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FINANCE 100 FINANCIAL SYSTEM, MARKET & MANAGEMENT The Basics

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Chapter 21 Chapter 22 Chapter 23 Chapter 24 Chapter 25
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Chapter 1
ROLE OF MONEY IN OUR ECONOMIC SYSTEM

Development of Monetary System

Money is something used by society as a medium of exchange and is widely acceptable for the payment of goods and services w/o questioning the integrity of the person offering it. The primary function of money is to facilitate the process of exchange.

Barter System
first

stage of monetary development. it is the direct exchange or swapping of goods for goods, services for services, goods for services or services for goods.

Society abandoned the barter system for the ff. reasons


1.

It was difficult to look for the person who has the things you need and who also wants the things you are offering for exchange.
There is no common denominator to measure the value of goods and services sought for exchange. Most of the goods traded have unequal values.

2.

3.

4.

It is time consuming, cumbersome and very inconvenient for individuals to use the barter system.
It lacks generalized purchasing power.

5.

Evolution of Money

The goldsmiths were instrumental in the evolution of money. Hundreds of years ago, the goldsmiths helped develop the use of money by accepting gold bullions to be converted into coins. They also accepted deposit for safekeeping, which were returned in another precious metal of the same weight and fineness. They also helped in the transfer of precious metals by means of receipts. Originally, a goldsmith was being paid a storage fee for the gold but when people came to know that the goldsmith was making money out of the gold deposited, they required him to share with them a part if the interest he earned. This is how banking started.

Minting of coins

when gold bullions were converted into coins, coins were considered the first type of modern money.

Significance of Money

Money has become a very important moving factor in our society. It has tremendous power over economic goods. Businessmen go into production and trade because of money profit. When people deposit their money in banks, and the banks in turn lend to borrowers for productive purposes, this induces employment which generates consumption, thereby encouraging more production, which leads to a multiplier effect and results to progress in the economy. There are also some unfavorable effects of money. The excessive desire for money profits sometimes induces businessmen and manufacturers to sacrifice the quality of their product. Money price and money income becomes a large measure of judging people and things. Society has the tendency to become materialistic. The depletion of our natural resources can be a result of the desire for too much money.

Functions of Money
As

a medium of exchange As a standard to measure the value of goods and services. As a stone of value As a means of deferred payment

Two Ways of Keeping Money For Future Use


By

saving By investing

Three Divisions of Investment in Business


Industrial

business Commercial business Servicing business

Attributes of a Good Money


General

Acceptability Stability of Value Portability Cognizability Divisibility Homogeneity Elasticity Durability

Kinds of Money
Commodity Money- this type of money that has a commodity value or value of its own.
Credit Money- this is the credit instrument that is widely acceptable in payment for goods and services. First Money- this is the kind of paper money issued by a government edict or decree. Legal Tender Money- this is the kind of money that circulates because of its legal tender power.

Coinage
it

is the process of making uniform coins from metals and stamping them with a specific design as a quantity of its weight and fineness and the integrity of the country it represents.

Fineness
is

defined as the ratio of pure gold and silver to the total weight of the coin.

Mint
is

a place or a factory manufactured or minted.

where

coins

are

Kinds of Coinage
Gratuitous
Brassage Seignorage Limited

Coinage

Coinage

Detecting Counterfeiting Bills


NOTES Paper Portrait Watermark Security Fiber Security Thread Background Design Color of the Denomination Style and size of serial number Vignette Cleanness of print

Detecting Counterfeiting Bills


COINS 1. Even flow of metallic coins. 2. High relief of letter and numerals 3. Regularity of reedings and beadings

A. NOTES
GENUINE
COUNTERFEIT

PAPER

The fingers can readily feel the main print. Appears life-like. Is the same as colored portrait Placed vertically on the paper

Generally smooth.

PORTRAIT WATERMARK

Appears dead Imitation of the paper is done with finished portrait

SECURITY FIBER

Red and blue scattered

prints

are

Faked by placing vertical lines on the inner side of the paper

Stimulated by prints which cannot be picked off.

Multi-colored.

BACKGROUND DESIGN

Often blurred.

A. NOTES
COLOR OF EACH DENOMINATION SERIAL NUMBER VIGNETTE
GENUINE Generally, there is an irregular spattering of white spot The prefix and number are clearly printed. The lines and dots are distinct and sharp The lines are clean and sharp
COUNTERFEIT
Have polychrome background

The letters and numbers are poorly printed

Usually dull and poorly printed

It is dirty.

CLEANNESS OF PRINT

B. COINS

Show an overflow of metallic grains

Feel greasy and appear slimy

End of Chapter
Chapter 1
ROLE OF MONEY IN OUR ECONOMIC SYSTEM

Chapter 2
HISTORY OF PHILIPPINE CURRENCY & PHILIPPINE MONETARY STANDARDS

Nature of Monetary Standard


Standard money
is

the monetary unit recognized by the government as the ultimate basic standard of value w/c all other kinds of money are convertible.

Monetary standard
refers

to the currency system adapted by a country to provide a stable medium of exchange for the domestic transactions and a means of international payment for foreign obligations

Classification of Monetary Standards


Commodity

Standard or Metallic

Standard Non-commodity Standard or Fiat Standard

A. Commodity Standard
is

a monetary in w/c the purchasing power of value of the monetary unit is equal to the value of a designated quantity of a particular commodity or set of commodities. It may either be monometallic or bimetallic.

Monometallic Standard
is

further divided into gold standard and silver standard. The gold standard is further divided into gold coin standard, golf billion standard and gold exchange standard. The silver standard is also divided into silver coin standard, silver bullion standard and silver exchange.

Classification of Monometallic standard


Gold

Coin Standard Gold Bullion Standard Gold Exchange Standard

Classification of Gold Exchange Standard


Automatic

Gold Exchange Standard Managed Gold Exchange Standard

Bimetallic Standard
when

each of two metals provides the basis for the money in calculation and the issues stands ready to buy or sell either two metals at stated prices. The monetary system is called a bimetallic standard.

Bimetallism
may

also be defined as a monetary system in w/c coins of two different metals at a fixed legal ration of weights and fineness are used as the monetary unit or the standard unit value.

Legal

refers to the ratio between the weights of gold coins and silver coins in the mint.

ratio

Market

refers to the ratio of value of gold and silver as being bought and sold in the market.
refers to the bad or overvalued money drives out the good or under valued money in circulation. When the value of the gold and silver are equal, then mint ratio or legal ratio are equal. But when silver becomes abundant thus reducing its value and becomes cheaper, silver would drive the gold coins out of the circulation.

ratio

Greshams

Law

B. Non-commodity or Fiat Standard


this

standard refers to a monetary system in w/c the face value of the monetary unit is much higher than that of the value of material used as money.

Types of Fiat Standard


Utopian

Standard or Pure Fiat

Standard Involuntary Paper Standard Managed currency Standard

Pre-Spanish Regime
Piloncito

it was made of crude gold coin with flat rides with a diameter of about three weights of an inch.

Commodity money
rice,

coffee, sugar, rolled silver wires, gold dust, and gold crown money.

Spanish Regime
Hilis Kalamay

irregular shaped coin hammered in Mexico

Spanish Barilla

the first coin minted in the Philippines.

Spanish Galleon

sailed across the pacific from Acapulo Mexico to Manila.

Colderillas

a second coin minted in the Philippines.

Spanish Dos Mundos

most famous coin.They came in various denominations :ocho, cuatro, and dos reales.

First Republic of the Philippines


Emilio

Aguinaldo issued a coin minted in denominations of two centimos.

American Regime
The principal currencies circulate were as follows:
Mexican

allowed

to

Silver Dollar American Dollar

Philippine Bank Note

El Banco De Las Islas Filipinas known as the Bank of Philippine Island was authorized to issue its own bank notes.

Japanese Regime
Japanese War Note also known as Mickey Mouse Money.

Post War Period

The monetary unit during this period was Victory Notes

Hawala
regulators

learned recently that one of the weak points in the payments chain through which illicit funds can enter. it is Hindi meaning trust or exchange. often used in relation with the word hundi which stands for bill of exchange. unofficial alternative remittance and money exchange system enabling the transfer of funds without their actual physical move.

End of Chapter
Chapter 2
HISTORY OF PHILIPPINE CURRENCY & PHILIPPINE MONETARY STANDARDS

Chapter 3

MODERN MEASURES OF MONEY

Modern Measures of Money

The narrow definition f money emphasizes on the medium-ofexchange function of money. Negotiable order of withdrawal account are interest bearing savings account on w/c limited number of checks may be written.

Broader Measures of Money:M2, M3


Although traditionally the Central Bank prefers the M1 money supply measure, others have preferred the broader measures of money. If one is inclined to emphasize the store-of-value function of money rather than the medium of exchange, broader measures are appropriate. Asset may be classified on the basis of liquidity, or the case and convenience with which they may be converted into medium of exchange. The principle involved in constructing these monetary aggregates is to combine assets of comparable levels of liquidity in each measure of money. Hence, in constructing M2, certain highly liquid assets are added to M1.

Weighted Measures of Money

M1, M2 and M3 are simple-sum weights and give equal weight to each of the items they include. For example, M2 gives the same weight to passbook savings accounts and money market mutual fund shares as to currency held by the public and demand deposits in bank.

Inflation

is a sustained increase on the price level of commodities.

Criteria of inflation
1. 2.

Whenever money supply or the level of credit increase by more than 15%, which is a normal increase Whenever the level of price index number is more than 10%.

Disadvantages of inflation
1. 2.

3.

It is unfavourable for the fix income group. It may induce the occurrence of recession in the economy. It may disrupts debtor-creditor relationship.

Deflation
is

characterized by an uncontrolled in the general process level as a result of undersupply of money.

Disadvantages of Deflation
Deflation

induces

curtailment

in

production. It may cause employment.

depression

in

Aggregate Demand Aggregate Supply Model


the

analysis of the relationship between the nations money supply and economic activity.

Aggregate DemandAggregate Supply Framework

the basic model of total demands and total supply the nations price level on the vertical axis and its real output level on the horizontal axis. defined as the relationship between the nations price level and the amount of real output demanded, other factors remaining constant.

is

Aggregate Supply Curve


is

defined as the relationship between the nations price level and the amount of output terms collectively desire to produce either factors remaining constant.

Factors that shift Aggregate Demand Curve


Consumption Investment

(C)

(I) Government Purchases of Goods And Services (G) Net exports of Goods and Services (X-M)

Factors that shift the Aggregate Supply Curve


Quantity

of output Prices of Inputs Technological Change

Equilibrium Output versus the Full Employment Output Level


Natural

Output- also called full employment Gap- the magnitude by which the
level falls short of full

output level. It is the level of output corresponding to this natural unemployment rate.
Recessionary

equilibrium output employment output.


Inflationary

Gap- is the magnitude by which

output exceeds the full employment output level

The Dilemma Posed by Adverse Aggregate Supply Shocks


Stagflation-

is a recession combined with higher inflation.

Misery

Index- is the sum of

unemployment and inflation rates.

Inflationary

the magnitude by which output exceeds the full employment output level.

Gap-

The Theory of the Value of Money


Demand

for Money

Lloyd B. Thomas says that the value of money is measured by what a unit of money will buy in terms of a representative group of economic goods.

The Velocity of Money

Refers to the rate of the turnover of money.

Institutional Factors that Underlie the Synchronization between Receipt and Expenditures

More frequent paydays and increase of use of credit cards reduce the demand for money and increase its velocity.

The State of Financial Technology

Comprising the financial technology are the availability of substitutes for money .

Interest Rate Level

An increase in interest rate reduces the demand for money.

Economic Uncertainty

Money is the safest of all assets in the sense that its normal value remains constant no matter what happens in the stock, bond, or real market .

Inflation Expectation

Inflation reduces the real value of money.

Income Level

An increase in income usually increase expenditure by individuals and firm.

MVT'PT
M VT

P
T

- average money supply - transaction demand for money - average price of the transaction - number of transaction occurring during the day

Velocity and Demand for Money


Currency

plus demand principle also applies to the income velocity of money.

The Demand for Money


Formula: Md=kPY, where: Md - demand K - fraction of GDP or (PY)

The Income Velocity of Money


Formula: where: M VT P Y MVYPY - average money supply - income velocity of money - average price of all final goods -number of final goods and services

Motives for Holding Money


Transaction Demand use to finance ordinary expenditures. Speculative Demand is held for purpose of good investment in business. Precautionary Demand it attribute its existence to the possibility of unforeseen event.

The Role of Interest Rate

The price one pays for holding money is called opportunity cost.

Interest Rate and the Transaction Demand transaction balances involve money which must be held in order to bridge the gap the receipt of funds and their later disbursement. Interest Rates and the Precautionary Demand precautionary money holdings may also be somewhat sensitive to interest rate. Interest Rate and the Speculative Demand one of the most significant hypothesis is that people and firm hold a significant amount of money for speculative purposes.

The Role of Interest in the Demand for Money


We have learned that the demand to hold money may be responsive to the opportunity cost of holding money- the market of interest. Each motives of holding money may depend in the part on the interest rate, and its increase makes holding money more costly.

End of Chapter
Chapter 3

MODERN MEASURES OF MONEY

Chapter 4
CREDITS, ITS USES, CLASSIFICATIONS & RISKS

Credit
is

simply defined as the power or ability to obtain money, goods or services at the present time in exchange for a promise to pay with money upon demand or at a future determinable time.

Functions of Credit
credit

includes people to save credit avoids the use of money is used as substitute for money credit thus facilitates the production consumption of goods and usually results in the growth economy serves as the medium of a exchange.

Characteristics of Credits
Credit

as Bipartite Contract Credit as a Pecuniary Contract Credit as a Fiduciary Contract In credit, risk is always involved Credit always involves futurity

Significance of Credit
allows

the possible production of goods

provides

financial means for businessmen who takes advantage of market opportunities in both domestic and foreign markets the consumers to buy goods and services beyond their ability to fulfill their desire

allows

Credit and the Business Cycle

All credits function as stimulants or activators of the fluctuations in the business cycle. During recession when business activities decline, business and consumer products are reduced. Actually, the expansion 0f credit in a declining phase of the business cycle softens the downward trend of business activity. Many creditors are not willing to shoulder the risk especially during such situation. Many of them tend to adopt strict credit policies to discourage borrowers.

A. Personal Credit
credits

obtained for ones use.

There are three types, namely: 1. service credit- credits obtained from professionals 2. retail credit- obtained mostly on retail 3. personal loan credit- granted for the purchase of expensive consumer items

Criteria for Granting Credit


employment

and personal resources wealth and accumulated resources operating expenses incurred by the borrower additional sources of income of family size of family paying habits of the borrower Occupation length of employment and permanence length of time a person has lived in an area

B. Commercial or Mercantile Credit


credits

extended by one businessman to another businessman. A commercial credit transaction takes place from the time goods are sold as raw materials to the time they reach the industrial consumer.

C. Bank Credit or Bank Loans


are

credits granted by banks to businessman to finance their short term credit needs.

D. Export and Import Credits


obtained

to finance the selling of goods outside the country. Import credits are also obtain to finance the buying of goods from other countries.

Chart 1
Financing an Export
(5)

IMPORTER
(1) (2) Pays Bank (8)

Ship of goods request importer to furnish Him with bankers L/C

EXPORTER
Notifies exporter

of L/C (4)
(7)Pays Exporter

Open L/C
Sends Bankers L/C (3) Draws drafts against Importers Bank (6)

IMPORTERS BANK

EXPORTERS BANK

Chart 2

Financing an Import
IMPORTER

SHIPPING CO.

(4)

GOODS SHIPPED Under Bill of Lending

EXPORTER

(11) Pays Local Bank

(1) Applicati on for L/C (8) Documents released under Trust Receipt (7) Documents attached and Drafts returned

(3) Notifies

Draws a draft thru his Bank (8) Pays (5)

LOCAL BANK

(2) L/C sent (6) Sends drafts for acceptance

FOREIGN BANK
(9) Sells accepted to

FINANCIAL INTERMEDIARY

E. Investment Credit
long

term borrowing is one of the most common forms of financing business enterprise .

F. Agricultural Credit
credits

given to farmers for the development, improvement and cultivation of their lands. They may be in the form of:
Crop loan Livestock Loan Agricultural Time Loan Commodity Loan

1. 2.

3.
4.

G. Industrial Credit
are

loans granted to industries

H. Real Estate Credits


are

loans to finance the purchase and improvement of real estate properties.

I. Government or Public Credit


are

credits obtained from any of the government institutions or their instrumentalities

J. Secured and Unsecured Credits


Secured credits
are

those which are covered by properties of value called collaterals to guarantee loans.

Unsecured credits
are those where the borrowers has mentioned the full trust and confidence of the creditor.

K. Short Term, Medium Term and Long Term loans


Short

Term- payable with in a

year
Medium

Term- payable with in 5

years
Long

Term- payable beyond 5

years

L. Direct Loan, Discount Loan, Credit Lines


Direct

Loan- interest payments are

made at the time the loan matures Discount Loan- interest payments are deducted at the time the loans are granted. Credit Lines- agreement between the debtor and creditor

Sources of Credit
Banks
most common sources of credit Classified into:

Commercial

Banks- give commercial loans to

businessmen
Thrift

Banks- give loans to individuals for personal

needs and to the industry for the enhancement of agriculture and economy. Rural Banks- are organized to cater the needs of farmers and small businessmen in the rural areas

Retail Stores

give personal consumer loans to their consumers on an open book account basis

Credit Unions- cooperative organization that lend savings of their member to other members who are in need Individual Money Lenders- individuals who have excess funds and who usually lend such funds to others who are in need Insurance Companies- source of credit for insured individuals

Sales Finance Companies- extend credit facilities to industrial, commercial and agricultural enterprises

Credit Risk

possibility of on-payment of the obligation when it falls due

Cs of Credit Character-

quality of credit risk which makes the debtor pay or intend to pay when his debt is due

Capacity- ability of a debtor to pay his obligation Capital- financial strength of a business Collateral- properties of value pledged to secure loan Conditionenvironment in the customers industry, economically, legally and politically in relation to growth

End of Chapter
Chapter 4
CREDITS, ITS USES CLASSIFICATIONS & RISKS

Chapter 5
CREDIT INSTRUMENTS & ITS NEGOTIATION

Credit Instrument Defined


A

credit instrument is a document evidencing the existence of a credit obligation.

Classification of Credit instruments


Credit

Instrument w/ General Acceptability Credit Instruments w/ Limited Acceptability

A. Credit Instrument for Investment Purposes


Credit instrument for Investment Purposes are subdivided into:
a)

Stock Certificates
of ownership in a corporation

evidences

b)

Bond Certificate
term indebtedness on the part of an issuing corporation.

long

Kinds of Bonds
Debenture Bonds Redeemable Bonds Collateral Bonds Serial Bonds Mortgage Bonds Income Bonds Sinking Bonds Coupon Bonds Registered Bonds Profit Sharing Bonds Guaranteed Bonds Convertible Bonds

A. Money Market Bills


negotiable

financial instruments bought and sold in

the market

Kinds of Money Market Instruments


1.Interbank Call Loans 2.Promissory Notes 3.Repurchase Agreement 4.Certificates of Assignments 5. Certificates of Participation 6.Commercial Papers 7. C. B. C. I.s 8. Treasury bills 9. D.B.P. Progress Bonds

B. Credit Instrument for Commercial Purposes


Credit

instrument for commercial purposes, w/c is better known as instruments are further subdivided into promise-to-pay and order-to pay.

Promise to Pay
A promissory note is a written promise of a person to pay another a sum certain of money on demand or at a determine future time. A negotiable promissory note is one that is transferable.

Non-negotiable

Promissory Note is non-transferable. Secured Promissory Notes are guaranteed w/ properties of value. Unsecured Promissory Notes greatly depend upon the character of the borrower. Financial Institution Deposits are promises of certain institutions to return money deposited with them.

Letter of Credit
is

a letter made by one bank addressed to another whether domestic or foreign. commercial letter of credit traveller letter of credit

1. 2.

Open Book Account


most

of our mercantile credit transactions are evidenced but by credit obligations but by a mere entry made in the ledger of the creditor.

Order to pay
are

the second type of commercial credit instruments. Checks, drafts and money orders fall under this type of credit instruments.

Checks
are

the most commonly used bills of exchange.

Classification of Checks

Crossed Checks Post Dated Checks Stale Checks Managers Check, Cashiers Check and Bouncing or Robber Check Counter Check Certified Check Falsified Forged Check Personal Check and Business Check Cancelled Check Returned Check

Treasurers Check

The Giro System


is

a technique in credit transaction w/c is now being used. It features the use of electronic machines.

Drafts
is

a bill of exchange w/c is an unconditional order made by the drawer requesting the drawer to pay the payee a sum certain in money on demand at a determined time.

Kinds of Drafts
Demand

and time drafts Bank Draft and the Commercial or Trade Draft Acceptance Draft Documented Draft Clean Draft

Money Order
Two Types:
Bank

Money Order w/c is an order of one bank to another banks Portal Money Order w/c is an order of a post office to another post office.

Requisites for Negotiability


It must be in writing signed by the maker or the drawer. It must be payable on demand or at a future determinable time. It must be payable to order or to bearer. It must contain no conditions. If it is addressed to a drawee, the name of the drawee must be indicated with certainty. Endorsement must be in the name appearing on the instrument. If, however, the name of the payee is misspelled or is erroneously written, the endorser may endorse it in the same manner as it was written but must indicate below the endorsement his real name with the word by.

Kinds of Endorsement
Special

of full endorsementspecifies the name of the person to whom, or to whose order, the instrument made payable. Endorsement in Bank- specifies no endorse. Restrictive Endorsement- prevents the further negotiation of instruments.

Qualified

Endorsementconstitute the endorser a mere assignor of the instrument.


Endorsement- is conditional, the person required to pay the instrument may disregard the condition.

Conditional

End of Chapter
Chapter 5
CREDIT INSTRUMENTS & ITS NEGOTIATION

CHAPTER 6

THE FINANCIAL SYSTEM

Financial Intermediation
One

of the most familiar activities of financial

firms Act simultaneously as BORROWERS and LENDERS middleman between those who want to lend and those who want to borrow.

Its

a financial institution that accepts money from savers or investors and loan those funds to borrowers, thus providing a link between those SEEKING EARNINGS on their funds and those SEEKING CREDIT. depositors believe that they are using the bank to safe keep their deposit, not realizing that they are the creditors of the bank.

Some

Financial System
provides

facilities for the transfer of purchasing power from individual to individual and from firm to firm both within the country and internationally Keep detailed set of records of transactions , they are the primary source of statistics used in analyzing national and international economic activity

Gross National Product


The

accepted measure of aggregate output of the economy

Value Added
Appropriate

measure of the output of any single industry The difference between the market value of the product produced and sold by the industry by way of financial intermediaries

Primary Claims
Issued by the ultimate deficit spending units, mainly : Businesses Government EXAMPLES: Money market instruments Government securities Commercial papers Corporate and municipal bonds Mortgages Common stocks

Secondary Claims
Banks,

life insurance companies, and mutual funds issue claims of their own to attract individuals and firms

EXAMPLES: Savings deposits Life insurance policies Shares of mutual funds

Economic Role Of Financial Intermediaries


If

there are no financial institution or you and society are penalized by the absence of financial institution, you are denied of the opportunity of having earnings and credits of funds.

Contributes

materially to the economic process Facilitate flow of funds from SURPLUS UNIT to SPENDING UNIT Enhance the societys welfare Increase capital expenditures Boosts productivity and living standard

Risks and Cost without Financial Intermediation


ASSYMETRIC INFORMATION Means one has better understanding of the business Gives rise to problems that reduce the willingness to allow lending:
1.

2.
3.

Adverse Selection Moral Hazard Transaction Cost

1. Adverse Selection

the tendency for those persons with highest probability of experiencing financial problems to seek out and be granted loans are more likely to borrow and are willing to pay relatively high interest rates to obtain funds

Individuals

2. Moral Hazard
Occurs

after the loan is made This arise because of the debt contract allows the borrower to keep any and all the returns that exceed the fixed payment called for in the loan agreement
The

borrower has an incentive to take on more risks than is consistent with the best interests of the lender, in an attempt to reap high return

Major Rationale of Financial Intermediaries


The

ability to deal with asymmetric information and the associated problems with adverse selection and moral hazards

Financial Institutions

1.

Specialize in assessing credit risks of the potential borrowers because: their access in private information such as loan applicants:

Deposit history Income Assets Liabilities Credit history

2.

They are equipped to monitor the borrowers activities

*** they are in better position to make better loan decision EXAMPLES: Commercial banks Thrift institution Finance companies

3. Transaction Cost
Involves

the money and time spent carrying out the financial transactions element in Transaction Cost : Search Cost Time and Money

Important 1. 2.

Benefits of Intermediation
1.

2.

Benefits to Surplus Units Benefits to Deficit Units

1. Benefits to Surplus Units


SURPLUS UNITS (savers) Pooling the funds of thousands of individuals to overcome the obstacles that stop savers from purchasing primary claims directly OBSTACLES: Lack of financial expertise Lack of information Limited access to financial markets Absence of many financial instruments in small denominations Regressive transaction cost

Diversification
The

spreading of risks made possible by pooling of funds that is important for the savers intermediaries have the fund to acquire the large variety of claims needed to spread the risks

Financial

2. Benefits to Deficit Units


Broaden

the range of instruments, denominations and maturities an institution can issue , which significantly reduce transaction cost

THE PHILIPPINE FINANCIAL SYSTEM


Plays

a vital role in our society and economy as a whole. It affect the lives of every person, family, business and the government Is greatly affected by our political, social and economic conditions in the country Also influenced by :
International

Monetary Fund Asean Development Bank Other international institutions

Banko Sentral ng Pilipinas


Supervises

and regulates the financial system Provide policy directions in areas of money, banking and credit Shall have supervision over the operation of the banks and exercise such regulatory powers and other pertinent laws over the operations of finance companies and non-bank financial institutions performing quasi-banking functions Its primary objective is to maintain price stability conducive to balanced and sustainable growth of the economy Shall also promote and maintain monetary stability and convertibility of the peso

Commercial Banks
Considered

the heart of financial system They hold the deposits of millions of people, government and business enterprises They play the role of channeling of funds They make funds available through their lending and investing activities to borrowers who could be businessmen, business firms, government and individuals They facilitate the flow of goods and services from producers to consumers including the of the government They help in the flow of goods and services in and out of the country

Banks
Are

conduits through which the Banko Sentral ng Pilipinas implements its monetary policies

STRUCTURE OF THE PHILIPPINE FINANCIAL SYSTEM


A. Bangko Sentral ng Pilipinas

B. Banking Institutions 1. Private Banking Institutions


a. Expanded Commercial Banks/ Universal Banks (EKB/UB) b. Commercial Banks (KB) c. Thrift Banks (TB) Savings and Mortgage Banks (SMB) Private Development Banks (PDB) Stock Savings and Loan Associations (SSLA) d. Rural Banks (RB) e. Cooperative Banks

2. Government Banking Institutions


a. Development Bank of the Philippines (DBP) b. Land Bank of the Philippines (LBP) c. Philippine Al-amanah Islamic Investment Bank

C. Non-Bank Financial Institutions 1. Private Non-Bank Financial Institutions


a. Investment Houses b. Investment Companies c. Financing Companies d. Securities Dealers/ Brokers e. Non-stock Savings and Loan Associations f. Building and Loan Associations g. Pawnshops h. Lending investors i. Fund Managers

j. Trust Companies/ Departments k. Insurance Companies l. Venture Capital Corporations

2. Government Non-Bank Institutions


a. Government Service Insurance System (GSIS) b. Social Security System (SSS) c. Pag-ibig

A. Commercial Banks
Is

any corporation, which accepts or creates demand deposits subject to withdrawal by means of checks

1.) Universal Bank/ Expanded Commercial Bank


Is

any commercial bank, which performs the investment house function in addition to its Commercial Banking Authority It may invest in the equities of allied and nonallied enterprises
ALLIED

ENTERPRISES may either be:

Financial Non-Financial

2.)
is

Commercial Bank/ Domestic Bank

any commercial bank that is confined only to commercial bank functions such as :
Accepting

drafts Issuing letters of credit Discounting and negotiating promissory notes , bills of exchange and other evidences of debts Accepting or creating demand deposits Receiving other types of deposits and deposits substitutes Buying and selling foreign exchange, gold and silver bullions Acquiring marketable bonds and other debt securities Extending credit subject to such rules as the Monetary Board may promulgate

Thrift Banks

Shall include savings and mortgage banks, stocks savings and loan associations and private development bank Their function is to Accumulate the savings of the depositors and Investing together with capital loans secured by

bonds, mortgages in real estate and insured improvements thereon chattel mortgages bonds other forms of securities and loans for personal and household finance, whether secured or unsecured, Financing for homebuilding and home improvement Readily marketable and debt securities Commercial papers Accounts receivables Drafts Bills of exchange Acceptances or notes arising out of commercial transaction Other investment and loans which the Monetary Board may determine as necessary I the furtherance of national economic objectives

1.) Stock-savings & Mortgage Banks


Any

corporation organized for the purpose of accumulating the savings of depositors and investing them, together with its capital, in the readily marketable bonds and debt securities; checks, bills of exchange, acceptances or notes arising out of commercial transactions or in loans secured by bonds, mortgages or real estate and insured improvements thereon and other forms of security or in loans for personal or household finances whether secured or unsecured , and financing for household building and house development.

2.) Savings & Loan Association


Any

corporation engage in the business of accumulating the savings of its members or stockholders using such accumulation, together with its capital for the loans and investment in the securities of productive enterprises, or in securities of the government and its instrumentalities, provided that they are primarily engaged in servicing the needs of household by providing personal finance and long term financing for home building and development

3.)Private Development Banks


a bank that exercises all the powers and shall assume all the obligations of the savings and mortgages bank as provided by in the General Banking Act except otherwise stated Helps construct, expand and rehabilitate our Agriculture and Industry It helps meet the needs of these sectors

Development Bank of the Philippines


The

government counterpart of the private development banks helps the private development banks augment their capitalization as provided under R.A. 4093 as amended

Rural Banks
Any

bank authorized by the Central Bank to make credits available for farmers, businessmen and cottage industries in the rural area Loans may be granted by the rural banks on the security of land without Torrents title where the owner of private property can show five (5) years or more peaceful continuous and uninterrupted possession of the land in the concept of ownership

This includes:
Portions

of friar land estates or other lands administered by the Bureau of Lands that are covered by sale contracts and purchases and have paid at least five (5) years installment thereon, without the necessity of prior approval and consent of the Director of Lands or; Portions of other estates under the administration of the Department of Agrarian Reform

Cooperative Banks
Banks

established to assist the various cooperatives by lending those fund at reasonable rates

B. Government Banks / Specialized Government Banks


LAND BANK OF THE PHILIPPINES Government bank which provides financial support in the implementation of the Agrarian Reform Program(CARP) of the government

AL-AMANAH ISLAMIC INVESTMENT BANK Republic Act No.6048 provides for the charter that authorizes the bank to promote and accelerate the socio-economic development of the Autonomous Region of Muslim Mindanao by performing banking, financing and investment operations, and to establish and participate in agriculture, commercial and industrial ventures based on the Islamic concept of banking

DEVELOPMENT BANK OF THE PHILIPPINES Provides loans for developmental purpose, gives loans to the agricultural sector, commercial sector and the industrial sector

C. Non- Banking Financial Institution


INVESTMENT HOUSE Any business enterprise where the primary purpose is to extend credit facilities to consumers and to industrial , commercial and agricultural entities either by :
Discounting

or factoring commercial papers or

accounts Buying installment contract, leases, chattel mortgages or other evidences of indebtedness Leasing motor vehicles, heavy equipment and industrial machineries and office equipment, appliance and other movable property

SECURITIES

DEALER Any person engaged in the business of buying and selling securities for his own account thereby making a profit from the difference between his buying and selling of securities
SECURITIES BROKER Any person engaged in the business of effecting securities transaction and earns through commission basis NON-STOCK SAVINGS AND LOAN ASSOCIATION AND COOPERATIVE CREDIT UNIONS Corporations engaged in the business of accumulating the savings of its members which are usually confined to a well-defined group of persons and uses such accumulated funds to lend to its own member-depositors

BUILDING AND LOAN ASSOCIATION Any corporation whose Capital Stock is periodically paid by its stockholder members Its purpose is to encourage frugality, home building among its members, and to loan its funds including funds it borrowed from its own members It also uses the accumulated funds to repay its stockholders upon surrender of their shares PAWNSHOP Refers to person or entity engaged in the business of lending money or personal property, jewelry, television, radio, camera, appliance etc. delivered as a security for loan.

D. Government Non-Bank Financial Institution

SOCIAL SECURITY SYSTEM (SSS) Provides retirement benefits , funeral benefits, housing loans, personal loans, and calamity loans to employees who are working in private companies and offices GOVERNMENT SERVICE INSURANCE SYSTEM (GSIS) Provides retirement benefits, housing loans, personal loans, emergency and calamity loans to government employees

PAG-IBIG Provides housing loans to both government and private employees

End of Chapter
Chapter 6

THE FINANCIAL SYSTEM

Chapter 7
BANKING INSTITUTIONS, HISTORY, CLASSIFICATIONS & FUNCTIONS

BANKS
Duly

authorized by the monetary board of central bank Lending fund Financial institutions Accepting deposits and lending

ROLE OF BANKS
Depository

of idle funds Major source of loanable funds Give counsel on financial matters

BRIEF HISTORY
2000 B.C. Babylon 9th Century- King Pharaoh Nebuchadnezzar Ancient Greece Greek Temples serve as depositories of wealth Greek Priests loan money to people 1157 A.D.- Venice 17th & 18th Century 1401- Bank Of Barcelona In Spain 1587- Bank Of Venice 1609- Bank Of Amsterdam

1619- Hamburg 1621- Nuremberg 1688- Stockton 1694- Modern Banking Bank Of England Private Owned Bank 1946-government Bank Monetary Authority Of England Medicci Family In Florence Fuggers In Germany Roothschild Family Most Influential

1800- Bank Of France Napoleon Bonaparte 1848- Dominant Financial Institution 19th Century- Rapid Development In Germany Goldsmiths- Best Facilities For Safekeeping Of Valuables Canadian Banking- U.S. & Great Britain 1822-Bank Of Montreal 1835- Bank Of Canada 1781- Bank Of North America 1791- Serve Both Government And Public

1838- Free Banking Law 1842- Louisana Enacted Legislation Civil War- Greenbacks 1865- Prices Grown -Gold & Silver Coins Were Hoarded - National Banking Act Of 1863 1907- Remedial Legislation Commercial 26,000 (1928) Banks 14000 (1933) 1934- Banking Systems Began To Recover

BANKING IN THE PHILIPPINES


1594- Obras Pias Father Juan Fernandez De Leon -Religious Foundation 1930- Rodriguez Bank- Francisco Rodriguez Gorricho Bank -Bank Owned By Mariano Tuason Family - El Banco Espanol-filipino De Isabel Ii

SPANISH TIME
Monte De Piedad Y Caja De Ahorros De Manila (Monte De Piedad & Savings Bank) Father Felix Huertas 1898- Roman Catholic Archbishop Of Manila

WORLD WAR II
Under Japanese Imperial Forces Pnb,bpi & Pbc

CLASSIFICATION OF BANKS
Commercial Banks Ordinary Commercial Bank -Confined To The Simple Functions Of Commercial Banks -Capitalized At 2.8 Billion Pesos Expanded Commercial Bank/Universal Bank -It Does The Commercial Bank Functions As Well As The Investment House Functions

THRIFT BANK
Banks Established To Encourage Thriftiness, Industry, Frugality & The Accumulation Of Savings Among The People. *SAVING MORTGAGE BANKS - Organized For The Purpose Of Accumulating The Savings Of Individuals & Investing Them Together With Their Capital Readily Marketable Bonds. - Specialize In Granting Industrial Loans

STOCK SAVINGS & LOAN ASSOCIATIONS - Primarily engaged in servicing the needs of household by providing personal finance PRIVATE DEVELOPMENT BANKS -Banks organized to expand, develop, construct, and rehabilitate our agriculture & industry

RURAL BANK

Organized to promote and expand the rural economy in an orderly and effective manner by providing farmers and small businessmen with means of facilitating and improving their facilities.

SPECIALIZED GOVERNMENT BANKS OF THE PHILIPPINES


1.

2.

Land Bank Of The Philippines -Help implement the land reform in the country -Established as a corporate and government instrumentality Development Bank Of The Philippines -Government counter part of the private development bank

3.

Al-Amanah Islamic Investment Bank Of The Philippines -Islamic bank; established to promote and accelerate the socio-economic development of the autonomous region of Mindanao.

Offshore Banking Unit (OBU)

Improve the access of the country to the worlds financial institutions.

FUNCTIONS: 1. Transaction with non-residents and or with other OBU 2. Transactions with foreign currency deposit units 3. Transactions with residents other than FCDU and other OBU subject to prior approval when required under Central Bank regulation, and offshore banking unit may invest in foreign currency denominated debt instruments of residents(other then FCDU and other OBU) and or extend foreign currency loans and advances to such residents.

CLASSIFICATION ACCORDING TO FORM OF ORGANIZATION


Unit Bank

single banking corporation, which makes implements its own policies.


office banking

Branch Banking System


multiple

Group Banking

majority shares of stock are held by a holding company. independent unit bank which are owned by a group of people.

Chain Banking

TRADITIONAL CLASSIFICATIONS OF BANKS


Privately Owned Banks

Banks owned by private individuals

Government Owned Banks

Owned by state or banks with a minimum private capital.

Branch Banking Adoption Reasons:


Lack

of capital Idle funds in one area of the country can be properly employed in other areas The convenience of its customer There is less overhead expense to run a branch than to organize a new bank.

ACCORDING TO PLACE OF INCORPORATION


Domestic Bank Bank incorporated under the laws of the country where it is doing business. Foreign Banks Incorporated under the laws of other countries that do business in the Philippines

FUNCTIONS OF BANK
DEPOSITORY

FUNCTIONS TRUST FUNCTION COLLECTION & REMITANCE FUNCTION LOANS AND DISCOUNT FUNCTION ADVISORY FUNCTION

Depository Function
*ACCORDING TO THE FORM OF WITHDRAWAL Savings Deposit accepted for safekeeping Demand Deposit maybe withdrawn anytime by presenting a check. Negotiable Order of Withdrawal Account Interest bearing deposit accounts that combine the payable on demand feature of checks and investment feature of savings account

Term Savings Account Saving account that is not to be withdrawn for a considerable period of time and allows the bank to lend it for a longer term. Special Time Deposit Deposit required by the government or central bank for a depositor to maintain with the bank for a particular purpose Time Certificate of Deposit Deposit evidenced by a certificate maturing at a definite future time. It carries a higher interest rate than the savings deposit since the depositor specifies the maturity date of the deposit an the bank can plan carefully on how the deposit is lent out or invested

AUTOMATED TELLER MACHINE


Use

for depositing and withdrawing money opened a new method for banks to obtain branches.

TYPE OF BANK ACCOUNTS


SINGLE NAME INDIVIDUAL Simplest type of bank account where in an individual transacts with the bank under his own name. JOINT ACCOUNT Opened by two or more individuals,

SOLE PROPRIETORSHIP ACCOUNT Opened by an individual for his own business.


PARTNERSHIP ACCOUNT Opened by a partner. It is an organization which is composed of two or more owners who agreed to conduct business & divide the profits among themselves.

CORPORATE ACCOUNT Opened by corporations in the conduct of its business.

FIDUCIARY ACCOUNT Opened by a trustee in behalf of another person


UNINCORPORATED GROUP OF ACCOUNT Opened by association, social clubs, professionals and etc. INACTIVE DEPOSIT ACCOUNT This is an account which does not have any activity through deposits or withdrawals over a period of time

Trust Function
SAFE DEPOSIT BOX Rented out by the bank to a client who would like to have a safe place to put his important documents and precious jewelry.

Collection and Remittance Function


CONCENTRATION BANKING System that spreads collection of companys receivable among a number of banks located at strategic areas.

Loans and Discount Function


Types of loans granted by the banks Demand or Callable Loans
Does

not have definite maturity dates at specified future time

Time

Loan

Payable

Classification of Bank Loans


According

to purpose According to the form on how credit is granted According to maturity According to security According to release of the loan According to manner of repayment

According to purpose
Commercial

or mercantile credit Investment credit Agricultural credit Real estate credit Personal credit

According to the form on how credit is granted


Direct

loan Discount loan and rediscount loan Overdraft line

According to maturity
Short

term loan Medium term loan and intermediate term loan Long term loan

According to security
Secured

loan or collateralized loans Unsecured loans or character loans

According to release of the loan


Lump

sum release Installment release as the project progresses

According to manner of repayment


Lump

sum basis Installment basis

Advisory Function
Banks

are experienced in helping out businesses because they have a variety of financial assistance to offer

End of Chapter
Chapter 7
BANKING INSTITUTIONS, HISTORY, CLASSIFICATIONS & FUNCTIONS

Chapter 8

Central Banking & The Effects of Its Monetary Policies in our Economy

Brief History
June

15, 1948

Central

bank act or the republic act no. 265 was approved This act provides for the creation of the central bank of the Philippines
January
The

3, 1949

bank finally opened its doors to the public The capital of the bank, as provided in the act, shall be ten billion pesos with the initial subscription coming from the liquidated assets of the Exchange Standard Fund

Central Bank
Responsible

of administering the monetary , banking and credit system of the Republic.

Bank Objectives
Primarily

to maintain internal and external monetary stability in the Philippines; preserve the international value of the peso and the convertibility of the peso into other freely convertible currencies; foster monetary, credit and exchange conditions conducive to a balanced and sustainable growth of the economy; and maintain price stability in the economy.

To

To

To

Old Monetary Board


the

policy making body of the Central Bank Composed of seven members

Seven Members of Old Monetary Board


Chairman

of the Board/ Governor of the bank Secretary of Finance Director General of the NEDA (National Economic Development Authority) Chairman of the Board of Investments Secretary of Budget and Management Two (2) appointed representatives from the private sectors

Qualifications:
Must

be a good person of good moral character and of unquestionable integrity and responsibility Must be competent in:
Economics Banking Finance Commerce Agriculture Industry

Must

be natural born Filipino Citizen

The New Central Bank


Republic

Act 7653

known as the Central Bank Act. Section I of R.A. 7653 it states that : the state shall maintain a Central Monetary Authority (CMA) that shall function and operate as an independent body in discharge of its mandated responsibilities concerning banking and credit.

Central Monetary Authority (CMA)


It

shall be a corporate body of known as Banko Sentral ng Pilipinas refered to as Banko Central

Banko Central
Shall

be capitalized at fifty billion pesos (P50,000,000.00) to be fully subscribed by the Government of the Republic of the Philippines. Ten Billion(P10,000,000.00) shall be fully paid for the Government upon effectivity of the Act and the balance to be paid for within a period of two (2) years from the effectivity of the Act in such manner and form as the Secretary of Finance and the Secretary of Budget and Management may thereafter be determined

The

Banko Central
Shall

provide policy directions in areas of money, banking and credit It shall have supervision over the operation of banks and exercise such regulatory powers as provided in the Act and other pertinent laws over the operations of finance companies and non-bank financial institutions in performing quasi-banking functions, referred to as Quasi-Banking

Composition of the New Monetary Board of Bangko Sentral


The

powers and functions of the Banko Sentral shall be exercised by the BANKO CENTRAL BOARD:
Seven

(7) members appointed by the President of the Philippines For a Six(6) year term

Banko Sentral Board


One

(1) Governor of the Banko Sentral/ Chairman of the Monetary Board

Shall be head of a department and his appointment shall be subject to confirmation by the Commission of Appointment
Acts as an alternate if the Governor of the Banko Sentral is not Present The Monetary Board shall designate one of its member as the Acting Chairman Designated by the President of the Philippines A designated Undersecretary in his Department will attend as alternate

One

(1) Deputy Governor

One

(1) Cabinet Member

Five

(5) Members from Private Sector whom shall serve full-time.

Qualifications of Monetary Board


Must

be natural born citizens of the Philippines At least thirty-five (35) years of age, with the exception of the Governor who shall be at least forty (40) years of age Of good moral character Of unquestionable integrity Of known probity and patriotism With recognized competence in social and economic disciplines

Banko Sentral ng Pilipinas as Bank of Issue


The

only bank authorized to manufacture and issue money It has monopoly of notes issue Anyone who makes money without the authority given by the Banko Sentral is guilty of Counterfeiting.

Counterfeiting
The

manufacture of money without due authority A criminal offense punishable by law

Banko Central as Lender of Last Resort


In

case the banks need fund for lending to their clients, they may avail of the rediscount facilities at Central Bank They may borrow through the Rediscount Window of the Central Bank by using their notes and having them rediscounted It charges interest money lent to borrowing banks When banks are distressed, the Banko Sentral comes to their rescue by lending to them extraordinary loans as to prevent banks from losing confidence of the general public

Domestic Monetary Stabilization

whenever abnormal movements in the monetary aggregates, in credit, or in prices endanger the stability of the Philippine economy or important sectors thereof, the Monetary Board shall:

A.
take

such remedial measures are appropriate and within the powers granted to the Monetary Board and the Banko Sentral under the provisions of Article I, Chapter III, Section 63, of the New Central Bank Act (Republic Act 7653)

B.
Submit

to the President of the Philippines and the Congress and make public, a detailed report which shall include, as a minimum, a description and analysis

the

causes of the rise and fall of monetary aggregates, of credit or of prices extent to which the changes in the monetary aggregates, in credit or in prices have been reflected in the level of domestic output, employment, wages and economic activity in general , and the nature and significance of any such changes measures which the Monetary Board has taken and other monetary, fiscal or administrative measures which it recommends to be adopted

the

the

The

monetary Board shall submit reports mentioned in this section and shall state therein whether, in the opinion of the Board, said changes in the monetary aggregates, credit or cost of living represent a threat to the stability of the Philippine economy or of important sectors thereof. Monetary Board shall continue to submit periodic reports to the President of the Philippines and to Congress.

The

Instrument of Central Bank Actions


In

order to maintain monetary stability within and out of the country, the Bangko Sentral endeavors to control the expansion or contraction of the money supply, the level of credit, or any rise or fall in prices

Devices
Control

of legal reserve requirement Control of discount and rediscount rates Open market operation Control of collaterals required Imposition of portfolio ceiling Minimum capital ration Margin requirements for L/C Moral suasion

Legal Bank Reserve Requirements


Legal

Bank reserve- refers to the portion of the banks deposit liability that cannot be available for lending, to meet the withdrawal needs of the depositors.

Inflation

decrease the volume of money supply; increase the percentage of the legal reserve required Deflation decrease the percentage of the legal bank required

Purposes of Imposing Legal Bank reserve


As a monetary device for credit expansion and contraction To protect the interest of depositors The pool of legal reserve deposits may be used by the Banko Sentral to help banks in financial distress The pool of legal bank reserve deposits may also be used by banks in their inter-bank call loan system. The pool of bank reserve deposits is also utilized in the settlement of bank claims and counter claims

Laws Covering Legal Bank Reserves (RA 7653, Sec. 96 to Sec. 102)
Required

Reserves Against Peso Deposit Required Reserves Against Foreign Currency Deposit Requires Reserves Against Unused Balances Of Overdraft Line Increase In Reserve Requirements Computation On Reserves Reserve Deficiencies Inter-bank Settlement

Bank Legal Reserve Requirement and its Effect on Banks Excess Reserves and Money Supply
The

kind of money held by the public in expandable form consists of notes and coins issued by the Banko Sentraland the net checking accounts in the commercial banks , which may sometimes call DEPOSIT MONEY.

Example
Total Currency In The Economy P 38 Billion Plus Total Demand Deposits In Bank 130 Billion P168 Billion Deduct:
Currency In Banks Currency In Government Demand Deposits Of Government P 2 Billion 1 Billion 8 Billion P 11 Billion

Total Money Supply

P 157 Billion

To

increase money supply, banks either:


Make

new loans Buy fewer securities

To

decrease money supply, banks either:


Make

fewer loans Sell more securities to the public Accept repayment of loans

Example
Suppose PNB has the following statement and the required reserve imposed by Banko Sentral is 20 %. ASSETS LIABILITIES Reserves P 2,000 Demand Deposits P 9,500 Other Assets 8,000 Net Worth 500 Total P10,000 Total P 10,000 Looking at the previous statement, the PNB has an excess reserve of P100. 20% of 9,500 = 1,900 2,000 1,900 = 100

Example
Now the PNB makes new loans on its excess reserves. The balance statement of PNB is as follows ASSETS Reserves P 2,000 Other Assets 8,100 Total P10,100 LIABILITIES Demand Deposits P 9,600 Net Worth 500 Total P 10,100

Example
After the burrower spends the P100 by writing out checks and after the checks are deposited in, for example, SBTC, the PNB Balance sheet is as follows: ASSETS Reserves P 1,900 Other Assets 8,000 Total P10,000 LIABILITIES Demand Deposits P 9,500 Net Worth 500 Total P 10,000

Example
For simplicity, suppose that the check for p100 is deposited in SBTC. The SBTC, having been required also to set a reserve of 20%, has the following statement before checks are deposited. SBTC statement is as follows: ASSETS Reserves P 1,000 Other Assets 4,300 Total P 5,300 LIABILITIES Demand Deposits P 5,000 Net Worth 300 Total P 5,300

Example
At this point, SBTC has no excess reserve . As the check of P100 is deposited in SBTC and it collects it from PNB, SBTC has the following statements: ASSETS Reserves P 1,100 Other Assets 4,300 Total P 5,400 LIABILITIES Demand Deposits P 5,100 Net Worth 300 Total P 5,400

Example
Since SBTC ahs an excess reserve of P80, it can increase money supply by P80. the balance sheet is as follows: ASSETS LIABILITIES Reserves P 1,100 Demand Deposits P 5,180 Other Assets 4,380 Net Worth 5300 Total P 5,480 Total P 5,480

Example

Again the borrower now spends the money and issues a check against SBTC. SBTC statement of condition is as follows: LIABILITIES Demand Deposits P 5,100 Net Worth 300 Total P 5,400

ASSETS Reserves P 1,020 Other Assets 4,380 Total P 5,400

Example
We just presume the spent money has found its way in another bank, for example RCBC. The statement of RCBC before the money is deposited is as follows: ASSETS Reserves P 1,200 Other Assets 5,000 Total P 6,200 LIABILITIES Demand Deposits P 6,000 Net Worth 200 Total P 6,200

Example
After the money has been deposited, RCBCs statement is as follows: ASSETS Reserves P 1,280 Other Assets 5,000 Total P 6,280 LIABILITIES Demand Deposits P 6,080 Net Worth 200 Total P 6,280

Example
RCBC can now safely increase money supply by its excess reserve of P64. When RCBC increase its loans by P64, its balance statement as follows: ASSETS Reserves P 1,280 Other Assets 5,064 Total P 6,344 LIABILITIES Demand Deposits P 6,144 Net Worth 200 Total P 6,344

Example
As a result, money supply increases. Now let as break the chain and see where we started:
BANKS EXCESS RESERVES INCREASE IN MONEY SUPPLY

PNB SBTC RCBC Total

P100 0 0

P 100 80 64 P 244

Explanation
So

far the money supply has been increased by P244 and it can still be further increased if the P64 finds its way to another banks

With a reserve of 20%, from how many more pesos of demand deposits will P100 serve as the required reserve?
Answer: P 500 20% of P 500 = P 100

The size of Multiplier is determined by dividing 1 by the required reserve ratio


RESERVE RATIO % 40 33 30 25 20 16 2/3 15 10 DEPOSIT MULTIPLIER 2 3 3 4 5 6 6 2/3 10

Assume that the balance statement below is the consolidated balance statement from commercial banks in the economy
ASSETS LIABILITIES Reserves P 35 billion Demand Deposits P 150 billion Other Assets 120 billion Net Worth 5 billion Total P 155 billion Total P 155 billion

With

every reserve ratio of 20%, the commercial banking system has an excess reserve of P5 Billion The actual reserve of P35 billion is 20% of P175 billion The commercial bank can increase the money supply from P150 billion to P175 billion

Changing Reserve Requirements

a decrease in the reserve ratio will serve to increase the excess reserve, the deposit multiplier and the money supply.

The

relationship is inverse between :

Reserve

ratio and deposit multiplier Excess money reserve and money supply

Spending in relation to Economy


Too

much spending = inflation Too little spending = unemployment

Control of the Discount and Rediscount Rates on Loans


The
a) b)

Banko Sentral extends credit to banking institutions for the following purposes:
Using it as a device for credit control Increase the liquidity of the banks through credit, whenever necessary

Interest and Rediscount Rates (R.A. 7653 section 85)


The

Banko Sentral shall collect interest and other appropriate charges on all loans and advances it extends, the closure, receivership or liquidation of the debtor-institution not withstanding.

Open Market Operation in Government Securities


Refers

to the buying and selling of government securities by the Banko Sentral for the purpose of Credit Control

GOVERNMENT SECURITIES Evidences of indebtedness of the government 2 Purposes of Government Securities: 1. To raise revenue 2. To control credit

Central Bank
Plays

a significant role in the issue and placement of government securities It maintains the security stabilization fund, which is a reserve intended to be used in the buying and selling of government securities to stabilize the value and liquidity of such government securities.

Remedies during Inflation


1.

2.

Sell to the public government securities to absorb the excess cash holdings Sell to the banking institutions government securities, so as to divert investment in loans to investment in the securities. The effects are:
a) b)

c)

Decrease in available funds for loans Decrease in lending operations for bank Decrease in credit expansion

Purchases and Sales of Government Securities (R.A. 7653 section 91)


In

order to achieve monetary policy, the Banko Sentral may, in accordance with the principle stated in Section 90 of RA 7653 and which such rules and regulations as may be prescribed by the Monetary Board, buy and sell in the open market for its own account:

a)

Evidences of indebtedness issued directly by the Government of the Philippines or by its political Subdivisions Evidences of indebtedness issued by the government instrumentalities and fully guaranteed by the Government

b)

Issue and Negotiation of Banko Sentral Obligations (R.A. 76536 section 92)
The

Banko Sentral may , subject to rules and regulations as the Monetary Board may prescribe , issue, place, buy and sell freely negotiable evidences of indebtedness of Banko Sentral: provided, the issuance of such certificates of indebtedness shall be made only in cases of extraordinary movement in price level.

Open Market Operations, and its effect on Banks Reserve and Money Supply
To

eliminate inflationary pressures, the Banko Sentral may increase reserve ratio, increase discount rates or sell government securities in the open market During the unemployment in the economy, the Banko Sentral tends to decrease the reserve ratio, discount rates, and buy government securities in the open market.

Control of the Collaterals Required on Bank Loans


The

Banko Sentral has the power to impose conditions or requirements on the securities against the loans extended in the banks. Thos in effect increases the loan value of collateral. INFLATION= Banko Sentral increase collateral = decrease the loan value of collaterals =discourage public from borrowing from the bank, decrease lending operations of banks and decrease credit expansion DEFLATION= Banko Sentral may decrease collateral = incentives to borrowers

Imposition of Portfolio Analysis


The

upper limit that the Banko Sentral may place on the loans and investment of banks It is instituted only during inflation It is a direct limitation on volume of loans, and investment that banks may extend

Portfolio Ceilings (R.A. 7653 section 107)


Whenever

the Monetary Board considers it advisable to prevent or check an expansion of bank credit , the Board may place an upper limit on the amount of loans and investments which banks may hold, or may place a limit on the rate of increase of such assets within specified period of time. The Monetary Board may apply such limits to the loans and investment of each bank or to specific categories thereof.

Minimum Capital Ratio (R.A. 7653 section 108)


Maximum

ratio that the combined capital accounts may bear on the banks corporate assets

RISK ASSET = TOTAL ASSETS NON- RISK ASSETS

Margin Requirements against Letter of Credit (R.A. 7653 section 105)


The

Monetary Board may at any time prescribe a minimum cash margins for the opening of letters of credit, and may relate the size of the required margin to the nature of the transaction to be financed

Moral Suasion

a more psychological approach in which the Banko Sentral may use its persuasive power to make the banks follow or support credit policies without direct imposition on restrictions

Other Monetary Policies To Stabilize Banking Operations


Banko

Sentral may fix maturities in the bank loans for the purpose of credit control or as a means of payment
Sentral may also fix the maximum interest that the bank may pay on deposit substitute for the purpose of preventing competition among banks in attracting depositors

Banko

Banko

Sentral may establish priorities for bank loans especially with respect to funds, which has been borrowed from the Banko Sentral. Sentral makes periodic examination of the banks accounting records and requires banks to submit their financial statement at the end of every quarter. Sentral looks into the character and integrity of the banks incorporators and members of the board as well as the top ranking executives of the banks.

Banko

Banko

Functions of Banko Sentral as Fiscal Agent


To

be the official representative of the government to financial entities To be depository banker of the government To be the financial adviser of the government To manage public debts

End of Chapter
Chapter 8
Central Banking & The Effects of Its Monetary Policies in our Economy

Chapter 9

COMMERCIAL BANK MANAGEMENT

BANKS are managed by the Board of Directors and the set of officers of the bank. STOCKHOLDERS elect the Board of Directors by virtue of their right to vote. The Board of Directors elect from among themselves the Chairman of the Board, the President, Vice President, the Secretary, Treasurer, Comptroller and the Senior and Junior officers of the bank. They hold their meeting once a year but the stockholders may also be called at any other time of the year on notice provided that is ordered by a majority of the Board of Directors.

Duties & Responsibilities Of The Stockholders


1. 2. 3. 4. 5.

6.

7.
8.

Amending the by-laws Amending the Articles of Incorporation Increasing and decreasing the Authorized Capital Stock in the bank Approving the minutes of the previous annual or special meeting of stockholders Examining and approving or disapproving the operations of the bank for the year ending , as disclosed through the annual report, books of accounts and other records submitted for their attention Approving the tentative budget for the ensuing year as presented by the president Electing the Board of Directors Delegating to the Board of Directors the authority to distribute earnings as dividends, as circumstances may dictate

BOARD OF DIRECTORS
responsible

to the stockholders for the management of the bank.

Duties of the Board of Directors of the Bank


1.

2. 3.

Elects one of their members as the Chairman of the Board and delegates to him the responsibilities of presiding at the meetings of the Board of Directors, the annual meetings of stockholders, and acting as the liaison officer between the stockholders and the Board of Directors Elects the President and the Chief Executive officer of the Bank Elects the heads of various committees appointed by them

4.

5.

Elects the Executive Secretary who has the responsibility of maintaining all the corporate records of the bank, the corporate seal, and for the recording all actions taken by the Board of Directors and Executive Committee; takes down the minutes of the meeting for both the board of directors and the stockholders meeting Appoints upon the recommendation of the Chairman and President, Senior or Junior Officers, to whom are delegated the responsibility of supervising certain operating and financial function of the bank

6. 7.

8.

9. 10.

Approves the compensation to be paid to the various officers and employees of the bank Approves the general assignment of duties and responsibilities of each officer as submitted by the Chairman and the President Determines, approves and set forth, for the guidance of all officers, the loaning limitations of each administrative officer Approves the amount of surety bonds to be carried on each officer and employee of the bank Determines the loan and investment policy of the bank setting forth for the guidance of administrative officers and , the percentage and amount of the time and demand deposits and, the capital funds which should have been invested in the various types of loans and investment.

11.

12.

13.

14.

Approves and decides on all matters involving changes in the Capital Account and the distribution of earnings or dividends in lieu of the authority granted by the stockholders Authorizes the maintenance of corresponding bank accounts and all borrowing agreements with other banks Approves all loans to directors, officers, stockholders and their related interest as to amount and security as approved by the Central Bank Reviews and approves or disapprove the actions of the various committees in carrying out their respective functions and responsibilities.

15.

16.

Appoints the Auditor, defines his duties and responsibilities, the scope of the audit routine, and the manner in which he is to report the result of his work to the Board of Directors Formulates the policies of the bank

COMMITTEES APOINTED BY THE BOARD OF DIRECTORS


EXECUTIVE

COMMITTEE- advisory body to the board in matters pertaining to the managerial conduct of the business. AND DISCOUNT COMMITTEE- in charge of all matters pertaining to loans and discounts, to credit lines and all other loan related functions of the bank.

LOANS

INVESTMENT

COMMITTEE- concerns itself with the banks Investment Portfolio.

TRUST

COMMITTEE- concerns with the fiduciary function of the bank. COMMITTEE-in charge of identifying all problems in connection with the audit and examination of the bank, finding solution and making recommendations.

EXAMINATION

OFFICERS OF THE BANK


CHAIRMAN

OF THE BOARD- presides on all meetings of the Board of Directors, Executive Committee and Stockholders. Chief Executive Officer of the

PRESIDENT-

bank.
EXECUTIVE

VICE PRESIDENT- sometimes called 1st Vice President or Senior Vice President, assist the President and acts in behalf of the President when latter is absent.

ADMINISTRATIVE

VICE PRESIDENTcoordinating officer of the bank and the liaison between the Presidents and all other officers. VICE PRESIDENT- officers designate to assist the Vice Presidents in their functions. SECRETARY- Chief recording officer of the bank.

ASSISTANT

EXECUTIVE

CASHIER-

Chief Financial officer of the bank and is elected according to the law by the Board of Directors of the bank. chief control officer of the

COMPTROLLER-

bank.
AUDITOR-

undertakes the examination of the bank in accordance with the established standards as approved by the Board of Directors.

VARIOUS DEPARTMENT OF THE BANK


1.

CASH DEPARTMENT- takes charge of all deposits and withdrawals in the bank.
CREDIT DEPARTMENT- in charge of all loans, discounts and collection of transaction entered into by the bank.

2.

3.

FOREIGN/INTERNATIONAL DEPARTMENTtakes charge of all transactions regarding importation and exportation of goods.

4.

TRUST DEPARMENT- take charge of funds, properties and securities entrust to the bank for management in behalf of a third party. INVESTMENT DEPARTMENT- take charge of the investment portfolio of the bank. MONEY MARKET DEPARTMENT- takes charge of buying and selling securities.

5.

6.

7.

BRANCHES DEPARTMENT- in charge of managing all the branches and extension offices of the bank. HUMAN RESOURCE AND DEVELOPMENT DEPARTMENT(HRD)- in charge of hiring, training, assigning personnel to the various department and branches of the bank, assessing their performance and recommending their promotion or dismissal from the bank.

8.

9.

LEGAL DEPARTMENT- takes charge of all legal matter regarding bank operation.

10.

GENERAL SERVICES DEPARTMENT- in charge of repair maintenance and security of the bank. ADMINISTRATIVE DEPARTMENT- in charge of running affairs of the bank. ACCOUNTING DEPARTMENT- takes charge of recording all transaction of the bank in chronological order as the transaction took place, including the preparation of the balance sheet, income statement and the budget of the bank.

11.

12.

End of Chapter
Chapter 9

COMMERCIAL BANK MANAGEMENT

Chapter 10

Over View of Business Finance

What Is Business?
It

is every economic activity which involves money, property and industry with a hope of making a profit. has an economic purpose, the production and marketing of every possible article and service that will help supply human wants at the most convenient and reasonable manner at a profit.

Business

Purpose of businessman
Make

profit Set aside saving s for future either for:


Expansion Retirement

of Business

Furnishes
Salary

a living to various groups of employees working for:


Commission Profit

sharing basis

Finance
An

important part of the organization of business A day-to-day problem of short-term or longterm needs of the business

FINANCIAL

MANAGER looks forward and make financial decisions which will achieve the objectives of the management

Categories Of Business
Industrial Service Business

Industrial Business
It

is concerned with manufacture of goods by


Physical

:
and chemical transformation of raw materials into finished product. Extraction of minerals from the ground Extraction of fishes from the sea
EXAMPLE:
Mining

Industry Oil Industry Fishing Industry

Commercial Business
Is

concerned with bridging the gap between the producer and the ultimate consumer Deals with the distribution of goods.
Dealing

with wholesalers and retailers Dealing with cargo transport

Servicing Business
EXAMPLES:
Restaurant
Tailoring Schools Law

Shop Dress Shop Beauty Parlor Recreation Centers Banks Hospitals

Offices Accounting Offices Management Advisory Offices Dental And Mental Clinics

Why Do People Go Into Business?


The

presence of business opportunity where a person sees the possibility of making a profit. availability of idle funds that could be possibly employed to earn a better income than what is earns from the bank. of technology due to the birth of new inventions led by amazing discoveries.

The

Advancement

To

raise ones standard of living

To

create employment for others

Opportunity

created by bi-product of ones existing business instead of going into waste

To

make ones presence felt in various industries


power as well as for social business prestige

For

Challenges

brought about by competition among business prestige.

Prominent Businessmen in Philippines


John

Gokongwei Henry Sy Lucio Tan

Factors Necessary for a Successful Business Venture

Enough capital resources to easily meet increase in product demand Efficient management Must able to create demand for the product that requires an adequate market analysis Effective advertisement of the product

Two Important Functions of Business


Production
Marketing Production

goes hand and hand with marketing. The proper combination of these two function are dependent upon the intelligent operation of assisting functions which though subordinate in scope are indispensable to the proper development of the two essential functions.

Assisting Functions
Organizing Financing Purchasing Advertising Accounting Office

Management Inventory Management Transportation Management Factory and Store Management

Over view of the sources of funds GOLD


MONEY (not in present circulation)

Credit Money
Of Unlimited Acceptability

Representative Paper Money/ Gold & Silver Certificate

Fiduciary Paper Money Banks Notes Promissory Notes Bills of Exchange Personal Credit

Money in Circulation

FUND
unsecured
CREDIT Of Limited Acceptability

Mercantile

Evidenced/Secured Unevidenced Deposits Loans Discounts Bonds

Banking

Public Investment Long Term Terms Of Credit Intermediate Term Short Term

Funds
Refers

to anything that could be used in business which is consists of money and credit instruments.

Credit instruments
CREDIT MONEY Is a credit instrument that is widely acceptable in payment for goods and services. PERSONAL CREDIT Refers to a credit obtained for personal purposes.

MERCANTILE CREDIT Is a credit given by a businessman to another businessman for further processing or for resale. SECURED CREDIT evidenced by document UNSECURED CREDIT Is given only on the basis of the character and integrity of the buyer.

Laurence Gitman
Defines

finance as the art and science of managing money.

Managerial finance
Is

concerned with the financial managers duties and responsibilities of financial manager of a business concern.

Relationship Of Finance And Economics


It

is very important that every financial manager must understand the economic framework of the country since every business operates with that framework. It is therefore very important that the finance manager should be knowledgeable of the basic theories in economics. He must be ready to see the consequences of the varying levels of economic activity such as changes of economic policies and conditions in relation to the business.

Relationship Of Finance To Accounting


Finance

is also related to accounting in that the firms accounting department or office that is headed by a comptroller and the treasury department is under the control of the vice president of finance. These functions are closely interrelated and at times overlap

1.Funds Recognition
The

accountants primary function is to develop and provide data for measuring the performance of the firm, while the financial manager places primary on the cash flows, its inflows and outflows.

2.Decision Making
Accountants

devote his time in collection and presentation of data, while the financial manager evaluates the accountants financial statements.

For example:
Accounting point of view:
Sales revenue Less expenses Net profit 200,000 170,000 30,000

Finance point of view:


Cash inflow Less cash outflow Net cash flow 0 170,000 (170,000)

Promoting a Business
Promotion

is a painstaking performance of many preliminary activities necessary in bringing together money, property and managerial ability to a point where the business is ready to operate.

Promoter

is one who undertakes to form a business.

Kinds of Promoter:
Owner Promoter
The

owner of the business who undertakes the promotional job himself a lawyer or a management consultant who is well-versed with the countrys laws, rules and regulations

Occasional Promoter
Usually

Professional Promoter/ Institutional Promoters


Undertaken

by people who do promotion as business or for a fee

Payment Forms
1.

2.
3.

Fixed fee Shares of stocks An amount equivalent to a percentage of the total capitalization of the business

Stages of Promotion
Discovery Stage

in this stage the promoter prepares a project study or feasibility study.

Financing Stage
in

this stage the promoter will raise capital need for the business.

Assembly Stage

this stage is undertaken when the promoter has enough initial capital to go into actual organization of the business.

Feasibility Study
CONTENTS OF FEASIBILITY STUDY: 1. Management Aspect
2. 3. 4. 5.

6.
7.

Marketing Aspect Production and Technical Aspect Taxation Aspect Financial Aspect Profitability Aspect Social and Economic Significance

Management Aspect
Pre-Operating

Stage Operating Stage

Production or Technical Aspect


Product
Size
Weight Physical

or service description and specification:


of product / service

Nature

appearance Chemical properties Mechanical component Clients to be topped


Process

of manufacturing

Technical

process Licensing contract, franchise contract, patent and copyrights Raw materials needed the specification, sources and cost
Plant

layout, size and production schedule

Taxation Aspect
Government

fees, permits, licenses, local tax Other business tax such as specific tax, advalorem tax, sales tax, incentive tax Strategies to maximize tax liabilities Tax exceptions

Financial Aspect
Initial

capital outlay Method and source of financing Financial assumption Financial projection Financial analysis

Profitability Aspect
Break

even point Earnings per share Return on assets Return on equity Return on sales Dupont system

End of Chapter
Chapter 10

Over View of Business Finance

CHAPTER 11

FORMS OF BUSINESS ORGANIZATION

FORMS OF BUSINESS ORGANIZATION


Sole

Proprietorship Partnership Corporation

Sole proprietorship
The

first type and most common type of business organization that was in use for years since the pre-historic times.

Advantages of a Sole proprietorship


Ease

of formation. Business decisions are only made by one person, the owner. All profits are accrue to the sole proprietor. He has the sole authority to manage the business. A sole proprietorship is more stable than partnership.

6. There is less government control. 7. It has flexibility of operation. 8. It is easy to transfer ownership without endangering the existence of the business. 9. Business secrecy can be easily preserved.

1. The sole proprietor has unlimited liability. 2. The sole proprietor has a limited ability to raise added capital for his business. 3. The business does not pay a separate income tax from the other income of the owner. 4. The owner has no one to share the burden of decision making.

Two or more persons bind themselves to contribute money, property and services to a common fund for the purpose of going into a business for a profit.

General Partner Limited Partner Capitalist Partner Industrial Partner Managing Partner Ostensible Partner

Dormant Partner Nominal Partner Silent Partner Liquidating Partner Secret Partner

Delectus Personarum - refers to the right of a partner to choose the people he wants to be partner with. Juridical Personality - refers to a legal entity inherent to both a partnership and a corporation in that the partnership and the corporation acquire a personality of its own, separate and distinct from the personality of the owners.

General Partnership - is a partnership where all the partners are general partners with one or more industrial partner. Limited Partnership - is a partnership where there are one or more general partners with one or more limited partners.

Joint Venture - it is an association of two or more persons for the purpose of carrying a particular business transaction or deal. Once the purpose for which the transaction or deal is attained the business venture ceases to exist. Joint Stock Company - this is a hybrid between a partnership and a corporation. It has some features similar to a partnership and also a feature similar to that of a corporation.

Unlimited Liability - refers to a partner who is answerable for partnership debt up to the extent of his personal properties incase the partnership becomes insolvent.

Limited Liability - refers to a partner who is not liable for partnership debts, what he can only possibly lose is his agreed contribution.

The term industry - refer to human faculties susceptible to useful application whether physical, intellectual or moral. Partnership Capital - refer to cash, goods and real properties such as lands and buildings.

Contribution to a common fund Voluntary agreement Hope for a profit Lawful business Contents of articles of co-partnership should be known to all partners Relationship among partners are fiduciary in character It has a separate and juridical personality from that of the owners

Conjugal Partnership - it arises from the celebration of marriage.


Syndicate - is always undertaking.

organized

for

temporary

Partnership Contract - may either be oral or written. Registration of a Partnership - is necessary as a condition for the issuance of license to engage into business.

1. Simple form of organization. 2. Efficiency in raising needed funds. 3. More efficient in obtaining credits.

4. Flexibility of operation.
5. Limited government control. 6. Does not pay income tax except when such profits are distributed to the partners. 7. Operated more efficiently.

1. Stability of the partnership/Dissolution of partnership.


2. Less ability to raise the needed capital funds. 3. Unlimited liability of the general partners. 4. Harder to achieve large-scale operation.

1. 2.
3. 4. 5. 6. 7.

Register the name with the Bureau of Trade. Prepare the notarized partnership agreement to be signed by all partners. Apply for tax account number with the BIR. Register the partnership agreement with the SEC. Apply for the municipal license of the firm with the local government. Apply for the Value Added Tax Account Number of the firm with the BIR. Register the firms book of accounts, sales invoice and official receipts with the BIR.

1.
2. 3. 4. 5. 6. 7. 8. 9. 10.

Name of the partnership ( If limited partnership, the word limited is attached to its frame) Purpose of the partnership business Name and address of the business partners The main place of the business Date when the partnership becomes effective Capital contribution of its partner (Incase of properties the description and value of such property must be stated) When may contributions of limited partners be returned? Term of existence of the partnership Rights, powers and duties of each partner Manner of sharing in profits and losses

11. 12. 13. 14. 15. 16.

17. 18.

Compensation of the services to be rendered by each partner Treatment of additional investment and withdrawal of partners Procedure of the settlement of partnership assets upon dissolution How may disputes be settled? Accounting period whether Calendar year or Fiscal year is adopted The right given to a limited partner to substitute an assignee as contributor in his place and the terms and condition of such substitution The right to admit additional limited partner if agreed upon The right of a limited partner if given, to demand a property other than cash in return for his capital distribution

1.

2. 3. 4.

If all liabilities of the partnership, except to general partners and to limited partners by way of their contribution, have been paid and a sufficient amount still remains to pay them. If all the other partners consent to the return of their capital contribution When the certificate of co-ownership is amended allowing the reduction of capital contribution? After giving six (6) months notice in writing to all of the other partners provided there is no time indicated in the certificate either for the return of their capital contribution or dissolution of the partnership.

1. For any unpaid contribution he has agreed to make in the certificate of co-partnership 2. For the difference of his supposed contribution and the contribution he has actually made to the business

o Each partner is an agent of the partnership for all businesses entered into by the partners. They bind the firm from all acts that is apparently done for carrying on the business of the partnership in the usual way. Agreement between the partners may be made which will limit the authority of any one of the partners to act in behalf of the partnership. In case of limitation of the act of any partner, this is not binding to outside parties unless such party is aware of such limitation. Should the act be done outside the partnership business? The partnership is not bound by the partners act.

1. 2. 3. 4. 5. 6.

Assign partnership properties in trust for creditors Do acts that would prevent the business to be carried on the unusual way Confess a judgment Sell the good will of the business Submit a partnership claim arbitration Sell a part or all the properties of the partnership

1.

2.

All the partners shall be considered agents and whatever anyone of them may do alone shall bind the partnership, without prejudice to provision of Article 1801. None of the partners may without the consent of the other, make any important alteration in the immovable property of the partnership even if it may be useful to the partnership. But if the refusal of the consent of the other partner is manifestly prejudicial to the interest of the partnership, the courts intervention may be sought (Article 1813).

1. His right in a specific partnership property 2. His interest in the partnership 3. His right to participate in the management (Article 1810)

o Articles of 1789 of the Law on Business organizations states, that profits and losses shall be distributed in conformity with the agreement. If the share of the partners in the profits has been agreed upon, the sharing of each in the losses shall be the same. Sharing therefore of profits and losses shall be in conformity with the agreement. In the absence of stipulation in a contract, sharing of profits and losses shall be in accordance with capital contribution.

1. In accordance to stipulation in the contract 2. In the absence of stipulation in the contract, profits are shared as follows :
a. b. Capitalist partner share profits in accordance to their capital contribution. If it is a partnership with capitalist and industrial partners, the industrial partner gets a just and equitable share for the services he has contributed while the capitalist partner share according to their capital contribution for the remainder of the profits. When a capitalist industrial partner exists, such partner gets a share in the profits as an industrial partner and gets an additional share for his capital contribution.

c.

1. Losses will be shared according to stipulation in the partnership contract. 2. In the absence of a stipulation in the contract, but the contract provides for sharing in profits, such profit sharing rates shall also be the same sharing for losses. 3. In the absence of a contract for sharing losses, the loss shall be shared in proportion of their capital contribution.

Dissolution is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business of the partnership (Civil Code of the Philippines, Article 1828). Winding up is the business process of settling the partnership affairs after dissolution.

Causes of Dissolution
1. 2. 3. 4. Admission of a partner Withdrawal or retirement of a partner Death of a partner Incorporation of the partnership

1. 2.

3.
4.

5.

When a partner is declared insane in a judicial proceeding. When the partnership business can only be carried at a loss. When a partnership intentionally commits a breach on the partnership contract. When the acts of the partner or partners become prejudicial to the business. When a partner becomes incapable of performing his duties as specified in the partnership contract.

1.

Partnership assets : a. Pay debt to creditors other than the partner creditors b. Pay debt to partner creditors other than their capital contribution c. Return of partnership capital contribution d. Division of profits in accordance with partnership agreement Personal assets of general partners incase of insolvency : a. Pay personal debt of the partner b. Pay partnership debt to outside creditors c. Pay partnership debt to partner creditor other than his capital contribution

2.

Article 1862 of the new Civil Code states that persons admitted as a partner into an existing partnership is liable for all the obligations of partnership arising before his admission as though he had been a partner when such obligations were incurred, except that this liability shall be satisfied only out of partnership property, unless there is stipulation to the contrary.

Example :
XYZ are partners in a general partnership. W was newly admitted to the already existing partnership. The Partnership business has an existing obligation amounting to 100,000. May W be liable for the existing obligation even if he was not a partner before the obligation was incurred?

A corporation is an artificial being created by the operation of law, having the right of succession, and of the powers, attributes and properties expressly authorized by law or incident to its existence (The Corporation Code of the Philippines, Sec. 2).

Attributes of a corporation
1. 2. 3. 4. It is an artificial being It is created by the operation of law It has the right of succession It has the powers, attributes and properties expressly authorized by law or incident to its existence.

1. 2. 3.

Corporation and partnership have a juridical personality Both comprise of several people as part of owners Both act only thru their respective agents

End of Chapter
Chapter 11
FORMS OF BUSINESS ORGANIZATION

Chapter 12

ORGANIZING A CORPORATION

The most complicated form of business organization used all over the world is a corporation. It is not only used for business but also in social clubs, churches, municipalities, government instrumentalities and many others. Most of the businesses in the country are in the form of corporations. The corporate name should not be the same with any registered entity. The reason behind it is to avoid confusion and possible fraud or misrepresentation to be committed.

The

word INC should be added to the firm name unless the word Corporation is already included. Banking institutions should always include the words bank, banking, commercial bank, trust and company savings bank, and building and loan association in its firm name. Only a duly licensed warehouse can include the word bonded in its firm name.

Stockholders

are the investors of the corporation. The corporations aggregate capital is divided into smaller units of ownership which we call stocks or shares of stocks. The subscribers or purchasers of these shares of stocks are called stockholders.

How

may a prospective investor acquire shares of stocks? By Subscription By Purchase

the corporations treasury stocks. From other stockholders who would want to dispose their stocks From the Stock Market Thru the declaration of stock dividends
From

Subscription

is a contract to buy certain number of shares from a corporation out of its un-issued stocks.

Two kinds of Subscription:


Pre-incorporation

subscription which arises when the contract to subscribe the shares of stocks made before the corporation has acquired its legal existence. subscription which arises when the contract to subscribe the shares of stocks made after the corporation has acquired its legal existence.

Post-incorporation

Stocks are paid either on cash basis or on

installment basis. If stocks are fully paid on cash basis, the stockholder is immediately entitled to the issuance of a stock certificate.

Private

Corporations Private corporations are

those corporations owned by private individuals. Government Corporations These are corporations formed by a legislature for governmental or political purposes such as the municipal, provincial or city governments and chartered cities and towns. Quasi Public Corporations These are corporations engaged in giving basic services to the public in general, whereby they are entitled or privileged to use public or government properties.
Government

Corporations These are corporations that are

Owned

and

Controlled

organized and controlled by the government. Here the government is the majority stockholder.

Ecclesiastical

Corporations those corporations

which are organized for religious purposes such as the Order of Preaches(OP), Society of the Divine Word (SDV), etc. Eleemosynary Corporations These are corporations organized specifically for charitable purposes. Civil Corporation These are public or private corporations other than an Ecclesiastical or Eleemosynary corporations. Stock Corporations are private corporations whose capital stocks are divided into shares which are sold to investors and entitle them to share in the dividends of the corporation when declared. Non-stock Corporations are those corporations that do not divide their capital into shares of stocks and therefore individuals become members of such corporations.

Domestic

Corporations are corporations

incorporated under the laws of the country where they are doing business. Foreign Corporations are those corporations incorporated under the laws of a country other than the place where they are doing business. Close End Corporations are usually corporations whose stockholders are members of a particular family or group of families. Open End Corporations are corporations whose shares of stocks are made available to all prospective investors.

Corporators

are the persons comprising the corporation whether stock or nonstock.


Incorporators

are first set of stockholders articles of incorporation.


Stockholders

stated in the

are part owners of a corporation, who hold shares of stocks to evidence their ownership.
Members

these are corporations.

corporators

in

non-stock

Steps in the Formation of a contract:


The

promoter undertakes the formation of a corporation. Collect payments of the shares of stocks from the incorporators and deposit them in a bank. File the articles of incorporation in the prescribed form with the Securities and Exchange Commission (SEC). File other documents required by the Securities and Exchange Commission. Pay the filing fee and publication fee. SEC issues Certificate of Incorporation.

Register

name with the Department of Trade. Apply for city or municipal license from the local government. Apply for VAT or Non-VAT account number from the Bureau of Internal Revenue (BIR). Register the corporate books of accounts, the invoice, and the official receipts with the BIR. By-laws are filed with the SEC at least one month after the issuance of the certificate of Incorporation.

By-Laws
They are sets of rules and regulations that govern the internal organization and operation of the incorporation.

Managing

a Corporation

Since the stockholders are the owners of the corporation, they delegate the management to a duly elected board of directors. The directors are elected from among the stockholders. In small corporations, there may be only a few stockholders but in large corporations, the stockholders may not know each other. As the business becomes larger and larger, the business becomes more and more difficult to manage.

Amendments of the Article of incorporation can be on the following:


Change

of corporate name Change in the purpose for which the corporation operates Change of authorized Capital Stock Increase or Decrease of the par value of a stock Change of certain stock from par value to no par value stock Change in the location of the main office Change in the members of the board of directors

Voting

All common stocks listed in the books of the corporation are entitled to vote except when specifically prohibited to do so in its charter. Preferred stocks on the other hand often have restricted voting rights in exchange for other privileges.

Two Methods of Voting


Voting under the common law This arises when stockholders cast one (1) vote regardless of the number of shares he own. If a stockholder has only one stock he is entitled to one vote in the same manner as when a stockholder owns ten or more stocks he could only cast one (1) vote.

Cumulative

Voting

Under this system, every stockholder can cast as many votes as the number of shares he owns multiplied by the number of board of directors to be elected. He may choose as to how he will distribute his votes among the directors he would want elected. He may even cast his votes for only one director.

Formula for Voting


A formula has been made to determine this. Formula: X= ac b+1 +1

Where: x represents the number of shares necessary to elect the board of director a represents the number of shares participating in the election b represents the total number of directors to be elected c represents the number of directors the stockholders or a group of stockholders would like to elect

Example
ABC Corporation has 20,000 voting tocks. They are to elect nine directors. How many shares are needed to elect majority of five of the directors?

Liability of Stockholders
Since stockholders have limited liability, they could only possibly lose their investment in the business. The following may be cases when a stockholder my still be liable for corporate obligations beyond his capital contribution:
1.

2.
3.

His unpaid subscription The watered stocks he holds Un-paid salaries of the employees of the firm If a stockholder shall have some unpaid subscriptions these are subject to the claim of the corporate creditors in case of dissolution. Therefore, the delinquent stockholder is liable to corporate creditors to the extent of his un-paid subscriptions.

Watered

stocks

are those stocks considered fully paid though the payment received is less than its par value. Stock watering may arise in the following circumstances: 1. Issuance of bonus shares for services rendered but the value of the service is less than the value of the shares. 2. Issuance of stock dividends where the stock dividends declared is more than the corporate profits or surplus available for dividends

The law specifies that there shall not be less than five (5) nor more than fifteen (15) incorporators and not more than five (5) nor more than eleven incorporating directors in stock corporation, while there should be not less than five nor more than fifteen board of directors in a non-stock corporation.

Qualifications of the Board of Directors:


He

must own at least one (1) share of stock of the same corporation. He must have good moral character such as; personal integrity and honesty and is impartial. He should have the capacity to contract, that is, he must be of legal age and not otherwise incapacitated. He must have the necessary business acumen to manage the business efficiently. Two thirds of the board of directors should be Filipino Citizens. Some corporations require 60% to even 100% depending on what corporation it is.

Basic provisions of the corporation law regarding board of directors include the following:

The directors are elected annually. The cumulative method of voting should be followed. Notice on meetings should be sent to the stockholders and published two weeks before the election in a newspaper of general circulation. The term of office of the board of director is one year. The majority of all outstanding subscribed stocks are entitled to vote. Voting may either be in person or by proxy. In case the date of election is not indicated in the by-laws, it should take place on the first Tuesday of every year.

Quorum
a

fixed minimum percentage or number of members of a legislative assembly, committee, or other organization who must be present before the members can conduct valid business. specified in the by-laws. Majority of the board of directors generally constitute a quorum.

Is

Directors acts must be within the corporate powers. They should be performed in good faith and exercised with care and diligence. As long as these are taken into consideration, the directors are not liable for their corporate acts.

The following acts can make the directors liable:


When

they re negligent in the performance of their task. When they are acted in bad faith. When they commit ultra vires act, that is, they acted beyond what is provided for in the corporate charter. When they commit fraudulent and wrongful acts inimical to the welfare of the corporation.

Functions of the Board of Directors


Elects

the chairman of the board from among themselves Elects the president and chief executive officer of the corporation Appoints the heads of the various committees created by them Elects the executive secretary Appoints with the recommendation of the chairman of the board and president, the senior and junior officers Approves the compensation to be paid to the various officers and employees

Approves

the general assignment of duties and responsibilities of each officer as submitted by the chairman and the president Appoints the auditor and define his duties and responsibilities and directing him to report directly to the board Formulates of major policies of the corporation Has overall supervision and control of personnel Evaluates the performance of the firm

The chairman of the board is elected from among the stockholders. He presides in the board meetings. In small corporations, the functions of the chairman of the board and the president are occupied by one person.

The

President He is the chief executive of

the firm. He is in-charge of the internal management and operation of the corporation.
Vice

President A corporations appoints an

executive vice president who assists the president when he is present and acts as president when the president is absent.
Treasurer

He is in charge of the corporate funds including securities of the corporation. He is in charge of disbursements of funds like the signing of checks, notes and other obligations.

Comptroller/Controller is the officer in

charge of the accounts of the firm. He supervises the bookkeeping, accounting and reporting procedures. He is also in charge of budgeting and financial planning. Auditor is in charge of verifying the authenticity of the recording of transactions in the books of the corporation. He checks into the authority of credit transaction and how this was recorded in the books of the firm. Secretary prepares the agenda for the meetings and keeps the minutes of the meetings of the stockholders, board of directors and committee meetings. He is in charge of stock transfer in the books of the corporation.

Corporate Powers

The corporation has two powers namely the express power and the implied power. The express power is specifically conferred upon it by its charter. It is specifically expressed in the certificate of incorporation. The implied powers are those powers necessary to carry out the express powers. They are incidental to the existence of the corporation.

Right of the stockholders


Right to attend or call meetings Right to receive certificates of stocks for fully paid shares Right to receive dividends Right to vote on matters which the law provides Right to be registered as a stockholder of a corporation Right to transfer his shares Pre-emptive right Right to protect his proprietary interest in the business

Right

to protect the corporation from ultra vires

acts Right to sue in behalf of the corporation Right to information and inspect the books of the corporation Right to withdraw his investment in the corporation under certain circumstances Right to amend the articles of incorporation and the by-laws of the corporation Right to participate in the distribution of the assets of the corporation in a total or partial liquidation of the corporation

Pre-emptive right
refers to the right of the stockholder to subscribe to any new shares of stocks issued by the corporation in proportion to the number of shares he owns before the new issues are offered to outsiders.

Voting by Proxy

This is a system by which the stockholder may exercise his voting power through a third party to cast his votes. A written authority is necessary for a stockholder to grant a third party to vote in his behalf. Voting by proxy enables the minority stockholders a chance to control the corporation. If all small stockholders group together and cast their votes for a particular director, then they can achieve this.

Voting Trust

This is a device where by minority stockholders surrender control over their shares of stocks to a trustee to exercise prerogatives for a particular purpose such as that which is indicated in the trust agreement.

End of Chapter
Chapter 12

ORGANIZING A CORPORATION

Chapter 13

STOCKS & BOND FINANCING

Stocks And Bond Financing


The shares of stocks are supposed to earn dividends for the owners. The board of directors should see to it that the corporation earns profits and grow through the years. Almost all of the initial capital of the corporation including a large segment of the future capital comes from the sale of stocks. Stocks just like any other commodity are bought and sold in the corporation, from the stockholders themselves or from the stock market.

Stock Financing
refers

to the procurement of corporate funds through the sale of shares of stocks to prospective investors, it is a method of financing by increasing the equity capital. the total amount of stocks of all classes authorized in the certificate of incorporation. It may consist of the issued stocks and the un-issued stock of the corporation. represents the actual amount of stocks of all classes, which are issued, and outstanding at any time and not necessary the total amount of authorized capital stock, a large part of which is un-issued.

Authorized capital stock


is

Capital stock

Capital
depends

on whose point of view it is being defined. To the accountant, capital refers to the total ownership of the business, which is obtained by deducting the total liabilities from the total assets. to the sum of the face or par value of all outstanding stocks and bonds issued by the corporation. In case of no par value stocks the value carried in the balance sheet will be used. This can be computed by adding to the capital stock all bonded indebtedness issued by the corporation.

Capitalization
refers

Example:
A corporation issued 200,000 shares of common stocks and 100,000 shares of preferred stocks both having a par value of P100.00 each share. The corporation sold 150,000 shares of common stocks and 100,000 shares of preferred socks at par. It also had a bond issue of 50,000 bonds having a face value of P1,000.00 per bond. The corporation borrowed from the bank P100,000,000.00 to augment its funds. Its books show a surplus of P20,000.00. What are the companys authorized capital stock, capital stocks, capital and capitalization?

Solution:
Authorized Capital Stock Common stocks 200,000 x 100 par value = P 200,000,000 Preferred stocks 100,000 x 100 par value = P 100,000,000 Authorized Capital Stock Capital stock
Common Stocks 150,000 x 100 par value = P 150,000,000 Preferred stocks 100,000 x 100 par value = P 100,000,000

P 300,000,000

Capital Stock

P 250,000,000

Capitalization

Capital stock Bonds 50,000 x 1,000 Capitalization


Capital Capital Stock Surplus Total Capital

P 250,000,000 50,000,000 P 300,000,000

P 250,000,000 P 100,000,000 P 350,000,000

Un-issued stocks

this is a portion of the authorized capital stock, which has not yet been subscribed and remains in the corporation.

Issued capital stock

this refers to the stock already issued and outstanding.


this refers to all issued and subscribed stocks, which may be fully paid or partly paid which are held by stockholder other than the issuing corporation. refers to those stocks issued and fully paid but reacquired by the issuing corporation. Re-acquisition may either be through purchase, gift and donation to the corporation.

Outstanding stocks

Treasury stocks

Unpaid

subscription on term basis is due and payable on demand and is subject to call.

call is a resolution passed by the board


of directors to demand payment for the unpaid subscription. The corporation may collect interest from the time the call is made.

board resolution must be made specifying the percentage of the un-paid balance due when and where and to whom payment should be made. The resolution must specify the date of delinquency, which shall not be less than 30 days nor more than 60 days from the date of the call. A notice of a call for payment must be sent to the stockholder.

Auction sale of Delinquent stocks

In case of auction sale of the delinquent stocks, it should take place not less than fifteen (15) days and not more than sixty (60) days from the date it was declared delinquent. Extension of the date of the public auction may be made by the board of directors provided that it shall not be more than thirty (30) days.

Cases when stocks sold on auction can be recovered by the delinquent stockholder:
Defect

or irregularity in the call for unpaid subscription Defect or irregularity in the notice of delinquency Defect or irregularity in the sale

Court Action
There

are instances when the corporation may want to sue the delinquent stockholder rather than resorting to auction sale. The corporation has to comply with some legal requirements such as the notice and publication of the call to be able to file a lawsuit against the delinquent stockholder. are divided into several classes providing numerous combinations of elements such as income, risk, and control of the corporation. Every prospective stockholder would like to buy stocks with a large steady income with the least possible risk. Control over the corporation may just be negligible.

Classes of Stocks
Stocks

Common Stocks

are the simplest form of ownership in a corporation. It has the fundamental rights of the stockholder without any special preference or privilege. They are entitled only to the residual claim on the dividends and assets of the corporation.

Preferred Stocks
are

those stocks with privileges and preferences aside from its fundamental rights unless of course when specified otherwise.

Preferred stocks are of two kinds namely:


Preferred as to assets
are

those stocks which share in the distribution of the proceeds from the sale of corporate assets first before the common stockholders received their share. are stocks entitled to receive dividend of the corporation first before the other stockholders of the corporation are paid their share.

Preferred as to dividends

Advantages of preferred stocks


1.

Preferred stocks will receive their dividends first before the common stockholders receive their share. The advantage of issuance of preferred stocks compared to the issuance of bonds is that dividend payment may not be declared by the corporation in the event the boards of directors believe that the corporation needs the income for expansion. Since payment of dividends is subject to the earnings of the corporation, the issuance of preferred stocks increases the firms financial leverage.

2.

3.

4.

In case of mergers preferred stocks can be exchanged for common stocks of the acquired company.

Disadvantages of preferred stocks


1.

Compared to bonds, preferred stocks are costlier for the corporation. Since dividends are not guaranteed unlike the interest in debt financing, corporations make their fixed dividends payment attractive in comparison to long term debt. It is also costly for the corporation because dividends are paid from the after tax earnings while interests paid to long term debt are taxdeductible.

2.

Participating preferred stocks


are

those stocks which still participate with the common stock even after they have received their preferential rate but only after the common stocks have been given that same preferential rate as a preferred stocks.

Non-participating preferred stocks

are only entitled to the preferential rate. All remainder of the dividends will go to the common stockholders.

Two kinds of participating preferred stocks


Full

Participation Partial Participation

Full

participation

refers to those preferred stocks that still participate with the common stocks have received the same preferential rates as those given to the preferred stocks. Here they have equal participation on whatever is left after both the preferred and the common stocks have received the same rates.

Example of full participating preferred stocks:


Say a corporation issues 20,000 shares of common stocks with a par value of P100.00 per share and participating preferred stocks of 4,000 shares with a par value P200.00 per share. They declare dividends worth P200,000. Preferential rate is .06 per share.

Solution:

4,000 x 200 = 800,000 x .06 = 48,000 for participating preferred stocks 20,000 x 100 = P2,000,000 x .06 = 120,000 for common stocks 200,000 48,000 = 152,000 120,000 = 32,000, to be shared by the two classes of stocks as if they belong to one class of stock 800,000/2,800,000 x 32,000 = 9,142.86 + 48,000 = 57,142.86 share of participating preferred stock 2,000,000/2,800,000 x 32,000 = 22,857.14 + 120,000 = 142,857.14 share of the common stock Total share of participating preferred stocks = P48,000 + 9,142.85 = 57,142.85/4,000 shares = P14.29 per share of stock Total share of common stocks = P120,000 + 22,857.14 = P142,857.14/20,000 = P7.14 per share

Cumulative stocks

are entitled to dividends even when dividends are not declared. Dividends are accumulated in periods when dividends are not declared and re not paid first when the company is in a position to declare them. are stocks entitled to dividends only when dividends are declared. They lose the dividends in periods when dividends are not declared.

Non-cumulative stocks

Callable and Redeemable stocks

Callable stocks are stocks that can be redeemed by the


issuing company before their maturity date. Redemption price is usually higher than the par value of the stocks to increase their salability. Preferred stocks are generally callable.

Two Kinds Of Redeemable or Callable Stocks :


Mandatory

type of callable stocks requires the

corporation to redeem the stocks with in a specific period of time. Optional type of callable stocks does not require the corporation to redeem the stocks. Stocks may be redeemed at the option of the corporation.

Sinking Fund which is an amount set aside from the earnings of the corporation specifically earmarked for the redemption of the stocks. Convertible stocks are stocks that can be exchanged to other securities of the corporation either for another class of stocks or bonds at a specified ratio.

Conversion Ratio is the rate at which a stock is exchanged with other stocks or bonds of the corporation.

Par Value and No par Value Stocks


Par
is one that has assigned value on its face. This can be found in the stock certificate. The par value is the minimum amount that the corporation should accept for the payment of the stocks below which the corporation is issuing a watered stock. are those stocks without any designated price on its face. The certificate of incorporation specifies in the authorized capital stock the number of shares issued and not its peso value.

Value Stocks

No

par value stocks

Restrictions In The Issuance of No Par Value Stocks:


No

par value stocks may be sold for less than P5.00. No par value stock may be issued which are preferred as to assets. Stocks without a par value cannot be sold on installment basis. Banks, trust companies, insurance companies and building and loan associations may not issue no-par value stocks. Capital stock without par values cannot be issued without the prior approval of the public service commission.

Guaranteed stocks are those stocks whose dividend payments are assured by a corporation other than the issuing corporation. Deferred stocks these are stock whose dividend payments are postponed for a time in the future and that is subject to the lapse of a period of time or the occurrence of a particular event which allows the corporation to declare dividends. Stock purchase warrants this is an instrument given to stockholders giving him the option to buy shares of stocks from the company within a specific period of time at a stipulated price.

Founders

shares these are stocks given to

the incorporators of the firm. It gives the founders an extra ordinary participation in the profits of the corporation hen the business is good.
Promoters

shares are those stocks used for

compensating promoters for the services they rendered in promoting the corporation.
Dividends are corporate profits or earnings set

aside by the board of directors to be distributed to stockholders in proportion to their stock holdings.

Kinds of dividends
Cash

Dividends Stock Dividends Property Dividends Scrip Dividends Liquidating Dividends

Cash dividends
are

distributed by the corporation when it has enough cash to declare s dividends. This will depend on the cash position of the firm.

Requirements in declaring cash dividends


There

must be an income of the corporation. The firm has enough cash to be given out as dividends. The dividends are declared by the board of directors. Notices are sent to the stockholders informing them of the declaration of cash dividends.

Stock dividends

arise when the board of directors decides to expand the business operation and therefore stockholders are given dividends in its equivalent in hares of stocks of the corporation.

Requirements in the distribution of stock dividends:


There

must be a corporate profit. The profit must be declared by the board of directors in stocks. The stock dividend must be approved by 2/3 of the outstanding stock in a meeting called for that purpose. . A notice must be sent to the stockholders.

Property dividends are those dividends given at the discretion of the board of directors in the form of properties of the corporation such as goods or stocks owned by the corporation but issued by other corporations. Scrip dividend is a written certificate issued by the corporation to its stockholders entitling them to the payment of cash at some future designated date.

Liquidating

generally dividends arises from the earnings of a corporation, but when a corporation is winding up its affairs or would like to narrow down its operation, they may declare liquidating dividends from the proceeds of the corporate assets sold.

dividend

Bond Financing
Corporate

Bonds are issued by the

corporation promising to pay the bondholder the face amount of the bond certificate at maturity date. Bond Issue is the aggregate amount of long-term indebtedness that a corporation creates and is divided into smaller units with a fixed rate of interest. Bond Certificates are evidences of the bond indebtedness and are negotiable in that they can be bought and sold or transferred and they can even be given as collateral for loan.

Rules in the creation of bonded indebtedness


The

creation of bonded indebtedness must be approved by majority of the stockholders in a meeting called for that purpose. Majority of the board of directors must approve it and must sign in the certificate of approval.

Features of a bond indebtedness


It

is in huge amount It is long of duration It is participated by several investors

Distinction of bonds from other forms of loans:


BONDS Always issued for large amounts Are long-term indebtedness Are participated by several creditors LOAN May be made for small or large amounts May be of short or long duration Are made by one or few borrowers

Bond Certificates
Are

negotiable instruments given to buyers of bonds and they evidence the long-term indebtedness of the corporation to the bondholder. a document which embodies the terms and conditions of a bonded indebtedness.

Trust Indenture
Is

Parties to a bond issue


Corporation Bondholder Trustee

Duties of the trustee


To

authenticate the bond issue To enforce the rights of the bondholders To enforce the faithful execution of the terms and conditions of the bond issue To act as transfer agent

Mortgage Contract
Is

a written contract where by a real or personal properties are pledged to secure a loan.

Mortgagor - debtor Mortgagee creditor Lien is the right of the mortgagee over the

mortgaged property. Foreclosure refers to the process of enforcing the lien on a mortgage property.

Kinds Of Corporate Mortgages


Open-end

mortgage a contract which

authorizes the issuance of bonds without specifying the number to be issued. Close-end mortgage a mortgage contract under which a corporation can issue bonds which will be issued all at the same time. Limited open-end mortgage similar to open-end mortgage except that an upper limit is placed on the maximum amount of the indebtedness that the corporation can create which may be outstanding under the same mortgage.

Restrictive Clause a clause attached to


open-end mortgage and is intended to protect the bondholders against possible abuses that the corporation may have in the issuance of bonds.

Three kinds of restrictive clause:


After

acquired clause Escrow provision Covenant of equal coverage

Classification of Bonds
Purpose Security

to be offered Interest income for investors Manner of paying interest Manner of paying the principal upon maturity

End of Chapter
Chapter 13

STOCKS & BONDS FINANCING

Chapter 14 EXTINCTION OF BOND INDEBTEDNESS

Ways of extinguishing bonded indebtedness:


Extinction

by conversion refers to the exchange of security with another security.

Reasons why bonds are made convertible:

It adds to the possibility of the appreciation of the value of the bonds which enables the corporation to sell it at a lower interest rate. In times of poor stock market conditions, the corporation may be prompted to attach the provision of conversion to the bond issue. The conversion of bonds to stocks allows a convenient and relatively easy way of getting rid of the bonded indebtedness which has fixed the interest charge.

Extinction by refunding
is the exchange of one issue by another bond issue
Refunding

by maturity Refunding before the maturity Refunding by short-term notes

Mandatory redemption
the corporation is obliged to redeem the bonds at the stated time. Redemption by solicitation Redemption price

Funds for redemption


Two methods of providing cash for redemption: The corporation voluntary sets up an amount to redeem the bonds. The corporation may be required to set up a sinking fund where in a certain percentage of the annual income of the corporation or a percentage of the surplus is set-aside for that purpose.

Refunding

through the banks a method where by corporation may enter into an agreement with an investment banker to put up cash for the redemption of the old bonds. Serial redemption these are bonds issued at serials.

End of Chapter
Chapter 14
EXTINGUISHMENT OF BOND INDEBTDNESS

CHAPTER 15
FINANCIAL STATEMENTS & ANALYSIS OF FINANCIAL STATEMENTS

FINANCIAL STATEMENTS
Income

of the firms operations during a specified period. Balance Sheet provides a summary of the firms financial position as of a given date. Statement on Retained Earnings reconciles the net income earned during a given year, and any cash dividend paid, with the change in retained earnings between the start and end of year. Statement of Cash Flows provides a summary of the cash flows over the period of concern, typically the year just ended.

Statement summarizes the results

RATIO ANALYSIS
review

and evaluation of the firms financial statements through the use of financial tools called ratio.

GROUPS OF FINANCIAL RATIOS


Liquidity

Ratios used to measure the firms

ability to pay its short-term debts as they fall due. Activity Ratio used to measure the ease or speed of converting various accounts into cash or sales. Debt Ratio used to measure the degree of indebtedness of the firm and its ability to service its debts. Profitability Ratio used to show the combined effects of liquidity, asset management, and debt management on operating results.

LIQUIDITY RATIOS
Current Ratio Current Ratio = Current Assets Current Liabilities

The value of current ratio that is considered acceptable depends on the industry in which the firm operates. Occasionally, a currents ratio of 2.0 is considered acceptable.

Quick or Acid Test Ratio Quick or Acid Test Ratio =Current Assets Inventories Current Liabilities OR =Cash + Receivables + Marketable Securities Current Liabilities

Considered as a more accurate test of liquidity since it excludes inventories, the last liquid current asset.

Cash Ratio Cash Ratio = Cash + Receivables + Marketable Securities Current Liabilities

Activity ratios (asset management ratio)


Inventory Turnover measures the activity or liquidity of a firms inventory

Inventory Turnover = Cost of Goods Sold Inventory

Average Collection Period (Days Sales Out)


used to appraise accounts receivable and in evaluating credit and collection policies. It represents the length of time that the firm must wait after making a credit sale before receiving. Average Collection Period = Accounts Receivable Annual Sales 360

Average Payment Period


Average Payment Period = Accounts Payable Annual Purchases 360

Total Asset Turnover


measures the firm efficiency in using all its assets to generate sales. Total Assets Turnover = Sales Total Assets

Fixed Asset Turnover


also measures the firms efficiency in using its fixed or earning assets to generate sale. Fixed Asset Turnover = Sales Net Fixed Assets

DEBT OR DEBT MANAGEMENT RATIO


Debt Ratio (Stability Ratio) measures the portion of total assets financed by creditors money.
Debt Ratio = Total Liabilities Total Assets

Debt-to-Equity Ratio
indicates the relationship between the longterm funds provided by creditors and those provided by the firms owners. Debt Equity Ratio = Long-term debt Stockholders Equity

Times Interest Earned Ratio (TIE)


measures the firms ability contractual interest payment. Time Interest Earned = to make

Operating Profits Interest

PROFITABILITY RATIO
Net Profit Margin measures the portion of sales that is available to the firms owners after deducting all costs and expenses including interest and taxes. Net Profit Margin = Net Profit Margin after Taxes Net Sales

Gross Profit Margin


measures the percentage of each peso sales remaining after goods had been paid. Gross Profit Margin = Gross Profits Sales

Operating Profit Margin


measures the percentage of each peso sales remaining after all costs and expenses excluding interest and taxes are deducted. Operating Profit Margin = Operating Profits Sales

Return on Assets (Return on Investment)


measure managements effectiveness in generating profits with its available assets.
Return on Assets = Net Profit after Taxes Total Assets

Return on Equity
measures the shareholders earnings relation to their investment in the firm. Return on Equity = Net Profit after Taxes Stockholders Equity in

Earnings Per Share


represent the earnings available outstanding share of common stock. Earnings per Share = earnings available for common stockholders
no. of shares of common stock outstanding

per

Price/Earnings Ratio
shows how much the investors are willing to pay per peso of reported profits. Price Earnings Ratio = Price per Share Earnings per Share

DUPONT SYSTEM OF ANALYSIS


merges

the Income Statement and the Balance into two summary measures of profitability: Return on Assets and Return on Equity.

ROA = Net Profit Margin

Total Asset Turnover

Net Profit Margin = Net Profit after Taxes Sales Total Assets Turnover = Sales Total Assets

ROA = Net Profit after Taxes Sales ROA = Net Profit after Taxes Total Assets

x Sales Total Assets

ROE
= NPAT Total Assets NPAT Stockholders Equity x Total Assets Stockholders Equity

End of Chapter
Chapter 15
FINANCIAL STATEMENTS & ANALYSIS OF FINANCIAL STATEMENT

CHAPTER 16

BREAKEVEN ANALYSIS

Breakeven Point
The

firms breakeven point refers to the level of sale/output where: Total revenue is equal to the total cost (TR=TC) There are no profit and losses Capital or investment was merely recovered

1.

2. 3.

Two (2) Types Of Costs


Fixed

Cost Variable Cost

Fixed Cost
Remains

constant in all levels of sales/output up to a certain extent

Example: Rent expense Depreciation Interest

Variable Cost
Change

in direct proportion to the level of

sales
If

sales increases, increases

variable

cost

also

Formula for Breakeven Point


Breakeven point (BEP)= TFC P AVC

Where: TFC = Total Fixed Cost P = Price AVC = Average Variable Cost

Formula for Checking


TR = TC
or or P x Q = TFC + TVC P x Q = TFC + (AVC x Q)

Where: TR = Total Revenue TC = Total Cost


P

= Price Q = Quantity TFC = Total Fixed Cost TVC = Total Variable Cost AVC = Average Variable Cost

Example:
An apple vendor has a total fixed cost of P1,500 and an average variable cost of P6. He sells his apples at P10 each. How many apples should he sell to breakeven? Requirement: 1. Compute for the Breakeven Point 2. Prove that TR=TC

Computation for BEP


BEP = TFC P AVC = 1500 10 6 = 1500 4 = 375 apples

Proving TR = TC
TR = TC
PxQ = TFC + TVC PxQ = TFC + (AVC x Q) 10 x 375 = 1500 x 6(375) 10 x 375 = 1500 x 2250

3750

= 3750

Graphical Presentation

EXPLANATION
The

graphic presentation shows that the breakeven point is where sales volume is 375 or sales in pesos is P3,750.At this point the TR curve and TC curve intersected.

The

portion of the breakeven point :

Below represents Losses Above represents Profits NOTE: TR curve starts from point of origin or 0 TC curve starts from the value of TFC

And Price to Breakeven Point


The firms breakeven point is sensitive to: Fixed cost (TFC) Selling Price per unit (P) Variable Cost per unit (AVC)

Changes
Increase

in FIXED COST Increase in break even point in VARIABLE COST Increase in break even point in PRICE Decrease in break even point

Increase

Increase

Acceptability
Lower

breakeven point is acceptable

The

firm should control or reduce its fixed cost and variable cost and increase price, if needed to have lower breakeven point.

Impact on Breakeven point


Apple vendor Original value: FC = 1500 P = 10 AVC = 6 TFC = 1500

New value: FC = 1650 P = 11

AVC
TFC

= 6.60
= 1650

Case 1: FC changes; P and VC remains constant


BEP = TFC P AVC = 1650 10 6 = 1650 4 = 412.5 apples

The new breakeven point is HIGHER than the original 375 breakeven point due to the increase in FIXED COST

Case 2: P changes; FC and VC remains constant


BEP = TFC P AVC = 1500 11 6 = 1500 5 = 300 apples

The new breakeven point is LOWER than the original 375 breakeven point due to the increase in PRICE

Case 3: VC changes; FC and P remains constant


BEP = TFC P AVC = 1500 10 6.60 = 1500 3.40 = 441.18 apples

The new breakeven point is HIGHER than the original 375 breakeven point due to the increase in VARAIBLE COST

Case 4: FC,VC and P changes all at the same time


BEP = TFC P AVC = 1650 11 6.60 = 1650 4.40 = 375 apples
The new breakeven point REMAINS as 375 due to the 10% increase in FC, VC and P

The Relationship between the Fixed Cost and Sales and its effect on EBIT
The

increase in sales cause bigger increase on EBIT

EBIT - earnings before interests and taxes

Example:
Using the same data for the apple vendor: TFC = 1500 P = 10 VC = 6 Compare the changes in EBIT assuming: Year 2000 Sales = 400 Year 2001 Sales = 500 (base year) Year 2002 Sales = 600

2000
- 20% + 20%

2001

2002

Sales in units Sales in pesos Less TFC Less TVC EBIT

400 4000 (1500) (2400) 100

500 5000 (1500) (3000) 500

600 6000 (1500) (3600) 900

- 80%

+ 80%

Explanation:
An

increase in sales by 20% causes EBIT to increase by 80% while a 20% decrease in sales causes 80% decrease in EBIT.

End of Chapter
Chapter 16

Breakeven Analysis

CHAPTER 17
CASH & MARKETABLE SECURITIES

Cash and Marketable Securities


Are

the most liquid in the firms assets Are used by businesses to pay their bills as they fall due Determination of appropriate balance of the two is important to reduce risk of technical insolvency

Cash

Is necessary to meet the daily expenditures of business It is the currency to which all liquid assets are ultimately converted It is the duty of the FINANCE OFFICER to maintain the proper cash flow and efficiently use the cash to maximize the value of the firm

Marketable Securities
Short-term

interest earning money market instrument that can readily be sold because they are invested on unconditional debt obligations of the government and bankers acceptance can be easily sold because there are a lot of buyers who would also want to invest on it

They

It

is important that businessmen should have a proper balance on their checking account and investment in marketable securities since the banks give very low interest on checking account deposits or even at times nothing at all , depending on what kind of checking account deposit it is.

If

it is the combination of a checking account and a savings deposit the banks give interest

Reasons for Holding or Investing in Securities


1.

2.
3.

Transaction Motive Safety Motive Speculative Motive

1. Transaction Motive
When

a firm has cash reserves for planned payments they usually invest these to earn an income until such time as the funds are needed invest these funds in the marketable securities since they are liquid time the firm is in need of the funds the company can easily sell these securities and turn it back to cash.

They

Any

2. Safety Motive
Marketable

Securities are safe investments. They are salable.


companies who are liquid and have no need for the funds at the moment are willing to buy them are earning from the investment instead of leaving as a deposit in the bank where it earns very little interest

Many

They

These

investments can easily be converted into cash , without a possible reduction in its value and therefore the company can easily satisfy unexpected demands for cash

Subjective Cash Approach Model

requires certain percentage to be maintained

Example: 10% of sales forecast of the coming month P1,000,000 = Sales forecast

10% of P1,000,000 = P100,000


P100,000 should be maintained

3. Speculative Motive
Many

companies who have excess funds are looking for investment outlets to earn more rather than leaving the deposit in the bank BUY these marketable securities when the price is LOW and Sell it when the price is BETTER or HIGHER the process they earn INCOME from Buying and Selling Marketable Securities

They

In

Decision Making
1.

Trade off between OPPORTUNITY TO EARN and HOLDING PERIOD BROKERAGE COST in purchasing and sale of securities.

2.

Example:
Assume

that John Paul wants to invest P30,000 for one month in the marketable securities with a yield of 8% annually. The brokerage cost to purchase and sell is P80.00. Will he make the investment?

YIELD: 1/12 of 8% 0.833 x 0.08 0.00666 x 30,000

= 0.833 = 0.00666 = 199.98

EXPENSE: 80.00 + 80.00

= 180.00

* He will have to decide between the opportunity to earn an the holding period

Marketable Government Securities


Securities can be either: 1. Non-Government issue 2. Government issue
unconditional

debt obligation of the government Short-term and marketable because the government is the issuer Always paid at the maturity Risk free and are strong in the secondary market The yield is lower than the other securities

Examples of Marketable Government Securities


Treasury

Notes

Obligations

of the Philippine Government issued weekly on auction basis Maturity date runs from 90-181 days depending on the issue They are bearer instrument Notes are issued at a discount from their face value. The face value are redeemed at maturity

Examples of Marketable Government Securities


Treasury
Direct

Bills

unconditional and general obligations of the government issued under authority of RA No. 245 and amended by PD No. 142 Offered by Banko Central ng Pilipinas as a Fiscal Agent They are Peso Denominated securities that are sold at a discount thus, they do not pay out of coupon

Maturity

dates of 91, 182 and 364 days Denominations: P1,000 P5,000 P10,000 P50,000 P100000 P500,000

Efficient Management of Cash


Influencers

in the maintenance of stock of cash

balance: production and sales technique collection of sales receipt Date of payment of purchase on account
It

is important to maintain that which is just necessary for the operation of the business High level of cash and investment in the marketable securities means the profitability of the firm will be lower.

Operating Cycle
The

amount of time it takes the firm to input the raw material; and labor into the productive process to the point when the cash is collected from the sale of finished product

2 Aspects: 1. 2.

Average Age of Inventory (AAI) Average Collection Period (ACP)

Example:
XYJ

Enterprise manufactured goods and sells it on a 60 day credit. The time involved in the purchase of the raw materials to the finished product takes 70 days. Inventory on account is payable within 30 days. Average age of inventory (AAI) is 70 days, and Average collection Period (ACP) is 60 days. Operating Cycle (OP) is 130(70+60) days. Average payment period (APP) is 30 days.

Operating Cycle OC =AAI + ACP OC = 70 + 60 = 130 days


Purchase of Raw Materials on account Average Age of Inventory (70 Days) 0 70 Purchase of Raw Materials on account Purchase of Raw Materials on account

Average Collection Period (60 Days) 130

30 Average Payment Period (30 Days)

Pay Accounts Payable Cash Conversion Cycle CCC = OC APP 100 = 130 - 30 Cash Outflow Time (days) Cash Inflow

Cash Conversion Cycle


Difference

between the number of days the firms funds tied up in the operating cycle and the number of days the firm can make the payment on the production inputs purchased on account

Positive Cash Conversion Cycle


Means

the firm will resort to:


of its marketable securities

Borrowing Liquidation

Negative Cash Conversion Cycle


Average

payment period exceeds the operating cycle Often happens in non-manufacturing business since they carry faster moving inventories and are those usually sold on cash basis

Strategies for Managing Cash Conversion Cycle


1.

Delay payments of accounts payable as far as you can without sacrificing the credits standing of the firm.

Study the tradeoff between the DELAYING PAYMENT and the advantage of TAKING CASH DISCOUNTS FOR EARLY PAYMENT.

EXAMPLE
Granting

that the Cassey Enterprise can stretch its payable from 30 days to 37 days, therefore cash conversion cycle can be reduced:

CCC = 70 + 60 37 CCC = 93 days


Granting

further that the operating cycle expenditure is 10,000,000 annually, paying accounts payable to an additional 7 days delay reduces the firms financing by :

10,000,000/360 x 7 = 194,444.43
With

the increase rate of 10%, the firm can reduce its financing cost by 19,444.44 which could also increase the firms profit by the same amount.

Strategies for Managing Cash Conversion Cycle


2. Inventory turnover should be as quick as possible but avoid depletion of stocks which may result to loss of sales May also : increase Raw materials inventory turnover Shorten the production cycle Reduce the amount of financing required Shorten cash conversion cycle

EXAMPLE
If Cassey Enterprise can increase its inventory turnover from 70 days to 58 days :

IT reduction = 70 - 58 IT reduction = 12 days


Granting that the firms operating cycle investment is 10,000,000 annually, the daily expenditure would be :

10,000,000/360 = 27,777.77
Since the cash conversion cycle is reduced by 12 days:

27,777.77 x 12 = 333,333.24
If the firm pays interest amounting to 10% , the firm can reduce its financing cost by 33,333.24 which could increase the profit by the same amount

Strategies for Managing Cash Conversion Cycle


3. Accounts receivables should be collected as soon as possible but be sure to take into consideration the loss of future sales

EXAMPLE
If Cassey Enterprise can reduce its average collection period from 60 days to 50 days :

ACP reduction = 60 - 50 ACP reduction = 10 days


10,000,000 is spent annually to support its operating cycle, the daily expenditure would be :

10,000,000/360 = 27,777.77
Since the average collection is reduced by 10 days it also reduce the financing expense by :

27,777.77 x 10 = 277,777.77
With the interest rate of 10% , the firm can reduce its financing cost by :

277,777.77 x 0.10 = 27,777.77

Strategies for Managing Cash Conversion Cycle


4. Combination of the 3 strategies

Things to avoid: Damage credit rating Sacrifice possible future sales Large number of stocks that are out of credit

EXAMPLE
Granting that the Cassey Enterprise decide to use the combination of all strategies
INITIAL CASH CONVERSION CYCLE INCREASE PAYMENT PERIOD (37-30) DECREASE IN INVENTORY AGE (70-58) DECREASE IN COLLECTION PERIOD (60-50) 100 days ( 7 days) (12 days) (10 days) 29 days 71 days

TOTAL REDUCTION IN CASH CONVERSION CYCLE NEW CASH CONVERSION CYCLE

Financing

needs of Cassey Enterprise can be reduced by 29 days. If the annual operating expenditures of the corporation is 10,000,000 the financing cost can be reduced to:

10,000,000/ 360 x 29 = 805,555.55


If

the corporation pays 10% interest on its financing it will be able to save:

805,555.55 x 0.10 = 80,555.55


Thereby

increasing the profit with the same amount.

Types of Floats
FLOAT- refers to payments made in the form of checks or drafts that can be used by the payee to discharge his obligations although debit of such check or draft will be done against the drawer at a future date.
1. 2. 3.

4.
5.

Collection Float Disbursement Float Mail Float Processing Float Clearing Float

1. Collection Float

Delay between the time the draft or check is issued by the drawer to the actual time when such checks or drafts are actually collected by the payee.

2. Disbursement Float

Refers to the time involved when a drawer issues a check and the time it is actually debited or deducted from his bank account.

3. Mail Float

Refers to the delay between the time a drawer mails the check or drafts to the payee at the time the payee receives the check or draft.

4. Processing Float

Refers to the delay involved between the receipt of the check or draft by the payee and depositing it with his bank.

5. Clearing Float

refers to the delay involve from the time the check or draft was deposited to the time the funds becomes available for spending.

Example :
Check issued and mailed by the payer Check received by the payee Book entries made and check Check cleared Deposited

Time (Days) 0 3 5 9

Total Float (9 Days)

Techniques in Cash Management

Used to speed up collections and slow down disbursements Aimed to minimizing the financing requirements of the firm by taking advantage of imperfections in the payment and collection system

A. Taking Advantage of Float


The payee take advantage of the time element involved in the actual collection of funds .

*DRAWER - person who draws the check or draft *DRAWEE bank or person from which the check or draft is drawn against *PAYEE - person receiving the payment

B. Enhancing Collection Process


The main objective is to minimize collection float and make the funds available for spending at the earliest possible time
1. 2.

3.
4. 5.

Concentration Banking Lockbox System Direct Collection Automated Clearinghouse Debit Minimize Disbursement

Concentration Banking

Designation of banks or offices as collection centers by the firms with customer scattered on wide areas.

*Correspondent Bank banks located in a local or foreign country that services the needs of the other banks

Lockbox System

This system reduces processing float as well as mailing float.


It allows the firm to use immediately as the need arise. the funds

The mail float is almost eliminated because the bank usually sends its messenger to pick up the payments at the post office or empties the lockbox several times a day.

Direct Collection

A system where a businessman can directly en-cash the check in the box where it is drawn against.

Automated Clearinghouse Debit

A paperless transfer of funds between the payer and the payee bank. It is a pre-authorized electronic withdrawal from the payers account to the payees account

Minimize Disbursement

The firm should as much as possible go slow in making payments to its creditors to conserve its available funds

This can be done through: a) Taking advantage of the float b) By arranging for an over draft line with the bank c) Maintaining a strong banking relationship

Investment Opportunity
Marketable Securities Are short term interest bearing money market instrument that can be easily converted into cash in the shortest possible notice. Considered as liquid assets of the firm

Characteristics of Marketable Securities


1. 2.

It must be marketable/ salable The principal investment must be safe

Two Types of Marketable Securities


1.
2.

Non- Government Securities Government Securities

Non- Government Securities

COMMERCIAL PAPERS

Short-term unconditional promissory notes issued by corporation with very high credit standing Issued directly by the issuer or through dealers Interest rates are below the Certificates of Deposits but above those paid by government issue with similar maturities

Non- Government Securities

NEGOTIABLE DEPOSITS

CERTIFICATE

OF

Negotiable instruments evidencing the deposit of a certain amount in pesos in a commercial bank The amount and maturities are normally tailored to investors needs Interest rates are slightly higher than Treasury Notes and Commercial papers

Non- Government Securities


Certificate of Assignment
-

non- negotiable, debt instruments that evidence lawful ownership of the holder in extent of the Peso value indicated on the face of the instruments or a batch of an original lump sum of promissory notes. Purchased on the basis of the recourse endorsement of the financial institution.

Non- Government Securities


Certificate of Participation
-

Debt instruments that evidence lawful ownership of the holder in extent of the Peso value indicated on the face of the instruments or a portion of an original lump sum obligation subsequently broken down and denominated in different Peso value The funds are invested and reinvested by the trustee in such investment outlets including those banks owned by the trustee or its subsidiaries or affiliates as may be authorized in the contract

Non- Government Securities

BANKERS ACCEPTANCE

Arise when the bank accepts the responsibility of paying a draft opened thru a letter of credit It is low risk security since the bank guarantees payment

Non- Government Securities

REPURCHASE AGREEMENT

An arrangement whereby a bank as a security dealer sells specific marketable securities to a firm and agrees to repurchase the securities at a specific price and at a specific future time

Non- Government Securities

MONEY MARKET MUTUAL FUNDS


1.

2.
3.

Professionally managed portfolios of marketable securities Many invest to these securities because of : High liquidity Comparative yields Low transaction cost

Government Securities
Unconditional

debt obligations of the Republic of the Philippines Denominated in local currency, the Philippine Peso Bureau of Treasury is the Fiscal Agent who is In-charge of the issuance Risk- free interest bearing securities because of the low probability that the government defaults in its debt when due.

Kinds of Government Securities


1. 2. 3. 4.

5.

Central Bank Certificate of Indebtedness Treasury Bills Treasury Notes Development Bank of the Philippines Progress Bonds Other Government Securities

Central Bank Certificate of Indebtedness


Tax-free
Earn

reasonable rate of interest Eligible for reserves Acceptable as collaterals for loans Had term of 3 years with interest payable annually Denominations:
10,000 50,000 100,000

Treasury Bills
Bearer

notes or debt instruments that are sold every week at a discount by the Central Bank through competitive auction Have various maturity dates not longer than one year. Denominations:
1,000 5,000 10,000

50,000
100,000 500,000

Treasury Notes
Sold

via closed auction Have fixed coupon rates determined at auction Yields are determined bat auction Pay coupon interest semi-annually

Development Bank of the Philippines Progress Bonds


Tax-free

Convertible

to preferred stocks of selective private corporations which were under the management of the Development Bank of the Philippines Denominations:
100 1,000

10,000

Interest

paid semi-annually

Other Government Securities


a)

PW and Ed Bonds

Direct unconditional obligation of the Philippine government for Public Works projects and for the improvements of Educational facilities Obligations of the Land Bank of the Philippines Long-term indebtedness issued by any government entity (e.g. Cultural Center of the Philippines) Issued by Agricultural Credit Administration Issued by Export Processing Zone Authority which finance the housing development in Bataan Export Processing Zone

b) c)

LBP Bonds

Cultural Bonds

d) e)

ACA Notes

EPZA Bonds

End of Chapter
Chapter 17
CASH & MARKETABLE SECURITIES

CHAPTER 18
ACCOUNTS RECEIVABLES & INVENTORIES

Accounts Receivable
Refers

to the credit granted by businessman to his customers. One of the two dominant current assets held by the firm

Liquidity and Profitability of Accounts Receivable


LIQUIDITY ASPECT
Relates

to the flow of funds from the accounts receivable to cash to both the rate of profits on the firms investment on accounts receivable

PROFITABILITY
Relates

Methods of Projecting Cash Flows from Receivables


1.

Ad-Hoc Method

Method used by experienced managers or treasurers who know their accounts so well that they can predict accurately the timing of the cash receipt. Viable for small business firms since they know their accounts so well Usually sell a single product or few product

2. Daily Sales Outstanding (DSO)

Most widely used method Published monthly for several lines of manufacturing and wholesaling by credit researchers. Requirements:

monthly sales average sales per day for each month Daily sales outstanding

AR = DSO projection x Average sales per day Total Receivables Outstanding + Sales For the Following Month Anticipated Outstanding Receivable At The End Of The Month

Consideration in Determining Credit ( The Cs of Credit)


1.

CHARACTER

Refers to the inner nature of an individual Primary consideration of credit man Refers to complete moral responsibility and complete honesty and integrity of the debtor to pay his debt Basic element in granting bank credit

2. CAPACITY

The ability of a debtor to pay his debts when due. Primary standards: Education Training and Technical Competence Business experience Business ability or acumen of the owner of management Combinations of attributes that are indicative of business ability are as follows:

a)

Technical Competence
refers to the knowledge of specifics in a line of business and its operation, as well as the advantage of location, and the ability to apply this knowledge in business. Refers to ones skill to organize, manage and direct the business as well as to manage his staff and bring out the best in them. A leader should be able to inspire his subordinates without recurring their resentment.

Leadership

b.) Secondary standard

Health Personal responsibilities Age Individuals record of employment Management of personal finances

3. CAPITAL
Refers

to the financial condition of the applicant and how much he is worth May also include the personal properties of the owners

Factors affecting the Cost of Credit


1. 2. 3. 4. 5. 6.

Cost of credit investigation Cost of record keeping Cost of overhead/ operating cost Cost of collection Cost of bad debts Cost of money

Cost of Credit Investigation


It

takes a lot of time, effort and money to verify the vital information given in the credit application

Cost of Record Keeping


The

extension of credit necessities expense in the recording transaction payment, making adjustments, computing balances and sending out statements.

Cost of Overhead
This

refers to the general operating expense of the firm such as :


Light
Rent Salaries Wages

Telephone

bill Office supplies


Which

are allocated to the expense of credit department

Cost of Collection
The

firms incurs expenses on collection even when the customers pay on time or whenever a customers account is past due

Cost of Bad Debts


There

are times when a small percentage of the consumers credit must be written off as uncollectible They make adjustments with their allowance or reserve for bad debts

Cost of Money
Refers

to the amount of money invested in the item or goods sold as credit When business extends credit, it allocates a portion of its working capital to support its credit sales. If the capitals has been obtained from banks or other financial institutions, interest will have to be paid by the business

Sources of Information
1. 2. 3. 4. 5.

Application Form Financial Statement Of The Burrower Personal Interview Mercantile Agency Services Credit Bureau

Application Form
The

application for credit initiates the relationship between the debtor and the creditor installment credit, a new application is oftentimes filed for every new purchase

In

Financial Statement Of The Burrower


A

very good source of information because the firm can analyze the firms:
Liquidity Liability Profitability Standing

in the industry

Personal Interview
Cheapest

and easiest source of information Enables personal judgment and assessment Verifies the information in the application form Enables interviewer to ask precise questions

Mercantile Agency Services


Best

and most common source of credit information

Two Types: 1. General mercantile agency


It

furnishes information regarding any business coming from various fields Scope of cover is limited to a single trade or limited to number of allied trades

2.

Special mercantile agency

Credit Bureau
Most

important source of credit information

Types of Credit Bureau 1. Retail Credit Bureau 2. Credit Interchange Bureau 3. Trade Group Interchange Bureau

Principal Source of Information for Credit Bureau Files


1.

2.
3. 4.

5.
6. 7.

Other creditors of the applicant References furnished by the applicant Public records Newspaper items Other credit bureaus Field investigators Correspondents

Information from Banks


1. 2.

3.

4.

5.

6.

7.

8.

Age of the accounts A general statement on the relationship of loans and deposit balances with the bank, including information on how the account is carried out Whether the borrower is meeting his obligation to the bank on time Whether the drafts presented to the banks for the payment are promptly honored by the borrower Comment on the borrowers financial statements , provided that he authorized it The banks opinion on the borrowers reputation including the general reputation he has in the locality In case of other banks, a request must be made on their general opinion regarding the risks involved A short summary of the history of the company

Information not obtained from Banks


1.
2. 3.

The exact amount of the depositors account Details of loans that are outstanding Information concerning the customers financial status

Importance of Credit Limit


avoid reviewing the customers account file each time an order is received Assessment of customers credit and records it on a ledger card Credit man can check on future orders without again analyzing the customers credit risks.
To

* Credit Limit can be changed from time to time depending on new conditions and additional information received about the customers.

Ways of Establishing Credit Limits for New Debtors


1. 2. 3. 4.

5. 6.

Income Arbitrary Limits Credit Investigation Recommendations Obtained from Mercantile Agencies for Credit Limits Adopting Other Suppliers Credit Limit Using Net Worth and Net Working Capital as Credit Limits

Importance of Telling the Customer of his Credit Limit


ADVANTAGE
Customer

can easily held to his credit limit Customer can schedule his purchase in accordance to his credit limit Awareness of customer of his credit limit at the outset leads to less embarrassment and misunderstanding between the merchant and the customer.

Importance of Telling the Customer of his Credit Limit


DISADVANTAGE
Customers

feel offended if they perceive that the limit is a reflection of their credit worthiness Customers believe that the limit is inflexible, he may curtail his purchases Instead of asking for an increase in credit limit, a customer would prefer to buy from other suppliers.

Credit Mans Action to Customers Beyond Credit Limit


There 1. 2.

3.

4.

5.

are times that a customer may request for an increase in credit limit. Credit man should: Investigate the prevailing business condition Find the reason why the customer asks for the increase Review the customers account to find out if he is becoming a credit risk May ask for new financial statements to fin out the status of the customers business Find out what other agencies say about the credit rating of the customer.

Revising Customers Credit Limit


Actions 1. 2. 3.

in Credit Limit Revision: Increase Decrease Cancelation

Cases when a Credit Man should Revise a Customers Credit Limit


When

the customer exceeds the credit limit set for him by the creditor When the debtor request for an additional credit When payments are not met promptly by the customer When the agency rating book shows a change of customers credit rating

Cases when a Credit Man should Revise a Customers Credit Limit


When

a new financial statement is received by the credit men When the credit agency or interchange reports indicates a change in the customers credit position When the credit manager acquires information from the firms salesmen, that the customer is experiencing problems in his business or when his business has improved

Steps Necessary To Find An Experienced Credit Limit


1.

2.

3.

Find out from the ledger card of the customer the total sale previously made Increase or decrease the total sales figure in accordance to changing conditions in the customers line of business Using the adjusted figures, divide it by twelve to find the average monthly credit you expect to extend in the future. For the seasonal business the monthly average should be favorable to both heavy and light months

Steps Necessary To Find An Experienced Credit Limit


4. Compare the monthly average obtained with

5.

6.

the average monthly credit sales of the preceding accounting period Take into consideration the credit worthiness of the debtor and check any unusual problems he may be having in his business Check to what extent is your firm a major source of the customers purchase

Ways of Watching Accounts


The practice of sending monthly statement is a preliminary step to collection procedure It serve as reminder of the amount owed and giving the customer opportunity to check the accuracy of the amounts. Customers Ledger Card Aging Accounts

1. 2.

Uses of Aging Accounts


1.

2.

3.

Used by management to determine how much the business is loss, by allowing the slow collection of the accounts receivables Used by accountants to determine how much reserves should be set up for the depreciation of the accounts receivables Used by management to know hoe efficient the collection system is.

Various Stages in Collection Procedure


1. 2. 3.

Reminder Stage Follow- Up Stage Drastic Action

1. REMINDER STAGE
Reminder Techniques a) Sending duplicate statement or invoice b) Sending an aged statement and reminder c) Sending a letter d) Sending a printed card e) Attaching sticker on the bill

2. FOLLOW-UP STAGE
Follow Up Techniques a) Follow Up by Letter b) Follow Up by Telephone c) Follow Up by Telegram d) Follow Up by Registered Letter e) Follow Up by Personal Calls

3. Drastic Action
Kinds a) b)

of Drastic Techniques Collection by Drafts Collection through a Lawyer or an Agency

Inventory Management
Inventory
Considered

as current asset of a firm Represents significant monetary investment of a business firm

Financial Manager
Puts

in place inventory management process Acts as watchdogs and gives advice to matters concerning inventory

Manufacturing Manager
In-charge

of making the production plans properly implemented Sees to it that the objectives of the firm regarding the quantity and quality of the finished products are attained and that they can meet the orders on time

Purchasing Manager
charge of making available whatever raw materials are required by their production manager at the best price possible Sees to it that the purchases are actually those needed
In

Inventories Relation to Accounts Receivable


Accounts

receivable will depend on the amount of inventory that the firm can tie up on this. When inventories ware sold they may either become cash or accounts receivables which when collected can ultimately be converted into cash

Inventory Management Techniques


1.

Economic Order Quantity (EOQ)


a)

Order Cost - fixed cost in placing or in receiving an order

b)

Carrying Cost variable cost per unit of handling inventory for a specific number of days
Total Cost sum of Order Cost and Carrying Cost

c)

Formula for EOQ

EOQ =

2 ( Order Cost) ( Annual Demand) Carrying Cost

Example
ABC Corporation has the following Data: Annual Demand........... 30,000 Cost of Placing the Order... 400 Unit Carrying Cost .... 600 Solution: EOQ = = = =

2(400) (30,000) 600 24,000,00 600 40,000 200

2. Reorder Point
= Lead time in number of days x daily usage

Example: A firm needs 5 days to place an order and its delivery. If the firm uses 100 units a day, the firms re-order point is :

5 x 100 = 500 units


When a firms inventory reaches 500 units, an order is placed which is equal to the economic order quantity. By the time the inventory reaches 0, the delivery would have been made

Problem
The Stacey Corporation sells table napkins. These are sold by the dozen per package for P20.00. they sell 2,000 packages per month. Each packages sells at P10.00 and requires six days lead time from the date of order to the date of delivery . The ordering cost is P 1.20 and the carrying cost is 10 % per annum.

Requirements:
a) b) c)

d)

The EOQ The number of orders per year The total coat of buying and carrying the table napkins for the year Assuming that the present inventory level is 200 packages and there is no safety stock, when is the next order placed? (use 360 days per year)

a.) EOQ
EOQ = = 2 (24,000) (1.20) (10)(10%) 57,600 1 57,600 240

= =

b.) Number of Order per year


Annual requirement EOQ 24,000 240 100 orders per year

=
=

c.) Total Cost of Buying and Carrying the Table Napkins for the year
EOQ
(Holding Cost per unit)

+ +

ANNUAL REQUIREMENT EOQ


(Ordering Cost)

240
(10 x 0.10)

240,000 240
(1.20)

240 ( the total cost for buying and carrying the table napkins per year)

d.) Optimal Order Point


= Lead time x Average Daily Usage = 6 days x 24,000 packages 360 days = 400 packages ***The firm should now place the order immediately since there is no safety stock.

3. ABC System
The

firm divides their inventory in groups A, B and C according to the type and inventory control procedures appropriate to each group.

4. Red Line Method


Some

companies place a red line bin where they keep their inventory. When the line is reached, it then signals that the level of inventory is already low and that re-order has to be made.

5. Material Requirement Planning (MRP) System


System
When

used by the firm to determine;

to order How much to order Priorities to be made in ordering the materials


Aims

to reduce the firms inventory investment without impairing its production

6. Just in Time (JIT) System


Purpose

is to reduce inventory investment at the minimum The firm uses very little safety stock or nothing at all.

Problems Encountered in Applying the EOQ formula


1.

EOQ requires the following estimates which may be difficult to obtain Annual sales Ordering cost Purchasing price Cost of carrying the inventory Inventory is not always used to a constant rate and the constant usage assumption is implied in the EOQ Formula

2.

End of Chapter
Chapter 18

Accounts Receivables and Inventories

Chapter 19
CASH FLOW, WORKING CAPITAL & SHORT TERM FINANCING

4 Basic Financial Statements


Income

Statement Balance Sheet Statement of Retained Earnings, and Cash Flow Statement

Concept of Cash Flow


The statement of cash flows provides information about cash receipts and cash payments of entity during the period. The formal statement that classifies cash receipts (inflows) and cash payments (outflows) into operating, investing and financing activities. This statement shows the net decrease or increase during the period and the cash balance at the end of the period.

Preparing Cash Flow Statement


Dok Corporation Balance Sheet As of December 31, 2009 Assets Cash Marketable Securities Receivables Inventories Prepaid Interest Gross Fixed Assets Accumulated Depreciation Liabilities Accounts Payable Long-term Debt Stockholder's Equity Common Stock at par Paid-in capital in excess of par Retained Earnings 700 200 300 400 0 100 500 1,500 600 1,500 2006 200 800 500 400 100 2,800 1,600 2005 180 620 550 430 120 2,000 1,300

Classifying the Balance Sheet items in any of the three categories:

Operating Changes in current assets Changes in current liabilities Depreciation and non-cash changes Net profit/(loss) after tax Investing Changes in gross fixed assets Changes in business interest

Financing Changes in long-term debt Changes in notes payable Changes in capital stock and PICEP dividends

Operating, Investing and Financing

CL CA

NCL
F I NCA OE

Procedures in preparing cash flow statements:


1. 2.

3.

4.

Compute the changes for each balance sheet item (except cash and marketable securities). Dissect the change in the retained earnings account by referring to the income statement or (better), the statement of retained earnings to find the Net Profits (Loss) and any dividends paid. Classify the changes as being under operating (O), investing (I) or Financing (F) activities. -A positive change in an asset account means use of cash while a negative change in the asset account means source of cash. - A positive change in the liability and stockholders equity account means source of cash, while negative change means use of cash. Prepare the normal cash flow statement

Dok Corporation Cash Flows Statement For the year ended, December 31, 2009 Cash Flows from Operating Activities Decrease in Receivables Decrease in Inventories Decrease Prepaid Interest Depreciation Decrease in Accounts Payable Net Profits Cash provided by Operating Activities Cash Flows from Investing Activities Increase in Gross Fixed Assets Cash Flows from Financng Activities Increase in Common Stocks Increase in PICEP Dividends Paid Cash provided by Financing Activities Net increase in Cash and Marketable Securities 300 200 (50) 450 200 (800) 50 30 20 300 (100) 250 550

Relevance of a Cash Flow


It

enables its user to analyze the firms cash flow. It is use to evaluate progress toward projected goals. If the CFS is developed from projected financial statements, it is intended to determine whether planned actions are desirable.

Working Capital
-It is the firms current assets. Current Liabilities These are short term debts e.g. accounts payable (suppliers), notes payable (banks), accruals (employees and government). Net Working Capital=CA-CL +WC if the CA > CL (financed by long-term funds) -WC if the CL > CA (financed short-term funds) Example: Assuming that the total CA worth of P150,000 and the total CL amounting to P120,000. Therefore, the firms NWC is P30,000 (P150,000-P120,000).

Changes in Current Assets


The

amount of current assets a firm has influences its profitability and risks. Current Assets / Total Assets An in the ratio = An in CA with the total assets unchanged. A in the Fixed Assets then profit of the firm. An in the ratio the risk involved. An in CA Networking Capital

Change in Current Liabilities


firms current liabilities also a bearing on its profitability and risks. Current liabilities/Total Assets The ratio indicates the % of TA financed by CL. If the current liabilities & long-term debts = profit. If the current liabilities & NWC = the risk.
The

Example:
CA FA TA 20,000 10,000 30,000 CL LTD Equity TL & Equity 12,000 5,000 13,000 30,000

Case # 1. If 2,000 of FA shifted to CA and assuming that CA generates 15% profit while FA 25% profit, the effect of this is: Initial Values After the Shift Ratio of CA/TA 20,000 = .67 22,000 =.73 30,000 30,000 *the ratio increased by .06 Profits 20,000x.15=3,000 22,000x.15=3,300 10,000x.25=2,500 8,000x.25=2,000 *profits decrease by 200 Working Capital 20,000-12,000=8,000; 22,00012,000=10,000 *WC increase by 2,000

Example:
CL 12,000 LTD 5,000 Equity 13,000 TL & Equity 30,000 Case # 2. If 1,000 of LTD transferred to CL and assuming that the firm pays 20% interest for short-term debts and 30% for LTD, the effect of this is: Initial Values After the Shift Ratio of CL/TL 12,000 = .40 13,000 =.43 30,000 30,000 *the ratio increased by .03 Profits 12,000x.20=2,400 13,000x.20=2,600 5,000x.30=1,500 4,000x.30=1,200 Total interest 3,900 Total Profits 3,800 *interest decrease by 100 . This effect will increase profits. Working Capital 20,000-12,000=8,000; 20,000-13,000=7,000 *WC decrease by 1,000 CA FA TA 20,000 10,000 30,000

Sources of Short-Term Funds


Internal

(w/ in the firm) -it includes proceeds from sale of old or unused fixed assets, utilized reserves, etc. (outside the firm e.g. borrowings) -it includes accounts payable and accruals.

External

Accounts Payable
These

are major sources of unsecured short-term financing for the business firms.

Stretching Accounts Payable


It

is a strategy used by a firm wherein it delays the payments of its obligations without necessarily damaging the its credit reputation. -This strategy reduces the cost of giving up cash discounts.

Example: A firm was granted by its suppliers a credit terms of 2/10 net 30. Formula=CD x (___________360____________) Net Period-Cash Discount Period Case # 1. Assuming payment would be made on the last day of the credit period. The cost of giving up cash discounts would be: 36% =.02 x (360) 30-10 Case # 2. Assume that the firm stretch its payable to 50 days without damaging its credit rating. The cost of giving up cash discounts would only be: 18% =.02 x (360) 50-10

Accruals
the firms obligations for services received but payment have not been made yet. Most common items accrued by the firm are wages and taxes.
Represent

Financing Mix
This

is a strategy wherein the firm uses two external sources of short-term funds, Trade Credit and Bank Credit. A firm buys merchandise on account and borrows money from a bank to avail the cash discount offered by the seller.

Example:
Assume

that Index Shoes bought merchandise worth P100,000. The seller gave a credit terms of 2/10 n/30 with the grace period of 10 days with a penalty of 20%. If Index Shoes can borrow from a bank at 20% interest per annum and will use such loan to pay the seller, how much will Index Shoes pay if:

Case # 1. Will not avail the CD and pay the seller on the last day of the grace period at 20%.
100,000 x .20 x (10/360) = 555.56-penalty for late payment +100,000.00 100,555.56payment to the seller *does not avail cash discount

Case # 2. Will avail CD; borrows money from the bank at 20% interest.
100,000 x .02 = 2,000-cash discount 100,000 2,000 = 98, 000 Amount to be paid to the seller on the last day of the discounted period (will be loaned from the bank)
Payment to the bank 98,000 x .20 x 31/360 = 1, 687.78 *avails cash discount

To

calculate the number of days the firm has to pay 20% interest for money borrowed, deduct discounted period of 9 days (CDP-1) from the net period of 30 days, then add the grace period of 10 days. Net period -CDP +Grace period + 30 days - 9 (10-1) 21 10 days 31 days

If

Index Shoes will avail CD, it will pay the bank a total amount of : 98,000 + 1,687.78 = 99,687.78 If it will not avail CD, it will pay the seller: 100,555.56 It is beneficial for Index Shoes to avail the CD because it will result to savings of : 100,555.56 98,687.78 = 1,867.78

End of Chapter
Chapter 19
Cash Flow, Working Capital And Short Term Financing

Chapter 20
TIME VALUE OF MONEY & CAPITAL BUDGETING

Introduction
Time Value of Money
helps

managers make sound corporate decisions in finance & portfolio analysis bridges the gap between consumption & investment

The Concept of Future Value


Future Value Techniques -used to find the future value of a certain amount of money invested today at a given interest rate over a given period of time

Calculation of Future Value of a Single Sum


Let FV=Future Value at the end of period n PV=Initial Principal or present value i = Annual rate of interest n = period/number of years money is left on deposit FV = PV x (1 + i)n

Compounding More Frequently than Annually


Let FV=Future Value at the end of period n PV=Initial Principal or present value i = Annual rate of interest n = period/number of years money is left on deposit m = number of compounding periods

FV = PV x (1 + i/m)n x m

Future Value of Annuity


2 Types : 1.) Ordinary Annuity
payments

occur at the end of each year

2.) Annuity Due


payments

occur at the beginning of each

year

Future Value of an Ordinary Annuity & Annuity Due


FVA = deposits x [(1 + i)n -1] i

The Concept of Present Value


Present Value Techniques is used to determine the value today of certain amount of money that will be received in the given interest rate over a given period of time referred to as discounting inverse of compounding

Present Value

PV =

FV (1 + i)n

or

PV = FV x

1 (1 + i)n

Present Value of Mixed Stream


1.) determine the present value of each future amount 2.) add all the individual present

PV of an Annuity

PV =

1 1-(1 + i)n

Capital Budgeting Techniques


Why do firms use capital budgeting techniques? to evaluate and select long term investments which are consistent with firms goal of wealth maximization to evaluate capital expenditures for decision making process

Payback Period
refers

to the length of time the firm can recover its initial investment in a project the shorter the better for the firm Payback Period(incase of annuity) = Initial Investment Annual cash inflows

The Decision Criterion


ACCEPT

the project if the payback period < maximum payback period the project if the payback period > maximum payback period

REJECT

Net Present Value


is

a technique that considers the time value of money because it discounts the firms cash inflows at a specified rate(discount rate)

Net Present Value


= PV of inflows firms initial investment

The Decision Criterion


ACCEPT

the project if NVP > 0 , because that means that the firm will earn a return greater than its cost of capital the project if NVP < 0

REJECT

Internal Rate of Return


is

considered as the most sophisticated capital budgeting technique it is the discount rate that equates the present value of cash inflows with the firms initial investment PV of cash inflows =initial investment

The Decision Criterion

ACCEPT the project if IRR > cost of capital the project if IRR < cost of capital

REJECT

*This criterion guarantees that the firms earns at least its required return

Steps in calculating IRR


A. Annuity 1.) Calculate for the Payback Period 2.) Using table for PVIFA, look for the factor closest to the Payback Period.

B. Mixed Stream
1.) Add the annual cash inflows and divide the sum by the no. of years to get the average annual cash inflow.
2.) Divide the initial investment by the average annual cash inflow to get the fake payback period.

3.) Look for the PVIFA for 5years that is closest to the payback value. 4.) Using this PVIFA, increase the interest factor if the early years cash inflow is greater than the average annual cash inflow, or decrease the interest factor if the early years cash inflows is less than the average cash inflow.

5.) Using the increase/decrease Initial factor as the case maybe, use PVIF to discount the annual cash inflows to get the Present Value of cash inflows, then subtract the initial investment to get NPV. The PVIF which will result in an NPV closest to zero, negative or positive, becomes the IRR.

End of Chapter
Chapter 20 Time Value Of Money & Capital Budgeting

Chapter 21

ROLE OF INTEREST RATES IN OUR ECONOMY

Role of Interest Rates

Interest Rate is the yearly price charge by a lender to a borrower for funds obtained by the borrower from the lender. This refers to the bank-lending rate. Rate dont always move in tandem because they are driven by different forces. Rates on longer-term loans such as 15 years and 30 years fixed mortgages are driven by 1 year, 5 year and 10 year Treasury note yields. These are auctioned in the open market and the yields respond to the market demand.

Importance of Interest Rates


1.

Interest control the flow of money in the economy. High interest rates curb inflation but also slow down the economy. Low interest rates stimulate the economy, but could lead to inflation. If the interest rates are increasing and the Consumers Price Index (CPI) is decreasing this indicates that the economy is not overheating, which is good.

2.

3.

If rates are increasing and the Gross Domestic Product (GDP) is decreasing, the economy is slowing too much, which is bad. If the rates are decreasing and Gross Domestic Product (GDP) is increasing, the economy is speeding up, and that is good. If the rates are decreasing and the Consumers Price Index (CPI) is increasing, the economy is headed towards inflation.

4.

5.

Effect of Interest Rates on Individuals and Businessmen


The

most direct impact of interest rates on individual is a home mortgage. If interest rates are relatively high, loan payments will increase. interest rate stays too high for too long time, it could cause recession which could cause layoffs as business slow down. monetary authoritys primary concern is to prevent inflation from wrecking the economy which can occur when the economy grows too fast. On the other hand, if the economy slows down too much, it will fall into recession.

If

The

The speed of the economy is regulated by the monetary authorities through the manipulation of the interest rates. If the economy is growing too fast, or inflation appears to be growing, the monetary authorities will raise interest rates.

What one should know about investing?


If

a company has a story of its earning growth, that is good sign that the future earnings of such company is possible. We may not know the future but, investing in companies that have delivered solid future, earning growth and have showed consensus-earning estimate, is a good choice for long term-investors. When choosing an investment portfolio, taking on risks is the price for obtaining returns. If one wants to make money, he cannot altogether remove risk.

Level of Risk:
Conservative Moderately

conservative Moderately aggressive Aggressive Very Aggressive

Determine your Risk Preference


There are two important things to consider in determining your preference:
1.

The time frame of the investment- If your time frame for your investment is relatively short there is always that possibility that you may be forced to liquidate your securities by selling it at a loss before maturity date. With a longer time frame you can have more time to recover any possible losses and therefore are more tolerant for a higher risk.

2.

Determining the amount of money you can afford to lose is another important factor to indicate your risk tolerance. By investing only the money you can tie up for a period of time or afford to lose, you will not be pressured to sell off any of your investment because of liquidity problems or panic.

The Pyramid of Investment Risk


Peak Risk Highest Risk

Medium Risk

Least Risk

Lowest Risk

A. Least Risk
it is the largest investment outlet and should comprise the balk of your investment since it has foreseeable returns. The following are your investment outlets arranged in chronological order in the pyramid:
1. 2. 3.

4.
5.

Bank Deposits Cash and Cash Equivalent Certificate of Deposit, Bankers Acceptance Money Market Government Bonds

B. Medium Risk
this comprises of a medium risk investment outlet that offers stable return while still allowing your capital to earn more although it is more risky than the base investment. These asset are relatively safe: 1. High Income Bonds 2. Stocks 3. Equity Mutual Funds 4. Real Estate

C. Peak Risk
this investment is reserved specifically for high risk investment. It consist of the smallest area of the pyramid portfolio because investors should only place here the money that they can afford to lose without serious effect on their financial status.
1. 2. 3.

Collectibles Futures Options

Risk/Return Measurement
Risk

is defined as the possibility of a financial loss. It refers to the probability that the return and therefore the value of the asset or security may have alternative outcomes. Risk is the uncertainty surrounding the eventual outcome of an event which will occur in the future. Risk is viewed not only with respect to the current period but also as an increasing function of time.
Return

is defined as a change in the value of an asset plus any cash distribution over a given period of time expressed as a percentage of the assets initial value.

Risk and Return Relationship


is

a fundamental concept in not only in financial analysis but also in every aspect of life. It is widely accepted that the major determinant of the required return on the asset is the degree of risk. In financial analysis the risk/return tradeoff states that financial decisions that subjects stockholders to more risk must offer a higher expected return.

Prospective investors should know the following:


1.

It is helpful for investor to know how a corporation performed in the past because it gives them a strong clue about how the corporation will handle the future. Many stock analysts of major investment banks, houses and brokerage as well as other institutions follow the actively traded stocks and compute their earning estimates from there.

2.

3.

We should view interest earnings estimates carefully because at times some of them are bound to be wrong. Risk is viewed not only with respect to the current period but also as an increasing function of time. The longer an asset is invested, the greater is the risk. The goal of financial manager is to create an efficient portfolio, one that can minimize and maximize profit for a given level of return.

4.

Types of Financial Risk:


1. 2. 3. 4. 5. 6.

7.
8.

Systematic Risk Unsystematic Risk Country Risk Interest Rate Risk Default on Credit Risk Foreign Exchange Risk Market Risk Political Risk

1. Systematic Risk

This type of Risk influences a large number of assets. An example of which may be an economic turmoil or problem arising in a country or a big political event that affects investors trust and confidence in the country. Virtually no one can do anything about this type of risk.

2. Unsystematic Risk
This

is referred to as specific risk. It only affects a small number of assets, example of which may be a sudden strike of employees in a particular corporation.

3. Country Risk
This

type of risk refers to the possibility that a particular country will fail to honor its financial commitments. This type of risk can be present in countries experiencing perennial deficit in their balance of payments. It can also be present in the emerging markets of the developing countries.

4. Interest Rate Risk

This is a risk whereby the value of an instrument changes as a consequence of a change in the interest rates. Here, bond investments are more affected than stocks.

5. Default on Credit Risk


This

risk is the particular concern of inventors who hold bonds in their portfolio.

6. Foreign Rate Risk


Foreign

Exchange Risk can be applicable to all financial investments denominated in foreign currencies.

7. Market Risk
Refers

to day-to-day fluctuations in the prices of stocks and options. It also referred to as volatility. Stocks perform well in bull market than in bear. Volatility is a measure of risk because it refers to the behavior or temperament of your investment rather than the reason this behavior, because market behavior is the reason why investors can make money on stocks. Volatility is important for returns.

for

8. Political Risk
It

to the risk that an investment will experience in a country due to sudden changes in a countrys policies because of political reason. Developing countries usually lack foreign investment because of the possibility of political risk.

Diversification
occurs

when different assets make up a portfolio. By diversification, the investors risk is reduced. The extent of the benefit derived from diversification depends upon how the returns of various assets behave over time. Through diversification we can lower risk without sacrificing expected income or we can increase expected income without having to assume more risk.

Portfolio
is

a collection of risky asset. If we view various individual asset as one big asset, we have a portfolio.

Returns from International Diversification


International

portfolio tends to be better than those yielded by domestic corporations. When it comes to a single short term or intermediate term period, international diversification can yield returns below par especially during periods when the value of the dollar is appreciating in relation to other currencies.

Capital Asset Pricing Model (CAMP)


According

to Ben Mc Clure contributor of Investopedia Advisor, no matter how much we diversify our investment its impossible to get rid of all the risks. As investors we deserve a rate of return that compensates us for taking on risk. The Capital Asset Pricing Model (CAMP) helps us calculate investment risk and what return on investment we should expect.

Birth of the Model


Ben

Mc Clure states that the Capital Asset Pricing Model was the work of a financial economist (and later, Nobel laureate in economics) William Sharpe set out in his 1970 book Portfolio Theory and Capital Markets His model starts with the idea that an individual investment contains two types of risk. Systematic Risk- these are risks that cannot be diversified away. Unsystematic Risk- also know as specific risk. This risk is specified to individual stocks and can be diversified away.

1. 2.

When calculating a desired return, systematic risk is what plaques investors most. CAMP evolved as a way to measure this systematic risk. The standard formula remains the CAMP, which describes risk and expected return. Here is the formula: ra = rf + ba (rm - rf) Where: rf a rm rm - r f

= Risk free rate = Beta of the security = Expected market return = Equity market premium

Beta
According

to CAMP, beta is the only relevant measure of a stocks relative volatility- that is, it show how much price of a particular stock jumps up and down compared with how much the stock market as a whole jumps up and down. If a share price move exactly in line with the market, then the stocks beta is 1. A stock with a beta of 1.5 would rise by 15% if the market rise by 10%, and would be fall by 15% if the market fell by 10%.

End of Chapter
Chapter 21
ROLE OF INTEREST RATES IN OUR ECONOMY

CHAPTER 22
INTERNATIONAL TRADE

International Trade

is the exchange of goods and services among nations. A nation imports goods and services that they want and also exports the goods and services that other nations want. In many ways international trade is very similar to trade within the nations. International trade differs from internal trade of a nation principally because of certain natural and artificial barriers that exist between nations. All nations , regardless of how big or small, profit from international trade.

Exporters and importers are confronted with currency complications that those engaged in domestic commerce do not have to contend with.

How importers pay exporters?


Foreign

exchange transactions are handled for exporters and importers by commercial banks. The importer goes to the bank and obtains letter of credit (L/C). The letter of credit states that the Filipino bank will honor a draft presented to it by the foreign exporter. obtained the letter of credit, the domestic bank sends the letter of credit to the exporters bank through its foreign correspondent bank. The exporter is then notified of the presence of the letter of credit and the foreign supplier, then shifts the goods to the Filipino importer.

Having

The

exporter therefore en-cashes the draft and receive payment in his currency. The commercial bank s maintain accounts with their foreign correspondent bank. The account balances are either increased or decreased whenever international payments are made.

Financing of foreign trade


The

constantly changing economic financial and political condition and various parts of the world have made it highly essential that foreign operation be transacted through a bank conversant with proper procedure, and with knowledge of existing conditions in constantly changing foreign markets. The kind of the service rendered by a bank to its client constitute one of the most important factors in financing foreign trade operations expeditiously and with the greater degree of safety. most important method of financing foreign trade is through the use of export and import credit.

The

Exporter credit procedures


The

greater part of export sales to buyer abroad through normal trade channels is handled on the following bases:

1.

2.

Sales against letter of credit, opened by order and for account of the buyer in favor of the seller. Sales against authorities to purchase or authorities to pay

Exporter credit procedures


3.

4.

5.

Sales on the basis of dollar drafts or foreign currency draft drawn by the seller on the buyer Sales against cash deposits in advance of shipment Sales on open account based on the entire value of the commitment of the bank as represented by the L/C. This is a credit matter between the bank and the buyer in which the seller has no interest whatsoever.

Necessary Contents of a Commercial L/C


The

name of the issuing bank The name of the party for whose account it is issued (buyers name) The date of the L/C The name of the beneficiary of the L/C (seller) The approximate value of the goods to be shipped

The

description of the nature and quantity of the merchandise to be shipped The usance in terms of the draft which the seller must draw and the name of the bank on which the draft would be represented for payment; The term of the sale which is to pay or negotiate the draft of the seller, may know if the shipping chargers and insurance are for the account of the seller or of the buyer; Whether the draft are to be drawn for 100% of the cost of the merchandise or a lesser percentage;

Whether

the shipping documents are to be attached to the draft when presented for the negotiation and/or payment; The shipping route; The latest date of shipment and the latest date by which the seller is to negotiate his draft; A clear and specific indication on the part of the issuing bank that the sellers draft meeting all the requirements specified on the face of the credit will duly honored.

Export Sales Procedure under a commercial L/C


Upon

completion of a contract by the seller (exporter) and the buyer (importer) containing provision that payment will be provided by a letter of credit, the buyer will go to his local bank to arrange for the issuance of the required L/C.

The

financial basis on which the credit is issued will not necessarily be known to the seller as a matter of arrangement between the bank and the buyer. With the necessary details, the opening bank will write or cable its correspondent to inform the exporter or beneficiary of the establishment or the L/C stating its terms and condition.

It

is apparent to the foreign bank, through which the foreign buyers credit is established has no direct contact with the foreign buyer or complete knowledge of the underlying purchase. Therefore, it must be guided solely by the instruction sent by its foreign banking correspondent at whose request and under whose responsibility the credit is established. The advising bank cannot deviate from the terms of conditions which are stipulated by its correspondent abroad, without the authority to make any necessary changes.

Where

all conditions and terms have been duly clarified, the supplier will prepare the shipment of the merchandise called for in the L/C together with the shipping documents and the drafts. In order to get paid for the goods already shipped, the supplier present his draft to the negotiating bank and complete all the documents required in the L/C.

The

bank affecting payment under the L/C on behalf of its foreign correspondent is required to examine all documents with care to determine that they conform to all the terms and conditions of the L/C. The bank cannot waive any requirement of a credit without specific authority from its correspondent bank.

Parties to a Commercial L/C


Buyer- is the one who initiates the opening of the

L/C.
Seller- is the beneficiary of the L/C.
Opening

buyers bank.

Bank or Issuing Bank- is the Bank- is the bank to whom the L/C

Advertising

is mailed and who advices or notifies the seller. Negotiating Bank- is the bank to whom the draft and documents are presented and who makes payment to the supplier. Confirming Bank- is the bank that adds its confirmation to the beneficiary that all drafts presented would be duly honored.

Why do Exporters Prefer to Receive through a Commercial L/C


For

credit security- This is to eliminate

for all practical purposes the inherent risk in credit.


For

credit facility- this will enable the

supplier to receive payment as soon as he has made the shipment and even if the merchandise is still in transit to the buyer.

For

exchange security- in recent years,

because of the shortage of dollar exchange in most foreign countries and the resulting exchange controls and restrictions, the seller never knows when he may expect to receive the dollar payment proceeds of his draft drawn on the buyer.

Advantages of the L/C from the buyers Point of View


Credit facility
whenever

a bank opens a commercial L/C for account of the buyer by means of the commercial credit agreement which he signs, he pledges the merchandise to him under the opening bank willingness to release the merchandise to him under some other satisfactory basis other than straight payment. it is extended to the buyer by means of the commercial credit becomes in nature a selfliquidating secured loan.

it

offers the buyer the opportunity to borrow the involve funds in a market which changes the lowest obtainable interest rate in discounting bankers acceptances. instead of sight drawings whereby the buyer will be compelled to pay the draft presented immediately, he can request the seller to extend him the letters credit facility by way of a time draft.

Sales against Authorities to Pay or Authorities to Purchase


Authorities

to pay or authorities to purchase take the form of a commercial L/C, except the it may be revoked without prior notice to the beneficiary. The advice usually contains a statement which reads as follows: The authority give to us is subject to revocation or modification at any time without notice to you.

Sales against Dollar Drafts Covering Exports


Such

instruction are as follows: Deliver documents against payment acceptance. Advice non-acceptance/non-payment by airmail. Exchange charges are for drawees account. Waive charges if refused. Hold until arrival of the shipment. Payable for the face amount with a prime bankers check. Protest for non-acceptance/non-payment.

Sales against Dollar Drafts Covering Exports


Such

instruction are as follows:

Protest

for non-acceptance/non-payment. Do not protest. Remit proceeds by airmail/cable. Advise maturity date of draft.

Sales against cash deposit in Advance of shipments.


This becomes necessary when:
Credit

risk are doubtful. Exchange restriction within the country destination are such that the return of funds from abroad maybe delayed for an unreasonable period. The exporter for any other reason maybe unwilling to sell in credit terms, may request payment in whole or in part in cash, in advance of shipment.

Sales on Open Account

The procedure on sales abroad on an open account basis is similar to that which applies to the sales on domestic market i.e. sales are made without drawing on the buyer who is supposed to make the payment at the expiration of a previously determined period. The practice does not generally prevail the foreign trade but is used by exporters particularly when they had relations of long standing with good buyers in nearby or old-established market or when sales are made to a branch or a subsidiary of the exporter.

Sales on Consignment Basis

The shipment of merchandise to foreign countries on a consignment basis maybe made to a branch office or a subsidiary of the exporter or to an agent representative of an import house abroad.

Foreign Exchange

The form of currency, drafts and bills of exchange in terms of foreign currency. Which maybe bought and sold in term of another currency for purposes of financing foreign transactions or for speculative purposes.

Purchases and Sales of Foreign Exchange (RA 7653, Art. 2, Sec. 70)

The Bangko Sentral may buy and sell foreign notes and coins, documents, instruments of types customarily employed for the international transfer of funds and may engage in future exchange operations.

Holding of Banks (RA. 7653, Sec. 76)

In order the Bangko Sentral may at all times have foreign exchange resources sufficient to enable it to maintain international stability and convertibility of the peso or in order to promote domestic investment of bank resources, the monetary board may require the bank to sell to the Bangko Sentral or to other banks or part of their surplus holdings of foreign currencies or for only certain of such currencies, according to the decision of the monetary board.

Regulation Of Non-Spot Exchange Transactions (RA. 7653, Sec. 78)

In order to restrain the banks from taking speculative positions with respect to the future fluctuations in foreign exchange rates the monetary board may issue such regulations governing bank purchases and sales of non-spot exchange as it may consider for said purpose.

Information of Exchange Operations (RA. 7653, Sec. 80)

The banks shall report to the Bangko Sentral the volume and composition of their purchases and sales of gold and foreign exchange each day, and must furnish such additional information as the Bangko Sentral may request with reference to the movement of their accounts in foreign currencies.

Foreign Exchange Rates (RA. 7653, sec. 74)

The monetary board shall determine the exchange rate policy of the country. The monetary board shall determine the rates at which the Bangko Sentral shall buy and sell spot exchange, and shall establish deviation limits from the effective exchange rates or rates as it maybe dimmed proper. The Central Bank shall not collect any additional commissions or charges of any sort, other than the actual telegraphic or cable cost incurred by it.

Significance of Exchange Rate


It

enables one to know the value of foreign currencies by knowing the exchange rate. It establishes the international value of a currency in international transactions. It establishes the cost of a countries imports and exports. It measures the external value of a countries currency. It serves as a connecting link between the price levels of two countries or one country with the rest of the world.

Types of Exchange Rates on the Basis of Monetary Policies


Adjustable

pegged rate

Fixed by the monetary authorities regardless of demand and supply condition in the market.

Free Floating Rate Without Official Interventions


This

is just the opposite of the pegged rate wherein the rate of exchange is determined by the interplay of demand and supply condition at the foreign exchange market. The monetary authorities do not intervene to influence the rate.

Free Floating Rate With Official Interventions


This

is known as the dirty float. The monetary allow the rate to fluctuate in accordance with the demand and supply factors but the government intervenes in cases of extreme fluctuations through open market operations. The Philippines is presently adopting this policy.

Balance of Tade
A

nations balance of trade is the difference between the money value of countrys imports and the value of its exports. If the nations export exceed its imports, the nation is said to have a favorable balance of trade. If imports exceed exports the balance is termed unfavorable.

Balance of Payments
A

nations balance of payments is a financial statement covering a year or part of a year, which summarizes receipts from abroad and disbursements to foreigners. It shows how a country met its obligations.

Sections in the Balance of Payments


1.Current Account Transactions- include all current exchanges for goods and services between a country and other countries. It includes the importation and exportation of goods and services. It constitutes the largest bulk in the balance of payment.

2.Capital movement- refers to the investments in the form of credit extension or investments in capital gods and services made by one citizen of a country to another country.

3.Unilateral Transfer- is a one-sided transaction such as donation, grants, foreign aid and war damage claims.

4.Gold Account- this refers to the amount of gold holdings a country has. 5.Errors and Omission- this refers to adjustments made for any inaccuracy in the recording of foreign trade.

MODEL BALANCE OF PAYMENT


I. CURRENT ACCOUNTS DEBIT CREDIT MERCHANDISE TRADE: Merchandise imports x Merchandise exports Service Transactions: Transportation a. rendered by foreign x vessels, airlines, etc. b. rendered to foreigners by x domestic vessels airlines etc.

DEBIT

CREDIT

2. Travel Expenditures a. in foreign countries b. by foreign countries in home country 3. Interest and dividends a. paid to foreigners b. received from abroad 4. Banking and insurance services a. rendered by foreign institutions b. rendered to foreigners by domestic institutions 5. Government Expenditures a. by home government abroad b. by foreign government in home country

x x

x x

x
x

x x

II. CAPITAL ACCOUNT DEBIT Long term 1. purchase of securities from foreigners x 2. Sale of securities to foreigners Short term 1. Increase of foreign-held bank balances x and brokerage abroad 2. Decrease of foreign-held bank balances and brokerage in home country 3. Increase in foreign-held bank x and brokerage balance in home country 4. Decrease of bank and brokerage balance abroad

CREDIT

III UNILATERAL TRANSFERS Private; 1. Personal and institutional remittances to non-residents 2. Remittance from abroad Governmental: 1. Grants indemnities and reparations made to other countries 2. Grants indemnities and reparations made from other countries

DEBIT x

CREDIT

x x

IV GOLD ACCOUNTS Import of gold and increase of Earmarked gold abroad Export of gold and increase of earmarked gold for our foreign account

DEBIT x x

CREDIT

Conditions in the Balance of Payments


1.

Surplus condition- is one where foreign exchange receipts exceed foreign disbursements. There is an excessive inflow of foreign exchange.
Deficit condition- is the situation where the countrys collective disbursement are greater that that of its collective receipts. Here, there is an excessive outflow of foreign exchange.

2.

3. Equilibrium- is a condition wherein a countrys total collective receipts are equal to that of its collective disbursements.

Unfavorable Effects of a Continuing Surplus in the Balance of Payments


It

may generate inflationary effects since foreign currencies are exchange with domestic currencies therefore, money supply will increase as foreign currencies are converted to local currencies. may disturb the foreign exchange market since there will be excessive supply of foreign currencies which will induce lower exchange rates

It

3.

When the rates goes down exporters and other foreign exchange earners will be placed at disadvantage, which will discourage exports.

4.

It may induce foreign countries to impose restrictions on their importations. Other countries are constrained to retaliate against them by imposing higher tariff duties.

Disadvantage of Deficit Condition


This

brings, in many unfavorable effects, which make countries adopt remedial measures. It is regarded more unfavorable that the surplus condition.

Visible and Invisible Items


Visible

Items- are those imports and

exports of merchandise or commodities which are recorded in the customs.


Invisible

Items- they consist of money

payments in foreign countries which are difficult to keep tract of because of their vey nature. Examples of these are: expenses of tourists, salaries of diplomatic representatives, service such as shipping , insurance and remittance of contract workers and immigrants abroad.

Hard Currencies and Soft Currencies


Hard

currencies are currencies difficult to obtain because their scarcity currencies are currencies easy to obtain because of their abundant supply.

Soft

Buying and Selling Foreign Currencies in the Foreign Exchange Market


Foreign

exchange can be brought at the foreign exchange market at par, at a premium and at a discount. When we buy at par it means buying at the official parity rate, while buying at a premium means buying above the official parity rate, and buying at a discount means buying the official parity rate.

Establishment of Official Parity of Domestic Currency with a Specific Currency


Most

countries establish a basis between their domestic currency and a particular currency, which usually international convertibility. The following are three general methods used in establishment of official parity domestic currency with a foreign currency:

1.By gold content: a method establishing the official parity on the basis of comparative gold contents of the domestic currency and foreign currency. 2.By purchasing power: the official parity of a domestic currency to foreign currency was determined on the basis of purchasing power of the monetary unit of each foreign country. 3.Conversion ratio of two currencies with a common currency: the parity of domestic currency can be established with foreign currency on the basis of the conversion ratio of the two currencies with a common currency to which that are both convertible.

Buying and Selling of foreign Currencies in the Foreign Exchange Market

Foreign exchange can be bought at the foreign exchange market at par, at a premium and at a discount. When we buy at par it means buying at the official parity rate, while buying at a premium means buying above the official parity rate, and buying at a discount means buying below the official parity rate.

Action when the International Stability of the Peso is Threatened (RA 7653, Sec. 67)
Take

such remedial measures as are appropriate and within the powers granted to the Monetary Board and the Banko Sentral under the provisions of act; and to the President of the Philippines and to Congress a detailed report which shall include as a minimum, a description and analysis of:

Submit

The

nature and causes of the existing or imminent decline;

The

remedial measures already taken or to be taken by the Monetary Board; monetary, fiscal or administrative measures further proposed; and character and extent of the corporation required from other government agencies for the successful execution of the policies of the Monetary Board.

The

The

Reserve may be maintained in two ways:


1.

Single foreign currency reserve system is a system of where only one


currency reserve. is maintained as international

2.

Multiple reserve system where the


international reserve comprises of as is more than one foreign currency

Single Foreign Currency


ADVANTAGES: The foreign exchange resources is concentrated to only one currency, therefore, there is a bigger bulk of such currency. Since the foreign exchange currency enjoys international convertibility, it may be used in trading with almost all trading countries.

DISADVANTAGES: It may limit trade with countries who have a shortage of that particular currency. Since the foreign exchange currency has universal demands it may be expensive. Multiple reserve system is a system where the international reserve comprises of as is more than one foreign currency.

Multiple Reserve System


ADVANTAGES: It may induce a more diversified form of our export products. The currency might not be expensive

DISADVANTAGES: It spreads foreign exchange resources among several currencies in that; there would be a small reserve for each currency. The currency of a particular country may only be used in trading with such country, in that it becomes sensitive to the economic condition of that country and the relationship between the two countries.

Devaluation

is a process where the par value of a monetary unit is depreciated either by gold content or by decreasing its par value with foreign currencies with which, its fixed parity is established.

Devaluation may be done in two ways by:


Decreasing

the gold content of the monetary

unit. Decreasing the fixed parity of the monetary unit.

Three Factors that Influence the Process of Devaluation as Remedial Measure


1.

2.
3.

elastic demand for the countries export product elastic supply elastic national discipline

Reasons why Countries have devalued their Currencies and their Effects
To

stop falling prices at home To improve their competitive position in the world market The usual cause of devaluation is that a country continually imports more goods and services than its exports.

REVALUATION
is

a monetary device where the par value of the monetary unit is increased either by increasing its gold contents or by increasing the par value of the currency in relation to a specific currency either which its fixed parity has been established

FOREIGN EXCHANGE CONTROL


It

is a device used to correct a deficit in the balance of payment and stabilize the foreign exchange market.

OBJECTIVES OF EXCHANGE CONTROL


To

maintain the exchange rates and avoid a flight of capital To assure imports of items considered essential to the countrys well being To stimulate the production of certain goods deemed vital to the economy To discourage the production of certain items To have a source revenue

Economic Effects of Exchange Control in General


It

avoids the depressive effects of deflation and it prevents the worsening of the terms of trade that is inherent in depreciation. During post war period, it prevents fluctuation of the foreign exchange rates and allows stability of the foreign exchange. During wartime, it provides for orderly procedure for appropriating short supply of foreign exchange for only the most essential use. It protects domestic industries and the economy from the world market. It makes possible for the country to attain a balance in its international account.

Undesirable Effects of Exchange Control


Exchange

restriction tends to have an inflationary effect on importation (scarce items). It will result in a general reduction of import and will contribute to internal scarcity especially on imported goods that are not produced in the country. It will cost a shift to a more expensive soft currency The economy will be more rigid

It

will discourage a flow of foreign capital There is a tendency to bilateralism It will cost reduction in the volume of world trade because overvaluation follows a system of exchange control It may result to trade discrimination, which give preference to imports originating from one country over those of other countries.

Kinds of Exchange Control


Blocked Accounts
Exchange

Rationing Exchange Stabilization Funds Bilateral- Multilateral Exchange Control


Cooperative

Management Clearing Agreement Payments Agreement

The Philippines Instituted the Exchange Control in 1949 for the following reasons:
To

prevent further deflation of the international reserve; To change the pattern of trade from customers to producers goods where capital good imports will be given priority; To encourage the establishment of local industries by protecting them from competition of foreign made goods; and To stabilize the foreign exchange market.

General Features of RP 1949 Exchange Control Policy (FECP)


The

Central Bank was designated as (CAA) Central Control Authority, and all commercial banks in Manila were designated as (AA) Authorized Agent. Central Bank pegged the rate at P2:$1 and other foreign exchange suppliers were required to sell the US$ to the Central Bank through the commercial banks at the rate of P2:$1.

The

All

importers of foreign exchange users were required to buy US$ from Central Bank and commercial banks at P2:$1. Sale of US$ to foreign exchange users was under a quota allocation system where importers were classified under different import categories with highest priority to producers goods (capital good imports).

The

Provisions to Compel Exporters to sell their Foreign Exchange to the Central Bank

All exporters were required to declare the volume, values and description of their exports before shipment. Payment for export were requested to be in US$ and coursed through commercial banks. The commercial banks pay the exporters the peso equivalent at the rate of P2:$1. At the next business day the commercial banks surrender their US$ receipts from their exports to the Central Bank at the exchange rate prevailing under the adoption of the 1949 Foreign Exchange Control Policy.

The Favorable Effects of the System


It

encouraged the growth of local industries and the establishment of branches of local firms which created job opportunities and an increase in productivity. It increased the pattern of foreign trade such that it was dominated by capital good imports while reducing customer good import. It helped in the stabilization of the foreign exchange market.

The Adverse Effects of the System


It

was instrumental to the growth of graft and corruption in government agencies i plementing the program. the pegged rate has been regarded as a very low rate where the peso is grossly overvalued. It was a disadvantage to the exporters since they were forced to sell their US dollar to CB at 2:1 when they can sell it at the free market above par.

The

situation caused capital flight since a great number of foreign exchange earners deposited their foreign exchange earning in foreign banks. system hardly succeeded because of the need to import capital goods which requires greater foreign exchange demand.

The

End of Chapter
Chapter 22

INTERNATIONAL TRADE

CHAPTER 23

FINANCIAL MARKETS

Financial markets
are

organized institutional structures or mechanism for creating and exchanging financial assets. It has the general market where many commodities are traded and specialized markets where only one commodity is traded. Markets work by placing many interested sellers in one place thus, making them easier to find for prospective buyers.

Functions of Financial markets


The

raising of funds in the capital market The transfer of risk in the derivative market International trade in the currency market

Kinds of Financial Markets


1. Capital Market
-subdivided into the ff.:

a. stock market-

provides capital to the issuance of shares and allows the subsequent trading.

b. Bond Market-

facilitates financing through the issuance of bonds and enables the subsequent trading.

2. Commodities Market - primary products such as raw materials are traded on a


regulated commodities exchange in which they are bought and sold in standardized contracts.

Commodities Exchange Regulators:


New

York board of trade National Futures Association Chicago Board of Trade Chicago Mercantile Exchange Commodities Future Trading Exchange Kansas City Board

Commodities Future market


in

a futures market, one deal in standardized contractual agreement only, which are called futures contract. It provides for the delivery of a specified amount of a particular commodity at a specified future time.

Marginal Requirement
When a trader enters a commodity futures market whether it is long or short he is required to make deposit with the broker an amount sufficient to protect the broker against lost in the even the trade becomes unprofitable. This deposit is called margin requirement. the clearing margin is the deposit of the broker. A full payment is made upon actual delivery.

Money Market

is a segment of the financial market in which financial instrument are traded. It is used by participants as a means of borrowing and lending in short term from several days to less than a year.

Kinds of Money Market Securities


Negotiable

Certificate of Deposit(CD) Treasury Bills Bankers Acceptance Commercial Papers Municipal and National Government Notes Mutual Fund Repurchase Agreement

Treasury Bills(TB)
the

most marketable money market securities.

Mutual Fund
form

of a collective investment that pools money from several investors and invest it in stocks, bonds, money market instruments and other securities

Derivatives
useful

for hedging the risk associated with business and finance. To reduce their risk that interest rate they pay .

Arbitrage

the system of taking advantage of a price differential between two or more markets. is a right not an obligation. An option is a contract or commitment to buy and sell financial products known as the option underlying instruments or underlying interest.
1.

Option

2 kinds of option:
Call(Buy)asset. 2. Put(Sell)- gives the holder the right to sell an asset at a certain price.

give you the right to buy the underlying

Strict price

refers to the price at which underlying stocks can be sold or purchase if the option is exercise.

Classifications of options:
1.Stock optionis a contract where the underlying asset is a stock. 2.Bond Option- is an option where in the underlying asset is bond. 3.Commodity Option-is an option contract wherein the underlying asset is a particular commodity. 4.Option on futures contract -conveys the right (but not the obligation) to the buyer to purchase a specific futures contract.

5.Over the counter Option-it is the dealers


option, traded between two private parties and it is not listed on an exchange.

Types of options commonly traded over-the-counter.


interest

rate option currency cross rate option option on swap employees stock option issued by companies to its employees as compensation.

6.Foreign

Exchange Option- It is a financial contract giving the forex option buyer the right(but not the obligation)to purchase or sell a specific forex spot contract(the underlying) at a specific price( the strike price)on or before a specific date.

End of Chapter
Chapter 23

FINANCIAL MARKET

CHAPTER 24
GLOBALIZATION & INTERNATIONAL CORPORATE MANAGEMENT

Globalization
Internationalization

of everything related to

different countries world wide Process of removing government imposed restrictions or movements between countries in order to create borderless world economy Defined as complex of forces that trends toward the single world society The product of planning

Woods conference was created and led to the founding of several international institutions such as; International Bank for Reconstruction and Development (IBRD) World Bank and the International Monetary Fund (IMF) General Agreement on Tariffs and Trade (GATT) World Trade Organization (WTO) Maastricht Treaty and the North America Free Trade Agreement (NAFTA)
Bretton

Favourable Effects of Globalization


Industrial-emergence of worldwide production markets and broader access to a range of foreign products for consumers and companies. Financial-emergence of worldwide financial markets and better access for corporate needs, national and sub-national borrowers. Economic-realization of global common market, based on the freedom of exchange of goods and capital.

Informational-increased in informational flows between geographically remote location

Cultural -growth of cross cultural contacts,

the advent of new categories of consciousness and identities such globalism which embodies cultural diffusion, the desire to consume and enjoy foreign products and ideas, and adopts new technologies and practices. Ecological-advent of global environmental challenges that cannot be solved without international cooperation, such climate, cross boundary, water and air pollution, over fishing of the ocean, spread of invasive species.

Technical

and Legal -development of

global telecommunications infrastructure and greater trans-order data flow using such technologies as communication satellites,, internet and use of fiber-optic cable, wireless telephone and broad band.

Other Favourable Effects of Globalization


Increase

in economic propensity Transfer of technology to developing countries Augmentation of domestic savings Reduction of cost of capital Enhances civil liberties and leads to a more efficient allocation of resources Leads to a lower prices of goods More employment in developing countries Increase growth rate

Higher

degree of economic freedom in the form of democracy and capitalism Produces high level of material wealth Life expectancy has almost doubled after world war two Democracy has increased from almost no nation in the year 1900, to 62.5% of all nations in the year 2000 Feminism has made advances by providing women with jobs and economic safety Global literacy increased from 50% to 80% from 1950-1999 and female literacy increased from 59% in 1970 to 80% in 2000

Percentage

of labor decreased from 24% in 10% in 2000. There is increased in the use of radio, electricity, telephone, cars, access to clean water and per capita income It increased the number of standards applied globally such as copy rights, patents, world trade agreement, and international criminal courts.

Unfavourable Effects of Globalization


Poorer

countries are disadvantaged in that while globalization encourages trade among countries on an international level, there are also negative consequences. economies are forced to open up their markets to foreign competition before they are ready to do so. workers of poorer countries are being exploited for cheap labor from powerful industrialized nations.

Developing

The

There

is the shift of manufacturing and out sourcing of service work from one higher cost country to other low cost country. investors have a tendency to engage in momentum trading and hording, which can be destabilizing for developing countries. government even if democratically elected, may not give sufficient weight to protect the interest of future generation.

International

For

newly developing countries and developed countries that find it difficult to compare for lower cost of labor, more corporations locate their business in the countries where cost of labor is cheaper is also that fear that globalization may lead to global monopoly or oligopoly.

There

Importance of International Environment

The protection of global environment has become one of the central objectives of the international community in recent years. When people around the world lack access to energy, clean water, food or livable environment, economic stability and political unrest may result and be felt at home in the form of costly peacekeeping and humanitarian interventions or lost market.

Issues

such as climate change, depletion of ozone layer and loss of biological diversity have resulted in a growing international awareness of problems facing the planet. Expanding global population, rapid conversion of critical habitat to other uses ,and the spread of invasive species to non-native habitats pose a serious threat to the worlds resources and to all of us who depend on them for food, shelter and medicine. Policies that distort markets and provide incentives for unfavourable devt intensify the problem. Every year there is a loss of 22 million of acres of forest area worldwide.

Many

toxic chemicals, some capable of travelling through thousands of miles from their source and lasting for decades in the environment which are released to earths atmosphere. Environmental problems respect no borders and threaten the health, prosperity and even the national security of nations. Pesticide of contamination of food and water, polluted air, and invasive plant and animal species can take their toll on our welfare and economy. 25% of prescription drugs, come from rapidlydisappearing tropical forest.

In order to address problems and achieve sustainable management of natural resources worldwide it requires the cooperation and commitment of all countries.

Multinational Corporations
are

corporate entities that are engaged in production or delivery of services in at least two countries. into broad groups according to the deliverance of their product facilities.
Horizontally

divided

integrated multinational corporations Vertically integrated multinational corporations Diversified multinational corporations

Horizontally integrated multinational corporations


manages production establishments located in different countries to produce the same or similar products.

Vertically integrated multinational corporations

manages production establishments in certain country/countries to produce products that services input to its production established in other countries.

Diversified multinational corporations

manages production establishments located in different countries that are neither horizontally, vertically or straight.

Transnational Corporations
refer

to economic entities operating in more than one country. referred to a cluster of economic entities operating in two or more countries.

also

Tax Competition
offering

incentives in the form of tax breaks, pledges of governmental assistance, improved infrastructures or lax environmental or labor standards.

Threat for Market Withdrawal


this

withdrawal can have a great impact on the countrys labor, supply and prices of their product.

Lobbying
Includes

attempts to influence legislators and officials whether through other legislators, constituents, or organized groups whose job is to lobby.

Government Power
these

are threats to nationalization of companies by forcing these companies to sell its local assets to the government or to other local businessman or make changes in local business laws, rules and regulations intended to limit the multinational corporations power.

Micro-multinational corporations
businesses

that are smaller compared to multinational corporations.

Managing Multinational Corporations


Some problems facing these industries are as follows:
1. The need for a continuous reorganization in respect to business challenges. 2. The need for accountability pushed closer to the frontline through smaller, more focused units.

3. The need for increasing non-uniform grouping units driven by business needs.

4. The need for an increasing willingness to enter into strategic partnership and outsource. 5. The need for a smaller more focused corporate organization with fewer staffs. 6. The need for the increasing use of high-level teams to address business challenges.

The Changing of the Multinational Corporations head Office


In

supporting new corporate structures and strategies, the role of the head office/head quarters is changing especially the head office of a multinational corporation with domestic and foreign subsidiaries. It pursuit to growth opportunities in rapidly changing markets, multinational corporation increasingly recognize, reward and promote entrepreneurial behavior.

Top Corporate officers


There

are countries which have a separate board. Some European countries have an executive board who manages the day-to-day business who is headed by the CEO and the supervising board who governs control of the business.

The Chief Financing Officer


is

the corporate officer primarily responsible for the managing the financial aspect of the business. He is responsible in making the budget plan, financial goals and objectives, record keeping as well as financial reporting to higher management. The same as Finance Director.

The Chief Strategic Officer


is

an executive responsible for assisting the CEO with creating, communicating, executing and sustaining strategic initiatives within a corporation. Many strategic officers are considered doers and use their past experience to advice and execute.

A CSO

is responsible for three critical jobs:

Must echo the CEOs strategy to every business unit with in the corporation so that all the employees, partners and contractors understand the corporate wide strategic plan and how it fits into to the companys over all plan. Must oblige immediate results within a corporation. Must drive decision-making that creates immediate change within a corporation as per the companys strategy.

The Chief Operating Officer


Is

a corporate officer responsible for managing the day-to-day activities of the corporation. The COO is one of the highest-ranking members of an organization monitoring the daily operations of the company and reporting to the CEO and/or the Board of Directors. the COO is usually an executive or senior vice-president .

The Chief Information Officer


Is

the head of the information technology group within an organization, who reports to the CEO. The CIO may be a member of the executive board of the organization depending on the structure of the organization.

The Chief Legal Officer


Is

the highest-ranking corporate officer concerned with corporate legal matters. A CLO must have a leadership skills and should be very decisive regarding legal challenges that the corporation encounters. He normally reports to the board directors.

Chief Procurement Officer


This

is an executive position which is focused on the management of supply for the corporation. There is now an increased need for this position in many enterprises.

Director for Human Resources


Every

organization wants to attract the most qualified employees match them to jobs available in the corporation for which they are best suited. For large corporations close contact between management and employees is quite difficult. This connection is provided by the human resources training and labor relations manager and specialists.

End of Chapter
Chapter 24
GLOBALIZATION & INTERNATIONAL CORPORATE MANAGEMENT

CHAPTER 25
BASIC BUILDING BLOCKS OF SUCCESSFUL PERSONAL FINANCIAL MANAGEMENT

BASIC BUILDING BLOCKS OF SUCCESSFUL PERSONAL FINANCIAL MANAGEMENT

Investing is an important part of the financial planning process. Managing finances successfully is a challenge for almost everyone. There is a need for proper information and hard work to be successful. There is also a need to understand the basic building blocks of sound personal financial management. Each building block relies upon the strength and stability of the personal finance strategies used in the blocks below it. Decisions for one building block may have a definite impact on options available in adjacent blocks.

WEALTH PROTECTION CASH MANAGEMENT

Cash Management
Strategies

for cash management include budgeting, financial booking records, maximizing the interest earned on deposit accounts, and the regular preparation of ones financial statements, such as cash flows and net worth.

Trying

to estimate the value of your assets and chart for financial progress, each year you should add together everything you own(assets), then subtract everything you owe(debts/liabilities), which includes all your credit card debts and your mortgage. This summary of assets and debts is called a net worth statement or balance sheet.

vital aspect of the cash management building block is financial bookkeeping. An effective record-bookkeeping system should be a convenient one and should not be too complicated to maintain.

Cash For Emergency Reserve


To

provide for a financial safety net that allows you to take advantage of financial opportunities as they arise, setting aside money to meet unexpected expenses is very important.
emergency fund you may set aside will depend upon your age, health, job, and personal financial situation(referring to the amount and kind of your insurance coverage).

The

Your

emergency cash reserve can be subdivided to minimize penalties for early withdrawal of large amount of funds at one time and to maximize interest earned on accounts should an emergency occur.

Risk Management
All

of us are exposed to many risks which can cause us a financial loss. Accidents, death, illness, damage on property, the possibility of being used or becoming disabled and unable to work, are risk that we have to consider.

There

are appropriate risk management strategies that can protect you against possible eventualities. These may be insurance on life, sickness, disability, car accidents, properties etc.

To

determine when you need to purchase insurance, consider the best way to handle each of your risks. Since your risks change over a lifetime, evaluate your situation every few years and make appropriate changes.

Can

your savings cover a financial loss so that you dont need to buy insurance?

Tax Management
The

goal of each taxpayer is to pay the least possible tax. Legally, avoiding taxes means using effective financial record keeping, decision-making , and planning strategies to reduce your total income tax. Avoiding taxes through legal tax strategies is not to be confused with illegal tax evasion.

Tax

laws continue to dictate how we structure our financial plans. As laws favor or disallow certain strategies, we need to make adjustments. As tax laws change, adjust your financial plans to use strategies which are most favorable to your situation. Most of us are aware of the tax advantage of taxdeferred savings.

Wealth Accumulation

Financial Goals
Financial

goals are important because they help you organize and direct your financial lives. They provide a framework for proper decision-making. They can help you cope with situations, provide some control in your environment and help you visualize your future.

HOW CAN YOU ESTABLISH FINANCIAL GOALS IN LIFE AND UTILIZE THE BUILDING BLOCKS YOU NEED TO ACHIEVE YOUR DREAMS?
You

have to write down your goals Contemplate on them and visualize how you will feel when you attain your goals Be sure to be able to set aside a particular amount of money foe each specific financial goal.

Credit Management
The

best time to stop a growing debt burden is before a debt become a burden. You will know when a debt becomes a problem by looking at indicators, such as the number of bills coming in each month.

Home Ownership
Home

ownership is a financial goal for many people. A home is often the largest investment and sometimes the only investment that many people make. Given the low appreciation rate of real estate in some areas, it is probably better to think of purchasing a home as a place to stay and not as an investment that you expect to rapidly appreciate in value.

Childrens Education
In

improving a plan for your child or childrens college education it is important to know how much it will cost you. How would you able to finance it? The earlier you start planning for your child or children, the more time you will have to accumulate funds.

Investments
You

do not have to be a big-time or a highincome earning investor to have an investment plan. You can still accumulate a minimal savings account as a part of your long-term strategy to achieve your specific goals.

Retirement Planning
It

is worthwhile to plan for your retirement as early as possible, if you can. If you begin early, you will have more time to accumulate the funds you could afford and take advantage of the compound interest you can earn, which in the long run becomes cheaper for you.

WEALTH DISTRIBUTION

Estate Planning
By

successfully implementing properly the strategies outlined in the financial management pyramid, surely you would have been able to accumulate enough wealth to be distributed to your heirs. It is therefore important for you to execute a will if you want properly distribute your properties after death. By having a carefully written legal will. You can provide for your family and others a distribution system which is in consonance with your desires.

End of Chapter
Chapter 25
BASIC BUILDING BLOCKS OF A SUCESSFUL PERSONAL FINANCIAL MANAGEMENT