PHILIPPINE STOCKEXCHANGE, INC.
FOREWORD
In its effort to educate and increase publicawareness, the Philippine Stock exchange has come up with aseries of Investors Primers that willprovide simplified answers to all inquiries related to thehistory, structure, components, operations, and procedures of thePhilippine securities industry.
Investors Primer I: The PhilippineFinancial Market is the first of a series which aims to providereaders with the necessary information needed to understand thePhilippine Financial Market.
We hope that the information provided herein willresult to a better understanding of the Philippine SecuritiesMarket and in turn, encourage local and foreign investors to takepart in our stock market.
JOSE LUIS U. YULO JR.
President and Chief Executieve Officer
Philippine Copyright 1999 by the Philippine Stock Exchange,Inc.
First Edition
Published by : PSE Training Institute and Research andInformation Department
Philippine Stock Exchange, Inc.
Philippine Stock Exchange Center
Exchange Road, Ortigas Center
1605 Pasig City
Telephone Nos. 636-0122 to 41 locals 805,509,510
http://www.pse.org.ph
Printed in Manila, Philippines
ISBN 971-92134-0-X
KNOWING THE PHILIPPINE FINANCIAL MARKET
AGuide for Investors
Investors Primer I: The Philippine FinancialMarket
Table of Contents
Part I The Investment Scenario
- What is an investment?
- What is the Investment Process?
- Who are the Participants in the investment process?
- What are the different types of investments?
- What is the life of an investment?
- What is the importance of investing?
- What are the rewards of investing?
Part II The Financial Market
- What are the money and capital markets?
- What are the primary and secondary markets?
- What is a stock market and stock exchange?
- What is the over-the-counter market?
- What are the advantages of the stock market?
- Who are the players in the stock market?
Part I The Investment Scenario
An investment is any vehicle into whichfunds can be placed with the expectation that they will generatepositive income and/or their value is preserved or increased.
The overall investment process is themechanism for bringing together suppliers (those having extrafunds) with demanders (those needing funds). Normally, suppliersor savers and demanders or issuers are brought together through afinancial institution or a financial market although there areinstances, such as property transactions, where buyers andsellers directly deal with one another. Financial institutionsare organizations through which the savings of individuals,corporations and governments are channeled into loans orinvestments. Example of financial institutions is banks,investment houses, mutual funds, pension funds and insurancecompanies. Financial markets provide the legal and taxframework/environment that bring together suppliers and demandersof funds to make safe and quick financial transactions, oftenthough intermediaries such as organized securities exchanges.
Suppliers or savers may transfer their fundsthrough financial markets, financial institutions, or directly tothe demanders or issuers. Financial institutions can alsoparticipate in the investment process either as suppliers ordemanders of funds.
The financial markets consist of two parts,namely, the money market and the capital market. The money marketdeals with short-term investments while the capital market is forlong-term investments. A more thorough discussion about thesemarkets can be found in Part II.
The three key participants in the investmentprocess are government, business and individuals. They can eitherbe a demander or supplier of funds.
Government
Both local and national government needlarge amounts of money. Funds are needed to finance capitalexpenditures like long-term infrastructure projects roadbuilding, schools and hospitals through the issuance of differenttypes of long-term debt securities. Also, government needs tofund operating costs that keep it running. Normally these fundsare sourced from taxes and fees collections. In cases where theoperating expenditures exceed government revenues or ifgovernment receipts are not yet available to meet governmentpayments, government resorts to borrowing funds by issuingshort-term debt securities. If government has temporary idlecash, it sometimes makes short-term investments to earn positivereturns. As such, government becomes suppliers of funds.
Business
Most businesses require big sums of money tosupport operations in both the long term and short-term. On theshort-term, funds are used to meet operating cost like financinginventory and accounts receivables. Long-term needs of businessesare concentrated on seeking funds to develop products, buildplants and buy equipment. Financing these needs requirebusinesses to issue a variety of debt and equity securities. Likegovernment, business firms also supply funds if they have excesscash. At the same time, they are both net demanders of fund sincethey demand more funds than they supply.
Individuals
We are more familiar of the fact that peopleneed money, in the form of loans, to buy property like cars andhouses. Yet individuals supply funds to help meet the needs ofboth government and businesses through deposits in savingsaccounts, purchases of debt or equity securities, buy insuranceor various types of property. As a group, individuals are netsuppliers of funds; they put money into the financial system thanthey take out.
Investors can either be individual orinstitutional.
Individual
Individual investors personally handle theirfunds to meet their financial goals. Earning interest from idlefunds, ensuring the familys security and building aretirement fund are some reasons why the individual investorinvests.
Institutional
People with large sums of money forinvestment or who are too busy or lack expertise for investmentdecisions often hire an institutional investor. Institutionalinvestors commonly know as fund managers, are investmentprofessionals paid to manage the funds of others using theirexpertise and sophistication in both investment knowledge andmethod. Aside from rich individuals and professional investorsinclude financial institutions and large non-financialcorporations. Individual investors trade in large amounts ofsecurities to earn high returns that can be used as additionalsources of interest payments (for banks) and benefits topolicyholders or beneficiaries (for insurance companies).
There is a wide range of investment vehiclesavailable to the investor such as securities, mutual funds,property and others.
Securities
Securities are investments that representevidence of debt or ownership interest in a business or otherassets. Bonds and stocks are the most frequently used types ofsecurities.
Investment in securities represents either adebt or an equity interest. Debt represents funds borrowed inexchange for receiving interest income and the promise that theloan will be repaid at a given future date. Bonds and commercialpapers are example of debt securities. Equity represents acurrent ownership interest in a specific business or property.Typically, an investor obtains an equity interest in a businessby buying securities collectively known as stocks (i.e., common,preferred and convertible preferred).
Debt securities are similar to bank loans,in that the corporation promises to pay the face value on thematurity date together with interest payments at regularintervals. But unlike a bank loan, bonds and commercial papersare represented by certificates, which are handed over to thebuyer who becomes the holder of the certificates. In this way,stocks are also similar to debt securities a stockcertificate is issued but differ in a way that the issuingcompany does not have the obligation to pay interest to theholder or repay the face value of the stock.
The investor also has a choice, of whichtype of securities to invest in depending on such considerationslike cost, rate of return, risk involved and taxes to be paid.
Short-term investment
Examples of short-term investment vehiclesare deposit accounts, Treasury bills (T-bills), commercialpapers, certificates of deposit, promissory notes and the like.The maturity of all these instruments is under one year. Theseinstruments are suitable for temporarily investing idle funds andearning a return, usually interest. Generally, they are popularto conservative investors because they carry little or no risk atall. They are highly liquid since they can be easily converted tocash with little or no loss in value, thus, enabling the investorto quickly obtain funds to meet unexpected obligations or shiftto more attractive investment opportunities.
Common stock
Buying a share of common stock is in factbuying a share of a business. An individual who owns shares in,say Petron or PLDT has an ownership interest in that company andis called a stockholder or shareholder. The he holds are evidenceof ownership in the corporation. The percentage or proportion ofownership depends on how many of the companys shares heowns.
For example, 1000 shares of common stock ina corporation that has 100,000 outstanding shares represent1,000/100,000 ownership interest. This means you have a onepercent ownership interest in the companys plant, itsbuilding, its inventories and, last but not the least, itsmanagement. You own one percent in everything that the companyhas or may have in the future. This type of ownership is alsoreferred to as having equity in a company; hence, stocks are alsocalled equity securities.
Fixed-income securities
Common examples of fixed-income securitiesare bonds, preferred stocks and convertible securities. Thesegroups of investment vehicles offers a fixed periodic return andare quite popular investments during periods of high interestrates since investors like to have guaranteed high returns.
Bonds
Are long-term debt instruments that offerthe holder a known interest return along with a return of thebonds face value (the value stated on the face of thecertificate) at maturity (usually 20 years). Bonds are commonlyissued by corporations and governments.
Preferred stocks
Represent an ownership interest in a firmand like common stocks, has no maturity date. It has however aspecific dividend rate. This dividend payment has preference ovestock dividends paid to common stockholders. Aside from thedividends it pays, investors buy preferred stocks for thepossibility of earning capital gains from its sale.
Convertible security
Is a special type of fixed-income obligation(bond or preferred stock) with a feature permitting the investorthe benefit of earning fixed income such as interest (for bonds)or dividends (for preferred stocks), while offering the potentialof capital gains (like common stocks)
Mutual funds
A mutual fund is the commonly used name foran investment company, which pools the money of many investorsinto a large fund. It is managed by a financial professional,called an investment adviser or fund manager. who invest thislarge accumulation of funds into a large portfolio of securities,such as debt and equity securities, and other financialinstruments.
Property
Investments in property can either be inreal property or tangible personal property.
Real estate
This term usually refers to raw land,buildings and that which is permanently affixed to the land suchas residential homes, commercial property (condominiums, officeand apartment buildings), and the like. Returns normally receivedfrom this form of investment are in the form of capital gains,rental income, etc.
Tangibles
Examples of tangibles include gold, preciousmetals and gemstones, along with collectible items such asartwork, antiques, coins and stamps. Investors purchase these inanticipation of price increases.
The life of an investment can either beshort or long-term. Sort-term investments usually mature withinone year while long-term investments have longer maturities, likebonds, or with no maturity at all, like common stocks.
Investing is the process of placing funds inselected investment vehicles with the expectation of generatingpositive income and/or preserving and increasing their value.
The availability of funds in the economylargely influences its growth and continuity. A cyclicalinterdependence dictates the flow of funds that are needed tofinance the activities of government, business firms, evenindividuals. For instance, if fewer individuals save their moneyin financial institutions, supply of funds for investments orborrowings will decline. A shortage in funds for housing loanswill result to fewer houses being bought. Corollary, fewer housesbeing bought will mean fewer people being employed to buildhouses and lower demand for construction materials. This wouldalso affect the demand for consumer goods such as appliances,furniture and fixtures, which would in turn affect the sales ofthe manufacturers of these goods. Lower sales translate to lowertaxes and lower income to be used for business expansion.
It must be noted that for the investmentprocess to run smoothly, the suppliers of funds must besufficiently compensated by the demanders of funds in exchangefor the risk involved in supplying the funds.
Returns or rewards form investing are in theform of current income or increase in value. An example ofearning current income is placing money in a savings account thatwould give periodic (usually quarterly) interest payments orinsurance policy that offers dividends. On the other hand,investing ina piece of property entails expectations of anincrease in its value between the time it was bought and the timeit will be sold.
Financial markets are classified into themoney market and the capital market. The money market is whereshort-term funds are raised through the buying and selling ofshort term debt securities such as commercial papers. The capitalmarket is where long-term funds are raised through the bondmarket, which deals with long-term debt securities such as bonds,the stock market which deals with equity securities or stocks.
Basically, it is in the capital market,called the stock market, where an investor can buy and sellstocks. This market consists of the primary market or secondarymarket, depending on whether the securities were sold by thecompany itself or by an existing shareholder(s).
Primary market
In the primary market, new shares are issuedand sold to the investing public for the first time. It is wherecapital is actually raised by the company selling stock directlyto investors typically through an initial public offering. Forinstance, if San Miguel Corporation decides to sell a new stockto raise equity funds, it will be a primary market transaction.Since it is the first time the company has sold stock to thepublic, it is called an initial public offering (IPO). Theproceeds of the sale go to San Miguel Corporation, the issuingcompany. Investors who have subscribed to the IPO have providedthe company with the necessary funds to continue its operationand expansion, and become part owners of the company.
An underwriter or investment banker assiststhe issuer of a new security in setting the offering price and inmarketing the securities to the public. The investment bankersserves as a middleman in the transfer of funds between thecompany in need of capital and the public, and facilitates theissuance of shares.
There is occasionally a secondary offeringin the primary market. This means that the shares of stock beingoffered were previously issued but is being offered to the publicfor the first time by a large or controlling shareholder. Assuch, the selling stockholder gets the proceeds of the sale.
Secondary market
The secondary market is where securities canbe bought and sold after they have been issued to the public inthe primary market. Thus, if you decide to buy existing shares ofSan Miguel Corporation, you cannot buy them directly from theissuing company anymore since they have all been sold to theinvesting public during the initial public offering.
So, how can you avail of San Miguel shareswhen the IPO has been completed? Investors can only buy theseshares from existing shareholders who are willing to sell theirshares. When they do so, it is a secondary market transaction.The proceeds from this transaction don not go to the issuingcorporation; instead they go to the investor who sold his shares.
The secondary market is where the originalshareholders sell their shares to other investors. An investorcan only make a profit when he can sell his shares at a pricehigher that the purchase price. This market gives a continuousreflection of the value of securities (prices) at some point intime according to the best available information.
Secondary markets include the stock exchangeand the over-the-counter (OTC) market.
There are differences in their definitionbut real concept of a stock exchange and stock market remainsconstant. Simply defined, a stock market is an organized activityinvolving the buying and/or selling of securities done within astock exchange.
In a fundamental sense, a stock exchangebrings buyers and sellers together. It is an organization whosefunction is to facilitate the purchase and sale of stocks andother securities. It is a market where investors can buy and sellsecurities after they have been offered in the primary market.
Remember that the stock exchange is not acapital raising mechanism. As part of the secondary market, it isonly adjunct to the capital raising market or primary market. Itis merely a place or means where existing shareholders can selltheir shares to those who are ready to buy.
The stock exchange and the stock marketfacilitate the flow of savings into investments by providing aready market for the resale of securities. The inflow of funds inthe stock market is one efficient way of directing a neededresource (in this case, money) into a growing economy. As such,the stock exchange plays a key role in economic development byproviding a centralized environment that brings together thedemanders and suppliers of funds to make secure and fasttransactions.
Stocks of corporations not listed andtherefore not traded in the stock exchange but registered andlicensed by the Securities and Exchange Commission for sale tothe public are only available in the so-called over-the-counter(OTC) market. This market is not a specific organization butanother way of trading securities. OTC transactions are carriedout by direct inquiries and negotiations among the buyers andsellers through the use of mail, telephone, telegraph, Teletype,or other forms of communications.
The stock market is a better market for thetrading of securities as opposed to the OTC because of thefollowing:
Most accessiblemarket
Through the offices of member firms locatedeverywhere, even in the provinces, stocks are available tomillions of people.
Ready market
With a simple phone call, an investor canbuy and sell stock, virtually within minutes. Market transactionsare done swiftly, conveniently and at a fair price.
Liquidity of the market
Hundreds of different stocks are availableto thousands of buyers and sellers and can readily be turned intocash due to the large number of market players. The OTC market isgenerally much thinner or less liquid which makes it moredifficult to sell at a certain time in a failing market due tolack of buyers.
Operates in full public view
Transactions and price data are readilyavailable through newspapers, radio, television and informationnetworks. Unlike the stock exchange, the over-the-counter stockprices are not published daily in the newspapers, which makes itmore difficult for an investor to keep track of his investment.
Investors are the ones who buy and sellsecurities in the hope of receiving dividend income and making aprofit through capital appreciation. These buyers and sellers arenot the only players in the stock market. Other persons orinstitutions ensure that the stock market is a readilyaccessible, efficient, orderly and transparent market. These are:
Stockbroker
Anyone who wishes to buy shares of stocks orbonds must have a stockbroker. He acts as an agent or middlemanbetween the investor and other buyers/sellers. As anintermediary, the stockbroker executes orders for clients,purchasing or selling the stocks on the stock exchange. He is theonly person or corporation authorized and licensed by theSecurities and Exchange Commission to trade in securities. Theyare commonly known as members, member-brokers, or member-firms ofthe Philippine Stock Exchange.
Stock exchange
This is the organization that oversees thetransactions of the buyers and sellers placed through themember-brokers. Its professional management ensures that themarket is efficient, fair, transparent and orderly by enforcingits rules and regulations.
Transfer agent
When shares are purchased and transferredfrom the seller to the buyer, the transaction should be recordedin the stock books of every listed company which record thecomplete shareholdings of each stockholder of the company. Butmost companies have his record keeping done by a separate agency,called the transfer agent. Thus, when a transaction has beendone, the details are kept in a ledger or record book by thecompanys transfer agent. As such, the transfer agentsmaintains the ledgers for each issuer company showing the nameand address of, and the number of shares held by each registeredstockholder. Another function of a transfer agent, which iseither a commercial bank or trust company, is to cancel oldcertificates, issue new certificates and change the name of thecertificates into the buyers name when the shares have beensold.
Clearing House
When a transaction has been made, the seller through his stockbroker has to deliver the stockcertificate to the buyer who in turn orders his stockbroker topay for the shares purchased. This seems to be an easy process.But considering the thousands of transactions executed everydayand the nearly 200 stockbrokers involved, broker-to-brokerpayments and delivery of certificates would become complicated.To facilitate transactions and make the market more orderly, allpayments by all stockbrokers are done to a centralizedinstitution, called the clearinghouse. Thus, all stockbrokerswill make payments to and receive payments from the clearinghousefor purchases and sales they have made for their clients. At thesame time, all stock certificates will be delivered to andobtained from this central institution.
Listed company
A corporation that offers and lists itsshares in the stock exchange is called a listed company orissuer. A listed company is also known as a publicly ownedcompany in view of the fact that its shares were sold to theinvesting public. These are the companies that raised theirrequired funds through such issuance of securities to the public.The capital raised provides the company with the necessary fundsto be invested in business facilities and equipment. An issuingcompany becomes a listed company, whose shares are traded in thestock market, after it has met the strict listing requirementsimposed by the stock exchange.
