Financial Markets Midterm Reviewer PDF

FINANCIAL MARKETS – MIDTERM REVIEWER B. Item of worth – most money originally has an intrinsic value, such as that of the precious metal that was used CHAPTER 1: RATIONALE IN STUDY...

FINANCIAL MARKETS – MIDTERM REVIEWER B. Item of worth – most money originally has an intrinsic value, such as that of the precious metal that was used CHAPTER 1: RATIONALE IN STUDYING FINANCIAL MARKETS AND to make the coin. INSTITUTIONS C. Means of exchange – it must be possible to exchange Financial markets and institutions – not only influence your money freely and widely for goods, and its value should everyday life, but also involve huge cash flows of funds be as stable as possible. throughout the world economy which in turn affect business D. Unit of account – money can be used to record wealth profits, the production of goods and services and the economic possessed, traded or spent personally and nationally. well-being of the countries around the world. E. Standard of deferred payment – money can facilitate The study of financial markets and institutions shows how funds exchange at a given point by providing a medium of are transferred from people who have excess of available funds exchange and unit of account. to people who have a shortage. THE EVOLUTION OF MONEY Financial markets – markets for stocks, bonds, and foreign 1. Barter (10000–3000BCE) – in early forms of trading, currency exchange. specific items were exchanged for others agreed by Financial institutions – includes banks, insurance companies, the negotiating parties to be of similar value. mutual funds, and other institutions that serves as financial Advantages: intermediaries that acquire funds by issuing liabilities and in turn a. Trading relationship – foster strong links use those funds to acquire assets by purchasing securities or between partners. making loan. b. Physical goods are exchanged – barter does not rely on trust that money will retain its value. Financial markets have been around ever since mankind settled down to growing crops and trading them with others. Disadvantages: THE NEED TO STUDY FINANCIAL INSTITUTIONS a. Market needed – both parties must want what the other offers. Direct fund transfers – are common among individuals and small b. Hard to establish a set value on items – two businesses and in economies where financial markets and goats may have a certain value to one party institutions are less developed. one day, but less a week later. Financial markets are what make financial market work. Without c. Goods may not be easily divisible – for them, financial markets would not be able to move funds from example, a living animal cannot be divided. people who save to people who have productive investment d. Large-scale transactions can be difficult – opportunities. Thus, they also have important effects on the transporting one goat is easy, moving 1,000 is performance of the economy as a whole. not. 2. Evidence of trade records (7000BCE) – pictures of items Financial institutions play an important role in the financial system were used to record trade exchanges, becoming more because they reduce transaction costs, allow sharing and solve complex as values were established and documented. problems created by adverse relation and moral hazard. 3. Coinage (600BCE-1100CE) – defined weights of precious metals used by some merchants were later ~~~END OF CHAPTER 1~~~ formalized as coins that were usually issued by states. CHAPTER 2: INTRODUCING MONEY AND INTEREST RATES 4. Bank notes (1100-2000) – states began to use bank notes, issuing paper IOUs that were traded as currency, Money – is any item or commodity that is generally accepted as and could be exchanged for coins at any time. a means of payment for goods and services or for repayment of 5. Digital money (2000 onward) – Money can now exist debt, and that serves as an asset to its holder. “virtually” on computers, and large transactions can On the simplest level, money is composed of the bills and coins take place without any physical cash changing hands. which have been printed or minted by the National Government ARTIFACTS OF MONEY (these are called currency). But money also includes the funds stored as electronic entries in one’s checking account and 1. Barter (5000BCE) – early trade involved directly savings account. exchange items – often perishable ones such as a cow. 2. Sumerian cuneiform tablets (4000BCE) – scribes Money in the modern economy is not directly backed by intrinsic recorded transactions on clay tablets, which could also value (e.g., the coin’s weight in gold or silver) the financial act as receipts. system works entirely in a fiduciary basis, relying on the publics 3. Cowrie shells (1000BCE) – used as currency across India confidence in the established forms of monetary exchange. and the South Pacific, they appeared in many colors CHARACTERISTICS AND KEY FUNCTIONS OF MONEY and sizes. 4. Lydian gold coins (600BCE) – in Lydia, a mixture of gold Money is not money unless it has all of the following defining and silver was formed into disks, or coins, stamped with characteristics: it must have value, be durable, portable, uniform, inscriptions. divisible, in limited supply, and be usable as a means of 5. Athenian drachma (600BCE) – the Athenians used silver exchange. from Laurion to mint a currency used right across the A. Store of value – money acts as a means by which Greek world. people can store their wealth for future use.  6. Han dynasty coin (200BCE) – often made of bronze or D. Japanese Regime – the Japanese issued the Japanese copper, early Chinese coins had holes punched in their war notes also called “mickey mouse” as it has no center. reserves nor backed up by any government asset. 7. Roman coin (27BCE) – bearing the head of the E. Post-War Period – all Japanese currencies circulating in emperor, these coins circulated throughout the Roman the Philippines were declared illegal. In 2010 the Empire. Central Bank launched the “New Generation 8. Byzantine coin (700CE) – early byzantine coins were Currency”, which is uniform in size where significant pure gold; later ones also contained metals such as events in Philippine history, iconic building and heritage copper. sites were featured. 9. Anglo-Saxon coin (900CE) – this 10th century silver THE SUPPLY AND DEMAND FOR MONEY penny has an inscription stating that Offa is King “rex” of Mercia. Money facilitates the flow of resources in the circular model of 10. Arabic dirham (900CE) – many silver coins from the macroeconomy. Not enough money will slow down the Islamic empire were carried to Scandinavia by Vikings. economy, and too much money can cause inflation because of higher price levels. THE ECONOMICS OF MONEY The Money Supply – the precise definition of the overall supply of 1. Potosi inflation (1540-1640) – the Spanish discovered money is complex because of the wide variety of forms of silver in Potosi, Bolivia and caused a century of inflation money in modern economies. by shipping 350 tons of the metal back to Europe annually. The Key Measures for the Money Supply are: 2. The Great Debasement (1542-1551) – England’s Henry A. M1 – the narrowed measure of the money supply. It VIII debased the silver penny, making it three-quarters includes currency in circulation held by nonbank copper. Inflation increased as trust dropped. public, demand deposits, other checkable deposits, 3. Early joint-stock companies (1553) – merchants in and traveler’s checks. M1 refers primarily to money England began to form companies in which investors used as a medium of exchange. bought shares (stock) and shared its rewards. B. M2 – this includes money held in savings deposits, 4. Bank of England (1694) – was created as a body that money market deposit accounts, noninstitutional could raise funds at a low interest rate and manage money market mutual funds and other short-term national debt. money market assets. M2 refers primarily to money used 5. The Royal Mint (1696) – Isaac Newton became Warden as store of value. and argued that debasing undermined confidence. All C. M3 – this measure includes the financial institutions. M3 coins were recalled and new silver coins were minted. refers primarily to money used as a unit of account. 6. US dollar (1775) – the Continental Congress authorized D. L – this measure includes liquid and near-liquid assets the issue of United States dollars in 1775, but the first (e.g., short-term treasury notes, high-grade commercial national currency was not minted by the US Treasury paper and bank acceptance notes). until 1794. 7. Gold Standard (From 1844) – the British pound was tied Bangko Sentral ng Pilipinas (BSP) – responsible for determining to a defined equivalent amount of gold. Other the supply of money. BSP also has an impact on the creation of countries adopted a similar Gold Standard. money by banks through reserve requirements and the discount 8. Credit Cards (1970s) – the creation of credit cards rate that is, the interest rate at which banks can borrow from the enabled consumers to access short-term credit to BSP as a lender of last resort. make smaller purchases. This resulted in the growth of THE DEMAND FOR MONEY personal debt. The sources of the Demand for Money are: 9. Digital Money (1990s) – the easy transfer of funds and convenience of electronic payments became A. Transaction demand – money demanded for day-to- increasingly popular as internet use increased. day payments through balances held by households 10. Euro (1999) – twelve EU countries joined together and and firms (instead of stocks, bonds, or other assets). This replaced their national currencies with the Euro. Bank kind of demand varies with GDP; it does not depend on notes and coins were issued three years later. the rate of interest. 11. Bitcoin (2008) – a form of electronic money that exists B. Precautionary demand – money demanded as a result solely as encrypted data on servers. of unanticipated payments. This kind of demand varies HIGHLIGHTS IN THE HISTORY OF MONEY IN THE PHILIPPINES with GDP. C. Speculative demand – money demanded because of A. Pre-Spanish Regime – commodity money such as gold, expectations about interest rates in the future. This gold dust, silver wires, coffee, sugar, rice, spices, means that people will decide to expand their money carabao were used as money. balances and hold off on bond purchases if they B. Spanish Regime – the Spanish introduced coins in the expect interest rates to rise. This kind of demand of Philippines when they colonized the country 1521. demand has a negative relationship with the interest C. American Regime – the country’s first local currency, rate. the Philippine Peso, was introduced replacing the Rate of interest – is the price paid in the money market for the Spanish-Filipino Peso. use of money. THE IMPACT OF MONEY system is a fiat money system because the BSP does not exchange paper currency for gold or any other commodity Quantity Theory of Money – holds that changes in the money money. supply directly influences the economy’s price level, but nothing else. Checks - are promises to pay on demand money deposited with a bank or other financial institution. They can be written for any THE TIME VALUE OF MONEY amount and using them is a convenient way to settle Interest – is defined as the cost of using money over time. transactions. Present value (or present discounted value) - is based on the NEW TECHNOLOGY AND THE PAYMENTS SYSTEM commonsense notion that a peso of cash flow paid to you one The Bangko Sentral ng Pilipinas supervises the payments system year from now is less valuable to you than a peso paid to you but doesn’t directly control it because many payments are today. processed by banks and other private firms. The BSP has listed Interest rates – link the future to the present. It allows individuals what it believes to be the five most desirable outcomes for a to evaluate the present value of future income and costs. In payments system: essence, it is the market price of earlier availability. 1. Security - episodes in which criminals have hacked into According to Keynesian theory, the rate of interest is determined retail credit card systems and other parts of the as a price in two markets: payments system have raised concerns about security. 1. Investment funds – The rate of balances the demand 2. Efficiency - resources devoted to processing paper for funds (required for investment) and the supply of checks or other aspects of processing payments are funds (from savings). diverted from producing other goods and services. 2. Liquid assets – households and businesses may have 3. Speed - fast settlement of payments facilitates reasons to hold assets in liquid form. Because borrowers transactions by both households and businesses. require cash in the long-term, they are willing to 4. Smooth international transactions - the increasing compensate lenders for giving up liquidity. amount of business that takes place across borders can be facilitated if payments can be made quickly and The Three Components of Money Interest conveniently. 1. Risk premium – reflects the probability of default (the 5. Effective collaboration among participants in the risk imposed on the lender by the possibility that the system - the payments system needs to efficiently borrower may be unavailable to repay the loan). involve governments, financial firms such as banks, and 2. Inflationary premium – reflects the expectation that the other businesses around the world. loan will be repaid with pesos of less purchasing power Automated Clearing House (ACH) - transactions include direct as the result of inflation. deposits of payroll checks into the checking accounts of workers 3. Pure interest – is the real price one must pay for earlier and electronic payments on car loans and mortgages, where availability. the payments are sent electronically from the borrower’s THE IMPACT OF CHANGING INTEREST RATES account and deposited in the lender's account. Control over short-term interest rates is one of the main tools of E-MONEY, BITCOIN, AND BLOCKCHAIN the BSP to achieve its main goals of controlling inflation, E-money or electronic money - which is digital cash people use smoothing out the business cycle and ensuring financial stability. to buy goods and services. Short-term interest rates – are relevant for loans with a relatively Bitcoin - is not owned by a firm is instead the product of a short length for repayment. decentralized system of linked computers. Long-term interest rates – are relevant for loans such as long-term Blockchain - is technically a distributed ledger, or an online corporate borrowing and 10-20-30 year fixed rate mortgages. network that registers ownership of funds, securities, or any other good, including movies and songs. ~~~END OF CHAPTER 2~~~ CASHLESS SOCIETY CHAPTER 3: INTRODUCING THE PAYMENTS SYSTEM A Federal Reserve study found that noncash payments continue Payments system - money facilitates transactions in the to increase as a fraction of all payments, and electronic economy. payments now make up more than two-thirds of all noncash THE TRANSITION FROM COMMODITY MONEY TO FIAT MONEY payments. Commodity money - refers to a good used as money that has ~~~END OF CHAPTER 3~~~ value independent of its use as money. CHAPTER 4: FINANCIAL INSTRUMENTS Fiat money - refers to money, such as paper currency that has no value apart from its use as money. Financial instrument - is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of Legal tender - means the government accepts paper currency another entity. in payment of taxes and requires that individuals and firms accept it in payment of debts. Contract - in the definition refers to an agreement between two or more parties that has clear economic consequences that the In modern economies, the central bank (Bangko Sentral ng parties have little, if any discretion to avoid, usually because the Pilipinas), issues paper currency. The modern BSP payments agreement is enforceable by law. Financial instruments include primary instruments and derivative (ii) To exchange financial assets or financial liabilities with financial instruments. another entity under conditions that are potentially unfavorable to the entity; or Based on the definition, financial instruments include financial assets, financial liabilities, equity instrument and derivatives. (b) A contract that will or may be settled in the entity's own equity instruments and is: Derivatives include financial options, futures and forwards, interest rate swaps and currency swaps. (i) A non-derivative for which the entity is or may be obligated to deliver a variable number of the entity's own equity instruments; A FINANCIAL ASSET IS ANY ASSET THAT IS: or A. Cash (ii) A derivative that will or may be settled other than by the B. Equity instrument of another entity (e.g., investment in exchange of a fixed amount of cash or another financial asset ordinary share of a corporation) for a fixed number of the entity's own equity instruments. C. Receivable (accounts, notes and loans receivable) Some of the most commonly encountered Financial Instruments representing Financial Assets are the following: EQUITY INSTRUMENTS (a) Cash on Hand and in Banks An equity instrument is any contract that evidence a residual interest in the assets of an entity after deducting all of its 1. Petty cash - refers to cash balances kept on hand at various liabilities. locations to pay for minor expenditures such as postage and other small out-of-pocket expenditures. Examples of Equity Instruments are: 2. Demand, savings and time deposits - represent amounts on A. Ordinary Shares deposit in checking, savings and time deposit accounts B. Preference Shares respectively. Time deposits are placements covering a relatively long period of time. C. Warrants or written call option that allow the holder to subscribe or purchase ordinary shares in exchange for a fixed 3. Undeposited checks - are checks payable to the enterprise or amount of each or another financial asset. bearer but not yet presented to the bank for payment. DERIVATIVE FINANCIAL INSTRUMENTS 4. Foreign currencies Derivatives - are financial instruments that "derive" their value on 5. Money orders - are financial instruments similar to bank drafts contractually required cash flows from some other security or but are drawn generally from authorized post offices or other index. For instance, a contract allowing a company to purchase financial institutions. example: Pera padala international a particular asset (say gold, flour, or coffee bean) a designated 6. Bank drafts - are commitments by banking institutions to future date, at a predetermined price is a financial instrument advance funds on demand by the party to whom the draft was that derives its value from expected and actual changes in the directed. checks!! price of the underlying asset. (b) Accounts, notes and loans receivable and investment in Examples of Derivatives: bonds and other debt instrument issued by other entities: 1. Futures Contracts - a futures contract is an agreement 1. Trade-receivables (signed delivery receipts and sales invoice) between a seller and a buyer that requires that seller to deliver a particular at a designated future date, at a predetermined 2. Promissory notes price. 3. Bond certificates 2. Forward Contracts - forward contract is similar to a futures (c) Interest in shares or other equity instruments issued by other contract but differs in three ways: entities a. A forward contract calls for delivery on a specific date. 1. Stock certificates b. Unlike a futures contract, a forward usually is not traded on a 2. Publicly listed securities market exchange. (d) Derivative Financial Assets c. Unlike a futures contract, a forward contract does not call for 1. Futures Contracts a daily cash settlement for price changes in the underlying contract. 2. Forward Contracts 3. Call Options - options give its holder the right either to buy or 3. Call Options sell an instrument, say a Treasury bill, at a specified price and 4. Foreign Currency Futures within a given time period. 5. Interest Rate Swaps 4. Foreign Currency Futures - foreign loans frequently are denominated in the currency of the lender (Japanese yen. Swiss FINANCIAL LIABILITIES franc, German mark, and so on). A financial liability is any liability that is: 5. Interest Rate Swaps -there are contracts to exchange cash (a) A contractual obligation flows as of a specified date or a series of specified dates based on a notional amount and fixed and floating rates. (i) To deliver cash or another financial asset to another entity; or ~~~END OF CHAPTER 4~~~ CHAPTER 5: OVERVIEW OF THE FINANCIAL SYSTEM 2. Moral hazard - this is the problem investors experience in verifying that borrowers are using their funds as intended. A vibrant and healthy economy requires a financial system that makes or channels funds from people who save to people who The financial system helps overcome an information asymmetry have productive investment opportunities. between borrowers and lenders. An information asymmetry can occur before or after a financial contract has been agreed NATURE AND OBJECTIVE OF THE FINANCIAL SYSTEM upon. The financial system consists of all financial intermediaries and Adverse selection - borrowers generally know more about their financial markets and their relations with respect to the flow of investment projects than lenders. Borrowers most eager to funds to and from households, governments, business firms and engage in a transaction are the most likely ones to produce an foreigners, as well as the financial infrastructure. undesirable outcome for the lender. Direct finance - borrowers borrow funds directly from lenders in Moral Hazard - more likely to occur when the borrower has an financial markets by selling them securities (also called financial incentive to conceal information or to act in a way that does not instruments), which are claims on the borrower's future income or coincide with the lender's interests. The borrower knows more assets. than the lender does about how the borrowed funds will actually Securities - are assets for the person who buys them buy liabilities. be used. (IOUs or debts) for the individual or firm that sells (issues) them. NATURE AND IMPACT OF TRANSACTION AND INFORMATION FUNCTIONS OF THE FINANCIAL SYSTEM COSTS The Transaction Costs - the cost of a trade or a financial transaction; main for example, the brokerage commission charged for buying or task of selling a financial asset. the Information Costs - the costs that savers incur to determine the creditworthiness of borrowers and to monitor how they use the funds acquired. HOW FINANCIAL INTERMEDIARIES REDUCE "ADVERSE SELECTION" The problem of "adverse selection" can be minimized if not totally avoided using the following approaches: financial system is to channel funds from sectors that have a surplus to sectors that have a shortage of funds. 1. Requiring borrowers to disclose material information on their financial performance and financial position. Economists believe there are three key services that the financial system provides to savers and borrowers: 2. Collecting information on firms and selling that information to investors. a. Risk sharing 3. Convincing lenders to require borrowers to pledge some of b. Liquidity their assets as collateral which the lender can claim of the c. Information borrower defaults. Risk - is the chance that the value of financial assets will change HOW FINANCIAL INTERMEDIARIES REDUCE MORAL HAZARD relative to what one expects. PROBLEMS Diversification - splitting of wealth into many assets to reduce risk. 1. Specializing in monitoring borrowers and developing effective techniques to ensure that the funds they loan are actually used Liquidity - is the ease with which an asset can be exchanged for for their intended purpose. money which savers view as a benefit. 2. Imposing Restrictive Covenants may involve placing limitations Securitization - this process has made it possible to buy and sell on the uses of funds borrowed or requiring the borrowers to pay securities based on loans. off the debt even before maturity date if the borrower's net Information - or facts about borrowers and expectations of worth drop below a certain level. returns on financial assets. Financial markets convey information HOW FINANCIAL INTERMEDIARIES REDUCE TRANSACTION COSTS to both savers and borrowers by determining the prices of stocks, bonds and other securities. Transaction costs may be reduced by adopting the following techniques: THE PROBLEMS OF ADVERSE SELECTION AND MORAL HAZARD 1. Financial intermediaries take advantage of economies of Asymmetric information - describes the situation in which one scale, which refers to the reduction in average cost that results party to an economic transaction has better information than from an increase in the volume of a good or service produced. does the other party. In financial transactions, typically the borrower has more information than does the lender. 2. Financial intermediaries can also take advantage of economies of scale in other ways. For example, because banks Two problems arising from asymmetric information are: make many loans, they rely on standardized legal contracts, so 1. Adverse selection - this is the problem investors experience in the costs of writing the contracts are spread over many loans. distinguishing low-risk borrowers from high-risk borrowers before 3. Financial intermediaries also take advantage of technology to making an investment. provide financial services, such as those that automated teller machine networks provide. 4. Financial intermediaries also increasingly rely on sophisticated 1. Universal Bank (UB) or Expanded Commercial Bank (EKB) - is software to evaluate the credit worthiness of loan applicants. any commercial bank, which performs the investment house function in addition to its commercial banking authority. ~~~END OF CHAPTER 5~~~ 2. Commercial Bank or Domestic Bank (KB) - is any commercial CHAPTER 6: THE PHILIPPINE FINANCIAL SYSTEM bank that is confined only to commercial bank functions such as accepting drafts and issuing letters of credit, discounting and The financial system, through the various financial markets and negotiating promissory notes. financial intermediaries, has the basic function of moving funds from those who have a surplus to those who have a shortage of 3. Thrift Banks (TB) - their function is to accumulate the savings of funds. depositors and invest them together with their capital, loans secured by bonds, mortgages in real estate and insured STRUCTURE OF THE PHILIPPINE FINANCIAL SYSTEM improvements thereon, chattel mortgages, bonds and other I. Bangko Sentral Ng Pilipinas forms of security or loans for personal or household finance, II. Banking Institutions whether, secured or unsecured, or in financing for home building and home development. A. Private Banking Institutions a. Stock Savings and Mortgage Bank (SSMB) - is any 1. Expanded Commercial Banks/Universal Banks corporation organized for the purpose of accumulating the 2. Commercial Banks (KB) savings of depositors and investing them, together with its capital, in readily marketable bonds and debt securities. 3. Thrift Banks (TB) b. Private Development Bank (PDB) - is a bank that exercises a. Savings and Mortgage Banks (SMB) all the powers and assumes all the obligations of the savings and b. Private Development Banks (PDB) mortgage bank as provided in the General Banking Act except as otherwise stated. c. Stock Savings and Loan Associations (SSLA) c. Stock Savings and Loan Association (SLA) - is any 4. Rural Banks (RB) corporation engaged in the business of accumulating the 5. Cooperative Banks savings of its members or stockholders and using such accumulated funds, together with its capital for loans and B. Government banking institutions investment in securities 1. Development Bank of the Philippines (DBP) 4. Rural Bank (RB) - is any bank authorized by the Central Bank to 2. Land Bank of the Philippines (LBP) accept deposits and make credit available to farmers, 3. Philippine Al-Amanah Islamic Investment Bank businessmen and cottage industries in the rural areas. III. Nan-Rank Financial Institutions 5. Cooperative Banks - are banks established to assist the various cooperatives by lending those funds at reasonable interest rates. A. Private non-bank financial institutions B. Government Banks or Specialized Government Banking 1. Investment houses Institutions 2. Investment banks 1. Development Bank of the Philippines (DBP) - provides loans for 3. Financing companies developmental purposes, gives loans to the agricultural sector. commercial sector and the industrial sector, 4, Securities dealers/brokers 2. Land Bank of the Philippines (LBP) - is a government bank, 5. Savings and loan associations which provides financial support in the implementation of the 6. Mutual funds Agrarian Reform Program (CARP) of the government. 7. Pawnshops 3. Al-Amanah Islamic Investment Bank - Republic Act No. 6048 provides for the charter of the Al-Amanah Islamic Investment 8. Lending investors Bank. This Act authorizes the bank to promote and accelerate 9. Pension funds the socio-economic development of the Autonomous Region of 10. Insurance companies Muslim Mindanao by performing banking, financing and investment operations. 11. Credit union III. NON-BANK FINANCIAL INSTITUTIONS B. Government Non-bank financial institutions A. Private non-bank Financial Institutions 1. Government Service Insurance System (GSIS) 1. Investment House - is any enterprise, which engages in 2. Social Security System (SSS) underwriting securities of other corporations. It also generates 3. Pag-ibig income from sale of investments in securities. BRIEF DESCRIPTION OF THE FINANCIAL INSTITUTIONS 2. Investment Banks - they provide advice to firms issuing stocks and bonds or considering mergers with other firms. They also II. BANKING INSTITUTIONS engage in underwriting, in which they guarantee a price to a A. Private Banking Institutions firm issuing stocks or bonds and then make a profit by selling the stocks or bonds at a higher price. 3. Financing Company - is any business enterprise where the SIGNS OF GROWTH IN THE DOMESTIC MARKET primary purpose is to extend credit facilities to consumers and to a. The Philippine banking system has been consistently posting industrial. commercial or agricultural entities. double-digit asset growth since January 2016. 4. Securities Dealer - is any person or entity engaged in the b. Meanwhile, total assets of the insurance industry more than business of buying and selling securities for his own or its client's doubled from 2008 to 2016 account thereby making a profit from the difference between the purchase prices and selling price of securities. c. The securities market has also exhibited growth, the bond market, in particular. 5. Savings and Loan Associations (S&Ls) - which have traditionally served individual savers and residential and commercial REGULATORY LANDSCAPE mortgage borrowers, accumulate the funds of many small savers A. Alignment with global standards and then B. Deepening Capital Markets 6. Mutual funds - are corporations which accept money from savers and then use these funds to buy stocks, long-term bonds, C. Strengthening Surveillance or short- term debt instruments issued by businesses or FINANCIAL STABILITY ASSESSMENT OF THE PHILIPPINE FINANCIAL government units. SYSTEM 7. Pawnshops - refer to persons or entities engaged in the Financial stability - is clearly understood to reflect a "well- business of lending money with personal property, jewelry, and functioning" financial market, addressing the financial needs of other durable goods as collateral for the loans given. stakeholders and avoiding distortions. 8. Lending investor - is any person or entity engaged in the CURRENT RISKS IN THE PHILIPPINE FINANCIAL SYSTEM business of effecting securities transactions, giving loans and A. Repricing, refinancing and repayment risks (3Rs) earns interest from them. Several jurisdictions have pointed to various sources of risks that 9. Pension funds - are retirement plans funded by corporations or heighten financial stability concerns. These are: government agencies for their workers and administered primarily by the trust departments of commercial banks or by life (1) The normalization of US monetary policy creates the incentive insurance companies. for global capital flows to be directed towards the US, affecting asset and currency prices along the way. 10. Insurance companies - take savings in the form of annual premiums, then invest these funds in stocks, bonds, real estate, (2) A slowdown in global growth and deceleration of and mortgages, and finally make payments to the beneficiaries international trade will undermine the growth of many of the insured parties. economies. 11. Credit unions - are cooperative associations whose members (3) Higher debt levels across countries will continue to leave have a common bond, such as being employees of the same economies vulnerable to the changes in the growth outlook and firm. Members' savings are loaned only to other members, the (continuing) rise in interest rates. generally for auto purchases, home improvement loans, and B. Developments in the credit market even home mortgages. Local intermediation continues to be peso-funded but with some B. Government Non-bank financial institutions support from foreign currency (FCY) sources. 1. Government Service Insurance System (GSIS) - provides C. Continuous demand for credit by corporate enterprises and retirement benefits, housing loans personal loans, emergency households is evident in the domestic economy and calamity loans to government employees. 2. Social Security System (SSS) – provides retirement benefits, ~~~END OF CHAPTER 6~~~ funeral benefits, housing loans, personal loans and calamity CHAPTER 7: FINANCIAL MARKETS: AN OVERVIEW loans to employees who are working in private companies and offers. Financial markets - are the meeting place for people, corporations and institutions that either need money or have 3. Pag-Ibig - provides housing loans to both government and money to lend or invest. private employees. Stock markets - are places where individual investors and THE EVOLVING PHILIPPINE FINANCIAL SYSTEM corporations can trade currencies, invest in companies, and To counteract the downside risks and smooth functioning of the arrange loans. Philippine financial system more stringent initiatives are being Public financial markets - participants in the financial markets pursued by the four regulatory agencies, namely: also include national, state and local governments that are 1. Bangko Sentral ng Pilipinas (BSP) primarily borrowers of funds for highways, education, welfare and other public activities. 2. Securities and Exchange Commission (SEC) Corporate financial markets – are places where large 3. Insurance Commission (IC) corporations raise funds. 4. Philippine Deposit Insurance Commission (PDIC) Corporations rely on the financial markets to provide funds for short-term operations and for new plant and equipment. A firm may go to the markets and raise financial capital by cither borrowing money through a debt offering of corporate bonds or 3. Price setting - markets provide price discovery, a way to short-term notes, or by selling ownership in the company through determine the relative values of different items, based upon the an issue of common stock. prices at which individuals are willing to buy and sell them. Primary market - when a corporation uses the financial markets 4. Asset valuation - market prices offer the best way to determine to raise new funds, the sale of securities is said to be made in the the value of a firm or of the firm's assets, or property. by way of a new issue. 5. Arbitrage - in countries with poorly developed financial Secondary market - after the securities are sold to the public markets, commodities and currencies may trade at very different (institutions and individuals), they are traded in the between prices in different locations.as traders in financial markets investors. It is in the secondary market that prices are continually attempt to profit from these divergences, prices move towards a changing as investors buy and sell securities based on their uniform level, making the entire economy more efficient. expectations of a corporation's prospects. 6. Investing - the stock, bond and money markets provide an FUNCTION OF FINANCIAL MARKETS opportunity to earn a return on funds that are not needed immediately, and to accumulate assets that will provide an Financial markets (bond and stock markets) and financial income in future. intermediaries (banks, insurance companies among others) have the basic function of getting people together by moving 7. Risk management - futures, options and other derivatives funds from those who have a surplus of funds to those who have contracts can provide protection against many types of risk, a shortage of funds. such as the possibility that a foreign currency will lose value against the domestic currency before an export payment is received. STRUCTURE OF FINANCIAL MARKETS Debt and Equity Markets Debt instrument - the most common method is to a bond or a mortgage, which is a contractual agreement by the borrower to pay the holder of the instrument fixed peso amounts at regular intervals (interest and principal payments) until a specified date (the maturity date). Discussion: Maturity - of a debt instrument is the number of years (term) until Those who have savings and are lending funds (the lender - that instrument's expiration date. savers), are at the left and those who must borrow funds to finance their spending (the borrowers-spenders), are at the right. Short-term - if its maturity is less than a year. The principal lender-savers are households, but business Long-term - if its maturity is ten years or longer. enterprises and the government as well as foreigners and their Intermediate-term - debt instruments with a maturity between government, sometimes also find themselves with excess funds one and ten years. and so lend them out. Equity instruments - such as common or ordinary stock, which are The most important borrower-spenders are businesses and the claims to share in the net income (income after expenses and government (particularly the material government) but taxes) and the assets of a business. households and foreigners also borrow to finance their purchases of cars, furniture's and houses. Dividends - equities often make periodic payments) to their holders and are considered long-term securities because they The arrows show that funds flow from lender-savers to borrower- have no maturity date. spenders both directly and indirectly. The main disadvantage of owning a corporation's equities rather Funds flow from lenders to borrowers indirectly through financial than its debt is that an equity holder is a residual claimant, that is, intermediaries such as banks or directly through financial the corporation must pay all its debt holders before it pays its markets, such as the Philippine Stock Exchange. equity holders. WHAT FINANCIAL MARKETS DO The advantage of holding equities is that equity holders benefit 1. Raising capital - firms often require funds to build new facilities, directly from any increases in the corporation's profitability or replace machinery or expand their business in other ways. asset value because equities confer ownership rights on the Shares, bonds and other types of financial instruments make this equity holders. Debt holders do not share in this benefit because possible. their peso payments are fixed. 2. Commercial transactions - as well as long-term capital, the Financial Market functions as both primary and secondary financial markets provide the grease that makes many markets for debt and equity securities: commercial transactions possible. This includes such things as A. Primary Market - refers to original sale of securities by arranging payment for the sale of a product abroad and governments and corporations. The primary markets for securities providing working capital so that a firm can pay employees if are not well known to the public because the selling of securities payments from customers run late. to initial buyers often takes place behind closed door. Public offering - as the name suggests, involves selling securities to the general public. Private placement - is a negotiated sale involving a specific THE PHILIPPINE STOCK EXCHANGE buyer. The Philippine Stock Exchange, Inc. (Filipino: Pamilhang Sapi ng B. Secondary Market - after the securities are sold to the public Pilipinas; PSE: PSE) - is the national stock exchange of the (institutions and individuals) they can be traded in the secondary Philippines. The exchange was created in 1992 from the merger market between investors. Secondary market is popularly known of the Manila Stock Exchange and the Makati Stock Exchange. as Stock Market or Exchange. Including previous forms, the exchange has been in operation since 1927. The PSE is overseen by a 15-member Board of Brokers - are agents of investors who match buyers with sellers of Directors, chaired by Jose T. Pardo. securities, dealers link buyers and sellers by buying and selling securities and stated prices. THE OVER-THE-COUNTER MARKET There are two broad segments of the stock markets: OTC trading requires a brokerage firm to match a prospective buyer and a prospective seller at a price acceptable to both. 1. The Organized Stock Exchange. The stock exchanges will have Alternatively, the brokerage firm may purchase shares for its own a physical location where stocks buying and selling transactions account or sell shares that it has been holding. take place in the stock exchange floor (e.g., Philippine Stock Exchange, New York Stock Exchange, Japan Nikkei, Shanghai DAY TRADING Components, NASDAQ, etc.) Day trading - is the buying and selling of shares, currency, or 2. The Over-the-Counter (OTC) Exchange - where shares, bonds other financial instruments in a single day. The intention is to profit and money market instruments are traded using a system of from small price fluctuations - sometimes traders hold shares for computer screens and telephones. The NASDAQ is an example only a few minutes. of an over-the-counter market in which dealers linked by Potential Day Traders should be knowledgeable of the following: computer buy and sell stocks. Market data - the current trading information for each day- Secondary markets serve two important functions: trading market. Rather than using market data that is available 1. They make it easier to sell these financial instruments to raise free of charge but can be up to an hour old, day traders pay a cash; that is, they make the financial instruments more liquid. premium for access to real-time data. 2. They determine the price of the security that the issuing firm Scalping - a strategy in which traders hold their share or financial sells in the primary market. asset (known as their "position") for just a few minutes or even seconds. Stock Exchange - is an organized secondary market where securities like shares, debentures of public companies, Margin trading - a method of buying shares that involves the day government securities and bonds issued by municipalities, public trader borrowing a part of the sum needed from the broker who corporations, utility undertakings, port trusts and such other local is executing the transaction. authorities are purchased and sold. Bid-offer spread - the difference between a price at which a The purpose of stock exchange is to facilitate the exchange of share is sol, and that at which it is bought. securities between buyers and sellers, thus providing a Potential Day Traders should be aware that: marketplace, virtual or real. A. Day trading is a high-risk occupation; Listing agreement - it regulates the company's behavior through requirements agreed upon by the company in order to be listed. B. Day trading is stressful; and This ensures that the company provides all the information C. Day trading is expensive. pertaining to its working from time to time, including events that affect its valuation, such as mergers, amalgamations and such THE RISE OF THE FORMAL MARKETS other sensitive matters. A. Liquidity - the ease with which trading can be conducted. The stock market is known as barometer of the company's B. Transparency - the availability of prompt and complete economy. information about trades and prices. LISTING OF SECURITIES ON STOCK EXCHANGE C. Reliability - particularly when it comes to ensuring that trades Listing - admission of securities to dealings on a recognized stock are completed quickly according to the terms agreed. exchange of any incorporated company, central and stage D. Legal procedures - adequate to settle disputes and enforce governments, quasi-governmental and other financial contracts. institutions/corporations, municipalities, electricity boards, E. Suitable investor protection and regulation - excessive housing boards and so forth. regulation can stifle a market. However, trading will also be Principal objective of listing - is to provide liquidity and deterred if investors lack confidence in the available information marketability to listed securities and ensure effective monitoring about the securities they may wish to trade. of trading for the benefits of all participants in the market. F. Low transaction costs - many financial-market transactions are Recognized stock exchange - a stock exchange being not tied to a specific geographic location, and the participants recognized by the national government through the Securities will strive to complete them in places where trading costs, and Exchange Commission (SEC). regulatory costs and taxes are reasonable. Official quotation - the price at which the securities are bought THE FORCES OF CHANGE and sold on a recognized stock exchange. A. Technology - almost everything about the markets has been Local government notes - are issued by, provincial or local reshaped by the forces of technology. governments, and by agencies of these governments such as schools’ authorities and transport commissions. B. Deregulation - the trend towards deregulation has been worldwide. It is not long since authorities everywhere kept tight Interbank loans - loans extended from one bank to another with controls on financial markets in the name of protecting which it has no affiliation. consumers and preserving financial stability. Time deposits, Certificate of deposit or CDs - are interest-bearing C. Liberalization - the reduction of regulations has been bank deposits that cannot be withdrawn without penalty before accompanied by a general liberalization of rules governing a specified date. participation in the markets. Repurchase agreements or repos - they serve to keep the D. Consolidation - liberalization has led to consolidation, as firms markets highly liquid, which in turn ensures that there will be a merge to take advantage of economies of scale or to enter constant supply of buyers for new money-market instruments. other areas of finance. CAPITAL MARKETS E. Globalization - most of the important financial firms are now Capital market - is a financial market in which longer-term debt highly international, with operations in all the major financial (original maturity of one year or greater) and equity instruments centers. are traded. Capital market securities include bonds, stocks, and ~~~END OF CHAPTER 7~~~ mortgages. The primary issuers of capital market securities are the: CHAPTER 8: MONEY MARKETS AND CAPITAL MARKETS 1) National and local government - issues long-term notes and MONEY MARKETS bonds to fund the national debt while local governments issue Money Market - refers to the network of corporations, financial notes and bonds to finance capital projects. institutions, investors and governments which deal with the flow 2) Corporations - issue both bonds and stock to finance capital of short-term capital. investment expenditures and fund other investment WHO USES THE MONEY MARKET? opportunities. A. Companies - When companies need to raise money to cover CAPITAL MARKET TRADING their payroll or running costs they may issue commercial paper - Primary market - is where new issues of stocks and bonds are short- term, unsecured loans for P100,000 or more that mature introduced. Investment funds, corporations, and individual within 1-9 months. investors can all purchase securities offered in the primary B. Banks - If demand for long-term loans and mortgages is not market. covered by deposits from savings accounts banks may then Initial public offering (IPO) - when firms sell securities for the very issue certificates of deposit, with a set interest rate and fixed- first time. term maturity of up to five years. Primary market transactions - subsequent sales of a firm's new C. Investors - Individuals seeking to invest large sums of money at stocks or bonds to the public. relatively low risk may invest in financial instruments. Sums of less than P50,000 can be invested in money market funds. Secondary market - is where the sale of previously issued securities takes place, and it is important because most investors WHAT MONEY MARKETS DO plan to sell long-term bonds before they reach maturity and Bond issuers - typically raise money to finance investments that eventually to sell their holdings of stock as well. will generate profits - or, in the case of government issuers, public There are two types of exchanges in the secondary market for benefits - for many years into the future. capital securities: Issuers of money-market instruments - are usually more 1. Organized exchange - has a building where securities concerned with cash management or with financing their (including stocks, bonds, options, and features) trade. portfolios of financial assets. 2. Over-the-counter exchanges - whereas most money market TYPES OF MONEY-MARKET INSTRUMENTS transactions originate over the phone. Commercial paper - is a short-term debt obligation of a private- BONDS sector firm or a government-sponsored corporation. Bond - is any long-term promissory note issued by the firm. Bonds Bankers' acceptance - is a promissory note issued by a non- are the most prevalent example of the interest only loan with financial firm to a bank in return for a loan. The bank resells the investors receiving exactly the same two sets of cash flows: (1) note in the money market at a discount and guarantees the periodic interest payments, and (2) the principal (par value payment. or face value) returned at maturity. Treasury bills or T-bills - are securities with a maturity of one year or less, issued by national governments. Government agency notes - national government agencies and government-sponsored corporations are heavy borrowers in the money markets in many countries. Trading Process for Corporate Bonds 2. Coupon Interest Rate - the percentage of the par value of the bond that will be paid out annually in the form of interest. The initial or primary sale of corporate bond issues occurs either Formula is: Stated interest payment divided the Par value. through a public offering, using an investment bank serving as a security underwriter or through a private placement to a small 3. Maturity - the length of time until the bond issuer returns the group of investors (often financial institutions). par value to the bondholder and terminates the bond. 4. Indenture - the agreement between the firm issuing the bonds and the bond trustee who represents the bondholders. 5. Current Yield - this refers to the ratio of the annual interest payment to the bond's market price. 6. Yield to Maturity - this refers to the bond's internal rate of Other arrangements can be as follows: return. It is the discount rate that equates the present value of 1. Competitive Sale - the investment bank can purchase the the interest and principal payments with the current market price bonds through competitive bidding against other investment of the bond. banks or by directly negotiating with the issuer. CREDIT QUALITY RISK 2. Negotiated Sale - with a negotiated sale, a single investment Credit quality risk - is the chance that the bond issuer will not be bank obtains the exclusive right to originate, underwrite and able to make timely payments. distribute the new bonds through a one-on-one negotiation Bond ratings - involve a judgment about the future risk potential process. of the bond. 3. Best Efforts Underwriting Basis - in their arrangement, the Bond ratings are favorably affected by: underwriter does not guarantee a firm price to the issuer. The investment bank incurs no risk of mispricing the security since it (a) A low utilization of financial leverage; simply seeks to sell the securities at the best market price it can (b) Profitable operations; get for the issuing firm. (c) A low variability of past earnings, The advantages and disadvantages of using bonds can be summarized as follows: (d) Large firm size; Advantages (e) Little use of subordinated debt. 1. Long-term debt is generally less expensive than other forms of Investment grade – are high quality corporate bonds. financing because (a) investors view debt as a relatively safe Speculative, Junk bonds, or high-yield bonds – are bonds with investment alternative and demand a lower rate of return, and higher credit risk. (b) interest expenses are tax deductible. Credit Ratings – they provide an indicator of default risk that in 2. Bondholders do not participate in extraordinary profits; the turn affects the rate of return that must be paid on borrowed payments are limited to interest. funds. 3. Bondholders do not have voting rights. TYPES OF BONDS 4. Flotation costs of bonds are generally lower than those of A. Unsecured Long-Term Bonds ordinary (common) equity shares. 1. Debentures - these are unsecured long-term debt and backed Disadvantages only by the reputation and financial stability of the corporation. 1. Debt (other than income bonds) results in interest payments 2. Subordinated Debentures - claims of bondholders of that, if not met, can force the firm into bankruptcy. subordinated debentures are honored only after the claims of 2. Debt (other than income bonds) produces fixed charges, secured debt and unsubordinated debentures have been increasing the firm's financial leverage Although this may not be satisfied. a disadvantage to all firms, it certainly is for some firms with 3. Income Bonds - an income bond requires interest payments unstable earnings streams. only if earned and non-payment of interest does not lead to 3. Debt must be repaid at maturity and thus at some point bankruptcy. involves a major cash outflow. B. Secured Long-Term Bonds 4. The typically restrictive nature of indenture covenants may 1. Mortgage Bonds – a mortgage bond is a bond secured by a limit the firm's future financial flexibility. lien on real property. Bond Features and Prices Mortgage bonds can further be subclassified as follows: The various features of corporate bonds and some of the (a) First Mortgage Bonds - the first mortgage bonds have the terminology associated with bonds follow: senior claim on the secured assets if the same property has been 1. Par Value - the face value of the bond that is returned to the pledged on more than one mortgage bond. bondholder at maturity. (b) Second Mortgage Bonds - these bonds have the second claim on assets and are paid only after the claims of the first mortgage bonds have been satisfied. (c) Blanket or General Mortgage Bonds - all the assets of the firm Treasury shares - previously issued shares that are reacquired are used as security for this type of bonds. and held by the firm. (d) Closed-end Mortgage Bonds - the closed-end mortgage 3. No maturity - ordinary equity share has no maturity and is a bonds forbid the further use of the pledged assets security for permanent form of long-term financing. other bonds. This protects the bondholders from dilution of their Tender offer - is a formal offer to purchase shares of a claims on the assets by any future mortgage bonds. corporation. (e) Open-end Mortgage Bonds - these bonds allow the issuance 4. Voting rights - each share of ordinary equity generally entitles of additional mortgage bonds using the same secured assets as the holder to vote on the selection of directors and in other security. However, a restriction may be placed upon the matters. borrower, requiring that additional assets should be added to the secured property if new debt is issued. Proxy - is a temporary transfer of the right to vote to another party. (f) Limited Open-end Mortgage Bonds - these bonds allow the issuance of additional bonds up to a limited amount at the same There are two common systems of voting: priority level using the already mortgaged assets as security. a) Majority voting - is a voting system that entitles each OTHER TYPES OF BONDS shareholder to cast one vote for each share owned. 1. Floating Rate or Variable Rate Bonds - a floating rate bond is b) Cumulative voting - is a voting system that permits the one in which the interest payment changes with market shareholder to cast multiple votes for a single director. conditions. 5. Book value per share - the accounting value of an ordinary 2. Junk or Low-Rated Bonds - are bonds rated BB or below. The equity share is equal to the ordinary share equity (ordinary share major participants of this market are new firms that do not have plus paid-in capital plus retained earnings) divided by the an established record of performance. number of shares outstanding. 3. Eurobonds - these are bonds payable or denominated in the 6. Numerous rights of stockholders - collective and individual borrower's currency, but sold outside the country of the rights of ordinary equity shareholders include among others: borrower, usually by an international syndicate of investment a) Right to vote on specific issues as prescribed by the corporate bankers. charter. 4. Treasury Bonds - carry the "full-faith-and-credit" backing of the b) Right to receive dividends if declared by the firm's board of government and investors consider them among the safest fixed- directors. income investments in the world. c) Right to share in the residual assets in the event of liquidation. B. ORDINARY (COMMON) EQUITY SHARES d) Right to transfer their ownership in the firm to another party. Ordinary equity shares (traditionally known as ordinary equity share) - is a form of long-term equity that represents ownership e) Right to examine the corporate banks. interest of the firm. f) Right to share proportionally in the purchase of any new Residual owners - ordinary equity shareholders are called issuance of equity shares. This is known as the pre-emptive right. residual owners because their claim to earnings and assets is VALUATION what remains after satisfying the prior claims of various creditors and preferred shareholders. Ordinary or common equity share valuation is complicated by the uncertainty of future returns and / or changes in the share's Residual domains - this means that ordinary shareholders have price. the right to claim any cash flows or value after all other claimants C. PREFERRED SHARE have received what they are owed. Preferred share - is a class of equity shares which has preference FEATURES OF ORDINARY EQUITY SHARES over ordinary (common) equity shares in the payment of 1. Par value/No par value - ordinary equity share may be sold dividends and in the distribution of corporation assets in the with or without par value. Whether or not ordinary equity share event of liquidation. has any par value is stated in the corporation's charter. Preference - means only that the holders of the preferred share Par value of ordinary equity share - is the stated value attached must receive a dividend (in the case of a going concern firm) to a single share at issuance. before holder of ordinary (common) equity shares are entitled to No par share - may either assign a stated value or place it on the anything. books at the price at which the equity share is sold. Preferred shares - generally has no voting privileges but it is a 2. Authorized, issued, and outstanding form of equity from a legal and tax standpoint. Authorized shares - is the maximum number of shares that a The issuance of preferred shares is favored when the following corporation may issue without amending its charter. conditions prevail: Issued shares - is the number of authorized shares that have 1. Control problems exist with the issuance of ordinary share. been sold. 2. Profit margins are adequate to make of additional leverage Outstanding shares - are those shares held by the public. Issued attractive, share less treasury share. 3. Additional debt poses substantial risk. 4. Interest rates are low lowering the cost of preferred share. 5. The firm has a high debt ratio, suggesting infusion of equity financing is needed. PREFERRED SHARE FEATURES The following are the major features of preferred share: 1. Par value - is the face value that appears on the stock certificate. In some cases, the liquidation value per share is provided for in the certificate. 2. Dividends - are stated as a percentage of the par value and are commonly fixed and paid quarterly but are not guaranteed by the issuing firm. 3. Cumulative and Noncumulative dividends Cumulative - if preferred dividends are not paid in a particular year, they will be carried forward as an arrearage. Noncumulative - dividends not declared in any particular year are lost forever and the preferred shareholders cannot claim such anymore. 4. No definite maturity date - preferred share is usually intended to be a permanent part of a firm's equity and has no definite maturity date. 5. Convertible preferred share - owners of convertible preferred share have the option of exchanging their preferred share for ordinary (common) equity share based on specified terms and conditions. 6. Voting rights - preferred share does not ordinarily carry voting rights. Special voting procedures may take effect if the issuing firm omits its preferred dividends for a specific time period. 7. Participating features - entitles its holders to share in profits above and beyond the declared dividend, along with ordinary (common) equity shareholders. 8. Protective features - often contain covenants to assure the regular payment of preferred share dividends and to improve the quality of preferred share. 9. Call provision - gives the issuing corporation the right to call in the preferred share for redemption. 10. Maturity - three decades ago, most preferred share was perpetual - it had no maturity and never needed to be paid off. However, today most new preferred share has a sinking fund and thus an effective maturity date. PREFERRED SHARE VALUATION Preferred share valuation is relatively simple if the firm pays fixed dividends at the end of each year. If this condition holds, then the stream of dividend payments can he treated in perpetuity and be discounted by the investor's required rate of return on a preferred share issue. Thus, the intrinsic value of a share of preferred share (P,) is the sum of the present values of future dividends discounted at the investor's required rate of return. ~~~END OF CHAPTER 8~~~