PHILIPPINE STOCK EXCHANGE, INC.
FOREWORD
In its effort to educate and increase public awareness, the Philippine Stock exchange has come up with a series of Investors Primers that will provide simplified answers to all inquiries related to the history, structure, components, operations, and procedures of the Philippine securities industry.
Investors Primer I: The Philippine Financial Market is the first of a series which aims to provide readers with the necessary information needed to understand the Philippine Financial Market.
We hope that the information provided herein will result to a better understanding of the Philippine Securities Market and in turn, encourage local and foreign investors to take part 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 and Information 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
A Guide for Investors
Investors Primer I: The Philippine Financial Market
Table of Contents
Part I The Investment Scenario
Part I The Investment Scenario
An investment is any vehicle into which funds can be placed with the expectation that they will generate positive income and/or their value is preserved or increased.
The overall investment process is the mechanism for bringing together suppliers (those having extra funds) with demanders (those needing funds). Normally, suppliers or savers and demanders or issuers are brought together through a financial institution or a financial market although there are instances, such as property transactions, where buyers and sellers directly deal with one another. Financial institutions are organizations through which the savings of individuals, corporations and governments are channeled into loans or investments. Example of financial institutions is banks, investment houses, mutual funds, pension funds and insurance companies. Financial markets provide the legal and tax framework/environment that bring together suppliers and demanders of funds to make safe and quick financial transactions, often though intermediaries such as organized securities exchanges.
Suppliers or savers may transfer their funds through financial markets, financial institutions, or directly to the demanders or issuers. Financial institutions can also participate in the investment process either as suppliers or demanders of funds.
The financial markets consist of two parts, namely, the money market and the capital market. The money market deals with short-term investments while the capital market is for long-term investments. A more thorough discussion about these markets can be found in Part II.
The three key participants in the investment process are government, business and individuals. They can either be a demander or supplier of funds.
Government
Both local and national government need large amounts of money. Funds are needed to finance capital expenditures like long-term infrastructure projects – road building, schools and hospitals through the issuance of different types of long-term debt securities. Also, government needs to fund operating costs that keep it running. Normally these funds are sourced from taxes and fees collections. In cases where the operating expenditures exceed government revenues or if government receipts are not yet available to meet government payments, government resorts to borrowing funds by issuing short-term debt securities. If government has temporary idle cash, it sometimes makes short-term investments to earn positive returns. As such, government becomes suppliers of funds.
Business
Most businesses require big sums of money to support operations in both the long term and short-term. On the short-term, funds are used to meet operating cost like financing inventory and accounts receivables. Long-term needs of businesses are concentrated on seeking funds to develop products, build plants and buy equipment. Financing these needs require businesses to issue a variety of debt and equity securities. Like government, business firms also supply funds if they have excess cash. At the same time, they are both net demanders of fund since they demand more funds than they supply.
Individuals
We are more familiar of the fact that people need money, in the form of loans, to buy property like cars and houses. Yet individuals supply funds to help meet the needs of both government and businesses through deposits in savings accounts, purchases of debt or equity securities, buy insurance or various types of property. As a group, individuals are net suppliers of funds; they put money into the financial system than they take out.
Investors can either be individual or institutional.
Individual
Individual investors personally handle their funds to meet their financial goals. Earning interest from idle funds, ensuring the family’s security and building a retirement fund are some reasons why the individual investor invests.
Institutional
People with large sums of money for investment or who are too busy or lack expertise for investment decisions often hire an institutional investor. Institutional investors commonly know as fund managers, are investment professionals paid to manage the funds of others using their expertise and sophistication in both investment knowledge and method. Aside from rich individuals and professional investors include financial institutions and large non-financial corporations. Individual investors trade in large amounts of securities to earn high returns that can be used as additional sources of interest payments (for banks) and benefits to policyholders or beneficiaries (for insurance companies).
There is a wide range of investment vehicles available to the investor such as securities, mutual funds, property and others.
Securities
Securities are investments that represent evidence of debt or ownership interest in a business or other assets. Bonds and stocks are the most frequently used types of securities.
Investment in securities represents either a debt or an equity interest. Debt represents funds borrowed in exchange for receiving interest income and the promise that the loan will be repaid at a given future date. Bonds and commercial papers are example of debt securities. Equity represents a current ownership interest in a specific business or property. Typically, an investor obtains an equity interest in a business by 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 the maturity date together with interest payments at regular intervals. But unlike a bank loan, bonds and commercial papers are represented by certificates, which are handed over to the buyer who becomes the holder of the certificates. In this way, stocks are also similar to debt securities – a stock certificate is issued – but differ in a way that the issuing company does not have the obligation to pay interest to the holder or repay the face value of the stock.
The investor also has a choice, of which type of securities to invest in depending on such considerations like cost, rate of return, risk involved and taxes to be paid.
Short-term investment
Examples of short-term investment vehicles are deposit accounts, Treasury bills (T-bills), commercial papers, certificates of deposit, promissory notes and the like. The maturity of all these instruments is under one year. These instruments are suitable for temporarily investing idle funds and earning a return, usually interest. Generally, they are popular to conservative investors because they carry little or no risk at all. They are highly liquid since they can be easily converted to cash with little or no loss in value, thus, enabling the investor to quickly obtain funds to meet unexpected obligations or shift to more attractive investment opportunities.
Common stock
Buying a share of common stock is in fact buying a share of a business. An individual who owns shares in, say Petron or PLDT has an ownership interest in that company and is called a stockholder or shareholder. The he holds are evidence of ownership in the corporation. The percentage or proportion of ownership depends on how many of the company’s shares he owns.
For example, 1000 shares of common stock in a corporation that has 100,000 outstanding shares represent 1,000/100,000 ownership interest. This means you have a one percent ownership interest in the company’s plant, its building, its inventories and, last but not the least, its management. You own one percent in everything that the company has or may have in the future. This type of ownership is also referred to as having equity in a company; hence, stocks are also called equity securities.
Fixed-income securities
Common examples of fixed-income securities are bonds, preferred stocks and convertible securities. These groups of investment vehicles offers a fixed periodic return and are quite popular investments during periods of high interest rates since investors like to have guaranteed high returns.
Bonds
Are long-term debt instruments that offer the holder a known interest return along with a return of the bond’s face value (the value stated on the face of the certificate) at maturity (usually 20 years). Bonds are commonly issued by corporations and governments.
Preferred stocks
Represent an ownership interest in a firm and like common stocks, has no maturity date. It has however a specific dividend rate. This dividend payment has preference ove stock dividends paid to common stockholders. Aside from the dividends it pays, investors buy preferred stocks for the possibility 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 investor the benefit of earning fixed income such as interest (for bonds) or dividends (for preferred stocks), while offering the potential of capital gains (like common stocks)
Mutual funds
A mutual fund is the commonly used name for an investment company, which pools the money of many investors into a large fund. It is managed by a financial professional, called an investment adviser or fund manager. who invest this large accumulation of funds into a large portfolio of securities, such as debt and equity securities, and other financial instruments.
Property
Investments in property can either be in real property or tangible personal property.
Real estate
This term usually refers to raw land, buildings and that which is permanently affixed to the land such as residential homes, commercial property (condominiums, office and apartment buildings), and the like. Returns normally received from this form of investment are in the form of capital gains, rental income, etc.
Tangibles
Examples of tangibles include gold, precious metals and gemstones, along with collectible items such as artwork, antiques, coins and stamps. Investors purchase these in anticipation of price increases.
The life of an investment can either be short or long-term. Sort-term investments usually mature within one year while long-term investments have longer maturities, like bonds, or with no maturity at all, like common stocks.
Investing is the process of placing funds in selected investment vehicles with the expectation of generating positive income and/or preserving and increasing their value.
The availability of funds in the economy largely influences its growth and continuity. A cyclical interdependence dictates the flow of funds that are needed to finance the activities of government, business firms, even individuals. For instance, if fewer individuals save their money in financial institutions, supply of funds for investments or borrowings will decline. A shortage in funds for housing loans will result to fewer houses being bought. Corollary, fewer houses being bought will mean fewer people being employed to build houses and lower demand for construction materials. This would also affect the demand for consumer goods such as appliances, furniture and fixtures, which would in turn affect the sales of the manufacturers of these goods. Lower sales translate to lower taxes and lower income to be used for business expansion.
It must be noted that for the investment process to run smoothly, the suppliers of funds must be sufficiently compensated by the demanders of funds in exchange for the risk involved in supplying the funds.
Returns or rewards form investing are in the form of current income or increase in value. An example of earning current income is placing money in a savings account that would give periodic (usually quarterly) interest payments or insurance policy that offers dividends. On the other hand, investing ina piece of property entails expectations of an increase in its value between the time it was bought and the time it will be sold.
Financial markets are classified into the money market and the capital market. The money market is where short-term funds are raised through the buying and selling of short term debt securities such as commercial papers. The capital market is where long-term funds are raised through the bond market, 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 sell stocks. This market consists of the primary market or secondary market, depending on whether the securities were sold by the company itself or by an existing shareholder(s).
Primary market
In the primary market, new shares are issued and sold to the investing public for the first time. It is where capital is actually raised by the company selling stock directly to investors typically through an initial public offering. For instance, if San Miguel Corporation decides to sell a new stock to raise equity funds, it will be a primary market transaction. Since it is the first time the company has sold stock to the public, it is called an initial public offering (IPO). The proceeds of the sale go to San Miguel Corporation, the issuing company. Investors who have subscribed to the IPO have provided the company with the necessary funds to continue its operation and expansion, and become part owners of the company.
An underwriter or investment banker assists the issuer of a new security in setting the offering price and in marketing the securities to the public. The investment bankers serves as a middleman in the transfer of funds between the company in need of capital and the public, and facilitates the issuance of shares.
There is occasionally a secondary offering in the primary market. This means that the shares of stock being offered were previously issued but is being offered to the public for the first time by a large or controlling shareholder. As such, the selling stockholder gets the proceeds of the sale.
Secondary market
The secondary market is where securities can be bought and sold after they have been issued to the public in the primary market. Thus, if you decide to buy existing shares of San Miguel Corporation, you cannot buy them directly from the issuing company anymore since they have all been sold to the investing public during the initial public offering.
So, how can you avail of San Miguel shares when the IPO has been completed? Investors can only buy these shares from existing shareholders who are willing to sell their shares. When they do so, it is a secondary market transaction. The proceeds from this transaction don not go to the issuing corporation; instead they go to the investor who sold his shares.
The secondary market is where the original shareholders sell their shares to other investors. An investor can only make a profit when he can sell his shares at a price higher that the purchase price. This market gives a continuous reflection of the value of securities (prices) at some point in time according to the best available information.
Secondary markets include the stock exchange and the over-the-counter (OTC) market.
There are differences in their definition but real concept of a stock exchange and stock market remains constant. Simply defined, a stock market is an organized activity involving the buying and/or selling of securities done within a stock exchange.
In a fundamental sense, a stock exchange brings buyers and sellers together. It is an organization whose function is to facilitate the purchase and sale of stocks and other securities. It is a market where investors can buy and sell securities after they have been offered in the primary market.
Remember that the stock exchange is not a capital raising mechanism. As part of the secondary market, it is only adjunct to the capital raising market or primary market. It is merely a place or means where existing shareholders can sell their shares to those who are ready to buy.
The stock exchange and the stock market facilitate the flow of savings into investments by providing a ready market for the resale of securities. The inflow of funds in the stock market is one efficient way of directing a needed resource (in this case, money) into a growing economy. As such, the stock exchange plays a key role in economic development by providing a centralized environment that brings together the demanders and suppliers of funds to make secure and fast transactions.
Stocks of corporations not listed and therefore not traded in the stock exchange but registered and licensed by the Securities and Exchange Commission for sale to the public are only available in the so-called over-the-counter (OTC) market. This market is not a specific organization but another way of trading securities. OTC transactions are carried out by direct inquiries and negotiations among the buyers and sellers through the use of mail, telephone, telegraph, Teletype, or other forms of communications.
The stock market is a better market for the trading of securities as opposed to the OTC because of the following:
Most accessible market
Through the offices of member firms located everywhere, even in the provinces, stocks are available to millions of people.
Ready market
With a simple phone call, an investor can buy and sell stock, virtually within minutes. Market transactions are done swiftly, conveniently and at a fair price.
Liquidity of the market
Hundreds of different stocks are available to thousands of buyers and sellers and can readily be turned into cash due to the large number of market players. The OTC market is generally much thinner or less liquid which makes it more difficult to sell at a certain time in a failing market due to lack of buyers.
Operates in full public view
Transactions and price data are readily available through newspapers, radio, television and information networks. Unlike the stock exchange, the over-the-counter stock prices are not published daily in the newspapers, which makes it more difficult for an investor to keep track of his investment.
Investors are the ones who buy and sell securities in the hope of receiving dividend income and making a profit through capital appreciation. These buyers and sellers are not the only players in the stock market. Other persons or institutions ensure that the stock market is a readily accessible, efficient, orderly and transparent market. These are:
Stockbroker
Anyone who wishes to buy shares of stocks or bonds must have a stockbroker. He acts as an agent or middleman between the investor and other buyers/sellers. As an intermediary, the stockbroker executes orders for clients, purchasing or selling the stocks on the stock exchange. He is the only person or corporation authorized and licensed by the Securities and Exchange Commission to trade in securities. They are commonly known as members, member-brokers, or member-firms of the Philippine Stock Exchange.
Stock exchange
This is the organization that oversees the transactions of the buyers and sellers placed through the member-brokers. Its professional management ensures that the market is efficient, fair, transparent and orderly by enforcing its rules and regulations.
Transfer agent
When shares are purchased and transferred from the seller to the buyer, the transaction should be recorded in the stock books of every listed company which record the complete shareholdings of each stockholder of the company. But most companies have his record keeping done by a separate agency, called the transfer agent. Thus, when a transaction has been done, the details are kept in a ledger or record book by the company’s transfer agent. As such, the transfer agents maintains the ledgers for each issuer company showing the name and address of, and the number of shares held by each registered stockholder. Another function of a transfer agent, which is either a commercial bank or trust company, is to cancel old certificates, issue new certificates and change the name of the certificates into the buyer’s name when the shares have been sold.
Clearing House
When a transaction has been made, the seller – through his stockbroker – has to deliver the stock certificate to the buyer who in turn orders his stockbroker to pay for the shares purchased. This seems to be an easy process. But considering the thousands of transactions executed everyday and the nearly 200 stockbrokers involved, broker-to-broker payments and delivery of certificates would become complicated. To facilitate transactions and make the market more orderly, all payments by all stockbrokers are done to a centralized institution, called the clearinghouse. Thus, all stockbrokers will make payments to and receive payments from the clearinghouse for purchases and sales they have made for their clients. At the same time, all stock certificates will be delivered to and obtained from this central institution.
Listed company
A corporation that offers and lists its shares in the stock exchange is called a listed company or issuer. A listed company is also known as a publicly owned company in view of the fact that its shares were sold to the investing public. These are the companies that raised their required funds through such issuance of securities to the public. The capital raised provides the company with the necessary funds to be invested in business facilities and equipment. An issuing company becomes a listed company, whose shares are traded in the stock market, after it has met the strict listing requirements imposed by the stock exchange.