENTIAL EXERCISE

Be prepared to be grouped by your teacher. Four groups will report on money instruments and the other
four will report on capital market instruments. The topic follows:

Money Market Instruments:

1. Banker's Acceptance and Letter of Credit

2. Negotiable CD and Repurchase Agreement
3. MMDA and MMMF
4. Certificate of Assignment and Certificate of Participation

Capital Market Instruments:

1. Loans and Leases

2. Mortgages and Lines of Credit
3. Long-Term Negotiable Certificates of Deposit and Mortgage-Backed Secur
4. Stocks and Bonds

Groups can go to banks, insurance companies, financial analysts working in the B Stock Exchange or in a
bank or non-bank financial company, and find someone to she the topic you will report on. Report your
group's findings in the class.

DISCUSSION QUESTIONS

1. Differentiate money market from capital market; money market instruments fr market
instruments.
2. Discuss at least three money market instruments.
3. Discuss at least three capital market instruments.
4. Differentiate negotiated market from securities market.
5. Differentiate the two basic types of lease.
6. Discuss how lease payments for the two basic types of lease are to be trea books of the lessee.
Discuss how the leased property should be treated in the
to the US commercial paper markets. Eurocommercial papers are issued in local currencies as well as in
US dollars. With the introduction of the Euro as the official currency in most European countries,
EuroCPs denominated in Euros are now common in Europe. The Euro market potential is essentially
bright. Eurodollars may be held by governments, corporations from anywhere in the world not directly
subject to US bank regulation. As a result, the rates paid on Eurodollar CDs are generally higher than that
paid on US-domiciled CDs (Sanders and Cornett 2007).

CAPITAL MARKET INSTRUMENTS

be After gaining knowledge in examining the different money market instruments, we are now ready to
learn the different capital market instruments available to investors.

As stated, these long-term instruments are basically either equity securities or debt securities. Capital
market instruments include corporate stocks, mortgages, corporate bonds, treasury securities, state and
local government bonds, US government agency securities, and non-negotiable bank, and consumer
loans and leases.

Capital market instruments, just like capital markets, can be classified as:

1. Non-negotiable/non-marketable instruments

2.Negotiable/marketable instruments

Non-Negotiable/Non-Marketable Instruments

Non-negotiable or non-marketable instruments in the capital markets are the following:

1.Loans

Loans are direct borrowings of deficit units from surplus units like banks. They can be short-term
or long-term. Companies needing large amounts of funds to finance special projects like purchase of
land or building, plant expansion, or even bond retirement usually resort to borrowing from capital
markets. They do one-on-one transaction with the lenders. Stockholders usually guarantee these loans.
The amount of loan granted depends on how well the lenders know the borrowers and generally on
their deposits with said banks or with the amount of transactions they do with the said banks. Long-
time, established companies can really borrow large amounts of funds to finance their capital needs.

2. Leases

Leases are rent agreements. The owner of the property is called the lessor and the one who is
renting and using the property is the lessee. The lease can be an operating lease, where the lessor
shoulders all expenses including insurance and taxes related to the property leased out and the lessee
pays a fixed regular amount usually on a monthly basis. It can also be a financing or capital lease, where
the lessee shoulders all expenses of the property as insurance and taxes. Generally, capital leases are
lease-to-own contracts where the lessee pays a big initial down payment, pays a fixed regular amount,
and later pays a minimal amount to finally own the asset or property being leased.
Companies who want to buy capital equipment or machinery can arrange for a lease-to-own contract
with a financial institution. They initially lease equipment or machinery and have the option to buy the
leased equipment or machinery at the end of . This is a convenient way to own equipment and
machinery. Even buildings the program are sometimes purchased in this manner.

3. Mortgages

Mortgages are agreements where a property owner borrows money from a covered by
mortgages are non-current assets or permanent assets as land, building, financial institution using the
property as a security or collateral for the loan. The assets and other real estate properties. Land,
building, and machineries are usually mortgaged upon purchase. The companies borrow money from
banks and other lending institutions to buy the land, building or machinery and such land, building, or
machinery are used as collateral for the loan thus obtained. Lending institutions are more secure
knowing that something of value guarantees the loan. In essence, mortgages are secured loans.

4. Lines of Credit

Line of credit is a bank's commitment to make loans to regular depositors up to a specific

amount. The line of credit includes letters of credit, standby letters of credit, and revolving credit
arrangements, under which borrowings can be made up to a maximum amount as of any point in time
conditional on satisfaction of specified terms, before, as of, and after the date of drawdowns on the line.
Lines of credit provide the convenience of a readily available source of money that can be used anytime
and for whatever purpose. Personal lines of credit are for households and can be used for home
renovation, buying a car, vacation, or any major purchase. Commercial lines of credit are for businesses
and can be used for current or short-term purposes like purchase of merchandise and pay operating
expenses or for capital expenditures. But since the credit is ongoing and has no termination, it is
considered long-term. It is flexible providing ongoing access to funds. Generally, it is secured against
home equity. Borrowers only pay interest on the funds used with flexible repayment options, sometimes
including the ability to pay as little as interest only. It can also have the option to combine with a
mortgage to benefit from automatic rebalancing; therefore, available credit increases automatically as
payment is made (revolving line of credit). It is a great option if you are looking for flexibility.

Negotiable/Marketable Instruments

The following are specific marketable or negotiable instruments dealt with in the capital markets:

Corporate Stocks

Corporate stocks are the largest capital market instruments. Stocks are evidences of ownership
in a corporation. The holders are called shareholders or stockholders. Shares of stocks are actually
intangible while the stock certificates are the tangible evidence of
ownership. While there are stocks held for short-term use, classified as current assets under marketable
securities or temporary investments, stocks are by nature long-term. They do not have maturity dates,
although redeemable preferred shares, like callable bonds, can be called for redemption at the option of
the issuing company.

The capital stock of a company is divided into shares and each share is denominated in Philippine peso
or in the currency of the country where the company is located. Domestic companies are incorporated in
the countries where they are located. Any other company is considered as foreign corporation as far as
that country is concerned. An American company doing business in the Philippines is foreign in the
Philippines, while considered domestic in the United States. Foreign companies with offices in the
country are called resident foreign corporations. Stocks can therefore be stocks of domestic companies
or stocks of foreign companies.

Shares of stock may be classified as:

A 1. Par value shares

2. No par value shares

a. With stated value

b. Without stated value

B. 1. Common shares

2. Preferred shares

a. As to assets

b. As to dividends

i. Cumulative

ii. Non-cumulative

iii. Participating

iv. Non-participating

Par value shares are shares where the specific money value is shown on the face of the stock certificate
and fixed in the Articles of Incorporation. The primary purpose of par value is to fix the minimum issue
price of the shares. The par value shares may be issued at a premium (above par value), but may not be
sold at a discount (below par value).

No par value shares are shares without any money value appearing on the face of the stock certificate.
Our Corporation Code provides that no par value shares may not be issued for less than five pesos per
share (P5.00). No par value shares may be assigned a stated value in the Articles of Incorporation in a
Board of Resolution made by the Board of Directors if authorized, or by a majority of the stockholders at
a meeting called for that purpose. The assignment of stated value for no par value shares defeats the
purpose of no par value shares. True no par value shares should not have a stated value.
shares) and each share has equal rights. To attract investors, corporations may issue more If a
corporation issues only one class of stock, it is called common stock (or ordinary than one class of stock,
one with preferential rights over the common stock. Such shares with preferential rights are called
preferred shares or preference shares. In cases where there is more than one class of stock-preferred
stock and common stock-common stock is referred to as residual being subordinate to preferred stocks
and therefore is entitled to an equal pro rata division of profits without any preference or advantage
over any other stockholder or

class of stockholders.

Preferred shares as to assets upon liquidation mean that the shares shall be given preference over
common shares in the distribution of the assets of the corporation in case of liquidation. Preferred
shares as to dividends refer to shares with preferential rights to share in the earnings of the corporation,
that is, the owners thereof are entitled to receive dividends before payment of any dividend to the
common stock is made. The dividend preference may be on a cumulative or non-cumulative basis and on
a participating or non-participating basis.

Payment of dividends cannot be made if the Board of Directors has not declared the same. All dividends
not declared by the Board of Directors in a given period are called passed dividends. Unpaid passed
dividends are called dividends in arrears.

Cumulative preferred shares are entitled to receive all passed dividends in arrears. Non- cumulative
preferred shares are not entitled to passed dividends or which are called dividends in arrears for
cumulative shares. They receive only dividends that are currently declared. Participating preferred shares
are entitled not only to the stipulated dividend, but also to the share with the common stock in the
dividends that may remain after the common shares have received dividends at the same rate as the
preferred for the current year. Non-participating preferred shares are entitled to a fixed amount or rate
of dividend only, say 10% or 8% or 12%.

Preferred shares can be a combination of the foregoing characteristics, that is, non- cumulative, non-
participating; non-cumulative, participating; cumulative, non-participating; and cumulative, participating.

The authority to declare dividends rests with the Board of Directors. As previously stated, unlike debt
instruments, stocks do not have maturity dates. They remain outstanding so long as the issuing
corporation is in business and is not retired or called in by the issuing company. Therefore, while there
are stocks held for short-term use, classified as current assets under marketable securities, stocks are
long-term.

Secondary markets provide liquidity and enhance the marketability of stocks reducing the real costs of
financing to business firms and expanding the possibilities for raising funds. Stocks were traded by
brokers in organized stock exchanges and over-the-counter or OTC markets. Any corporation with more
than 300 stockholders may have its stock traded over- the-counter. Large corporations that meet certain
standards of size and stability may apply with SEC for listing in an organized stock exchange, such as PSE.
Stocks are entitled to dividends. Dividends can be:

1. Dividends out of earnings (share of stockholders in the profit of the company)

2. Liquidating dividends
a. Dividends in case of liquidation/bankruptcy
b. Dividends representing return of capital in case of extractive industries or mining companies

Dividends out of earnings can be in the form of:

1.Cash dividend

2.Stock dividend

3.Property dividend

4.Scrip dividend

Cash dividends are dividends distributed in the form of cash, say #10/share cash dividend, which means
the company will pay those who own shares in the company at the rate of $10/ share. If you own 1,000
shares, you will receive $10,000 (1,000 shares x 10 dividend per share) in cash dividend. Cash dividends
can also be a certain percent, say 10% or 5%. In terms of share, if the par value or stated value of a stock
is P20, a 10% cash dividend will mean 10% of $20 or P2/share, and if you own 1,000 shares, you will
receive 1,000 shares x P2 or $2,000.

Stock dividends are dividends given out to stockholders in the form of the company's own shares. If a
company declares a 10% stock dividend, it will be 10% of the shares owned by the stockholder. If you
own 1,000 shares of stock in a corporation, a 10% stock dividend will mean that you will receive 10% of
1,000 shares or 100 shares of the company's own stock as stock dividend. Stock dividends are like "paper
transactions" because they do not involve any asset on the part of the company declaring the dividend.
All that the company needs is enough unissued common stock, enough retained earnings, and a board
declaration.

Unissued common stock refers to that part of the authorized capital stock that has not been fully paid,
meaning, stock certificates have not been issued, hence unissued. Retained earnings refer to the profits
of the company that have not been declared as dividends and retained by the business to help in its
operations. A board declaration means a resolution issued by the Board of Directors to the effect that
dividends are being declared.

Property dividends are in the form of non-cash assets of the company distributed as dividends to
stockholders. A company can declare property dividends and then distribute its own holdings of
government securities, or marketable securities or even inventories. Instead of selling the securities or
inventories and giving cash dividends, the company distributes the government securities, marketable
securities, or inventories as property dividends.

Scrip dividends are deferred cash dividends. Scrips are promissory notes that will be paid by the
company in cash at a certain future date.

Unlike dividends out of earnings, liquidating dividends (return of capital) are given by companies who
are in the process of liquidation (going out of business) or by companies in
the extractive industry. Natural resources are depleted and stockholders of these companies receive
what is known as liquidating dividends, which are in effect return of capital.

Bonds

Bonds are debt instruments issued by private companies and government entities to borrow large sums
of money that no single financial institution may be willing or able to lend. A government bond is issued
by a national government and is denominated in the country's own currency. Bonds issued by the
Bureau of the Treasury are called T-bonds. Bonds issued by national governments in foreign currencies
are normally referred to as sovereign bonds. These bonds are certificates of indebtedness with definite
maturity dates, that is, the date when the bond issuers need to redeem the bonds (redemption dates).
They also pay interest at regular intervals (monthly, quarterly, every six months, or even yearly) and the
holders are the creditors or investors (surplus units or SUs), while the issuer is the debtor or borrower
(deficit units or DUs). They earn a fixed rate of interest, which issuers pay at regular intervals (monthly,
quarterly, every six months, or even yearly). The earnings on bonds, therefore, are in the form of interest
or coupons (hence, coupon bonds).

Corporate Bonds

Corporate bonds are certificates of indebtedness issued by corporations who need large amount of cash.
Bond agreements are called bond indentures. At times, it is impossible to borrow a large amount from a
single institution. This is the time corporations decide to issue bonds instead. In the case of bonds, the
investors are the lenders; therefore, we have several lenders for a single amount borrowed, say $5
million. Bonds have specific interest rates and maturity dates. While there might be short-term bonds,
most corporate bonds are long-term bonds because they mature in more than a year.

Bonds can be classified as follows:

1.As to security:

A. Secured bonds

Secured bonds are collateralized either by mortgages or other assets. Securitized mortgages (mortgage-
backed securities) are mortgages packaged together by financial institutions and sold as bonds backed by
mortgage cash flows such as interest and principal repayments on these mortgages.

b. Unsecured bonds

Unsecured bonds, also called debenture bonds, do not have any sort of guarantee. They do not provide
any lien against any specific property or security for the obligation, that is, there is no collateral. This is
the reason why debenture bonds are generally issued by companies with a steady high credit rating.
Companies such as large mail-order houses and commercial banks are

some of these companies.

As to interest rate:

Variable rate bonds

Variable rate bonds are bonds whose interest rate fluctuates and changes when the market rates change

Fixed rate bonds

Fixed rate bonds have rates that are fixed as stated in the bond indenture

As to retirement:

Putable bonds

Putable bonds are bonds that can be turned in and exchanged for cash at the holder's option. The put
option can only be exercised if the issuer takes some specified action as being acquired by a weaker
company or increasing its outstanding debt by a large amount. A putable bond allows the investor to sell
the bond back to the issuer, prior to maturity, at a price specified at the time the bond is issued. This
type of bond protects investors: if interest rates rise after bond purchase, the future value of coupon
payments will become less valuable. Therefore, investors sell bonds back to the issuer and may lend
proceeds elsewhere at a higher rate. Bondholders are ready to pay for such protection by accepting a
lower yield relative to that of a straight bond. Putable bonds have not been used to a large extent. The
holder of a putable bond is essentially long the bond and long the embedded put option. This has the
effect of increasing the convexity of the price-yield relationship associated with this security, thus
reducing the downside risk to the investor. This has the effect of increasing the price of the security,
hence reducing the potential return to the investor. As the price of the bond increases, you get longer. As
the price of the bond decreases, you are naturally somewhat hedged because you get less long.

Callable/redeemable bonds

Callable/redeemable bond is bond in which the issuer has the right to call the bond for retirement for a
price determined at the time the bond is issued. This amount will typically be greater than the principal
amount of the bond. In the case of a callable bond, the individual with a long position in this security will
essentially be long the bond and short the embedded call option. The call feature is positive for the
issuer of the bond as it allows the issuer to essentially refinance debt at more favorable terms when
interest rates fall. For the investor, on the other hand, this represents a drawback as it causes the price
behavior of this security to exhibit negative convexity when interest rate levels fall. This limits the capital
appreciation potential of the bonds when interest rates fall. Investors are usually compensated for this
drawback through a greater return potential as callable bonds are usually priced at a discount to other
comparable non-callable fixed income securities.
When callable/putable bonds are issued, the terms governing the bond (frequency, coupon, maturity)
and the terms governing the embedded option such as the strike schedule are defined. The terms of the
bond component are virtually identical to those of other bonds. The embedded call/put option, on the
other hand, may have a lockout period associated with it (i.e., an initial period during which it cannot be
called). (PNB.com.ph)

Convertible bonds

Convertible bonds can be exchanged for common stocks. This feature attracts investors, but these
convertible bonds usually carry lower interest rates. Usually, these bonds come with warrants, which are
options to buy

common stock at a stated price.

Other classification

Income bonds

Income bonds are bonds that pay interest only when the interest is earned by the issuing company. If the
issuing company incurs a loss, it is not required to pay interest on the income bonds. These bonds cannot
put issuing companies into bankruptcy, but from the point of view of the investor, these bonds are more
risky than the ordinary bonds.

Indexed or purchasing power bond

Popular in Brazil, Israel, Mexico, and a few other countries plagued by high rates of inflation is the
indexed or purchasing power bond. The interest rate paid on these bonds is based on an inflation index
such as the consumer price index (CPI). Therefore, the interest paid rises automatically when the
inflation rate rises protecting the bondholders against inflation. This is similar to the variable rate bond.
The British government has issued an indexed bond whose interest rate is set equal to the British
inflation rate plus 3%. These bonds, as such, provide a "real return" of 3%. Mexico has also used indexed
bonds whose interest rate is pegged to the price of oil to finance the development of its huge petroleum
reserves since oil prices and inflation are correlated offering some protection to investors against
inflation (Weston and Brigham 1993). An increase in the inflation rates increases the return on these
bonds, which are favorable to investors. Inflation-indexed bonds in the United States bear coupons
indexed to reflect inflation and even the final principal payment is an inflation-adjusted principal.

Junk bonds

Junk bonds are speculative, below-investment grade, high-yielding bonds. They are a big default risk
investment; hence, these bonds are high: yielding. High-yield bond mutual funds and other institutional
investors, like energy-related firms, cable TV companies, airlines, and other industrial companies, buy
these bonds. These bonds are usually used to finance corporate restructuring or company buy-outs.
Investors are generally large
companies involved in multibillion dollar takeovers. These bonds are not attractive to individual
investors.

Interest payments on bonds are regular, unlike dividends, which depend on the company's profits and
discretion of the Board of Directors. Moreover, most companies redeem bonds prior to maturity or can
be rolled over. Each year, new corporate bond issues exceed new stock issues substantially despite the
total value of corporate bonds outstanding is less than one- third the value of stocks (Thomas 1997).

The behavior of the bond market is important in companies' financing decisions. When bond yields are
high, many investment projects are postponed because the cost of borrowing is high and the cost of
borrowing is very important in every financial decision. The rate of return of a particular project should
always be higher than the cost of borrowing to finance the project. If the cost of financing is high, the
project is generally postponed until the bond market becomes favorable for borrowers. Clearly, what is
desirable for borrowers and bond issuers is unfavorable to investors who need higher returns on their
investments. They will not invest in bonds that will give lower yields.

Corporate bonds generally have original maturities of 10 to 30 years and are traded over the counter in a
market that is "thin" compared to the major stock exchanges and the US government securities market.
Buyers of corporate bonds are primarily institutions that do not require highly liquid financial assets.
These include life insurance companies, private pension funds, state and local government retirement
funds, and nonprofit organizations. Treasury Bonds

Similar to T-bills, Treasury notes and bonds are issued by the treasury of the country concerned. T-bonds
are government securities which mature beyond one year. At present, the following are the tenor or
term of bonds: 2, 3, 4, 5, 7, 10, 15, 20, and 25 years. These are sold at its face value on origination. The
yield is represented by the coupons, expressed as a percentage of the face value on per annum basis,
payable semi-annually (Infest.cfo.gov.ph). T-notes could be over 1- to 10-year notes.

Retail treasury bonds (RTBS) are like T-notes, but are usually longer in maturity (10 years and above).
They are direct and unconditional obligations of the national government that primarily cater to the
retail market or the end-users. RTBs are safe, liquid, and offer attractive returns to investors. The interest
coupons of T-bonds are paid to the investor quarterly. Furthermore, RTBS serve as a critical part of the
government's program to make government securities available to small investors. They are issued to
mobilize savings and encourage retail investors to purchase long-term papers. In the retail market, the
minimum placement of RTBS is $5,000 in contrast to $500,000 in the wholesale market.
(Infest.cfo.gov.ph)

Floating rate notes (FRNS) in which interest payments rise and fall are based on discount rates for 13-
week T-bills. FRNs are issued for a term of 2 years and pay interest quarterly. Savings bonds are low-risk
savings product that earns interest while protecting you from inflation. They are sold at face value. EE
and E Savings Bonds are secure savings product that pay interest based on current market rates for up to
30 years. Electronic EE Savings Bonds are sold at face value in TreasuryDirect (Treasurydirect.gov). Fixed
rate treasury notes (FXTNs) are direct and unconditional obligations of the national government. The
Bureau of the Treasury

(BTR) issues them. They are interest-bearing and carry a term of more than one year and c be traded in
the secondary market before maturity. The tenors for these debt instruments can

The interest rate on the T-notes and T-bonds are generally higher than the interest rates on T-bills
because of the longer maturity period. Like T-bills, they are almost default-free being T-bills, T-notes and
T-bonds are not discounted. They pay coupon interest semi-annually. They backed by the government,
but are subject to interest rate fluctuations and changes. Unlike come in denominations of P1,000 and
multiples of P1,000. These T-notes and T-bonds are registered issues, which means the Treasury records
the name and address of the current holder of each security and credits the bank account of the owner
of record for accrued interest every 6 months. Like stocks, their ask and bid prices are reported in major
business newspapers and journals like The Wall Street Journal in the United States or business sections
of regular newspapers. T-notes and T-bonds are actively traded in secondary markets.

T-notes and T-bonds are usually issued to fund the national debt and other national expenditures. While
default-risk-free, they are not entirely risk-free. These instruments experience a wider price fluctuation
than money market instruments as interest rates change, and therefore are subject to interest rate risk.
Also, many of the older issued bonds and notes ("off the run" issues) may be less liquid than newly
issued bonds and notes ("on the run" issues) and therefore, subject to liquidity risk.

Municipal Bonds

State and local governments and other political subdivisions must finance their own capital investment
projects like roads, schools, bridges, sewage plants, and airports. These projects need financing and
these local governments usually issue municipal bonds or local government unit (LGU) bonds. New
issues of municipal bonds are generally bought by investment bankers and resold to commercial banks,
insurance firms, and high-income individuals. They are not, however, as saleable as corporate bonds.
Municipal/LGU bonds come in the following two varieties:

1. General obligation bonds (GO)

2.Revenue bonds

General obligation bonds are issued to raise immediate capital to cover expenses and are supported by
the taxing power of the issuer. Revenue bonds, on the other hand, are issued to fund infrastructure
projects and are supported by the income generated by those projects. Both types of bonds are tax
exempt and particularly attractive to risk-averse investors because they are default-risk-free.

Long-Term Negotiable Certificates of Deposit

Long-term negotiable certificates of deposit (LTNCDs) are negotiable certificates of deposit with a
designated maturity or tenor beyond 1 year, representing a bank's obligation to pay the face value upon
maturity, as well as periodic coupon or interest payments during the life of the deposit. It is exactly the
same as the short-term negotiable CDs, but is long. term. LTNCDs are covered by deposit insurance with
the Philippine Deposit Insurance Corp.

(PDIC) up to a maximum amount of $500,000 per depositor. The minimum denomination is $100,000 to
$500,000 depending on the issuer, with increments of $50,000. The interest is paid quarterly and is tax
exempt for qualified individuals if they are held for at least 5 years. Majority of the country's commercial
banks engage in capital-raising activities in accordance with Bangko Sentral ng Pilipinas (BSP)
requirements by issuing LTNCDs. Instead of issuing more shares or launching a new debt instrument,
banks are resorting to LTNCDs, which consumers find more attractive because they are relatively safe yet
high-yielding compared to traditional deposits. These certificates form part of a bank's deposits and rank
senior to all unsecured and subordinated debts, and all classes of equity securities. A long-term time
deposit cannot be transferred during its life, while there is a market for LTNCDs should the holder wish to
sell it prior to maturity date. Big commercial banks like Hong Kong and Shanghai Banking Corp. Ltd.
(HSBC), ING Bank NV Manila Branch, and Standard Chartered Bank, PNB, First Metro Investment Corp.,
and Multinational Investment Bancorporation are leading arrangers, book runners, and selling agents.

Mortgage-Backed Securities

Individual mortgages are non-negotiable and as such are neither liquid nor suited to trading on
secondary markets. As a result, an instrument that came as a result of mortgage companies and banks
grouping mortgages into a standard million block group and issuing securities backed up by these
mortgages, called mortgage-backed securities, came to evolve. These are the mortgage-backed
securities, which are usually in the form of bonds. These are usually sold to pension funds or life
insurance companies. The mortgage houses or banks continue to collect the payments on the mortgages
and pass them on to the owner of the security in the form of interest on the bonds held. This has
resulted in a more efficient mortgage market contributing to lower mortgage rates for homeowners..