EQUITY SECURITIES

MARKET

Mercado, Eimerene J.
Mercado, Marshie
Micosa, Shane Melit
Morallas, Hazel Jane
Pitero, Ronel C.
Financial Markets- Chapter 7
Equity Security Market

In Accounting perspective, Shareholder’s equity, or more commonly

known as equity, refers to the difference between the assets and liabilities of a
company. Fundamentally, equity represents ownership of a firm. Same with
debt, investors can put out cash to purchase equity and trade these in financial
markets through equity instruments.

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EQUITY INSTRUMENT

Is a type of financial instrument wherein the issuer (company) agrees to pay an

amount to the investors in the future based on the future earnings of the company, if
any.
Basically, shares (or stock) represent ownership in a company. May it be one
share, 10% of total outstanding shares, having shares means that a party owns a
portion of the business

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AUTHORIZED CAPITAL STOCK

Refers to the total maximum amount stated in the article of incorporation that
can be subscribed to or paid by the investors of a corporation if the shares have a par
value.

If the Share do not have a par value, the corporation not have an authorized
capital stock, but it has an authorized number of share it may issue

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Basic Forms of Organization
 SOLE PROPRIETORSHIP
 PARTNERSHIP
 CORPORATION

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Sole Proprietorship
Type of business organization which an individual personality owns a business.

ADVANTAGES DISADVANTAGES

It is simple and the owner has freedom to make
all decisions and enjoy all the profit
It has minimal legal restrictions and
government regulations
It can be discontinued with great ease and the
tax is relatively at the minimum
The owner may lack expertise or experience to
run business
The owner may also incur unlimited liability
The owner has relatively limited availability of
outside financing

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Partnership
Formed when two or more persons binds themselves to contribute money,
property or industry to a common funds with the intention of dividing the profits and
ownership among themselves.

ADVANTAGES DISADVANTAGES

There ease of organization compared to
corporation
There are combined talents, more available
brain power and managerial skills
In terms of available financing, it can raise
more capital for the firm than sole
proprietorship.
There is unlimited liability for general partners
and limited life for the firm.
Limited life for the firm
Partnership is dissolved when a partner
withdraws or dies
It is difficult to liquidate or transfer partnership.

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Corporation
Legal entity has a personality separate and distinct from the owners /
shareholders.

ADVANTAGES DISADVANTAGES

Stockholders are not responsible for the debts Time and cost organizing
or taxes of the business
Limited liability and unlimited Life More government regulation/restriction and
maybe expensive to organize
Ability to raise large amount of money Double taxation maybe a disadvantages
Salaries and benefits are tax-deductible
expenses.

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Among the three, only corporations can issue shares. Investors prefer to put their
money or shares because of the concept of limited liability.

Why invest in Equity Instrument

Investors may earn from equity instruments through two methods: capital
appreciation and dividends.

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Capital appreciation
Is a rise in an investment's market price. Capital appreciation is the
difference between the purchase price and the selling price of an investment.

Capital appreciation
Refers to the portion of an investment where the gains in the market price
exceed the original investment's purchase price or cost basis. When the value of an
investment decreases lower than the purchase price it is called capital depreciation.

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Example :

If an investor buys a stock for P10 per share, and the stock price rises to P12,
the investor has earned P2 in capital appreciation. When the investor sells the
stock, the P2 earned becomes a capital gain. Assume that the stock price dipped to
P8 per share then the investor now has P2 capital depreciation.

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Dividends
Are payment made by corporations to the shareholders representing excess
earnings of the company. It is usually paid out quarterly, but some company pay it
semi-annually or annually.

Dividends are not dependent on capital appreciation of the shares; instead, it is

based on current performance of the business. Dividends may be declared even if
share price is going down as long as the company is allowed to declared dividends.
Creditors are paid first before distributing the cash to shareholders because of the
restrictive rule in declaration.

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Comparison between Debt vs Equity
Debt is money raised by the company in the form of borrowed capital.
In debt, creditors or lenders possess the legal right to receive payment on the
amount that they invested or lent out .

Equity are funds raised by the company by issuing shares.

In equity, shareholders only have an expectation of being repaid in the future as the
value that they may enjoy depends on the future performance of the company.

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Comparison Chart
Basis of Comparison Debt Equity
What is it ? Loan Fund Own Fund
Reflects Obligation Ownership
Term Comparatively short term Long term
Status of Holder Lenders Proprietors
Risk Less High
Types Term loan, Debentures, Bonds Shares and Stocks
etc.
Return Interest Dividend
Nature of Return Fixed and Regular Variable and irregular
Collateral Essential to secure loans, but Not required
funds can be raise otherwise also.

Voice in Management No Yes

Claim on Asset and Income Prioritize over equity Subordinate to debt
Types of Financing Temporary Permanent
Maturity Has maturity date Has no maturity date
Risk Profile Lower risk compared to equity High risk compared to debt

Return Expectation Lower than equity Higher than debt 14

TYPE OF SHARES

Investors should have an idea what type of shares they want to put their
money on based on their investment objectives. There are two types of shares that
corporations can issue: preference (or preferred) shares and ordinary (or common)
shares. Both shares represent ownership of the corporation but differ in several
aspects.

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PREFERENCE SHARES
Give its holders distinct rights that enable them to be prioritized over
ordinary shares. A fixed periodic dividend, whether percentage or peso amount, is
promised to holders of preference shares. Par-value preference shares have stated
face values and the annual dividend is expressed as a percentage of the face value.
On the other hand, no-par preference shares do not have stated face value; its
annual dividend usually stated in peso amount per share. Since dividends on
preference shares are ted, its share price is usually stable

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 Other features that may be
included with preference shares
are the following:

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Cumulative

All dividends in arrears (e. dividends not paid in previous periods) together
with the current dividend, should be paid prior to paying dividends to ordinary
shareholders. If preference shares are non-cumulative, this means that the
corporation can pass on paying dividends on preference shares and will only be
required to pay the current dividend, not the dividend in arrears.

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CALLABLE

Allows the issuing corporation to retire or repurchase outstanding shares

within a predetermined period of a time at a specified price. Usually, the call price
is established higher than the issuance price but may gradually decrease over time
Callable preference shares permit the issuing corporation to end the feed payment
commitment associated with preference shares if market conditions make it
favorable to do so.

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Convertible

Allows shareholders to convert the preference shares to a stated number of

ordinary shares after a certain date. The number of ordinary shares that the
preference shares can be exchanged into may also change over time based on a
predetermine formula

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ORDINARY SHARES

Represent the true owners of a corporation. They are called as residual

owners since they will only receive what will remain after all claims of creditors
and preference shareholders on the income and assets are satisfied. It is possible
that shareholders would be multiples times richer if the business goes well in the
future. Although, if upon liquidation, the corporation has no leftover assets,
ordinary shareholders also get nothing.

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Ordinary shares can be:

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• Privately owned- Owned by private investors and shares are generally.
not publicly traded (if to be traded, transactions are usually between private
investors only and consent of the organization is needed)

• Closely owned- Owned by an individual investor or a small group of

private investors like a family

• Publicly owned / Publicly Traded- Owned by mix of public and

private investors and shares are actively traded in stock market

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•Widely owned- . Owned by many unrelated individual or institutional
parties

• Preemptive right- permits ordinary shareholders to retain their

proportionate ownership in the fem in case of new share issuances, hereby
protecting them against dilution of ownership.

• Dilution- of ownership occurs when fractional ownership of an existing

shareholder is reduced as a result of the company issuing additional shares

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•Super-voting shares. . Shares that have multiple votes associated with
one share. This allows controlling shareholders to maintain control against any
outside group who may plan for a hostile takeover

•Nonvoting ordinary shares- . Shares that have no voting rights.

Offered by companies that want to raise capital but does not want to give up any
voting control.

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Stock Market is composed of exchanges and over the counters where shares
are issued and traded publicly.

*Primary market
*Secondary market

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Stock exchange Physical site where shares are purchased and sold face-to-
face on a trading floor.

“New York Stock Exchange” Organized exchanges - being auction

markets, employ floor traders that oversee and facilitate the trading of specific
shares.

Floor traders Are responsible to maintain an orderly market for the share
even if it requires buying shares in a declining market.

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Over-the-counter market Refers to the market wherein shares can be
traded by dealers that are connected electronically by computers.

Dealers Also called as “market makers” operating in an OTC market try to

"make a market” by matching the buy and sell orders they receive from investors.
Dealers are very important in the success of the OTC market.

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 The most popular OTC market in the world is the National Association of
Securities Dealers Automated Quotation System or NASDAQ. NASDAQ
provides the current bid and ask prices for about 3,000 actively traded securities.

Electronic communications network (ECN) is a network which directly links

major brokerage firms and traders and removes the need for a middleman. ECN
has been gaining ground lately because of the following reasons:

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Transparency Traders in the EC can easily view if there are unfilled orders
timely.

Cost reduction Removal of middleman and commission reduces the

transaction costs associated with the trade.

Faster execution Trades are matched faster and confirmed quicker since
the ECN is fully automated.

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After-hours trading- Trading can continue at any time of the day
because of the availability of ECN.
However, ECNs can only work well with shares that has a substantial
amount of trading volume.

Exchange-traded funds (ETF) happens when a portfolio containing

various securities is purchased and a share is created based on this specific
portfolio which can be traded in the exchange.

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ETFs do not have minimum investment amount unlike mutual funds.

ETFs can be preferable since they can be traded like a normal share - limit
orders, short sales, stop-loss orders and ability to purchase on margin.

ETFs also have lower management fees than comparable index mutual funds.

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In terms of value the top 10 largest stock market in the world are the
following:

1. New York stock exchange

2. Tokyo SE group
3. NASDAQ QMX
4. NYSE Euronext(Europe)
5. London stock exchange

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In terms of value the top 10 largest stock market in the world are the
following:

6. Shanghai stock exchange

7. Hongkong stock exchange
8. TSX group(Canada)
9. BME Saprish exchange
10. BM and FBOVESPA

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 Economists believe that changes in stock prices may
affect the economy since it affects spending households and
businesses. Increasing share prices may influence higher
spending while declining share prices may lead to lowest
pending increase pending means higher production level and
company and vice versa.

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Impact of change in stock prices can be felt at the following level:

A. Large street the stock market as an essential fund source for expansion
projects. High share prices allow them to receive higher funds they can use for
capital investment such as machineries and plants and research and development
when they issue new shares.

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Impact of change in stock prices can be felt at the following level:

B. At a macro level shares account for significant portion of household wealth

share price and household wealth has a positive correlation. If shares prices
increase household wealth also increase and vice versa household tends to spend
more if they have higher wealth and spend less if their wealth declines.
Consequently movements in share prices affect household spending.

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Impact of change in stock prices can be felt at the following level:

C. Fluctuations in share prices affect expectation of consumers and business This is

perhaps the most important consequence of movement in share prices. Historically
significant declines in share prices are usually followed by economic recessions .As a
result consumers who observe significant decline in share prices tend to have more
uncertainly regarding the future of their jobs and income. This uncertain outlook may
consumer more conscious on their spending .They spend less on consumer durables like
vehicles application and furniture. The reduce spending consequently leads to decline in
production and employment lower share prices also deter firm in spending on capital
investment as the funds they will receive if they issue new share are lower.

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Thank you!

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