Security Analysis

What Is Security Analysis?
Security analysis helps in finding which securities are good investments. Real investments will
keep the principal safe. They’ll also give good returns. Hence, anything which doesn’t do this is
speculation.
There are three functions of security analysis:
1. “Descriptive function” – This compares different securities. Plus, it smartly outlines

facts.
2. “Selective function” – It helps judge if an investor must sell, buy or hold a security.
3. “Critical function” – This observes management, company policies, and structure
regularly.
Market analysis is different than securities analysis. It tries to predict the prices of individual
securities. Or the performance of the market in general. It doesn’t consider the core facts of
different firms. Technical analysis is a form of market analysis. Under this, future values are
predicted by seeing old market values. Another type of checks indices of economic activity
external to the market. These activities influence security prices to some level. None of these
market analyses have proven effective. Both mainly promote speculation.
Internal value is a crucial concept in security analysis. But, it’s also a vague concept. It’s a
value justified by facts. These include earnings, assets, dividends, etc. Such facts are then
manipulated artificially. Investors can’t measure the exact intrinsic value of a security. This is
because there’re many variables involved. But, careful analysis can help find if the price quoted
by the market is proper. Securities should pass safety tests to be profitable investments. Also,
they must sell below their internal value.
Types of Securities
Securities are of two kinds: bonds and stocks. But, such classification isn’t enough. This’s
because it focuses more on the type of security than its purpose and safety. Hence, securities
can be more accurately grouped into three classes. These are:
1. Common Stocks;
2. Fixed-value securities which include preferred stocks and high-grade bonds;
3. Variable-value senior securities, which include preferred stocks and speculative bonds.
GREEN VALLEY COLLEGE FOUNDATION, INC. Document Code: FM-DEA-031
Km.2, Bo.2, Gensan Drive., Koronadal City South Cotabato Issue No: 01 Revision No: 00
INSTRUCTIONAL MATERIALS Effectivity Date: June 4, 2020
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SCHOOL OF MANAGEMENT
Part I. Investment Environment, Markets Instruments &

Securities
1. Real Assets versus Financial Assets
Assets are the lifeblood of the economy, enabling us to store, transfer, and create wealth. They
can typically be classified as either “real” or “financial” assets.
Definitions
Before we dig into an investment comparison of the two types of assets, some definitions are in
order:
 Financial assets are highly liquid assets that are either cash or can quickly be
converted into cash. These include the traditional investments such as stocks (i.e.,
equity) and bonds (i.e., fixed income). The defining characteristic of a financial asset is
that it has some type of known monetary value that can readily be realized. However, it
in and of itself lacks any intrinsic value.
 Real assets, on the other hand, are value-generating physical assets that a business
and/or investor owns. These include land, buildings, ships, and other infrastructure or
commodities. The defining characteristic of a real asset is that it has intrinsic value in
and of itself does not rely on monetization and/or exchange in order to provide value
for its owner.
Similarities
Real and financial assets do share a key similarity: Their valuations are generally based on
cash flow generation potential. According to the discounted cash flow valuation method, the
value of an asset is the sum of all of its future cash flows discounted back to their present
value. In the case of commodities, this is not quite the case, though their value is still tied to
investor sentiment regarding how current and future economic conditions will impact their ability
to help generate cash flow.
Differences
Real and financial assets also have some key differences:
(1) Real assets are typically less liquid than financial assets since they are usually more
cumbersome to exchange and their markets are not as efficient or populated.
(2) The value of real assets also is much more dependent on factors such as location, function,
and operation and exchange costs, whereas financial assets are typically fungible, thereby
making them location independent.
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Investment Comparison
Financial assets offer the advantage of convenience, liquidity, and efficiency whereas real
assets are safer in that they do not rely on a public marketplace to derive value for the owner
while also being more inflation and “ black-swan event” resistant … so, which is it?
Given that right now:
(1) Interest rates remain at historically low levels and stock market valuations are historically
high:
2) Allocations to real assets are expected to nearly double.
It would appear that the answer is a no brainer in favor of real assets. In fact, retirement
pensions and endowment funds – which have the mandate of generating highly reliable and
regular income for distribution – are no longer able to achieve their investing goals by focusing
solely on bonds (LQD, VCLT, IEF) after a multi-decade-long decline in interest rates and are
instead looking to real assets to meet their needs. Already, trillions of dollars have flown to real
assets and the trend appears to be just getting started. In less than 10 years, institutional
capital in this space has grown by $20 trillion, and another ~$40 trillion is expected in the
decade ahead.
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This is because, in a world of low interest rates and elevated stock market valuations, real
assets offer:
1. Higher income yield: The 10-year Treasury may yield only 2.1%, but real assets will
often trade at yields in the 6%-10% range – and can be leveraged (using record low
long term interest rates) to generate even greater cash-on-cash returns.
2. Greater total returns: Real assets generate high income, but they also appreciate in
value and grow cash flow. A well-located office tower may yield 6% and grow in value
by 3% per year. Add to that a bit of leverage and you can reasonably expect double-
digit total returns.
3. Inflation protection: One of the biggest and most underrated risks today is accelerating
inflation. When you invest in low yielding bonds, you are at big risk. Real assets, on the
other hand, are well-protected as their income and values tend to grow along with
inflation. As such, they provide a good hedge against inflation risk.
4. Valuable Diversification: Traditional assets (stocks and bonds) are highly volatile and
adding real assets to a portfolio has proven to lower volatility. As such, investors can
profit from diversification benefits while boosting returns and income.
Investors have historically been overly exposed to traditional assets, including stocks and
bonds, and it's only since 2000 that investors have started to heavily increase their allocation to
real assets. Allocations to real assets were only 5% in 2000. Today, it's closer to 25%. And in
10 years, this figure could reach up to 40%:
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With interest rates expected to remain exceptionally low for years to come and the stock
market is poised for disappointing results due to high valuations, according to many economists
and regarded investors; we believe that allocation trends toward real assets should continue
and even accelerate.
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Real Asset Investing For Individual Investors
OK, so real assets win hands down. What next? How is the average do-it-yourself retirement
investor supposed to put this into practice to profit from the rush to real assets? While the
arguments for real assets over financial assets may seem convincing, many small investors –
especially retirees – are intimidated and/or scared away by their illiquidity, inefficiency
(especially when purchased on a small scale), lack of passivity, and even liability.
Fortunately, you do not need to be a multi-billion-dollar institution to invest in real assets. At

High Yield Landlord, we specialize in helping the individual retirement investor enjoy the best of
both worlds by investing in financial assets that are directly backed by real assets. We have a
strong preference for relying on these real asset-backed financial assets rather than traditional
physical real asset investments for monthly income due to the numerous advantages they offer
that lead to better risk and hassle adjusted returns over the long run. These include:
 Economies of scale – Large portfolios of real assets are much cheaper to operate per
unit than smaller portfolios due to the fact that larger portfolios have greater bargaining
power with suppliers, sales and marketing agents, tenants, property management, and
maintenance companies and can also spread fixed costs out over a much larger
amount of rental revenue, resulting in significantly higher profit margins.
 Safety through broad diversification – If one or two real asset investments encounter
problems and/or underperform, large portfolios can absorb this blow quite easily
whereas small portfolios will be unable to.
 Easy liquidity – The ability to quickly and cheaply buy and sell real asset investments
through publicly traded entities makes for considerably less risk, cost, and commitment
than is born in typical physical real asset investments.
 Professional management – Owning real assets managed by professionals with

decades of experience and – ideally – skin in the game, offers a huge investing
competitive advantage over having to manage real asset investments yourself or via a
management team that lacks skin in the game and/or the decades of experience
boasted by the typical management team of a publicly-traded real asset entity.
 Total passivity – Real asset-backed financial assets are totally passive investments,
unlike many other forms of real asset investing.
 Transparency – Despite being totally passive, these entities are bound by law to
release quarterly, semi-annual, and/or annual reports on their business, providing
tremendous transparency and insight into the performance of your real assets.
 Occasionally trading at discounts to NAV– Thanks to the tendency for publicly-traded

markets to fluctuate wildly with daily news headlines that are often entirely
disconnected from the underlying performance of the real assets held in real asset
backed financial assets, it's not uncommon for these investments – despite all of their
advantages – to trade at discounts to the value of their underlying holdings. This
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provides savvy investors with the opportunity to achieve profits that exceed the already
superior total return outlook for real assets.
Depending on real asset-backed financial assets that pay safe and growing dividends for
retirement income combines the lucrative cash flow and long-term leveraged appreciation of
real asset investing with the benefits of passivity, liquidity, and easy diversification that can be
found in financial asset investing. Additionally, the monthly cash flow alleviates many of the
worries that come with traditional financial asset market volatility by preventing retirees from
having to sell shares while prices are low since they only live off of the income. Focusing on
growing dividend income rather than the noise caused by volatile stock prices fits well with a
long-term investment strategy and removes some of the emotional risk associated with
investing.
Finally, because high-quality real asset backed financial assets will only pay out excess cash
flows as dividends, retirees do not have to worry about reinvesting their dividends if they don't
want to, knowing that these investments retain all of the cash flow they need to sustain and
even grow their business. As a result, investors can spend 100% of their dividend income and
still very likely see their income and portfolio value appreciate over time. In contrast, real asset
investors typically have to practice much more savvy math in forecasting for themselves how
much they will need to set aside for future repairs and/or to keep their properties competitive in
their local market.
Our Two Favorite Real Asset Classes:
Though we cover many different forms of real asset-backed financial assets, two of the most
popular investment sectors include:
(1) Commercial Real Estate via real estate investment trusts, commonly referred to as REITs.
Just like mutual funds, they allow investors of all kinds to invest in real estate without actually
having to go out and buy, manage and finance properties themselves. Besides, most REITs
are publicly traded on a stock exchange and allow investors to participate in the ownership of
large scale, well diversified real estate portfolios in the same way as investors would invest in
any other industry. Specially designed for investors looking for superior income, along with
reasonably good price appreciation prospects over time, this vehicle is ideally suited to retirees.
Those looking for these benefits while also guarding against the downside will want to focus on
apartment communities, industrial buildings, grocery-anchored shopping centers, and net lease
properties. While some time ago, these highly profitable investments may have been reserved
to high net worth individuals and institutions, it is today easier than ever before to invest in real
estate through readily liquid, high-yielding REITs. Of the over 200 REITs trading on public
exchanges today, a few popular examples include Realty Income (O), Simon Property Group
(SPG) and STAG Industrial (STAG).
(2) Energy Pipelines via master limited partnerships (commonly referred to as MLPs) and other
companies that own energy infrastructure. Just like commercial real estate, these assets
generate a lot of cash and are an essential component of our infrastructure. Pipelines generally
offer even greater income than traditional real estate properties but have lower appreciation
potential in the long run. Just like with REITs, investors can get exposure to high yielding
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energy pipelines through the purchase of MLPs. Popular examples include Energy Transfer
(ET) and Magellan Midstream Partners (MMP).
1.1 Financial Markets and The Economy
Thinking about economic development has evolved over the past half century, partly in
response to perceptions of poverty and theorizing about its causes (and inferring from those
the presumed needed policy actions) and partly through the experience of development in
countries both successful and unsuccessful. During these years, there have been a number of
"fads", or virtually single causation theories, as to "the" causative factor (or, perhaps, two
factors), largely in response to perceptions that development was less rapid than it should have
been.
During the past decade, much of the "fad" and the emphasis has been placed on
understanding the role of the financial sector, in part because earlier lessons were learned, and
in part as a consequence of the financial crises of the 1990s. Understanding of the role of the
financial sector has increased markedly, but research and insights continue to mount. As that
has happened, some have turned to "governance issues" as "the key" to development, but
lessons about the importance, and key role, of the financial sector in development have
certainly been learned.
There has been no time at which economists and policy makers denied the role of the financial
sector. However, I think it is fair to say that its importance was systematically underestimated
prior to the experience of the 1990s. Certainly, I myself was guilty of nodding agreement with
those who argued for its importance, while turning my focus almost immediately back to issues
of trade, agriculture, public administration, and the like.
I start with a brief review of the earlier foci of analysis, noting how they interacted with
understanding of development at the time. In the final part of my talk, I will then relate the
earlier understandings and the role of financial variables in development. In between, I will
come to financial markets, and the experience of the 1990s, illustrating with some data from the
Korean experience. I will end with an analysis of the policy implications of the improved
understanding of the role of the financial system and its components.
Analyzing Poverty and Growth
Prior to the Second World War, analysis of economic growth was almost the exclusive domain
of economic historians, and focus was largely on how the west grew rich - in particular, the
industrial revolution. Although everyone knew that citizens of some countries had much higher
living standards than those in others, that seemed to be taken as a "state of nature", not an
issue to be addressed or understood.
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And, indeed, there appeared to be some justification for that bipolar view. Few countries were
in the "middle". Ignoring the centrally planned economies, which were generally seen as sui
generis, the world was seen as consisting of the "developed" and the "underdeveloped"
(subsequently less developed, then developing) countries. Ignoring a few mineral rich places,
generalizations could be made that almost all developing countries had low per capita incomes,
low life expectancies, low levels of literacy and educational attainment, poor health statistics,
little capital stock and low savings rates, and an economic structure heavily skewed toward
subsistence agriculture with exports consisting overwhelmingly of primary commodities and
imports of manufactured goods.
From these stylized, but mostly valid, generalizations, came the initial "fad" in development:
poverty and low productivity were rife because of low levels of capital stock per worker; low
levels of capital stock per worker resulted from the inability of poor people to save; and hence
there was a "vicious" circle. The policy implications were seen, by most, to be that government
had to take a leading role in development, and that development should be spurred by
undertaking accelerated investments in industry (which was by hypothesis of higher
productivity), doing so by increasing investment in both the public and the private sectors. The
Government of India's Planning Commission, for example, concluded that, if India could reach
a savings rate of 25 per cent of GDP within a quarter century, growth would accelerate
sufficiently to result in economic development.
By the early 1960s, there came recognition that capital accumulation was insufficient: attention
had to be paid to augmenting "human capital", and the focus shifted to education and other
factors (such as health and nutrition) that would increase individuals' productivity in all areas
including industry but also agriculture. With the notable exception of a few East Asians,
however, development policy remained heavily oriented to developing industry (in the public
and private sectors) and raising rates of investment. Moreover, efforts to encourage industrial
development focused on protection of domestic industry from imports through import
prohibitions or restrictive import licensing and high tariff levels.
One result, which happened in most developing - as they were then called - countries was that
chronic "foreign exchange shortages" resulted in gross inefficiencies in a variety of ways, and
certainly were a disincentive for the development of any new export activities. It came
increasingly to be appreciated by the 1970s and 1980s that an overvalued exchange rate itself
was one disincentive for development of exports, but so too were high tariff levels and
prohibitions or restrictions on imports. Some East Asian countries were already following a
development strategy that focused on shifting away from "inner oriented" growth toward "outer
oriented" strategy. They experienced rapid growth of real output and exports, and were
successful to a degree that had earlier not seemed feasible.
Hence, by the late 1980s, focus was on the reduction of trade barriers and an open economy
as an essential part of the prescription for rapid economic growth, alongside education and
other investments in humans, and high savings rates. At the same time, and both from direct
experience and because of the collapse of central planning, skepticism grew regarding the
efficacy of state-owned enterprises engaging in manufacturing activities. Recognition of the role
of competition increased, although it was never a central fad.
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With all of this, the experience of the East Asian "tigers" - Hong Kong, Singapore, South Korea,
and Taiwan - was phenomenal. By 1990, South Korea had realized a rate of real economic
growth that more than doubled per capita income every decade. The country, and others
experiencing similar growth rates, was transformed. It no longer made sense to regard all non-
industrial countries as homogeneous - a variety of distinctions (emerging markets, middle-
income countries, etc.) came to be employed. But all those in the policy and academic
communities concerned with development recognized the outstanding success of the "tigers"
over a very long period of time. While they debated the relative contributions of different factors
to those high growth rates, no one could doubt the sustained success of those economies over
the decades.
By the 1980s, other Asian countries had begun to follow the same pattern. China, Thailand,
Malaysia, and Indonesia all experienced real rates of growth that were very high contrasted
with their earlier experience and with that of other countries in other regions. Thus, although
Mexico experienced a crisis in 1994 (and Russia and Brazil crises in 1998 and 1999), the Asian
"miracle" countries were widely regarded as immune from growth slowdowns, much less crises
of the Mexican variety.
It should be noted that there had earlier been any number of "foreign exchange" or financial
crises. In most instances, these had occurred when economic policies had sustained unrealistic
(overvalued) exchange rates through the use of exchange controls and restrictions on capital
flows, if not current account transactions. Those crises were normally precipitated by difficulties
in domestic banking systems, in the case of financial crises (such as Sweden in 1992) or by a
country's inability either to borrow further to finance its current account deficit (such as in
Turkey in 1980) or to restrict its imports further.
It was the "Asian crises" of 1997 that shocked the world: seemingly unstoppable successful
countries had apparently foundered. There was a relentless outflow of foreign exchange, and
governments faced the possibility that they might be unable to honor their foreign obligations.
Korea, for example, had experienced capital inflows of as much as l0 percent of GDP during
the 1960s and 1970s, but had avoided the "debt crises" of other countries in the 1980s both
because of the rapid growth of exports and because the debt-GDP ratio and debt-export ratio
actually fell during that same period. As a symptom of their success, the Asian economies were
regarded as highly creditworthy, so that the shocks of 1997 were all the greater.
The proximate "causes" of the crises were capital outflows, and the crises were initially blamed
on "speculators", "hot money", "contagion', and the like. But further analysis showed that,
although capital outflows were the "forcing" phenomenon that led to crisis, there were
underlying factors that had come into play. While these factors differed from case to case, there
were significant commonalities.
It is not the purpose here to review the panoply of lessons learned, nor to analyze the policy
responses to the crises (about which there has been considerable controversy). Suffice it to
say that there is widespread agreement that a fixed exchange rate regime in most cases
removes a major shock absorber and can, in the absence of appropriate supporting policies,
itself result in major difficulties. There are far fewer fixed exchange rate regimes in the world
than there were in the mid-1990s. There is also a greatly heightened awareness of the need to
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examine debt sustainability, as well as current flows. And there is increased recognition of the
importance of the need for consistency between domestic monetary and fiscal policy and the
exchange rate regime. For all these reasons, there is certainly reduced risk of crisis. But, in
addition, as the experience of the late 1990s has been further analyzed, recognition of the
necessity of financial sector development in the course of economic growth has increased.
The Role of the Financial Sector
We have long known about the importance of the financial sector in supporting an efficient
allocation of resources and economic growth. But it has perhaps not been so well recognized
that as economies develop, the financial system becomes increasingly important either as a
facilitator of economic growth (if it is performing its functions and developing with the rest of the
economy) or as an inhibitor (if it remains underdeveloped). When economic activity is at its
most basic, carried out within a confined geographical area with much subsistence activity, a
relatively small fraction of total economic output is traded, and hence the need for money and
finance is limited. Reliance on family finance can serve as a sufficient source of funds for small
and even larger businesses.
Moreover, in those circumstances, it may even be that credit rationing can do a fairly
reasonable job of allocating credit: high real rates of return opportunities (such as in mining or
the manufacture of those few items consumed by poor households such as candles, matches,
radios, and the like) may be relatively self-evident in economies with very simple structures. But
as the variety of economic activities increases, not only in manufacturing, but also in agriculture
(as rising incomes lead consumers to shift more of their consumption away from basic food
grains) and services, ease of recognition of "best projects" becomes more difficult. Reliance on
family finance soon starts to inhibit growth. More financial intermediation is needed if
incremental resources are to be allocated efficiently, because of constraints otherwise imposed
on the growth of more profitable activities, especially when small. Banking comes to play a
greater role in increasing resources for high-return activities and reducing the amount wasted in
lower return ones. But, with healthy growth, competition is important, and both risk and return
considerations are important. Hence, the financial system must grow in its ability to allocate
resources.
As the economy grows, and grows more complex, the financial sector needs to keep pace.
Banks need to grow and become more sophisticated in their ability to assess prospects for
risks and returns; and, in parallel, there needs to be the development of other financial sources
of investment capital. Sustained and rapid growth needs to be underpinned by a broadening
and deepening of the financial system, capable of serving the needs of all parts of the
economy. Those economies that have sustained rapid growth over the long term have
experienced enormous structural change, as they have shifted from being predominantly rural
and agricultural to a more urban, manufacturing-and-service-based structure.
This was certainly the history of the industrialized countries. As they grew in the eighteenth,
nineteenth and twentieth centuries, their financial systems grew in depth and breadth. In the
19th century, London achieved its status as the world's leading financial center, because the
financial sector had developed rapidly in order to serve the needs of British industry and British
exporters. As it grew in order to support Britain's economic growth, it also became a major
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contributor to that growth - and, for that matter, to growth in other parts of the world as it
exported capital and financial skills.
In the 20th century, New York played a similar role in relation to the American economy. As
New York developed as a financial center to serve the needs of the dynamic and rapidly
growing American economy, so it developed the skills and services that could themselves be
exported.
And this process has continued. The growth in hedge funds in recent years is an example of
this continuing development in financial markets. And as the financial sector in industrial
countries has become more complex, it has posed fresh challenges for those charged with
ensuring that the financial sector is sound and well-functioning.
Even 20 or 30 years ago, no one would have quarreled with anything I have said so far. Ronald
McKinnon wrote of "financial repression" and its costs in terms of foregone growth in the 1970s,
and most development economists included "credit rationing" among the policies and practices
in developing countries that hampered their growth. But the financial crises of the 1990s
brought home to everyone the importance of the financial system and its smooth functioning.
What we had perhaps not fully appreciated was the extent to which the health and
effectiveness of the financial sector was bound up with the performance of the economy as a
whole. I shall illustrate the argument with an overview of the ways in which the failure of the
financial system to develop pari passu with the rest of the economy contributed to the Korean
crisis of 1997-1998.
Korea
It is hard to remember that what is today the world's 11th largest economy and one of the
richest economies in Asia was, in the 1950s, one of the poorest in the world, and the third
poorest in Asia. In the 1950s, many informed observers believed that the Korean economy
could never be viable without sustained foreign aid transfers, as Korea had the highest density
of population on the land (which was in any event very infertile), while the domestic savings
rate had been zero, and investment had been almost entirely financed by foreign aid.
Yet the reforms of the late 1950s and early 1960s had a remarkable impact. Real GDP grew at
an average annual rate above 10 percent for the entire decade starting in 1963. Real per capita
income in 1995 was estimated to be close to 9 times what it had been in the early 1960s. The
thrust of the reform program was to turn Korea into an open economy. In 1960, Korean exports
(88 percent of which were primary commodities) were 3 percent of GDP, imports 13 percent.
Already by 1970, exports had risen to 14 percent of GDP and by 19890 they were 33 percent.
Between 1960 and 1969 (when world prices were fairly constant), dollar export earnings grew
at an average annual rate of 41 percent.
The chaebol played a central role in this spectacular export performance, which was seen by
all to be the major driver of growth. The chaebol were conglomerates, usually family-owned,
that grew rapidly after the reforms, taking advantage of the (uniform) incentives offered for
exporters. Government policies mandated that all exporters should have access to low-interest
credit (as well as tax breaks). The real exchange rate had been depreciated to a realistic level -
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Korea had had multiple exchange rates, severe import licensing, and exchange controls in the
1950s in the context of the then-highest rate of inflation in the world. As companies grew
rapidly, access to credit was vital, and this was allowed in proportion to export performance.
It is often forgotten, and it is important, that export incentives were uniform, available to any
that increased exports But the chaebol were those successful firms that grew most rapidly and
they did so, given the incentive structure, by increasing their exports rapidly. In the early years
of Korean growth, the chaebol were national heroes, seen as spearheading the remarkably
successful growth performance, itself understood as a result of the opening up of the economy.
And, this is crucial: because the Korean economy had been so closed, there was probably very
little resource misallocation in the early years from allocating credit on preferential terms almost
exclusively to exporters. Indeed, despite the favorable terms, many chaebol borrowed beyond
their allocated credit amount on the curb market, at much higher interest rates, suggesting that
much of the implicit subsidy in their borrowing was intramarginal.
Over the first decade of rapid growth, the chaebol enjoyed real rates of return estimated to
average 35 percent or more. But, over the next three decades, as high rates of growth of the
overall economy continued, these rates of return fell, as indeed they should have. The real
interest rate charged on those loans rose and the gap between the controlled rate and the
market-clearing rate narrowed, but credit continued to be rationed.
In contrast to trade, which was liberalized at an early stage in the Korean reform process, the
banking system continued to be tightly controlled.. Although the real interest rate charged was
positive, credit rationing continued well beyond the initial years. Deregulation of interest rates
only started in the late 1980s.
By the 1980s, rates of return were estimated to be slightly lower for the chaebol than for
Korean manufacturing firms as a whole. By the latter part of the decade, rates of return in
Korea were, on average, only slightly above 4 percent; they fell to under 2 percent in the early
1990s and were negative by 1997. By contrast, even after the Asian crisis and during the long
period of slow growth in Japan, rates of return there were still about 2.3 percent.
Because of their rapid growth, the chaebol had continued to increase their share of output, and
credit continued to be allocated to them. From the mid-180s, the largest 30 chaebol were
growing around 20 percent annually, and the largest 5 at 30 percent. By the time of the crisis,
their assets were many times higher than they had been in 1985 (14 times higher for the
largest 30 and 19 times higher for the big 5), but their profits were growing much more slowly, if
at all. By 1997, the largest 5 chaebol accounted for about 40 percent of manufacturing sector
assets. But the close links between firms in a chaebol included investing in each other and
guaranteeing bank debt for each other, and indeed, borrowing from banks owned by the same
chaebol.
Worse yet, these firms were highly leveraged. In the manufacturing sector as a whole, debt
was about 3.5 times equity in the mid-1990s, 2-3 times that in the United States. And chaebol
were even more highly leveraged than Korean firms as a whole, with strong incentives to
continue to rely on debt financing because of subsidized credit. It should be noted that the flip
side of the increased attractiveness of debt financing was the failure of the equity market in
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Korea to grow as rapidly as it might have had chaebol had less inducement to borrow at
subsidized interest rates.
Moreover, the position of the chaebol - both their importance and their highly leveraged state -
had serious implications for the Korean economy as a whole. Sustaining rapid growth seemed
to require a continuing flow of credit to them. But as rates of return declined, so maintaining the
credit flow had lower and lower rates of return.
Although bank assets rose sharply in the five years prior to the crisis, net banking income had
peaked in the early 1990s and the rate of return on bank assets was falling continuously, as
was the rate of return on equity. Nonperforming loans had not significantly increased prior to
the crisis - although NPLs rose sharply after the crisis started - but in hindsight that appears to
have been in significant part the result of "evergreening".
Conventional wisdom at the time of the crisis attributed the source of the trouble to the foreign
currency exposure of the banking system. But this foreign borrowing had been undertaken in
order to sustain rapid credit expansion at home. And much credit went to evergreening, and
covering losses, rather than generating new income streams. The real source of Korea's
problems was largely home-grown, as the quality of bank portfolios declined.
In a paper with Jungho Yoo, we described early 1997 Korea as a disaster waiting to happen.
Because of the need to sustain lending to the chaebol, the banking system, and ultimately the
economy, had become so vulnerable that something was bound to trigger a crisis.
Korea's painful experience brought home the importance of a well-regulated and transparent
banking system - and the damage that can be inflicted on the economy as a whole by the
absence of a healthy financial sector. Attention to balance sheet soundness, and any
mismatches between the currency denomination of assets and liabilities, is essential.
But the events in Korea demonstrated something further: well-functioning financial markets
become increasingly important as growth progresses. While credit rationing may be compatible
with growth at early stages of development (or when severe imbalances are obvious in highly
distorted situations) a well-functioning financial system must grow with the economy as a whole
if growth is to be sustainable.
In the Korean case, the vulnerabilities inherent in continued credit rationing were not sufficiently
critically examined, in part because of the historically excellent performance of the economy as
a whole in spite of it. But credit rationing resulted in excessive reliance on bank credit, the
failure of efficient bond and equity markets to develop, and ultimately in an unsustainably
leveraged situation. Crisis or stagnation were bound to occur, or in the worst case, the
economy was bound to contract. In Korea's case, reforms were undertaken so that output had
rebounded to precrisis levels within 18 months (a much shorter period than analysts at the time
predicted) and growth rates have been solid since that time.
14
Policy Implications
For countries experiencing rapid growth, development of a healthy financial sector is critical.
Hence, in many emerging markets and developing countries today, emphasis must be placed
(among other things) on reforms that enable improved functioning of the financial system. At
early stages of development, this entails strengthening the rights of borrowers and lenders,
development of a credit rating system, lowering the costs of obtaining credit (not the interest
rate), and streamlining means for settlement of disputes.
The World Bank has recently provided data on a number of these phenomena across
countries. It has created a scale ranging from 1 to 10 (highest) to indicate the degree to which
borrowers' and creditors' rights are protected. Industrial countries generally (but not always)
receive high ratings, with the US and Australia for example receiving ratings of 10 and 9
respectively. By contrast, Argentina scores 3, Mexico 2, and some countries 1 and even 0.
Provision of credit ratings, normally through private credit bureaus, is also highly variable
across countries. Again, industrial countries normally score well, with coverage of most of the
economy, whereas Brazil has coverage of about half the population, and Costa Rica less than
5 percent. More than half of the 55 countries surveyed had no private credit bureau coverage at
all.
The cost of creating collateral for loans also varies widely. World Bank numbers estimate that it
is less than 0.1 percent of per capita income in the United States and the United Kingdom. By
way of comparison, it is 8.1 percent of per capita income in Korea, 2.7 percent in Japan, 11.7
percent in India, 20.7 percent in Nigeria, and 62.2 percent of per capita income in Morocco.
The ability to enforce contracts also matters. In most industrial countries, the time to achieve
legal enforcement is around 6 months (250 days in the United States, 75 days in France), while
in developing countries it can be much more: 591 days in Bolivia, 425 in India, and 1,000 in
Poland. Clearly, inability to enforce loan obligations can itself stymie financial development.
Policy reforms entailing increasing the efficiency of bankruptcy proceedings, reducing the cost
of collateral, enforcing contracts, and improving other aspects of the financial nexus are clearly
important. But so, too, is the development of an efficient (and implemented) regulatory
framework, and competition within the banking system. How this is achieved can vary greatly
from country to country, but there is a strong presumption that the development of arms-length
lending, competition within the banking system, and arrangements that permit timely
enforceability of contracts clearly matter.
In Korea, reforms in many of these dimensions were undertaken in response to the crisis, and,
as already indicated, growth resumed quickly and has been sustained. In some other emerging
markets, reforms are proceeding, although with varying degrees of rapidity. And, as some of
the numbers just mentioned indicate, there are many countries where significant improvements
will need to be made in order to enable the financial system even to begin to carry out its role.
Clearly, the financial sector is not THE key to development, any more than human capital or
physical capital accumulation were. Equally, however, failure to develop the financial sector
15
can put an enormous brake on growth prospects and, indeed, if the issue is not addressed, can
thwart development efforts. For countries where there is a strong commitment to growth, the
lesson is clear: attention needs to be paid to financial sector issues as growth proceeds, unless
it is preferred to wait for a crisis to force the necessary reforms.
Financial markets help to efficiently direct the flow of savings and investment in the economy in
ways that facilitate the accumulation of capital and the production of goods and services. The
combination of well-developed financial markets and institutions, as well as a diverse array of
financial products and instruments, suits the needs of borrowers and lenders and therefore the
overall economy.
What are financial markets and institutions?
Financial markets (such as those that trade stocks or bonds), instruments (from bank CDs to
futures and derivatives), and institutions (from banks to insurance companies to mutual funds
and pension funds) provide opportunities for investors to specialize in particular markets or
services, diversify risks, or both. As noted by Demirgüç-Kunt and Levine, together financial
markets and financial institutions contribute to economic growth; the relative mix of the two
does not appear to be an important factor in growth.
Large financial markets with lots of trading activity provide more liquidity for market participants
than thinner markets with few available securities and participants and thus limited trading
opportunities. The U.S. financial system is generally considered to be the best developed in the
world. Daily transactions in the financial markets—both the money (short term, a year or less)
and capital (over a year) markets—are huge. Many financial assets are liquid; some may have
secondary markets to facilitate the transfer of existing financial assets at a low cost. Table I
provides a list of several well-known U.S. financial markets, ranked by outstanding assets or
liabilities as of 2004.
1.2 Clients of the Financial System
A financial system is a network of financial institutions, financial markets, financial instruments

and financial services to facilitate the transfer of funds. The system consists of savers,
intermediaries, instruments and the ultimate user of funds. The level of economic growth
largely depends upon and is facilitated by the state of financial system prevailing in the
economy. Efficient financial system and sustainable economic growth are corollary. The
financial system mobilizes the savings and channelizes them into the productive activity and
thus influences the pace of economic development. Economic growth is hampered for want of
effective financial system. Broadly speaking, financial system deals with three inter-related and
interdependent variables, i.e., money, credit and finance.
The financial system provides channels to transfer funds from individual and groups who have
saved money to individuals and group who want to borrow money. Saver (refer to the lender)
are suppliers of funds to borrowers in return with promises of repayment of even more funds in
the future. Borrowers are demanders of funds for consumer durables, house, or business plant
and equipment, promising to repay borrower funds based on their expectation of having higher
16
incomes in the future. These promises are financial liabilities for the borrower-that is, both a
source of funds and a claim against the borrower’s future income.
Main Functions of Financial System
The functions of financial system can be enumerated as follows:
 Financial system works as an effective conduit for optimum allocation of financial

resources in an economy.
 It helps in establishing a link between the savers and the investors.
 Financial system allows ‘asset-liability transformation’. Banks create claims (liabilities)
against themselves when they accept deposits from customers but also create assets
when they provide loans to clients.
 Economic resources (i.e., funds) are transferred from one party to another through
financial system.
 The financial system ensures the efficient functioning of the payment mechanism in an
economy. All transactions between the buyers and sellers of goods and services are
effected smoothly because of financial system.
 Financial system helps in risk transformation by diversification, as in case of mutual
funds.
 Financial system enhances liquidity of financial claims.
 Financial system helps price discovery of financial assets resulting from the interaction
of buyers and sellers. For example, the prices of securities are determined by demand
and supply forces in the capital market.
 Financial system helps reducing the cost of transactions.
As discussed above, financial markets play a significant role in economic growth through their
role of allocation capital, monitoring managers, mobilizing of savings and promoting
technological changes among others. Economists had held the view that the development of
the financial sector is a crucial element for stimulating economic growth. Financial development
can be defined as the ability of a financial sector acquire effectively information, enforce
contracts, facilitate transactions and create incentives for the emergence of particular types of
financial contracts, markets and intermediaries, and all should be at a low cost. Financial
development occurs when financial instruments, markets and intermediaries ameliorate
through the basis of information, enforcement and transaction costs, and therefore better
provide financial services. The financial functions or services may influence saving and
investment decisions of an economy through capital accumulation and technological innovation
and hence economic growth. Capital accumulation can either be modeled through capital
externalities or capital goods produced using constant returns to scale but without the use of
any reproducible factors to generate steady-state per capita growth. Through capital
accumulation, the functions performed by the financial system affect the steady growth rate
thereby influencing the rate of capital formation. The financial system affects capital
accumulation either by altering the savings rate or by reallocating savings among different
capital producing levels. Through technological innovation, the focus is on the invention of new
production processes and goods.
17
As market frictions and laws, regulations and policies differs to a greater extent across
economies and over time, the impact of financial development on growth may have different
implications for resource allocation and welfare in the economy.
Services Provided by the Financial System
1. Risk Sharing: Financial system provides risk sharing by allowing savers to hold many
assets. It also means financial system enables individuals to transfer risk. Financial
markets can create instruments to transfer risk from savers to borrowers who do not
like uncertainty in returns or payments to savers or investors who are willing to bear
risk. The ability of the financial system to provide risk sharing makes savers more
willing to buy borrowers’ IOUs. This willingness, in turn, increases borrowers’ ability to
raise funds in the financial system.
2. Liquidity: The second service that financial system provides for savers and borrowers
is liquidity, which is the ease with which an asset can be exchanges for money to
purchase other assets or exchanges for goods and services. Most of the savers view
the liquidity as a benefit. If an individual need their assets for their own consumption
and investment, they can just exchange it. Liquid assets allow an individual or firm to
respond quickly to new opportunities or unexpected events. Bonds, stocks, or checking
accounts are created by financial assets, which have more liquid than cars, machinery
and real estate.
3. Information: The third service of financial system is collection and communication of
information or we can say that it is the facts about borrowers an expectations about
returns on financial assets. The first informational role the financial system plays is to
gather information. That includes finding out about prospective borrowers and what
they will do with borrowed funds. Another problem that exists in most transactions is
asymmetric information. This means that borrowers possess information about their
opportunities or activities that they don’t disclose to lenders per creditors and can take
advantage of this information. The second informational role that financial system plays
is communication of information. Financial markets do that job by incorporating
information into the prices of stocks, bonds, and other financial assets. Savers and
borrowers receive the benefits of information from the financial system by looking at
asset returns. As long as financial market participants are informed, the information
works its way into asset returns and prices.
1.3 Markets and Markets Structure
The analysis of market structures is of great importance when studying

microeconomics. How the market will behave, depending on the number of buyers or sellers,
its dimensions, the existence of entry and exit barriers, etc. will determine how an equilibrium is
reached. Even though market structures were thoroughly analysed by economists from the
early 20th century on, its study can be traced back to economists such as Antoine Cournot,
Alfred Marshall or even Adam Smith. Managers perform the main managerial functions in the
organization and assume different roles in the performance of their duties. This results in the
assignment of diverse responsibilities to managers which in turn create the different levels of
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organizational hierarchy. That is why they should be equipped with the skills needed to manage
the organization well
A market is a set of buyers and sellers, commonly referred to as agents, who through their
interaction, both real and potential, determine the price of a good, or a set of goods. The
concept of a market structure is therefore understood as those characteristics of a market that
influence the behavior and results of the firms working in that market.
The main aspects that determine market structures are: the number of agents in the market,
both sellers and buyers; their relative negotiation strength, in terms of ability to set prices; the
degree of concentration among them; the degree of differentiation and uniqueness of products;
and the ease, or not, of entering and exiting the market. The interaction and differences
between these aspects allow for the existence of several market structures, from which we can
highlight the following:
Perfect competition: the efficient market where goods are produced using the most efficient
techniques and the least amount of factors. This market is considered to be unrealistic but it is
nevertheless of special interest for hypothetical and theoretical reasons.
There are certain assumptions when discussing the perfect competition. This is the reason a
perfect competition market is pretty much a theoretical concept. These assumptions are as
follows,
 The products on the market are homogeneous, i.e. they are completely identical
 All firms only have the motive of profit maximization
 There is free entry and exit from the market, i.e. there are no barriers
 And there is no concept of consumer preference
Imperfect competition, which includes all situations that differ from perfect competition. Sellers
and buyers can influence in the determination of the price of goods, leading to efficiency
losses. Imperfect competition includes market structures such as:
Monopoly: it represents the opposite of perfect competition. This market is composed of a sole
seller who will therefore have full power to set prices.
Oligopoly: in this case, products are offered by a series of firms. However, the number of
sellers is not large enough to guarantee perfect competition prices. These markets are usually
studied by analyzing duopolies, since these are easier to model and the main conclusions can
be extrapolated to oligopolies.
Monopolistic competition: this market is formed by a high number of firms which produce a
similar good that can be seen as unique due to differentiation that will allow prices to be held up
higher than marginal costs. In other words, each producer will be considered as a monopoly
thanks to differentiation, but the whole markets considered as competitive because the degree
of differentiation is not enough to undermine the possibility of substitution effects.
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Monopsony: it’s similar to a monopoly, but in this case there are many firms selling products,
but only one buyer, the monopsonist, who will have full power when negotiating prices.
Oligopsony: similar to oligopolies, but with buyers. Sellers will have to deal with the increased
negotiating power of the only few buyers in the market, the oligopsonists.
2. The Money Markets
The money market is an organized exchange market where participants can lend
and borrow short-term, high-quality debt securities with average maturities of one
year or less. It enables governments, banks, and other large institutions to sell
short-term securities to fund their short-term cash flow needs. Money markets
also allow individual investors to invest small amounts of money in a low-risk
setting.
Some of the instruments traded in the money market include Treasury bills, certificates of
deposit, commercial paper, federal funds, bills of exchange, and short-term mortgage-backed
securities and asset-backed securities.
Large corporations with short-term cash flow needs can borrow from the market directly
through their dealer while small companies with excess cash can borrow through money
market mutual funds. Individual investors who want to profit from the money market can invest
through their money market bank account or a money market mutual fund. A money market
mutual fund is a professionally managed fund that buys money market securities on behalf of
individual investors.
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Functions of the Money Market
The money market contributes to the economic stability and development of a country by
providing short-term liquidity to governments, commercial banks, and other large organizations.
Investors with excess money that they do not need can invest it in the money market and earn
interest.
Here are the main functions of the money market:
1. Financing Trade
The money market provides financing to local and international traders who are in urgent need
of short-term funds. It provides a facility to discount bills of exchange, and this provides
immediate financing to pay for goods and services.
International traders benefit from the acceptance houses and discount markets. The money
market also makes funds available for other units of the economy such as agriculture and
small-scale industries.
2. Central Bank Policies
The central bank is responsible for guiding the monetary policy of a country and taking
measures to ensure a healthy financial system. Through the money market, the central bank
can perform its policy-making function efficiently.
For example, the short-term interest rates in the money market represent the prevailing
conditions in the banking industry and can guide the central bank in developing an appropriate
interest rate policy. Also, the integrated money markets help the central bank to influence the
sub-markets and implement its monetary policy objectives.
3. Growth of Industries
The money market provides an easy avenue where businesses can obtain short-term loans to
finance their working capital needs. Due to the large volume of transactions, businesses may
experience cash shortages related to buying raw materials, paying employees, or meeting
other short-term expenses.
Through commercial paper and finance bills, they can easily borrow money on a short-term
basis. Although money markets do not provide long-term loans, it influences the capital market
and can also help businesses obtain long-term financing. The capital market benchmarks its
interest rates based on the prevailing interest rate in the money market.
4. Commercial Banks Self-Sufficiency
The money market provides commercial banks with a ready market where they can invest their
excess reserves and earn interest while maintaining liquidity. The short-term investments such
as bills of exchange can easily be converted to cash to support customer withdrawals.
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Also, when faced with liquidity problems, they can borrow from the money market on a short-
term basis as an alternative to borrowing from the central bank. The advantage of this is that
the money market may charge lower interest rates on short-term loans than the central bank
typically does.
Types of Instruments Traded in the Money Market
Several financial instruments are created for short-term lending and borrowing in the money
market, they include:
1. Treasury Bills
Treasury bills are considered the safest instruments since they are issued with a full guarantee
by the United States government. They are issued by the U.S. Treasury regularly to refinance
Treasury bills reaching maturity and to finance the federal government’s deficits. They come
with a maturity of one, three, six, or twelve months.
Treasury bills are sold at a discount to their face value, and the difference between the
discounted purchase price and face value represents the interest rate. They are purchased by
banks, broker-dealers, individual investors, pension funds, insurance companies, and other
large institutions.
2. Certificate of Deposit (CD)
A certificate of deposit (CD) is issued directly by a commercial bank, but it can be purchased
through brokerage firms. It comes with a maturity date ranging from three months to five years
and can be issued in any denomination.
Most CDs offer a fixed maturity date and interest rate, and they attract a penalty for
withdrawing prior to the time of maturity. Just like a bank’s checking account, a certificate of
deposit is insured by the Federal Deposit Insurance Corporation (FDIC).
3. Commercial Paper
Commercial paper is an unsecured loan issued by large institutions or corporations to finance

short-term cash flow needs, such as inventory and accounts payables. It is issued at a
discount, with the difference between the price and face value of the commercial paper being
the profit to the investor.
Only institutions with a high credit rating can issue commercial paper, and it is therefore
considered a safe investment. Commercial paper is issued in denominations of $100,000 and
above. Individual investors can invest in the commercial paper market indirectly through money
market funds. Commercial paper comes with a maturity date between one month and nine
months.
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4. Banker’s Acceptance
A banker’s acceptance is a form of short-term debt that is issued by a firm but guaranteed by a
bank. It is created by a drawer, providing the bearer the rights to the money indicated on its
face at a specified date. It is often used in international trade because of the benefits to both
the drawer and the bearer.
The holder of the acceptance may decide to sell it on a secondary market, and investors can
profit from the short-term investment. The maturity date usually lies between one month and six
months from the issuing date.
5. Repurchase Agreements
A repurchase agreement (repo) is a short-term form of borrowing that involves selling a security
with an agreement to repurchase it at a higher price at a later date. It commonly used by
dealers in government securities who sell Treasury bills to a lender and agree to repurchase
them at an agreed price at a later date.
The Federal Reserve buys repurchase agreements as a way of regulating the money supply
and bank reserves. The agreements’ date of maturity ranges from overnight to 30 days or
more.
1.1 The Bond Market
The bond market often called the debt market, fixed-income market, or credit
market is the collective name given to all trades and issues of debt securities.
Governments typically issue bonds in order to raise capital to pay down debts or
fund infrastructural improvements. Publicly-traded companies issue bonds when
they need to finance business expansion projects or maintain ongoing operations.
Understanding Bond Markets
The bond market is broadly segmented into two different silos: the primary market and the
secondary market. The primary market is frequently referred to as the "new issues" market in
which transactions strictly occur directly between the bond issuers and the bond buyers. In
essence, the primary market yields the creation of brand new debt securities that have not
previously been offered to the public.
In the secondary market, securities that have already been sold in the primary market are then
bought and sold at later dates. Investors can purchase these bonds from a broker, who acts as
an intermediary between the buying and selling parties. These secondary market issues may
be packaged in the form of pension funds, mutual funds, and life insurance policies among
many other product structures.
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Types of Bond Markets
The general bond market can be segmented into the following bond classifications, each with
its own set of attributes.
Corporate Bonds
Companies issue corporate bonds to raise money for a sundry of reasons, such as financing
current operations, expanding product lines, or opening up new manufacturing facilities.
Corporate bonds usually describe longer-term debt instruments that provide a maturity of at
least one year.
Government Bonds
National-issued government bonds (or Treasuries) entice buyers by paying out the face value
listed on the bond certificate, on the agreed maturity date, while also issuing periodic interest
payments along the way. This characteristic makes government bonds attractive to
conservative investors.
Municipal Bonds
Municipal bonds—commonly abbreviated as "muni" bonds—are locally issued by states, cities,

special-purpose districts, public utility districts, school districts, publicly-owned airports and
seaports, and other government-owned entities who seek to raise cash to fund various
projects.
Mortgage-Backed Bonds
These issues, which consist of pooled mortgages on real estate properties, are locked in by the
pledge of particular collateralized assets. They pay monthly, quarterly, or semi-annual interest.
Emerging Market Bonds
Issued by governments and companies located in emerging market economies, these bonds
provide much greater growth opportunities, but also greater risk, than domestic or developed
bond markets.
The borrowing organization promises to pay the bond back at an agreed-upon date. Until then,
the borrower makes agreed-upon interest payments to the bondholder. People who own bonds
are also called creditors or debt holders. In the old days, when people kept paper bonds, they
would redeem the interest payments by clipping coupons. Today, this is all done electronically.
Of course, the debtor repays the principal, called the face value, when the bond matures. Most
bondholders resell them before they mature at the end of the loan period. They can only do this
because there is a secondary market for bonds. Bonds are either publicly traded on exchanges
or sold privately between a broker and the creditor. Since they can be resold, the value of a
bond rises and falls until it matures.
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Example
Imagine The Coca-Cola Company wanted to borrow $10 billion from investors to acquire a
large tea company in Asia. It believes the market will allow it to set the coupon rate at 2.5% for
its desired maturity date, which is 10 years in the future. It issues each bond at a par value of
$1,000 and promises to pay pro-rata interest semi-annually. Through an investment bank, it
approaches investors who invest in the bonds. In this case, Coke needs to sell 10 million bonds
at $1,000 each to raise its desired $10 billion before paying the fees it would incur.
Each $1,000 bond is going to receive $25.00 per year in interest. Since the interest payment is
semi-annual, it is going to arrive at $12.50 every six months. If all goes well, at the end of 10
years, the original $1,000 will be returned on the maturity date and the bond will cease to exist.
1.2 Equity Securities
Equity almost always refers to stocks and a share of ownership in a company (which is
possessed by the shareholder). Equity securities usually generate regular earnings for
shareholders in the form of dividends. An equity security does, however, rise and fall in value in
accord with the financial markets and the company’s fortunes.
The table from the opening portion of this chapter distinguished between investments in debt
securities and investments in equity securities. Attention is now turned to the specific details of
accounting for investments in equity securities. Equity securities infer an ownership claim to the
25
investor, and include investments in capital stock as well as options to acquire stock. The
accounting method for an investment in equity securities primarily depends on the level of
investment.
Most investments in equity securities are relatively small, giving the investor less than a 20%
ownership stake. These investments are ordinarily insufficient to give the investor the right to
control or significantly influence the investee company. The purposes for such smaller
investments varies; suffice it to say that the end goal is usually to profit from price appreciation
and dividends. Such investments may be short- or long-term in nature.
Short-term investments in equity securities were covered in Chapter 6, and that presentation is
equally applicable to long-term investments. That is to say, the manner of accounting for short-
term and long-term investments (those “generally below the 20% level”) does not vary. The
investment is reported on the balance sheet at fair value, and changes in value are booked in
income each period. The only notable difference is that the short-term investments would be
presented in the current asset section of a balance sheet, while the longer-term investments
would be positioned within the long-term investments category.
The Equity Method
An investor may acquire enough ownership in the stock of another company to permit the
exercise of”significant influence” over the investee company. For example, the investor has
some direction over corporate policy and can sway the election of the board of directors and
other matters of corporate governance and decision making. Generally, this is deemed to occur
when one company owns more than 20% of the stock of the other. However, the ultimate
decision about the existence of significant influence remains a matter of judgment based on an
assessment of all facts and circumstances.
Once significant influence is present, generally accepted accounting principles require that the
investment be accounted for under the equity method. Market-value adjustments are usually
not utilized when the equity method is employed. In global circles, the term “associate
investment” might be used to describe equity method investments.
With the equity method, the accounting for an investment tracks the “equity” of the investee.
That is, when the investee makes money (and experiences a corresponding increase in equity),
the investor will record its share of that profit (and vice-versa for a loss). The initial accounting
commences by recording the investment at cost:
04-01-2019 investment 50,000

cash 50,000
To record the purchase of 5,000
shares of legg stock $ 10per share.
Legg has 20,000 shares outstanding &
the investment in 25% of legg
(5,000/20,000) =25%) is sufficient to
give the investor significant influence.
26
Next, assume that Legg reports income for the three-month period ending June 30, 20X3, in
the amount of $10,000. The investor would simultaneously record its “share” of this reported
income as follows:
07-01-2019 investment 2,500

Investment income 2,500
To record investor’s share of
legg’s reported income (25% x $
10,000)
Importantly, this entry causes the Investment account to increase by the investor’s share of the
investee’s increase in its own equity (i.e., Legg’s equity increased $10,000, and the entry
causes the investor’s Investment account to increase by $2,500), thus the name “equity
method.” Notice, too, that the credit causes the investor to recognize income of $2,500, again
corresponding to its share of Legg’s reported income for the period. Of course, a loss would be
reported in the opposite fashion.
07-01-2019 cash 1,000

investment 1,000
To record the receipt of $ 1,000 in
dividends from legg—legg
declared and paid a total of $
4,000 ($ 4,000 x 25%= $ 1,000)
When Legg pays out dividends (and decreases its equity), the investor will need to reduce its
Investment account as shown below.
The above entry is based on the assumption that Legg declared and paid a $4,000 dividend.
This treats dividends as a return of the investment (not income, because the income is
recorded as it is earned rather than when distributed). In the case of dividends, consider that
the investee’s equity reduction is met with a corresponding proportionate reduction of the
Investment account on the books of the investor.
3.0 Market Indexes
A market index is a hypothetical portfolio of investment holdings that represents a segment of

the financial market. The calculation of the index value comes from the prices of the underlying
holdings. Some indexes have values based on market-cap weighting, revenue-weighting, float-
weighting, and fundamental-weighting. Weighting is a method of adjusting the individual impact
of items in an index.
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Understanding a Market Index
A market index measures the value of a portfolio of holdings with specific market
characteristics. Each index has its own methodology which is calculated and maintained by the
index provider. Index methodologies will typically be weighted by either price or market cap. A
wide variety of investors use market indexes for following the financial markets and managing
their investment portfolios. Indexes are deeply entrenched in the investment management
business with funds using them as benchmarks for performance comparisons and managers
using them as the basis for creating investable index funds.
Market Index Methodologies
Each individual index has its own method for calculating the index’s value. Weighted average
mathematics is primarily the basis for index calculations as values are derived from a weighted
average calculation of the value of the total portfolio. As such, price-weighted indexes will be
more greatly impacted by changes in holdings with the highest price, while market
capitalization-weighted indexes will be most greatly impacted by changes in the largest stocks,
and so on, depending on the weighting characteristics.
Market Indexes as Benchmarks
As a hypothetical portfolio of holdings, indexes act as benchmark comparisons for a variety of

purposes across the financial markets. As mentioned, the Dow Jones, S&P 500 and Nasdaq
Composite are three popular U.S. indexes. These three indexes include the 30 largest stocks in
the U.S. by market cap, the 500 largest stocks, and all of the stocks on the Nasdaq exchange,
respectively. Since they include some of the most significant U.S. stocks, these benchmarks
can be a good representation of the overall U.S. stock market.
28
Other indexes have more specific characteristics that create a more narrowly targeted market
focus. For example, indexes can represent micro-sectors or maturity in the case of fixed
income. Indexes can also be created to represent a geographic segment of the market such as
those that track the emerging markets or stocks in the United Kingdom and Europe. The FTSE
100 is an example of such an index.5
Investors may choose to build a portfolio with diversified exposure to several indexes or
individual holdings from a variety of indexes. They may also use benchmark values and
performance to follow investments by segment. Some investors will allocate their investment
portfolios based on the returns or expected returns of certain segments. Further, a specific
index may act as a benchmark for a portfolio or a mutual fund.
Index Funds
Institutional fund managers use benchmarks as a proxy for a fund’s individual performance.
Each fund has a benchmark discussed in its prospectus and provided in its performance
reporting, thus offering transparency to investors. Fund benchmarks can also be used to
evaluate the compensation and performance of fund managers.
Institutional fund managers also use indexes as a basis for creating index funds. Individual
investors cannot invest in an index without buying each of the individual holdings, which is
generally too expensive from a trading perspective. Therefore, index funds are offered as a
low-cost way for investors to invest in a comprehensive index portfolio, gaining exposure to a
specific market segment of their choosing. Index funds use an index replication strategy that
buys and holds all of the constituents in an index. Some management and trading costs are still
included in the fund’s expense ratio, but the costs are much lower than fees for an actively
managed fund.
3.1 Derivatives Markets

The derivatives market refers to the financial market for financial instruments such as
underlying assets and financial derivatives.
Participants in the Derivatives Market
The participants in the derivatives market can be broadly categorized into the following four
groups:
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1. Hedgers is when a person invests in financial markets to reduce the risk of price volatility in
exchange markets, i.e., eliminate the risk of future price movements. Derivatives are the most
popular instruments in the sphere of hedging. It is because derivatives are effective hedges in
correspondence with their respective underlying assets.
2. Speculators is the most common market activity that participants of a financial market take
part in. It is a risky activity that investors engage in. It involves the purchase of any financial
instrument or an asset that an investor speculates to become significantly valuable in the
future.
Illustration: Currently ICICI Bank Ltd (ICICI) is trading at, say, Rs 500 in the cash
Market and also at Rs 500 in the futures market (assumed values for the example
Only). A speculator feels that post the RBI’s policy announcement, the share price of
ICICI will go up. The speculator can buy the stock in the spot market or in the
Derivatives market. If the derivatives contract size of ICICI is 1000 and if the
Speculator buys one futures contract of ICICI, he is buying ICICI futures worth Rs 500
X 1000 = Rs 5, 00,000. For this he will have to pay a margin of say 20% of the
Contract value to the exchange. The margin that the speculator needs to pay to the
Exchange is 20% of Rs 5, 00,000 = Rs 1, 00,000. This Rs 1, 00,000 is his total
Investment for the futures contract. If the speculator would have invested
Rs 1, 00,000 in the spot market, he could purchase only 1, 00,000 /500 =200 shares.
Let us assume that post RBI announcement price of ICICI share moves to. Rs 520.
With one lakh investment each in the futures and the cash market, the profits
Would be:
(520 –500) X 1,000 =Rs 20, 000 in case of futures market and
(520 –500) X 200 =Rs 4000 in the case of cash market.
It should be noted that the opposite will result in case of adverse movement in
Stock prices, wherein the speculator will be losing more in the futures market than
In the spot market. This is because the speculator can hold a larger position in the
Futures market where he has to pay only the margin money.
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1. Arbitrageurs is a very common profit-making activity in financial markets that comes

into effect by taking advantage of or profiting from the price volatility of the market.
Arbitrageurs make a profit from the price difference arising in an investment of a
financial instrument such as bonds, stocks, derivatives, etc.
For example, if on 1st August, 2009 the SBI share is trading at Rs. 1780 in
The cash market and the futures contract of SBI is trading at Rs.17 90, the
Arbitrageur would buy the SBI shares (i.e. make an investment of Rs. 1780) in the
Spot market and sell the same number of SBI futures contracts. On expiry day
(Say 24 August, 2009), the price of SBI futures contracts will close at the price at
Which SBI closes in the spot market? In other words, the settlement of the futures
Contract will happen at the closing price of the SBI shares and that is why the
Futures and spot prices are said to converge on the expiry day. On expiry day, the
Arbitrageur will sell the SBI stock in the spot market and buy the futures contract,
Both of which will happen at the closing price of SBI in the spot market. Since the
Arbitrageur has entered into off-setting positions, he will be able to earn Rs.10
Irrespective of the prevailing market price on the expiry date.
There are three possible price scenarios at which SBI can close on expiry day.
Let us calculate the profit/ loss of the arbitrageur in each of the scenarios
Where he had initially (1 August) purchased SBI shares in the spot market at
Rs 1780 and sold the futures contract of SBI at Rs.1790:
Scenario I: SBI shares closes at a price greater than 1780 (say Rs. 2000) in the
Spot market on expiry day (24 August 2009)
SBI futures will close at the same price as SBI i n spot market on the expiry
Day i.e., SBI futures will also close at Rs. 2000. The arbitrageur reverses his
Previous transaction entered into on 1 August 2009.
Profit/ Loss (–) in spot market = 2000 –1780 =Rs.220
Profit/ Loss (–) in futures market = 1 790 –2000 =Rs. (–) 210
Net profit/ Loss (–) on both transactions combined = 220 –210 =Rs.10
Profit.
Scenario II: SBI shares close at Rs 1780 in the spot market on expiry day (24
August 2009) SBI futures will close at the same price as SBI in spot market on
Expiry day i.e., SBI futures will also close at Rs 1780. The arbitrageur reverses his
Previous transaction entered into on 1 August 2009.
Profit/ Loss (–) in spot market = 1780 –1780 =Rs 0
Profit/ Loss (–) in futures market = 1790 –1780 =Rs. 1 0
Net profit/ Loss (–) on both transactions combined = 0 + 10 =Rs.10 profit.
Scenario III: SBI shares close at Rs. 1500 in the spot market on expiry day (24
August 2009) Here also, SBI futures will close at Rs. 1500. The arbitrageur
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Reverses his previous transaction entered into on 1 August 2009.

Profit/ Loss (–) in spot market = 1500 –1780 =Rs. (–) 280
Profit/ Loss (–) in futures market = 1790 –1500 =Rs.290
Net profit/ Loss (–) on both transactions combined = (–) 280 + 290 = Rs.10
Profit.
4. Margin traders in the finance industry, the margin is the collateral deposited by an investor
investing in a financial instrument to the counterparty to cover the credit risk associated with the
investment.
Types of Derivative Contracts
Derivative contracts can be classified into the following four types:
1. Options are financial derivative contracts that give the buyer the right, but not the obligation,
to buy or sell an underlying asset at a specific price (referred to as the strike price) during a
specific period of time. American options can be exercised at any time before the expiry of its
option period. On the other hand, European options can only be exercised on its expiration
date.
2. Futures contracts are standardized contracts that allow the holder of the contract to buy or
sell the respective underlying asset at an agreed price on a specific date. The parties involved
in a futures contract not only possess the right but also are under the obligation, to carry out the
contract as agreed. The contracts are standardized, meaning they are traded on the exchange
market.
3. Forwards contracts are similar to futures contracts in the sense that the holder of the
contract possess not only the right but is also under the obligation to carry out the contract as
agreed. However, forwards contracts are over the counter products, which means they are not
regulated and are not bound by specific trading rules and regulations.
Since such contracts are unstandardized, they are traded over the counter and not on the
exchange market. As the contracts are not bound by a regulatory body’s rules and regulations,
they are customizable to suit the requirements of both parties involved.
4. Swaps are derivative contracts that involve two holders, or parties to the contract, to
exchange financial obligations. Interest rate swaps are the most common swaps contracts
entered into by investors. Swaps are not traded on the exchange market. They are traded over
the counter, because of the need for swaps contracts to be customizable to suit the needs and
requirements of both parties involved.
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Criticisms of the Derivatives Market

1. Risk the derivatives market is often criticized and looked down on, owing to the high risk
associated with trading in financial instruments.
2. Sensitivity and volatility of the market many investors and traders avoid the derivatives
market because of its high volatility. Most financial instruments are very sensitive to small
changes such as a change in the expiration period, interest rates, etc., which makes the market
highly volatile in nature.
3. Complexity owing to the high-risk nature and sensitivity of the derivatives market, it is often a
very complex subject matter. Because the derivatives trading is so complex to understand, it is
most often avoided by the general public, and they often employ brokers and trading agents in
order to invest in financial instruments.
4. Legalized gambling owing to the nature of trading in financial markets, derivatives are often
criticized for being a form of legalized gambling, as it is very similar to the nature of gambling
activities.
1.2 What are Securities
A security is a financial instrument, typically any financial asset that can be traded. The nature
of what can and can’t be called a security generally depends on the jurisdiction in which the
assets are being traded.
Types of Securities
1. Equity securities almost always refers to stocks and a share of ownership in a company
(which is possessed by the shareholder). Equity securities usually generate regular earnings
for shareholders in the form of dividends. An equity security does, however, rise and fall in
value in accord with the financial markets and the company’s fortunes.
2. Debt securities differ from equity securities in an important way; they involve borrowed
money and the selling of a security. They are issued by an individual, company, or government
and sold to another party for a certain amount, with a promise of repayment plus interest. They
include a fixed amount (that must be repaid), a specified rate of interest, and a maturity date
(the date when the total amount of the security must be paid by).
Bonds, bank notes (or promissory notes), and Treasury notes are all examples of debt
securities. They all are agreements made between two parties for an amount to be borrowed
and paid back – with interest – at a previously-established time.
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3. Derivatives are a slightly different type of security because their value is based on an
underlying asset that is then purchased and repaid, with the price, interest, and maturity date
all specified at the time of the initial transaction.
The individual selling the derivative doesn’t need to own the underlying asset outright. The
seller can simply pay the buyer back with enough cash to purchase the underlying asset or by
offering another derivative that satisfies the debt owed on the first.
A derivative often derives its value from commodities such as gas or precious metals such as
gold and silver. Currencies are another underlying asset a derivative can be structured on, as
well as interest rates, Treasury notes, bonds, and stocks.
Derivatives are most often traded by hedge funds to offset risk from other investments. As
mentioned above, they don’t require the seller to own the underlying asset and may only
require a relatively small down payment, which makes them favorable because they are easier
to trade.
4. Investment Banking
Investment banking is the division of a bank or financial institution that serves governments,
corporations, and institutions by providing underwriting (capital raising) and mergers and
acquisitions (M&A) advisory services. Investment banks act as intermediaries between
investors (who have money to invest) and corporations (who require capital to grow and run
their businesses). This guide will cover what investment banking is and what investment
bankers actually do.
What Do Investment Banks Do?
There can sometimes be confusion between an investment bank and the investment banking
division (IBD) of a bank. Full-service investment banks offer a wide range of services that
include underwriting, M&A, sales and trading, equity research, asset management, commercial
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banking, and retail banking. The investment banking division of a bank provides only the
underwriting and M&A advisory services.
Full-service banks offer the following services:
 Underwriting – Capital raising and underwriting groups work between investors and
companies that want to raise money or go public via the IPO process. This function
serves the primary market or “new capital”.
 Mergers & Acquisitions (M&A) – Advisory roles for both buyers and sellers of
businesses, managing the M&A process start to finish.
 Sales & Trading – Matching up buyers and sellers of securities in the secondary
market. Sales and trading groups in investment banking act as agents for clients and
also can trade the firm’s own capital.
 Equity Research – The equity research group research, or “coverage”, of securities
helps investors make investment decisions and supports trading of stocks.
 Asset Management – Managing investments for a wide range of investors including
institutions and individuals, across a wide range of investment styles.
Underwriting Services in Investment Banking
Underwriting is the process of raising capital through selling stocks or bonds to investors (e.g.,
an initial public offering IPO) on behalf of corporations or other entities. Businesses need
money to operate and grow their businesses, and the bankers help them get that money by
marketing the company to investors.
There are generally three types of underwriting:
 Firm Commitment – The underwriter agrees to buy the entire issue and assume full
financial responsibility for any unsold shares.
 Best Efforts – Underwriter commits to selling as much of the issue as possible at the
agreed-upon offering price but can return any unsold shares to the issuer without
financial responsibility.
 All-or-None – If the entire issue cannot be sold at the offering price, the deal is called
off and the issuing company receives nothing.
M&A Advisory Services
Mergers and acquisitions (M&A) advisory is the process of helping corporations and institutions
find, evaluate, and complete acquisitions of businesses. This is a key function in i-banking.
Banks use their extensive networks and relationships to find opportunities and help negotiate
on their client’s behalf. Bankers advise on both sides of M&A transactions, representing either
the “buy-side” or the “sell-side” of the deal.
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M&A Process
Banking Clients
Investment bankers advise a wide range of clients on their capital raising and M&A needs.
These clients can be located around the world.
Investment banks’ clients include:
 Governments – Investment banks work with governments to raise money, trade

securities, and buy or sell crown corporations.
 Corporations – Bankers work with both private and public companies to help them go
public (IPO), raise additional capital, grow their businesses, make acquisitions, sell
business units, and provide research for them and general corporate finance advice.
 Institutions – Banks work with institutional investors who manage other people’s money
to help them trade securities and provide research. They also work with private equity
firms to help them acquire portfolio companies and exit those positions by either selling
to a strategic buyer or via an IPO.
Investment Banking Skills
I-banking work requires a lot of financial modeling and valuation. Whether for underwriting or
M&A activities, Analysts and Associates at banks spend a lot of time in Excel, building financial
models and using various valuation methods to advise their clients and complete deals.
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Investment banking requires the following skills:
 Financial modeling – Performing a wide range of financial modeling activities such as

building 3-statement models, discounted cash flow (DCF) models, LBO models, and
other types of financial models.
 Business valuation – Using a wide range of valuation methods such as comparable
company analysis, precedent transactions, and DCF analysis.
 Pitch books and presentations – Building pitch books and PPT presentations from
scratch to pitch ideas to prospective clients and win new business (check out CFI’s
Pitch book Course).
 Transaction documents – Preparing documents such as a confidential information
memorandum (CIM), investment teaser, term sheet, confidentiality agreement, building
a data room, and much more (check out CFI’s library of free transaction templates).
 Relationship management – Working with existing clients to successfully close a deal
and make sure clients are happy with the service being provided.
 Sales and business development – Constantly meeting with prospective clients to pitch
them ideas, offer them support in their work, and provide value-added advice that will
ultimately win new business.
 Negotiation – Being a major factor in the negotiation tactics between buyers and
sellers in a transaction and helping clients maximize value creation.
Careers in Investment Banking
Getting into i-banking is very challenging. There are far more applicants than there are
positions, sometimes as high as 100 to 1. We’ve published a guide on how to ace an
investment banking interview for more information on how to break into Wall Street.
In addition, you’ll want to check out our example of real interview questions from an investment
bank. In preparing for your interview it also helps to take courses on financial modeling and
valuation.
The most common job titles (from most junior to senior) in i-banking are:
 Analyst
 Associate
 Vice President
 Director
 Managing Director
 Head, Vice Chair, or another special title
Who are the Main Investment Banks?
The main banks, also known as the bulge bracket banks in investment banking, are:
 Bank of America Merrill Lynch
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 Barclays Capital
 Citi
 Credit Suisse
 Deutsche Bank
 Goldman Sachs
 J.P. Morgan
 Morgan Stanley
 UBS
4.1 Securities Trading

Trading securities are securities that have been purchased by a company for the purposes of
realizing a short-term profit. Companies do not intend to hold such securities for a long period
of time; thus, they will only invest if they believe they have a good chance of being
compensated for the risk they are taking. A company may choose to speculate on various debt
or equity securities if it identifies an undervalued security and wants to capitalize upon the
opportunity.
Purchase by Companies
Trading Securities Held for Short Periods of Time
Strong Expectation of Capital gains
Trading securities purchased by companies are usually securities that are issued within the
company’s industry, since these are the securities that industry-leading organizations have the
most insight about. Any industry trends or impending news announcements can also influence
companies to purchase trading securities.
How are trading securities shown on the balance sheet?
Trading securities are treated using the fair value method, whereby the value of the securities
on the company’s balance sheet is equivalent to their current market value. These securities
will be recorded in the currents assets section under the “Short Term Investments” account and
will be offset in the shareholder’s equity section under the “Unrealized Proceeds from Sale of
Short Term Investments” account. The Short Term Investments account amount represents the
current market value of the securities, and the “Unrealized Proceeds from Sale of Short Term
Investments” account represents the cash proceeds that the company would receive if it were
to sell the investments at the end of the specified accounting period. The example below
assumes that the investments are purchased at the end of the 2017 accounting period:
[XYZ COMPANY]
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Balance Sheet 2017 2018
Assets
Current Assets:
Cash 211,069 239,550
Accounts Receivable 7,117 7,539
Sort Term Investment 10,000 8,000
Inventory 10,531 11,342
Total Current Assets 244,715 272,112
Property & Equipment 36,602 37,531

Goodwill 3,870 3,850
Total Assets 287,187 313,483
Liabilities
Current Liabilities:
Accounts Payable 5,265 5,671
Accrued Expense 1,865 1,899
Unearned Revenue 1,952 1,724
Total Current Liabilities 9,082 9,294
Long-Term Debt 30,000 30,00

Other Long-Term Liabilities 6,051 5,909
Total Liabilities 45,133 45,203
Shareholder’s Equity
Equity Capital 170,000 170,000
Retained Earnings 62,053 90,280
Unrealized Proceeds from Sale of Short Term Investments 10,000 8,000
Shareholder Equity 242,053 268,280
Total Liabilities & Shareholder’s Equity 287,187 313,483
Changes in the fair value of the trading securities are recorded through journal entries that
reflect any increases or decreases in the value of the assets. For instance, in the above
example, we see that there has been a loss of $2 billion, as the market value of the trading
securities held by the company has declined over the course of the holding period. To account
for this, a company creates journal entries where the loss is debited from a “Trading Securities
Market Value Adjustment” account, and credited to the “Unrealized Gain (Loss) On Short Term
Investments”. Below is an example of how this may look:
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Date Account Title Debit Credit

2018 Trading Securities Market Value Adjustment (2,000)
31-Dec Unrealized Gain (Loss) On Short Term Investments (2,000)
How are trading securities shown on the income statement?
On an income statement, trading securities are recorded at the time of sale. Any gains or
losses realized as a result of the securities in question are to be attributed to operating income
as a new line item titles “Gain (Loss) on Sale of Trading Securities.” The gains or losses that
are attributable to the trading securities are only recorded at the time of sale since this is when
they will materialize. Prior to the sale, the securities can still fluctuate in value – changes that
will be captured on the company’s balance sheet. Below is an example of how this would look:
[XYZ COMPANY]
Income Statement 2017 2018
Revenue 142,341 150,772

Cost of Goods Sold (COGS) 52,654 56,710
Gross Profit 89,687 94,062
Gross Profit Margin 63% 63%
Expenses
Salaries and Benefits 23,002 25,245
Rent and Overhead 11,020 11,412
Depreciation & Amortization 16,544 16,080
Operating Expenses 50,466 52,737
Operating Profit 39,122 41,325
Operating Profit Margin 27.48% 27.41%
Interest 1,500 1,500

Gain (Loss) on Trading Securities - (2,000)
Other 3,911 5,996
Total Expenses 55,977 58233
Earnings Before Tax 33,711 35,829
Taxes 10,908 11,598

Net Earnings 22,802 24,231
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4.2 Local Exchange Trading System
Local exchange trading systems are locally organized economic organizations that allow
members to participate in the exchange of goods and services among others in the group.
Local Exchange Trading Systems (LETS) use a locally created currency as denominations of
units of value which can be traded or bartered in exchange for goods or services. Members of
LETS typically view the systems as organized and cooperative schemes that maximize
purchasing power while benefiting members and the community.
How Local Exchange Trading Systems Work
The local exchange trading system traces its roots back to 1983, when Michael Linton came up
with the term. When Linton started the Comox Valley LET System in British Columbia, Canada,
he designed it so members could manage an alternate currency system to that of the federal
government.
This organization between members would allow them to participate in the local economy even
when they lacked traditional currency. Essentially, members would earn and spend credits by
doing business with each other.
Local exchange trading systems typically exhibit five fundamental traits:
 Cost of service
 Consent
 Disclosure
 Equivalence to the regional currency
 All interest-free
These traits—along with general guidelines such as membership fees, detailed logs of
transactions, and member directories—allow for an organized and well-run exchange.
Members who participate are given an account. They are listed in a directory of services that
are both offered and required in exchange for green dollars. These dollars are equal to federal
currency, but are never deposited, issued, or exchanged. Instead, they act like credits, so when
someone completes a service for another member, their accounts are updated with the
corresponding value.
Transactions don't necessarily require a nominal exchange of units. For instance, members
can repay other members who have performed for them a service by providing a service in
return, as opposed to paying for the original service.
Special Considerations
Most LET’S groups range from 50 to 150 members, with a small core group who use the
system as the basis of a lifestyle. That group of aging people currently makes up the
movement. But there has been a shift in the local currency is designed to include voucher
systems backed by dollars and time-based currency—a value which is based on time and labor
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hours rather than actual money. Rather than using a credit or local currency system like green
dollars, many countries have started using units of time between members.
The LETS movement, on a whole, hasn't been able to keep up with technology. In fact, there's
been a degree of unwillingness for groups to do so. That's because of a lack of funds and the
belief that the internet may decentralize their system.
Many people have difficulty adjusting to this type of money system, which is quite different from
conventional currency, which yields interest to savers and costs interest to borrowers. A LETS
system incentivizes different behaviors to mutual credit which has no commodity value and no
interest.
Example of a Local Exchange Trading System
Let's use a hypothetical situation as an example. Say Mary wants her house painted and John
accepts the job. When John completes it, his account is credited with the appropriate value
from Mary's account. John can then use those green dollars somewhere else. The system also
allows people to spend even when they don't have any credits, making up the value by doing
jobs when they can.
4.3 Foreign Exchange Markets
In the foreign exchange market, people and firms exchange one currency to purchase another
currency. This market is influence by both demand and supply:
 The demand for dollars comes from those U.S. export firms seeking to convert their
earnings in foreign currency back into U.S. dollars; foreign tourists converting their
earnings in a foreign currency back into U.S. dollars; and foreign investors seeking to
make financial investments in the U.S. economy.
 On the supply side of the foreign exchange market for the trading of U.S. dollars are
foreign firms that have sold imports in the U.S. economy and are seeking to convert
their earnings back to their home currency; U.S. tourists abroad; and U.S. investors
seeking to make financial investments in foreign economies.
Most countries have their own currencies, but not all. Sometimes small economies use the
currency of an economically larger neighbor. For example, Ecuador, El Salvador, and Panama
have decided to dollarize—that is, to use the U.S. dollar as their currency. Sometimes nations
share a common currency. The best example of a common currency is the Euro, a common
currency used by 19 members of the European Union. With these exceptions duly noted,
most international transactions require participants to convert from one currency to another
when selling, buying, hiring, borrowing, traveling, or investing across national borders. The
market in which people or firms use one currency to purchase another currency is called the
foreign exchange market.
Every exchange rate is a price—the price of one currency expressed in terms of units of
another currency. The key framework for analyzing prices, whether in this course, any other
economics course, in public policy, or business examples, is supply and demand in markets.
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The Extraordinary Size of the Foreign Exchange Markets
The quantities traded in foreign exchange markets are breathtaking. A survey done in April,
2013 by the Bank of International Settlements, an international organization for banks and the
financial industry, found that $5.3 trillion per day was traded on foreign exchange markets,
which makes the foreign exchange market the largest market in the world economy. In
contrast, 2013 U.S. real GDP was $15.8 trillion per year.
Table 1 shows the currencies most commonly traded on foreign exchange markets. The foreign
exchange market is dominated by the U.S. dollar, the Euro, the Japanese yen, and the British
pound.
Table 1. Currencies Traded Most on Foreign Exchange Markets as of April, 2016 (Source:
http://www.bis.org/publ/rpfx16fx.pdf)
Currency % Daily Share
U.S. dollar 87.6%
Euro 31.3%
Japanese yen 21.6%
British pound 12.8%
Australian dollar 6.9%
Canadian dollar 5.1%
Swiss franc 4.8%
Chinese yuan 2.6%
Demanders and Suppliers of Currency in Foreign Exchange Markets
In foreign exchange markets, demand and supply become closely interrelated, because a
person or firm who demands one currency must at the same time supply another currency—
and vice versa. To get a sense of this, it is useful to consider four groups of people or firms who
participate in the market: (1) firms that import or export goods and services; (2) tourists visiting
other countries; (3) international investors buying ownership (or part-ownership) in a foreign
firm; (4) international investors making financial investments that do not involve ownership.
Let’s consider these categories in turn.
Firms that sell exports or buy imports find that their costs for workers, suppliers, and investors
are measured in the currency of the nation where their production occurs, but their revenues
from sales are measured in the currency of the different nation where their sales happened. So,
a Chinese firm exporting abroad will earn some other currency—say, U.S. dollars—but will
need Chinese yuan to pay the workers, suppliers, and investors who are based in China. In the
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foreign exchange markets, this firm will be a supplier of U.S. dollars and a demander of
Chinese yuan.
International tourists need foreign currency for expenses in the country they are visiting; they
will supply their home currency to receive the foreign currency. For example, an American
tourist who is visiting China will supply U.S. dollars into the foreign exchange market and
demand Chinese yuan.
Financial investments that cross international boundaries, and require exchanging currency,
are often divided into two categories. Foreign direct investment (FDI) refers to purchasing (at
least ten percent) ownership in a firm in another country or starting up a new enterprise in a
foreign country. For example, in 2008 the Belgian beer-brewing company InBev bought the
U.S. beer-maker Anheuser-Busch for $52 billion. To make this purchase of a U.S. firm, InBev
had to supply euros (the currency of Belgium) to the foreign exchange market and demand
U.S. dollars.
The other kind of international financial investment, portfolio investment, involves a purely
financial investment that does not entail any management responsibility. An example would be
a U.S. financial investor who purchased bonds issued by the government of the United
Kingdom, or deposited money in a British bank. To make such investments, the American
investor would supply U.S. dollars in the foreign exchange market and demand British pounds.
Portfolio investment is often linked to expectations about how exchange rates will shift. Look at
a U.S. financial investor who is considering purchasing bonds issued in the United Kingdom.
For simplicity, ignore any interest paid by the bond (which will be small in the short run anyway)
and focus on exchange rates. Say that a British pound is currently worth $1.50 in U.S.
currency. However, the investor believes that in a month, the British pound will be worth $1.60
in U.S. currency. Thus, as Figure 2(a) shows, this investor would change $24,000 for 16,000
British pounds. In a month, if the pound is indeed worth $1.60, then the portfolio investor can
trade back to U.S. dollars at the new exchange rate, and have $25,600—a nice profit. A
portfolio investor who believes that the foreign exchange rate for the pound will work in the
opposite direction can also invest accordingly. Say that an investor expects that the pound,
now worth $1.50 in U.S. currency, will decline to $1.40. Then, as shown in Figure 2(b), that
investor could start off with £20,000 in British currency (borrowing the money if necessary),
convert it to $30,000 in U.S. currency, wait a month, and then convert back to approximately
£21,429 in British currency—again making a nice profit. Of course, this kind of investing comes
without guarantees, and an investor may suffer losses if the exchange rates do not move as
predicted.
Many portfolio investment decisions are not as simple as betting that the value of the currency
will change in one direction or the other. Instead, they involve firms trying to protect themselves
from movements in exchange rates. Imagine you are running a U.S. firm that is exporting to
France. You have signed a contract to deliver certain products and will receive 1 million euros a
year from now. But you do not know how much this contract will be worth in U.S. dollars,
because the dollar/euro exchange rate can fluctuate in the next year. Let’s say you want to
know for sure what the contract will be worth, and not take a risk that the euro will be worth less
in U.S. dollars than it currently is. You can hedge, which means using a financial transaction to
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protect yourself against currency risk. Specifically, you can sign a financial contract and pay a
fee that guarantees you a certain exchange rate one year from now—regardless of what the
market exchange rate is at that time. Now, it is possible that the euro will be worth more in
dollars a year from now, so your hedging contract will be unnecessary, and you will have paid a
fee for nothing. But if the value of the euro in dollars declines, then you are protected by the
hedge. Financial contracts like hedging, where parties wish to be protected against exchange
rate movements, also commonly lead to a series of portfolio investments by the firm that is
receiving a fee to provide the hedge.
Both foreign direct investment and portfolio investment involve an investor who supplies
domestic currency and demands a foreign currency. With portfolio investment less than ten
percent of a company is purchased. As such, portfolio investment is often made with a short
term focus. With foreign direct investment more than ten percent of a company is purchased
and the investor typically assumes some managerial responsibility; thus foreign direct
investment tends to have a more long-run focus. As a practical matter, portfolio investments
can be withdrawn from a country much more quickly than foreign direct investments. A U.S.
portfolio investor who wants to buy or sell bonds issued by the government of the United
Kingdom can do so with a phone call or a few clicks of a computer key. However, a U.S. firm
that wants to buy or sell a company, such as one that manufactures automobile parts in the
United Kingdom, will find that planning and carrying out the transaction takes a few weeks,
even months. Table 2 summarizes the main categories of demanders and suppliers of
currency.
Table 2. The Demand and Supply Line-ups in Foreign Exchange Markets

Demand for the U.S. Dollar Comes
Supply of the U.S. Dollar Comes from…
from…
A U.S. exporting firm that earned A foreign firm that has sold imported goods in the United
foreign currency and is trying to pay States, earned U.S. dollars, and is trying to pay
U.S.-based expenses expenses incurred in its home country
Foreign tourists visiting the United
U.S. tourists leaving to visit other countries
States
Foreign investors who wish to make U.S. investors who want to make foreign direct
direct investments in the U.S. economy investments in other countries
Foreign investors who wish to make
U.S. investors who want to make portfolio investments
portfolio investments in the U.S.
in other countries
economy
Participants in the Exchange Rate Market
The foreign exchange market does not involve the ultimate suppliers and demanders of foreign
exchange literally seeking each other out. If Martina decides to leave her home in Venezuela
and take a trip in the United States, she does not need to find a U.S. citizen who is planning to
take a vacation in Venezuela and arrange a person-to-person currency trade. Instead, the
foreign exchange market works through financial institutions, and it operates on several levels.
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Most people and firms who are exchanging a substantial quantity of currency go to a bank, and
most banks provide foreign exchange as a service to customers. These banks (and a few other
firms), known as dealers, then trade the foreign exchange. This is called the interbank market.
In the world economy, roughly 2,000 firms are foreign exchange dealers. The U.S. economy
has less than 100 foreign exchange dealers, but the largest 12 or so dealers carry out more
than half the total transactions. The foreign exchange market has no central location, but the
major dealers keep a close watch on each other at all times.
The foreign exchange market is huge not because of the demands of tourists, firms, or even
foreign direct investment, but instead because of portfolio investment and the actions of
interlocking foreign exchange dealers. International tourism is a very large industry, involving
about $1 trillion per year. Global exports are about 23% of global GDP; which is about $18
trillion per year. Foreign direct investment totaled about $1.4 trillion in 2012. These quantities
are dwarfed, however, by the $5.3 trillion per day being traded in foreign exchange markets.
Most transactions in the foreign exchange market are for portfolio investment—relatively short-
term movements of financial capital between currencies—and because of the actions of the
large foreign exchange dealers as they constantly buy and sell with each other.
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Chapter 2 Securities Regulation Macroeconomics & industry Analysis

5.0 The Securities and Exchange Comission
The Securities and Exchange Commission was formed in 1936 to safeguard public interest.
The Securities and Exchange Commission (SEC), the government agency which exercises
supervision and jurisdiction over all corporations and persons acting on their behalf, was
reorganized in 1976 through Presidential Decree No. 902-A.
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Local and foreign investors that intend to establish corporations, partnerships or associations in
the Philippines are required to register their business entities with the Securities and Exchange
Commission (SEC) before they can conduct business activities and participate in the country’s
securities market to buy or trade shares of stock, bonds, interests in a company, and other
types of financial assets.
SEC is the national government regulatory agency tasked with supervising the corporate sector
in the Philippines. It is also mandated to formulate policies and recommendations on issues
concerning the securities market as well as advise Congress and other government agencies
on all aspects of the securities market.
Registering your business with SEC is mandatory not only to legitimize its juridical entity but
also to enable it to legally engage in business, issue receipts, trade financial assets, and be
entitled to certain rights under the country’s corporate and investment laws.
The specific list of SEC registration requirements vary depending on the type of business entity
you want to register as well as the nature of activities and type of enterprise you plan to
undertake, but it is a general requirement to undergo the following processes to obtain a
Certificate of Registration from SEC:
 Secure a unique business name (you can reserve your business name through SEC’s
online services portal – the SEC i-View [https://ireport.sec.gov.ph/iview/index.html])
 Accomplish an Application Form from SEC
 Draft the necessary documents required for the specific business entity you plan to
register, which are as follows:
o Articles of Incorporation and By-laws
o Treasurer’s Affidavit
 Deposit the minimum paid-up capital requirement
 Obtain necessary licenses or permits from appropriate government agencies (for
regulated industry sectors and business activities).
Types of Business Entities Required to Register with SEC
Stock Corporations (for-profit business entities which have shareholders who hold ownership of
the corporation through shares of stock)
Types:
 Domestic Corporations
 Resident Foreign Corporations
o Branch Office
o Representative Office
o Regional Headquarters (RHQ)
o Regional Operating Headquarters (ROHQ)
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Non-Stock Corporations (non-profit business entities which do not issue stocks and distribute
dividends to their members)
Types:
 Non-Governmental Organizations (NGOs)

 Foundations
 Associations
 Religious Organizations
Partnerships (for-profit business entities established by two or more persons who share
management and profits among themselves)
Types:
 General Partnership
 Limited Partnership
Major Functions:
 The SEC has absolute jurisdiction, supervision, and control over all corporations,
partnerships, and association.
 It is also responsible for administering, and implementing such laws as the Corporation
Code, the Securities Regulation Code, Investment Houses Law, the Financing
Company Act, and the Investment Company Act.
5.1 The International Organization of Security Commission
The International Organization of Securities Commissions (IOSCO) is a global cooperative of

securities regulatory agencies that aims to establish and maintain worldwide standards for
efficient, orderly and fair markets. The stated goals of the IOSCO are to:
 Promote high standards of regulation for the sake of orderly and efficient markets
 Share information with exchanges and assist them with technical and operational
issues
 Establish standards toward monitoring global investment transactions across borders
and markets
The International Organization of Securities Commissions (IOSCO) is the international body

that brings together the world's securities regulators and is recognized as the global standard
setter for the securities sector. IOSCO develops, implements and promotes adherence to
internationally recognized standards for securities regulation.
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Understanding the International Organization of Securities Commissions (IOSCO)
There were more than 218 members in the International Organization of Securities
Commissions (IOSCO) as of February 2018. Membership is divided into three categories.
These include:
 Ordinary members, which include the primary futures markets and securities regulators
in a given jurisdiction. Each ordinary member has one vote.
 Associate members, consisting of additional futures and securities regulators in those
jurisdictions that have multiple regulatory bodies. Associate members do not have a
vote and aren’t eligible for the Executive Committee, but are members of the
Presidents’ Committee.
 Affiliate members, which include self-regulatory organizations, stock exchanges, and
stock market industry associations. These members do not have a vote and are not
eligible for either the Executive Committee or the President’s Committee, but may be
members of the Self-Regulatory Organizations (SRO) Consultative Committee.
The IOSCO is made up of several committees that meet at conferences that take place around
the world several times a year. Its administrative offices of the General Secretariat are based in
Madrid. It has four regional committees and a technical committee, which does much of the
organization’s regulatory work.
History of the IOSCO
In 1983, the Inter-American Regional Association, which had been formed in 1974, expanded
its operations into a global cooperative that became the IOSCO. The first regulators from
outside the Americas to join the IOSCO were from Indonesia, France, Korea, and the United
Kingdom. The first IOSCO Annual Conference to take place outside the Americas was the July
1986 Paris Annual Conference.
The IOSCO currently operates in more than 100 jurisdictions, covering more than 90% of the
world's markets, and is considered to be the source for global standards of market operation. In
1998, it approved the IOSCO Principles, which set the benchmark for securities markets
worldwide. The IOSCO has since released a methodology for how to achieve those
benchmarks. The IOSCO's work has been praised at the highest levels of government,
especially in the aftermath of 9/11, as transactions between different countries became
something that required increased scrutiny and regulatory control.
The global securities market has been constantly evolving over the years to better serve the
needs of traders and investors alike. Traders require liquid markets with minimal transaction
and delay costs in addition to transparency and assured completion of the transaction. Based
on these core requirements, a handful of securities market structures have become the
dominant trade execution structures in the world.
5.2 Registration of Securities
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Provided under Section 3 of Presidential Decree No. 902-A, the SEC has absolute jurisdiction,
supervision, and control over all corporations, partnerships, and associations that are grantees
of primary franchises and licenses or permits issued by the government.
Pursuant to Section 5 of the Securities Regulation Code, the major powers and functions of
SEC shall include the following:
 Approve, reject, suspend or revoke registration license applications;

 Regulate, investigate or supervise the activities of entities under its jurisdiction to
ensure compliance;
 Enlist the aid and support of enforcement agencies of the government, civil or military
as well as any private institution, corporation, firm, association or person in the
implementation of its powers and functions;
 Compel the officers of any registered corporation or association to call meetings of
stockholders or members thereof under its supervision;
 Impose sanctions for the violation of laws, rules, regulations, and orders; and
 Suspend, or revoke, after proper notice and hearing the franchise or certificate of
registration of corporations, partnerships or associations, upon any of the grounds
provided by law.
Before your enterprise can legally conduct business in the Philippines, you have to register with
a number of important government agencies, chief among which is the Securities and
Exchange Commission or the SEC if you’re operating a corporation or a partnership. On top of
being the agency responsible for regulating securities or tradable financial assets in the
Philippines, SEC—an agency within the Department of Finance—also maintains a registry of
business entities in the country, possessing powers to regulate, investigate, or supervise the
activities of companies and individuals to ensure their compliance with the law.
On top of ensuring that your business conforms to the laws and rules set forth under the
Securities Regulation Code, registering with the SEC is necessary if you want to have access
to the host of financing options available to other registered businesses in the Philippines. First
Circle, for example, is only able to extend its invoice financing and purchase order financing
facilities to B2B businesses that are already registered with the SEC and other important
government agencies. Whether you’re in the business of exporting goods to foreign retailers,
manufacturing apparel for a well-known clothing brand, supplying medical supplies to hospitals,
or something else entirely, having your business fully registered with the SEC will open doors
to a lot of opportunities you wouldn’t have access to otherwise.
Which Types of Businesses Require Registration with the SEC?
As part of the powers and functions provided by Presidential Decree No 902-A, the Securities
and Exchange Commission is given absolute “jurisdiction, supervision and control over all
corporations, partnerships, or associations, who are the grantees of primary franchise and/or a
license or permit issued by the government to operate in the Philippines.”
The entities or juridical persons referred to above include the following:
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Stock Corporations
Stock corporations are corporations that engage in income-generating activities and are
permitted to declare dividends. They have shareholders that are given a portion of the
ownership of the business through shares of stock. Stock corporations include both domestic
stock corporations and foreign stock corporations.
Non-Stock Corporations
Non-stock corporations are corporations with no authorized capital stock, which means they
don’t issue shares of stock. These corporations’ incomes are not distributable as dividends to
their members, trustees, or officers.
According to the SEC, non-stock corporations in the Philippines may be organized for a range
of purposes, including charitable, religious, educational, professional, cultural, fraternal, literary,
scientific, social civil service, and others of the sort. Like stock corporations, non-stock
corporations can also be either domestic or foreign.
Partnerships
Another legal type of business operation in the Philippines is a partnership, which is set up
between two or more individuals who will have equal share of both management of—and
profits from—the business. A partnership can take the form of any of the following: professional
partnership, general partnership, or limited partnership.
Unlike a corporation, partners or co-owners in a partnership are taxed according to their

individual incomes (instead of being subject to a corporate rate), and legally, they may be
personally liable to the debts and obligations of the business. This means that the assets of
individual owners in a partnership may be used to pay off the debts of the business, whereas
with corporations, stockholders are liable only to the extent of their subscribed capital stock.
One key difference between corporations and partnerships that you need to be aware of is that
a corporation becomes a juridical person only after the business is registered with the SEC,
while a partnership becomes one from the time the agreement between partners is finalized.
Furthermore, corporations cannot exist beyond a period of 50 years, whereas partnerships can
exist for as long as the partners or owners decide to keep their contract in effect.
It is also important to note that if you own a business where you are the sole proprietor, you will
have to register your business with the Department of Trade and Industry (DTI) instead of the
SEC.
SEC Registration Process: Three “Lanes” to Choose From
Through the years, the Securities and Exchange Commission has made it easier for business
owners to register their business with the agency. Since November 2017, for example, the
agency’s company registration procedure has gone fully online with the launch of their
proprietary Company Registration System or CRS, which replaced the timeworn SEC iRegister
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system. With the launch of the CRS, users were able to take advantage of many benefits,
including 24/7 access to the system, free account registration and name verification, online
payment facility, and minimal physical visits to the SEC office. The only times applicants were
required to visit the SEC office was when they had to submit copies of notarized documents
and when it was time to claim their Certificate of Registration.
Then, in March 2019, SEC launched a special new lane in its CRS in order to make one-day
processing and approval of applications possible. The lane, currently known as Lane for
Express Application Processing (LEAP) allows applicants to take advantage of a pro-forma
online application in which they only need to input the required information and to tick items off
the pre-provided lists. This system addresses major bottlenecks in the application process,
which include manual document processing and compliance checks, among others.
Before the launch of LEAP, only the Regular Lane and the Fast Track Lane were available to
users of the SEC CRS. The Fast Track Lane streamlined the original CRS process by
implementing a hybrid-manual transition measure that enabled the quicker resolution or
approval of pending applications. Under this process, specific applicants—namely corporations
that had to submit additional documentation—were still required to manually submit original
copies of notarized documents before they could claim their Certificates of Registration. With
the introduction of LEAP, a special lane was made accessible to another class of corporations
—specifically non-specialized ones that didn’t need to submit additional documentation.
Here’s a summary of the main differences between the three lanes:
Lane for Express Application Processing (LEAP)
 With LEAP, one-day processing and approval is made possible because no human
intervention is needed to review the applications.
 LEAP employs a pro-forma application form, which is a lot easier to use because the
applicant has to simply tick items off the given lists. In other sections of the form, users
can fill in the required information instead. However, LEAP removes the option for
users to create their own provisions or to upload their own documents into the system.
 LEAP is designed for use by general-purpose or non-specialized corporations,
particularly those that do not need to submit extra documentary requirements like
secondary licenses or endorsements from other government agencies.
Fast Track Lane
 As previously mentioned, the Fast Track Lane is a hybrid-manual transition system that
simplifies the business registration process by expediting the approval of unfinished or
unresolved CRS applications.
 Although applicants using the Fast Track Lane will be able to encode their applications
online, they will still be required to manually present original copies of notarized
documents to the SEC, which can then check and process the documents before the
Certificate of Registration can be created.
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 The Fast Track Lane can be used by corporations that have to submit additional
documentary requirements, including secondary licenses or prior endorsements from
other government agencies.
Regular Lane
 Under the Regular Lane, all types of corporations and partnerships can be
accommodated.
 The entire registration process can be done online, from the encoding of company
details and the uploading of necessary documents all the way to paying the required
registration fees.
 Applicants will only be required to go to SEC once: when their Certificate of
Registration is ready for claiming.
Making the three lanes available to applicants is just one of the technological interventions
conceived of by the SEC in order to streamline the overall business registration process, to cut
down the time it takes to complete each application, and to improve the client experience of all
those who rely on the agency’s services. In the next section, we shall discuss some of the most
important requirements for registering a business with the SEC.
Business Name
After creating an account in the SEC Company Registration System and being asked what type
of application you wish to pursue, you will then be prompted to verify your business name. The
system will let you know whether or not the proposed trade name is still available, and if it is,
you’ll be able to add it and submit it for evaluation. Afterwards, the SEC will send you an email
notifying you on either the approval or the rejection of your proposed business name.
While you can always file an appeal for the re-evaluation of a rejected trade name, it’s best
practice to prepare 2 or 3 more names that you can use, just in case your first choice doesn’t
get approved (or isn’t available in the first place). You’ll be well advised to consult the SEC
Memorandum Circular No. 14, s. 2017 or the Consolidated Guideline and Procedures on the
Use of Corporate and Partnership Names, which can help you make sure that you’re picking an
appropriate name for your business.
Basic Company Details
In order for the CRS to be able to generate documents such as your company’s Articles of
Incorporation or Articles of Partnership, By-Laws, Treasurer’s Affidavit, Cover Sheet, and other
documents, you must input several details about your company. The requirements and options
will vary depending on the type of company you are registering and the kind of application you
are pursuing, but in general, you will be asked by the system to define or provide details for the
following:
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 Company Information
 Company Address
 Company Classification
 Purpose Clause (the kind of business or operation you will engage in)
 Term of Existence (how many years your company will be in operation)
 Capital Structure (includes the amount of your authorized capital stock, total number of
shares, and so on)
 Number of Incorporators
 Role or Profile of Incorporators
 Corporate Subscribers
 Others
Documents to Be Submitted
Finally, you need to prepare the documents that are relevant to your application. Again, the
documentary requirements for registering a business with the SEC will depend on the kind of
application you are working on. As mentioned, some of the required documents will be
generated by the CRS, while others will have to be obtained elsewhere and submitted manually
to the SEC. The documents you have to generate or secure can include the following, among
several others:
 Cover Sheet
 Articles of Incorporation or Articles of Partnership
 By-Laws
 Treasurer’s Affidavit
 Secondary Licenses
 Endorsements from Other Government Agencies
6.0 Investor Protection
Investor protection may be broadly interpreted as safeguarding the interests of investors by

instituting a combination of measures in areas relating to corporate governance of listed
companies (e.g. shareholder rights, disclosure and accountability), market regulation, trading
and settlement system efficiency and reliability, as well as financial institutions’ dealings with
investors. For the purpose of the survey, we have limited its scope to three key areas:
(a) market misconduct

(b) false and misleading statements or omissions in prospectuses; and
(c) recommendations without a reasonable basis
Some of the investor protection initiatives of the PSE are, but are not limited to the following:
1. Self-Regulatory Organization
(SRO) as granted by the SEC in June 1998. As such, the PSE acts as the ‘police’ of the stock
market and it is the SRO status that empowers it to formulate marketplace rules, and impose
penalties or sanctions to market participants who will not comply with this rules.
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2. Customer First Policy
The PSE regularly monitors and audits the operations of stockbrokers. It ensures that
business and trading practices of stockbrokers conform with the laws stipulated in the
Securities Regulation Code of the Philippines, including the Customer First Policy,
whereby stockbrokers’ orders must always surrender priority to their clients.
3. Risk Based Capital Adequacy is a PSE regulation which ensures that stockbrokers have
enough capital to cover its exposure to risks. It also ensures that stockbrokers are financially
sound or liquid enough to promptly settle claims and other obligations to clients.
4. Disclosure rules since timely and reliable company disclosures are essential components of a
fair and efficient market, the PSE also sees to it that listed companies promptly disclose factual
truthful information only.
a. 10-Minute Rule
The PSE requires that material information that which may affect a listed company’s share
price positively or negatively, are disclosed within 10 minutes after its occurrence.
b. Selective Disclosure Rule
Disclosures must also be done first to the PSE so that it will cascade information to every
investor and general public through its communication channels and not to a selected group of
individuals only.
c. PSE Electronic Disclosure Generation Technology or PSE EDGE
The PSE Electronic Disclosure Generation Technology or PSE EDGE is a state-of-the-art, fully
automated system that facilitates the efficient processing, validation, submission, distribution,
and analysis of time-sensitive disclosure reports submitted to the Exchange. The new
disclosure system, which was acquired from the Korea Exchange and replaces the PSE Online
Disclosure System (ODiSy), is equipped with a variety of features to further standardize the
disclosure reporting process of PSE’s listed companies, improve investors’ disclosure
searching and viewing experience, and enhance overall issuer transparency in the market.
5. Capital Markets Integrity Corporation (CMIC).
CMIC was established for the primary purpose of reinforcing the confidence of the investing
public in capital market institutions and promoting a more active and vibrant market
participation. Accordingly, CMIC acts as the independent audit, surveillance and compliance
arm of the Exchange.
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As a self-regulatory organization, CMIC's primary mandate is to maintain the integrity of the

market and minimize the risk of the investing public by ensuring that the TPs adhere to all
pertinent rules, regulations, and code of conduct of CMIC and the Exchange, as well as all
related legislative and regulatory requirements.
6. Total Market Surveillance (TMS)
To further enhance investor confidence, the CMIC oversees the market through a world-
class and sophisticated surveillance system called TMS, which was developed by the Korea
Exchange. TMS is equipped with the critical elements of the surveillance process and
provides a robust monitoring and warning mechanism. It is designed to safeguard the
integrity of the stock market from fraud, manipulation, and breaches of marketplace rules.
The CMIC conducts investigation of unusual price and volume movements to identify and
sanction trading participants, issuers or investors who might have committed unfair market
practices.
7. Securities Investor Protection Fund (SIPF).
Another tool created for the protection of investors is the Securities Investors Protection
Fund, Inc. or SIPF. The SIPF, which is comparable to the Philippine Deposit Insurance Corp.
providing insurance for bank deposits, seeks to build and enhance investors’ confidence in
the market and is envisioned to protect the investing public from extraordinary losses, other
than the ordinary market fluctuations, arising as a result of fraud, failure of business, or
judicial insolvency of PSE-accredited stockbrokers.
6.1 Manipulating of Security Prices
Market manipulation refers to artificial inflation or deflation of the price of a security. Also known
as price manipulation or stock manipulation, it involves the literal manipulation of a financial
market for personal gain. It means influencing the behavior of the securities with the intent to
do so.
Market manipulation can be difficult for authorities and market regulators to detect, given that
multiple variables affect the price movement of a security. Some of these variables may not
even be perfectly quantifiable. However, when detected, market manipulation is met with
serious civil liability.
Market manipulation can be difficult not only for authorities but also for the manipulator. These
difficulties are exacerbated by the increase in the size of the market and the number of
participants in it.
Therefore, it is easier for one to manipulate the prices of the stock of a small company, like a
penny stock. This is because other market participants and regulators tend to pay closer
attention to companies with medium or large market capitalization.
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There are several ways of manipulating stock prices in the market. Deflating the price of a
security can be achieved by placing a significantly large amount of small order at a price that is
lower than the current market price of that security.
Investors interpret it as a signal that there is something wrong with the company. A negative
perception pushes investors to sell the securities, thus pushing the price of the stock even
lower.
One of the ways of inflating the price of a security is by placing an equal number of buy and sell
orders for the same security simultaneously, but by using different brokers. Thus, the orders
cancel each other out.
The large volume of orders executed gives an investor the impression that there is an
increased interest in the security. This convinces them of the possibility of future price
appreciation, then they buy that security, which ultimately ends up pushing the actual stock
price higher.
Techniques of Market Manipulation
Market manipulation techniques involve spreading false information via online channels that
are frequently visited by investors. The barrage of bad information on message boards, when
combined with market signals that seem legitimate on the surface, can encourage traders to
execute a given trade.
The two major techniques of market manipulation are:
1. Pump and Dump
Pump and dump is a manipulation technique that is used frequently in order to inflate the price
of security artificially. The manipulator then sells out, and followers are left with an overvalued
security. This works on stocks with micro-market capitalization.
2. Poop and Scoop
The poop and scoop technique is not as frequently used as the pump and dump. Here, the
price of the stock of a medium or large-cap company is artificially deflated. Once it happens,
the manipulator buys the undervalued shares, thus making a profit.
Poop and scoop is rarer because it is significantly tougher to artificially affect the prices of a
good company.
Currency Manipulation
This is also a type of market manipulation but is considered a different class, given that it is
executed by legal authorities such as central banks and sovereign governments. Currency
manipulation isn’t effectively illegal but is frowned upon and considered to be malpractice by
the World Trade Organization (WTO).
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Trading partners may also choose to impose sanctions on currency manipulators. Under the
floating exchange rate system, countries can deflate or inflate the value of their own currency
as opposed to that of other countries. They may devalue by selling government bonds or
printing currency in order to make exports cheaper, and imports more expensive, thus
addressing trade imbalances.
6.2 Insider Trading
Insider trading refers to the practice of purchasing or selling a publicly-traded company’s

securities while in possession of material information that is not yet public information. Material
information refers to any and all information that may result in a substantial impact on the
decision of an investor regarding whether to buy or sell the security.
By non-public information, we mean that the information is not legally out in the public domain
and that only a handful of people directly related to the information possess. An example of an
insider may be a corporate executive or someone in government who has access to an
economic report before it is publicly released.
Detailed rules regarding insider trading are complicated and generally, vary from country to
country. The definition of an “insider” can differ significantly under different jurisdictions. Some
may follow a narrow definition and only consider people within the company with direct access
to the information as an “insider.” On the other hand, some may also consider people related to
company officials as “insiders.”
Hypothetical Examples of Insider Trading
 The CEO of a company divulges important information about the acquisition of his
company to a friend who owns a substantial shareholding in the company. The friend
acts upon the information and sells all his shares before the information is made public.
 A government employee acts upon his knowledge about a new regulation to be passed
which will benefit a sugar-exporting firm and buys its shares before the regulation
becomes public knowledge.
 A high-level employee overhears some conversation about a merger and understands
its market impact and consequently buys the shares of the company in his father’s
account.
Real-life Examples of Insider Trading

1. Martha Stewart
Shares of ImClone took a sharp dive when it was found out that the FDA rejected its new
cancer drug. Even after such a fall in the share price, the family of CEO Samuel Waskal
seemed to be unaffected. After receiving advance notice of the rejection, Martha Stewart sold
her holdings in the company’s stock when the shares were trading in the $50 range, and the
stock subsequently fell to $10 in the following months. She was forced to resign as CEO of her
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company and Waskal was sentenced to more than seven years in prison and fined $4.3 million
in 2003.
2. Reliance Industries
The Securities and Exchange Board of India banned RIL from the derivatives sector for a year
and levied a fine on the company. The exchange regulator charged the company with the
intention of making profits by skirting regulations on its legally permissible trading limits and
lowering the price of its stock in the cash market.
3. Joseph Nacchio
Joseph Nacchio made $50 million by dumping his stock on the market while giving positive
financial projections to shareholders as chief of Qwest Communications at a time when he
knew of severe problems facing the company. He was convicted in 2007.
4. Yoshiaki Murakami
In 2006, Yoshiaki Murakami made $25.5 million by using non-public material information about
Livedoor, a financial services company that was planning to acquire a 5% stake in Nippon
Broadcasting. His fund acted upon this information and bought two million shares.
5. Raj Rajaratnam
Raj Rajaratnam made about $60 million as a billionaire hedge fund manager by swapping tips
with other traders, hedge fund managers, and key employees of IBM, Intel Corp, and McKinsey
& Co. He was found guilty of 14 counts of conspiracy and fraud in 2009 and fined $92.8 million.
Penalties for Insider Trading
If someone is caught in the act of insider trading, he can either be sent to prison, charged a
fine, or both. According to the SEC in the US, a conviction for insider trading may lead to a
maximum fine of $5 million and up to 20 years of imprisonment. According to the SEBI, an
insider trading conviction can result in a penalty of INR 250,000,000 or three times the profit
made out of the deal, whichever is higher.
6.3 White Collar Crimes Related to Securities
Securities are stocks and bonds an investor may purchase. Stocks give the investors an
ownership share in the company.
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Securities Regulation
Between 1929 and 1941 the people of the United States suffered through the Great
Depression, the deepest and most prolonged economic crisis in American history. Although
many factors contributed to the economic depression, the crash of the stock market in October
1929 marked its beginning. Investors in securities, stocks, and bonds lost everything in the
unregulated market.
Following the leadership of President Franklin D. Roosevelt (1882–1945; served 1933–45),

Congress passed new legislation known as the New Deal, designed to protect citizens from
economic fluctuations. Two of these legislative remedies were the Securities Act of 1933 and
the Securities Exchange Act of 1934. Both laws restored investor confidence in the market by
providing more structure and government regulation.
The 1933 Securities Act required both businesses who desired to sell their stock and
stockbrokers who sold stock to provide full information about stocks to potential investors. The
Securities Exchange Act of 1934 prohibited certain activities in stock market trading and set
penalties for violations. It also established the Securities and Exchange Commission (SEC) to
oversee stock market trading.
These laws were based on two ideas. First, companies offering stock on the market had to tell
the public the truth about their businesses and the risks involved in investing in them. Second,
stockbrokers were to put the interests of investors above any other consideration and deal with
them fairly and honestly.
The two 1930s acts remain the foundation of securities regulation. The SEC continued to be
the top regulatory agency at the beginning of the twenty-first century. The SEC oversees all key
participants in the securities market including the stock exchanges, stock brokerage firms, the
actions of individual stockbrokers, investment advisors, and mutual funds (groups of stocks in
which people may invest). They are the overseer to protect investors against deceptive or
illegal activities such as security fraud.
Stock ownership entitles investors to a dividend or payment per share of stock if the company
earns a profit (money left over after all expenses are paid). Stock increases in value if the
company is growing and profitable. Investment in bonds pays the investor a set amount over a
period of time like a bank pays interest in a savings account. Bonds do not grant the investor
any ownership in the company. Commodities are economic goods being sold and purchased in
large quantities. Securities fraud is committed by an individual or firm intending to influence the
price of a stock or commodity by providing misleading information to investors.
As more people invest in securities and business practices become more complex, securities
fraud involving company officials, investment bankers, and others operating in the industry also
increases. Dealing with millions of dollars every day, some individuals cannot resist fraudulent
schemes to pad their own pockets. A stable securities industry is essential for the nation's
economic health and financial growth. By the early twenty-first century, approximately 80
percent of the American population owned some kind of stock, bond, or commodity. Only 20
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percent of these citizens bought and sold stocks themselves; the majority were invested in
retirement plans or company stock option plans.
The FBI is responsible for uncovering securities and commodities fraud schemes. They work in
close cooperation with the Securities and Exchange Commission (SEC), the National
Association of Securities Dealers (NASD), the Commodities and Futures Trading Commission
(CFTC), the North American Securities Administrators Association (NASAA), and state and
local agencies.
The usual types of securities fraud are embezzlement and insider trading. Embezzlement is the
unlawful use of money belonging to a company or its investors. Types of embezzlement include
brokers (those who buy and sell securities) writing forged checks from investor accounts,
illegally transferring funds, or purposely misleading investors with falsified documents.
Insider trading involves the sale or buying of stock by people who have knowledge about a
company that is not available to the public. For example, executives from a drug manufacturer
learn a new drug their company is marketing will not be approved by the FDA (Federal Drug
Administration) for general use. They learn this before any public announcement is made and
warn a few investors to sell their stock in the drug company before the news breaks and the
stock's value falls sharply, leaving the stocks worthless and making them nearly impossible to
sell.
Kickbacks, or money payouts, are often paid to persons who have advance knowledge about a
product or company and are willing to tell others. If the insider uses the information for his or
her own gain, it is insider trading; if the person tells someone else and receives money in return
after the information has been verified, it is called a kickback.
The New York Stock Exchange is the center of stock trading.
A well-known case of insider trading that gained national attention in 2003 and 2004 involved
celebrity homemaker Martha Stewart (1941–). Stewart was allegedly told privately that stock in
ImClone Systems Inc., a biotechnology company, would plunge in the next few days. Stewart
sold her stock to avoid a loss. While Stewart was only prosecuted for lying to the FBI about the
incident, her actions were a high-profile example of insider trading.
Another type of securities fraud concerns illegal trading referred to as Micro-Cap. Micro means
very small and Cap refers to capital, or the money invested in a company. Micro-Cap stocks
are low priced shares of new companies with little or no business track record. Securities fraud
rings included organized crime, which often used highly persuasive calls to pressure people
into investing money in a Micro-Cap. Any money received is generally hidden in foreign bank
accounts, and investors rarely see their money again.
Other twenty-first century securities fraud schemes make use of the Internet. Investors often
check the Internet daily for information on stocks. Many fake get-rich-quick stocks are offered
over the Internet, tricking unsuspecting or inexperienced investors (see chapter 11 on Cyber
Crime).
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Securities and Commodities Fraud
The continuing integration of global capital markets has created unprecedented

opportunities for U.S. businesses to access capital and investors to diversify their
portfolios. Whether through individual brokerage accounts, college savings plans, or
retirement accounts, more and more Americans are choosing to invest in the U.S.
securities and commodities markets. This growth has led to a corresponding rise in the
amount of fraud and misconduct seen in these markets. The creation of complex
investment vehicles and the tremendous increase in the amount of money being
invested have created greater opportunities for individuals and businesses to
perpetrate fraudulent investment schemes.
The following are the most prevalent types of securities and commodities fraud schemes:
 Investment fraud: These schemes—sometimes referred to as “high-yield investment

fraud”—involve the illegal sale or purported sale of financial instruments. The typical
investment fraud schemes are characterized by offers of low- or no-risk investments,
guaranteed returns, overly-consistent returns, complex strategies, or unregistered
securities. These schemes often seek to victimize affinity groups—such as groups with
a common religion or ethnicity—to utilize the common interests to build trust to
effectively operate the investment fraud against them. The perpetrators range from
professional investment advisers to persons trusted and interacted with daily, such as
a neighbor or sports coach. The fraudster’s ability to foster trust makes these schemes
so successful. Investors should use scrutiny and gather as much information as
possible before entering into any new investment opportunities. Here are some
examples of the most common types of investment fraud schemes:
o Ponzi schemes: These schemes involve the payment of purported returns to
existing investors from funds contributed by new investors. Ponzi schemes
often share common characteristics, such as offering overly

consistent returns, unregistered investments, high returns with little or no risk,
or secretive or complex strategies.
o Pyramid schemes: In these schemes, as in Ponzi schemes, money collected
from new participants is paid to earlier participants. In pyramid schemes,
however, participants receive commissions for recruiting new participants into
the scheme. Pyramid schemes are frequently disguised as multi-level
marketing programs.
o Prime bank investment fraud/trading program fraud: In these schemes,
perpetrators claim to have access to a secret trading program endorsed by
large financial institutions such as the Federal Reserve Bank, Treasury
Department, World Bank, International Monetary Fund, etc. Victims are often
drawn into prime bank investment frauds because the criminals use
sophisticated terms and legal-looking documents, and also claim that the
investments are insured against loss.
o Advance fee fraud: Advance fee schemes require victims to pay upfront fees in
the hope of realizing much larger gains. Typically, victims are told that in order
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to participate in a lucrative investment program or receive the prize from a

lottery/sweepstakes, they must first send funds to cover a cost, often disguised
as a tax or participation fee. After the first payment, the perpetrator will request
additional funds for other “unanticipated” costs.
 Promissory note fraud: These are generally short-term debt instruments issued by
little-known or nonexistent companies. The notes typically promise a high rate of return
with little or no risk. Fraudsters may use promissory notes in an effort to avoid
regulatory scrutiny; however, most promissory notes are securities and need to be
registered with the Securities and Exchange Commission and the states in which they
are being sold.
 Commodities fraud: Commodities fraud is the illegal sale or purported sale of raw
materials or semi-finished goods that are relatively uniform in nature and are sold on
an exchange (e.g., gold, pork bellies, orange juice, and coffee). The perpetrators of
commodities fraud entice investors through false claims and high-pressure sales
tactics. Often in these frauds, the perpetrators create artificial account statements that
reflect purported investments when, in reality, no such investments have been made.
Instead, the money has been diverted for the perpetrators’ use. Additionally, they may
trade excessively merely to generate commissions for themselves (known as
“churning”). Two common types of commodities fraud include investments in the
foreign currency exchange (Forex) and into precious metals (e.g., gold and silver).
 Broker embezzlement: These schemes involve illicit and unauthorized actions by
brokers to steal directly from their clients. Such schemes may be facilitated by the
forging of client documents, doctoring of account statements, unauthorized
trading/funds transfer activities, or other conduct in breach of the broker’s fiduciary
responsibilities to the victim client.
 Market manipulation: These “pump and dump” schemes are based on the manipulation
of lower-volume stocks on small over-the-counter markets. The basic goal of market
manipulation frauds is to artificially inflate the price of the penny stocks so that the
conspirators can sell their shares at a large profit. The “pump” involves recruiting
unwitting investors through false or deceptive sales practices, public information, or
corporate filings. Many of these schemes use boiler room methods where brokers—
who are bribed by the conspirators—use high pressure sale tactics to increase the
number of investors and, as a result, raise the price of the stock. Once the target price
is achieved, the perpetrators “dump” their shares at a huge profit and leave innocent
investors to foot the bill.
7.0 Global Economy
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The global economy refers to the interconnected worldwide economic activities that take place
between multiple countries. These economic activities can have either a positive or negative
impact on the countries involved.
The global economy comprises several characteristics, such as:
 Globalization: Globalization describes a process by which national and regional

economies, societies, and cultures have become integrated through the global network
of trade, communication, immigration, and transportation. These developments led to
the advent of the global economy. Due to the global economy and globalization,
domestic economies have become cohesive, leading to an improvement in their
performances.
 International trade: International trade is considered to be an impact of globalization. It
refers to the exchange of goods and services between different countries, and it has
also helped countries to specialize in products which they have a comparative
advantage in. This is an economic theory that refers to an economy's ability to produce
goods and services at a lower opportunity cost than its trade partners.
 International finance: Money can be transferred at a faster rate between countries
compared to goods, services, and people; making international finance one of the
primary features of a global economy. International finance consists of topics like
currency exchange rates and monetary policy.
 Global investment: This refers to an investment strategy that is not constrained by
geographical boundaries. Global investment mainly takes place via foreign direct
investment (FDI).
We can understand the importance of the global economy by looking at it in relation to

emerging markets:
 Economic importance at a micro and macro level: The increase in the world’s
population has led to emerging markets growing economically, making them one of the
primary engines of world economic growth. The growth and resilience shown by
emerging markets is a good sign for the world economy. Before delving into the next
point, you need to understand the concept of microeconomics. It refers to the study of
the behaviour of households, individuals, and firms with respect to the allocation of
resources and decision-making. In simpler terms, this branch of economics studies
how people make decisions, what factors affect their decisions, and how these
decisions affect the price, demand, and supply of goods in the market. Therefore, from
the perspective of microeconomics, some of the largest firms with high market value
and a few of the richest individuals in the world hail from these emerging markets,
which has helped in the higher distribution of income in these countries. However,
many of these emerging countries are still plagued by poverty, and work still needs to
be done to work towards eradicating it.
 Long-term world economic outlook: According to financial and economic projections
based on demographic trends and capital productivity models, the GDP in emerging
market economies in 2019 are likely to keep increasing at a positive rate. According to
an emerging markets economic forecast for 2019 conducted by Focus Economics, the
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economy is set to increase by 7.5% in India, 6.6% in Philippines, 6.3% in China, 5.3%
in Indonesia, 5.1% in Egypt, 4.9% in Malaysia, 3.8% in Peru and 3.7% in Morocco.
Many people think that the global economy is controlled by governments of the largest
economies in the world, but this a common misconception. Although governments do
hold power over countries’ economies, it is the big banks and large corporations that
control and essentially fund these governments. This means that the global economy is
dominated by large financial institutions. According to world economic news, US banks
participate in many traditional government businesses like power production, oil
refining and distribution, and also the operating of public assets such as airports and
train stations. This was proven when certain members of the US Congress sent a letter
to the Federal Reserve Chairman Ben Bernanke. Here’s an excerpt from the letter:
“Here are a few examples. Morgan Stanley imported 4 million barrels of oil and
petroleum products into the United States in June, 2012. Goldman Sachs stores
aluminum in vast warehouses in Detroit as well as serving as a commodities
derivatives dealer. This “bank” is also expanding into the ownership and operation of
airports, toll roads, and ports. JP Morgan markets electricity in California.
In other words, Goldman Sachs, JP Morgan and Morgan Stanley are no longer just
banks – they have effectively become oil companies, port and airport operators,
commodities dealers, and electric utilities as well.”
The functioning of the global economy can be explained through one word —transactions.
International transactions taking place between top economies in the world help in the
continuance of the global economy. These transactions mainly comprise trade taking place
between different countries. International trade includes the exchange of a variety of products
between countries. It ranges all the way from fruits and foods, to natural oil and weapons. Such
transactions have a number of benefits including:
 Providing a foundation for worldwide economic growth, with the international economy
set to grow by 4% in 2019 (source: World Trade Organization);
 Encouraging competitiveness between countries in various markets;
 Raising productivity and efficiency across countries;
 Helping in the development of underdeveloped countries by allowing them to import
capital goods (machinery and industrial raw materials) and export primary goods
(natural resources and raw materials).
Nearly every country in the world is in some way affected by things that happen in what may
seem at times, like unrelated countries - due to the influence of the global economy. A good
example of this is the economic impact that the Brexit vote will have other countries, not only in
Europe, but across the globe. Brexit was referendum decision for the United Kingdom to
withdraw from the European Union (EU).
The main cause of these effects is economics — based on the production and exchange of
goods and services. Restrictions on the import and export of goods and services can potentially
hamper the economic stability of countries who choose to impose too many.
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The purpose of international trade is similar to that of trading within a country. However,
international trade differs from domestic trade in two aspects:
 The currencies of at least two countries are involved in international trade, so they
must be exchanged before goods and services can be exported or imported;
 Occasionally, countries enforce barriers on the international trade of certain goods or
services which can disrupt the relations between two countries.
According to the latest economic news, here are some of the key factors that influence and
affect how well the global economy works:
 Natural resources;
 Infrastructure;
 Population;
 Labor;
 Human capital;
 Technology;
 Law.
There are numerous benefits of a global economy, which include:
 Free trade: Free trade is an excellent method for countries to exchange goods and
services. It also allows countries to specialize in the production of those goods in which
they have a comparative advantage.
 Movement of labor: Increased migration of the labor force is advantageous for the
recipient country as well as for the workers. If a country is going through a phase of
high unemployment, workers can look for jobs in other countries. This also helps in
reducing geographical inequality.
 Increased economies of scale: The specialization of goods production in most
countries has led to advantageous economic factors such as lower average costs and
lower prices for customers.
 Increased investment: Due to the presence of global economy, it has become easier
for countries to attract short-term and long-term investment. Investments in developing
countries go a long way in improving their economies.
7.1 Domestic Economy
The Philippines’ economic freedom score is 64.5, making its economy the 70th freest in the
2020 Index. Its overall score has increased by 0.7 point due primarily to a higher government
integrity score. The Philippines is ranked 14th among 42 countries in the Asia–Pacific region,
and its overall score is well above the regional and world averages.
The Philippine economy has retained its moderately free rank for the seventh year in a row.
GDP growth has boomed as well, averaging more than 6 percent for the past five years, but the
pace of growth is slowing along with global commerce.
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To boost economic growth and continue to gain more economic freedom, the government
needs to focus on the country’s lagging Index indicators related to the rule of law and the
regulatory environment. The president’s 2019 veto of a bill to make labor laws more rigid was a
good sign, as was the indictment of the former chief of the Philippine National Police on
corruption charges.
A former colony of Spain and then of the United States that is spread over 7,000 linguistically
diverse Western Pacific islands, the Philippines became a self-governing commonwealth in
1935. President Rodrigo Duterte, elected in 2016, has consolidated power by marginalizing his
opponents. The brutality of his crackdown on illegal drug trafficking reflects authoritarian
tendencies. Nevertheless, in a sign of widespread public support, Duterte was strengthened
politically when his allies swept the 2019 midterm Senate elections. To improve economic
relations, Duterte has downplayed tensions with China. Agriculture is still a significant part of
the economy, but industrial production in such areas as electronics, apparel, and shipbuilding
has been growing rapidly. Remittances from overseas workers are equivalent to 10.5 percent
of GDP.
The Philippines recognizes property rights, but the enforcement of relevant laws is weak and
fragmented. Property registration processes are tedious and costly. Judicial independence has
deteriorated under the Duterte administration. Courts are inefficient, biased, corrupt, slow, and
hampered by low pay, intimidation, and complex procedures. Corruption and cronyism are
pervasive, and a culture of impunity hinders anticorruption efforts.
The top individual income tax rate is 35 percent, and the top corporate tax rate is 30 percent.
Other taxes include value-added and environmental taxes. The overall tax burden equals 14.2
percent of total domestic income. Government spending has amounted to 20.1 percent of the
country’s output (GDP) over the past three years, and budget deficits have averaged 0.6
percent of GDP. Public debt is equivalent to 39.6 percent of GDP.
Protection of minority investors and risk-management practices in the construction sector have
been improved, but the overall competitiveness of the business regulatory environment has
deteriorated. Tax registration costs have increased. Labor costs are low. Workers are highly
motivated. The government budgeted more funds for subsidies to state-owned enterprises in
2019, but actual payments to some SOEs have declined.
The total value of exports and imports of goods and services equals 76.1 percent of GDP. The
average applied tariff rate is 1.7 percent, and 285 nontariff measures are in force. In a move to
attract longer-term foreign investment, foreign ownership ceilings in a number of sectors have
been raised. The financial sector, which is gradually modernizing, remains relatively stable and
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7.2 Fiscal, Monetary and Supply Side Policies
Both Fiscal policy and monetary policy are demand management policy, they are aim at
influencing the Aggregate Demand of the economy and achieve the macroeconomic aims.
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What is the difference between monetary and fiscal policy?
 Monetary policy involves changing the interest rate and influencing the money supply.
 Fiscal policy involves the government changing tax rates and levels of government
spending to influence aggregate demand in the economy.
Monetary policy – government manipulates the money supply to achieve its macroeconomic
aims. Conventional tools include interest rate (overnight rate) and OMO Open Market
Operation. The government do not directly spend money, but manipulate the money supply
through monetary tools.
Supply-side policy – Government reduces intervention, encourage market competition and

allow the market to determine the allocation of resources. The policies include deregulation,
privatization, reduce government expenditure, free trade and promote competition.
How monetary policy works
 The Central Bank may have an inflation target of 2%. If they feel inflation is going to go
above the inflation target, due to economic growth being too quick, then they will
increase interest rates.
 Higher interest rates increase borrowing costs and reduce consumer spending and
investment, leading to lower aggregate demand and lower inflation.
 If the economy went into recession, the Central Bank would cut interest rates.
 See also: Cutting interest rates
Fiscal policy is carried out by the government and involves changing:
 Level of government spending

 Levels of taxation
1. To increase demand and economic growth, the government will cut tax and increase
spending (leading to a higher budget deficit)
2. To reduce demand and reduce inflation, the government can increase tax rates and cut
spending (leading to a smaller budget deficit)
Example of expansionary fiscal policy
In a recession, the government may decide to increase borrowing and spend more on
infrastructure spending. The idea is that this increase in government spending creates an
injection of money into the economy and helps to create jobs. There may also be a multiplier
effect, where the initial injection into the economy causes a further round of higher spending.
This increase in aggregate demand can help the economy to get out of recession.
In recent decades, monetary policy has become more popular because:
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 Monetary policy is set by the Central Bank, and therefore reduces political influence
(e.g. politicians may cut interest rates in the desire to have a booming economy before
a general election)
 Fiscal policy can have more supply side effects on the wider economy. E.g. to reduce
inflation – higher tax and lower spending would not be popular, and the government
may be reluctant to pursue this. Also, lower spending could lead to reduced public
services, and the higher income tax could create disincentives to work.
 Monetarists argue expansionary fiscal policy (larger budget deficit) is likely to cause
crowding out – higher government spending reduces private sector expenditure, and
higher government borrowing pushes up interest rates. (However, this analysis is
disputed)
 Expansionary fiscal policy (e.g. more government spending) may lead to special
interest groups pushing for spending which isn’t really helpful and then proves difficult
to reduce when the recession is over.
 Monetary policy is quicker to implement. Interest rates can be set every month. A
decision to increase government spending may take time to decide where to spend the
money.
8.0 Business Cycle
A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP) around its
long-term natural growth rate. It explains the expansion and contraction in economic activity
that an economy experiences over time.
A business cycle is completed when it goes through a single boom and a single
contraction in sequence. The time period to complete this sequence is called the
length of the business cycle. A boom is characterized by a period of rapid economic
growth whereas a period of relatively stagnated economic growth is a recession.
These are measured in terms of the growth of the real GDP, which is inflation-
adjusted.
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Stages of the Business Cycle
In the diagram above, the straight line in the middle is the steady growth line. The business
cycle moves about the line. Below is a more detailed description of each stage in the business
cycle:
#1 Expansion
The first stage in the business cycle is expansion. In this stage, there is an increase in positive
economic indicators such as employment, income, output, wages, profits, demand, and supply
of goods and services. Debtors are generally paying their debts on time, the velocity of the
money supply is high, and investment is high. This process continues as long as economic
conditions are favorable for expansion.
#2 Peak
The economy then reaches a saturation point, or peak, which is the second stage of the
business cycle. The maximum limit of growth is attained. The economic indicators do not grow
further and are at their highest. Prices are at their peak. This stage marks the reversal point in
the trend of economic growth. Consumers tend to restructure their budgets at this point.
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#3 Recession
The recession is the stage that follows the peak phase. The demand for goods and services
starts declining rapidly and steadily in this phase. Producers do not notice the decrease in
demand instantly and go on producing, which creates a situation of excess supply in the
market. Prices tend to fall. All positive economic indicators such as income, output, wages, etc.,
consequently start to fall.
#4 Depression
There is a commensurate rise in unemployment. The growth in the economy continues to

decline, and as this falls below the steady growth line, the stage is called depression.
#5 Trough
In the depression stage, the economy’s growth rate becomes negative. There is further decline
until the prices of factors, as well as the demand and supply of goods and services, reach their
lowest point. The economy eventually reaches the trough. It is the negative saturation point for
an economy. There is extensive depletion of national income and expenditure.
#6 Recovery
After this stage, the economy comes to the stage of recovery. In this phase, there is a
turnaround from the trough and the economy starts recovering from the negative growth rate.
Demand starts to pick up due to the lowest prices and, consequently, supply starts reacting,
too. The economy develops a positive attitude towards investment and employment and
production starts increasing.
Employment begins to rise and, due to accumulated cash balances with the bankers, lending
also shows positive signals. In this phase, depreciated capital is replaced by producers, leading
to new investments in the production process.
Recovery continues until the economy returns to steady growth levels. It completes one full
business cycle of boom and contraction. The extreme points are the peak and the trough.
Explanations by Economists
John Keynes explains the occurrence of business cycles as a result of fluctuations in

aggregate demand, which bring the economy to short-term equilibriums that are different from
a full-employment equilibrium. Keynesian models do not necessarily indicate periodic business
cycles but imply cyclical responses to shocks via multipliers. The extent of these fluctuations
depends on the levels of investment, for that determines the level of aggregate output.
On the contrary, economists like Finn E. Kydland and Edward C. Prescott, who are associated
with the Chicago School of Economics, challenge the Keynesian theories. They consider the
fluctuations in the growth of an economy not to be a result of monetary shocks, but a result of
technology stocks, such as innovation.
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8.1 Industry Analysis
Industry analysis is a market assessment tool used by businesses and analysts to understand
the competitive dynamics of an industry. It helps them get a sense of what is happening in an
industry, e.g., demand-supply statistics, degree of competition within the industry, state of
competition of the industry with other emerging industries, future prospects of the industry
taking into account technological changes, credit system within the industry, and the influence
of external factors on the industry.
Industry analysis, for an entrepreneur or a company, is a method that helps to understand a

company’s position relative to other participants in the industry. It helps them to identify both
the opportunities and threats coming their way and gives them a strong idea of the present and
future scenario of the industry. The key to surviving in this ever-changing business environment
is to understand the differences between yourself and your competitors in the industry and use
it to your full advantage.
Types of industry analysis
There are three commonly used and important methods of performing industry analysis. The
three methods are:
1. Competitive Forces Model (Porter’s 5 Forces)

2. Broad Factors Analysis (PEST Analysis)
3. SWOT Analysis
#1 Competitive Forces Model (Porter’s 5 Forces)
One of the most famous models ever developed for industry analysis, famously known as
Porter’s 5 Forces, was introduced by Michael Porter in his 1980 book “Competitive Strategy:
Techniques for Analyzing Industries and Competitors.”
According to Porter, analysis of the five forces gives an accurate impression of the industry and
makes analysis easier. In our Corporate & Business Strategy course, we cover these five
forces and an additional force — power of complementary good/service providers.
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1. Intensity of industry rivalry
The number of participants in the industry and their respective market shares are a direct
representation of the competitiveness of the industry. These are directly affected by all the
factors mentioned above. Lack of differentiation in products tends to add to the intensity of
competition. High exit costs such as high fixed assets, government restrictions, labor unions,
etc. also make the competitors fight the battle a little harder.
2. Threat of potential entrants
This indicates the ease with which new firms can enter the market of a particular industry. If it is
easy to enter an industry, companies face the constant risk of new competitors. If the entry is
difficult, whichever company enjoys little competitive advantage reaps the benefits for a longer
period. Also, under difficult entry circumstances, companies face a constant set of competitors.
3. Bargaining power of suppliers
This refers to the bargaining power of suppliers. If the industry relies on a small number of
suppliers, they enjoy a considerable amount of bargaining power. This can particularly affect
small businesses because it directly influences the quality and the price of the final product.
4. Bargaining power of buyers
The complete opposite happens when the bargaining power lies with the customers. If
consumers/buyers enjoy market power, they are in a position to negotiate lower prices, better
quality, or additional services and discounts. This is the case in an industry with more
competitors but with a single buyer constituting a large share of the industry’s sales.
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5. Threat of substitute goods/services
The industry is always competing with another industry producing a similar substitute product.
Hence, all firms in an industry have potential competitors from other industries. This takes a toll
on their profitability because they are unable to charge exorbitant prices. Substitutes can take
two forms – products with the same function/quality but lesser price, or products of the same
price but of better quality or providing more utility.
#2 Broad Factors Analysis (PEST Analysis)
Broad Factors Analysis, also commonly called the PEST Analysis stands for Political,
Economic, Social and Technological. PEST analysis is a useful framework for analyzing the
external environment.
To use PEST as a form of industry analysis, an analyst will analyze each of the 4 components
of the model. These components include
1. Political
Political factors that impact an industry include specific policies and regulations related to
things like taxes, environmental regulation, tariffs, trade policies, labor laws, ease of doing
business, and overall political stability.
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2. Economic
The economic forces that have an impact include inflation, exchange rates (FX), interest rates,
GDP growth rates, conditions in the capital markets (ability to access capital), etc.
3. Social
The social impact on an industry refers to trends among people and includes things such as
population growth, demographics (age, gender, etc.), and trends in behavior such as health,
fashion, and social movements.
4. Technological
The technological aspect of PEST analysis incorporates factors such as advancements and
developments that change the way a business operates and the ways in which people live their
lives (e.g., the advent of the internet).
#3 SWOT Analysis
SWOT Analysis stands for Strengths, Weaknesses, Opportunities, and Threats. It can be a
great way of summarizing various industry forces and determining their implications for the
business in question.
1. Internal
Internal factors that already exist and have contributed to the current position and may continue
to exist.
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2. External
External factors are usually contingent events. Assess their importance based on the likelihood
of them happening and their potential impact on the company. Also, consider whether
management has the intention and ability to take advantage of the opportunity/avoid the threat.
Importance of Industry Analysis
Industry analysis, as a form of market assessment, is crucial because it helps a business

understand market conditions. It helps them forecast demand and supply and, consequently,
financial returns from the business. It indicates the competitiveness of the industry and costs
associated with entering and exiting the industry. It is very important when planning a small
business. Analysis helps to identify which stage an industry is currently in; whether it is still
growing and there is scope to reap benefits, or has it reached its saturation point.
With a very detailed study of the industry, entrepreneurs can get a stronghold on the operations
of the industry and may discover untapped opportunities. It is also important to understand that
industry analysis is somewhat subjective and does not always guarantee success. It may
happen that incorrect interpretation of data leads entrepreneurs to a wrong path or into making
wrong decisions. Hence, it becomes important to collect data carefully.
8.2 Industry Life Cycle
An industry life cycle depicts the various stages where businesses operate, progress, and
slump within an industry. An industry life cycle typically consists of five stages — startup,
growth, shakeout, maturity, and decline. These stages can last for different amounts of time –
some can be months, some can be years.
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Startup Stage
At the startup stage, customer demand is limited due to unfamiliarity with the new product’s
features and performance. Distribution channels are still underdeveloped. There is also a lack
of complementary products that add value for the customers, limiting the profitability of the new
product.
Companies at the startup stage are likely to generate zero or very low revenue and experience
negative cash flows and profits, due to the large amount of capital initially invested in
technology, equipment, and other fixed costs.
Growth Stage
As the product slowly attracts attention from a bigger market segment, the industry moves on to
the growth stage where profitability starts to rise. Improvement in product features increases
the value to customers. Complementary products also start to become available in the market,
so people have greater benefits from purchasing the product and its complements. As demand
increases, product price goes down, which further increases customer demand.
At the growth stage, revenue continues to rise and companies start generating positive cash
flows and profits as product revenue and costs surpass break-even.
Shakeout Stage
Shakeout usually refers to the consolidation of an industry. Some businesses are naturally
eliminated because they are unable to grow along with the industry or are still generating
negative cash flows. Some companies merge with competitors or are acquired by those who
were able to obtain bigger market shares at the growth stage.
At the shakeout stage, the growth rate of revenue, cash flows, and profit start slowing down as
the industry approaches maturity.
Maturity Stage
At the maturity stage, the majority of the companies in the industry are well-established and the
industry reaches its saturation point. These companies collectively attempt to moderate the
intensity of industry competition to protect themselves, and to maintain profitability by adopting
strategies to deter the entry of new competitors into the industry. They also develop strategies
to become a dominant player and reduce rivalry.
At this stage, companies realize maximum revenue, profits, and cash flows because customer
demand is fairly high and consistent. Products become more commonplace and popular among
the general public, and the prices are fairly reasonable, as compared to new products.
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Decline Stage
The decline stage is the last stage of an industry life cycle. The intensity of competition in a
declining industry depends on several factors: speed of decline, the height of exit barriers, and
the level of fixed costs. To deal with the decline, some companies might choose to focus on
their most profitable product lines or services in order to maximize profits and stay in the
industry. Some larger companies will attempt to acquire smaller or failing competitors to
become the dominant player. For those who are facing huge losses and that do not believe
there are opportunities to survive, divestment will be their optimal choice.
8.3 Industry Structure and Performance
The structure–conduct–performance model refers to an analytical framework that explains the

connection between economic or market structure, market conduct and its performance. This is
a concept or model in Industrial Organization Economics that examines and describes the
interaction between organization structure (environment), organizational conduct (behavior)
and organizational performance (achievement).
The structure–conduct–performance model presents a causal theory explanation of these three

concepts. It presents, their strengths, characteristics as well as downsides.
The SCP model or paradigm is a crucial aspect of industrial organization theory. This model
was first published in 1933 by two economists Edward Chamberlin and Joan Robinson before it
was later developed by Joe S. Bain in 1959. The SCP model examines the interplay between
three major components of an industrial organization which are structure, conduct and
performance.
As developed by Joe S. Bain in 1959, SCP paradigm was considered as a pillar of the
industrial organization theory because it serves as an analytical framework for analyzing the
major elements of market. Market structure and conduct are major determinants of market
performance.
These elements are structure, conduct and performance.
 Structure – this refers to the construction, formation and the makeup of an industrial
organization. It also describes the kind of environment in which an organization or
market operates.
 Conduct – this describes the behavior or comportment of buyers and sellers to the
structure of a market. It also refers to the way buyers and sellers interact with each
other and the way they behave.
 Performance – this refers to the achievement or accomplishment or results of a
particular market or industry. Performance variables that are considered in the market
include product quantity, product quality, and production efficiency.
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However, due to the effects of the behaviors of buyers and sellers on market, it is often difficult
to predict market structure. Also, the multiple definitions and extension of markets and its
structure make an inquiry into this paradigm more complex. Some studies also establish that
the structure of the market will always be determined by the nature of the product and the
technology available.
Oftentimes, people tend to ask when the SCP model becomes useful. The SCP model is very
useful in analyzing a non-changing industry, it is also useful in the prediction of the effects of
external shock on an industry’s profitability. It is useful in the analysis of the response of an
industry’s structure to price conduct and vice versa. It studies whether structure drives
performance and also influence conduct.
Also, any inquiry into structure, conduct and performance of an industry or a market makes the
SCP model useful. This model can be used to justify consolidation in the industry. It also helps
in the analysis of the effects of a more attractive industry structure on the performance of the
industry.
This is an example of how to analyses the structure, conduct and performance using the SCP
model. First is a highlight in structure which includes an analysis of the Industry concentration
(Herfindal index), minimum efficient scale, the market share pattern and the ownership of major
companies in the industry.
Second is a highlight in conduct which reflects why industries compete in prices, services and
product innovation. It also looks at the stability of the conduct and different strategies displayed
by players in the market. The notion of good competitors and bad competitors are also
explored.
Third is a highlight in performance such as return on capital employed, economic profit,

shareholders returns and others. It also entails an analysis of factors responsible for certain
performances in the industry.
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What Is Security Analysis?

There are three functions of security analysis:

1. “Descriptive function” – This compares different securities. Plus, it smartly outlines

Part I. Investment Environment, Markets Instruments &

1. Real Assets versus Financial Assets

Real and financial assets also have some key differences:

Given that right now:

2) Allocations to real assets are expected to nearly double.

Real Asset Investing For Individual Investors

Fortunately, you do not need to be a multi-billion-dollar institution to invest in real assets. At

 Professional management – Owning real assets managed by professionals with

 Occasionally trading at discounts to NAV– Thanks to the tendency for publicly-traded

Our Two Favorite Real Asset Classes:

1.1 Financial Markets and The Economy

Analyzing Poverty and Growth

The Role of the Financial Sector

What are financial markets and institutions?

1.2 Clients of the Financial System

A financial system is a network of financial institutions, financial markets, financial instruments

Main Functions of Financial System

The functions of financial system can be enumerated as follows:

 Financial system works as an effective conduit for optimum allocation of financial

Services Provided by the Financial System

1.3 Markets and Markets Structure

The analysis of market structures is of great importance when studying

2. The Money Markets

Functions of the Money Market

Here are the main functions of the money market:

2. Central Bank Policies

4. Commercial Banks Self-Sufficiency

Types of Instruments Traded in the Money Market

2. Certificate of Deposit (CD)

Commercial paper is an unsecured loan issued by large institutions or corporations to finance

1.1 The Bond Market

Types of Bond Markets

Municipal bonds—commonly abbreviated as "muni" bonds—are locally issued by states, cities,

Emerging Market Bonds

1.2 Equity Securities

The Equity Method

04-01-2019 investment 50,000

07-01-2019 investment 2,500

07-01-2019 cash 1,000

3.0 Market Indexes

A market index is a hypothetical portfolio of investment holdings that represents a segment of

Understanding a Market Index

Market Index Methodologies

Market Indexes as Benchmarks

As a hypothetical portfolio of holdings, indexes act as benchmark comparisons for a variety of

3.1 Derivatives Markets

Participants in the Derivatives Market

1. Arbitrageurs is a very common profit-making activity in financial markets that comes

Reverses his previous transaction entered into on 1 August 2009.

Types of Derivative Contracts

Derivative contracts can be classified into the following four types:

Criticisms of the Derivatives Market

1.2 What are Securities

What Do Investment Banks Do?

Full-service banks offer the following services:

Underwriting Services in Investment Banking

There are generally three types of underwriting:

M&A Advisory Services

Investment banks’ clients include:

 Governments – Investment banks work with governments to raise money, trade

Investment Banking Skills