Financial Markets

Chapter 8: money markets and capital markets

MONEY MARKETS

Introduction

Money Market
- refers to the network of corporations, financial institutions, investors and
governments which deal with the flow of short-term capital.
- When a business needs cash for a couple of months until a big payment
arrives, or when a bank wants to invest money that depositors may withdraw
at any moment, or when a government tries to meet its payroll in the face of
big seasonal fluctuations in tax receipts, the short-term liquidity transactions
occur in the money market.

Disintermediation
- The money markets have expanded significantly in recent years as a result of
the general outflow of money from the banking industry, a process referred to
as disintermediation.

How it works
● The money market exists to provide the loans that financial institutions and
governments need to carry out their day-to-day operations.
● Banks may also find that they have greater demand for mortgages or loans
than they do for savings accounts at certain times. This creates a mismatch
between the money they have available and the money they have loaned out,
so the bank will need to borrow in order to be able to fulfill the demand for
loans.
● The money markets are the mechanisms that bring these borrowers and
investors together without the comparatively costly intermediation of banks.
They make it possible for borrowers to meet short-run liquidity needs and deal
with irregular cash flows without resorting to more costly means of raising
money.
● There is an identifiable money market for each currency, because interest
rates vary from one currency to another. These markets are not independent,
and both investors and borrowers will shift from one currency to another
depending upon relative interest rates. However, regulations limit the ability
of some money- market investors to hold foreign-currency instruments, and
most money-market investors are concerned to minimize any risk of loss as a
result of exchange-rate fluctuations. For these reasons, most money-market
transactions occur in the investor's home currency.

Who uses the money market?

● The primary function of the money market is for banks and other investors
with liquid assets to gain a return on their cash or loans.
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Chapter 8: money markets and capital markets

● They provide borrowers such as other banks, brokerages, and hedge funds
with quick access to short-term funding. The money market is dominated by
professional investors, although retail investors with P50,000 can also invest.
● Smaller deposits can be invested via money market funds.
● Banks and companies use the financial instruments traded on the money
market for different reasons, and they carry different risks.

At the centre of each web is the central bank whose policies determine the short-term
interest rates for that currency.

WHAT MONEY MARKETS DO

● Buying and selling of debt instruments maturing in one year or less.
● Bond markets - in which corporations and governments borrow and lend
based on longer-term contracts.
● Similar to bond investors, money-market investors are extending credit,
without taking any ownership in the borrowing entity or any control over
management.

Bond issuers
- typically raise money to finance investments that will generate profits or, in the
case of government issuers, public benefits for many years into the future.
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Chapter 8: money markets and capital markets

Issuers of money-market instruments

- are usually more concerned with cash management or with financing their
portfolios of financial assets.

● A well-functioning money market facilitates the development of a market for

longer-term securities. Money markets attach a price to liquidity, the
availability of money for immediate investment. The interest rates for
extremely short-term use of money serve as benchmarks for longer-term
financial instruments.

Money markets are active, or "liquid"

- borrowers and investors always have the option of engaging in a series of
short-term transactions rather than in longer- term transactions, and this
usually holds down longer term rates.

Absence of active money markets to set short-term rates

- issuers and investors may have less confidence that longer-term rates are
reasonable and greater concern about being able to sell their securities
should they so choose. For this reason, countries, with less active money
markets, on balance, also tend to have less active bond markets.

TYPES OF MONEY-MARKET INSTRUMENTS

Money market securities

- are short-term instruments with an original maturity of less than one year.

There are numerous types of money-market instruments. The best known are:
● commercial papers
● bankers acceptances
● treasury bills
● repurchase agreements,
● government agency notes
● local government notes
● interbank loans
● time deposits
● bankers' acceptance
● papers issued by international organizations.

Money market securities are used to "warehouse" funds until needed. The returns
earned on these investments are low due to their low risk and high liquidity. Money
market securities are usually more widely traded than longer-term securities and so
tend to be more liquid.
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Chapter 8: money markets and capital markets

1. Commercial paper
- Commercial paper is a short-term debt obligation of a private sector firm or a
government-sponsored corporation.
- Only companies with good credit ratings issue commercial paper because
investors are reluctant to bring the debt of financially compromised
companies.
- They tend to be issued by highly rated banks and are traded in a similar way
to securities.
- In most cases, the paper has a lifetime, or maturity, greater than 90 days but
less than nine months. This maturity is dictated by regulations.
- In the Philippines, most new securities must be registered with the regulator,
the Securities and Exchange Commission
- Commercial paper is usually unsecured although a particular commercial
paper issue may be secured by a specific asset of the issuer or may be
guaranteed by a bank

2. Bankers acceptances
- Before the 1980, bankers acceptances were the main way for firms to raise
short-term funds in the money markets.
- An acceptance is a promissory note issued by a non-financial firm to a bank
in return for a loan.
- The bank resells the note in the money market at a discount and guarantees
payment.
- Acceptances usually have a maturity of less than six months
- They are usually tied to the sale of storage of specific of specific goods, such
as an export order for which the proceeds will be received in two or three
months.
- They are not issued at all by financial industry firms.
- They do not bear interest, instead, an investor purchases the acceptance at a
discount from face value and then redeems it for face value at maturity
Investors rely on the strength of the guarantor bank, rather than of the issuing
company, for their security

3. Treasury bills
- Treasury hills, often referred to as t-bills, are secunties with a maturity of one
year or less, issued by national governments
- Treasury bills issued by a government in its own currency are generally
considered the safest of all possible investments in that currency
- Such securities account for a larger share of money market trading than any
other type of instrument

4. Government agency notes

- National government agencies and government-sponsored corporations are
heavy borrowers in the money markets in many countries.
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Chapter 8: money markets and capital markets

- These include entities such as development banks, housing finance

corporations, education lending agencies and agricultural finance agencies.

5. Local government notes

- Local government notes are issued by provincial or local governments, and by
agencies of these governments such as schools authorities and transport
commissions.

6. Interbank loans
- Loans extended from one bank to another with which it has no affiliation are
called interbank loans.
- Many of these loans are across international boundaries and are used by the
borrowing institution to re-lend to its own customers.

7. Time deposits
- Time deposits, another name for certificates of deposit or CDs, are
interest-bearing bank deposits that cannot be withdrawn without penalty
before a specified date.
- Although time deposits may last for as long as five years, those with terms of
less than one year compete with other money-market instruments.
- Time deposits with terms as brief as 30 days are common.

Repos
- Repurchase agreements known as repos, play a critical role in the money
markets.
- They serve to keep the markets highly liquid, which in turn ensures that there
will be a constant supply of buyers for new money-market instruments.
- A repo is a combination of two transactions.
- In the first, a securities dealer, such as a bank, sells securities it owns to an
investor, agreeing to repurchase the securities at a specified higher price at a
future date.
- In the second transaction, days or months later, the repo is unwound as the
dealer buys back the securities from the investor. The amount the investor
lends is less than the market value of the securities, a difference called the
spread or haircut, to ensure that it still has sufficient collateral if the value of
the securities should fall before the dealer repurchases them.

CAPITAL MARKETS
- The capital market is a financial market in which longer-term debt (original
maturity of one year or greater) and equity instruments are traded.
- Capital market securities include bonds, stocks, and mortgages.
- Capital market securities are often held by financial intermediaries such as
insurance companies and pension funds, which have little uncertainty about
the amount of funds they will have available in the future.
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Chapter 8: money markets and capital markets

Capital Market Participants

The primary issuers of capital market securities are the:

1) National and local government, and

2) Corporations

National government
- issues long-term notes and bonds to fund the national debt

Local governments
- issue notes and bonds to finance capital projects.

Corporations
- issue both bonds and stock to finance capital investment expenditures and
fund other investment opportunities

Capital Market Trading

- occurs in either the primary market or the secondary market.

Primary market
- is where new issues of stocks and bonds are introduced.
- one where the issuer of the security actually receives the proceeds of the
sale.
- When firms sell securities for the very first time, the issue is an initial public
offering (IPO).
- Subsequent sales of a firm's new stocks or bonds to the public are simply
primary market transactions (as opposed to an initial one).

Secondary market
- is where the sale of previously issued securities takes place, and it is
important because most investors plan to sell long-term bonds before they
reach maturity and eventually to sell their holdings of stock as well.
- There are two types of exchanges in the secondary market for capital
securities: organized exchanges and over-the-counter exchanges.

A. BONDS
- A bond is any long-term promissory note issued by the firm.
- A bond certificate is the tangible evidence of debt issued by a corporation or
a governmental body and represents a loan made by investors to the issuer
- Bonds are the most prevalent example of the interest only loan with investors
receiving exactly the same two sets of cash flows:
(1) the periodic interest payments, and
(2) the principal (par value or face value) returned at maturity.
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Chapter 8: money markets and capital markets

Trading Process for Corporate Bonds

The initial or primary sale of corporate bond issues occurs either through a:
● public offering
● using an investment bank serving as a security underwriter
● a private placement to a small group of investors (often financial institutions).

Generally, when a firm issues bonds to the public, many investment banks are
interested in underwriting the bonds. The bonds can generally be sold in a national
market.

Most often, corporate bonds are offered publicly through investment banking firms as
underwriters. Normally, the investment bank facilitates this transaction using a firm
commitment underwriting.

Other arrangements can be as follows:

1. Competitive Sale
- The investment bank can purchase the bonds through competitive bidding
against other investment banks or by directly negotiating with the issuer

2. Negotiated Sale
- With a negotiated sale, a single investment bank obtains the exclusive right to
originate, underwrite and distribute the new bonds through a one-on-one
negotiation process. With a negotiated sale, the investment bank provides the
origination and advising services to the issuers

3. Best Efforts Underwriting Basis

- In their arrangement, the underwriter does not guarantee a firm price to the
issuer. The investment bank incurs no risk of mispricing the security since it
simply seeks to sell the securities at the best market price it can get for the
issuing firm.
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Chapter 8: money markets and capital markets

The advantages and disadvantages of using bonds can be summarized as follows:

Advantages
1. Long-term debt is generally less expensive than other forms of financing because (a)
investors view debt as a relatively safe investment alternative and demand a lower rate
of return, and (b) interest expenses are tax deductible
2. Bondholders do not participate in extraordinary profits, the payments are limited to
interest.
3. Bondholders do not have voting rights
4. Flotation costs of bonds are generally lower than those of ordinary (common) equity
shares

Disadvantages
1. Debt (other than income bonds) results in interest payments that, if not met, can
force the firm into bankruptcy
2. Debt (other than income bonds) produces fixed charges, increasing the firm's
financial leverage Although this may not be a disadvantage to all firms, it certainly is for
some firms with unstable carnings streams
3. Debt must be repaid at maturity and thus at some point involves a major cash
outflow
4 The typically restrictive nature of indenture covenants may limit the firm's future
financial flexibility.

As of September, 2019, the following are bond issuances by the government business
firms in the Philippines secured by Rond Funds and part of the Investment Portfolio of
Mutual Funds

● ALFM Peso Bonds

● Grepalife Bonds
● Philam Bonds
● Philequity Peso Bonds
● Sun Life Prosperity Bonds
● RCBC "Sustainability” Bonds
● Robinsons Bank
● Fixed Rate Corporate Bonds
● PH Samurai Bonds
● Ayala Land Inc (PH) Bonds

Bond Features and Prices

Par Value - The face value of the bond that is returned to the bondholder al maturity

Coupon Interest Rate - The percentage of the par value of the bond that will be paid
out annually in the form of interest. Formula is Stated interest payment divided the Par
value
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Chapter 8: money markets and capital markets

Maturity - The length of time until the bond waver returns the par value to the
bondholder and terminates the bond

Indenture - The agreement between the firm issuing the bonds and the bond trustee
who represents the bondholders. It provides the specific terms of the loan agreement,
including the description of the bonds, the rights of the bondholders, the rights of the
issuing firm and the responsibilities of the trustees

Current Yield - This refers to the ratio of the annual interest payment to the bond's
market price.

Yield to Maturity - This refers to the bond's internal rate of return. It is the discount
rate that equates the present value of the interest and principal payments with the
current market price of the bond.

Credit Quality Risk

- Credit quality risk is the chance that the bond issuer will not be able to make
timely payments.

Bond ratings
- involve a judgment about the future risk potential of the bond provided by
rating agencies such as Moody's, Standard and Poor's and Fitch IBCA, Inc.
Dominion Bond Rating Services. Bond ratings are favorably affected by:

(a) A low utilization of financial leverage;

(b) Profitable operations,
(c) A low variability of past carnings:
(d) Large firm size,
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Chapter 8: money markets and capital markets

(e) Little use of subordinated debt.

The poorer the bond rating, the higher the rate of return demanded in the capital
markets.

High quality corporate bonds - are considered investment grade, while

Higher credit risk bonds - are speculative, also called junk bonds and high-yield
bonds.

Credit Ratings

Credit Risk Credit Description

Rating

Investment Grade

Highest quality AAA The obligor's (issuer's) capacity to meet its

financial commitment on the obligation is
extremely strong.

High quality AA The obligor's capacity to meet its financial

commitment on the obligation is very strong.

Upper medium grade A The obligor's capacity to meet its financial

commitment on the obligation is still strong,
though somewhat susceptible to the adverse
effects of changes in circumstances and
economic conditions.

Medium grade BBB The obligator exhibits adequate protection.

However, adverse economic conditions or
changing circumstances are more likely to
lead to a weakened capacity to meet its
financial commitment.

Below Investment
Grade

Somewhat BB Faces major ongoing uncertainties or

speculative exposure to adverse business, financial, or
economic conditions which could lead to the
obligor's inadequate capacity to meet its
financial commitment.
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Chapter 8: money markets and capital markets

Speculative B Adverse business, financial, or economic

conditions will likely impair the obligor's
capacity or willingness to meet its financial
commitment.

Highly speculative CCC Currently vulnerable to nonpayment, and is

dependent upon favorable business,
financial, and economic conditions for the
obligor to meet its financial commitment.

Most speculative CC Current highly vulnerable to nonpayment.

Imminent default C Used to cover a situation where a

bankruptcy petition has been filed or similar
action taken, but payments. on this
obligation are being continued.

Default D Obligations are in default or the filing of a

bankruptcy petition has occurred and
payments are jeopardized.

TYPES OF BONDS

A. Unsecured Long-Term Bonds

1. Debentures
- These are unsecured long-term debt and backed only by the reputation and
financial stability of the corporation. Because these bonds are unsecured, the
earning ability of the issuing corporation is of great concern to the bondholder.
- To provide some protection to the bondholder, the issuing firm may be
prohibited from issuing future secured long-term debt that would create
additional encumbrance of assets.
- To the issuing firm, debentures will allow it to incur indebtedness and still
preserve some future borrowing power.

2. Subordinated Debentures
- Claims of bondholders of subordinated debentures are honored only after the
claims of secured debt and unsubordinated debentures have been satisfied.

3. Income Bonds
- An income bond requires interest payments only if earned and non- payment
of interest does not lead to bankruptcy.
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Chapter 8: money markets and capital markets

- Usually issued during the reorganization of a firm facing financial difficulties,

these bonds have longer maturity and unpaid interest is generally allowed to
accumulate for some period of time and must be paid prior to the payment of
any dividends to stockholders.

B. Secured Long-Term Bonds

1. Mortgage Bonds
- A mortgage bond is a bond secured by a lien on real property. Typically, the
market value of the real property is greater than that of the mortgage bonds
issued.
- This provides the mortgage bondholders with a margin of safety in the event
that the market value of the secured property declines.
- Should the issuing firm fail to pay the bonds at maturity, the trustees can
foreclose or sell the mortgaged property and use the proceeds to pay the
bondholders.

Mortgage bonds can further be subclassified as follows:

a. First Mortgage Bonds - The first mortgage bonds have the senior claim on
the secured assets if the same property has been pledged on more than one
mortgage bond.

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 Bond - All the assets of the firm are used as
security for this type of bonds.

d. Closed-end Mortgage Bonds - The closed-end mortgage bonds forbid the

further use of the pledged assets security for other bonds. This protects the
bondholders from dilution of their claims on the assets by any future mortgage
bonds.

e. Open-end Mortgage Bonds - These bonds allow the issuance of additional

mortgage bonds using the same secured assets as security. However, a
restriction may be placed upon the borrower, requiring that additional assets
should be added to the secured property if new debt is issued.

f. Limited Open-end Mortgage Bonds - These bonds allow the issuance of

additional bonds up to a limited amount at the same priority level using the
already mortgaged assets as security.
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Chapter 8: money markets and capital markets

OTHER TYPES OF BONDS

1. Floating Rate or Variable Rate Bonds

- A floating rate bond is one in which the interest payment changes with market
conditions. In periods of unstable interest rates this type of debt offering
becomes appealing to issuers and investors.
- To the issuers like banks and finance companies, whose revenues go up
when interest rates rise and decline as interest rates fall, this type of debt
eliminates some of the risk and variability in earnings that accompany interest
rate swings
- To the investor, it eliminates major swings in the market value of the debt that
would otherwise have occurred if interest rates had changed.
- A common feature of all the floating rate bonds is that an attempt is being
made to counter uncertainty by allowing the interest rate to float

2. Junk or Low-Rated Bonds.

- Junk or low rated bonds are bonds rated BB or below. The major participants
of this market are new firms that do not have an established record of
performance, although in recent years junk bonds have been increasingly
issued to finance corporate buyouts.

3. Eurobonds
- These are bonds payable or denominated in the borrower's currency, but sold
outside the country of the borrower, usually by an international syndicate of
investment bankers.
- This market is denominated by bonds stated in U.S. dollars
- The Eurobond is usually sold by an international syndicate of investment
bankers and includes bonds sold by companies in Switzerland, Japan,
Netherlands, Germany, the United States and Britain, to name the most
popular countries.
- Eurobonds are also referred to as bonds issued in Europe by an American
company and pay interest and principal to the lender in U.S. dollars.
- The use of Eurobonds by U.S. firms to raise funds has fluctuated dramatically
with the relative interest rates an abundance or lack of funds in the European
markets dictating the degree to which they are used

4. Treasury Bonds
- Treasury bonds carry the "full-faith-and-credit" backing of the government and
investors consider them among the safest fixed- income investments in the
world.
- The BSP sells Treasury securities through public auctions usually to finance
the government's budget deficit. When the deficit is large, more bonds come
to auction. In addition, the BSP uses Treasury securities to implement
monetary policy.
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Chapter 8: money markets and capital markets

B. ORDINARY (COMMON) EQUITY SHARES

Ordinary equity shares (traditionally known as ordinary equity share)

- is a form of long-term equity that represents ownership interest of the firm.
- Ordinary equity shareholders are called residual owners because their
claim to earnings and assets is what remains after satisfying the prior claims
of various creditors and preferred shareholders.
- Ordinary (common) equity shareholders are the true owners of the
corporation and consequently bear the ultimate risks and rewards of
ownership

FEATURES OF ORDINARY EQUITY SHARES

1. Par value/No par value

- Ordinary equity share may be sold with or without par value. Whether or not
ordinary equity share has any par value is stated in the corporation's charter.
- Par value of ordinary equity share is the stated value attached to a single
share at issuance. It has little significance except for accounting and legal
purposes. If ordinary equity share is initially sold for more than its par value,
the issue price in excess of par is recorded as additional paid-in capital,
capital surplus, or capital in excess of par.
- A firm issuing no par share may either assign a stated value or place it on the
books at the price at which the equity share is sold.

2. Authorized, issued, and outstanding

- Authorized shares is the maximum number of shares that a corporation may
issue without amending its charter.
- Issued shares is the number of authorized shares that have been sold.
- Outstanding shares are those shares held by the public. Both the firm's
dividends per share and
- Treasury shares are previously issued shares that are reacquired and held
by the firm shares.
- Thus, outstanding share is issued share less treasury share

3. No maturity
- Ordinary equity share have no maturity and is a permanent form of long-term
financing. Although ordinary share is neither callable nor convertible, the
firm can repurchase its shares in the secondary markets either through a
brokerage firm or a tender offer.
- Tender offer is a formal offer to purchase shares of a corporation

4. Voting rights
- Each share of ordinary equity generally entitles the holder to vote on the
selection of directors and in other matters. Shareholders unable to attend the
annual meeting to vote may vote by proxy.
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- Proxy is a temporary transfer of the right to vote to another party.

- Proxy voting is done under the rules and regulations of the Securities and
Exchange Commissions, but proxy solicitations are the firm's responsibility.
Not all ordinary equity shareholders have equal voting power. Some firms
have more than one class of share.

There are two common systems of voting:

a. Majority Voting
Majority voting is a voting system that entitles each shareholder to
cast one vote for each share owned. Majority voting is used to
indicate the ordinary (common) equity shareholders' approval of
disapproval of most proposed managerial actions on which
shareholders may vote. The directors receiving the majority of the
votes are elected. If a group over 50 percent of the wotes, it can
elect all of the directors and prevent minority shareholders from
electing any directors

b. Cumulative voting
Cumulative song is a voting system that permits the shareholder to
cast multiple votes for a single director. Cumulative voting avarots
mimonty shareholders in electing at least one director Cumulative
voting is required in some jurisdictions for electing the board of
directors

5. Book value per share

- The accounting value of an ordinary equity share is equal to the ordinary
share equity ordinary share plus paid-in capital plus retained earnings) divided
by the number of shares outstanding

6. Numerous rights of stockholders

- Collective and individual rights of ordinary equity shareholders include among
others
a. Right to vote on specific issues as prescribed by the corporate
charter such a election of the board of directors, selecting the firm's
independent auditors amending the articles of incorporation and
bylaws, increasing the amount of authorized stock, and so forth.
b. Right to receive dividends if declared by the firm's board of directors
c. Right to share in the residual assets in the event of liquidation.
d. Right to transfer their ownership in the firm to another party.
e. Right to examine the corporate banks
f. Right to share proportionally in the purchase of any new issuance of
equity shares. This is known as the pre-emptive right.
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VALUATION
- Ordinary or common equity share valuation is complicated by the uncertainty
of future returns and or changes in the share's price.

C. PREFERRED SHARE

Preferred share
- a class of equity shares which has preference over ordinary (common) equity
shares in the payment of dividends and in the distribution of corporation
assets in the event of liquidation.
- Preference means only that the holders of the preferred share must receive a
dividend (in the case of a going concern firm) before holder of ordinary
(common) equity shares are entitled to anything.
- Preferred shares generally has no voting privileges but it is a form of equity
from a legal and tax standpoint.

The issuance of preferred shares is favored when the following conditions prevail:
1. Control problems exist with the issuance of ordinary shares.
2. Profit margins are adequate to make additional leverage attractive.
3. Additional debt poses substantial risk.
4. Interest rates are low, lowering the cost of preferred shares.
5. The firm has a high debt ratio, suggesting infusion of equity financing is needed.

PREFERRED SHARE FEATURES

1. Par value
- 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
- 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. Some
recent preferred share issues called adjustable rate, variable rate, or floating
rate preferred, do not have a fixed dividend rate but peg dividends to an
underlying index such as one of the Treasury bill rate or other money market
rates.

3. Cumulative and Noncumulative dividends

- Dividends payable to preferred shares are either cumulative or
noncumulative, most are cumulative.
- If preferred dividends are cumulative and are not paid in a particular year,
they will be carried forward as an arrearage. Usually, both accumulated (past)
preferred dividends and the current preferred dividends must be paid before
the ordinary equity shareholders receive anything.
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- If the preferred dividends are 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. However, preferred shares sometimes carry
special retirement provisions.
- Almost all preferred shares have a call feature that gives the issuing firm the
option of purchasing the share directly from its owners, usually at a premium
above its par value.
- Some preferred shares have a sinking fund provision that requires the issuer
to repurchase and retire the share on a scheduled basis.
- Owners of convertible preferred share have the option of exchanging their
preferred share for ordinary (common) equity share based on specified terms
and conditions.

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. Preferred shareholders are then permitted to elect a
certain number of members to the board of directors in order to represent the
preferred shareholder interests.

7. Participating features
- Participating preferred share entitles its holders to share in profits above and
beyond the declared dividend, along with ordinary (common) equity
shareholders. Most preferred share issues are nonparticipating. Without
nonparticipated preferred, the return is limited to the stipulated dividend.

8. Protective features
- Preferred share issues often contain covenants to assure the regular payment
of preferred share dividends and to improve the quality of preferred share.
- Preferred shareholders have priority over ordinary (common) equity
shareholders with regard to carnings and assets. Thus, dividends must be
paid on preferred share before they can be paid on the ordinary (common)
equity share, and in the event of bankruptcy, the claims of the preferred
shareholders must be satisfied before the ordinary (common) equity
shareholders receive anything. To reinforce these features, most preferred
shares have coverage requirements similar to those on bonds.
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- These restrictions limit the amount of preferred share a company can use and
they also require a minimum level of retained earnings before common
dividends can be poid.

9. Call provision
- A call provision gives the issuing corporation the right to call in the preferred
share for redemption. As in the case of bonds, call provisions generally state
that the company must pay an amount greater than the par value of the
preferred share, the additional sum being termed a call premium.

10. Maturity
- Three decades ago, most preferred share was perpetual it had maturity and
never needed to he 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 be treated in
perpetuity and be discounted by the investor's required rate of return on a
preferred share issue.
- A perpetuity is an annuity with an infinite lifespan. If the preferred share has
high risk, investors normally require a higher rate of return. This is because
creditors have priority over preferred share holders in their claims to both
income and assets
- 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.

In the Philippines, the following preferred shares are actively traded in the Philippine
Stock Exchange:

● First Philippine Holding - Preferred

● San Miguel Purefoods - Preferred
● Petron Corporation Perpetual - Preferred
● Swift Foods, Inc. - Convertible Preferred
 Financial Markets
Chapter 8: money markets and capital markets

COMPARATIVE FEATURES OF ORDINARY EQUITY SHARES, PREFERRED

SHARES AND BONDS

The characteristics of ordinary shares, preferred shares and bonds are compared in
the following table.